Brooks Wilson's Economics Blog

GDP Growth for 2011

2012-01-28T11:36:00.000-06:00

The Bureau of Labor Analysis released its estimate of GDP growth yesterday; fourth quarter growth for 2011 was 2.8%, slightly below projections and 1.7% for the year.

The graph “GDP Growth: 1970-2011” gives some historical context to the current recession. The orange line plots GDP growth from 1970 through 2011 and the green dashed line plots average growth for the same period. Because I used annual data rather than quarterly and recessions are normally defined by quarterly data, the graph smoothes out the depth of some recessions. The yellow boxes represent recessions and the length of the boxes, their duration. The black vertical lines represent the end of one presidency and the beginning of another.

One insight from the graph is that the current recession is the deepest during the time frame and that the 1982 recession was the second biggest.

The second graph, “GDP Growth Following Three Recessions,” shows the GDP growth beginning with the first year of negative growth and following the subsequent nine years. The Great Depression (1929-1939) was clearly the longest and deepest, followed by the recession of 2008 and 1982.

The Great Depression and the 2008 recession were both financial crises. Work by Reinhart and Rogoff, This Time Is Different: Eight Centuries of Financial Folly, concludes that financial crises are the most enduring. Not only is the fall in growth larger, but the subsequent growth more shallow. The second graph supports their conclusion.

Next year’s growth statistics will be interesting. Will growth accelerate, more closely mirroring growth following the Great Depression, or will it continue to tract under the recovery following the 1982 recession?

The graphs leave many more questions unanswered than answered. Does policy encourage recovery and if so what type? Rather than focusing on GPD contraction and growth, why not focus on movements in the unemployment rate? How do recessions impact sovereign debt? Asking a good question is exciting, searching for its answer, invigorating, and finding an answer, satisfying.

Rogoff on Capitalism

2012-01-26T14:55:00.001-06:00

Most economists agree with Greg Mankiw’s sixth principle of economics, “markets are usually the best way to organize economic activity. Kenneth Rogoff, a coauthor of This Time Is Different: Eight Centuries of Financial Folly, illustrates economists trust in capitalist markets.

I am often asked if the recent global financial crisis marks the beginning of the end of modern capitalism. It is a curious question, because it seems to presume that there is a viable replacement waiting in the wings. The truth of the matter is that, for now at least, the only serious alternatives to today’s dominant Anglo-American paradigm are other forms of capitalism.

Read “Is Modern Capitalism Sustainable?” to learn Rogoff’s alternatives to Anglo-American capitalism, their weaknesses and strengths.

An Energy Revolution?

2012-01-24T14:07:00.001-06:00

Hydraulic fracturing, a process that allows drillers to extract natural gas from shale formations, is reshaping markets for energy. The U.S. Energy Administration reports that natural gas production from hydraulic fracturing increased 48 percent in 2009 to 3,383,532 billion cubic feet from the previous year. The EA does not report more recent data but producers claim that production continues to grow.

The price of natural gas has fallen as the its supply increased and its the demand decreased due to the world wide recession and warm winter temperatures in the U.S., benefiting consumers of natural gas and products derived from it like electricity.

Natural gas fired power plants are an important consumer of natural gas and the consumers of the electricity derived from it are indirect consumers. The supply of electricity from these plants can be stated as an equation without functional form, E=S(P, PI) where E is electricity production, P is the price of electricity and PI is the price of inputs, and as a graph. As the price of inputs falls, the production of electricity increased from S08 to S11 and as incomes fell and winter temperatures rose demand fell from D08 to D11. The combined increase in supply and decrease in demand caused prices to fall from $87 per megawatt hour to $39 (“Electricity Declines 50% as Shale Spurs Natural Gas Glut: Energy”).

Natural gas plants are now the cheapest producers of electricity. They are also the cheapest to build. As might be expected, electricity producers have abandoned some plans to produce electricity with other fuels such as coal, nuclear and wind and are developing plans to build natural gas plants.

The switch to natural gas may have important environmental consequences. As a fuel, it produces significantly less carbon per megawatt of electricity than coal but more than nuclear or wind. Natural gas does not produce nuclear waste and uses much less surface land than wind, preserving the landscape.

The Obama administration has not been a friend of natural gas production proposing many regulations that producers claim could halt new production but President Obama believes that greater reliance on natural gas production could be an area of compromise between Democrats and Republicans and will call for cooperation in promoting its production (“Obama to tout natural gas benefits in State of Union”). For years, the federal government under both Democrats and Republicans has promoted the production of alternative fuels such as ethanol, wind, and solar. Again, the wisdom of markets surpassed that of the wisest government planners. Markets are usually the best way to organize economic activity.

France and Social Welfare Programs

2011-11-22T11:23:00.001-06:00

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.

NBPA and Kevin Murphy

2011-11-17T12:31:00.001-06:00

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.

NBA.com: 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.

The Obama Administration’s Pipeline Punt

2011-11-10T14:40:00.001-06:00

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”).

Cuba’s Long Road to Capitalism

2011-11-04T12:53:00.001-05:00

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.”

Sowell on Greed

2011-11-03T19:15:00.001-05:00

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.

Bankruptcy and Home Loan Defaults

2011-11-01T21:20:00.000-05:00

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.

Epstein on Inequality

2011-11-01T20:21:00.000-05:00

(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. http://video.pbs.org/video/2160792049

Milton Friedman and Illegal Immigration

2011-10-24T19:58:00.001-05:00

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.

http://www.youtube.com/watch?v=3eyJIbSgdSE&feature=youtu.be

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.

The Demise of Community Living Assistance Services and Supports

2011-10-15T13:10:00.001-05:00

(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.

2011-10-07T14:25:00.000-05:00

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.

The Keystone XL Pipeline

2011-10-07T13:57:00.001-05:00

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.

Some Consequences of Government Rationing

2011-09-30T12:27:00.000-05:00

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.

The Market Structure of the NCAA

2011-09-24T10:32:00.000-05:00

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.

Why?

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.

Why?

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.

A Natural Experiment

2011-09-20T11:22:00.000-05:00

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”).

So Close and Yet So Far

2011-09-16T14:20:00.001-05:00

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

When a Win Is Not a Win

2011-09-16T10:26:00.000-05:00

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?

Mankiw, Krugman, Barro and Causation

2011-09-15T11:47:00.001-05:00

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.

2011-09-13T12:54:00.002-05:00

A graphic from a reader
Created by: Online Graduate Programs

Glaeser on Earnings Gap

2011-09-13T11:47:00.001-05:00

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.

McArdle on Bias

2011-09-13T11:30:00.001-05:00

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)…”

It Is Not from the Benevolence of the Butcher…

2011-09-09T09:43:00.000-05:00

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

Glaeser on Green Energy

2011-09-08T12:23:00.000-05:00

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.

Acemoglu on Innovation

2011-09-06T12:34:00.000-05:00

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.

Additional Child Tax Credits

2011-09-05T09:15:00.001-05:00

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.

Comments on Lowenstein’s “Stop the Panic

2011-08-28T22:17:00.000-05:00

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.

Wartime Malinvestment in the Civilian Sector

2011-08-17T15:20:00.000-05:00

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.

Pellagra

2011-08-12T09:17:00.000-05:00

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.

More on “The Allegory of the Breast Pump”

2011-08-10T12:03:00.000-05:00

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.

I Stand Corrected

2011-08-10T08:19:00.000-05:00

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.

Learn Math. It Pays

2011-08-08T11:53:00.001-05:00

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.

Some Impacts of the Downgrade?

2011-08-08T09:24:00.000-05:00

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.

Summers or Taylor

2011-08-05T19:24:00.000-05:00

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.

The Allegory of the Breast Pump

2011-08-02T14:05:00.000-05:00

(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.

Barro on the Fiscal Crisis and How We Got Here

2011-07-29T14:43:00.000-05:00

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.

Trade-offs: Germany’s Choice for Power Generation

2011-07-22T13:10:00.000-05:00

(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.

Schwarz on Pay-for-Play

2011-07-16T15:17:00.000-05:00

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.

California Tries to Tax Out-of-State Internet Merchants

2011-06-30T13:32:00.000-05:00

(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 Overstock.com 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.”

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

2011-06-30T09:42:00.001-05:00

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.

Rewrite of Political Chicken and the Debt Ceiling

2011-06-29T13:27:00.000-05:00

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.

McAuliff on the Restarting American Offshore Leasing Now Act

2011-06-28T09:34:00.000-05:00

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.

The IMF and S&P on Playing Chicken

2011-06-22T09:24:00.001-05:00

In “Political Chicken and the Debt Ceiling” I compared the current impasse between Democrats and Republicans were playing a game of chicken. Incumbent politicians, the drivers and voters, the bystanders are affected. The outcomes for voters differ from those of politicians and depend more on the economic outcome of the political game. Incumbent politicians gain or lose votes depending on the outcome of the game and voters gain or lose from the nation’s change in financial stability which is again an outcome of the game. Both parties are using the debt ceiling crisis to leverage a solution to the larger and looming sovereign debt crisis.

The worst outcome is for both parties to hold their course and fail to raise the debt ceiling. Incumbent politicians in both parties lose votes. Voters lose as well because the impasse would trigger a financial crisis. The best outcome for a party is for the other party to swerve or capitulate, accepting the other party’s solution. Voters gain or lose depending on which party’s plan best solves the sovereign debt crisis. A compromise does not affect incumbents but is better for voters than a political impasse and has the potential to be better or worse than one party capitulating to the other. Hopefully, a compromise might include the best ideas of both parties but could include the worst, or more likely still, something between the best and worst of each plan.

I prefer tying the increase in the debt limit to cutting the budget deficit. The remainder of the post quotes to articles, one I believe that supports my position and another that does not. In “IMF cuts U.S. growth forecast, warns of crisis,” Luciana Lopez writesblockquote>SAO PAULO (Reuters) - The International Monetary Fund cut its forecast for U.S. economic growth on Friday and warned Washington and debt-ridden European countries that they are "playing with fire" unless they take immediate steps to reduce their budget deficits. Yet that relatively benign global outlook could quickly fall apart if politicians in the United States and Europe do not start showing more leadership in addressing their countries' debt problems, the fund warned...

"You cannot afford to have a world economy where these important decisions are postponed, because you're really playing with fire," said Jose Vinals, director of the IMF's monetary and capital markets department.

"We have now entered very clearly into a new phase of the (global) crisis, which is, I would say, the political phase of the crisis," he said in an interview in Sao Paulo, where the updates to the IMF's World Economic Outlook and Global Financial Stability Report were published.In “S&P restates political threat to U.S. AAA rating,” William James and Emelia Sithole-Matarise write

The risks of the U.S. losing its prized triple-A rating over the medium term have increased as the country faces a political impasse and nears its debt ceiling, Standard and Poor's said on Tuesday.

While the ability to adapt both fiscal and monetary policy was a positive for the United States, the risk of a credit rating downgrade had increased due to a lack of political consensus on how to employ that flexibility, Moritz Kraemer, head of sovereign credit ratings for Europe at Standard & Poor's, said on Tuesday.

"The problem is this flexibility needs to be employed and for that you need political consensus. That's not very visible right now," he said.

The Social Cost of Illegal Immigration

2011-06-21T12:02:00.000-05:00

Bloggers and economics teachers face a paradox. We want to convince students and readers that economic ideas are valuable and the best way to grab attention is to use those ideas to analyze the economics of current events. The best way to lose them is to use economic ideas to come to a conclusion that contradict their prior beliefs. The intersection of economic analysis and prior beliefs is small; if it were large, there would be no reason to teach economics.

The current debate about illegal immigration illustrates the gulf that often separates the views of economists and everybody else. The popular debate posits high domestic net costs to illegal immigration and the economic literature finds empirical evidence of net benefits or small net costs.

Arizona, Georgia, Indiana, Oklahoma, Texas and Utah have passed or are considering legislation aimed at reversing the tide of illegal immigration. The severity of these laws hints at the large costs that backers believe illegal immigration imposes on society. The new Alabama law, heralded or decried as the toughest yet to be enacted would require public schools to determine the citizenship status of students, force police to detain someone they have stopped for any reason if they believe that person may be an illegal alien and if the person cannot produce documentation. It would make it a crime to transport or harbor someone who is in the country illegally, and allows government to suspend or revoke the business licenses of a business that knowingly hires an illegal alien. It also requires businesses to use the E-Verify database to confirm the immigration status of new employees.

In my last post, “Political Chicken and the Debt Ceiling,” I sided with the Republican position on the debt ceiling negotiations. In this post, I will take a shot at them. Republicans claim to support smaller government, a lighter regulatory burden, and constitutional rights. The anti immigration law is more strongly supported by Republicans than Democrats. It is increases the size and scope of government, increases regulatory burden of schools and businesses, and limits my first amendment right of freedom of assembly, the right to collectively gather to promote, pursue and defend common interests. The impact of these laws is the opposite of the claimed position of the Republican party.

A petition to President Bush and the Congress that was signed by 523 economists presents what I believe is the majority opinion. In part, it reads

Overall, immigration has been a net gain for American citizens, though a modest one in proportion to the size of our 13 trillion-dollar economy.

