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Brooks Wilson's Economics Blog: 2011

Tuesday, November 22, 2011

France and Social Welfare Programs

Voters in democratic societies like benefits and don’t like taxes.  The French confront a growing national debt caused by large social programs, the financial crisis, and the European debt crisis.  Voters have protested at the suggestion of cuts in benefits and taxes are high.  Proposals for tax increases are modest and are probably regressive (“Analysis: France needs tough reforms to halt debt spike”).  Like other countries in Europe that we call social welfare states, France has a tax structure that is less progressive than the United State’s tax structure (Piketty and Saez “How Progressive is the U.S. Federal Tax System? A Historical and International Perspective,” Journal of Economic Perspectives, Volume 21, Number 1, Winter 2007).  Piketty and Saez write      

During most of the postwar period, income tax progressivity has been substantially greater in Anglo-Saxon countries than in France and most other continental European less in France than in the United Kingdom or the United States. For example, the top .01 percent of the distribution paid 75 percent of income in taxes in the United States in 1970 and over 90 percent of income in taxes in the United Kingdom; but only 49 percent of this group’s total income went to taxes in France. During most of the postwar period, income tax progressivity has been substantially greater in Anglo-Saxon countries than in France and most other continental European countries. For example, Dell (2006) presents an analysis of Germany, which appears fairly close to France.

This pattern illustrates a general point made by Lindert (2004): countries in which government spending is a fairly high share of GDP have always relied on a mix of taxes that create relatively low distortion, with less progressivity, large exemptions for capital income, and so on. Meanwhile, Anglo-Saxon countries in which government spending is a relatively low share of GDP have historically relied on more progressive taxes.

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Thursday, November 17, 2011

NBPA and Kevin Murphy

Steve Aschburner does an excellent job interviewing Kevin Murphy, an economist from the University of Chicago who has been hired to advise the National Basketball Players Association (“Renowned economist Murphy lends smarts to NBPA's cause”).  I wonder how many hours he prepared for the interview and if in part that preparation was motivated by the fear of sounding foolish by asking a world class economist bad questions.

How good is Murphy?  Aschburner quotes Steve Levitt, a John Bates Clark Award winner and the author of Freakonomics who said

Kevin is far and away the smartest guy in the field.  Not only is he widely regarded as the smartest economist on Earth, but he can also fix your refrigerator.

If you are a fan of the NBA and economics you should read the entire article but I have included an answer to one question as a teaser. Where do you see this landing?

KM: Ultimately what it comes down to is, you get what you can negotiate. It's not what you deserve, what's "right," that ends up carrying the day. But then they ought to be straight up. They ought to say, "We've got the ability to negotiate. We'll hold your feet to the fire and get what we can."

The one thing I don't want to see happen: I don't want to see any lingering bad blood between the two sides. That's not good either. You run the risk that, if it gets too personal, that creates its own set of frictions going forward. I think people on both sides are cognizant of that.

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Thursday, November 10, 2011

The Obama Administration’s Pipeline Punt

The Obama administration is scheduled to announce a decision to approve or deny the $7 billion Keystone XL project, a oil pipeline that would ship oil from Canada’s tar sands to refineries in Texas.  Environmentalists, a key Obama constituency, oppose the pipeline in general because it ships oil and specifically because oil from tar sands which generate more carbon in production and refining than other oil.  Labor unions that would build the pipeline, another key Obama constituency, favor that project. 

Reuters and the AP report that rather than fish or cut bait, the administration has decided to punt by exploring a new route for the pipeline.  The review process would push the pipeline decision past next year’s presidential election.  Many view the delay as a win for environmentalists (“Exclusive: U.S. to seek new Keystone route, delaying approval” or “State Department Delays Oil Pipeline From Canada, Orders Developer to Reroute”).

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Friday, November 4, 2011

Cuba’s Long Road to Capitalism

A few communist era jokes from behind the Iron Curtain touch on the nature of communism.  A polish worker observes, “We pretend to work and the communist pretend to pay us.”  A Soviet economist opines that “communism is the slowest, most painful road to capitalism. 

Mankiw’s sixth principle of economics reads, “Markets are usually a good way to organize economic activity.”

According to an AP article (Cuba legalizes sale, purchase of private property) written by Paul Haven.  The economy has not thrived under communist rule.  Eighty percent of workers are employed by the government.  The workers are paid $20 per month and receive free but bad medical care, transportation, and education. 

The housing sector provides an example how bad property rights destroy wealth. Shortly after the revolution in 1959, Castro gave title to those living in an apartment or house but not the right to sell it.  People are mobile but buildings are not.  Without the right to sell, and with few incentives to improve property, the quality of buildings deteriorated.  Complex barter transactions and black markets based on extralegal property rights developed that returned some degree of mobility. 

Those interested in the Cuban economy should read Arch Ritter’s blog, “The Cuban Economy La Economia Cubana.”

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Thursday, November 3, 2011

Sowell on Greed

Economics teaches that self-interest is a great motivator and, within a market setting, is good for society.  Thomas Sowell provides good argument on the insignificance of greed within markets (Democracy Versus Mob Rule).  The mob he refers to are the occupiers but the sloppy use of “greed” is pervasive.

Among the favorite sloppy words used by the shrill mobs in the streets is "Wall Street greed." But even if you think people in Wall Street, or anywhere else, are making more money than they deserve, "greed" is no explanation whatever.

"Greed" says how much you want. But you can become the greediest person on earth and that will not increase your pay in the slightest. It is what other people pay you that increases your income.

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Tuesday, November 1, 2011

Bankruptcy and Home Loan Defaults

Balance that must exist between households and firms if markets are to function well.  I often use the market for consumer loans to demonstrate what many students initially find counterintuitive.  Consumers allow banks to take collateral to facilitate lending and banks support bankruptcy to facilitate borrowing.

This does not mean that laws support the correct balance between consumers and banks. In an American Economic Journal, Economic Policy article,  Li, White, and Zhu offer evidence supporting the hypothesis that 2005 bankruptcy reform that made it more difficult to write off debt through bankruptcy increased defaults on home loans after the housing bubble burst.  Their abstract reads

Homeowners in financial distress can use bankruptcy to avoid defaulting on their mortgages, since filing loosens their budget constraints.  But the 2005 bankruptcy reform made bankruptcy less favorable to homeowners and therefore caused mortgage defaults to rise. We test this relationship and find that the reform caused prime and subprime mortgage default rates to rise by 23% and 14%, respectively. Default rates rose even more for homeowners who were particularly negatively affected by the reform. We calculate that bankruptcy reform caused mortgage default rates to rise by one percentage point even before the start of the financial crisis.

It is interesting to note that banks were supporting laws making it harder to declare bankruptcy as they were lowering lending standards. 

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Epstein on Inequality

(HT Cafe Hayek) Paul Sloman of PBS interviews Richard Epstein on the benefits of income inequality. Epstein, who studies the effects of law on economic outcomes gives a remarkable libertarian defense of inequality.
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Monday, October 24, 2011

Milton Friedman and Illegal Immigration

Circa 1976, Milton Friedman takes on the issue of illegal immigration and comes to the startling conclusion that it is good so long as it remains illegal.

As the debate has morfed over time, opponents to illegal immigration argue that these immigrants rely more heavily on government resources, particularly education and medical care, than the population as a whole.  The argument continues that the costs of illegal immigration dwarf the benefits.  If I could bring Milton down from the heavenly hosts, I would ask him to elaborate on these new arguments.

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Saturday, October 15, 2011

The Demise of Community Living Assistance Services and Supports

(HT Drudge Report) Ricardo Alonso-Zaldivar wrote a interesting article that describes how and why the Obama administration abandoned a part of health care reform that provides long-term nursing care including but not limited to nursing homes, home health aides for the disabled, etc.  The insurance plan (CLASS: Community Living Assistance Services and Supports) was to be open to working adults regardless of preexisting conditions. 

Insurance policies are inexpensive when the pool of insured consists a representative sample of society with the typical person facing a small probability of incurring the event such as a fire for a home, or an accident for a car that would result in a claim against the pool’s fund.  Those with the greatest probability of needing the insurance will try to populate the pool.  This problem is known as adverse selection.  One method that insurance companies use to protect their profits and the cost of insurance for others in the pool is by eliminating those with preexisting conditions like a bad driving record or ill health. 

The problem with CLASS was in the selection of the pool.  The program was intended resolve the catch-22 facing those in need of long-term nursing care.  They did not have the money to purchase the services and insurance companies would not provide funding for care of those with preexisting conditions.  The young and healthy were to fund the self-sustaining as young, health workers insured themselves against possible long-term care needs and paid for older workers who had those needs.  The Obama administration learned that eliminating people with preexisting conditions was not just a way to raise insurance company profits but a necessary means to establish an insurance pool.  It is a market mechanism for rationing goods and services. 

