Economist's View

"Standard Models Predict That We Should Have No Safety Net"

It seems that Harvard's Raj Chetty was a motivated student:

Chetty finished his bachelor’s degree, wrote a prize-winning thesis, and completed the course work for a doctorate in economics — all in three years. ...

Sounds like he's some kind of human calculator:

Chetty, who just turned 30, is looking for ways to make ... mathematical economic theory more descriptive of the tangle of economics in the real world. “People are not human calculators,” he said...

OK, maybe not. His goal is to "refine the economic models behind public policy ... to ... save money and align government programs more closely with everyday life." An example is his work on government safety nets for the unemployed:

Chetty’s 2003 Ph.D. dissertation..., called “Consumption, Commitments, and Risk Preferences,”... [studies] the optimal level of unemployment benefits. When someone is laid off, should the government provide high benefits? Traditional theory says no, since big benefits seemingly reduce the incentive to find a job. “Standard models predict that we should have no safety net,” said Chetty.

But in reality, higher benefits are more in line with actual needs, because most Americans have so much income tied up in fixed commitments, such as payments for houses, cars, and furniture. “There are a lot of things you can’t adjust in the short term,” he said.

So the traditional economic models that are used to determine unemployment benefits miss a simple fact: People have bills to pay. “You miss certain features of reality,” said Chetty, “when you’re trying to write down simple models of the world.”

Unfortunately, in reality, some bills for houses, cars, furniture, etc. may not get paid:

States' jobless funds are being drained in recession, by Peter Whoriskey, Washington Post: The recession's jobless toll is draining unemployment-compensation funds so fast that ... 25 states have run out of unemployment money and have borrowed $24 billion from the federal government to cover the gaps. By 2011, according to Department of Labor estimates, 40 state funds will have been emptied by the jobless tsunami. ...

State unemployment-compensation funds are separated from general budgets, so when there is a shortfall, only two primary solutions are typically considered -- either cut the benefit or raise the payroll tax. ...

The troubles the state programs face can be traced to a failure during the economic boom to properly prepare for a downturn, experts said.

Unemployment benefits are funded by the payroll tax on employers that is collected at a rate that is supposed to keep the funds solvent. Firms that fire lots of people are supposed to pay higher rates. ... But over the years, the drive to minimize state taxes on employers has reduced the funds to unsustainable levels.

"The benefits haven't grown -- that's not the problem," said Richard Hobbie, director of the National Association of State Workforce Agencies. Even so, he said, he expects to see unemployment checks reduced. A shortfall in a state unemployment fund, he said, "usually means cuts in eligibility or benefits." ...

Wayne Vroman, an expert in unemployment insurance at the Urban Institute, said that entering the recession, state programs were on average funded at only one-third the level they should have been, according to generally accepted funding guidelines.

"If you fund a program adequately, you don't need to come to these kinds of difficult decisions," he said. Before the recession, he said, the funding guidelines "were rarely honored." ...

We can add the inadequate funding of unemployment compensation programs to the ever growing list of things that the crisis has revealed need to be fixed.

"Why Welfare Reform Fails its Recession Test"

Was welfare reform enacted during the Clinton administration a mistake?:

Why welfare reform fails its recession test, by Peter Edelman and Barbara Ehrenreich, Commentary, Washington Post: We all like to imagine that there'll be something to stop our fall if we hit hard times. ... "There's always welfare, isn't there?"

Actually, no. When President Bill Clinton signed welfare reform into law, he didn't just end welfare as we knew it. For all practical purposes,... he brought an end to cash help of any kind for families with children in much of the country. While welfare reform was long ago declared a success in some quarters, it was deeply flawed from the beginning. The recession has shown how seriously unprepared it left us for hard times. ...

"Half of US Children -- and Most Black Children -- Will Use Food Stamps"

Following up on the post below this one on poverty, I hope we realize the importance of social insurance for children. Our social insurance programs for children are not as good as they should be, but what we do have does some good:

Half of US children -- and most black children -- will use food stamps, Cornell study reports, EurekAlert: Nearly half of American children – including 90 percent of black children and 90 percent of children who spend their childhoods in single-parent households – will eat meals paid for by food stamps at some point during childhood, reports a Cornell researcher.

Nearly one-quarter of U.S. children will live in homes that receive food stamps for five or more years. Food stamps are important indicators of poverty and risk of food insecurity, "two of the most detrimental economic conditions affecting a child's health," says Thomas A. Hirschl, Cornell professor of development sociology...

The study is based on an analysis of the Panel Study of Income Dynamics, a 32-year study of about 4,800 U.S. households...

"Children in poverty are significantly more likely to experience a range of health problems, including low birth weight, lead poisoning, asthma, mental health disorders, delayed immunization, dental problems and accidental death," write Hirschl and co-author Mark R. Rank of Washington University in St. Louis. "Poverty during childhood is also associated with a host of health, economic and social problems later in life."

It also adds some $22 billion per year in additional health care costs, the researchers report.

And the risk of living in homes using food stamps is far from equitably distributed: Ninety percent of children who live with single parents (compared with 37 percent who live in married and other two-parent households), 90 percent of black children (compared with 37 percent of white children) and 62 percent of those whose head of household did not graduate from high school (compared with 31 percent where the head has more than 12 years of school) "encounter spells of food stamp use," the authors find.

Putting those risk factors together, the researchers found that 97 percent of black children living in non-married households where the household head has less than 12 years of education will have received food stamps, compared with 21 percent of white children living in married households whose head of household has 12 or more years of education.

"The situation is likely bad for children," says Hirschl, "because families eligible for food stamps who participate tend to be worse off nutritionally than eligible families who don't participate." Only about 60 percent of families eligible for food stamps actually participate, he said, because of the stigma associated with government help. Although the sample used is representative of the U.S. populations, it does not reflect the immigrant population.

To pick up another theme in the posts today, this also shows the importance of providing jobs programs that employ low-income workers having trouble finding work due to the recession.

And isn't it nice that children likely go hungry due to the stigma associated with seeking help from the government? Who shall we thank for that?

"Five Myths About Our Land of Opportunity"

Five myths about social mobility from Isabel V. Sawhill and Ron Haskins of Brookings:

Five Myths About Our Land of Opportunity, by Isabel V. Sawhill and Ron Haskins, Brookings: Americans have always believed that their country is unique in providing the opportunity to get ahead. ... But rising unemployment and financial turmoil are puncturing that self-image. The reality of this "land of opportunity" is considerably more complex than the myths would suggest:

1. Americans enjoy more economic opportunity than people in other countries.

Actually, some other advanced economies offer more opportunity than ours does. For example, recent research shows that in the Nordic countries and in the United Kingdom, children born into a lower-income family have a greater chance than those in the United States of forming a substantially higher-income family by the time they're adults.

If you are born into a middle-class family in the United States, you have a roughly even chance of moving up or down the ladder by the time you are an adult. But the story for low-income Americans is quite different; going from rags to riches in a generation is rare. ...

2. In the United States, each generation does better than the past one.

As a result of economic growth, each generation can usually count on having a higher income, in inflation-adjusted dollars, than the previous one. ... But that kind of steady progress appears to have stalled. Today, men in their 30s earn 12 percent less than the previous generation did at the same age.

The main reason today's families have modestly higher overall income than prior generations is simple:... Women have joined the labor force in a big way, and their earnings have increased as well. But with so many families now having two earners, continued progress along this path will be difficult unless wages for both men and women rise more quickly.

3. Immigrant workers and the offshoring of jobs drive poverty and inequality in the United States.

Although immigration and trade are often blamed, a more important reason for our lack of progress against poverty and our growing inequality is a dramatic change in American family life. Almost 30 percent of children now live in single-parent families, up from 12 percent in 1968. Since poverty rates in single-parent households are roughly five times as high as in two-parent households, this shift has helped keep the poverty rate up... Among women under age 30, more than half of all births now occur outside marriage...

In addition, we have seen a growing tendency among well-educated men and women to marry each other, exacerbating income disparities. If we add to these family changes the fact that wages for low-skilled workers have stagnated or declined in recent decades, we can explain most of the increase in poverty and much of the increase in the income gap as well.

4. If we want to increase opportunities for children, we should give their families more income.

Of course money is a factor in upward mobility, but it isn't the only one; it may not even be the most important. Our research shows that if you want to avoid poverty and join the middle class in the United States, you need to complete high school (at a minimum), work full time and marry before you have children. If you do all three, your chances of being poor fall from 12 percent to 2 percent, and your chances of joining the middle class or above rise from 56 to 74 percent. ...

Many American families need supplements to their incomes in the form of food stamps, affordable housing and welfare payments. But such aid should not be given unconditionally. First, the public is concerned that unconditional assistance will end up supporting those who are not trying to help themselves. Second, new research ... has shown that individuals frequently behave in ways that undermine their long-term welfare and can benefit from a government nudge in the right direction.

And third, policies with strings attached have had considerable success. ...[S]ocial policies will be more successful if they encourage people to do things that bring longer-term success.

5. We can fund new programs to boost opportunity by cutting waste and abuse in the federal budget.

Can we cut enough ineffective programs or impose enough new taxes to put better teachers in classrooms, expand child-care assistance for working families and provide more financial aid to disadvantaged students while reducing projected deficits? The answer is a resounding no. ... Just three rapidly growing programs - Medicare, Social Security and Medicaid - along with interest on the debt threaten to crowd out all other spending in a few decades.

So we also need to revise the contract between the generations in a way that gradually reallocates resources from the more affluent elderly to struggling younger families and their children. Such a shift would not only help create more opportunity, it would improve the productivity of the next generation, making its members better able to contribute to the costs of retirement - including their own.

The idea that the poverty problem would be much smaller if people would get married seems to me to avoid the important question of what factors are driving the change in the marriage trend. To the extent that these factors are economic and hence that poverty is also a cause of the falling marriage rate (if it is), then it's more complicated than suggested above.

Also, with respect to the last sentence, retirement funds -- Social Security funding -- is not the long-run budget problem we should be worried about, this can be handled relatively easily with a few minor changes. It's health care costs that are the problem. The argument that we should help people in poverty so that they can help pay for Social Security is far down the list of reasons I'd put forth for helping.

Update: See Mathew Yglesias on single parents and poverty.

"Myth of Rising Protectionism"

Dani Rodrik says that fears that the economic crisis would protectionist measures have largely gone unrealized, and that "much of the credit must go the social programs that conservatives and market fundamentalists would like to see scrapped":

Myth of Rising Protectionism, by Dani Rodrik, Commentary, Project Syndicate: There was a dog that didn't bark during the financial crisis: protectionism. Despite much hue and cry about it, governments have in fact imposed remarkably few trade barriers on imports. Indeed, the world economy remains as open as it was before the crisis struck.

Protectionism normally thrives in times of economic peril. Confronted by economic decline and rising unemployment, governments are much more likely to pay attention to domestic pressure groups than to upholding their international obligations.

As John Maynard Keynes recognized, trade restrictions can protect or generate employment during economic recessions. But what may be desirable under extreme conditions for a single country can be highly detrimental to the world economy.

When everyone raises trade barriers, the volume of trade collapses. No one wins. That is why the disastrous free-for-all in trade policy during the 1930s greatly aggravated the Great Depression.

Many complain that something similar, if less grand in scope, is taking place today. An outfit called the Global Trade Alert (GTA) has been at the forefront, raising alarm bells..." ... with China as the most common target. ...

The reality is that the international trade regime has passed its greatest test since the Great Depression with flying colors. Trade economists who complain about minor instances of protectionism sound like a child whining about a damaged toy in the wake of an earthquake that killed thousands.

Three things explain this remarkable resilience: ideas, politics, and institutions.

Economists have been extraordinarily successful in conveying their message to policymakers ― even if ordinary people still regard imports with considerable suspicion. Nothing reflects this better than how "protection" and "protectionists" have become terms of derision.

After all, governments are generally expected to provide protection to its citizens. But if you say that you favor protection from imports, you are painted into a corner with Reed Smoot and Willis C. Hawley, authors of the infamous 1930 U.S. tariff bill.

But economists' ideas would not have gone very far without significant changes in the underlying configuration of political interests in favor of open trade. For every worker and firm affected adversely by import competition, there is one or more worker and firm expecting to reap the benefits of access to markets abroad. The latter have become increasingly vocal and powerful, often represented by large multinational corporations. ...

But the relative docility of rank-and-file workers on trade issues must ultimately be attributed to something else altogether: the safety nets erected by the welfare state. Modern industrial societies now have a wide array of social protections ― unemployment compensation, adjustment assistance, and other labor-market tools, as well as health insurance and family support ― that mitigate demand for cruder forms of protection.

The welfare state is the flip side of the open economy. If the world has not fallen off the protectionist precipice during the crisis, as it did during the 1930s, much of the credit must go the social programs that conservatives and market fundamentalists would like to see scrapped.

The battle against trade protection has been won ― so far. But, before we relax, let's remember that we still have not addressed the central challenge the world economy will face as the crisis eases: the inevitable clash between China's need to produce an ever-growing quantity of manufactured goods and America's need to maintain a smaller current-account deficit.

Unfortunately, there is little to suggest that policymakers are yet ready to confront this genuine threat.

I don't think we should draw the conclusion that because social insurance helped to avoid destructive protectionism, the amount of social protection we provide is adequate. In many areas, e.g. adjustment insurance and health care, it isn't.

"When the Going gets Tough, the Tough Run to the Government"

Uwe Reinhardt notes that social insurance is much more pervasive than many people realize, and that many of the most vocal opponents of extending social insurance to health care are heavily dependent upon social insurance themselves:

Lehman’s Last Contribution to Society: A Lesson on Social Insurance, by Uwe E. Reinhardt, Commentary, Economix: A year ago, century-old Lehman Brothers lapsed into bankruptcy... [T]he oligarchy that runs our nation’s financial sector. ... had fully expected to see Lehman bailed out by the federal government that serves them, especially after the government had dutifully bailed out Bear Stearns earlier in the year. When Lehman was not so served, panic set in, unleashing global economic turmoil and pain. ...

In the end, like teenagers who hate Mother’s strictures when all is well, but run to Mommy whenever they get in trouble, the swashbuckling oligarchs of the financial sector ran to government for cover, owning up once again to the time-honored mantra of this country’s legendary rugged individualists:

When the going gets tough, the tough run to the government. ...

It is a social contract with government that Americans quietly love, but ... so often profess to hate — as when they cry for government to stay out of Medicare, or when they sit on their beachfronts in the Hamptons waxing worried about government intrusion in the economy, all the while basking in the security of federal flood insurance.

After seeing the evaporation of so much of the wealth they had imagined to reside in their 401(k) plans, mutual-fund accounts and private pension plans,... millions of middle-class Americans surely must have gained a renewed appreciation for ... Social Security ... along with two other popular social insurance programs: Medicare and Medicaid.

Social insurance is routinely called to the rescue also whenever governors of all political stripes ask the federal government for help after a natural disaster... Along with direct financial relief, the Federal Emergency Management Agency is an instrument of social insurance.

It can be asked, of course, why that form of social insurance generally is judged highly desirable — even by the most staunchly conservative politicians — when so often they mistakenly decry as “socialism” proposals that government come to the assistance of an individual ... struck by a natural disaster called “illness,” like cancer. ... Why is it the American way ... to give financial help to a family whose beach house in Mississippi was blown down by a hurricane, but it is socialist and un-American to help a Mississippi woman struck by breast cancer?