Immigrants do not take American jobs. The American economy can create as many jobs as there are workers willing to work so long as labor markets remain free, flexible and open to all workers on an equal basis.

In recent decades, immigration of low-skilled workers may have lowered the wages of domestic low-skilled workers, but the effect is likely to have been small, with estimates of wage reductions for high-school dropouts ranging from eight percent to as little as zero percent.

While a small percentage of native-born Americans may be harmed by immigration, vastly more Americans benefit from the contributions that immigrants make to our economy, including lower consumer prices. As with trade in goods and services, the gains from immigration outweigh the losses. The effect of all immigration on low-skilled workers is very likely positive as many immigrants bring skills, capital and entrepreneurship to the American economy.

Legitimate concerns about the impact of immigration on the poorest Americans should not be addressed by penalizing even poorer immigrants. Instead, we should promote policies, such as improving our education system, that enable Americans to be more productive with high-wage skills.

To my knowledge, there is not a competing anti-illegal immigration petition (see David Hedengren, Daniel B. Klein, and Carrie Milton. “Economist Petitions: Ideology Revealed,” Econ Journal Watch, Volume 7, Number 3, September 2010, pp 288-319).

Political Chicken and the Debt Ceiling

2011-06-16T13:54:00.001-05:00

Congress is engaged in a game of political chicken. Instead of two cars racing toward each other in a single lane, our two parties are screaming at each other across the aisle about conditions that they will require to raise the federal debt ceiling. Democrats and Republicans alike 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.

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 crisis caused by unfunded entitlement programs, the big three being Social Security, Medicare and Medicaid. To greatly simplify arguments, the Republicans want to cut spending and reduce the federal government’s size and scope through reform of entitlement programs. Democrats want the federal government to retain its size and scope and would rather close deficits with increased taxes; their reforms to entitlements would attempt to cut expenditures through government reform. It is beyond the scope of this blog post to comment on the merit of their agendas.

Incumbents in both parties are wooing voters through political theater and both parties will gain are lose support depending on the actions of the other party. If both parties stay the course causing a financial meltdown, incumbents in both parties will lose support (say 10 million national). If Democrats stay the course and Republicans capitulate, Democrats will gain votes and Republicans will lose votes (say Democrats gain 2 million and Republicans lose 2 million). 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.

Pick one side or the other. I would like to see smaller government so on this issue I tend to support the Republicans. I want Democrats to swerve. Federal Reserve Chairman Ben Bernanke wants Republicans to swerve. Yesterday, he urged Republicans to not block legislation tying deeper cuts in spending to passage of legislation raising the debt ceiling (“Bernanke urges GOP to support raising debt ceiling”). On this issue, he prefers the Democrat’s position. I believe that we would both prefer a quick compromise. Let’s just be honest and admit that both Republicans and Democrats are playing chicken and that the stakes are high.Replace this text with...

Gene Autry and DDT

2011-06-15T11:41:00.001-05:00

I watched another Gene Autry movie with good economics underlying the plot. In Riders of the Whistling Pines, produced in 1949 and written by jack Townly, 60,000 acres of forest is infested with moth larva that will destroy the timber. The forest land is a common resource sheltering land, timber, water and wildlife that is shared by all in the community.

The forest is patrolled by the forest rangers, and under contract, a logging company has an exclusive permit to harvest flagged timber, but the company would be more efficient if it could harvest more timber. The infestation provides a profit enhancing scenario. All dead timber is flagged for harvest. The logging company and the forest rangers simultaneously discover the infestation. A logger first attempts to suppress knowledge of the infestation by shooting the ranger, but fail as Gene Autry, a second forest ranger, discovers the infestation.

At Autry’s suggestion, his superiors decide that a DDT solution mixed in a proper proportion will save the timber and not harm wildlife or domesticated livestock. This was certainly the best “scientific” response to the problem at the time, a response that Department of Agriculture would have approved. Continued study of DDT demonstrated that it produces a negative externality. It does affect more than just the moth larva, but how great is the negative externality?

The writer notes the controversy the use of DDT divides the community. One group supports the forest rangers. Another group fears that DDT would affect all local wildlife including livestock; the loggers attempt to incite this group to violent action. A final group is composed of environmentalists concerned with the impact of DDT on both livestock and wildlife. A conversation at 22:30 into the movie illustrates the divisions.

Logger: I hate to think what will happen when they lose it [DDT] from those airplanes.

Rancher 1: They claim it won’t do any harm.

Logger: If it kills the bugs in the trees, it will kill everything else won’t it?

Rancher 1: They say not.

Rancher 2: I heard of a fella that sprayed DDT on his dog to kill fleas. It killed the fleas alright, but it killed the dog too.

Loie: What is going to happen to the fish in the streams?

Rancher 3: Oh, you talk foolish Loie, besides the timber is more important than the fish.

Loie: Not to the fish it ain’t.

One may laugh at the naive scientific view that spraying DDT would not harm the ecosystem but it may be no more naive than the view that followed. In 1962, Rachel Carson published Silent Spring, a book noting that DDT did not biodegrade quickly and that it harmed all creatures, including people. The book caused led to a worldwide ban on the use of DDT, but the ban had a negative externality of its own. DDT was used to kill malaria carrying mosquitoes in Africa and it has no close substitutes. Millions of Africans died from malaria that might have been controlled by spraying DDT. In 2006 a better balance was reached; the World Health Organization (WHO) recommended the use of DDT to control malaria and governments around the world including the Bush administration. Some environmental groups including Sierra Club and Environmental Defense support a limited use of DDT to control for malaria (“WHO Backs Use of DDT Against Malaria”).

Are Kids Normal or Inferior Goods?

2011-06-14T12:16:00.001-05:00

Justin Wolfers asks the following question in post in Freakonomics.

Are you likely to have more kids if you are rich or poor? Or to put this in econo-jargon: Are kids normal or inferior goods? (Reminder: When you get rich you buy more of a “normal good,” and less of an “inferior good.” And yes, the language of economics can be a bit cold.)

Read the post “The Rich vs Poor Debate: Are Kids Normal or Inferior Goods?” to get the answer.

Adam Smith and Jane Austen

2011-06-10T11:05:00.001-05:00

In “Economics: A Moral Inquiry with Religious Origins,” Benjamin Friedman persuasively argues that Adam Smith, a man not noted for religious observance, was highly influenced by religious thought that was pervasive in 18th-Century Scotland. Jane Austen was a near contemporary of Smith, and a near opposite in upbringing being raised in a religious home as the daughter of Anglican Reverend George Austen and having little formal education[1]. As Smith’s writings reflected the religious thought of his time, Austen’s writing reflected Smith’s contributions to the Scottish Enlightenment. Characters in Jane Austen’s “Pride and Prejudice” exhibit sentiments described in Adam Smith’s “The Theory of Moral Sentiments.” Austen concludes that bad behavior by one person can lead to good outcomes for another and Adam Smith more completely describes the conditions under which self-interest, described as vice by others, results in social good.

I begin with a situation described by Smith in “The Theory of Moral Sentiments” and follow up with a parallel situation experienced by Austen’s characters from “Pride and Prejudice.” Smith writes

We sometimes feel for another, a passion of which he himself seems to be altogether incapable; because, when we put ourselves in his case, that passion arises in our breast from the imagination, though it does not in his from the reality. We blush for the impudence and rudeness of another, though he himself appears to have no sense of the impropriety of his own behaviour; because we cannot help felling with what confusion we ourselves should be covered, had we behaved in so absurd a manner.

In the scene from “Pride and Prejudice” I quote, Lydia Bennet and her new husband, Wickham, return home after a scandalous affair and mercenary marriage in which Wickham is paid to marry Lydia. The newlyweds show no sign of embarrassment.

Their sister’s wedding day arrived; and Jane and Elizabeth felt for her probably more than she felt for herself. The carriage was sent to meet them at___, and they were to return in it, by dinner time. Their arrival was dreaded by the elder Miss Bennets; and Jane more especially, who gave Lydia the feeling which would have attended herself, had she been the culprit, was wretched in the thought of what her sister much endure….

Wickham was not at all more distressed than herself, but his manners were always so pleasing, that had his character and his marriage been exactly what they ought, his smiles and his easy address, while he claimed their relationship, would have delighted them all. Elizabeth had not before believed him quite equal to such assurance; but she sat down, resolving within herself, to draw no limits in the future to the impudence of an impudent man. She blushed, and Jane blushed; but the checks of the two who caused their confusion, suffered no variation of colour.

Adam Smith demonstrated conditions under which self-interest causes social good in “The Wealth of Nations.” A quote illustrates this marvelous insight.

It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.

Jane Austen seems to struggle more with the idea that individual vice (self-interest) can lead to good outcomes but note that it is only an individual’s vice leading to a good outcome for that individual that concerns her. In the book, Elizabeth Bennet and Mr. Darcy discuss the events that lead to their engagement. Two were particularly important. Lydia revealed to Elizabeth that Mr. Darcy had attended her wedding. Anxious for details, she improperly solicited information from her aunt who also attended the wedding and would have known of the arrangements made to induce Wickham to marry. In another scene, Mr. Darcy’s officious aunt attempts to convince Elizabeth not to marry Mr. Darcy. Even though Elizabeth had no understanding with Dr. Darcy, she refused to promise that she would spurn a proposal.

I wonder when you would have spoken [proposed], if I had not asked you [about Lydia]! My resolution of thanking you for your kindness to Lydia had certainly great effect. Too much, I am afraid; for what becomes of the moral, if our comfort springs from a breach of promise, for I ought not to have mentioned the subject? This will never do.

You need not distress yourself. The moral will be perfectly fair. Lady Catherine’s unjustifiable endeavors to separate us, were the means of removing all my doubts. I am not indebted for my present happiness to your eager desire of expressing your gratitude. I was not in a humour to wait for any opening of your’s. My aunt’s intelligence had given me hope, and I was determined at once to know every thing.

Lady Catherine has been of infinite use, which ought to make her happy, for she loves to be of use.

A reader might conclude that Austen was a student of Smith, but a more probable explanation is that both were products of the same culture, and with keen powers of observation, interpreted the outcomes caused by the interactions of people in much the same way.

[1] Biographical information on Jane Austen was found at Jane Austen.org.

Initial Claims for Jobless Benefits

2011-06-09T10:44:00.001-05:00

The level of unemployment can be viewed as a combination of stock and flow variables. The level of unemployment at any given time is a stock variable and is affected by recent layoffs, recent hires, and changes in the labor force, each of which is a flow variable. Holding the labor force constant, the level of unemployment increases when recent layoffs exceed recent hires.

Initial claims for state jobless benefits is a statistic produced by the BLS that is often used as a proxy for recent layoffs. For the week ending May 28 was 427,000, an increase of 1,000 from the previous week. The four week moving average of initial claims, which is viewed as a more stable statistic of changes in unemployment, fell 2,750 to 424,000. Most economists believe that initial claims will have to fall below 400,000 per week for the employment market to improve.

Akerson on Gas Tax and CAFE Standards

2011-06-08T12:24:00.000-05:00

In an EconTalk podcast of Milton Friedman hosted by Russ Roberts, Friedman explains that businesses leaders do not usually support policy that strengthens markets. They do what is best for them.

[I]t's always been true that business is not a friend of a free market...It's in the self-interest of the business community to get government on its side. It's in the self-interest of a particular business...But the real puzzle—puzzle isn't quite the right word—the real problem here is where do you find the support for free markets? If free markets weren't so damn efficient, they could never have survived because they have so many enemies and so few friends. People think of capitalism or free markets as something that obviously is supported by business. People think that if a business party is a party in politics, it will promote free market. But that's wrong. It will be in the self-interest of individual businesses to promote a tariff here and a tariff there…

With Friedman’s admonition in mind, I read the following interview of GM’s CEO, Dan Akerson (David Shepardson and Christina Rogers, “GM's Akerson pushing for higher gas taxes,” The Detroit News).

Detroit — General Motors Co. CEO Dan Akerson wants the federal gas tax boosted as much as $1 a gallon to nudge consumers toward more fuel-efficient cars…Akerson would like to see it (the federal government) step up to the challenge of setting a higher gas tax, as part of a comprehensive energy policy.

A government-imposed tax hike, Akerson believes, will prompt more people to buy small cars and do more good for the environment than forcing automakers to comply with higher gas-mileage (CAFE) standards.

If you believe that Americans should consume less oil, Akerson’s statement holds up pretty well. GM does sell an electric car, the Volt that is highly subsidized by the government and the cost of driving the Volt would be much less sensitive to gas prices than a car that is only powered by gas. They also make a number of fuel efficient cars that might do well relative to competitors if the cost of fuel rises due to a $1.00 per gallon tax. Consumers would face a tradeoff. They would substitute new car purchases toward more fuel efficient cars but the increase in gas prices is the same as a decrease in income. The income effect would lower the overall sales of new cars.CAFE standards have several disadvantages relative to increasing the gas tax. They increase the cost of making a vehicle, but lower the marginal cost of driving by increasing fuel efficiency. We will drive more because we will spend less at the pump, but not as much as we would have driven in absence of the increase in the CAFE standards.