Health and Human Services Secretary Kathleen Sebelius acknowledged that the service cannot be provided with self-sustaining funding.  Alonso-Zaldivar quotes officials who estimate premiums from $235 to $391, with some estimates as high as $3,000 per month. 

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Friday, October 7, 2011

Economists' on Immigration

As best I can tell, economists favor increased immigration by a large margin. Nick Schulz, an author of "From Poverty to Prosperity” makes an economic pitch for immigration that illustrates typical economic thought in “Yes, There Is Such Thing As A Free Lunch: It’s Called Immigration.”
Kick open the nation’s doors to high-skilled immigrants. There isn’t a bigger no-brainer move than this…
Put aside concerns about low-skilled immigration for a moment. There is wide consensus among those who have studied the issue that skilled immigrants are a net positive for the receiving country.
As Barry Chiswick, the editor of “High-Skilled Immigration in a Global Labor Market” and one of America’s deans of immigration research, notes, “ High-skilled immigrants expand the productive potential of the economy in which they reside, thereby increasing the growth rate of total-factor productivity [technology for principles students]. High-skilled immigration to the United States, therefore, enhances the international competitiveness of the U.S. economy and attracts foreign capital to the country. High-skilled immigration adds workers to the labor force who tend to pay more in taxes than they receive in public benefits… As a result, they tend to have a positive net fiscal balance.”
Immigration of high-skilled labor can be depicted using a simple supply and demand model familiar to principles students.  The first graph depicts the supply and demand for laborers with a BA degree in genetics.  The normal disclaimer applies.  I have no idea how many geneticists with BA degrees are hired nor do I know their monthly salary.  Equilibrium occurs at a monthly salary of $3,600 with 89,760 geneticists employed.

The supply of geneticists is a function of the wage, the number of native born workers (N) and the number of foreign born workers (F) [Q=S(W, N, F)].  As immigration of foreign born geneticists increases, supply shifts outward (from S0 to S1 in the second graph), and the wage decreases to $3,500 per month. 

Many Americans fear that immigration will lower wages stop their analysis here, but this excludes perhaps the most important change, the change in demand.  The demand for geneticists is a function of the wage and technology, and, in turn, technology is a function of the number of native born and foreign born workers [Q=D(W, Tc(L(N, F))]. 
Technology advances with the interaction of high-skilled laborers, the more laborers, native or foreign born, the more interactions between these high valued workers, the greater the technological advance.  As technology advances, the demand curve for geneticists increases in the third graph.  The new equilibrium wage is $4,000.  Because the market is in equilibrium, any geneticist who wishes to work at $4,000 will be employed and the number of geneticists employed increases.  Firms hiring geneticists are better off as well because the burst of creativity achieved by the greater interaction between geneticists allows them to produced new and varied products.  Consumers are better off as well as they have a wider variety of products to buy. 
Students who wish to disagree with my analysis may want to examine the relative shifts in the supply and demand curves. 

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The Keystone XL Pipeline

Tim Devaney who writes for the Washington Times in “White House feels pressure on oil pipeline” describes an impasse at the White House on the construction of an oil pipeline from Alberta, Canada to Texas.

The State Department’s support of a controversial oil-pipeline project is putting pressure on the White House to move forward after three years, despite objections from environmentalists.

A series of public hearings concludes Friday on the Keystone XL pipeline, which would run from Canada’s oil sands in Alberta down through America’s midsection to the Texas Gulf Coast.

So far, the State Department has published reports in favor of the project, which is projected to create 20,000 jobs and reduce the nation’s dependence on overseas oil.

Still, it isn’t an easy decision for the Obama administration because it doesn’t want to disappoint its environmental supporters, who are opposed to the project. The president is expected to make a decision by the end of the year.

Students who comment on this article can take the State Department’s or environmentalists’ position.  The production possibilities frontier or supply and demand models could guide critical thinking.

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Friday, September 30, 2011

Some Consequences of Government Rationing

In “Rationing Health Care” and “More on Rationing Health Care” I describe why employer provided health care how employer provided health care was created as a response to the price and wage controls imposed during WWII.  Employers could not raise wages but the government permitted them to offer health care benefits to employees in addition to wages.  New laws made health care expense deductible for the employers and did not count the health care benefits as taxable income for the employees.  Because health care payments paid with the employees wages were taxable, both the employer and the employee had a financial motive to push more medical employee paid health care expenses onto the group plan paid by the employer.

The law created a tragedy of the commons and the common resource was the group plan.  Health care is over consumed because the employees have no incentive to control expenditures but all pay for the increasing costs because the cost of the group plan has increased.  There are basically two ways to control rising costs.  Employees must be again be exposed to market prices or the employer through the group provider must ration health care.

Medicare and Medicaid have created similar tragedies of the commons.  The elderly and the poor get benefits paid for largely by taxpayers, and consequently have little incentive to control consumption.  President Obama’s health care reform would ration health care benefits through expert committees.  A couple of articles describe the impact of government rationing in the Tennessee and the United Kingdom (“Patients to wait longer for care under new health law, think tank says,” “Cataracts, hips, knees and tonsils: NHS begins rationing operations”).

In Tennessee, approximately 700,000 citizens will gain health coverage (demand expands from D0 to D1), most will be younger men with low incomes who will become eligible for Medicaid.  The remainder are people who qualify for subsidies to buy insurance though newly created state health exchanges.  As demand expands without a corresponding increase in health care providers, the price of health care increases as does the quantity of health care provided (the increase in demand has caused a change in quantity demanded along the original supply curve and equilibrium has shifted from A to B).  More health care will be demanded at a higher price.  Somebody has to pay.  Sources cited in the article suggest that taxpayers and healthy young adults that do not qualify for subsidies will subsidize the poor and infirm. 

The second article explains that the National Health Service will ration hip replacements, cataract surgery and tonsil removal as well as other operations to control burgeoning budgets. 

Society cannot afford to provide all the health care that people desire.  As health care becomes more effective and more expensive, people will not be able to afford all beneficial care.  Public payment for health care has or will hit the same ceiling.  We as individuals or collectively cannot afford everything we want.  Resources are scarce.  It seems cruel to force a dying person to examine their financial records to determine if they wish to spend their remaining wealth on a procedure that might be effective.  Many will not have the resources to pay.   It also seems cruel to tell a dying patient that she does not meet the cost benefit criteria for a procedure that might extend her life.

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Saturday, September 24, 2011

The Market Structure of the NCAA

As I prepare to watch the Men of Troy take on the Sun Devils, I reflect on a broad based misunderstanding of the economics of college sports expressed by most fans including my students.  We love the product and perhaps this affection causes us to accept the way that product is brought to market.  My analysis will be descriptive rather than numerical.  Examples are taken from Huma and Staurowsky, "The Price of Poverty in Big Time College Sport.” 

The NCAA is a monopoly producer of college athletics.  It is probably a complement to both the NFL and the NBA meaning that as a fan consumes more NCAA sports he or she is more likely to consume NFL or NBA sports as well.  The NCAA is big business and highly professional organization.  In 2008, more than 100 million people attended a college sporting event.  Broadcasting contracts are in the billions of dollars.  CBS and Turner Sports will pay $10.8 billion over 14 years to broadcast NCAA division I men’s college basketball. 

The NCAA is virtually a monopsony buyer of 18 to 24 year-old football and basketball players.  Although estimates vary, college football and basketball would be paid in excess of $150,000 annually.  Top players would be paid more than $1 million annually.  My guess is that most players will never command such a value in their “professional” careers if they are not drafted into the NFL or NBA and I am somewhat mystified by suggestions that such valuable employees are somehow “amateurs” when their value over a four year period greatly exceeds the median household income.

They are amateurs only because the NCAA has branded them as amateurs to suppress their wages.  Michael Rosenberg reports the following conversation with former NCAA President Myles Brand.  Brand begins

They can’t be paid.


Because they’re amateurs.

What makes them amateurs?

Well, they can’t be paid.

Why not?

Because they’re amateurs.

Who decided they are amateurs?

We did.


Because we don’t pay them.

Their wages (the scholarship money) fall short of covering college related expenses by approximately $3,222 and more than 85 percent live below the poverty line of $10,890 for a single individual.  The NCAA recognizes the penury the scholarship system produces advising students on the acceptability of food stamps, forcing taxpayers to subsidize a multibillion dollar industry.