One of the most thoughtful recent books on the topic of government risk-management is “When All Else Fails: Government as the Ultimate Risk Manager” (2004), by David A. Moss, a Harvard Business School professor. ... Professor Moss explains that the first application of social insurance in our latitudes actually was aimed ... at ... supporting the growth of modern capitalism. Its main instrument to that end was the legal sanction of the principle of limited liability of the owners of corporations.

Prior to this form of social insurance, the owners of a business were legally liable with their personal wealth for damages the business might have inflicted on others. With limited liability, the corporation’s shareholders are liable only up to their equity stake in the company. ... Beyond that, someone else in society — often the taxpayer — bears the financial risk for damages attributable to the corporation.

One wonders how many business executives and members of chambers of commerce ... realize that the limited liability of shareholders is social insurance.

The most pervasive form of social insurance for the business sector in recent times, of course, has been the massive government bailout of the financial sector following the Lehman Brothers bankruptcy. Without the huge array of public assistance ... the financial sector would have collapsed...

One would hope that by now this lesson on the beneficial role of government in risk management in our society has sunk into the minds of the American public. One must also hope that eventually it will penetrate even the minds of economic theorists...

Poverty is Up, Median Income is Down, and Employer Based Health Insurance Continues to Trend Downward

The news on the number of people in poverty, median income, and the number of people who have lost employer based health insurance is not so good. Without public insurance programs and the stimulus package, the news would be even worse:

Poverty Rose, Median Income Declined, and Job-Based Health Insurance Continued to Weaken in 2008, by Arloc Sherman, Robert Greenstein, Danilo Trisi and Paul N. Van de Water, CBPP: Poverty increased, median household income fell, and the percentage of Americans with employer-based health coverage continued to decline in 2008, according to Census data for 2008 issued today.

The figures reflect the initial effects of the recession. Median household income declined 3.6 percent in 2008 after adjusting for inflation, the largest single-year decline on record, and reached its lowest point since 1997. The poverty rate rose to 13.2 percent, its highest level since 1997. The number of people in poverty hit 39.8 million, the highest level since 1960.

These data include only the early months of the recession. The figures for 2009, a year in which the economy has weakened further and unemployment has climbed substantially, will look considerably worse, and the figures will likely worsen again in 2010 if, as many economic forecasters expect, unemployment continues to rise in that year. (In the last two recessions, the unemployment rate continued rising for 15 to 19 months after the recession officially ended.)

Health Insurance Data  The overall percentage of people without health insurance edged up from 15.3 percent in 2002 to 15.4 percent in 2008, a change that was not statistically significant, while the number of people who are uninsured jumped by 682,000 (a change that was significant) and reached 46.3 million. The continuing decline in job-based health coverage, which has been falling since 2001, did not lead to an increase in the overall percentage of people without insurance because it was offset by an expansion of public insurance programs. ...

Poverty Expected to Rise Much More in 2009 But Would Be Worse Without Recovery Act  The worsening job situation since 2008 portends much higher poverty in 2009 and 2010. ...

While the increases in poverty in 2009 are likely to be large, they would have been much greater without the economic recovery legislation. A Center analysis issued on September 9 that examines the effects of seven recovery act provisions finds those provisions will keep an estimated 6.2 million Americans — including 2.4 million children — from falling into poverty and will reduce the severity of poverty for 33 million others.[2] These figures are conservative because they do not include the poverty-preventing effects of other recovery act provisions, such as increases in housing assistance and child care services, or the effects of the recovery package in preserving or creating jobs.

Income of Working-Age Households at Lowest Level in Years, Poverty at Highest ...

Employer-Provided Health Insurance Expected to Continue Dropping in 2009 and Beyond  Some 46.3 million U.S. residents lacked health insurance in 2008, an increase of 682,000 over the previous year and 6.6 million more than in 2001. ...

The percentage of people with employer-provided health insurance, the principal source of coverage for the non-elderly, has been trending downward since 2001 and is the leading contributor to the increase over time in the number of uninsured. ...

Employment-based coverage is likely to drop significantly in 2009, due to the loss of jobs. In the short term, some families losing their jobs and health insurance may become eligible for Medicaid or qualify for other assistance such as temporary COBRA subsidies for formerly employed workers, which the recovery act temporarily strengthened. But, the long-term decline in private coverage is likely to continue to drive up the number and percentage of uninsured.

The Congressional Budget Office projects that under current law, the number of uninsured will continue to rise and reach 54 million by 2019. The health reform bill currently moving through the House of Representatives, as well as health reform bills in the Senate, would seek to reverse the sizable increase in the number of uninsured people that has occurred in recent decades. ...

"Keynes was Really a Conservative"

Bruce Bartlett argues that the conservative position that governments "do nothing in the face of the greatest economic downturn since the Great Depression" would endanger the very thing free market ideologues are trying to preserve, the capitalist system itself. This was something that Keynes understood very well.

Though this argues that Keynes was a conservative, I don't think it much matters what label we attach to Keynes, it is the idea that government intervention preserves rather than destroys the capitalist system that is important. If we had no government intervention at all, no automatic stabilizers such as unemployment compensation and food stamps, no Social Security for the elderly to fall back upon when equity and stock values plummet, no stimulus package, and no financial bailout package, conditions would be much, much worse and the calls to overthrow the basic capitalist system would be amplified far beyond what we hear even with these programs in place.

Keynes is right that these programs help to make the cyclical swings in capitalist systems less devastating and hence help to preserve the system that we have. But that's not the only reason to provide social insurance. The capitalist system is unmatched in its ability to provide goods and services, and to respond to changing demand, but it is also highly cyclic and the swings in the economy can cause great misery for people who have done nothing to deserve the misfortune the system has bestowed upon them. The people who have lost their jobs and their ability to provide for their families deserve our collective help not just because that's the only way to preserve the capitalist system, but also because it's the right and moral thing to do:

Keynes Was Really A Conservative, by Bruce Bartlett, Commentary, Forbes: Conservatives continue to decry the $787 billion stimulus package... At best, they think it accomplished nothing because the additional federal borrowing took as much out of the economy as the stimulus put in. At worst, the deficits and enlargement of government will lead to slower growth and inflation not too far down the road.

Those on the right have been making this same argument ever since ... John Maynard Keynes popularized the idea of using budget deficits to stimulate growth in ... 1936... For this reason, Keynes, even more so than Karl Marx, is the principal bête noire of free market economists. They believe governments should never do anything to counteract economic downturns. ...

What Keynes understood is that ...[i]n really severe downturns, such as we suffered in the 1930s and are suffering today, government action is essential to turn the economy around; the private sector simply can't do it on its own. He also understood that democratic societies cannot long tolerate high levels of unemployment. At some point, people will jettison capitalism for some sort of socialism, which would threaten democracy as well.

Keynes' efforts were motivated by a strong desire to maintain the liberal capitalist order. Honest conservatives have always understood this. In 1945, economist David McCord Wright noted that a conservative political candidate could easily run a campaign "largely on quotations from The General Theory." The following year, economist Gottfried Haberler, of the conservative Austrian school, conceded that the specific policy recommendations of Keynesian economics were not at all revolutionary. "They are in fact very conservative," he admitted.

Peter Drucker, a conservative admirer of Keynes, viewed him as not merely conservative, but ultraconservative. "He had two basic motivations," Drucker explained in ... 1991... "One was to destroy the labor unions and the other was to maintain the free market. Keynes despised the American Keynesians. His whole idea was to have an impotent government that would do nothing but, through tax and spending policies, maintain the equilibrium of the free market. Keynes was the real father of neoconservatism, far more than [economist F.A.] Hayek!"

John Kenneth Galbraith, whose politics were well to the left of Keynes,... agreed with this assessment. "The broad thrust of his efforts, like that of Roosevelt, was conservative; it was to endure that the system would survive," he wrote. But, Galbraith added, "Such conservatism in the English-speaking countries does not appeal to the truly committed conservative." ...

It was obvious to those on the political left ... that Keynes was one of socialism's greatest enemies, even if some on the right still view Keynes as a crypto-communist. ... Keynes told playwright George Bernard Shaw that the whole point of The General Theory was to knock away the Ricardian foundations of Marxism. ...

Indeed, the whole point of The General Theory was about preserving what was good and necessary in capitalism, as well as protecting it against authoritarian attacks... In order to preserve economic freedom..., which Keynes thought was critical for efficiency, increased government intervention ... was unavoidable. While pure free marketers lament this development, the alternative, as Keynes saw it, was the complete destruction of capitalism and its replacement by some form of socialism.

"It is certain," Keynes wrote, "that the world will not much longer tolerate the unemployment which … is associated--and, in my opinion, inevitably associated--with present-day capitalistic individualism. But it may be possible by a right analysis of the problem to cure the disease whilst preserving efficiency and freedom."

In Keynes' view, it was sufficient for government ... to use monetary and fiscal policy to maintain total spending (effective demand), which would both sustain growth and eliminate political pressure for radical actions to reduce unemployment. "It is not the ownership of the instruments of production which is important for the State to assume," Keynes wrote. "If the State is able to determine the aggregate amount of resources devoted to augmenting the instruments and the basic rate of reward to those who own them, it will have accomplished all that is necessary."

One of Keynes' students, Arthur Plumptre, explained Keynes' philosophy this way. In his view, Hayek's "road to serfdom" could as easily come from a lack of government as from too much. If high unemployment was allowed to continue for too long, Keynes thought the inevitable result would be socialism--total government control--and the destruction of political freedom. This highly undesirable result had to be resisted and could only be held at bay if rigid adherence to laissez-faire gave way, but not too much. As Plumptre put it, Keynes "tried to devise the minimum government controls that would allow free enterprise to work."

The threat of totalitarianism may not be as great today as it was in the 1930s. But it would be naïve to believe that it was possible for the government to stand by and do nothing in the face of the greatest economic downturn since the Great Depression, as many conservative economists advised. The alternative to stimulus could ultimately have been something far worse from the conservative point of view, as Keynes well understood.

"An International Comparison of Small Business Employment"

John Schmitt and Nathan Lane of the CEPR:

An International Comparison of Small Business Employment, by John Schmitt and Nathan Lane, CEPR: Contrary to popular perceptions, the United States has a much smaller small-business sector (as a share of total employment) than other countries at a comparable level of economic development, according to this new CEPR report. The authors observe that the undersized U.S. small business sector is consistent with the view that high health care costs discourage small business formation, since start-ups in other countries can tap into government-funded health care systems. [Note: Click on figures for larger versions]

     

There's another factor that could also be contributing besides competitive disadvantages with countries that have government funded health care systems. A more extensive social safety net can reduce the risk of attempts at entrepreneurship. If there is an extensive social safety net to fall back upon if things don't work out, you might be more willing to quit the job you hate (the one with health insurance for the kids) and sink everything you have into a small business that you've always wanted to run. But I'm not sure the data above support this interpretation, i.e. that there is an obvious positive association between the strength of social insurance and the prevalence of small business. But it is highly suggestive, and regressions that control for other cross-country differences could help to settle the issue. In any case, one thing is clear, according to these measurements the US has low numbers relative to other countries in the sample.

Stabilization Policy and Intertemporal Shifts in Output and Consumption

I've seen lots of objections to the Cash for Clunkers program based upon the fact that all the program does is shift consumption intertemporally, it doesn't actually create sales that wouldn't have occurred anyway.

But that is not, in and of itself, a valid objection. Shaving the peaks in output and consumption to fill the valleys stabilizes the economy. When the economy is in recession, creating brand new things that wouldn't have existed otherwise to lift the economy back toward full employment is preferred, but generally there aren't enough opportunities along these lines to give the economy the help it needs. In the cases where we cannot create enough new output and consumption to bring the economy back to health, moving consumption from a time when the economy is overheated to a time when it is underperforming helps by bringing both time periods closer to the long-run trend.

Now, Cash for Clunkers is not the the best way to shift consumption from the future to the present, or anywhere close since the intertemporal shifting is generally only for a month or two rather than from good times to bad, so this should not be interpreted as a defense of the program on this basis. But that doesn't mean the idea of intertemporal shifting is inherently flawed.

There seems to be an idea that policy must create something new, that simply rearranging consumption intertemporally is of no value. But there is value in avoiding large cyclical swings in the economy, i.e. value in stability, and when we have the opportunity to shave the peak of housing and other booms - times when the overheating is dangerous as it could result in bubbles, inflation, and other problems - and then use the "shavings" to fill the troughs of recessions, we should do so. [Again, let me stress that I am not supporting the Cash for Clunkers program with this argument, I simply wanted to use that program as a lead in to make a general point about stabilization policy and intertemporal substitution. Also, because I had a very simple model in mind, one, for example, without inventories, I wasn't as careful as I should have been and used the  term consumption rather than output.]

"Did Welfare Reform Work for Everyone?"

Mary Daly and Joyce Kwok give their assessment of "how one particularly vulnerable group, young single mothers age 18 to 24, fared in the aftermath of welfare reform" in this Economic Letter from the Federal Reserve Bank of San Francisco:

Did Welfare Reform Work for Everyone? A Look at Young Single Mothers, by Mary Daly and Joyce Kwok, Economic Letter, FRBSF: Passage of the Personal Responsibility and Work Opportunity Reconciliation Act (PRWORA) in 1996 marked the most far-reaching reform of the U.S. welfare system since the 1930s. Advocates for low-income groups, front-line service providers, and many policymakers expressed serious reservations about the legislation. Their concerns largely revolved around how the movement from Aid to Families with Dependent Children (AFDC), a cash transfer system with no time limits, to Temporary Assistance for Needy Families (TANF), a work-based program with strict time limits, would affect the household incomes of the target population of impoverished single mothers. But fears that families headed by single mothers would sink deeper into poverty turned out to be unfounded. Following the reforms, welfare caseloads declined rapidly, and employment and household incomes of single mothers rose. Importantly, these improved outcomes largely survived the challenges posed by the 2001 recession, suggesting that the initial successes were not simply due to a booming economy.

Now, more than a decade after passage of the legislation, policymakers and academics alike view welfare reform as a success. Few experts question whether the reform accomplished its stated goals of moving single mothers into the labor market and keeping them out of the cash welfare system. (See Blank 2006 and Moffitt 2008 for excellent reviews of the literature evaluating the success and failures of the reforms.) Although employment and income data point to the overall success of welfare reform, important questions remain, including the extent to which aggregate improvement may hide problems among important subgroups. In other words, how much does the experience of the average single mother accurately reflect that of more vulnerable single mothers, such as those with serious barriers to employment? This issue is especially critical now that we are in a deep economic recession. Research has shown that such downturns can have disproportionately negative effects on those least attached to the labor market (Hoynes 2000).

In this Economic Letter we examine how one particularly vulnerable group, young single mothers age 18 to 24, fared in the aftermath of welfare reform. We choose this group because they may face especially difficult challenges in finding employment due to low educational attainment and lack of work experience. Yet data show that, like the broader population of single mothers, single mothers in this age group had lower welfare dependency, greater workforce participation, and higher household income in 2004 than they did prior to welfare reform. Although it’s still too early to judge, recent work indicates that this increased attachment to the labor market has also given these young women increased access to an important safety net—unemployment insurance.

Social Insurance and the Severity of Recessions

The question of how bad would economic conditions be right now if there had been no stimulus package and no financial bailout is receiving considerable attention. There's no way to know for sure, but I believe the economy would have been much worse off without these two policy interventions. But without actually running the alternative scenario - something we can't do - there's no way to know for sure.