Increased CAFE standards only result in increased fuel efficiency of new cars that meet higher standards. It does nothing to increase the efficiency of cars we already drive. Furthermore, to the extent that drivers resist buying efficient cars as they have in the past, the higher CAFE standards will result in an older U.S. fleet. Crandall (1992),[1] estimates that the full impact of the higher standards would not be realized for eight years after implementation. Old cars also pollute more than new cars.

An increase in the gasoline tax would decrease the impact on automakers and consumers compared with increasing CAFE standards. People would drive less, reducing the demand for new vehicles. Demand would shift from less fuel efficient vehicles to more efficient vehicles. More subtle market signals for increased efficiency would replace heavy handed mandates.

All drivers, including those with older vehicles, face incentives to drive less with an increase in the gasoline tax. Gone is the adverse impact of the CAFE standards which incentives people to drive more by reducing the marginal cost of driving. Less driving also lowers pollution and congestion.

Crandall concludes that

The existing empirical literature suggests that CAFE costs about 7 to 10 times as much as a petroleum tax that would induce comparable reductions in oil consumption, because CAFE fails to equate the marginal costs of reducing fuel consumption across all uses, including usage of older vehicles and nonvehicular consumption.

CAFE is an even less efficient mechanism to reduce greenhouse gases. To reduce CO2 emissions, a carbon tax is much more efficient than a petroleum tax, which in turn is decidedly more efficient than CAFE standards. The empirical evidence suggests that CAFE would cost the economy at least 8.5 times as a carbon tax with equivalent effects on carbon emissions.

[1] Crandall, Robert W. Journal of Economic Perspectives, "Policy Watch: Corporate Average Fuel Economy Standards," Vol. 6, Num. 2, Spring 1992.

A B Western with a Great Economic Foundation

2011-06-07T13:22:00.000-05:00

Feeling nostalgic for old cowboy movies I watched every Saturday morning when I was a lad, I downloaded a Gene Autry movie, “Cow Town” through Netflix. In addition to a few songs, horse chases and shootouts, it had a very plausible economic foundation, a rare event in any movie let alone a B Western.

The story was written by Gerald Geraghty in 1950 and explains how barbed wire changed the West. The movie opens with a documentary description of hardships faced by cattlemen raising their herds on the open range: lightning caused stampedes, hard winters, and rustling. The description could have been improved by explaining how the common range was a “common resource” and was overgrazed, a problem that economists named the “tragedy of the commons.”The story pitted open range cattlemen against those who wished to control it by fencing property with barbed wire. Closed range cattlemen believed that barbed wire fences would reduce operating costs and improve cattle genetics. Cow hands, who were after all an operating cost, feared that the innovation would reduce employment opportunities, opposed closing the range. Finally, two sheepherders attempted to fan the animosity between the three other groups into open warfare to push down land prices so they could make a killing on the market and turn cattle country into sheep country.

Two scenes exemplified problems with ill defined property rights and resource allocation. In one scene, open range cattlemen complain to the sheriff about fences blocking roads, the delivery of the mail and injuring cattle. The sheriff asks for time to solve the problem stating that their is no law to covering their complaints. These cattlemen were asking for enforcement of “range rights” or unwritten but respected rules governing behavior on the frontier. Another scene anticipates the Coase theorem: if private parties can bargain without costs, they can solve problems with externalities (fences) and allocate resources efficiently. In the scene, Autry confronts a neighbor who cut his fence. She said she had the right to use the road to get to town. He replies that he would have built a gate had she asked.

Enough Fossil Fuel for Now?

2011-06-06T10:57:00.000-05:00

Michael Lind writes a very good column for Salon entitled “Everything you’ve heard about fossil fuels may be wrong.” At least I think it is a great article because it eloquently states opinions I hold. While I should beware of confirmation bias, I hope other readers will be exposed to new ideas.

In short, the Lind writes that new technologies like hydraulic fracturing have dramatically increased reserves of natural gas and oil. Governments are funding basic research into other methods of producing gas hydrates that could supply enough hydrocarbons to fuel civilization for centuries. Countries with now exploitable natural gas and oil reserves are numerous, stable and friendly. This implies that energy markets will be more competitive, dramatically weakening if not eliminating OPECs ability to set price. Finally, he observes that most governments are treating CO2 emissions as a low priority because catastrophic outcomes of global warming are low probability outcomes.Lind makes a supporting argument that I believe deserves more attention.

All energy sources have potentially harmful side effects. The genuine problems caused by fracking and possible large-scale future drilling of methane hydrates should be carefully monitored and dealt with by government regulation. But the Green lobby’s alarm about the environmental side-effects of energy sources is highly selective. The environmental movement since the 1970s has been fixated religiously on a few "soft energy" panaceas -- wind, solar, and biofuels -- and can be counted on to exaggerate or invent problems caused by alternatives. Many of the same Greens who oppose fracking because it might contaminate some underground aquifers favor wind turbines and high-voltage power lines that slaughter eagles and other birds and support blanketing huge desert areas with solar panels, at the cost of exterminating much of the local wildlife and vegetation. Wilderness preservation, the original goal of environmentalism, has been sacrificed to the giant metallic idols of the sun and the wind.

I might add to his arguments that supporters of alternative energy often act as if the cost of switching from hydrocarbon based fuels to alternative energy sources is low but experience has taught that the opportunity cost is high. If it were easy to switch to alternative energy sources, we would have done it already.

A Gallup Poll on Attitudes Toward the Wealthy

2011-06-03T12:44:00.000-05:00

A Gallup poll released today released a survey of American’s opinion on the distribution of earnings and wealth. It is an ongoing survey conducted for more than a decade. The three questions and response are provided below.

Do you feel that the distribution of money and wealth in this country today is fair, or do you feel that the money and wealth in this country should be more evenly distributed among a larger percentage of the people? (Distribution is fair, 35%; should be more evenly distributed, 51%; no opinion, 8%)
As far as you are concerned, do we have too many rich people in this country, too few, or about the right amount? (Too many, 31%; too few, 21%, right amount, 42%, no opinion 7%)
People feel differently about how far a government should go. Here is a phrase which some people believe in and some don’t. Do you think our government should or should not redistribute wealth by heavy taxes on the rich? (Yes, should, 47%; no, should not, 49%; no opinion, 4%)

The majority of respondents clearly answered the second question incorrectly. There are obviously too few rich people. The percentage of rich should approach 100%.

The results of the first and third questions are interesting in and of themselves, but I would like to see deeper results. As follow up questions to the first, I would ask why and give the following options.

The economic system favors the wealthy.

The political system favors the wealthy.

I want the rich to pay for benefits I receive from the government.

I want to pay for the benefits of others so long as others in my socioeconomic class do as well.

To the third question, I would again ask why and give following options.

Taxing the rich more will help the economy grow.
Taxing the rich more will not affect the economy.
Taxing the rich more will harm economic performance, but I want to punish the rich.
Taxing the rich more will help economic performance, but it not fair to more heavily tax the rich.
Taxing the rich more will harm economic performance.

Portraits on U.S. Currency

2011-06-02T11:42:00.001-05:00

Politicians are over represented on our currency creating the false impression that service through elected office is our nation’s highest calling. I suggest that the portraits of the following great Americans be added to those on our currency and that the portraits change periodically much as portraits the portraits on stamps.

William Gates (dollar Bill)
Amadeo Giannini
George Mellon
Susan B. Anthony and Sacagawea (put them on coins that people carry)
Emily Dickinson
John Steinbeck
Mark Twain
William Rittenhouse
Joseph Smith
Martin Luther King Jr.
Muhammad Ali
Babe Ruth
Adam Smith (technically not an U.S. citizen)
Milton Friedman
Luis Walter Alvarez
Thomas Edison
George Washington Carver
Barbara Streisand
Paul Simon and Art Garfunkel (two dollar bill)

Certainly, many other great Americans deserve the honor of appearing on our currency.

More Oil or a Cleaner Environment

2011-06-01T14:09:00.001-05:00

There is little that a president can do in the short-run to lower oil prices but policy does affect prices in the long-run. The prices we pay today are in part the result of policy executed over the past forty years. Those policies were aimed at restricting drilling or increasing regulatory standards to protect the environment, vilifying and harassing oil companies to drive up costs and replacing oil with an alternative energy source.

The prices that we pay in the future are in part the result of policies that we enact today and those policies seem to be a continuation of past policy. New hydraulic fracturing (fracking) techniques hold the potential to vastly expand oil and gas production but at a potential environmental cost to water quality. Cheaper energy for degraded water quality is an important tradeoff, and no we cannot drill for oil or gas without environmental cost. Given our very high quality of water standards and the strain to the economy by high energy prices, I favor moving the balance on the tradeoff toward more oil and gas.

The U.S. Fish and Wildlife Service may place the sand dune lizard that lives in an rich section of West Texas on the endangered species list creating a huge new hurdle oil producers must clear to bring oil based products to market (Jerry Patterson, “Patterson: Texas lizard represents the latest example of failed U.S. energy policy”). This seems like harassment to me. I wonder what it would cost to breed the lizards then place them back in their native environment.

The tradeoff between cheaper energy and a cleaner environment exists. If we as voters wish to push that tradeoff towards a cleaner environment we must not complain when energy prices rise.

Special Tax Breaks for Big Oil?

2011-05-31T08:43:00.000-05:00

The Senate recently concluded a debate on ending Section 199 deductions of the American Job Creations Act of 2004 for the five largest American oil companies. With a few exceptions, the debate was framed by language that I believe was designed to elicit an emotional rather than an informed response from voters. After reading or listening to news accounts of the debate, I was unable to express an informed decision. I went back to the original legislation and read it. Because it uses both arcane accounting and legal language, I searched the Internet for short descriptions of the legislation.

William Perez does a nice job of summarizing Section 199 (“Domestic Production Activities Deduction: Section 199 Deduction”). The entire article is well written and worth the time spent in reading it. In part, he writes

Here's the basics:
Businesses with "qualified production activities" can take a tax deduction of 3% from net income. This is a tax break pure and simple. The more complicated the business, the more complicated the math for calculating the Domestic Production Activities Deduction. In a nutshell, businesses engaged in manufacturing and other qualified production activities will need to implement cost accounting mechanisms to make sure their tax deduction is accurately calculated.

Domestic Production Activities Deduction
A business engaged in a qualfying production activity is eligible to take a tax deduction of 3% in tax years 2005 and 2006. The deduction increases to 6% in year 2007, and 9% in year 2010.

Qualified Production Activities
A business engaged in the following lines of business may qualify for the Domestic Production Activities Deduction. These are the "qualified production activities" eligible for claiming the deduction under Internal Revenue Code Section 199:

Manufacturing based in the United States,
Selling, leasing, or licensing items that have been manufactured in the United States,
Selling, leasing, or licensing motion pictures that have been produced in the United States,
Construction services in the United States, including building and renovation of residential and commercial properties,
Engineering and architectural services relating to a US-based construction project,
Software development in the United States, including the development of video games.

I hope that this information helps readers obtain an informed opinion.Replace this text with...

Cut the First Lady’s Staff

2011-05-28T12:11:00.001-05:00

I know a good place to cut the budget. It is with the first lady’s staff. Please don’t interpret my opinion on a particular dislike of Michelle Obama or any other first lady. As an aside, I do not like the title of First Lady of the United States. Because they are not elected, I prefer Mrs. Obama, Mrs. Bush, etc. According to Snopes.com (“Mixture of True and False Information”), Mrs. Obama has 23 or 24 staffers assisting her, approximately the same number as Laura Bush and significantly less than Betty Ford, Lady Bird Johnson or Jacqueline Kennedy. Four should be more than enough. The Congress should also cut all funds to support pet projects of the presidents’ wives.

Yertle on Circumcision

2011-05-28T08:31:00.001-05:00

When I write against an opinion presented in a blog or news article I try to sick to the issue and avoid name calling. I do make an exception for those who would make their private opinions law without a compelling cause. They are a pack of Yertles who, unsatisfied with being king of the pond, force their opinions on others through law.

MGM Bill (Male Genital Mutilation Bill) is currently stacking turtles to expand their importance. They recently made the news by introducing a ballot initiative in Santa Monica that would outlaw circumcision but that is not their only effort. They have introduced similar initiatives in other cities and are attempting to introduce legislation that would outlaw circumcision at the state and national level as well (“Ban on Circumcision Could Become Law in Santa Monica,” “Male circumcision opponents propose ballot measure in Santa Monica”). If their arguments are good, let them persuade others to not to circumcise their male children. If they are not good enough to persuade they should accept that others should be free to make decisions that they believe are in the best interest of their male children.

Your Report Card for President Obama

2011-05-27T10:57:00.000-05:00

Voters on the left claim that President Obama is extraordinary, restoring employment while transforming the economy to meet the challenges of the 21st century. Voters on the left claim that he is among the worst presidents, a reincarnation of President Carter who has ineffectively dealt with the Great Recession and through health care and regulatory reform has placed the dynamic American economy into a comatose state.