Food Stamps.  A grant-in-aid recipient who lives and eats off campus may use the money provided for his or her board to obtain governmental food stamps, provided the stamps are available to the student body in general.  Additionally, the student-athlete must be eligible for such stamps without any special arrangements on the part of athletics department personnel or representatives of the institution’s athletics interest. 

NCAA rules make it difficult to take advantage of the educational opportunity that scholarships are claimed to provide.  In 1973, the NCAA changed scholarships from four year contracts to one year renewable contracts.  If you do not live up to your expected athletic value, it’s one and done.  The NCAA surrendered basketball game scheduling to television broadcasters for larger television contracts.  Broadcasters predictably spread games throughout the week reducing time that athletes could spend in class.  The NCAA rules limit practices to 20 hours per week during the relevant playing season but allow “voluntary” practices.  Athletes who do not attend these practices are not physically ready to play and are frequently dropped from teams.  The average football and basketball player works over 40 hours per week.  Given the rigors of athletic training, it is amazing the graduation rates of a little less than 50% are not lower. 

I believe that colleges should bid for athletes just as the bid for faculty staff and students but Huma and Staurowsky make a more modest proposal that would dramatically improve the welfare of students.  I believe that their most important recommendations are

1. Support legislation that will allow universities to fully fund their athletes’ educational opportunities with scholarships that fully cover the full cost of attendance.

2.  Lift restrictions on all college athlete’s commercial opportunities by allowing the Olympic amateur model.  The Olympics’ international definition of amateurism permits amateur athletes access to the commercial free market.  They are free to secure endorsement deals, get paid for signing autographs, etc.

3.  Promote the adoption of legislation that will allow revenue-producing athletes to receive a portion of new revenues that can be placed in an educational lockbox, a trust fund to be accessed to assist in or upon the completion of their college degree.   

As a reminder, students are free to disagree with my normative values.  Students who wish to disagree the ideas expressed in this post may start with my characterization of NCAA sports as a monopoly and a monopsony.  They may also believe that NCAA sports products are a substitute for rather than a complement of the NFL and NBA.

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Tuesday, September 20, 2011

A Natural Experiment

Since the end of the Jim Crow era, elected officials have attempted to mitigate poverty and racial inequality.  A slew of policies poured money into programs designed to improve educational achievement of poor minority urbanites.  Measuring the success of different programs is challenging.  In Triumph of the City: How Our Greatest Invention Makes Us Richer, Smarter, Greener, Healthier, and Happier, Edward Glaeser describes how Will Dobbie and Roland Fryer (“Are High-Quality Schools Enough to Close the Achievement Gap? Evidence from a Bold Social Experiment in Harlem”) cleverly used data to measure the success of the Promise Academy in Harlem.  I divide two of Glaeser’s paragraphs into three parts: the first explaining the school and available data, the second, how Fryer organized the data, and third, the conclusions he reached.  If, after reading his the section about the problem and data, you figure out how he organized the data, perhaps you too can be a Harvard economist.

In 2004, as New York began to allow more experimentation in its schools, the Harlem Children’s Zone opened its own charter school, the Promise Academy.  The school’s curriculum is intense, requiring long hours from its students, and it offers financial incentives for success.  The school’s leaders worked aggressively to lure the best teachers available, and the academy fired almost 50 percent of its teachers in its first year.  Entrance into the school is determined by lottery…

Dobbie and Fryer organized data.

, which led my colleague Roland Fryer to perform a true natural experiment comparing similar lottery winners and losers. 

Dobbie and Fryer found

…that the school had strong, positive effects on its students: the Promise Academy eliminated the block-white achievement gap in mathematics.  The teachers had particular success with boys, which is unusual and remarkable.

The Harlem Children’s Zone proves that investing in segregated areas can work, as long as that investment targets children, not stadiums or monorails. 

While writing this post, I learned from Greg Mankiw’s Blog that Fryer was named as a recipient of this year’s MacArthur Foundation fellowships.  The award includes a $500,000 grant to conduct research that follows his natural interests (“Three named MacArthur Fellows”). 

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Friday, September 16, 2011

So Close and Yet So Far

In another gaming story, Elida Betancourt’s emotions ran the gamut from ecstasy to depression, and she burst into tears as she matched her lottery ticket numbers one by one to those reported by the Fresno Bee as the winning numbers to a $54 jackpot only then to learn that the newspaper reported the wrong numbers.  She is threatening to sue.

I would be angry too, but does she have a case?

Error ilusiona a mujer con ganar lotería

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When a Win Is Not a Win

Last Saturday, USC welcomed Utah into the Pac-12 with a victory that frustrated SC fans.  The Utes kept the game close by recovering 3 turnovers while losing 1.  One the last play of the game, Utah attempted a 41-yard field goal that was blocked by USC lineman Matt Kalil and returned by Torin Harris for a touchdown.  USC players rushed onto the field drawing an excessive celebration penalty, and apparently disallowing the touchdown.  For the next two hours, the score was given as USC 17, Utah 14.  The betting line in Las Vegas favored USC by 8.5 points.  SC failed to cover but that is wee the story begins because in Vegas a win is not a win.

Two hours after the game ended, the Pac-12 announced that a miscommunication between the press box and the officials caused an error in reporting the score.  Excessive celebration is a dead ball foul that is automatically declined by rule at the end of a game.  The final score was 23 to 14 and SC did cover. 

The casinos, who took in about $500,000 in bets mostly on Utah, were prepared.  They have house rules on bets for just such circumstances and the rules between casinos are different.  Some casinos pay based on the score reported at the end of the game.  They paid betters that took Utah.  Those who took SC and gave the points were not happy.  Other casinos pay according to the official score.  These casinos initially paid betters who took Utah but switched to paying out SC betters after the score was correctly reported.  At these casinos, betters were happy and the casinos took a bath.  Betters who, thinking that they had losing tickets, destroyed their tickets are hopping mad.   

Some unhappy betters who took SC and gave the points complained to the Nevada Gaming Commission.  Should the Commission establish rules of the (betting) game?  Should the Pac-12 or the NCAA establish reporting rules that better mesh with the gaming industry?

See also “Too late to bet on USC-Utah?” and “USC-Utah scoring change creates stir.”

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Thursday, September 15, 2011

Mankiw, Krugman, Barro and Causation

Economists develop models that imply causation and test them with statistics that measure correlation.  As everybody with statistical training knows, including economists, correlation does not imply causation.  It is an easy mistake to make and in a blog post Greg Mankiw argues that Paul Krugman falls victim to this error in his critique of an article by Robert Barro.  

The problem that Paul glosses over is that correlation does not imply causation.  Paul appears to jump to the conclusion that this correlation establishes that the business cycle is the driving force behind investment spending.  But it could just as easily be the opposite (or a third factor driving both).  I am completely confused as to why Paul thinks this graph establishes much of anything at all.

The points of this post are that causation is difficult to establish and that economists expend a great deal of energy at it.

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Tuesday, September 13, 2011

A graphic from a reader Recession Proof - 10 Hot Careers
Created by: Online Graduate Programs
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Glaeser on Earnings Gap

I read the following paragraph in Triumph of the City by Edward Glaeser and found two ideas that might interest my students. First, why did less-skilled workers in Cleveland and Detroit earn more than more-skilled workers in Boston and Minneapolis. Glaeser suggests that unionization of low-skilled workers is at least a partial explanation. Second, the earnings gap between skilled and unskilled workers has grown causing increased earnings inequality.  As you read the paragraph, ask yourself if, from a normative perspective, it is more fair that less skilled worker who organized through unions earned more than workers who increased their skills set.

The connection between urban skills and urban productivity has grown steadily stronger throughout the developed world since the 1970s. In those days, less-skilled places that were filled with highly paid, unionized factory workers often earned more than more-skilled areas. In 1970, per capita incomes were higher in industrial areas like Cleveland and Detroit than in better-educated metropolitan areas like Boston and Minneapolis. Over the past thirty years, however, the less-skilled manufacturing cities have faltered while the more-skilled idea-producing cities have thrived. In 1980, men with four years of college earned about 33 percent more than high school graduates, but by the mid-1990s, that earnings gap had increased to nearly 70 percent. Over the past thirty years, American society has become more unequal, partly because the marketplace increasingly rewards people with more skills.

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McArdle on Bias

In my lecture notes, I write,

A goal of economic or any scientific training is to think logically and free of bias.  Bias ties our conclusions to our prior beliefs, eliminating the need for study.

In a comment about a book, Megan McArdle eloquently expands beyond my conclusion, reaching a profound conclusion that bias affects the questions asked.

