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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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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Pellagra

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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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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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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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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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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