To help readers grade President Obama’s performance and the economy’s performance since the beginning of recession, I have included three characteristics that Reinhart and Rogoff (“This Time is Different”) believe that financial crisis share juxtaposed with corresponding U.S. statistics which are bolded.

Asset Markets

First, Asset market collapses are deep and prolonged. Declines in real housing prices average 35 percent stretched out over six years, whereas equity price collapses average 56 percent over a downturn of about three and a half years.

Housing prices fell 24.7 percent from the their peak in the third quarter of 2007 and are forecast to fall another 5.5 percent in total (“Fiserv Case-Shiller Home Price Insights: After Five Years of Record Declines, U.S. Home Prices Begin To Stabilize”). The DJIA fell 43% from a high of 14,164.53 on October 9, 2007 to a low of 8,046.42 on November 21, 2008. The index has recovered to 88 percent of its high value and now stands at 12,468.19 at the opening of trading on May 27, 2011.

Output and Employment

Second, the aftermath of a banking crisis is associated with profound declines in output and employment. The unemployment rate rise an average of 7 percentage points during the down phase of the cycle, which lasts on average more than four years. Output falls (from peak to trough) more than 9 percent on average, although the duration of the downturn, averaging roughly two years, is considerably shorter than that of unemployment.

The U.S. unemployment rate rose 5.4 percentage points from 4.7 percent in September 2007 to 10.1 percent in October 2009. Nearly four years later, unemployment stands at 8.8 percent. Real GDP (2005 dollars) fell 4.1 percent from $13.363 trillion in December 2007 to $12,810 trillion in June 2009. By first quarter 2011, real GDP had fully recovered to $14,438 trillion.

Government Debt

Third, as noted earlier, the value of government debt tends to explode; it rose an average 86 percent (in real terms, relative to precrisis debt) in the major post-World War II episodes.

Nominal debt held by the public has increased from $5,055 trillion on August 29, 2007 and rose 90 percent as of April 2011.

A few other facts may be useful in grading the president’s success in managing the economy. The Troubled Asset Relief Program was signed on October 3, 2008 during the Bush administration. Funds were immediately released. Senator Obama voted in favor of the bill and retained the services of Tim Geithner and Ben Bernanke both have played significant roles during the Bush and Obama administrations. These facts will make it difficult to separate the performance of the two presidents.

The American Recovery and Reinvestment Act was signed on February 17, 2009. Very few funds were released prior to the ending of the recession in June 2009.

Rising oil prices may be harming the recovery. There is little a president can do in the short-run to lower energy prices.

Light Bulbs

2011-05-23T11:52:00.000-05:00

Governments face daunting yet ignored difficulties imposing efficiency standards on markets. They presume to have the knowledge and foresight that producers and consumers acting in markets lack. Hayek called this presumption the fatal conceit and famously wrote, “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”

The government’s imposition of energy standards for light bulbs illustrates the fatal conceit. I believe that their thinking went something like this.

Edison’s incandescent light bulb is more than 100 years old. When lighting the bulb, more energy is lost to heat than used in light. Certainly, it would be easy to make lighting more energy efficient. We will require bulbs to be 30 percent more efficient by 2014 and 70 percent more efficient by 2020.

In 2007, the Congress passed and President Bush signed legislation with this energy requirement and since that time manufacturers have had problems meeting new standards. Compact Fluorescent Lights (CFL’s) cost more, don’t last as long as promised, and pose a small environmental hazard. Light emitting diode bulbs (LED’s) are very expensive and will remain expensive even after production costs fall and competition increases.

Elected officials do not seem to realize that consumers pay attention to cost, both the purchase price and operating cost. I own a minivan rather than an SUV because it gets better gas mileage. My wife and I recently considered buying a bigger home. We considered the extra energy and water cost of maintaining the home. Manufactures have a profit incentive to provide products with characteristics that consumers desire and if consumers want energy efficient products, they will get them.

If our elected officials believe that energy consumption results in a negative externality, they should tax it and not establish “command and control” regulations like those imposed on light bulbs that are fraught with inefficiencies. Faced with higher costs for electricity, the interaction between buyers and sellers will efficiently determine the lowest cost method to consumers for lowering the consumption of electricity.

Boehner at the Catholic University of America

2011-05-18T12:02:00.000-05:00

President Obama is not the only politician to land in an awkward political position (See “Obama on Government Jobs”). As House Speaker John Boehner prepared to deliver a commencement speech at the Catholic University of America he was greeted with a letter signed by 70 signatories including faculty, priests and nuns that chided him for cuts in the social safety net contained in the budget that he guided through the House. In part, the letter read (transcript),

Mr. Speaker, your voting record is at variance from one of the Church’s most ancient moral teachings. From the apostles to the present, the Magisterium of the Church has insisted that those in power are morally obliged to preference the needs of the poor. Your record in support of legislation to address the desperate needs of the poor is among the worst in Congress. This fundamental concern should have great urgency for Catholic policy makers. Yet, even now, you work in opposition to it.

The 2012 budget you shepherded to passage in the House of Representatives guts long-established protections for the most vulnerable members of society. It is particularly cruel to pregnant women and children, gutting Maternal and Child Health grants and slashing $500 million from the highly successful Women Infants and Children nutrition program. When they graduate from WIC at age 5, these children will face a 20% cut in food stamps. The House budget radically cuts Medicaid and effectively ends Medicare. It invokes the deficit to justify visiting such hardship upon the vulnerable, while it carves out $3 trillion in new tax cuts for corporations and the wealthy.

I once read the majority of a book used in a Catholic high school that suggested social policies that Catholics in a market oriented society should support. That ideas the book were consistent with the values expressed in the letter. Both suggest that Catholics should support a government that actively helps the poor. Normative values are visions of what ought to be and as such are close to impossible to argue against and a vision of government rendering assistance to the poor is probably held by most Americans. I hold similar normative beliefs but different positive interpretation about how markets work and the impact of many social policies on the poor and the economy as a whole. I would not use the same policies the signatories to achieve their objectives. More often than not, policies that support competitive markets are best at aiding the poor.

In a similar vain, Speaker Boehner’s budget is defendable as aiding the poor. The budget cuts he supported are significant but less significant than the cuts that will be forced on the government should the national debt continue to grow unabated. A sovereign crisis could be more severe than the market crash of 2008.

Obama on Government Jobs

2011-05-16T12:54:00.000-05:00

Last week, President Obama was the guest at a Town Hall meeting hosted by CBS News. As I watched the interchange between Karin Gallo and President Obama I shook my head and wondered why any president would expose them self to this sort of event (transcript)(video).

KARIN GALLO: About three years ago, just under three years ago, I took a job with the federal government, thinking it was a secure job. Recently I've been told I'm being laid off as of June 4th. And it is not an opportune time for me, I am seven months pregnant in a high-risk pregnancy, my first pregnancy. My husband and I are in the middle of building a house. We're not sure if we're gonna be completely approved. I'm not exactly in a position to waltz right in and -- and do great on interviews, based on my timing with the birth. And -- so, I'm stressed, I'm worried. I'm scared about what I -- what my future holds. I definitely need a job. And -- I just wonder what would you do, if you were me? (LAUGH)

Where did CBS News find this woman? She is at the end of a high risk pregnancy, and was fired from a job after her husband and she began to build a new home. She is articulate and has a good sense of humor with a great sense of comedic timing. What are the odds that another person would have her skill set and experience this series of unfortunate events? She is certainly not a representative American. President Obama starts well suggesting that she should get a job but then gives a normative opinion that does not have positive support.

…let me just first of all say that -- workers like you for the federal, state, and local governments are so important for our vital services. And in -- and it frustrates me sometimes when people talk about "government jobs" as if somehow those are worth less than private sector jobs. I -- I think there's nothin' more important than -- workin' on behalf of the American people.

Is someone collecting trash for the government really “working more on the behalf of the American people” than someone who collects trash for a private firm? Is a government doctor or professor really more valuable to society than a private doctor or professor? Taking his statement to its logical conclusion, should we all work for the government to maximize our benefit to the American people?

Economists agree that government can provide valuable jobs within an economy. Milton Friedman, an economist famed for supporting a minimalist government, wrote in “Capitalism and Freedom”

A government which maintained law and order, defined property rights, served as a means whereby we could modify property rights and other rules of the economic game, adjudicated disputes about the interpretation of the rules, enforced contracts, promoted competition, provided a monetary framework, engaged in activities to counter technical monopolies and to overcome neighborhood effects widely regarded as sufficiently important to justify government intervention, and which supplemented private charity and the private family in protecting the irresponsible, whether madman or child—such a government would clearly have important functions to perform.

The correct question to ask is, given the current allocation of private and government jobs, should the next job added be private or government.

Speculators

2011-05-09T12:25:00.002-05:00

Every time oil prices rise rapidly, politicians seeking to curry support from beleaguered consumers blame speculators, a nebulous gang of ne’er-do-wells. If speculators have the power to drive up oil prices, why would Brent crfe prices fall by 13.3% and U.S. crude fall 14.7% for the week (“Oil falls again, gutted in record weekly drop”)?

The price of oil is determined by the interaction of supply and demand. The demand for oil has been growing because consumers in developing countries like China, India and Brazil have more income. Supply of oil has largely stagnated. It is not just that the supply of oil beneath the earth’s surface is finite, in many countries governments restrain exploration and production. Policies that limit production when demand is growing cause to higher prices.

The expectation of future price affects both the demand and supply for oil. If buyers expect prices to increase in the future, they buy now. If sellers expect prices to increase in the future, they sell later. Profit motivates speculators. If they guess the direction of prices correctly they can make hefty profits. If wrong, they will face similar losses. On the whole, speculators act in future markets to adjust and smooth prices over time, providing an important service to producers and consumers.

Oil prices will remain volatile because both supply and demand are not particularly responsive to price and much of the production for export markets is in politically unstable countries (For more information on the function of speculators see “Oil Speculators: Bad or Good”).Replace this text with...

An Observation on Chairman Bernanke’s Press Conference

2011-05-03T15:04:00.000-05:00

On April 27, 2011 held his first press conference as Fed Chairman Bernanke, such press conferences will now be held quarterly. Beginning at 53 minutes and 40 seconds, Chairman Bernanke was asked by a reporter who prefaced his question by quoting Reinhart and Rogoff’s book, “This Time is Different,” in which they found that recoveries following financial crisis tended to be slow if he thought that Americans expected too much from monetary policy.

Bernanke praised Reinhart and Rogoff’s now classic work but correctly explained that the book did not provide a full explanation of why these recoveries were slower and offered some possibilities from his research. These included problems in credit markets and housing sector, and inadequate fiscal and monetary response.

What constitutes and adequate or appropriate response is controversial and inspires an interesting and heated debate. I will focus on fiscal policy and debt accumulation. Reinhart and Rogoff write that “Arguably, the true legacy of banking cries is greater pubic indebtedness—far over and beyond the direct headline costs of big bailout packages.” The Bush and Obama administrations have followed a traditional path of bailing out financial institutions (TARP authorized spending of $700 billion) and offering fiscal stimulus through deficit spending (ARRA authorized expenditures of $787 billion). The recession has also reduced tax receipts.

The graph shows an index of the national debt held by the public. The index begins at 100 at the end of August 2007 as the housing bubble bursts. The gray area is represents the eighteen month recession that began in December 2007. The index has increase to 190.7, meaning that debt held by the public has increased 90.7 percent. This is an unfortunate sequence of events given the anticipated explosion of debt due to unfunded entitlements.Replace this text with...

Past Policy and Today’s Oil Price

2011-04-30T13:10:00.000-05:00

President Obama has correctly stated that there is little that the federal government can do to lower the oil prices in the short run but that is where the story begins, not where it ends. Recognizing that oil production results in pollution, environmentalists have engaged in a decades long battle to enact policies that restrict the production of oil while subsidizing renewable energy sources like wind, solar and biofuels. These policies have been consequential; supply has contracted and equilibrium price increased. Subsidies of wind, solar and ethanol have been expensive to taxpayers and resulted in little if any commercially viable production. Not satisfied with subsidies alone, the government has often mandated the use of these alternative energies forcing consumers to bear the higher cost.

President Obama supports a continuation of past environmentalist policies. David Harsanyi provides a couple of quotes that support high oil prices (“Why Isn't Obama Celebrating High Oil Prices?”).

In 2008, candidate Barack Obama was asked by CNBC's John Harwood, "So could the (high) oil prices help us?" Obama: "I think that I would have preferred a gradual adjustment."…That same year, current U.S. "Energy" Secretary…Steven Chu clarified that "somehow we have to figure out how to boost the price of gasoline to the levels in Europe."

In response to rising oil prices, President “Obama reissues call to end oil company tax breaks.” When you tax something, you get less of it. Taxing oil would not encourage production. While calling for more drilling, EPA has denied Shell a permit that would allow it to drill in the Arctic Ocean in Alaska. Shell is preparing to scrap its five year, $4 billion investment. Dan Springer writes (“Energy in America: EPA Rules Force Shell to Abandon Oil Drilling Plans”). The Obama administration dramatically slowed the issuance of permits for deep-water drilling after the BP blowout (“First deep-water drilling permit issued for gulf since BP oil spill”). These policies will result in higher oil prices in the future just as past policies have resulted in higher prices today.