What bias does--in science, in media, in any situation where information is gathered--is affect what questions you ask…

Bias matters not because researchers* deliberately slant their stories, but because they are much more likely to interrogate the facts that contradict their ideological beliefs, than the ones that support them.  When they come across an uncomfortable fact, they'll go out of their way to figure out why it isn't really true.  When they come across a fact that confirms what they believe, they'll be more likely to accept it at face value.

*I substituted the word liberals with researchers to conform with the impact of bias that I am teaching students.  I feel comfortable making this substitution because McArdle also writes, “I'm not claiming that liberals do this more than conservatives (I think that being human, they're equally prone to this phenomenon)…”

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Friday, September 9, 2011

It Is Not from the Benevolence of the Butcher…

In Ogden, a man was butchering a cow in his driveway located in a high density neighborhood.  Household production is not counted when calculating GDP so transforming the cow into burgers does not add to GDP despite the value added, but I wonder where he got the cow and if he paid for it (“Police called after man butchers cow in his driveway”).

OGDEN -- Charges may ensue for an Ogden man who startled the neighbors by butchering a cow in his driveway over the weekend.

Police were called to the scene at 1:44 p.m. Sunday after the cow's owner began harvesting the animal. A patrolman was responding to a caller who saw a cow being trailered to the home in the 2700 block of Gramercy Avenue.

The caller then reported hearing the cow's audible mooing, followed by what sounded like a gunshot, said Police Lt. Troy Burnett. Then the mooing stopped.

The patrolman's report said when he arrived at the scene a half-block above Monroe Boulevard, "the cow was in the process of losing its head," Burnett said.

The man sawing at the animal's neck, the owner of the beef, denied shooting the cow on the premises, telling the officer the animal had been dispatched outside the city limits.

The officer took the information and filed a report that will be screened by the city attorney's office for possible charges, Burnett said.

What crimes might have been committed?  Here’s a partial list:

  • discharging a firearm within the city limits
  • disorderly conduct
  • health code violations
  • animal cruelty

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Thursday, September 8, 2011

Glaeser on Green Energy

Yesterday, I linked to Daron Acemoglu’s article “The Real Solution Is Growth” in which he suggested that policy should focus

ON green technology, the next area that has the best promise of creating a platform for more innovation…The United States is lagging behind other countries in these activities. To regain leadership, we need both more and smarter subsidies to research in green technologies and a carbon tax that naturally encourages the use of cleaner technologies and triggers more research to seek such technologies.

Another exceptional economist from a nearby institution, Edward Glaeser, explains why green technology is not an engine for job creation, why it increases productivity, and what types of activities should be subsidized in “Why Green Energy Can’t Power a Job Engine.”

He uses Evergreen Solar which had a factory that received $40 million in subsidies and recently announced that it was moving production from Massachusetts to China as a case study.  Evergreen’s comparative advantage was its proximity to one of America’s foremost centers of engineering, Boston, and its principles worked with MIT profession Emanuel Sachs who invented the “string ribbon” process for producing solar cells. 

The new company’s innovative product brought international partners willing to finance the company’s expansion.  When the time came to begin commercial production, the lure of cheap labor enticed Evergreen to move production to China.

Glaeser conclusion expounds on Acemoglu’s recommended policy that government funds research in green technologies.

Failed public investments, like the money spent in Devens, reflect the fact that public officials are rarely skilled venture capitalists and that governments pursue many objectives that lead them away from solid investments. It’s easy to see why any governor would be excited about a green-energy manufacturing plant in a less prosperous area of his or her state. But the same forces that made Devens political catnip meant that it was unlikely to be a long-term success…

Massachusetts’s edge lies in ideas, not products. Those ideas are best produced in creative clusters, built around cities, where knowledge moves easily from inventor to entrepreneur. The only production that really needs to occur in greater Boston is the early-stage manufacturing that can be an important part of the research process. Mature companies, like Evergreen Solar, naturally move their factories to lower-cost areas…

As long as solar panels are getting cheaper, we shouldn’t worry about where they are being produced. We should continue financing research on solar technology as long as that research continues to produce cost-cutting breakthroughs, like “string ribbon” technology, but we shouldn’t pretend that cheaper solar energy will end up employing millions of our less-skilled citizens.

For decades, local economic success has come from entrepreneurship and education, not large-scale manufacturing. The Devens closing doesn’t imply that there is anything wrong with clean energy, but it does suggest the difficulties inherent in trying to beat China at cheap manufacturing. In the long run, America will be richer than China only by having smarter citizens, and that requires the skills that come from schools and cities, not dispersed factories.

If this post is of interest, read Glaeser’s entire article linked above.  If the article leaves you wanting more, read his book, Triumph of the City: How Our Greatest Invention Makes Us Richer, Smarter, Greener, Healthier, and Happier.

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Tuesday, September 6, 2011

Acemoglu on Innovation

When evaluating policy, the American public focuses on its potential job creation, economists focus on potential improvements in productivity.  In The Myth of the Rational Voter: Why Democracies Choose Bad Policies, Bryan Caplan assumes economists know better than non-economists on economic issues and refers to this difference as make-work bias.
Daron Acemoglu, an MIT economics professor, describes his solution to the debt ceiling, the recent credit rating downgrade, unemployment in “The Real Solution Is Growth” which is quoted in part below.  I recommend the entire article.
We should not take our eye off the really important ball: economic growth and the innovation process that underpins it.
Though the U.S. economy has tremendous innovative capacity, even in the depths of the current recession, this means neither that policies to encourage high-value innovation are not possible nor that we should ignore the danger of significantly damaging this capacity.
Here are the dangers.
  • Patent protection is becoming a more bureaucratic, red-tape-ridden, and uncertain process
  • The explosion of salaries on Wall Street has attracted many of the talented individuals who otherwise would have gone into research, design, and engineering occupations
  • Markets will not generate enough innovation.
  • Innovation also relies on the political infrastructure of society

And here are some positive measures for fostering innovation.
  • Encourage skilled foreign workers to work and settle in the United States
  • Foster the commercialization of innovation. Much more can be done to facilitate this process. The Bayh-Dole Act of 1980 was only a small step toward encouraging commercialization of academic research…
  • Focus on green technology, the next area that has the best promise of creating a platform for more innovation
Different economists might emphasize different policy measures to secure productivity through innovation but Acemoglu’s list is a good place to start.  This week, Mit Romney will present his economic platform, the Republican presidential candidates will debate and President Obama will deliver his jobs program.  I listen for policies that will improve productivity as candidates propose solutions to the economic malaise.

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Monday, September 5, 2011

Additional Child Tax Credits

Economists refer to economic problems that result from government action as government failure.  These failures are analogous to market failures that justify government interventions that Mankiw summarizes as principle 7; government can sometimes improve market outcomes.  These failures generally span several administrations both Republican and Democratic.  According to the Treasury Inspector General for Tax Administration, (“Individuals Who Are Not Authorized to Work in the United States Were Paid $4.2 Billion in Refundable Credits”) through a series of unfortunate events spanning fifteen years and three administration, the federal government has created conditions that allow undocumented workers to fraudulently claim $4.2 billion in 2010 on refundable tax credits most coming from the additional child tax credits (ACTC). 

All people who earn income in the United States are required to pay taxes even if they earn that income through illegal activities or are in the country illegally.  Refundable tax credits are earned when refunds to individuals exceed taxes paid.        

In 1996 Congress passed and President Clinton signed into law the Personal Responsibility and Work Opportunity Reconciliation Act, fulfilling a Clinton campaign promise to “end welfare as we know it” and a plank on the Republican’s Contract with America.  A minor section of the new law attempted to discourage illegal immigration with provisions authorizing denial of public welfare benefits to illegal aliens.  Guidance on implementing these provisions was not provided and the importance of that lack grew with subsequent legislation.     

A year later, the Taxpayer Relief Act of 1997 was enacted with main provisions that lowered capital gains taxes, exempted from taxation homes sold for less than $500,000 that had been lived in for at least two of the last five years, and increased the child deduction.  The Economic Growth and Tax Relief Reconciliation Act of 2001 made it possible for filers to receive a return that exceeded taxes paid by removing the requirements that the Child Tax Credit be refundable only if the taxpayer had three or more qualifying children and Social Security taxes exceeded earned income credits.  The new law also increased the Child Tax Credit from $500 to $1,000 per child, making more families eligible for the refundable portion known as the Additional Child Tax Credit (ACTC).  The American Recovery and Reinvestment Act of 2009, the Obama stimulus legislation, similarly increased potential refunds by raising the income threshold for calculating the ACTC. 