But one thing I am fairly certain of, and something I don't think is getting enough attention, is the effect that automatic stabilizers have had in helping to ease the impact of the recession for individual households on and for the overall economy.

What are automatic stabilizers? Automatic stabilizers are taxes and transfers (e.g. unemployment compensation and food stamps) that automatically change with changes in economic conditions in a way that dampens economic cycles. For example, when the economy turns downward, the amount spent on food stamps automatically goes up as more people apply (or eligibility rules are eased), and the extra spending the food stamps helps to soften the downturn for the individuals receiving the help and for the businesses and employees where the money is spent (and then the multiplier process spreads the benefits more widely). Similarly, unemployment compensation, which obviously rises as jobs are eliminated, goes up when conditions deteriorate and that also provides a boost to demand. In addition, income tax as a share of GDP goes down in recessions and that helps to offset the fall in GDP as well.

How much worse would things be now if we had followed the advice of the hardcore rightwing and eliminated the welfare state programs that function so effectively as automatic stabilizers? It still wouldn't be like the pictures you see of the Great Depression because we are a much wealthier nation than we were then and thus have more private resources to rely upon. But even so, not everyone has wealth to rely upon and the recession would be much more evident, and the amount of human suffering would be much greater, without the social insurance programs we put in place in the years since the Great Depression -- programs that we, for the most part, now take for granted. I don't mean there is no suffering due to the downturn, there is and I don't want to minimize it - I wish our social insurance programs were even more generous than they are now for that reason - and I don't mean to say there are no signs at all of economic problems, there are, but we shouldn't overlook the important role that social insurance plays during recessions.

I think we can have a debate over the appropriate level and form of social insurance, as I said, I don't think it is generous enough and I would also broaden it to include health care. But I don't think there can be any doubt about the importance and effectiveness of social insurance in helping to limit the impact of economic downturns.

So when we are assessing the effectiveness of government interventions designed to ease the recession, there are two alternative (or baseline) scenarios to think about. One is a world without the stimulus package and without the financial bailout, and that would be bad enough. But the other is a world without the stimulus package, without the financial bailout, and without social insurance, and that would be much, much worse.

"Will Europe’s Economies Regain Their Footing?"

Kenneth Rogoff on the prospects for recovery in Europe:

Will Europe’s Economies Regain Their Footing?, by Kenneth Rogoff, Commentary, Project Syndicate: What will Europe's growth trajectory look like after the financial crisis? ...

True, things are pretty ugly right now. ... Yet, ugly or not, the downturn will eventually end. Yes, there is still a real risk of hitting an iceberg, beginning perhaps with a default in the Baltics, with panic first spreading to Austria and some Nordic countries. But, for now, a complete meltdown seems distinctly less likely than gradual stabilization followed by a tepid recovery, with soaring debt levels and lingering high unemployment.

It is not a pretty picture. Some commentators have savaged Europe's policymakers for not orchestrating as aggressive a fiscal and monetary policy as their U.S. counterparts have. ...

But these critics seem to presume that Europe will come out of the crisis in far worse shape than the U.S., and it is too early to make that judgment. An epic, financial-crisis-driven recession, such as the one we are still experiencing, is not a one-year event. So policymakers' responses cannot be evaluated by short-term measures... It is just as important to ask what happens over the next five years as over the next six months, and the jury is still very much out on that.

America's hyper-aggressive fiscal response means a faster rise in government debt, while its hyper-expansive monetary policy means that an exit strategy to mop up all the excess liquidity will be difficult to execute. ... Europe's more tempered approach, while magnifying short-term risks, could pay off in the long run, especially if global interest rates rise, making it far more painful to carry oversized debt loads.

The real question is not whether Europe is using sufficiently aggressive Keynesian stimulus, but whether Europe will resume its economic reform efforts as the crisis abates. If Europe continues to make its labor markets more flexible, its financial market regulation more genuinely pan-European, and remains open to trade, trend growth can pick up again in the wake of the crisis. If European countries look inward, however, with Germany pushing its consumers to buy German cars, the French government forcing car companies to keep unproductive factories open, etc., one can expect a decade of stagnation.

Admittedly, the past year has not been a proud one for policy reform in Europe. Recessions have never proven an easy time for ... reforms. ...

The recent recession has presented challenges, but European leaders were right to avoid becoming intoxicated with short-term Keynesian policies, especially where these are inimical to addressing Europe's long-term challenges.

If reform resumes, there is no reason why Europe should not enjoy a decade of per capita income growth at least as high as that of the U.S. Moreover, with growing concerns about the sustainability of U.S. fiscal policy, the euro has a huge opportunity to play a significantly larger role as a reserve currency.

One shudders to think what will happen if Europe does not pull out of its current funk. ...

European leaders argued they didn't need to be as aggressive as the U.S. at putting new fiscal policy in place because they had much larger social safety nets that would kick in automatically as the crisis deepened. In addition, Europeans noted, they already had much higher levels of government spending as a share of output than the U.S., so it was much harder for them to increase this share further. Another way to say this is that Europeans do not believe they have an inferior short-run response, especially when it comes to labor and providing jobs.

Thus, the very thing that Rogoff believes is Europe's biggest long-run challenge - the extensive social safety net, including provisions affecting adjustment in labor markets - is the reason why Europe was able and willing to choose a different strategy relative to the U.S. to attenuate the effects of the recession. If the U.S. had European levels of debt and, more importantly, the same degree of social protections for people affected by recession, then the U.S. would not have needed or been able (politically) to increase deficit spending as much as it did. I am among those who believe Europe could have reacted more vigorously, and should have, but I don't think it's correct to say they avoided Keynesian type policy (and see this post concerning France's stimulus package).

If, in the long-run, we look back and see that Europe's more extensive protections did, in fact, smooth the adjustment to the crisis, the motivation for long run change of the type Rogoff hopes for will diminish. If having European style social protections does lower growth - and that is a debatable assertion - that may be an insurance premium people are willing to pay to avoid more severe downturns. If the opposite happens, if the social safety net does not do its job (and that cannot be measured through unemployment rates alone), then the motivation for change could become stronger. But the crisis is far from over and the jury is still out.

"Europeans Rely on Concessions to Save Jobs"

Some of the ways European labor markets are reacting to the economic slowdown:

Europeans Rely on a Mix of Concessions to Save Jobs, by Mathew Saltmarsh, NY Times: Rising European unemployment has business and government looking to offset the pain, and some of the solutions belie the region’s reputation for inflexibility.

A report released ... by the European Union found that some 1.9 million jobs were lost in the first quarter, the worst drop since figures were first collected starting in 1995. The unemployment rate was 8.6 percent in April, up from 6.8 percent a year earlier.

But analysts and labor experts say the figures would have been even starker without some of the job-saving measures used to combat the worst recession in decades. ...

Many countries have short-time compensation programs, tailored for the manufacturing sector, under which employers can apply for temporary assistance to lift the wages of workers working reduced hours.

France has a publicly financed partial unemployment plan, allowing companies experiencing difficulties to temporarily lay off workers and draw on state money to pay them during those periods. ... In the Netherlands,... companies ... use... a similar program...

Germany also has several measures to reduce working time, many of which are specifically framed as employment-saving measures. ... German unions have also shown some flexibility. ...

In France, as in other European countries, employers are not normally allowed to lower contracted salaries without employee consent.

But if a business with operations in France has “serious grounds” to think that its economic viability is in danger, and employees refuse a reduced salary, then a company could proceed to layoffs.

To avoid this kind of situation, some companies have tried to negotiate salary reductions. The auto rental company Hertz ... asked French management ... to swallow a pay cut of around 5 percent over three months, without offsetting time off. Slightly more than two-thirds of the 150 managers offered the deal agreed... Hewlett-Packard ... confirmed that it was engaged in similar negotiations to cut the salaries ... ranging from 2.5 to 15 percent.

The Finnish carrier Finnair announced in December plans to temporarily lay off 1,700 cabin crew members on a staggered basis this year to cut costs. The layoffs will last two to three weeks a worker.

"Reducing Inequality: Put the Brakes on Globalization?"

We shouldn't even think of limiting trade, investment abroad, and immigration as a means of reducing inequality:

Reducing inequality: put the brakes on globalization?, Consider the Evidence: Trade, outward foreign investment (movement of plants and services abroad), and immigration very likely have contributed to the growth of U.S. earnings inequality over the past several decades. Reducing any or all of them might well help to boost wages among Americans in the lower half of the distribution.

But in my view this shouldn’t be even a minor part of a strategy for inequality reduction, much less its chief focus. Trade, investment abroad, and immigration tend to benefit citizens in and from poor countries...

Yes, globalization enriches some rapacious corporations and despotic rulers, and vulnerable workers are exploited. But access to the American market and to employment by U.S.-based transnational firms has helped improve the lives of hundreds of millions of Chinese, Indians, and others in recent decades. And moving to the United States almost invariably enhances the living standards of immigrants from poor nations. It would be a bitter irony if American progressives succeeded in making a real dent in our inequality problem at the expense of the world’s poorest and most needy. We should look elsewhere for solutions. ...

Among the things we Americans can learn from the Danes, Swedes, and Dutch ... is that it’s possible to embrace globalization (and other sources of economic change and disruption) and still have a high-opportunity, low-inequality, low-poverty society. The following chart offers one indication of this. It shows earnings inequality by imports as of the mid-2000s. Import-heavy countries are by no means doomed to high inequality.

Most of us want policies like wage insurance, better unemployment compensation, portable health insurance and pensions, support for retraining, and assistance with job placement not just because they can help to blunt the adverse consequences of globalization, but because they do so for economic change in general — whether it’s a product of technological progress, geographical shifts of industries and firms within the United States, or what have you. Arguing for limits on globalization directs attention away from these policies, making their adoption less likely. Paradoxically, then, we end up with the worst of both worlds: marginal trade limits, half-hearted steps to curtail investment abroad, confused and ineffective immigration policy, and too little of the supports and cushions needed for successful adjustment. ...

"The Truth Behind the Social Security and Medicare Alarm Bells"

Robert Reich reacts to yesterday's report on Social Security and Medicare finances:

The Truth Behind the Social Security and Medicare Alarm Bells, by Robert Reich: What are we to make of yesterday's report from the trustees of the Social Security and Medicare trust funds that Social Security will run out of assets in 2037, four years sooner than previously forecast, and Medicare’s hospital fund will be exhausted by 2017, two years earlier than predicted a year ago?

Reports of these two funds' demise are not new. Fifteen years ago, when I was a trustee of the Social Security and the Medicare trust funds ... both funds were supposedly in trouble. But as I learned, the timing and magnitude of the trouble depended a great deal on what assumptions the actuary used in his models. As I recall, he then assumed that the economy would grow by about 2.6 percent a year over the next seventy-five years. But go back into American history all the way to the Civil War -- including the Great Depression and the severe depressions of the late 19th century -- and the economy's average annual growth is closer to 3 percent. Use a 3 percent assumption and Social Security is flush for the next seventy-five years. ...

Even if you assume Social Security is a problem, it's ... a tiny problem, as these things go. Medicare is entirely different. It's a monster. But fixing it has everything to do with slowing the rate of growth of medical costs -- including, let's not forget, having a public option when it comes to choosing insurance plans under the emerging universal health insurance bill. With a public option, the government can use its bargaining power with drug companies and suppliers of medical services to reduce prices. And, as I've noted, keep pressure on private insurers to trim costs yet provide effective medical outcomes.

Don't be confused by these alarms from the Social Security and Medicare trustees. Social Security is a tiny problem. Medicare is a terrible one, but the problem is not really Medicare; it's quickly rising health-care costs. Look more closely and the real problem isn't even health-care costs; it's a system that pushes up costs by rewarding inefficiency, causing unbelievable waste, pushing over-medication, providing inadequate prevention, over-using emergency rooms because many uninsured people can't afford regular doctor checkups, and spending billions on advertising and marketing seeking to enroll healthy people and avoid sick ones.

"A Strong Safety Net Encourages Healthy Risk-Taking"

The social safety net is old, tattered, and in need of repair:

A Strong Safety Net Encourages Healthy Risk-Taking, by Jacob Hacker, Commentary, The American Prospect: Remember the "ownership society"? Just an election cycle ago, conservatives were urging Americans to give up their antiquated social-insurance programs--Social Security, Medicare, unemployment insurance--in favor of tax-subsidized individual accounts... Thankfully, the most extreme elements of that agenda failed, and the vision behind it ... is now discredited.

Yet while the ownership society was a practical and intellectual failure, it was more of a political success than commentators generally acknowledge. Even before the financial crisis, the broad set of economic protections that arose in the Great Depression and expanded in the decades after --sometimes called the "safety net,"...-- lay in tatters. ...

If ever there were a time for an alternative to the reigning orthodoxies of risk management, this is it. Now is the time to adopt a vision ... of all of us providing the common foundation for economic prosperity and advancement through smarter and broader sharing of risk..: a new public-private partnership that builds upon and extends the basic underlying principle of the New Deal. That principle ... is that security is not opposed to opportunity but essential to it. In a dynamic and flexible economy, well-designed policies of economic security are critical if workers are going to have the confidence they need to invest in and achieve the American dream. ...

The Social Security Obsession

Something to keep an eye on, the "Very Serious People" inside the beltway are at it again:

Lawmakers Seeking Consensus On Social Security Overhaul, by Lori Montgomery, Washington Post: Key lawmakers from both parties have held tentative talks about overhauling the Social Security system, and Congress could turn its attention to the federal retirement program as soon as this fall if a bipartisan consensus emerges...

So far, Democrats have found a willing partner in the Senate, where Sen. Lindsey O. Graham (R-S.C.) has stated his desire to work with President Obama to make changes to keep Social Security solvent. ... Graham said yesterday that he has spoken to Hoyer and Sen. Richard J. Durbin of Illinois, the second-ranking Senate Democrat, about the issue and that he stands ready "as a Republican to more than meet the president in the middle."

"I know what it takes to get a solution," Graham said. "I think we can get double-digit Republican support for a reasonable compromise. But the key to this, at the end of the day, is presidential leadership."

Graham ... sketched out a plan that would include lower benefits for wealthy Americans, a higher retirement age and additional revenues. With the stock market devastated by the recession, the traditional Republican option of diverting Social Security taxes to new private retirement accounts is, he said, "off the table." ...

Hoyer is expected to sketch out a similar plan in a speech today... According to an advance copy of the speech, Hoyer will suggest that Congress could approve "more revenues," "restrain the growth of benefits, particularly for higher-income workers," "and/or we can raise the retirement age, recognizing that our life expectancy is higher today."

"What is missing here is not ideas -- it is political will," the speech says. ...

"Right now energy and health-care bills are the major focus," Hoyer said. But if those issues are finished by the August break, he said, "we could start focusing on . . . Social Security early this fall." ...

"At the end of the day, most Americans would embrace a balanced solution that did not require Draconian impact. They are ready to make some hard decisions for the benefit of future generations," Graham said. "If there were ever a time to do it, it's now."

Remember that the "Beltway obsession with Social Security reflects ideology and fashion, not the real problems facing America." They may think that they can wait until health care reform is completed before turning to this issue, but if they continue to have these meetings and push this agenda, there's a good chance Social Security will become a bargaining chip during the health care debate. However, trading Social Security against health care is not an outcome I'd like to see. There is no pressing need to modify the Social Security program, fairly minor changes will solve whatever problems the program has, and there are many other possible tradeoffs within the budget that could fund a new health care system (on both the revenue and spending sides). But I'm sure conservatives would love the chance to pit these two porgrams against each other as part of the health care reform process.