There is nothing morally wrong or logically inconsistent with environmentalists’ beliefs. Oil production, like the production of any form of energy, results in pollution. A cleaner environment is a worthwhile objective. Everyone wants it but everybody wants cheap energy as well. This is where my disagreement with traditional policies supported by President Obama ends.

Government policies to find a cheap alternative to fossil fuels have failed and there is no reason to believe that future efforts will be more productive. Traditional environmental policy seems to underestimate the pollution caused by “green” energy sources. Windmills are ugly and blight areas where they are located. Ethanol production pollutes air and water and drives up food prices. I believe the tradeoff between wealth and a clean environment is steeper than traditionalist admit and as wealth falls, pollution increases. For example, people drive older cars and spend less on maintenance.

With no real evidence to support my opinion, I believe that support for traditional environmental policy comes largely from people earning more than the median income. This may cause a fissure in the Democrat’s voting coalition. Highly educated high income Democrats will continue to support these policies but the poor and many union members may not.

Counterintuitive?

2011-04-27T13:52:00.000-05:00

Josh Kraushaar writes (“Gallup: Seniors Most Favorable To Ryan Budget”)

A new Gallup/USA Today poll contains a counterintuitive finding: the age group most receptive to House Budget Chair Paul Ryan's plan to deal with the budget - seniors.

The poll finds 48 percent of seniors (those 65 and over) support Ryan's plan over President Obama's plan, while 42 percent back the president.

That's the highest total among the age groups tested - a 47 percent plurality between the ages of 50 and 64 backed Ryan, and a 45 percent plurality of those between 30-49 backed Ryan. But young voters overwhelmingly sided with Obama by a 23-point margin, 53 to 30 percent.

I do not think that the results are counterintuitive. President Obama’s health care reform takes $57.5 per year over the next decade from Medicare to fund an expansion of Medicaid, harming those who are Seniors now and those who will soon be seniors. The Ryan plan would maintain Medicare at current inflation adjusted levels for anyone currently under 55.

Seniors are supporting their interests and there is nothing counterintuitive in that (See Betsy McCaughy, “Medicare As We've Known It Isn't an Option” for a good comparison of the impact of President Obama’s health care reform and Representative Ryan’s proposed changes). Permanent Link

Downgraded Outlook

2011-04-22T10:10:00.000-05:00

When is bad news good? It makes that transition when it alerts us of a problem that is resolvable. On Monday, the rating agency Standard and Poor’s downgraded the outlook for the United States federal government from stable to negative because they believe that there is a significant risk that elected officials may not reach an agreement that addresses the country’s long-term fiscal imbalances caused by unfunded entitlement programs (“S&P Affirms US AAA Rating, Cuts Outlook to Negative”).

Some believe that the political class is so polarized that compromise is impossible. Others, knowing that voters to not like cuts in benefits nor increases in taxes and that any serious plan will require one or both, believe that any serious plan to resolve the problem offered by one party will be used as an effective campaign issue against the other. Good politics usually trumps serious economic reform.

The Chinese government sees the problem. As one of America’s biggest creditors with about 2 trillion in exchange reserves in dollar denominated assets “China Urges US to Protect Creditors After S&P Warning.” China is as trapped by our debt as we are. Any rush to sell dollar denominated assets, like United States Treasury bonds, will quickly lead to a collapse in price seriously damaging the value of remaining Chinese holdings.

Of course, the impact on the federal government’s fiscal crisis would be monstrous as well. The Greek debt crisis may illustrate the worst case scenario of what we could face. Greek debt currently has a yield of over 15% on 10-year bonds compared with the German rate of 3.27%, and the U.S. rate of 3.43% (“Greek PM: Ratings agencies running our lives”). The average maturity of the U.S. government debt is approximately 5 years. As a back of the envelope calculation, assume all debt is held in five years notes and the yield is 2.25%. Interest payments comprise approximately 15% of all federal outlays. If interest rates double to 4.5%, interest payments on the debt would rise to 30% of all current outlays. If they rose to 10%, interest payments would rise to 60% of all outlays. If interest rates rose to Greek levels of 15%, interest payments would rise to 100% of current outlays.

Federal government outlays are currently 24% of GDP. To maintain current levels of expenditures on all other programs, outlays would have to rise to 44% of GDP if interest rates rise to 15%. Not to lose the main point, it is the projected growth in unfunded entitlements that threatens our country’s fiscal stability. Rather than vote against a party that offers need reform, the wise voter will use time as a fulcrum to leverage future cuts in entitlements.

2011-04-15T12:44:00.000-05:00

I love my new 2010 Prius. They are fun to drive slow, something I thought I would never say about a car, and there is nothing like a long glide after a short pulse to increase gas mileage. I got 53.8 mpg on my last tank of gas and anticipate exceeding 55 mpg on this tank. The hybrid technology used in the Prius is a technological wonder but it comes at a price. It is more expensive than similarly sized cars. I figure that at $3.50 per gallon I will need to drive the car about 60,000 miles to recoup the initial sales price but that is dependent on a high resale value in six or seven years.

(HT Watts Up With That) Two new inventions threaten to knock the stuffing out of the resale value of current hybrids. Both projects are funded by Department of Energy’s ARPA-E grants. Researchers at the University of Minnesota have figured out how to combine carbon dioxide, sunlight and bacteria and turn it into oil (“The greens worst nightmare? A CO2 to Oil process”). If oil can be successfully produced using this technological advance, the price of gasoline would at least stabilize and could potentially fall making cars powered by the internal combustion engine cheaper to drive and environmentally less threatening.

The second invention is a new gasoline engine that was developed at the Michigan State University (“New gasoline engine design has 4x efficiency of pistons”). The team that made the Wave Disk Generator believe that it will provide a driving range exceeding 500 miles. They also believe that it will be 30% lighter and 30% less expensive than a plug-in hybrid, and that it will cut carbon emissions by 90% relative to gasoline engines.

Often, the invention is the easy part. The more difficult part is successfully producing a good in a market setting with the invention. Economists refer to this step as innovation. Let’s hope that these projects are successful innovations. What I lose in value on my Prius will make up with reduced driving costs on my future vehicles. Permanent Link

The Trouble with Tribbles and Entitlements

2011-04-14T12:47:00.000-05:00

In the Star Trek episode, “The Trouble with Tribbles,” the crew of the Enterprise docked at a space station where they found tribbles, small cuddly creatures that emit a warm, cooing sound. Tribbles are very much like federal unfunded entitlements. The promise of a worry free retirement with all the medical care that we desire is comforting. Unfunded entitlements have something else in common with Tribbles; they both grow rapidly when fed, stressing food supplies in the case of tribbles and debt levels in the case of unfunded liabilities.

The graph, “Total Revenues and Outlays,” shows actual revenues and outlays between 1971 and 2010 and projected revenues and outlays until 2021. The graph does not reflect the budget deal that reduced expenditures by $38 billion or less than two tenths of one percent of GDP. The vertical black line in 2011 separates actual budget numbers from the projected numbers. The dashed red line is the average level of outlays as a percentage of GDP for the years 1971 through 2010. The dashed blue line is the average level of revenue as a percentage of GDP for the same years.

The last two years have produced historically large deficits of 11.0 and 9.4 percent of GDP. Outlays are higher than the historical average and revenues are lower. Beginning in 2011, the gap between revenues and outlays narrows dramatically but both are well above the historical average of revenues and outlays as a percentage of GDP. The CBO’s major assumptions in the projection include (The Budget and Economic Outlook: Fiscal Years 2011 to 2021”)

Sharp reductions in Medicare’s payment rates for physicians’
services take effect as scheduled at the end of 2011;

Extensions of unemployment compensation, the one-year reduction in the payroll tax, and the two-year extension of provisions designed to limit the reach of the alternative minimum tax all expire as scheduled at the end of 2011;

Other provisions of the 2010 tax act, including extensions of lower tax rates and expanded credits and deductions originally enacted in the Economic Growth and Tax Relief Reconciliation Act of 2001, the Jobs and Growth Tax Relief Reconciliation Act of 2003, and ARRA, expire as scheduled at the end of 2012; and

Funding for discretionary spending increases with inflation rather than at the considerably faster pace seen over the dozen years leading up to the recent recession.

The CBO must use these assumptions because they are part of current law but they seem rosy. There would be huge political blowback for politicians that allow taxes to increase or Medicare payments to decrease implying that the national debt will almost certainly grow faster than the CBO projection. But these projections show the national debt continuing to rise past the dangerous level of sixty percent. Beyond the projection, unfunded Medicare, Medicaid and Social Security entitlements continue to increase.

Doctor McCoy learned that tribbles would not reproduce if they were not fed. Some economists have suggested a similar “starve the beast” strategy to limit the growth of entitlements and other government expenditures.

Gary Becker, Edward Lazear, and Kevin Murphy present evidence in a 2003 article, “The Double Benefit of Tax Cuts,” that the Reagan tax cuts of the 1980’s starved the beast producing reform and lower spending in the 1990’s.

In a 2008 paper, “Do Tax Cuts Starve the Beast: The Effect of Tax Changes on Government Spending,” Christina Romer and David Romer present empirical evidence that cutting taxes does not starve the spending beast. They suggest two alternative theories that they believe better fit the data: fiscal illusion, a tax cut without a spending cut weakens voters’ association of spending and taxes leading to an increased demand for spending, and shared fiscal irresponsibility, in which supporters of lower taxes or bigger expenditures jointly agree to ignore the impact of their actions on deficits.

I see evidence that all three effects influence political behavior. In light of the growing national debt, today I would place my money on fiscal illusion but being a small government guy, I am pulling for starve the beast.

Biofuels and Government Subsidies

2011-04-07T14:24:00.000-05:00

The United States is not the only country that mandates that food crops be converted to fuel. These mandates are a factor driving up food costs (“Biofuel rush driving up global food prices”).

Each year, an ever larger portion of the world's crops - cassava and corn, sugar and palm oil - is being diverted for biofuels as developed countries pass laws mandating greater use of nonfossil fuels and as emerging powerhouses like China seek new sources of energy to keep their cars and industries running. Cassava is a relatively new entrant in the biofuel stream.

But with food prices rising sharply in recent months, many experts are calling on countries to scale back their headlong rush into green fuel development, arguing that the combination of ambitious biofuel targets and mediocre harvests of some crucial crops is contributing to high prices, hunger and political instability.

This year, the United Nations Food and Agriculture Organization reported that its index of food prices was the highest in its more than 20 years of existence. Prices rose 15% from October to January alone, potentially "throwing an additional 44 million people in low- and middle-income countries into poverty," the World Bank said.

These renewable sources of fuel were to make oil importing nations less dependent on Middle Eastern oil. Maybe we are somewhat less dependent, but not sufficiently independent to free us from military entanglements.

The article concludes

While no one is suggesting that countries abandon biofuels, Dubois and other food experts suggest that they should revise their policies so that rigid fuel mandates can be suspended when food stocks get low or prices become too high.

My blogging voice is small, but I would be honored to be the first to suggest that governments eliminate all programs that subsidize or mandate the use of crops for fuel.

LearnLiberty.org

2011-04-07T13:09:00.000-05:00

I received an e-mail from LearnLiberty.org with links to the embedded video and to and its site. The video address a little understood characteristic of human society, spontaneous order which result in human action but are not of human design. These orders can solve most economic and other societal problems without planned orders, which are also necessary. Government officials often oversell the importance of their solution and fall prey to what Hayek called the “fatal conceit,” that government planners can organize society as if it were an assembly line or a military operation. They should recall Hayek’s admonition, “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”Replace this text with...

Another Skirmish in the Happy Meals War

2011-04-07T06:25:00.000-05:00

New York City Councilman Leroy Comrie would have his city join San Francisco’s attack on fast food chains that sell toys with meals deemed inappropriate for children by a political authority (“NYC Councilman Leroy Comrie Proposes Bill Banning ‘Happy Meals’”). He would require that toy laden meals be light on calories, fat and sodium. Without proof, or at least without proof proffered in the article he finds malevolent design in corporate headquarters.

It comes as no surprise that these ads and meals are also targeted in low income and minority neighborhoods that are already at risk for childhood obesity. These are the same communities that have limited access to supermarkets, limited access to healthy food options.

Assuming that fast food ads target low income and minority neighborhoods, I interpret corporate decisions differently. Corporate decision makers are expanding opportunities of residents by offering food that provides the biggest bang for the consumer buck. If parents want “healthy” food, these restaurants will provided it. One wonders how Comrie views parents. His statement suggests that they have limited options, yet markets provide options that consumers desire. His law suggests that parents are incompetent to make proper choices for their children without the guiding hand of a benevolent government.

In the article, Mason Smoot, vice president and general manager for McDonald’s in the New York Metro Area, offers a different view, my view.

Our Happy Meals make it easier for families to choose the right foods in portions just for kids. We provide options for our customers and trust them to make the decisions that are right for their families. Politicians should too.