The graph shows that the number of ITIN has increased from 796 thousand in 2005 to 1,526 thousand in 2010 as laws increased the benefits of filing.  During the same period, the ACTC increased from $924 million to $4,000 million.  The greater slope of the ACTC one compared to the ITIN line implies that the benefits per filing increased.  By 2010 the average filing claimed $1,325 of ACTC. 

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Sunday, August 28, 2011

Comments on Lowenstein’s “Stop the Panic

A friend asked for my thoughts about a Newsweek article by Roger Lowenstein titled “Stop the Panic.  It’s Not 2008.”  I have two fundamental disputes with his article.  First, he paints a picture of the President as the Capitan at the helm of the ship of the economy guiding it in good times as well as bad.  Second, Lowenstein assumes that the Capitan’s effective tools are Keynesian, an assumption disputed by a great deal of economic literature (see for example Robert Barro, “Keynesian Economics vs. Regular Economics”), and more problematic, these tools are so powerful that they can calm the raging storm.

As the narrative builds, the analogy worsens.  Bush (43) was really Ahab and his Pequod’s Republican crew were monomaniacally hunting their Great White Whale of “no new taxes” while the economy was expanding and the population aging.  Their obsession tore the sails, cracked the mast and depleted the weapons leaving the ship’s next Capitan, Obama, dead in the water and unable to fight the Great Recession and its hangover of slow growth.  Lowenstein fairly notes Obama’s obsession with raising taxes on the rich, but his rhetorical tongue lashing is largely reserved for Bush (43).   

To make his case, Lowenstein describes government revenues and outlays as parallel lines with revenues slightly below outlays.  These lines are depicted as the orange dot-dash line and the green dot-dash line in the graph.  Both are measured as a percentage of GPD and are the average level of revenues and outlays from 1971 through 2010.  The average budget deficit as a percentage of GPD is the distance between the two lines.  Noting that the budget was balanced in the last year of the Clinton administration, Lowenstein writes
But since the Bush tax cuts went into effect, the lines have wildly diverged. Spending has soared to 25 percent of GDP. And, alarmingly, tax receipts have crashed to 15 percent of GDP, the lowest level since World War II.

Lowenstein is cherry picking data.  To demonstrate this point, I have included a graph depicting actual revenues (orange line) and outlays (green line) of the federal government between 1971 and 2010.  Recessions are soon as yellow rectangles.  During each of the six recessions since 1971, outlays soared as revenues plunged.  The large deficit he sites is not largely the result of the Bush tax cuts but of the Great Recession.

Likewise, Lowenstein exaggerates the impact of the tax cuts on the national debt.  The debt did increase under Bush from 34.7%, the last full year that Clinton served as President to 36.2% in 2007.  The explosion of debt was due more to the response to the financial crisis and its byproduct, the Great Recession, than the Bush tax cuts. 

I have a different vision of the economy that I believe better fits the data.  The President is the chief forest ranger of a country with land that is both publically and privately held.  Everybody manages their land as they see fit.  Public lands run by the forest rangers can be improved by good practices or degraded by bad but the changes, even if they have some immediate effect, take years and sometimes decades to be generally noticeable.  Fires are the chief threat to prosperity making fire management particularly important.  Fires can be set by private land owners, bad policy or outside “shocks” like lightning strikes and they can affect both public and private land.  The long lag between policy implementation and effect makes it hard to disentangle which practices are productive and which are not.  Rather than focus on rewarding chief rangers that implement good policy voters sadly reward those that “boldly” respond to fires.  Bold action, more often than not, does little to reduce current fires and encourages the growth of scrub brush on the forest floor. 

A final point can be made with the graph.  Increasing or decreasing outlays as a percentage of GDP seem to have little to do with the President’s party affiliation.  Outlays as a percentage of GDP rose under Nixon, Ford and Carter and then fell under Reagan, Bush (41) and Clinton, only to rise under Bush (43) and Obama.  One might also ask, given that Bush (43) borrowed many advisors from his father’s administration, and Obama from Clinton, why the earlier administrations had more success that the latter. 

What types of policies have little short-run impact but lead to long-run growth?  Sustainable low levels of taxation, low levels of transfer payments, a good legal system that protects property rights and honors contracts and monetary policy that relies on rules rather than case-by-case decisions.  Bad policy does the opposite.  Certainly, neither party has a monopoly on good policy or bad. 

Lowenstein calls on Obama to run a campaign promising to raise taxes on all.  This is an honest position.  His vision of American would mold us into something like a European social welfare state.  The CBO projections of revenues and outlays as percentages of GDP for 2011 through 2021 are shown in the graph as dashed lines.  Outlays average 23.5% of GDP and revenues, 19.3%.  Debt held by the public as a percentage of GDP stabilizes at reaches 75% of GDP in 2013 and rises by less than one percent a year thereafter but the assumptions need to realize these results are heroic.  In addition to the end of the Bush tax cuts, they include sharp reductions in Medicare’s payment rate for physicians; the end of the extension of unemployment compensation, payroll and the alternative minimum tax; and increases in discretionary spending limited to the rate of inflation.  I wouldn’t bet on all of these assumptions coming to fruition.

If Obama ran such a campaign, Republicans should match it and campaign on lowering taxes in exchange for fundamental reform to entitlement programs.  Such a Republican campaign would match my preference for an America with a small government in which individuals are primarily responsible for their retirement and health care.  I believe that Lowenstein and I are likely to be disappointed.

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Wednesday, August 17, 2011

Wartime Malinvestment in the Civilian Sector

In “Wartime Prosperity?  A Reassessment of the U.S. Economy in the 1940s,” Robert Higgs persuasively argues against the “consensus” view World War II got the U.S. economy out of the Great Depression.  One argument he makes asserts that resources were transferred from industries producing consumer goods into industries producing armaments causing wartime production of consumer goods to fall.

Holly George Warren describes problems Gene Autry’s had in maintaining production of consumer records and cap pistols during the war (“Public Cowboy No. 1: The Life and Times of Gene Autry”).  War shortages forced Autry to invest in jukeboxes rather than record records suggesting that malinvestment was not limited to to movement of resources from civilian to noncivilian activities but within the civilian sector as well.
With fewer records being pressed due to shellac shortages and no new recordings released, including the reissues he had requested, Gene’s Columbia earnings plummeted from $29,332 in 1942 to $16,662 in 1943.  Royalties from tie-ups also had been negatively affected by rationing of raw materials, with some items being discontinued, including the Gene Autry cap pistols.  His investments improved his bottom line, however, with his share of the Championship Rodeo bringing in a hefty $22,457 by year’s end.  He also bought into the Automatic Phonograph Company, an Arizona-based jukebox concern, which he staffed with employees from his prewar businesses.  What better investment for a man who wanted to keep his own discs playing in roadhouses and diners?  His connection to Columbia also assured enough platters to stock jukeboxes during a time when new records were quite scarce. 

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Friday, August 12, 2011


Many Americans have suffered during the Great Recession and subsequent slow recovery but we should recall how fortunate we are to live now rather than during the Great Depression.  While reading Public Cowboy No. 1: The Life and Times of Gene Autry, by Holly George Warren, was moved by the following account of the death of Nora Autry, Gene’s mother.
Nora Autry…suffered from pellagra, c scourge during the Depression among impoverished Americans whose diet consisted primarily of corn.  Pellagra raged in epidemic proportions in the South and Southwest in the 1930s.  The disease occurs when a person does not get enough niacin (B3) or tryptophan (an amino acid) in the diet.  It can also occur if the body fails to absorb these nutrients.  Pellagra is characterized by red, scaly skin sores (dermatitis), diarrhea, inflamed mucous membranes, and mental confusion and delusions.  Early stages of pellagra often exhibit as malaise, apathy, weakness, and lassitude.  The final phase of the illness is dementia, which can become so severe it mimics schizophrenia, including delusions, hallucinations, and stupor.  Then comes organ failure and death.  According to epidemiological data collected during the U.S. pellagra epidemic in the 1930s, women, children, and the elderly of both sexes were most commonly stricken with pellagra while infants, adolescents, and working young males were affected least frequently.  Medical professionals theorized that the disparity in prevalence resulted from an unbalanced distribution of food within households.
The Pellagra epidemic is more than a tragic story, it teaches about societal organization.  Households do seem to be the appropriate unit of measurement and not the individual.  The strongest, most productive members of the household could have withdrawn and had more resources for themselves but they remained, sacrificing for the household.  Other household members sacrificed to protect the households’ current and expected future income.  It is unlikely that the strongest members of the household took what they needed, exploiting the weaker members, because the weak like the strong were free to withdraw from the household if their prospects as individuals were better.
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Wednesday, August 10, 2011

More on “The Allegory of the Breast Pump”

In response to “The Allegory of the Breast Pump” anonymous wrote
The purpose of this legislation is to PROMOTE feeding of our future generation with breast milk. Not an easy task when women are often expected to return to work full-time within few weeks after giving birth.