"The 'Hundred Days' of F.D.R."

Arthur Schlesinger, Jr. on FDR and the New Deal:

The 'Hundred Days' of F.D.R., by Arthur Schlesinger, Jr., Commentary, NY Times, April 1983: Exactly half a century ago, the Republic plunged into the Hundred Days - that time of tumultuous change when a flood of legislation swept away venerable market practices and gave the American economic system a new contour. ...

The Hundred Days were only the start of a process that ended by transforming American society. Who can now imagine a day when America offered no Social Security, no unemployment compensation, no food stamps, no Federal guarantee of bank deposits, no Federal supervision of the stock market, no Federal protection for collective bargaining, no Federal standards for wages and hours, no Federal support for farm prices or rural electrification, no Federal refinancing for farm and home mortgages, no Federal commitment to high employment or to equal opportunity - in short, no Federal responsibility for Americans who found themselves, through no fault of their own, in economic or social distress?

These social changes have won general approval. Even the Reagan counterrevolution, for all its 19th-century laissez-faire and Social Darwinist passions, shrinks from abolishing the framework of social protection -the ''safety nets'' - created by the New Deal.

But what of the narrowly economic results? How effective was the New Deal in reducing unemployment, promoting economic growth and altering the distribution of income? And does the experience of half a century ago offer any guidance to the nation in its economic perplexities today?

A "Quite Sophisticated Mixing of Public and Private"

A convert to the European social insurance system:

Going Dutch, by Russel Shorto, NY Times Magazine: ... For 18 months now I’ve been playing the part of the American in Holland, alternately settling into or bristling against the European way of life. ... For the first few months I was haunted by a number: 52... For it represents the rate at which the income I earn ... is to be taxed. To be plain: more than half of my modest haul ... was to be swallowed by the Dutch welfare state. ... I am politically left of center in most ways, but from the time 52 entered my brain, I felt a chorus of voices rise up within my soul, none of which I knew I had internalized, each a ghostly simulacrum of a right-wing, supply-side icon: Ronald Reagan, Jack Kemp...

And yet as the months rolled along, I found the defiant anger softening... I have found myself not only giving the Dutch system a personal test drive but also wondering whether some form of it could be adopted by my country. ...

"Uncertainty and Capitalism"

Edmund Phelps defends capitalism:

Uncertainty bedevils the best system, by Edmund Phelps, Commentary, Financial Times: In countries operating a largely capitalist system, there does not appear to be a wide understanding among its actors and overseers of either its advantages or its hazards. Ignorance of what it can contribute has in the past led some countries to throw out the system or clip its wings. Ignorance of the hazards has made imprudence in markets and policy neglect all the more likely. Regaining a well-functioning capitalism will require re-education and deep reform.

Capitalism is not the “free market” or laisser faire – a system of zero government “plus the constable”. Capitalist systems function less well without state protection of investors, lenders and companies against monopoly, deception and fraud. These systems may lack the requisite political support and cause social stresses without subsidies to stimulate inclusion of the less advantaged in society’s formal business economy. Last, a huge social insurance system, with resulting high taxes, low take-home pay and low wealth, may not hurt capitalism. ...

From the outset, the biggest downside [to capitalism] was that creative ventures caused uncertainty not only for the entrepreneurs themselves but also for everyone else in the global economy. Swings in venture activity created a fluctuating economic environment. ...

Unfortunately, there is still no wide understanding among the public of the benefits that can fairly be credited to capitalism and why these benefits have costs. This intellectual failure has left capitalism vulnerable to opponents and to ignorance within the system.

Capitalism lost much of its standing in the interwar period, when many countries in western continental Europe shifted to corporatist systems. This was a low point in the public’s grasp of political economy. In the end, the promises of greater prosperity and lesser swings could not be delivered. The nations that kept capitalism while making reforms, some good and others maybe not, ultimately performed well again – until now. Those that broke from capitalism were less innovative. After the disturbances of the 1970s, they saw unemployment rise far more than the capitalist nations did. They were worse on economic inclusion too.

Now capitalism is in the midst of its second crisis. An explanation offered is that ... the crisis flowed from a failure of corporate governance to curb bonuses and of regulation to rein in leveraging of bank capital...

But why did big shareholders not move to stop over-leveraging before it reached dangerous levels? Why did legislators not demand regulatory intervention? The answer, I believe, is that they had no sense of the existing Knightian uncertainty. So they had no sense of the possibility of a huge break in housing prices and no sense of the fundamental inapplicability of the risk management models used in the banks. “Risk” came to mean volatility over some recent past. The volatility of the price as it vibrates around some path was considered but not the uncertainty of the path itself: the risk that it would shift down. The banks’ chief executives, too, had little grasp of uncertainty. Some had the instinct to buy insurance but did not see the uncertainty of the insurer’s solvency.

Much is dysfunctional in the US and the UK... If we still have our humanist values we will try to restructure these sectors to make capitalism work well again – to guard better against reckless disregard of uncertainty in the financial sector while reviving innovativeness in business. We will not close the door on systems that gave growing numbers rewarding lives.

I was glad, and somewhat surprised, to hear Phelps say that "a huge social insurance system ... may not hurt capitalism." However, he does imply that economic growth is necessarily lower as a consequence and I'm not sure that follows. But even if growth is lower - and again, I'm not conceding that - it doesn't mean that people are necessarily worse off. If people value economic stability, and I believe it is highly valued, then this benefit has to be counted against any potential loss of growth. Thus, when this benefit is factored in, even if growth is lower, people may still be better off due to the greater amount of economic stability that they enjoy.

To cast this in terms of a recent (re)post from Brad DeLong, part of what matters here is whose utility function gets the most weight in the social welfare function that is implicitly maximized by policymakers. If the people who benefit most from growth and suffer least from uncertainty get the most weight in this function, and the wealthy fall into this category, then policy will be devoted mostly to growth and security will take a back seat (even if the tradeoff between growth and security is imagined rather than real). But if the weights are changed, then policymakers might be guided to a different choice, one that places a high value on stability. Thus, the choices we have made relative to other countries - the choice of growth versus security - may reflect who has the most influence over the political process as much as anything else, and may have also been driven by a false sense of the size of the tradeoff that exists between the two supposedly opposite goals. (I think the relationship between growth and security is shaped like an inverted-U. If security is very low or non-existent, growth will also be low. Then, as security increases growth also increases and reaches some maximum shown as point A on the diagram, and any further increases in sucurity do harm economic growth. The argument above is that the point where societal welfare is maximized is not necessarily the point where economic growth is maximized. The maximum could lie to the right of point A if security is valued over growth, i.e. there is no reason why point B cannot be the point where the measure of social welfare is highest).

Information Technology and Economic Security

One more at TPMCafe Book Club's discussion of Eric Rauchway's book, The Great Depression and the New Deal: A Very Short Introduction:

Information Technology and Economic Security, by Mark Thoma: Eric asks a good question:

As the New Deal abetted America's move from the countryside to the city, it also saved memories of the ways of life lost.

Are we truly in a similar transition now -- to a post-suburban world, to a post-paper world? What folkways do we want documented?

I don't think we fully understand or appreciate the social, economic, and political changes the information revolution revolution will bring. I will leave it to the historians to document these changes, and I'll talk briefly instead about how the advance of information and other technology will impact -- has already impacted -- our economic security. [...continue reading...]

[Complete discussion.]

The Brand New Deal

Another post at TPMCafe Book Club's discussion of Eric Rauchway's book, The Great Depression and the New Deal: A Very Short Introduction:

The Brand New Deal, by Mark Thoma: I'd like to follow up on the discussion about a New New Deal, i.e. the need for an updated version of the New Deal to fit the modern economy. In the posts so far, there have been discussions of the types of policies Obama may implement (Card check? Health care reform?), and who will actually benefit from those policies relative to who ought to benefit. In particular, there have been cautions against limiting the recovery package to the typical "males in hard hats with families to support" image that many people seem to have in mind when thinking about stimulus policies.

As we think about a Brand New Deal, I think it's important to recognize that the structure of families and households has changed considerably over time. The notion of a family was very different in the 1930s. Men were the bread winners, that was their responsibility to the household, and by and large, it was assumed that there was a spouse at home taking care of household needs and supporting this effort. Men who let down their families by losing a job, or who failed to provide for them adequately in other ways, were not fulfilling their proscribed social function.

The Great Depression upset this social norm. When the Great Depression hit, males could no longer fulfill this essential role. No matter how hard they tried, they could not find jobs and they could not give their families the economic security that society said they were responsible for providing. They had failed their families in a time of great need.

The New Deal, I think, did two things that stopped people from blaming themselves. [...continue reading...]

The Evolution of Social Insurance

Given all of the talk about the Great Depression and the New Deal lately, I thought this brief history of social insurance from the Social Security web site might be of interest. What I want to stress is that the New Deal was more than simply a stimulus program to lift the economy out of the depression, it was also a means of dealing with economic and social changes that rendered old forms of social insurance obsolete, and beyond that, it was a means of rebalancing power in society, an important factor that shouldn't be overlooked.

We have heard a lot about lifting the economy out of the recession and whether this or that policy instrument will be effective at that task, and there have been lots of comparisons to the Great Depression along this dimension. But there hasn't been much talk about the need to update our social insurance programs to cope with a world that is very different from the world in the 1930s, or the need to rebalance economic and political power. Perhaps our current social insurance institutions are adequate - though I would argue that health care is one area where there is a clear need for change - and perhaps the balance of power is as it should be - though there are reasons to suspect that it isn't - so we should at least look at these issues to see if change is needed. And if change is needed in these and other areas such as employment insecurity related to globalization, and I think it is, we shouldn't let this unique opportunity for change go to waste.

Here's the (perhaps not so) brief historical account:

The March of Coxey's Army

The Great Depression of the 1930s was not the only one in America's history. In fact, it was the third depression of the modern era, following previous economic collapses in the 1840s and again in the 1890s. During the depression of the 1890s unemployment was widespread and many Americans came to the realization that in an industrialized society the threat to economic security represented by unemployment could strike anyone--even those able and willing to work. Protest movements arose--the most quixotic and notable being that of "Coxey's Army."

"Recession Insurance"

Robert Shiller:

Recession Insurance, by Robert J. Shiller, Commentary, Project Syndicate: The Chief Economist of the International Monetary Fund, Olivier Blanchard, and several IMF economists have proposed ... that governments should offer what they call “recession insurance.” Companies and/or individuals would buy insurance policies, pay a regular premium for them, and receive a benefit if some measure of the economy, such as GDP growth, dropped below a specified level. ...

Recession insurance might ... help alleviate the economic crisis by reducing uncertainty. After all, the real problem that we are currently facing is one of paralysis: uncertainty has placed many spending decisions – by businesses ... and by consumers ... – on hold. Reducing uncertainty might augment, or even be superior to, fiscal stimulus programs, for it would address the root cause of the unwillingness to spend.

Moreover, recession insurance might, in contrast to fiscal policy, impose no costs on the government, for if it stimulates confidence, then the risk being insured against is prevented. The government’s ability to offer such insurance on a scale sufficient to make it costless is one reason to favor a public scheme over private insurers. ...

Governments are in a good position to create new risk-management policies... But, as an alternative..., there could be purely private recession insurance.

Such insurance already exists on a small scale in the form of credit insurance against unemployment. A New York-based firm, the Assura Group, has been working for four years on a plan to launch privately issued supplemental unemployment insurance to anyone. Their policies would piggyback on US state unemployment insurance programs, allowing Assura to avoid getting into the monitoring business.

One problem with market-based policies is strategic adoption and cancellation. GDP risk is a long-term risk. The price of the insurance would have to be adjusted regularly to adjust for varying ... likelihood of a recession, and people could not be allowed to cancel their policies, and stop making payments, whenever the economic outlook became rosier.

The Assura Group ... will set prices by a formula, rather than using a fixed rate, so that their prices vary in rapid response to changing economic conditions. ...

Once we have a market price for recession insurance or similar products, the question then arises: will it be so high that few people want to buy? We know that we are probably in a recession right now, and may be for some time, so the expected losses currently are enormous. As a result, people may balk at the price and not want to buy the insurance. ...

There are uncertainties with any really new proposal. But the proposal from the IMF is an important step, because it deals with the essential problem...: fears about the future of the economy become a self-fulfilling prophesy. We should not look askance at such a policy because of its potential shortfalls.

The current global economic crisis is an opportunity for some new experimentation that might not only lead to its resolution, but might also set in place institutions that help to prevent future crises. Recession insurance is one such idea.

I have a hard time getting by the argument that if a private market for this insurance could exist, it would already be operating, so I am not confident that the Assura Group proposal will work. (And if it does work and turns into a large program covering most households, would the government step in if the insurance company failed during a recession due to, say, oh, I don't know, the mispricing of risk? I think they would, so there would be an implicit government backing of the insurance in any case.) This is likely something the government does directly or indirectly through guarantees or other mechanisms, or it doesn't get done at all (due to market failures). And in that regard, this comes under the general heading of social insurance, and there are a variety of ways that we could strengthen our social insurance programs. The only question is where the highest return for an effort to reform social insurance is likely to be. Right now, I think the highest potential return is in the area of health care reform, so that is where I would like to see the social insurance reform effort concentrated (the unemployed are particularly vulnerable to losing health care coverage). If we can make households less vulnerable to business cycle variation, and to exogenous variation in household income more generally, we should do so, and if the private sector is up to the task, great, it can help with this task. But right now, beyond the immediate task of stabilizing the economy, the primary focus should be on providing broad-based, affordable health care.

Starving the Unemployed

During the Bush administration, the federal debt " nearly doubled," going from $5.7 trillion to $10.6 trillion. This was no accident, but rather part of the Republican's "starve the beast" strategy for shrinking government. While this was going on, many of us warned that if big trouble hit, and if we had high deficits at the time, it would limit our ability to respond in the most effective manner. E.g., from January 2006:

We are in a better position with respect to monetary policy now, but for awhile we had very low interest rates coupled with very high budget deficits. In such a case, when you've already thrown your two best punches, what do you do if trouble hits? It's important to reload the policy guns - get deficits and interest rates in order - so when trouble hits you won't have already fired your best shots. I also wonder if we are saving enough for the next rainy day.

We weren't, and as I said, that was intentional. You see, the advocates of starve the beast policies believed that capitalism had entered a new era since Reagan. We had thrown off the limitations imposed by intrusive government making us, unlike Europeans who had not followed suit to anywhere near the same degree, highly resistant to shocks. Much was written about how effectively the relatively government free U.S. economy could absorb shocks relative to Europe (Phelps comes to mind). We could take a licking and keep on ticking. So they saw no real danger in pushing a large deficit, starve the beast type policy. Many denied that government could help, government is always the problem, never the solution, but in any case big shocks - the kind that produce depressions - couldn't happen in a free, capitalist system, and they would point to the Great Moderation and events such as Katrina where the economy hardly lost a breath as evidence for that position.

But they were wrong about that, and what many of us were so worried about has now come to pass. Because of the high levels of government debt, our hands are not as free as they should be to deal with the crisis. Republicans - the very party that created the such a large problem by denying that it could ever occur - are now the ones wringing their hands about increasing the deficit any further. But instead of complaining, they should be apologizing profusely for leaving us in such a bad position. Their belief that capitalist economies, if only freed of government, can absorb any shock almost without blinking, and their conscious decision to try to starve government, particularly social insurance programs so necessary in a downturn like this one, has left us in a bad position. We may not be able to do as much as we need to do because of the objections to increasing the debt as much as will be needed. And if we cannot do what we need to do, it won't be the beast that is starved, it will be families who no longer have jobs, healthcare, etc., and have no place to turn to get the help that they need, at least not in sufficient quantity. "Starving the unemployed" may not have been the goal, but if Republicans get their way and limit the recovery package based upon deficit fears, it could very well be the result.