Freeman on Unions

2011-03-25T14:24:00.000-05:00

I am under the general impression that unions are, on the whole, not good for an economy. In “Barro on Public Employee Unions and Collective Bargaining,” I drew from Robert Barro’s article “Unions vs. the Right to Work” to express something close to my opinion. Barro’s most significant paragraph read

There is evidence that right-to-work laws—or, more broadly, the pro-business policies offered by right-to-work states—matter for economic growth. In research published in 2000, economist Thomas Holmes of the University of Minnesota compared counties close to the border between states with and without right-to-work laws (thereby holding constant an array of factors related to geography and climate). He found that the cumulative growth of employment in manufacturing (the traditional area of union strength prior to the rise of public-employee unions) in the right-to-work states was 26 percentage points greater than that in the non-right-to-work states.

I am not a labor economist nor have I spent many hours poring over the economic literature on unions so I will my opinion with a little humility and offer a second, more favorable evidence-based opinion on the impact of unions. Richard B. Freeman is labor economist who, with colleague James Medoff, wrote “What Do Unions Do?” They come to the conclusion that unions are a net benefit to society. Freeman explains their conclusions in “Richard B Freeman on Labour Unions.”

[We] looked at unions from two perspectives: first, what we called the monopoly face of union – unions acting as raisers of benefits for their members – and second, the voice face of unions, or how unions represented labour in the workplace and in the body politic, giving voice to people who otherwise wouldn’t have had much say. I think, in the long run, this is the stronger and more important face of unions.

The first thing unions do is to raise wages for working people, and that obviously benefits the working people. They also increase the kind of benefits that workers want. So, if workers want pensions, the unions negotiate for that. If workers want maternity leave, that’s what they bargain for…>

Because unions make working life better for workers, they lower turnover in unionised workplaces. Employers with unions traditionally have workers who stay longer and contribute to raising the productivity of the enterprise. Employers also get more credible information about what workers really want in the workplace, because the union representatives are democratically elected and they really speak for the workers. So a good, functioning union is a real positive…

Often, a union that exercise market power is a bad thing, but not always. For example, professional athletes need a union to protect their interests from owners. I might add that job protection through unions may allow union members to acquire skills that are specific to a certain employer and not easily transferable to another job. This protection also increases productivity. Public unions may be differently placed. Freeman continues

Public sector unions are different in an interesting way. Private sector unions can do very little to raise the demand for their services. But public sector unions can try to convince voters that we need more police and better education. By politicking, they can help public sector employers raise the funds to provide more and better public services. They have that unique attribute.

I might add that public officials have less incentive than private employers to limit union gains in wages, benefits and number of jobs available.

Consensus of Economists on the Debt?

2011-03-24T13:16:00.000-05:00

(HT Mankiw) Economists believe that the mounting national debt threatens the long term financial stability of the United States. Cutting waste, a solution from the right and taxing the rich, a solution from the left are inadequate; entitlement programs must be addressed. Ten former chairmen and chairwomen of the Council of Economic Advisers, four who served Democratic presidents and six who served Republican presidents support the Bowles-Simpson report, “The Moment of Truth,” as the starting point of legislative action involving both parties (Politico, “Unsustainable budget threatens nation”).

While the actual deficit is likely to shrink over the next few years as the economy continues to recover, the aging of the baby-boom generation and rapidly rising health care costs are likely to create a large and growing gap between spending and revenues. These deficits will take a toll on private investment and economic growth. At some point, bond markets are likely to turn on the United States — leading to a crisis that could dwarf 2008…This is your teaser

“The Moment of Truth” documents that “the problem is real, and the solution will be painful.” It is tempting to act as if the long-run budget imbalance could be fixed by just cutting wasteful government spending or raising taxes on the wealthy. But the facts belie such easy answers.

Alice Rivlin, the first Director of the Congressional Budget Office, makes a similar observation (Brookings, “Address the Real Budget Issues”)

Squabbling over federal spending for the few months left in this fiscal year is a distraction from the serious deficit threats of the future. Threatening a costly, pointless government shutdown is just plain silly. Our elected leaders should turn to next year's budget and start sorting out needed government activities from lower priority ones we can live without. The president has offered cuts in long-standing programs to fund investment in future growth within a constrained total. He and Congress should work together to decide what we most want our government to do as we all tighten our belts. This will take hard work and willingness to compromise, not posturing and sound bites.

Even more important, we must also slow the long-term growth of Medicare and Medicaid and make Social Security solvent. We must reform our absurdly complex, inefficient tax code so it raises more money at lower rates. Otherwise, we face a debt catastrophe that could destroy our prosperity and world influence. These tough decisions must involve both parties working together so that neither side can blame the other for what has to be done.

Brave young people are risking their lives in the name of democracy in far places. Can't we show that our democracy works right here right now?

The added emphasis through bolding is mine.

Conceal Carry Laws on Texas Campuses

2011-03-17T13:45:00.000-05:00

The Texas legislature is deliberating a law that would allow all citizens with concealed handgun licenses to carry handguns on college campuses. Most debates about the impact of gun ownership on crime generate much heat but little light and this debate appears no different. Little evidence is presented to support a position. I have four objectives in this post. First, I will do a very quick review of the literature on the relationship between gun ownership and crime. Next, I will present a simple model that incorporates both positive and negative consequences of allowing concealed handguns on college campuses. I will also present my prior beliefs about the effects of gun ownership on crime. Finally, I will also suggested a method of phasing in laws allowing concealed weapons that could be reversed if data suggests that the laws increased rather than decreased crime on college campuses.

My review of the literature on the relationship between gun ownership and crime will of necessity be short. I know little about it. What I know is that the current assertion that crime decreases as gun ownership in a community increases is based on the influential work of John Lott. His book, “More Guns, Less Crime,” neatly summarizes his empirical findings. Before his research, the conventional wisdom held that there was a direct causal relationship between gun ownership and crime. Controversial research sparks additional research to confirm or disprove results. Ian Ayres and John Donohue published results that found no relationship between gun ownership and crime (“Shooting Down the ‘More Guns, Less Crime’ Hypothesis,” Sanford Law Review, Vol. 55, 1193, 2003; “The Latest Misfires in Support of the ‘More Guns, Less Crime’ Hypothesis,” Sanford Law Review, Vol. 55, 1193, 2003). Ayres and Donohue’s position seems to represent what might be called the academic “consensus” if it exists although research showing increased gun ownership having a positive or negative effect on crime exists (See also Ayers, “Super Crunchers”).An econometric model could be applied to measure the impact of any change in the use of conceal carry laws, but I will apply it to the current legislation which would allow concealed weapons on college campuses in Texas. A simple version of the model assumes that there are both direct and externality benefits and costs associated with increased gun ownership. Direct benefits include a student, staff or faculty member using a concealed weapon to stop a crime on campus. A positive externality results when someone with criminal intent reduces activities on campus out of fear that the envisioned victims might be able to protect themselves with guns. A direct cost includes a student acquiring a concealed carry license to plan a crime against a student or faculty member. A negative externality includes accidental shootings and crimes of passion.

My prior belief is that the direct benefits and costs would be low and would be overwhelmed by the externality benefits and costs. My father was a cop and provided anecdotal evidence. He told me that he never responded to a call in which someone had successfully protected themselves or their families with a gun, but that he responded to many calls in which a person shot a friend or family member fearing that they were a criminal. I also do not believe that the number of students or faculty who plan murderous escapades will change much with expanded rights. The level of crime will move depending on changes in the positive and negative external effects. If the positive effects were larger than the negative, then the law would be beneficial. If not, the law is harmful.

But why is opinion important when the impact of this law can be measured? A phased in law would create a natural experiment. It might work something like this. Twenty five percent of campuses, selected randomly, would allow faculty to carry concealed weapons. Annual data on campus related crime would be compared to crime rates on these campuses prior to the new law, and with the crime rates of campuses without the new right. If statistical evidence showed that the new law increased crime, the law would be rescinded. If the law reduced crime, faculty at all campuses would be allowed to carry concealed weapons and 25 percent of campuses would be selected to expand the right to carry concealed weapons to students as well. Annual data would again be collected. If the expansion of conceal carry rights to students increased crime, that portion of the law would be rescinded but faculty and staff could still carry concealed weapons. If the law reduced crime, it could be expanded to include students on all campuses. A phased in version of conceal carry laws accompanied by measurement of impact would take the guess work and some of the heat out of the debate.

Barro on Public Employee Unions and Collective Bargaining

2011-03-09T08:09:00.000-06:00

The dispute in Wisconsin between Governor Walker and the teachers union has brought a lot of political heat but little economic light with both sides claiming moral high ground but offering little evidence why that ground is theirs. In “Unions vs. the Right to Work,” published in the Wall Street Journal, Robert Barro makes four contributions to the debate: He offers a statement of economic theory concerning unions, a brief history of state law regarding collective bargaining, evidence of the impact of collective bargaining, and future battleground states between unions and state governments trying to impose fiscal discipline. I will summarize Barro’s first two points and use quotations to summarize the remaining two. The article is well worth reading.

Collective bargaining through unions gives its members market power in setting wages and for this reason was considered an antitrust violation. As time passed, unions were granted exemptions from antitrust laws by the Clayton Antitrust Act of 1914 and the National Labor Relations Act of 1935. Currently, 38 states allow union shops and 22 recognize the right to work.

Barro presents evidence that unions impede economic growth.

There is evidence that right-to-work laws—or, more broadly, the pro-business policies offered by right-to-work states—matter for economic growth. In research published in 2000, economist Thomas Holmes of the University of Minnesota compared counties close to the border between states with and without right-to-work laws (thereby holding constant an array of factors related to geography and climate). He found that the cumulative growth of employment in manufacturing (the traditional area of union strength prior to the rise of public-employee unions) in the right-to-work states was 26 percentage points greater than that in the non-right-to-work states.

Barro predicts states that will witness battles over collective bargaining.

In general, the most likely arenas are states in which the governor and both houses of the state legislature are Republican (often because of the 2010 elections), and in which substantial rights for collective bargaining by public employees currently exist. This group includes Indiana, which has recently been as active as Wisconsin on labor issues; ironically, Indiana enacted a right-to-work law in 1957 but repealed it in 1965. Otherwise, my tentative list includes Michigan, Pennsylvania, Maine, Florida, Tennessee, Nebraska (with a nominally nonpartisan legislature), Kansas, Idaho, North Dakota and South Dakota.

Fitzgerald on MIT Students and Economics

2011-03-08T06:56:00.001-06:00

Deborah Fitzgerald is the Dean of the School of Humanities, Arts and Social Sciences. At the beginning of the MIT150 Symposia, she made the following comment on MIT students and economics.

Economics is one of the 10 departments of school of Humanities Arts and Social Sciences. It is the largest department and it has the most faculties, the largest of graduates, and has the largest number of graduate students. It also has the most Nobel Prize winners of all the departments in my school. All 10 department of the school are dictated to the education of MIT students. Each student at MIT under graduate is required to take 8 classes in their fields in Humanities Arts and Social Science which is quite high by pier standards we see a lot of under graduates in our school. From all fields across the board the under MIT graduates tend to gravitate to Economics Department drawn by illustrious faculty as well as by rigor of the classes they encounter. MIT students in my experience tend to scoff at materials that are not very difficult. They find in economics more than adequate challenge to their considerable abilities.

A Problem with Medicare

2011-03-01T20:59:00.001-06:00

In “Let's Begin Obama's 'Conversation' on Entitlements,” the Wall Street Journal identifies a major problem with Medicare.

According to Eugene Steuerle of the Urban Institute, an average couple retiring last year can look forward to consuming Medicare benefits with a present value of $343,000, having paid Medicare taxes with a present value of $109,000.

And don't let that figure get your hopes up, because even that $109,000 is not available today. That money was spent long ago. The government's trust funds are a fraud. Indeed, by some large amount, society missed out over many decades on domestic savings and investment that would have taken place had workers not been relying on unfunded government promises to support them in retirement.

There are only four solutions: raise taxes, cut benefits, reform Medicare, or some combination of the other three.

Driving Costs and the Demand for Cars

2011-02-28T13:47:00.000-06:00

Gasoline is an important complement to cars. Other things equal, as gasoline prices rise, miles driven and car sales decline, but more can be learned by separating cars into makes and models, making one a substitute for another. But the strength of that relationship depends on a number of characteristics. One make and model, a Honda Civic, may be a strong substitute for another, a Toyota Corolla, and a weak substitute for another, a Chevy Tahoe.

With the price of related goods for the demand car model in mind, I constructed a table based on the per mile total cost to operate the seven different models over five years assuming the cars were driven 15,000 miles per year. All the costs except fuel were taken from Yahoo Autos. Fuel costs were estimated using the average of EPA City and Highway estimates at gasoline price beginning at $2.75/gallon, increasing at $.25 increments to $4.25/gallon. Fuel economy ranged from 18 City/27 Highway for the Ford Taurus to 51 City/48 Highway for the Toyota Prius.