If you are going to write about the economics of providing breast pumps, without out-of-pocket expenses to a woman, please consider all aspects of this topic. Few points you have not considered:

1. Breast milk is rich in antibodies that protect the baby from infections and are not found in commercial formulas. According to WebMD, "Except for wellness baby visits, ear infections are the most common reason for trips to the pediatrician, accounting for approximately 30 million doctor visits a year in the U.S. Today, almost half of all antibiotic prescriptions written for children are for ear infections, and the cost of treating middle ear infections in the U.S. has been estimated at $2 billion a year."

2. Breast milk has the right amount of fat, sugar, water, and protein to help the baby grow appropriately. Something to think about while our nation is struggling with morbid obesity and obesity related health care costs. For example, a bariatric surgery for weight loss, performed on adults and children, ranges from $6,000 to $8,000 per procedure.

3.  For most babies and especially premature babies, breast milk is easier to digest than commercial formula made with cow's milk. Take a look at rising incidences of child and adult allergies and gastrointestinal conditions, that may be prevented.

So, "How much better off are we as a country?" The benefits might take time, the time it takes for these breast-milk-fed children to grow up and become healthy, intelligent and productive members of our society.

I thank anonymous for the polite and informative information provided on breast feeding.  I do not wish to argue the value of breast milk to formula; I concede this point.

I explicitly assumed that Molly and other women were informed about the benefits of breast feeding.  I implicitly assumed that Molly and other women consider their welfare and that of their child as one.  Mothers want the best for their children.

I have two problems with the regulatory mandate.  First, I believe that the price elasticity of breast feeding is very inelastic meaning that a large reduction in price of breast feeding will have a small impact on the number of women who choose to breast feed.  Second, health care costs will explode because the price of the breast pump (health care) is separated from the benefit of breast feeding. 

My assumption that women are informed might be wrong.  If so, an educational campaign might be appropriate.  My assumption that women love their babies and care as much or at least almost as much about their baby’s welfare as their own might be wrong.  Heaven help us if they don’t.  Neither additional education nor small subsidies will have much impact on the number of babies who are breast fed.
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I Stand Corrected

A Texan in Wisconsin contributed a notable comment to my post, “Learn Math. It Pays.”
This story is truly a reflection of the Obama administration's view on fiscal stimulus.

While we gaze longingly at her winnings, we get no indication of what she spent in tickets and effort to win these jackpots. What if she bought every number possible each time?

Obama wants to give away tax dollars to everyone under the sun...but he sure doesn't want to discuss how much it costs or where the money will come from (other than taxes on corporate jet owners).

I'm not so sure I want to win the $10 million lottery if it costs me $16 million...and I have to borrow the $6 million delta from China...
I made a number of assumptions that may or may not be correct.  I stick by the assumption that the hard work in learning math and statistics gave Joan R. Ginther the knowledge to “beat the system.” 

I also assumed that given the revenues earned, the repeated wins and the ability to finance those wins is suggestive of high profits.  In short, I assumed that marginal revenue equaled or exceeded marginal costs but this may not be true.  I believe the assumptions are probably correct, in fact I would bet on them, but as a Texan in Wisconsin correctly points out, we should pay attention to costs as well as revenues. 
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Monday, August 8, 2011

Learn Math. It Pays

Its pays to know math (“'Lucky' woman who won lottery four times outed as Stanford University statistics PhD”). 

Joan R. Ginther, 63, from Texas, won multiple million dollar payouts each time.

First, she won $5.4 million, then a decade later, she won $2 million, then two years later $3 million and finally, in the spring of 2008, she hit a $10 million jackpot.

The odds of this has been calculated at one in eighteen septillion and luck like this could only come once every quadrillion years.

Harper's reporter Nathanial Rich recently wrote an article about Ms Ginther, which questioned the validity of this 'luck' with which she attributes her multiple lottery wins to.

First, he points out, Ms Ginther is a former math professor with a PhD from Stanford University specialising in statistics.

I suspect that Rich is correct.  I suspect that hard work had more to do with her lottery winnings than luck. 

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Some Impacts of the Downgrade?

Standard & Poor’s, one of three credit rating agencies, downgraded the U.S. federal government’s credit rating to AA+ from AAA.  It is the first time in the agency’s history that it or any other rating agency has downgraded the federal government’s debt.  Two other rating agencies, Moody’s Investors Service and Fitch Ratings, retained their AAA ratings. 

Most analyses on the impact of the downgrade that I have seen have focused on its immediate impact.  I do not know how market participants will react today, nor do I know which other factors such as the debt crisis in Europe or earnings will contribute to investors’ reactions.  Rather, than this immediate focus, I would like to explore the economic implications of the downgrade over a longer time horizon, but I do so lacking a great deal of specific information as I will explain.

I believe that there will be two types of responses: one directly through markets due to reactions of market participants and one indirectly through markets via regulations.  Markets are forward looking.  The debt crisis is not a surprise just as downgrades due to a deteriorating debt to GDP ratio is not a surprise. Many financial economists boil down financial assets to two characteristics: risk and return.  As risk increases, investors must receive a higher expected return.  Other things equal, U.S. government debt will sell at a higher price relative to other assets such as corporate bonds and stock.  As the economy strengthens, and it will at some point, money will flow out of treasuries into these other assets.  In general, the price of corporate bonds and stocks will increase driving down their rates of return.  Firms deemed too big to fail have been able to borrow at close to the government’s rate.  That advantage will lessen because the government’s cost of borrowing will rise relative to corporate borrowers and the value of these firms will fall relative to others. 

Regulation may cause more immediate turmoil from the downgrade than the direct reaction of market participants.  For example, the Basel III regulatory standard, which is accepted by most countries, requires financial institutions to maintain more capital on assets as risk rises.  The downgrade may require some foreign institutions to raise more capital on the U.S. treasuries they own or to sell those treasuries and buy government debt from countries with a AAA rating.  If they sell, prices of U.S. treasuries will fall and interest rates will rise.  I do not know how many foreign governments base their assessment of risk on Standard & Poor’s.  I also don’t know how quickly these foreign financial firms will have to react.  I doubt that many investors have the knowledge that I lack, but I bet that many are currently seeking the same information. 

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Friday, August 5, 2011

Summers or Taylor

The effectiveness of fiscal policy is an issue that divides macroeconomists.  “Tinkerers” believe that aggregate demand can be stimulated by federal deficit spending and cutting taxes.  Larry Summers is a well respected economists that supports active fiscal policy to improve economic outcomes.  In an interview with Charlie Rose, he describes the policies he believes that are or would be helpful in today’s economy.  Please keep in mind that Summers was an important policy maker in both the Clinton and Obama administrations and that he has acquired a tendency to blame Republicans for bad outcomes rather than stick strictly to the economics of policy options.  While the tendency is natural and appropriate for a policymaker, it is sometimes a distraction.  Please ignore the politics and stick to the economics.     

Another group of macroeconomists believe in “rules” and doubt the effectiveness of tinkering.  These rules are largely attempt to build stability and predictability and abandon stimulus policies.  John Taylor argues for rules and against discretionary fiscal and monetary policy in an EconTalk interview with Russ Roberts.  Rather than increase deficit spending to stimulate aggregate demand, he argues that cutting deficits would create a more stable governmental fiscal environment allowing market participants to operate with less risk.   
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Tuesday, August 2, 2011

The Allegory of the Breast Pump

(HT Drudge Report)  Yesterday, Health and Human Services Secretary Kathleen Sebelius announced that beginning January 1, 2013, that insurance companies must cover women's preventive care without copays under the Affordable Care Act of 2009.  Tens of millions of women are initially expected to gain benefits and that number is expected to grow over time (“Federal health department approves free birth control”).  Included under the decision are breast pumps and here begins the allegory. 

In our fictitious economy, 1% of GDP is spent on breast pumps and 10% of pregnant women use them.  The government changes insurance laws so that all women have a zero copay.   Prior to the change in insurance law, on average, women paid $200 for a breast pump.  After the change in the law, doctors recommend pumps that cost 50% more than the average expenditure.