"A Safety Net in Need of Repair"

As we tinker with the social insurance system in response to the crisis, here's an area that could use some work:

A safety net in need of repair, The Economist: Compared with ... other industrialised countries, the American unemployment-insurance (UI) scheme pays lower benefits for less time and to a smaller share of the unemployed. In expansions this encourages the jobless to return quickly to work—and unemployed Americans do indeed work harder at finding jobs than their European counterparts (see chart). But in recessions, when there is less work to return to, it causes hardship. ...

Like much of the social safety net, the current UI system was a product of Franklin Roosevelt’s New Deal. ... But the system has not kept up with changes in America’s labour force.

The Insurance Value of High Home Equity

Awhile back, I talked about how home equity serves as insurance against unexpected costly events, and how falling home values would increase economic insecurity as that insurance disappears.

According to the research described below, many households have, in fact, been using home equity to sustain consumption when there are fluctuations in income or unexpected expenses, more than we realized. Households have been accused of using their bubble induced home equity to go on consumption binges (me joining in the fun), but that's not true in many cases:

Credit crunch hits cash-strapped homeowners, EurekAlert: Homeowners have drawn on their biggest asset, the roof over their heads, not to fund 'champagne moments' but to get through hard times...

Mortgage equity withdrawal is a much more popular and frequent event than previously thought. New figures show that borrowers haven't just used their housing equity to splash out on holidays or cars; struggling households have borrowed against their homes to meet their basic needs like bringing up the kids. ...

Durham University housing expert Susan Smith said: ..."In the early years of this century we saw a form of self-administered welfare payment develop where home-owners cash in on their homes, in boom times: to support children, smooth over a fall in income, or meet the costs of relationship breakdown." ...

The research ... uses panel survey data that tracks the same households through every year. This ongoing study is monitoring what prompts households' use of a growing range of flexible mortgages and low cost refinancing opportunities to draw from housing wealth, and release money to spend on other things.

The findings show that this facility – to borrow against housing wealth cheaply, easily and without moving home – is a factor in the recent escalation of personal debt. However, these findings also suggest that the popular perception of equity withdrawal is not always used for life's luxuries - it's used to meet more basic needs.

Professor Smith said "This suggest that the credit crunch is not just precipitating a crisis in the finance community... Without the option to use mortgages to channel housing wealth into spending money, families under pressure lose access to their most significant asset base ... and are forced to look at other ways of getting by.

"The figures show that housing equity withdrawal has provided a lifeline for struggling families but the credit crunch threatens what has become a new form of self-administered welfare."

The insurance households relied upon in tough times is gone, and it's up to government to fill the void for those households who now have nowhere else to turn.

Welfare

The question is "Why do Americans still hate welfare?":

Why Do Americans Still Hate Welfare?, by R.M. Schneiderman, Economix: As I explained in a post last month, the word “welfare” remains a charged one in the American lexicon. So in the throes of a prolonged recession ... it’s worthwhile asking: Why is this the case?

Americans – going back as far as Colonial times, when Elizabethan poor laws were in vogue – have never favored unlimited government handouts that are not contingent upon work. The Great Depression is a prime example. Various polls and historical accounts taken during that time period indicate that the American people largely favored government public works programs like the Civilian Conservation Corps.

Direct relief, on the other hand, was unpopular... It was also highly limited. Only children, the blind and those over 65 could receive it. ... James Patterson ... writes that “the image of the poor person in the 1930s was the agrarian farmer, down on his luck, but not complaining.”...

Starting in the mid-1960s, however, that image began to change: poverty – especially welfare – became seen by many as largely an African-American phenomenon. It was also during this decade that the word “welfare,” which previously did not have a negative connotation, became “a political epithet,”...

A Populist Backlash?

Now that the crisis is spreading to the real economy, you can feel the anger and resentment starting to build. Robert Reich thinks we may be "courting a populist backlash":

Are We Courting a Populist Backlash?, by Robert Reich: The government is doing a lousy job helping distressed homeowners. And according to ... the Comptroller of the Currency, the little that's been done has had surprisingly little effect. Nearly 36 percent of homeowners holding mortgages whose terms were adjusted to give them more leeway defaulted on payments within three months, and almost 53 percent were behind on payments by six months.

What's going on? It's hard to know for sure, because the homeowners who have qualified for help so far were supposed to have been fairly good credit risks.... My guess is the worsening economy is making it harder for just about all homeowners to pay their mortgages, and those who were teetering on the edge months ago ... are now way under water. Two of the biggest culprits: Layoffs and fewer working hours. ...

It wouldn't surprise me if many of these Americans were starting to look at the size of the bailouts of Wall Street and the bailout of the Big Three -- at the executives, well-paid professional employees, upscale creditors and shareholders, and even well-paid blue-collar workers, who are the major beneficiaries of this federal largesse -- and conclude that a fundamental principle of fairness is being violated.

These Americans aren't revolutionaries. To the contrary, they're deeply conservative. They've worked hard, but their hard work hasn't paid off. Some have tried to save, only to see their savings disappear. They're worried about the future and about their kids' futures. They never expected anything like this.

This is the angry soil in which populist backlashes can take root.

We may be able to do a better job of sorting out which homeowners to help now that we have some experience with the program, so the 53% number may be improved upon going forward. But if the goal is to prevent a certain number of foreclosures, and if the number cannot be improved, we could also help twice as many people. That might help with the backlash problem.

On the populist backlash, maybe that was part of the reason for this?:

Deal to Rescue American Automakers Is Moving Ahead, by David M. Herszenhorn, NY Times: The White House and Democratic Congressional leaders said Monday that they were close to agreeing on the terms of a $15 billion government rescue of the American automobile industry that would be directed by one or more appointees of President Bush and would impose expansive federal oversight of the auto companies.

The House speaker, Nancy Pelosi, said she hoped that Mr. Bush’s appointee — or car czar, as the position has come to be known — would not need to be replaced by President-elect Barack Obama, raising the prospect that the outgoing and incoming administrations would cooperate in selecting someone.

The president’s designee would disburse the short-term emergency loans to General Motors and Chrysler, which are at risk of financial collapse, and would directly supervise the reorganization plans that the auto manufacturers have agreed to carry out in exchange for government aid. The government also could receive warrants that would give it equity stakes in the companies.

The Ford Motor Company announced Monday evening that it would not seek short-term federal aid, denying that it faced the same “near-term liquidity issue” as G.M. and Chrysler. ...[O]fficials expressed optimism that they would reach a deal and that Congress would vote on the package this week.

The progress in the Washington talks helped lift the stock markets...

By Jan. 1, according to the draft bill, the car czar would be required to develop benchmarks for assessing the automakers’ progress in carrying out the restructuring plans. The car czar would also have the power to convene meetings of an array of interested parties in the auto companies, including unions, creditors, suppliers, auto dealers and shareholders. ...

The White House had earlier proposed that the auto czar reside within the Commerce Department with the title of “financial viability adviser.” The Democrats’ draft would seem to allow the administration to do just that, and would not require Senate confirmation for the post. The Democrats’ draft legislation includes an array of stringent taxpayer protections. ...

Will Americans be more likely to buy cars from GM and Chrysler if they are part owners in the companies? Market share will be critical as car sales decline in coming months - output will have to fall - so will foreign carmakers move to protect themselves with offsetting subsidies, etc. of their own? I'm not comfortable with this for a variety of reasons, but losing that many jobs right now is not an attractive option, so there doesn't seem to be much of a choice.

One question to ask is how we ended up putting ourselves into a position where we could not allow firms to fail. There are lots of reasons, but if we had better social insurance, good enough so that the health and welfare of workers and their families was not threatened by the failure of the automakers, it would be a lot easier to avoid a bailout.

"The Bailout Paradox"

Robert Reich:

The Bailout Paradox: As a condition of getting a federal bailout, the Big Three are promising, among other things, to cut costs. Among the costs to be cut will be jobs. This is paradoxical, since the reason Congress is considering bailing them out in the first place is to preserve jobs and avoid the social costs of large-scale job loss (unemployment insurance, lost tax revenues, pension payments that have to be picked up by the Pension Benefit Guarantee Corporation, and so forth) .

We should take a lesson from the Chrysler bailout of the early 1980s. The ostensible reason Congress voted for it was to preserve Chrysler jobs. Yet once the bailout was underway, in order to generate the money it needed to restructure itself, Chrysler laid off more than a third of its workforce. Most of these jobs never came back.

And it's much the same with the mammoth bailout of Wall Street. Absent an explicit understanding of why public money is needed and what it's to be used for, taxpayer dollars end up bolstering executives, creditors, and shareholders rather than the workers and communities that need the most help.

Short-Sighted?

According to this research, welfare reform caused adult women to reduce their education:

Welfare reform undermined, Free Exchange: Getting poor mothers off welfare and into employment as quickly as possible seems to be a useful policy goal. But a new paper by economists Dhaval Dave, Nancy E Reichman, and Hope Corman suggests it can be short-sighted.

The Personal Responsibility and Work Opportunity Reconciliation Act of 1996 limited the time mothers could spend on welfare and required some work as a condition for receiving it. The reforms were, by most measures, successful at reducing the number of women on welfare and increasing their levels of employment. ... But..., the authors ... found that the reforms made adult women less likely to pursue education.

The reforms do not penalise minor (under 18) women who still attend school. Actually, the reforms encourage the younger women to finish their education. To receive some of the government funds, single, minor mothers must attend high school or some training program. The authors found this incentive decreased the teen dropout rates of the population between 9 and 13%.

By contrast, the reforms aimed at adult women, which promoted work and not training, made education less attractive. The authors found the reforms decreased the probability of adult women attending high school or college by 20 to 25%.

The number of welfare claims unambiguously decreased, but at what cost? More education increases the value of your human capital which leads to higher wages and more self-sufficiency. The authors wonder if discouraging education might ultimately leave the women more dependent on state benefits than they would if education were encouraged. The trade-off is a classic example of the choice of short-term gain and long-term pain.

"Trapped in the New 'You're on Your Own' World"

This is the start of a long essay by Robert Solow on the need for social insurance that is disguised as a book review:

Review of Peter Gosselin's High Wire: The Precarious Financial Lives of American Families, by Robert M. Solow, NYRB: When the Bush-Cheney administration proposed to replace Social Security with a system of individually accumulated, individually owned, and individually invested accounts, my first thought was that its goal was to take the Social out of Social Security. It took a few minutes longer to realize that it also intended to take the Security out of Social Security.

That attempt failed. In recent years, however, a mixture of public and private policy decisions and impersonal market developments has had the broad effect of shifting many financial risks from established institutions, including even society at large, to individuals who are unable to cope with them in an adequate way. Information may be impossibly difficult for citizens to process; or else the basic information may not be available to individuals or private groups. Sometimes the scale of the possible bad outcomes may be overwhelming. Sometimes the appropriate insurance market cannot function or just does not exist. The result is that individuals and families can be the casualties of situations that once would have been handled by a more centralized and more bearable allocation of risks.

The current turmoil in credit markets and the recession that is sure to follow are likely to drive this trend further. Banks, insurance companies, and other financial institutions have seen too many risks go sour. They will be more determined than ever to push further risks onto those needy borrowers who are too weak and too ignorant to bargain hard. Families, small businesses, and other borrowers of last resort will be under great pressure. ...

He ends with:

The standard argument for leaving all the responsibility and decisions to the individual in the free market is that, in appropriate circumstances, that is the route, and maybe the only practical route, to economic "efficiency." Any interference is a "distortion," and the consequence of such distortion is that the economy produces less than it could. (A more up-to-date version is that messing with the atomistic market tends to cripple "innovation," but we actually know little about how that works, in either direction.)

One standard counterargument is that the circumstances are not always appropriate. The classic example is that private economic activity, for instance, the burning of coal or oil in furnaces or cars, may damage everyone's environment by emitting carbon dioxide and changing the climate. In those cases, and there are many, market prices give the wrong signals; regulation or taxation or subsidization is justified precisely to restore efficiency. ...

But efficiency is not the issue here, at least not the main issue. The transfer of risk from social and private institutions to individuals transfers a burden, mainly from the strong to the weak. That is primarily an issue of equity. It will surely become more urgent in current circumstances, perhaps urgent enough to be seen as a central political issue. Suppose that the best way to relieve that burden is by sharing the risk through universal social insurance. The premium then has to be a tax, a tax on work or enterprise, or some productive activity, and such a tax is a distortion, a source of inefficiency, a true cost to society. What then? I know what Gosselin would say: a society that won't pay a small cost to preserve equitable and fair treatment of, among others, the sick, the old, the unemployed, and the victims of natural disaster is not much of a society. Is that a minority view? [...read more...]

"Greenspan's Folly"

Jeff Sachs says that Greenspan's bubbles and the problems they have caused make clear that it's time to abandon "the economic model adopted since president Ronald Reagan came to office in 1981." I think Fed policy contributed to the housing bubble, but I am not convinced it was the primary cause. However, whatever the primary cause of the problems we are experiencing, I have no disagreement with Sach's call for "a new economic strategy":

Greenspan Folly makes room for a new New Deal, by Jeff Sachs, Project Syndicate: This global economic crisis will go down in history as Greenspan’s Folly. This is a crisis made mainly by the US Federal Reserve Board during the period of easy money and financial deregulation from the mid-1990s until today. ...

At the core of the crisis was the run-up in housing and stock prices... Greenspan stoked two bubbles — the Internet bubble of 1998-2001 and the subsequent housing bubble that is now bursting. In both cases, increases in asset values led US households to think that they had become vastly wealthier, tempting them into a massive increase in their borrowing and spending — for houses, automobiles and other consumer durables.

Financial markets were eager to lend to these households, in part because the credit markets were deregulated... This has all come crashing down. ...

The challenge for policymakers is to restore enough confidence that companies can again obtain short-term credit to meet their payrolls and finance their inventories. The next challenge will be to push for a restoration of bank capital so that commercial banks can once again lend for longer-term investments.

But these steps, urgent as they are, will not prevent a recession... The US will be hardest hit, but other countries with recent housing and consumption booms (and now busts) — particularly the UK, Ireland, Australia, Canada and Spain — will be hit as well. Iceland ... now faces national bankruptcy...

It is no coincidence that, with the exception of Spain, all of these countries explicitly adhered to the US philosophy of “free market” and under-regulated financial systems.

Whatever the pain felt in the deregulated Anglo-Saxon-style economies, none of this must inevitably cause a global calamity. I do not see any reason for a global depression, or even a global recession.

Yes, the US will experience a decline..., lowering the rest of the world’s exports to the US. But many other parts of the world will still grow. Many large economies, including China, Germany, Japan and Saudi Arabia, have very large export surpluses and so have been lending to the rest of the world — especially to the US — rather than borrowing.

These countries are flush with cash and not burdened by the collapse of a housing bubble. Although their households have suffered to some extent from the fall in equity prices, they not only can continue to grow, but can also increase their internal demand to offset the decline in exports to the US.

They should now cut taxes, ease domestic credit conditions and increase government investments in roads, power and public housing. They have enough foreign-exchange reserves to avoid the risk of financial instability from increasing their domestic spending — as long as they do it prudently.