This is a simple model; the only cost that changes as gasoline prices rise is fuel. I expect that other elements of cost would change as the price as well, For example, the price of fuel efficient cars would rise relative to less efficient automobiles both in the new and used markets. Because I don’t have data to predict the changes in new car purchase price and the used car sales price, I did not modify Yahoo’s cost estimates. The graph of the per mile total cost of the seven vehicles yielded some expected results and some surprises. As expected, the total cost per mile of the hybrids rose more slowly than non-hybrids, but not dramatically so. I anticipated that the total cost per mile of the non-hybrids would be lower at low gasoline prices but would be higher than the hybrids at high gasoline prices. The Civic and the Fusion both came in non-hybrid and hybrid models and in both cases, the hybrids had lower total cost per mile than their counterparts at $2.75, and that cost differential grew as prices rose.

The reason that gasoline prices did not influence total cost per mile is that they are a relatively small part of overall cost. Fuel cost never rose above 33% of total cost (Mazda 3 Sports i), and were as low as 17% of total cost at $4.25/gallon (Toyota Prius). In general, models that were relatively less expensive at low gasoline prices were less expensive at high gasoline prices.

Consumers will try to lower the cost of owning a car, but how? A more sophisticated inquiry might study the complementarity of makes and models. Is a minivan a stronger or weaker complement to a large SUV than a crossover? Likewise, is a compact hybrid a stronger or weaker complement to a compact than a subcompact?

Thoughts on Revolution and Oil Disruption

2011-02-23T13:48:00.001-06:00

Revolution is sweeping through North Africa and the Middle East. The governments facing this spontaneous uprising are universally totalitarian. Some have had good relations with the United States and some have not. No one knows if the new governments will be more democratic or less, or if more democratic regimes will be less friendly to the United State and our allies. Assume the worst, that anti-American, totalitarian, radicalized pro-Iranian governments replace current regimes. What will this mean for oil output and prices?

I believe that after a temporary spike due to the fear of disruption of or actual disruption of supplies, output and production will resort to their pre-revolution trend. My conclusion is based on two assumptions. First, like their predecessors, the new regimes will attempt to maximize oil revenue. This means setting a monopoly price through OPEC or some similar cartel. These countries are poor, and long-run reduction of production below the optimal cartel price would reduce economic activity leading to greater discontent. The new regimes would face counter revolution elements in their own government willing to supply oil to the rest of the world and these challengers would be able to promise bigger rewards to backers than the current regime based on increased oil production. Second, although the new regimes would set prices through a cartel, they would have as much incentive to cheat on cartel prices as those they replace, making it difficult for the cartel to maintain production quotas. In short, the revolutionary frenzy may be bad for the U.S. diplomatically, it will not mean a great deal economically.

Two Problems with Profiling

2011-02-18T14:45:00.000-06:00

Profiling is a method of observing characteristics, actions and circumstances to draw conclusions about a person. It is a useful tool that we all use every day. Doctors build health profiles based on age, weight, race, sex and personal habits such as drinking and smoking. Amazon books uses profiling to suggest books you might be interested in based on past purchases and current browsing.

Profiling becomes controversial when race is one of the observed characteristics or when the profiler can legally use coercion on the profiled even when the profiled characteristic is statistically based. Suppose Officer Holmes of the Arcadia Police Department observes that drug use has crept into his normally peaceful jurisdiction. He travels to Gotham and notes that four times as many Hispanic males are arrested on drug charges than Asian males. Based on that observation, he focuses his time and other police resources on Hispanic males to reduce drug related crime. The problem could be one of reverse causality. Perhaps more Hispanic males were arrested in the past because the police harbor prejudices against Hispanic males. They are arrested more frequently because they are investigated more frequently.

Now assume that Officer Holmes has read scientifically conducted research based on surveys that finds that 12% of Hispanic males acknowledge illegal drug compared to 3% of Asian males. He is scientifically justified in using race as a profiling characteristic, but problems remain. In the course of his work, using race, sex, location and other behaviors to profile potential drug users, he observes 1,000 Hispanic males. Of these, he stops and questions 270, and of these, he arrests and charges 60 with a drug related crime and all are convicted. The remaining 210 Hispanic males were innocent and while they were only stopped and questioned, may resent Holmes’ behavior and grow to distrust the police.

Profiling becomes more objectionable as the ability to correctly identify offenders decreases and the level of coercion increases. On January 8, 2011, Jared Loughner made himself notorious by killing six and wounding twelve in a failed assassination attempt of Congresswoman Gabrielle Giffords. Some called for more stringent gun control. Second Amendment supporters and gun owners argued that it would be wrong to inconvenience many gun owners for the actions of a single deranged man. Others noting that friends, family, students and teachers had observed Loughner’s erratic behavior and on several occasions had called the police for assistance suggest that a stronger enforcement mechanism be developed to help youths with mental disorders and protect the public.

Let’s say that Arizona imposes a new law that that allows authorities to medicate youths profiled by behavioral characteristics as potentially violent. Assume that researchers followed the behavior of 10,000 young adults and one in a thousand (10 young adults in our sample) have a disorder that will lead to acts of violence. Now assume that we implement a system that correctly identifies 80% of those with potentially violent mental disorders (8 of the ten potentially violent young adults are identified. Two are not.). But there is a tradeoff. In our example, there are 9,990 young adults who are not potentially violent yet one time in a hundred, or 99.9 times a young adult will be wrongly identified as being potentially violent and subject to forced mediation. Is catching 8 of 10 potentially violent worth the cost of forcefully medicating nearly 100 who are not? If this tradeoff is too high, how many wrongful forced medications will you tolerate to stop the violence these youths will cause?

Jeffrey on Social Welfare Programs

2011-02-17T14:30:00.000-06:00

(HT Drudge Report) Terence Jeffrey’s article, “Jeffrey on Socialism's Trajectory: Obama's HHS Is Bigger Than LBJ's Government,” is an interesting blend of the good, the bad and the ugly. To be sure, the bad and the ugly are small, and the good is big. His main point is that in the past increased spending on social welfare programs has dramatically increased the size of government and placed us on a socialist path to ruin and that Patient Protection and Affordable Care Act (healthcare reform) pushes us further down that path.

The ugly is the overuse of the word “socialism.” The Merriam-Webster Dictionary defines socialism as

a system or condition of society in which the means of production are owned and controlled by the state.

None of the programs he mentions, Social Security, Medicare, Medicaid, the prescription drug benefit, and now healthcare reform is a socialist program. The government exercises control without owning the means of production. Like socialism, the healthcare programs, as they have been designed and implemented, have weakened markets by limiting the role of prices. Socialism is only one road to serfdom.

The bad is the exaggeration of the growth of government associated with the introduction of Medicare and Medicaid in 1965 and the prescription drug benefit in 2003. He introduces his ideas with an interesting fact he discovered while examining the historical tables published with Obama administration’s $3.7 trillion budget. If the budget is passed as the administration proposes, the Department of Health and Human Services will spend $909.7 billion, more than the entire 1965 inflation adjusted budget of $822.6 billion. The fact is a good literary tool because it catches the eye, but it also exaggerates the still impressive growth of government. It exaggerates because America’s population and wealth have grown; we should expect a bigger budget. Measuring the budget as a percentage of gross domestic product is a more meaningful measure.

As Jeffrey noted, budget expenditures, which were 17.2% of GDP in 1965, grew to 25.3% of GDP in 2010. Expenditures by Health and Human Services represented a miniscule .68% of GDP in 1965 to 6.25% in 2010. The contribution of Health and Human Services expenditures to the total budget is similarly impressive. Those expenditures were 6.24% of total budget expenditures in 1965 and grew to 24.7% in 2010.

The good was Jeffrey’s brief tour of important events leading to an expansion of the size of government. In 1937, Roosevelt attempted to pack the Supreme Court with politically like-minded justices. He failed to pack the Court, but he succeeded in intimidating it. Social welfare programs deemed unconstitutional prior to the attempted Court packing were found constitutional thereafter. Medicare and Medicaid began in 1965 and government grew. The prescription drug benefit was signed into law in 2003 and the government grew. The new programs are at least correlated with an increase in the size of the federal government as a percentage of GDP and because they programs have grown rapidly, they are probably one of the causal factors of government’s growth.

Wind Farms: Production Costs and Externalities

2011-02-15T13:55:00.000-06:00

The pollution that results from the consumption of carbon based fuels is well known. Less well known is the pollution produced by alternative sources of energy. This post highlights pollution generated by wind farms. The document I am quoting, “Why Wind Won't Work? - it's Weaker than Water.,” was produced by the Carbon Sense Coalition. As the name implies, the group is doubtful of the value of alternative sources of energy. They describe themselves as

…a voluntary group of people concerned about the extent to which carbon is wrongly vilified in Western societies, particularly in government, the media, and in business circles. We aim to restore balance and reason to the carbon debate, and to explain and defend the key role of carbon in production of most of our energy for heat, light, and transportation, and all of our food.

The scientific method involves methodical study and measurement and prudent researcher should examine sources and our own biases. The article is not a scientific article but I believe that it makes valid points about problems associated with wind farms. In part, the executive summary reads

Wind power is very dilute, and thus a large area of land is required to gather significant energy. Wind energy needs a wide network of roads, transmission lines and turbines which degrades any area containing wind farms. It has a huge land footprint.

The operating characteristics of turbine and generator mean that only a small part of wind energy can be captured.

Wind power is also intermittent, unreliable and hard to predict. Therefore large backup or storage systems are required. This adds to the capital and operating costs and increases the instability of the network.

Wind farms are uniformly hated by neighbours and will not be willingly accepted without heavy compensation payments. Their noise, flicker, fire risk and disturbing effect on domestic and wild animals are well documented.

The wind is free but wind power is far from it. Its cost is far above all conventional methods of generating electricity. Either taxpayers or consumers will pay this bill.

The third paragraph begins, “Wind power is also intermittent, unreliable and hard to predict.” The article provides evidence from Texas and reported in the Daily Kos.

Wind turbines are prominent in Texas, but a cold snap in early 2008 caused power demand to soar and winds to drop. This sudden loss of wind power (from 1,700 MW to 300 MW) just as demand reached the evening peak caused the grid operator to declare a power emergency and start shedding load and cutting power to customers. The operator cut supply by 1,100 MW within ten minutes.

Source: http://www.dailykos.com/story/2008/2/28/1303/48225/299/465497

The authors also comment on carbon emissions associated with wind. Note that they do not say if wind generates more or les carbon emissions than a coal fired plant, but that wind produces a lot of carbon.

Superficial commentators think that because wind itself does not rely directly on carbon fuel, its introduction thus reduces carbon dioxide emissions. This is not necessarily so, and promoters should be required to prove their case.

Firstly wind requires backup to maintain steady power generation when wind power fails. The best backups are probably hydro power or gas power, both of which can be turned on and off as quickly as the wind changes. Coal and nuclear can provide backup, but it is very expensive to do it that way. Nuclear is forbidden in Australia and coal of course emits the dreaded carbon dioxide.

Secondly, wind farms are usually in remote locations and the turbines themselves are necessarily spread over a large area. Each turbine has 1,500 tonnes of concrete, 2 tonnes of rare earth metals, and lots of steel and copper and requires much heavy transport and earth moving equipment to construct the towers, the access roads and the transmission lines. They also need maintenance over this large area. Every one of these activities emits carbon dioxide.

Finally, the authors compare the cost per kilowatt hour of various energy sources.

Energy Source USA Cents/Kwh
Natural Gas 8
Coal 9
Nuclear 11
Hydro-electric 12
Wind 14
Wind offshore 23
Solar thermal 26
Solar voltaic 40

Eventually, we will run out of oil and coal and these energy sources produce pollution even if you believe that these fuels contribute little to global warming or that the cost associated with global warming are relatively small. My point is that other energy sources, particularly renewables, are expensive and dirty. Rather than subsidize alternative sources of energy, the government should tax each according to the level of pollution they generate. Setting the tax would be contentious but I would prefer this problem to rewarding government funding based in part of the political pull of recipients.

Bauman, the Stand-up Economist, Updated

2011-02-10T12:38:00.003-06:00

(Edited 2/2/2011) Yoram Bauman, the stand-up economist, is a funny man and a good economist, and apparently, that is not an oxymoron. Watch his new video for two reasons. First, Bauman humorously explains Mankiw’s ten principles of economics, and second, he gives an example of an external cost and why markets cannot solve the problem. The standard solutions are a tax on the good producing the pollutant or a cap-and-trade system. He then pushes a carbon tax as a replacement to some part of the current tax system such as the corporate tax or the payroll tax.

I am skeptical about some results that climate scientist reach. Data may be corrupted by the urban heat island effect. Proxies used to estimate past temperatures beyond fifty years do not seem to be statistically robust. I also believe that the opportunity cost of alternative energy is well above the $.30 per gallon tax he seems to support, meaning that the cost of solving the problem is greater than the cost of the problem. Finally, I doubt that unilateral action by the United States would significantly reduce global carbon emissions; it is a global emissions problem without a global enforcement mechanism. With all my doubts, I still favor a carbon tax as a substitute to some other portion of our tax code. It is a better, meaning less distorting tax.