An informed pregnant woman, Molly, considers breast feeding her baby.  Given her schedule, she estimates that she will need to use a breast pump eight times per week or make small alterations to her schedule.  After talking to friends, she learns that pumps are a little uncomfortable and somewhat time consuming.  As part of her research she looks at the price of breast pumps.  Because Molly believes that there is a good chance that she will decide that it is easier to alter her schedule than use the pump, she tentatively decides to buy an inexpensive $100 pump.  If she does not like it, her loss would be small.

During her next checkup Molly asks her doctor, Dr. Who, about feeding options for her baby.  The conversation centers on breast feeding.  She describes her research.  Who realizes that she is unaware of the change in law and suggests that she try using a breast pump costing $300 because it causes less discomfort and because of the zero copay.  Molly agrees.  The order is processed through her insurance company adding an additional $100 to the cost. 

This conversation is repeated with all pregnant women. The 10% of women who originally decided to use breast do not alter their decision but they do decide to alter the breast pump models that the purchase so that the average cost is $300 per pump.  Women who had decided to use a less expensive pump decide to use the $300 model.  An additional 20% of women decide to try pumps.  Half find the pumps satisfactory and continue their use and half stop using the pumps after a brief time.  Another 10% of women are embarrassed that they do not want to breastfeed and agree to try the pumps with no intention of continuing their use.  All women who are persuaded to try a breast pump choose the $300 model.  

The change in the law chased an 800% increase in breast pump purchases.  Because women now on average buy $300 pumps rather than $200 pumps and four times as many women purchase them, breast pump purchase now represent 6% of GDP.  The cost of processing claims represents 2% of GDP.  Breast pump manufacturers wake up and smell the coffee.  There is no reason to specialize in producing inexpensive pumps.  The average price of pumps increases.  Doctors retain their practice of recommending breast pumps that costs 50% more than last year’s average.  Breast pump prices spiral upward.

How much better off are we as a country?  The original 10% of women using breast pumps are clearly better off.  They wanted to use breast pumps and they end up using a more expensive model at a cheaper price.  The next 10% of women who chose to try a breast pump and continue its use are $300 better off if they correctly measured their costs and benefits.  The remaining women are no better or worse off.  In total, pregnant women are gifted an additional 6% of GDP but their welfare gains total only 2% of GPD.  Insurance companies also gain 2% of GDP.

The same cannot be said of taxpayers.  They are clearly worse off.  They are paying an additional 7% of their income for breast pump purchases and insurance processing.  The lesson from this allegory is simple.  Markets produce a better allocation of resources that produces a higher level of well-being for society.

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Friday, July 29, 2011

Barro on the Fiscal Crisis and How We Got Here

Robert Barro is one of those economists whose ideas deserve careful consideration.  In “Robin Hood Can't Lead Us Out of the Debt Hole,” he provides a summary of how the United States got into the current economic mess, the relative effectiveness of government actions, and provides thoughts on policy that would help clean up the mess.  I particularly like his ideas on tax reform, which I quote in part.
One possible package of reforms would include setting the U.S. corporate and estate tax rates permanently to zero. These taxes are inefficient and generate little revenue. Also, to restore a more efficient allocation of capital across the economy, we should phase out—gradually—tax preferences for home-mortgage interest, state and local income taxes, and employee fringe benefits. Marginal income tax rates should also be lowered across the board. Finally, to raise additional revenue to meet entitlement obligations, we could adopt some kind of broad-based, flat-rate consumption tax such as a value-added tax of the kind used in Europe. In this country, a rate of 10% with few exemptions should raise around 5% of GDP annually.
The political danger of a value-added tax is that it is so efficient at raising money it will encourage governments to grow even larger. That's why it only makes sense as one component of a fiscal reform, including reductions in the long-term path of entitlement outlays.

Lowering the corporate to zero makes sense for at least two reasons.  First, there is a difference between the incidence of a tax, who writes the check and the burden of that tax, who ultimately pays it.  In the long run, that burden falls mostly on consumers.  Lowering the corporate tax rate to zero would acknowledge that economic fact.  Second, it would take an arrow out of the political quiver of corporations that benefit the most politically entrepreneurial business leaders.  A similar arrow would be removed from politician’s quiver.  Politicians would lose some ability to bribe or extort businesses to further a politician’s or group of politician’s policies.  Investment decisions would more closely be linked to the fundamental profitability of projects. 

Lowering estate taxes to zero would free estates to allocate funds to the best possible investments not the best investment given tax treatment.  Again the economic efficiency would increase.  

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Friday, July 22, 2011

Trade-offs: Germany’s Choice for Power Generation

(HT Watts Up With That)  In response to disasters at Chernobyl and throughout Japan, the German government led by Chancellor Merkel is replacing nuclear plants with coal and natural gas powered plants.  The phase out will be completed by 2022.  One small irony is that the government will finance the conversion using funds designated for projects promoting “clean energy” and “combating climate change” (“Germany to fund new coal plants with climate change cash”).

A spokeswoman from the Economics Ministry said that the new plants would not affect Germany’s goal of reducing greenhouse gas emissions by 40% by 2020. 

We all face trade-offs, including governmental officials.  Nuclear power plants are vulnerable to occasional releases of radioactive gasses into the atmosphere.  Coal, and to a lesser extent natural gas, release carbon into the atmosphere and many believe that these emissions dangerously warm the earth.  The damage of radioactive gas releases would largely be confined to Germany and her immediate neighbors but the damages of carbon releases would be shared with the world.  Wind and solar plants use vast tracks of land and German climatic conditions are not suited for their production.  Excluding external costs, coal and natural gas plants generate electricity most cheaply.  Cheap electricity is necessary for Germany to maintain its healthy manufacturing sector.

Reading the tealeaves, and with the understanding that I have no special insights into German politics, I conclude that the Merkel government has chosen jobs over the environment, but in a somewhat subtle manner. Government officials have chosen to discount the costs of global warming relative to a nuclear plant meltdown perhaps from a reassessment of the relative costs of each, perhaps from a heightened sense of nationalism that focus on national external costs rather than world external costs associated with global warming. 

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Saturday, July 16, 2011

Schwarz on Pay-for-Play

Draft quality NCAA football and basketball athletes are underpaid to the tune of several hundred thousand dollars per year (reference).  I believe that the difference between the competitive wage and the actual wage is sufficiently large to constitute exploitation.  Walter Byers, a former NCAA president (1951-1988) agrees. In his book “Unsportsmanlike Conduct: Exploiting the Student-Athlete” goes further labeling the NCAA scholarship system a “neo-plantation belief that the enormous proceeds from college games belong to the overseers (administrators) and supervisors (coaches). The plantation workers performing in the arena may only receive those benefits authorized by the overseers (reference).” 

From the pages of ESPN, Andy Schwarz cogently argues that the NCAA could step aside and allow top athletes to earn a competitive wage (“Pay-for-play -- the truth behind the myths”).  I quote from his opening statement and then list the myths he busts.  His selection of myths could be taken from my class discussions on the NCAA and labor markets.  To learn his answer to the myths, you must to read the linked article.   
It happens so often that it's barely even scandalous anymore.

Some college or its boosters are caught giving "extra benefits" to college football players. In some case the allegations range into the tens or hundreds of thousands of dollars, as was the case with Auburn quarterback Cam Newton and Ohio State's Terrelle Pryor. Economically, these scandals are clear evidence that the NCAA's level of compensation for athletes is so far below the market rate that cheating is irresistible. Despite this, it seems inevitable that well-intentioned columnists, coaches and sports legends weigh in, saying it would be great to pay players, but a long list of impediments makes impossible anything except the NCAA's scholarship-only system.

Every one of those reasons is wrong. Join me on a tour of the top myths about paying college athletes.

Myth 1: It's too hard to figure out how to pay players fairly.

Myth 2: Title IX outlaws paying players.

Myth 3: Pay will ruin competitive balance.

Myth 4: Paid athletes can't be real students.

Myth 5: Paying athletes means that fans won't watch.
I have two additional points to make, one positive and the other normative.  If the NCAA allowed universities and colleges to determine wages for players, it is likely that athletes playing football and basketball would be paid much more.  Compliance costs should plummet but probably less than wages increase.  Colleges and universities are likely to cut athletic programs that lose money. 

A student of economics need not believe that universities and colleges should increase wages of athletes.  They are not free to deny empirical evidence that college and university athletes playing football and basketball are paid significantly less than the competitive wage. 

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Thursday, June 30, 2011

California Tries to Tax Out-of-State Internet Merchants

(HT Drudge Report) By a 1992 Supreme Court decision, Internet merchants do not have to collect sales taxes in states if they do not have a physical presence in that state.  Legally, consumers are still required to pay the tax but collection is problematic.  The California legislature passed and Governor Brown signed a bill that attempts to circumvent the decision by taxing out-of-state merchants through affiliates that have a physical presence in California.  Most affiliates are related to out-of-state merchants through click through advertising.  Internet merchants located outside of California hate the legislation and instate merchants love it.