As for the US, the current undeniable pain for millions of people, which will grow..., is an opportunity to rethink the economic model adopted since president Ronald Reagan came to office in 1981. Low taxes and deregulation produced a consumer binge that felt good while it lasted, but also produced vast income inequality, a large underclass, heavy foreign borrowing, neglect of the environment and infrastructure, and now a huge financial mess.

The time has come for a new economic strategy — in essence, a new New Deal.

"Taxes, Bailouts and Socialism"

Is it socialism?

Taxes, Bailouts and Socialism, by James Edward Maule: ...When Senator Barack Obama replied to the question ... about his tax plan by noting that "I think when you spread the wealth around, it's good for everybody," he opened the floodgates of accusations that his tax proposals would amount to socialism. ...

Obama's tax plan is to increase taxes for individuals with incomes exceeding $250,000. Most Americans do not fall into that category, and 95 percent are unaffected by this particular proposal. Americans in that category are paying taxes at lower rates than they were paying a decade ago. The theory was that reducing rates on the rich would generate benefits not only for the rich, but also for everyone else. This "trickle down" theory turned out to be a failed experiment. All that trickled down was the economic pain inflicted on America by the casino capitalist gamblers. Technically, Obama proposes revocation of tax cuts for the wealthy. They had their chance. It failed, other than to make the wealthy wealthier, the middle class smaller, and the gap between the haves and have-nots wider. ...

Will Obama's tax plan redistribute wealth? Hardly. The additional revenue generated by the revocation of tax cuts for the wealthy very well may end up paying the interest on the national debt that was incurred because taxes were cut and kept too low during wartime. One could consider those tax cuts to have been a loan to the wealthy, and the events of the past month have demonstrated what they did with it.

But perhaps there's some wealth redistribution involved. One reasonably can argue that the revenue raised by revoking the tax cuts for the wealthy will be used to fund government programs that help only the poor or only the middle class or only the poor and middle class. Does that make it socialism? More important, does that make it bad policy? ...

Colin Powell has suggested that "Taxes are always a redistribution of money. Most of the taxes that are redistributed go back to those who pay them -- in roads and airports and hospitals and schools. And taxes are necessary for the common good, and there's nothing wrong with examining what our tax structure is or who should be paying more, who should be paying less. For us to say that makes you a socialist, I think, is an unfortunate characterization that isn't accurate." Hooray for Colin Powell. I might disagree that taxes always are a redistribution, because to the extent that they pay for services being rendered to the paying taxpayer, they do not transfer wealth. They simply represent an exchange of cash for services or property. But that articulation technicality aside, there are, and have been for decades, valid arguments for imposing higher taxes on those on whom America has bestowed better opportunities and greater fortune. Undoing the mistaken tax cuts, and fixing the problems caused by trying to fight a war without raising taxes, isn't socialism. It's an attempt to undo the problems caused by welfare for the wealthy. ...

A total ban on wealth redistribution would mean tens of millions of people in need would not get assistance, and in many instances would die. Social Security is wealth redistribution. So, too, is Medicare. So, too, are food stamps. So, too, is the program that provides breakfasts and lunches to school children who would otherwise go unfed. So, too, are all sorts of other programs. If these programs are socialism, and if support for these programs make someone a socialist, then here's some news: by that definition, America has been a socialist nation for decades, and most of its Presidents and legislators have been socialists. So what would it mean to purge "socialism" from public policy? What then would life in America be?

"Free Traitors"

I'm wondering if the guy quoted in the second to last paragraph of this article on growing resistance to free trade has any clue what he is talking about:

Free Traitors, by Christopher Hayes,  The New Republic: Jagdish Bhagwati is a humble man. He will tell you so himself. Describing the effect of his book In Defense of Globalization during a speech at the John Hopkins School of Advanced International Studies (SAIS) last fall, the Columbia economist politely refused credit for single-handedly dampening growing concerns about the fallout from free trade. Fears of trade are "low-key," he said. "I won't say it's because of my book. I have colleagues who would say that. ... People believe I have a large claim to fame, so I don't have to do it myself."

But, for all his bluster, Bhagwati was in something of a defensive crouch. His talk was titled "Free Trade Policy Today: Why Is the United States in Retreat?" and, although he was tempted to pin the blame on idiots in the press--he called New York Times writer Louis Uchitelle a protectionist who "never saw a tariff [he] didn't like"--a wayward economics reporter or two could hardly explain the shift in public opinion. Although Washington's trade deal with Peru--largely modeled on the North American Free Trade Agreement (NAFTA)--managed to pass Congress in December 2007 on a bipartisan vote, many politicians have become increasingly vocal in their opposition to future deals. One need only look at the dustup that preceded the Ohio primary, in which senators Hillary Clinton and Barack Obama competed to out-anti-NAFTA each other, despite the fact that it was Clinton's husband who pushed NAFTA through a resistant Congress 15 years ago. Nor are concerns about the effects of trade agreements limited to Democrats campaigning in the hard-hit manufacturing belt. Poll after poll shows that a majority of Americans, skeptical of their benefits, oppose NAFTA-style deals. A Wall Street Journal/NBC survey last year found that about 60 percent of Republicans believed foreign trade has been bad for the United States, up from 31 percent nine years ago.

The public's increasing wariness of trade agreements is easy enough to integrate into the narrative of eternal besiegement that free trade's advocates tend to construct. (Adam Smith's The Wealth of Nations was born, more or less, as an argument against the prevailing protectionist consensus of the day.) But what truly irritated Bhagwati was the perception that economists were rethinking the fundamentals of their pro-trade arguments. Two high-profile "defections" in particular merited Bhagwati's ire. In 2004, the father of modern trade theory, Nobel laureate Paul Samuelson, published a paper which argued that, as China developed economically--from manufacturing children's toys to, say, programming software--the net effect on the U.S. economy could be negative. Then, last year, Princeton economist (and former Federal Reserve governor and adviser to President Clinton) Alan Blinder circulated a working paper that calculated the number of U.S. jobs that could be shipped overseas. The number was headline-grabbing: 40 million. ... [...continue reading...]

Funding the Bailout: A Contingent Surtax on the Rich

Robert Waldmann:

What Is to be done?, by Robert Waldmann: 
OK what ... to do now that the House Republicans (and some Democrats) have voted down the Paulson-Dodd-Frank bailout bill.

The contingent consensus of the Left Blogosphere seems to have been to go for the Swedish solution if the Paulson solution is rejected -- that is nationalize banks with inadequate capital. I think this is still politically impossible. Even if the Democrats go alone and Bush is afraid to veto, the blue dogs will be blue dogs.

I think 2 complementary and more moderate proposals might pass over Republican objections and save the financial system. They are, of course, exactly what I have already proposed here and here.

First preferred shares. Economists of all ideologies agree that what the banks need to do now is increase their equity by selling shares. ... I think a bill which allows banks to sell a lot of preferred shares to the Treasury and makes sure that the Treasury will lose money only if the bank goes bankrupt might make enough sense ... that it would be a political winner. See the old post for details.

I add one clause -- a contingent surtax on the rich. Withhold an extra 10% of income over $1,000,000 and, each year, return the part that wasn't needed to cover losses in the Buffet X 100 plan (plus the chained 3 month t-bill interest rate). This is very much in the interests of the rich as they will get their money back and the financial system will be saved. The under a million crowd will be protected.

Also squabbling over exactly what to do with the profits that the Treasury will make might convince people that there will be profits (I think there will be if the purchase is at share prices as of today September 30).

The other is Toxic Sludge Inc....

I think these ideas might be popular enough (both have guarantees that they cost most people nothing and don't add to the deficit long term) that the Democrats can afford politically to pass them over Republican objections.

I've proposed something similar in terms of paying for the bailout, but instead of taking the money up front and then refunding it if there are no losses, we wait until we know how much the bailout costs, then raise taxes progressvely through a temporary surcharge of some sort, e.g. as above. If there's a surplus rather than a loss, then there's no need for the temporary tax increase. The effect is the same, but somehow the plan above seems politically more platable.

Summers: Taxpayers Can Still Benefit from a Bail-Out

This is an argument I've been making too, i.e. that "we don't have to give up our aspirations for the future." So I'm in full agreement with the points made below that the expected cost of the bailout is far less than $700 billion and hence not as constraining in terms of out ability to address other problems as many pundits have implied, that countercycical measures are needed immediately, and that fiscal policy dominates monetary policy as a stimulus tool. (And with fiscal policy, I prefer government spending to tax cuts as a means of stimulating the economy since the effect on aggregate demand is more certain, and spending can be directed toward particular, high employment, high economic return projects such as rebuilding infrastructure and addressing environmental concerns). I also agree with the final point made below that as fiscal policy measures are undertaken to stimulate the economy in the short-run, it is best if they also help with long-run problems. But right now, the short-run is the biggest concern:

Taxpayers can still benefit from a bail-out, by Lawrence Summers, Commentary, Financial Times: Congressional negotiators have now completed action on a $700bn authorisation for the bail-out of the financial sector. This step was as necessary as the need for it was regrettable. ...

The idea seems to have taken hold in recent days that because of the ... bail out..., the nation will have to scale back its aspirations in other areas such as healthcare, energy, education and tax relief. ...[T]he events of the last weeks suggest that for the near term, government should do more, not less.

First,.... No one is contemplating that the $700bn will simply be given away. All of its proposed uses involve either purchasing assets, buying equity in financial institutions or making loans that earn interest. ... It is impossible to predict the ultimate cost to the Treasury of the bail-out... But it is very unlikely to approach $700bn and will be spread over a number of years.

Second, the usual concern about government budget deficits is that ... government bonds ... will crowd out other, more productive, investments or force greater dependence on foreign suppliers of capital. To the extent that the government purchases assets such as mortgage-backed securities with increased issuance of government debt, there is no such effect.

Third, since Keynes we have recognised that it is appropriate to allow government deficits to rise as the economy turns down if there is also a commitment to reduce deficits in good times. ...[T]he US made a serious error in allowing deficits to rise over the last eight years. But it would be compounding this error to override ... “automatic stabilisers” by seeking to reduce deficits in the near term.

Indeed, in the current circumstances the case for fiscal stimulus ... is stronger than at any time in my professional lifetime. Unemployment is now almost certain to increase – probably to the highest levels observed in a generation. Monetary policy has very little scope to stimulate the economy... And ... economic downturns caused by financial distress ... ... are almost always of long duration. ...

The more people who are unemployed the more desirable it is that government ... put them back to work by investing in infrastructure, energy or simply through tax cuts that allow families to avoid cutting back on their spending.

Fourth, it must be emphasised that nothing in the short-run case for fiscal stimulus vitiates the argument that action is necessary to ensure the US is financially viable in the long run. We still must address issues of entitlements and fiscal sustainability.

From this perspective the ... best measures would be those that represent short-run investments that ... over time ... improve the budget. Examples would include investments in healthcare restructuring or steps to enable states and localities to accelerate, or at least not slow down, their investments.

A time when confidence is lagging in the household, financial and business sectors is not a time for government to step back. ...

A Worker Bailout Fund?

In response to the financial crisis, as we help firms that are deemed too big and too interconnected to fail, hundreds of billions of dollars are being tossed around as though it is mere pennies.

Since it is widely expected that the crisis will get worse before it gets better, and since there is a non-trivial chance of a substantial uptick in unemployment, shouldn't we begin thinking about a worker bailout fund?

Or are workers too little to be helped?

I don't think so. So instead of waiting until unemployment goes way up, and then watching Congress fight over what to do about it while people struggle to make ends meet, let's get a plan in place now that dedicates some of the money being tossed around to helping workers. If unemployment goes up, what will we do? How will we help?

If we are going to bail out the big players - take toxic paper off their hands - there's no reason at all not to bail out workers too.

I want to think about this more, so help me out. How should such a proposal be structured? What should the worker bailout fund look like?

Why We Need Community Organizers

Are you better off today than you were eight years ago? If you are the top of the food chain, the answer is yes, but for everyone else the answer is generally no. And today's news doesn't help. The unemployment rate rose from 5.7 to 6.1 percent in August, and the broadest measure of unemployment (U6) now stands at 10.7%. That's up from 10.4% a month ago, and 8.4% a year ago.

When you look further into the numbers and break them down into groups who generally struggle economically, conditions are much worse. If you are a woman trying to maintain a household, your unemployment rate rose from 8.5% to 9.6%. The unemployment rate for blacks rose from 9.7% to 10.6%, and for Hispanics from 7.4% to 8.0%. Teen unemployment actually fell by 1.6% as compared to last month, but it still stands at 18.9%. And for the slightly older age group, ages 20-24, the rate stands at 10.5%. And those are all the narrow measure of unemployment, U3. The broader measures such as U6 would, of course, show conditions to be much worse.

Have Republicans devoted enough attention to these issues? No. This brings us to an important point.

Republicans have been targeting Community Organizers this week, but one of the important things Community Organizers do is clean up after Republicans. Without their help, and given Republicans blindness to these issues and the needs of these communities, and given that their trickle down economic policies have not, in fact, trickled down, conditions would be much worse.

Here's more discussion of the report:

The New Wave of Globalisation: This Time, It’s Really Different

The "Great Unbundling" is more unpredictable, sudden, and individual than in the past:

Globalisation as the great unbundling(s): What should governments do?, by Richard Baldwin, Vox EU: The Kiel Institute’s Global Economic Symposium – something like a New Century Davos – is being held in a Northern German castle... Globalisation is on the agenda. Alan Blinder has contributed his thoughts on “Offshoring, Workforce Skills, and the Educational System.” Here are my comments on the subject.

The new new

This is the second time in as many decades that I write about “the new wave of globalisation”. But this time, it’s really different. It’s tempting to rattle off the conclusions and hope readers have forgotten the 1990s contributions on globalisation. But that would be too easy. It is important to understand why things are different this time.

"What's Wrong with This Hurricane?"

At the moment, the expected path for Hurricane Gustav threatens the Gulf Coast. Is the Bush administration ready?:

What's wrong with this Hurricane?, by Moira Whelan: I just noticed that the daily brief customarily done in advance of a hurricane is ... being given by NORTHCOM. So what does this tell us and why does it matter? It tells us that things are as broken as they were before Katrina.

The military, like EPA, Commerce, or anyone else, is only involved in emergency management to the point that they are requested to do so by the governor or the FEMA director (who acts on behalf of the President).

When it comes to disasters, the governor is always in charge. At any point, he or she can call in their state’s National Guard, and/or ask other governors for their help... If a governor is worried things are getting out of control, they ask the President to provide help through FEMA... FEMA is then in charge of coordinating the resources of the federal government to support the governor and the state. In a sense, when FEMA is working properly—as it did under Clinton—when the FEMA director tells another Federal agency to do something, it’s as if the President is calling. The government agency is expected to deliver and cut through red tape to make things happen and happen fast.

There is no allowance or legal authority for the Department of Defense to take any sort of control or command in this scenario. In a hurricane, DoD, like Human Services, Transportation, etc, all work for FEMA and the governor of the impacted state.

This is done for a very specific and important reason: here in America, we believe that governors should have control over their own states. The federal government needs to be there to help, but they absolutely do not move in and take over. We also do not believe that the military should ever forcibly operate inside the United States unless they are under civilian control.

With NORTHCOM taking the lead on briefing the public, it’s clear the Bush Administration wants to send the message that everything is under control. Instead, to those that do this for a living, the message is clear that everything is absolutely and completely broken.

Perhaps the state governments need help. Perhaps FEMA is not up to the job. Perhaps the Bush Administration simply wants a uniform on camera, and this way of doing things is preferable to things happening the way that they should (a process, by the way, that WORKED before Bush screwed it up).

NORTHCOM taking the lead in public relations is a clear indication that nothing has been fixed in DHS and FEMA since Katrina. As a result, there is no confidence in FEMA’s ability to respond to this hurricane. With NORTHCOM at the helm, the Bush Administration either doesn’t care if, or doesn’t want, the systems to work. ...

The bottom line is that things will not work the way they should with NORTHCOM in charge. Governors don’t take orders from Generals. No one else in government takes orders from DoD. No one in emergency management even knows what NORTHCOM does, except come in and issue “orders” to a bunch of civilians who don't work for them.

I hope for the sake of the people on the Gulf Coast that the hundreds of civilians who want to do right by them prevail over the system that the Bush Administration has failed to fix. ...

Income Based Affirmative Action

Robert Reich says it's time to link affirmative action programs to family income:

Robert Reich, Marketplace: Here's an idea Democrats probably won't endorse but should: Affirmative action based on family income.

The latest data from the Census tell us that inequality keeps growing. ...

At the same time, it's become harder for lower-income people to move upward. With wider inequality, the distance poor kids -- whatever their color -- has to climb to reach the upper-middle class is much longer. And the loss of millions of manufacturing jobs has removed many rungs in the middle of the income ladder, making that climb even harder.

In the new economy, education and connections mean more. Increasingly, lower-income people without adequate education and connections are competing for a smaller and smaller slice of the economic pie.

If there was ever a good time to offer affirmative action based on family income -- giving kids from lower income families extra consideration in college admissions, for example -- it's now.

Despite the fact that one of the great social achievements of the last quarter century is the emergence of a black middle and professional class, people of color are still over-represented among the poor and working class. The advantage of income-based affirmative action is it would address many of the same issues as race-based affirmative action, but it would also address the needs of low-income whites. ... Demagogues would have a harder time using race to stoke the fires of economic resentment.

Finally, income-based affirmative action would lead to more economic diversity on our college campuses. And more economic diversity is a key to reversing America's trend toward widening inequality.

Income-based affirmative action makes sense. Democrats, as well as Republicans, should consider it.

New Census Data on Poverty, Income, and Health Insurance

Here's a round up or reactions to the Poverty, Income, and health Insurance Report released today by the Census Bureau:

Statement by Robert Greenstein on the New New Census Bureau Data on Poverty, Income, and Health Insurance, CBPP: ...[T]he new Census data are disquieting. Though 2007 was the sixth (and likely the final) year of an economic expansion, poverty was significantly higher, the median income of non-elderly households significantly lower, and the number and percentage of Americans who are uninsured substantially greater than in 2001 — even though the economy was in recession that year.

This is unprecedented. Never before on record has poverty been higher and median income for working-age households lower at the end of a multi-year economic expansion than at the beginning. The new data add to the mounting evidence that the gains from the 2001-2007 expansion were concentrated among high-income Americans. ...

In addition, the number of children living in poverty jumped by 500,000 to 13.3 million, and the child poverty rate climbed from 17.4 percent in 2006 to 18.0 percent in 2007. There was some welcome news on child health insurance – the number of children lacking health insurance declined in 2007, but it remained 400,000 above the number of children who lacked insurance three years earlier, in 2004.

The data also show that employer-based health coverage — and private health coverage in general — continued to erode in 2007, and that all of the improvement in health care coverage in 2007 was due to more Americans obtaining coverage through government health insurance programs, principally Medicare and Medicaid.

Data for 2008 Expected to Be Unfavorable The data for 2007 are of particular concern given that the economy is now in a slowdown, and poverty is almost certainly higher now — and incomes lower — than in 2007. ... This suggests that significant pain may lie ahead for many Americans. ...

Paul Krugman summarizes the significance of the implications of the Census data:

About that Bush Boom …, by Paul Krugman: The 2007 income, poverty and health insurance numbers are out. As far as I can tell on a first read, there’s nothing deeply surprising. Still, they represent a landmark — and not in a good way.

The key point is that 2007 was the end of an economic expansion — whether or not the NBER declares a recession, the employment situation, which is what matters to most people, has deteriorated sharply this year. So 2007 was as good as it got in this cycle. Yet median household income was lower than in 2000, while both the poverty rate and the percentage of Americans without health insurance were higher.

In short, the economic policies we’ve been following just aren’t working.

Is the bad economic news all Bush’s fault? No, of course not — but remember, the key argument of the right has always been that tax cuts and deregulation would produce good news, a rising tide that raised all boats. Boy, has that not happened.

But remember, we’re just a nation of whiners.

Michael Mandel notes the bad news for recent college graduates:

No Income Gain for Young College Grads, by Michael Mandel: The latest income distribution numbers are out from the Census Bureau. ...

For my part, I’m back to my regular business of being concerned with young college grads—the ones who don’t have advanced degrees. Basically, the last numbers show almost no change between 2006 and 2007 (as the chart below shows). Young college grads still have not made back their losses from the earlier part of the decade. ...

Jared Bernstein at the EPI echoes the above:

Income Picture, by Jared Bernstein: [See also..., Overall health insurance coverage rises, but masks decline in private coverage.] ...While last year’s overall income gains are good news, the longer-range view is quite different. The Census figures show that the economic cycle that began in 2000 and ended late last year was one of the weakest on record for working families, despite strong overall economic growth during the same period (see Table 1 and Figure 1). ...

Looking at the full cycle across economic peak years—a more useful measure in evaluating economic performance—reveals that household income was no higher in 2007 than in 2000, the previous peak. Given rising joblessness and declining real wages, next year’s numbers will certainly be worse. ...

... The economy of course expanded in the 2000s, but that growth clearly failed to reach most households, a dynamic that implicates growing income inequality. ...

Next, Brad DeLong

Barack Obama on the Income-Poverty-Health Release, by Brad DeLong: Statement From Senator Obama on the Census Income, Health Insurance and Poverty Numbers

Today’s news confirms what America’s struggling families already know – that over the past seven years our economy has moved backwards. We have now lived through first so-called economic ‘expansion’ on record where typical families saw their incomes fall, and working-age households lost more than $2,000 from their paychecks. Another 816,000 Americans fell into poverty in 2007 – including nearly 500,000 children – bringing the total increase in Americans in poverty under President Bush to 5.7 million. And on Bush’s watch, an additional 7.2 million Americans have fallen into the ranks of the uninsured. This is the failed record of George Bush’s economic policies that Senator McCain has called ‘great progress.’ While Senator McCain is promising four more years of the failed Bush economic policies, my economic plan will restore bottom up economic growth that benefits all Americans by cutting taxes for working Americans, providing affordable, accessible health care for all, and investing in new energy, education and infrastructure so we can create millions of good jobs here in America,” said Senator Barack Obama.

Highlights from the Census report:

• Between 2000 and 2007, median income for working age households fell by $2,176. When elderly households are included, median income declined by $324 over the same period. This is the first economic expansion on record where typical households have seen their incomes decline. Under the Clinton Administration, median household income increased by $6,200.
• African American household income fell by $1,804 between 2000 and 2007; Hispanic household income fell by $1,256 over the same period...
• An additional 816,000 Americans fell into poverty in 2007, bringing the total increase in Americans in poverty under President Bush to 5.7 million.
• 500,000 children fell into poverty in 2007. There are 1.7 million more children living in poverty than in 2000.
• Between 2000 and 2007, an additional 7.2 million Americans have fallen into the ranks of the uninsured. This is the largest increase in the number of people without health insurance of any Presidential Administration on record.
• The share of Americans with private health coverage fell from 67.9% in 2006 to 67.5% in 2007. This share has fallen every year that President Bush has been in office, declining a total of 5 percentage points since 2000.
• 940,000 African Americans have lost health insurance since 2000, along with 3 million Hispanics

Mathew Yglesias emphasized the importance of the public sector as a health insurance backstop:

Public Sector to the Rescue, by Mathew Yglesias: Today’s Census numbers show a slight downtick in the proportion of Americans who lack health insurance. This, Jonathan Cohn notes, despite a continued decline in the number of people with private sector health insurance. “The reason the overall numbers look good is rising enrollment in public insurance programs, particularly Medicaid.” He also notes that when you peer into the numbers, the state with the largest overall two-year increase in health insurance rates is Massachusetts, which has adopted the most aggressive health care reform agenda of any state and serves as a kinda sorta model for what progressive reform at the federal level — especially something authored by Ted Kennedy — might look like.

And, finally, one more from Brad DeLong

Income and Poverty Over the 2000-2007 Business Cycle, by Brad DeLong: 2000-2007: the first business cycle during which median household income in America falls from peak to peak. ...

http://www.census.gov/prod/2008pubs/p60-235.pdf

It's not all George W. Bush's fault, but I can think of a number of things he did to hurt and not a damned thing he did to help. ...

"The Liberal Hour"

Comments on this?:

The ’60s: Once Upon an Optimistic Time, by Barry Gewen, Book Review, NY Times: ...“The Liberal Hour” by G. Calvin Mackenzie and Robert Weisbrot ... [contends that t]oo many historians who write about the 1960s ... have focused on the decade’s very visible rebellions and disruptions — all that sex, all those drugs, all that rock ’n’ roll.

What is often ignored, they say, is the hard work of little-known politicians and bureaucrats who were methodically creating a ’60s revolution from within. ... Senators and congressmen ... were permanently transforming the country with a tsunami of social and economic legislation.

Granted, it’s more fun to read about Abbie Hoffman than about Edmund Muskie, but ... their overall argument is a valuable corrective to a lot of hackneyed thinking about the significance of the ’60s.

The “liberal hour” lasted only a few years, from 1963 to 1966, from the final days of John F. Kennedy’s presidency through the first three years of Lyndon B. Johnson’s, but in that brief period of time came two civil rights acts...; ...Medicare and Medicaid; pioneering environmental laws; education and immigration bills; stronger protections for consumers; a host of antipoverty programs, including food stamps and Head Start; new federal departments of transportation and housing and urban development; and other reform measures, literally hundreds. Washington hadn’t seen such legislative energy since the New Deal.

If it was poverty and want that drove the New Deal, it was prosperity that provided the momentum for the ’60s, and with it the confidence to take on any challenge. “In the early years of the 1960s,” Mr. Mackenzie and Mr. Weisbrot write, “national optimism reached epidemic levels.” Inspired by Kennedy’s rhetoric and Johnson’s acumen, hundreds of inside-the-Beltway role players set about to change their country and the world. ...

[I]t seemed that liberals would be on top for a very long time..., even a liberal century. Yet their moment quickly passed. ... What happened?

It’s not a question that lends itself to easy answers, but ... they come up with a powerful one: liberal overreaching. During the ’60s liberals were certain they could solve any problem — at home or abroad — with the right expertise, appropriate government policies, the application of reason and gobs of money.

“Do we have or can we develop a knowledge of human social relations that can serve as the basis of rational, ‘engineering’ control?” the eminent sociologist Talcott Parsons asked. “The answer is unequivocally affirmative.” Officials puffed up with a sense of their own omnipotence spoke of a “world New Deal.” Johnson himself exclaimed: “We’re the richest country in the world, the most powerful. We can do it all.”

Such arrogance led directly into the mire and jungles of Vietnam, the prime example of liberal overreaching... Suddenly, Americans were being called upon to make sacrifices, not only of money but also of blood, sacrifices that seemed endless.

It was little better at home. The legislation of the liberal hour was supposed to end poverty, heal racial divisions. Yet all at once, the cities were going up in flames. The primary beneficiaries of liberal largesse, it seemed, were ungrateful for the assistance, while Democratic leaders looked helpless in the face of riots and rising crime. Great Society solutions weren’t working, and so voters turned elsewhere.

“By 1966,” Mr. Mackenzie and Mr. Weisbrot report, “more than half of northern whites had come to believe that government was pushing too fast for integration.”

Johnson had come to grief because, to use Mr. Mackenzie and Mr. Weisbrot’s word, he had “overpromised.” Not every problem had a solution. Reasoning together didn’t work in the urban ghettos or the Mekong Delta. “The Liberal Hour” presents itself as a book about the brilliant legislative legacy of the ’60s, but by the end it has become a book about the legacy of the Johnson administration’s failings....

More optimistic than most of his optimistic countrymen, more confident and overbearing too, Johnson seemed incapable of understanding the virtues of skepticism and caution, the wisdom of pessimism. He never appreciated the limits of good intentions, especially his own. Like many a tragic hero, Johnson was brought down by hubris. And Democrats, Mr. Mackenzie and Mr. Weisbrot tell us, are still paying the price.

Have we just been through a period of "conservative overreaching"? Andrew Samwick quotes Warren Coats on the swing back to the left:

The Death of the Right?: As public sentiment swings back to the left what the public wants (domestically), I think, are largely free but better regulated markets and a better social safety net (health care and pensions). Those like me who think that too much regulation stifles beneficial market innovation and worry about the work incentive stiffing effects of excessive or poorly designed safety nets need to take note of these sentiments. The freedom for me to lead my life largely as I choose and to enjoy the fruits of my labor depends heavily on the willingness of my neighbors (fellow citizens and residents) to accept those rules of the game. Our society functions as it does because of a broad social consensus on the rules of public behavior. This consensus rests in part on each player’s confidence that if he fails there is a safety net that makes it worth his taking the risk of playing. We need to compromise what we consider first best for society (and Republicans and Democrats tend to differ on what this is) to the extent needed to preserve that broad consensus.

He goes on to say:

Congressman Barney Frank, Chairman of the House Financial Services Committee, epitomizes the best of the new left wing reaction to the Reagan Revolution. Frank is fully aware of the virtues of the market ... and the need to get the incentives right, but insists that market excesses and rough edges should be removed with limited and well focused regulation. His collaboration with Republican Treasury Secretary Henry Paulson to fashion a Housing Rescue and Foreclosure Prevention Law enjoyed sufficient bipartisan support to gain the President’s signature on July 30. The bill’s many provisions were generally sensitive to moral hazard problems and market incentives... There were things for both Republicans and Democrats to like and to dislike in this bill.[8]

Frank is a pragmatist who is willing to sacrifice his version of “the best” for “the good.” He sees a major victory for his preference for limited, market friendly regulations in the Federal Reserve’s new rules (Regulation Z – Truth in Lending) to prohibit “unfair, abusive or deceptive home mortgage lending practices.” ... These are not the sentiments of a wild eyed socialist and this is not a return to the heavy handed economic (as apposed to prudential) regulations of the 50s and 60s when government regulated, e.g., capital flows and interest rates on bank deposits. When asked why congress refuses to pass the no brainer free trade treaty with Columbia, which Frank has visited several times, he replied that “it has nothing to do with Columbia, nor the failure to recognize the benefits of trade. No trade liberalization deal will be passed by this Congress until more attention is given to compensating the losers. And don’t forget that today when someone losses their job, they also loss their health insurance.”[12]

For the next few years, maybe even a decade, until the next swing back in the political center, we can expect more regulation and more extensive safety nets. If we collaborate with market friendly Democrats like Frank, we can not only fix some of the genuine deficiencies with existing arrangements, but we can probably prevent some of the worst excesses of the over extension of government, until it is our turn again. ...

Would health care reform guaranteeing universal coverage be considered one of "the worst excesses of the over extension of government"? The "brilliant legislative legacy of the ’60s" produced important programs that are still with us today. If Obama wins the election, I'm not too worried about overreaching, I more worried about Democrats not reaching far enough.