I will not offer an opinion about the merit of the legislation.  I do wish to comment on the difficulty of taxing highly mobile businesses and households.  Amazon and announced that they were immediately cutting ties to all California affiliates.  California expected to collect $200 million annually.  With the largest Internet marketer pulling out, that total will be smaller. 

The affiliates are also responding.  There are 25,000 affiliates in California and they pay $152 million in state income taxes last year.  Many have already announced that they will leave California and the state will lose their tax revenues.  Consumers will pay a higher price because at least part of the tax will be passed on to them.  There is a difference between the incidence of the tax, who writes the check to the government, and the burden of the tax.  Economic literature suggests that consumers will pay part of the burden through higher prices as part or all of the tax is passed on to consumers. 

Instate merchants view the tax as a fairness issue because they believe that they pay the sales tax that out-of-state merchants avoid but there is now question that they will gain sales as the price of products on out-of-state Internet merchants rise relative to their prices.

States that place high taxes on high income households or corporation will see these entities exit for states with lower taxes.  Countries that place high taxes on high income households or corporations will see these entities exit for countries with lower taxes.  Low income households and small corporations have less ability to “vote with their feet.”  Many complain that this phenomenon will create a raise to the bottom in which government will be deprived of necessary resources.  Certainly pressure will increase to make government smaller, but it will also increase to make government more efficient and that is good.

For more information information see, “California tells online retailers to start collecting sales taxes from customers,” “New Internet Tax Grab Will Burden Companies and Your Portfolio,” “Web retailers say they'll fight new California sales tax,” and “Sales Tax on the Internet.”

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Victor Fuchs, “Three ‘Inconvenient Truths’ about Health Care”

Without comment, I have quoted Victor Fuchs’ “Three ‘Inconvenient Truths’ about Health Care” which was published in the New England Journal of Medicine.  Each truth that Fuchs states is supported by argumentation.  As always, the entire article is worth reading.

1. Over the past 30 years, U.S. health care expenditures have grown 2.8% per annum faster, on average, than the rest of the economy. If this differential continues for another 30 years, health care expenditures will absorb 30% of the gross domestic product— a proportion that exceeds that of current government spending for all purposes combined.

2. Advances in medicine are the main reason why health care spending has grown 2.8% per annum faster than the rest of the economy.

3. Universal coverage requires subsidies for the poor and those too sick to afford insurance at an actuarially appropriate premium; it also requires compulsion for those who don't want to help pay for the subsidies or who want a “free ride,” expecting that they will get care if they need it.

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Wednesday, June 29, 2011

Rewrite of Political Chicken and the Debt Ceiling

This post is a rewrite and combination of two recent posts that evaluate the debt ceiling impasse as a game of political chicken.  This first (here) was incomplete and the second (here) completed the game but required readers to view two posts.

Congress is engaged in a game of political chicken over raising the debt ceiling.  Instead of two cars racing toward each other in a single lane, Republicans and Democrats are screaming at each other across the aisle about conditions that they will require to raise the ceiling.  If left unresolved, this political crisis will precipitate an economic crisis.  Leaders in both parties acknowledge that the ceiling must be raised or the government will not be able to use debt to meet its financial obligations, and both sides know that the government could not simply cut more than a trillion dollars from this year’s budget to remove the need to borrow.  In short, if a political solution is not found the government will default on its obligations.

This is where the game of chicken begins.  Both parties are attempting to use the current crisis as a fulcrum to leverage future budget negotiations over a bigger looming economic crisis caused by unfunded entitlement programs, the big three being Social Security, Medicare and Medicaid.  To greatly simplify arguments, the Republicans prefer to cut spending and reduce the federal government’s size and scope through reform of entitlement programs[1].  Democrats want the federal government to retain its size and scope and would rather close deficits with increased taxes[2]; their reforms to entitlements would attempt to cut expenditures through government reform.  It is beyond the scope of this post to comment on the merit of their agendas. 

Incumbents in both parties are wooing voters through political theater and both parties will gain or lose support depending on the actions of the other party and the economic outcome of those actions.  The following political outcomes are pure conjecture, and are only meant to illustrate the game.  If both parties stay the course causing a financial meltdown, incumbents in both parties will lose votes, say 10 million nationally.  If Democrats stay the course and Republicans capitulate, Democrats will gain 2 million votes and Republicans will lose 2 million votes.  If Republicans stay the course and Democrats swerve, the opposite outcome occurs (Democrats lose 2 million votes and Republicans gain 2 million).  If the parties compromise neither party gains or loses votes.Voters are affected by the economic outcomes of political actions.  The best outcome depends on the economic effectiveness and political sustainability of each party’s solution and the compromise solution.  Voters are members of a party because they believe that it offers the best economic solutions.  Their beliefs may or may not be correct but the implications of this assertion on the political game of chicken are clear.  The best outcome for a Democratic voter would be for Congressional Republicans to swerve and Congressional Democrats to stay the course.  The best outcome for a Republican voter would be the reverse.  Voters from both parties benefit from a compromise but less so than if their party holds the course and the other swerves.  The worst outcome for voters is for both parties to hold their course and fail to raise the debt ceiling because the impasse would trigger a financial crisis.     

I believe that tying the increase in the national debt ceiling to spending cuts and market oriented institutional reforms to entitlements is the best economic solution.  On this issue, I hew closer to Republicans.  I believe that it would cause the greatest level of economic growth and that growth would be balanced.  I would hope that the subsequent prosperity would be sufficient to make a more limited government politically sustainable.  I fear that my preferred solution or any political solution offered by one party is not politically sustainable or even attainable.  Our country is politically divided.  Republicans hold the House and the Democrats, the Senate and the executive branch.  A compromise solution that acknowledges this fact and takes the best elements of each party’s offerings represents the least political risk and offers a reasonable economic outcome.   

[1] A small group of Republicans insist that they will not support an increase in the debt ceiling under any circumstance.  I am not sure if this is a negotiating stance or a statement on their future vote.  I do not know if an economist that supports this position or believes that not raising the debt ceiling will have anything less than major costs to the economy.

[2] A small group of Democrats that they will not support an increase in the debt ceiling that reduces entitlement benefits or increases taxes on anybody but the wealthy.  The wealthy do not earn enough to make projected levels of entitlement programs financially sustainable.

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Tuesday, June 28, 2011

McAuliff on the Restarting American Offshore Leasing Now Act

Michael McAuliff, a writer for the Huffington Post, seems to oppose the Restarting American Offshore Leasing Now Act, which would expedite drilling in Alaska and the Gulf, largely because he finds arguments offered by supporters as specious (“More U.S. Oil Drilling Won't Lower Gas Prices, Experts Say”). 

The Bill was sold as a plan to bring lower oil prices, move the country towards energy independence and create jobs.  McAuliff hits an easy target; politicians always oversell the benefits of their activities.  He uses Mike Lynch, an oil analyst for Strategic Energy and Economic Research, Inc. who identifies himself as a moderate Republican and Phyllis Martin, an analyst with the U.S. Energy Information Administration to evaluate the oversold benefits.Lynch and Martin argue that implementation of the legislation would not reduce oil prices now and would have little impact in the future.  Lynch believes potential production increases in the U.S. are too small to have much impact on world prices.  They also argue that increased production would not make us energy independent.  The analysts agree that new drilling in Alaska would create jobs, increase tax revenue, and earn a lot of people a lot of money.

I believe that the analysts are largely correct, but a little depends on your interpretation of key words.  Assuming that drilling in Alaska increases world production by one percent, that gas prices are $4.00 per gallon and elasticity of demand ranges between 2 and 3, prices would fall between 8 and 12 cents a gallon.  I would call that a significant project.  Drilling in other locations and increased use of hydraulic fracturing and other new technologies would further increase production and, holding other things constant, decrease prices.  I agree with the analysts that the U.S. is unlikely to achieve energy independence through increased drilling even if it would reduce the amount of oil we import.  McAuliff seems to have a problem with oil companies profiting from their activities.  I do not.  If big oil can create jobs, increase profits and reduce the price of gas and other oil-based products, I am all for it.

McAuliff seems to have an unstated argument--drilling increases pollution.  It is an argument that I respect.  There is a tradeoff of pollution and wealth.  Wealth enhancing economic projects increase pollution even when cost benefit analysis justifies a pollution causing project.  Some people value a more pristine environment than a little more wealth and for them, marginal costs would exceed marginal benefits.

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