Feldstein: A Tale of Two Monetary Policies

Martin Feldstein says there are good reasons for the difference in monetary policy between the Fed and the ECB, the most important being that unions are stronger in Europe than the US. This means there is a greater chance of a wage-price spiral developing in Europe forcing the ECB to adopt a tougher stance on inflation: 

The crisis: a tale of two monetary policies, by Martin Feldstein, Commentary, Financial Times: The European Central Bank and the Federal Reserve are facing similar problems but pursuing different policies. The ECB has been raising interest rates while the Fed has been cutting them. ... Which central bank is doing the right thing? Or could they both be?

Inflation is a significant problem in both the eurozone and the US... Both economies are also facing declining economic activity with falling employment... The sharp rise in the prices of energy and food ... will undoubtedly spill over into higher prices... The primary challenge for both central banks is to limit this inflationary shock to a one-time pass through, avoiding the ... wage-price spiral that drove inflation rates in the 1970s to double-digit levels. Preventing a repetition of that requires convincing the public that today’s high inflation rate will soon decline.

Despite the similar problems faced by the two central banks, there are important differences that justify their separate strategies. The contrast between the ECB’s mandate to achieve price stability and the Fed’s “dual mandate” to balance the goals of price stability and employment is ... a reflection of fundamental differences between the two economies. Those differences make it more difficult to tame inflation expectations in Europe and therefore require the ECB’s tougher policy.

The role of trade unions is the most important difference. Only 7.5 per cent of US private sector employees are union members... In contrast, more than 25 per cent of employees in the European Union are members of trade unions and in some EU countries the wages set in union contracts are automatically extended to other companies in the same industry.

Because of this union power, the ECB must persuade union members and their leaders that it is determined to bring inflation down to its target level... The ECB’s tough stance and exclusive emphasis on price stability is crucial to shifting inflation expectations and persuading unions to accept the rise in food and energy prices without pressing for offsetting wage gains.

In contrast, the Fed does not have to worry in the same way about union power... Wage setting is decentralised and wage contracts do not have the formal links of wages to inflation that intensified the wage-price spiral of the 1970s.

Differences in the inflation histories also influence today’s appropriate policies of the ECB and the Fed. Although Americans remember the double-digit inflation of the late 1970s and early 1980s, there has been no US experience similar to the earlier hyperinflations in Germany and other EU countries. The ECB pursues a tough inflation target policy to persuade Europeans that there is not even a small probability of returning to those conditions.

Finally, the ECB recognises that it is still a very young institution that must prove ... that it will follow the successful anti-inflation tradition of the German Bundesbank. ... The ECB is only now facing its first challenge of imported high inflation...

The power of Europe’s unions, its history of hyperinflation and the need to develop credibility for a young institution all justify the ECB’s tough stance. Because the Fed does not have these problems but faces a potentially serious recession, it is prepared to gamble that the weakness in US employment and the general decline in economic activity will prevent a wage-price spiral without further increases in the interest rate. ... I think the Fed’s current interest rate strategy makes sense but would be too risky for the ECB.

There's another hypothesis that says the reason the ECB is able to focus more on inflation is because of the stronger social safety net that is in place in Europe relative to the US. With a stronger social safety net, variations in employment are less costly and that allows more focus on inflation.

I don't think either explanation gets at the essential reason for the difference in strategies among central banks with some more committed to inflation fighting than others, at least in their official pronouncements.

If you look at the history of who adopted inflation targets first, you will see that the order was New Zealand, Chile, Canada, UK, Sweden, Australia, Norway, Brazil, Hungary, Poland, Mexico, and the Czech Republic (I may not have the order exactly right, source), and the move to inflation targets was largely driven by a desire for more central bank independence. When monetary policy is in the hands of elected officials, the result tends to be high rates of inflation. There is a tendency for elected officials to print new money to pay for government spending rather than using politically more explosive means such as increasing in taxes, cutting spending, or increasing government debt, and this leads to high rates of inflation. Moving from government control over the money supply to an independent central bank dedicated to long-term objectives is a way to solve this problem, but there is a need for the new institution to be credible. That's where explicit inflation targets come in. They are a transparent way of committing to a target, and this allows the credibility of the monetary authority to be easily assessed.

There may be a correlation between high degrees of unionization and highly interventionist governments that is driven by societal preferences for, say, a strong social safety net for workers. And highly interventionist governments may, if they can get their hands on monetary policy, tend to be inflationary. But it's not the unions that are the problem, the problem is the lack of an independent monetary authority and lack of commitment (or lack of ability to commit) to long-run price stability goals. Countries that have moved to a more independent central bank with transparent inflation goals have experienced lower inflation rates even when they have high degrees of unionization. It was the desire for an independent monetary authority and the need to establish credibility that led to the difference in emphasis on inflation and output between the US, which already had a relatively independent and credible central bank, and other central banks around the world.

Finally, it is misleading, I think, to characterize the ECB as strict inflation targeters, "inflation nutters" to use Mervyn King's term for it. Output targets remain important. First, in the short-run, inflation targeting central banks will allow inflation to move outside the target range if they are worried about weakness in output and employment. Second, an inflation target above zero, say 2%, recognizes the potentially destructive effect of deflation on output (a reason why many people have urged the Bank of Japan to adopt an inflation target above zero - deflation has been a problem for the Japanese economy). Thus, output is clearly part of the central banks' objective function. Third, well, let me quote Bernanke:

Several authors have made the distinction between so-called "strict" inflation targeting, in which the only objective of the central bank is price stability, and "flexible" inflation targeting, which allows attention to output and employment as well. In the early days of inflation targeting, this distinction may have been a useful one, as a number of inflation-targeting central banks talked the language of strict inflation targeting and one or two came close to actually practicing it. For quite a few years now, however, strict inflation targeting has been without significant practical relevance. In particular, I am not aware of any real-world central bank (the language of its mandate notwithstanding) that does not treat the stabilization of employment and output as an important policy objective. ... Moreover, virtually all (I am tempted to say "all") recent research on inflation targeting takes for granted that stabilization of output and employment is an important policy objective of the central bank. In short, in both theory and practice, today all inflation targeting is of the flexible variety.

I don't disagree that unions can magnify inflation pressures and give inflation more inertia, but the answer to the inflation problem is an independent, credible central bank. Without that, inflation is likely to be a problem whether strong unions are present or not.

"Commercial Banks, River Banks, and Moral Hazard"

Jeff Frankel:

Commercial Banks, River Banks, and Moral Hazard, Jeff Frankel: Quite a few economists are worried about moral hazard in financial markets. ...

Of course moral hazard is a serious problem that lies close to the heart of the financial market crises. But I am not sure that I completely share the priority at this point on drawing a tougher line with the ex post bailouts. It may be futile advice. Fixing the hole in the roof when it is raining is, after all, rather difficult.

Consider two other areas where moral hazard is an issue: commercial banks and river banks. Some economists would prefer that the government refrain from helping the victims of banking panics and river floods, respectively. The worry is that if those who overlend or overbuild do not bear the full costs of their mistakes, they will have no incentive to be more careful in the future.

But I think we figured out some time ago that in practice no democratic government will ever ex post turn its back on poor shivering families who appear on TV huddled in front of the ruins of their flooded out homes (or banks). It is wiser that we recognize this fact, and design a regulatory system that explicitly incorporates mandatory federal flood insurance and deposit insurance, and charges for them up front. We already do this for commercial banks. To me, the lesson of recent months is that we need to do it for a wider range of financial institutions. ...

Beyond helping flooded out homeowners, as with Bear Stearns, if there was ever a natural disaster costly enough to threaten the health of the insurance industry and the financial system more generally, I suspect the government would step in with a bailout for insurance companies. We can argue that the insurance companies never should have written such risky policies, but having a dysfunctional insurance industry would be stifling.

Some risks are too large for the private sector to carry on its own, when very large shocks hit the private sector may not be able to fully absorb them, and we rely upon and expect government to step in when shocks are so large that they endanger the overall economy. The government can and should act as insurer of last resort when the health of the economy is threatened, it really has no choice, and because of that regulation will be needed to, as much as possible, limit the the chance that the impact from a shock will require the government to intervene.

Medicare Privatization and Health Care Costs

Alex Tabarrok wonders what you will think about this. I don't have the institutional details I need to comment, and time is short this morning, so I'll leave it to all of you to to analyze the claim made below that Medicare Advantage programs do not cost more than traditional Medicare programs. But there doesn't seem to be any evidence here that Medicare Advantage programs cut health care costs to any significant degree - the main concern in health care reform - nor is it clear how the program will solve the adverse selection problems. As Krugman, one of the targets of Alex's post, says, "a ... private system ... has never worked for the elderly, for whom adverse selection issues are especially acute." Alex argues that adverse selection is unimportant in these markets, but that runs counter to the general view of how these markets operate:

Democrats Proudly Cut Medicare Benefits, by Alex Tabarrok: Last week Congress cut benefits to Medicare recipients and liberal pundits applauded. Indeed, Paul Krugman said this was "Kennedy's Big Day" and "the first major health care victory that Democrats have won in a long time." Of course, Krugman and the others who applauded this "victory" didn't say that they were cutting Medicare benefits - even though that is exactly what they were doing - instead they framed the victory as one over privatization and waste. Here's the story.

Medicare beneficiaries can enroll in Medicare's fee for service plan or they can choose Medicare Advantage joining, for example, an HMO. In the latter case, Medicare pays the HMO a rate per enrollee and the HMO competes to obtain enrollees by offering them a package of benefits and premiums.

Now what you will be told about Medicare Advantage is that it is more expensive than traditional Medicare. Thus the CommonWealth Fund says:

Private Medicare Advantage (MA) plans were paid an average 12.4% more per enrollee in 2005 compared with what the same enrollees would have cost in the traditional Medicare fee-for-service program...

That much is true. But why are MA programs more expensive? The answer, which one gets by innuendo and implication, is that Medicare Advantage programs are wasteful and the extra money is being pocketed by corporations. ...

Thus the message is that traditional Medicare is cheaper because it eliminates the middleman, doesn't involve private corporations, and is more efficient at lowering costs. None of this is true. ...

Here is how the MA program pays a private provider (quoting the CBO).

Private plans that want to participate in the Medicare Advantage program must submit bids indicating the per capita payment for which they are willing to provide Medicare’s Part A (Hospital Insurance) and Part B (Supplementary Medical Insurance) benefits—and to take on the financial risk of doing so.

The government compares those bids with county level benchmarks that are determined in advance through statutory rules. The benchmarks are the maximum payment the government will make for enrollees in private plans; in most cases the plans’ bids (and the resulting payments) are lower than the benchmarks....

If a plan’s bid is less than the benchmark, Medicare pays the plan its bid plus 75 percent of the amount by which the benchmark exceeds the bid.

So far you might think that Krugman et al. have a point. If the benchmarks are set too high and Medicare pays the plan its bid plus 75% of the amount by which the benchmark exceeds the bid then the plans could bid their costs and get extra payments. ...[H]ere is the kicker (quoting the OMB again, italics added):

If a plan’s bid is less than the benchmark, Medicare pays the plan its bid plus 75 percent of the amount by which the benchmark exceeds the bid. Such a plan must return that 75 percent to beneficiaries as additional benefits or as a rebate of their Part B or Part D premiums.

Now the solution to our puzzle becomes clear. Why do beneficiaries choose MA plans?

...because such plans provide additional benefits beyond those available within traditional Medicare, including coverage for services not covered by FFS Medicare (for instance, dental services) and cash rebates of premiums or reduced cost-sharing.

In fact, the OMB estimates that the vast bulk of the increased payments to private providers flow to enrollees who get better benefits and lower payments. Indeed, in the case of HMOs enrollees benefit twice - first because the benchmarks are higher and second because, contra Krugman et al., the HMOs actually have lower costs than traditional Medicare! Thus the OMB writes:

In contrast, payments to HMOs averaged 10 percent above FFS costs...On average, HMOs offered extra benefits and rebates equal to 13 percent of FFS costs; those additional benefits and rebates reflected the difference between the benchmark (which averaged 10 percent above FFS costs) and the plans’ bids (which averaged 3 percent below FFS costs).

That could be written more clearly but what they are saying is that Medicare pays HMOs 10 percent more than they would pay for an enrollee in traditional Medicare but the HMOs offer the enrollee 13 percent more worth of extra benefits and rebates. In other words, the HMOs pass on to the enrollee all of Medicare's "extra payments" plus some. ...

Now, I am not saying that higher Medicare payments are a good idea. But I dislike the fact that politicians are being lauded for fighting "wasteful privatization" when what they are really doing is cutting medical benefits for the elderly.

"'Means Testing, for Medicare"

Tyler Cowen:

Means Testing, for Medicare, by Tyler Cowen, Economic View, NY Times: Right now, ... pressing problems may lie ahead — and the presidential candidates aren’t addressing them.

No matter who sits in the Oval Office next year, there won’t be many degrees of freedom in the federal budget. That’s because spending on entitlement programs is largely locked into place, and the situation will become much worse as Americans age and health care costs rise. ... The main problem is Medicare, which reimburses the elderly for many of their health care expenses. ...

There’s one important idea lurking in the shadows that neither campaign is keen to talk about: paying out government benefits more efficiently. To put it bluntly, it means paying out full benefits only to those who really need them, and cutting back on payments to everybody else. ...

"These Job Losses are Good News"

Nicholas Crafts says Europe would be better off "if the dark side of productivity improvement implied by creative destruction – exit of established producers and re-deployment of labour – were accepted and facilitated." He also wishes that "ministers could bring themselves to think (better still occasionally to say) 'these job losses are good news.'"

Sorry, but job losses aren't good news. Structural change may require it, and we may be better off when the process is complete, but cheering the job losses themselves is heartless.

As for the more general question of whether Europe needs fixing, what do those of you who live there think? I like a "flexicurity" type approach which is, I suppose, a process of creative destruction that recognizes job losses are bad news, and tries to do something about it without interfering with the creative process:

Want faster European growth? Learn to love creative destruction, by Nicholas Crafts, Vox EU: Paul Krugman once observed that 3% per year is about as good as it gets for GDP growth in advanced economies. While the United States has achieved this since 1995, the EU15 have fallen well short – averaging only 2.3%.

The real European problem is in sluggish labour productivity growth - over the same period it averaged 1.4% per year compared with 2.1% in the United States, so that Europe has been falling behind rather than catching up during the last decade, in contrast with the whole of the post-war period until the mid-1990s.¹ There is, of course, huge variation around this European average, from Irish labour productivity growing at 3.7% down to Spanish labour productivity growth of -0.2%.

Two further aspects of comparative productivity growth should be flagged:

• Weak European performance compared with United States is characterised by a shortfall in TFP growth rather than in capital deepening.
• As analysis of the EUKLEMS dataset by Bart van Ark and his colleagues has revealed, market services are the key problem area, notably, but not only, in information technology-intensive sectors such as distribution (van Ark, O'Mahony, and Timmer 2008).

Again, the variation in the contribution from labour productivity growth in the service sector is considerable, from 1.6% per year in United Kingdom to -0.1% in Italy during 1995 to 2004.

Policy concerns

Understanding the policy implications of comparative growth outcomes requires an appropriate model. The most suitable is the Schumpeterian framework developed by Philippe Aghion and Peter Howitt.² This places innovation and, indeed, creative destruction at the heart of the growth process and views these as determined endogenously by incentive structures.