Spontaneous vs. Government Order and Oil

2011-02-10T11:39:00.000-06:00

In 1973, Arab oil producers cut production and began an embargo of the United States in response to the government’s decision to supply the Israeli military during the Yom Kippur War. In the short run, neither demand nor supply are responsive to prices. As Arab nations withheld oil, prices surged and in a misguided attempt to manage rising prices, the government instituted price controls that added fuel to the crisis and energized a government subsidized search for alternatives to oil.

Wind, solar and ethanol have largely been failures and still heavily rely on subsidies. Programs to encourage conservation have spent taxpayer dollars but were the expenditures necessary? In the summer of 2008, did consumers need incentives from Uncle Sam to conserve gas?

The spontaneous interactions of consumers and producers has mitigated the problem. High prices encouraged oil exploration. New sources oil were found. Deep water drilling and other technologies were developed.

This is but one chapter in a long story of the battle between scarcity and market led innovation in oil production. Jonathan Fahey reports in “New drilling method opens vast oil fields in US” that a new and non subsidized drilling technology first developed for extracting natural gas but now applied to oil has the potential to greatly expand U.S. production.

Companies are investing billions of dollars to get at oil deposits scattered across North Dakota, Colorado, Texas and California. By 2015, oil executives and analysts say, the new fields could yield as much as 2 million barrels of oil a day — more than the entire Gulf of Mexico produces now.

This new drilling is expected to raise U.S. production by at least 20 percent over the next five years. And within 10 years, it could help reduce oil imports by more than half, advancing a goal that has long eluded policymakers.

As with other market developed technologies, it is cost effective.

…drilling for shale oil is not dependent on high oil prices. Papa [chief executive of EOG Resources, the company that first used horizontal drilling to tap shale oil] says this oil is cheaper to tap than the oil in the deep waters of the Gulf of Mexico or in Canada's oil sands.

Problems remain. Oil is still a finite resource and like all energy sources, it pollutes. If environmental critics are right, and burning oil results in global warming by releasing carbon into the atmosphere and warming is costly, then developing relatively cheap new sources of oil is a mixed blessing, but a blessing nonetheless. Other things equal, I would rather struggle with carbon emission with relatively cheap oil prices.

Sessions Wrong on Trade

2011-02-06T08:10:00.001-06:00

Since Adam Smith wrote the An Inquiry into the Nature and Causes of the Wealth of Nations economists have supported removing restrictions on trade. Alston, Kearl and Vaughn reported the results of a survey of economists in “Is There Consensus among Economists in the 1990’s?” which was published in the American Economic Review. Of those responding to the survey, 93% agreed with the statement that “tariffs and import quotas usually reduce general economic welfare.”

I am assuming that Jeff Sessions is a smart man and understands the economics of trade as well as the calculus of governing. In an ugly example of relationship capitalism, he has apparently concluded that it is more important to make constituents happy than it is to do what is best for the American economy. The Wall Street Journal reports in “Fair Trade for One” that in December, Sessions “put a hold on the renewal of GSP [Generalized System of Preferences] on behalf of Exxel Outdoors, which makes sleeping bags in his state.” The General System of Preferences was a program that has been in place since the 1970s that aided poor countries by lowering our tariffs on their products. This was not only beneficial to poor countries but to consumers and the economy as a whole. The program had a review process conducted by a subcommittee in the House and Exxel Outdoors had appealed to the subcommittee and lost. They made a second appeal but Sessions intervened before the second decision.

Bangladesh is the economic powerhouse that Sessions claims is pushing its way into U.S. markets by unfairly subsidizing its products. Their sleeping bag sales rose to 8.4% of U.S. imports due to manufactures moving production from China to escape “high cost” labor. Bangladesh has a per capita GDP of $1,500, about the same as Haiti. Perhaps Bangladesh has a comparative advantage in the production of products manufactured with low skilled labor.

The Chevy Volt

2011-02-05T10:33:00.003-06:00

The video is of a test drive of the Volt in which the reviewer comments on the quality and price of the Volt.

The Chevy Volt is an interesting vehicle that makes use of new technology. It uses a lithium-ion battery which holds more charge and is heavier and pricier than the nickel-metal hydride battery pack used in the Toyota Prius and similar hybrid vehicles. The back up to the Volt is an electric motor that is powered by a gasoline electric generator. A fully depleted battery takes eight hours to from a 120 volt outlet or three hours from a 240 VAC outlet.
The Volt will sell for approximately $42,000 but with $7,500 federal tax credit that will reduce the cost for most buyers to $34,500. The EPA gives the Volt a combined gasoline/electric fuel economy of 60 mpg, or about twice the mileage of a similarly sized car. Assuming that a typical Volt owner will drive 15,000 miles per year, and that gasoline costs $4.00 per gallon, the Volt will save its owner approximately $1,000 per year in fuel expenses. If a traditional subcompact costs $20,000, the Volt will have a fourteen year payback period for the owner and a twenty-one year payback period for society due to the tax credit.The graph of the “Market for the Chevy Volt” provides some important economic details of the Volt market and the impact of the federal tax credit subsidy. A lot of guess work went into the shape of the supply and demand curves, but the guess work does not affect the direction of movements of prices, only the size of the movements. The supply (S) and original demand curve (DO) represent the market for the Volt prior to the federal tax credit subsidy. At equilibrium on the supply and original demand, 34,667 cars sell for a price of $40,333.

With the subsidy, the demand expands (DN). The new equilibrium quantity increases by 5,000 Volts to 39,667 and equilibrium price increases to $42,833. The subsidy is shared by Chevrolet and the buyer. Chevrolet charges $2,500 more per car (The difference between the new equilibrium price and the original equilibrium price), and after the subsidy, the consumer pays $5,000 less (The new equilibrium price less $7,500. The price paid by consumers is shown on the graph at the point where the dashed line showing the new equilibrium quantity crosses the original demand curve and then moving horizontally to the price axes).

The private market has a new partner, the taxpayer. The yellow rectangle is the subsidy paid by taxpayers. It is $297.5 million dollars ($7,500 times 39,667 Volts). The government estimates that approximately one third of buyers will not qualify for the subsidy, reducing the taxpayer’s bill to approximately $200 million, or approximately $40,000 per additional Volt sold. To benefit society, the sale of Volts must generate sizeable positive externalities, reduction in pollution, etc. Does the subsidy benefit taxpayers?

De Soto on Egypt

2011-02-04T08:52:00.000-06:00

Hernando De Soto, a Peruvian economist argues that the economic situation of the poor can be substantially improved by establishing and enforcing property rights for all citizens within a country. His books, “The Other Path: The Economic Answer to Terrorism”, and “The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else” are important contributions to the economic literature. He describes his involvement as an adviser to the Egyptian government and explains why the lack of property rights contributed to discontent in Egypt in “Egypt's Economic Apartheid.”

In 1997, the Egyptian government hired the Institute for Liberty and Democracy, De Soto’s think tank, to measure the size of the extralegal economy, those working and living without the protection of property through law and the institutions that enforce it. Those living outside the boundaries of the property rights system define the economically and politically marginalized citizens.

De Soto led a team of over 120 experts who worked with over 300 local Egyptian leaders and interviewed thousands of marginalized Egyptians. They issued a 1,000 page report in 2004 that estimated the underground economy hired 9.6 million people, 2.8 million more than the above ground legal private sector, and 3.7 million more than the public sector. An astounding 92% of the population lives without legal titles to their homes. De Soto’s team measured the value of extralegal businesses and homes at over $400 billion. If afforded legal protection, the value of these assets would grow rapidly as would the Egyptian economy.The report was approved for implementation by Minister of Finance Muhammad Medhat Hassanein, but before the plan was to be implemented Hassanein was ousted and the reforms shelved. Why would anyone oppose reforms that would directly improve the lot of the poor and contribute to the overall prosperity of Egypt?

North, Willis and Weingast suggest an answer in “Violence and Social Order.” Governments in developing nations, termed limited access orders by the authors, trade economic rights to groups who can cause violence for a promise to maintain peace. The marginalized citizens began a popular uprising that is at the point of turning violent as the powerful political insiders jostle violently or otherwise to establish a new political equilibrium that will maintain or enhance their privileged position in society. The difficult to impossible task of democratic elements is to maintain the peace, disarm political insiders who can violently demand their privilege, and expand legal access to the economy to the marginalized Egyptians.

Corn and Sugar Subsidies

2011-02-01T17:27:00.000-06:00

As mentioned in previous posts, corn growers are subsidized by laws that require consumers to buy ethanol which is more expensive than gasoline. If it were not more expensive, you would not have to force people to buy it. The subsidies come in three forms: forced consumption of ethanol paid by consumers, blending fees paid by taxpayers, and tariffs on the importation of sugar based ethanol which is again paid indirectly by consumers. Included below are quotes by two Nobel Laureates in economics and a former head of the Council of Economic Advisors to President Bush, the president who greatly increased the subsidies to corn growers.

Paul Krugman is a Nobel Prize winner who sometimes criticizes President Obama from the left. He writes from his column, The Conscience of a Liberal in a post titled “Demon Ethanol,”

I’m almost never censored at the Times. However, I was told that I couldn’t use the lede I originally wrote for my column following the 2007 State of the Union address, in which Bush made ethanol the centerpiece of his energy strategy: “Before the State of the Union address, there had been hints and hopes that President Bush would offer a serious plan to reduce our dependence on imported oil. Instead, however, he took refuge in alcohol.”

Well, anyway — the news on ethanol just keeps getting worse. Bad for the economy, bad for consumers, bad for the planet — what’s not to love?

Gary Becker is a Nobel Prize winner often associated with the political right. He writes in “Let's Make Gasoline Prices Even Higher”

Other ways to reduce dependence on oil take much longer to implement, but a long view is necessary since the terrorism threat will last into the foreseeable future. The federal government has been trying to develop a cleaner substitute for gasoline by subsidizing production of ethanol, made primarily from corn. This program has essentially been a flop: Ethanol is still too expensive, and ethanol factories create pollution consisting of nitrogen dioxides and other gases. The ethanol subsidy of about 50 cents a gallon is just another way to subsidize corn growers, not a serious attempt to find efficient ways to reduce dependence on gasoline.

Greg Mankiw was a head of the Council of Economic Advisors to President Bush. What follows is a post from his blog that quotes Thomas Friedman and Mankiw’s short reply to the comment (“Sugar Ethanol”).

In today's NY Times, columnist Tom Friedman arrives at the intersection of energy, farm, and trade policy and doesn't like what he finds:
Thanks to pressure from Midwest farmers and agribusinesses, who want to protect the U.S. corn ethanol industry from competition from Brazilian sugar ethanol, we have imposed a stiff tariff to keep it out. We do this even though Brazilian sugar ethanol provides eight times the energy of the fossil fuel used to make it, while American corn ethanol provides only 1.3 times the energy of the fossil fuel used to make it. We do this even though sugar ethanol reduces greenhouses gases more than corn ethanol. And we do this even though sugar cane ethanol can easily be grown in poor tropical countries in Africa or the Caribbean, and could actually help alleviate their poverty.
Friedman calls this state of affairs "stupid." This is a word I usually avoid (for it is hard to use politely), but it does seem particularly apt here.

Sugar growers are also subsidized by consumers. Their subsidies come through quotas on foreign imports at the expense of domestic consumers and foreign producers. Mark J. Perry, a professor of economics and finance in the school of management at the Flint campus of the University of Michigan describes the program’s cost to American consumers (“Sugar Policy: Sweet Deal for Producers, Sour for Consumers”).

Due to protectionist trade policies that limit the amount of sugar imports entering the United States at the much lower world price, the American sugar producers are protected from more efficient foreign sugar growers in Central America, Africa, and the Caribbean who can produce sugar at half the cost of beet sugar farmers in Minnesota, North Dakota, and Michigan…

Last year, Americans paid an average of 53.3 cents per pound for domestic sugar, almost double the average world price of 27.7 cents per pound. Exactly how much did Americans pay last year for our “no cost” sugar policy? An astounding $4.5 billion…

That is approximately $150 per American. If all the money went to the 4,700 farmers that grow sugar beets, that’s about $950,000 per farmer. Now that’s a sweet deal for farmers!

Wolf on Obama and Obamacare

2011-02-01T08:56:00.000-06:00

Quoting from the Washington Time’s byline, “Dr. Milton R. Wolf is a board-certified diagnostic radiologist, medical director and cousin of President Obama. He blogs daily at miltonwolf.com.” As an aside that must be dealt with, I do not care that he is a cousin to the president; it has nothing to do with his qualifications to write on healthcare reform. His medical degree does.

Section 2711 of the Public Health Service Act prohibits insurers from establishing annual or lifetime limits of benefits for any insured person or group. In his Washington Times Op-ed, Wolf finds three problems with our nation’s recent healthcare reform based on the 733 exemptions to section of the act, political corruption, the implicit acknowledgement that healthcare reform increases healthcare costs, and lack of transparency.

Wolf views the granting of exemptions to several cities, Massachusetts, New Jersey, Ohio, Tennessee, businesses and unions including the Service Employees International Union as evidence of corruption. Without additional evidence, I not only don’t see fire, I don’t even see smoke. There were 733 exemptions granted. Perhaps there were 733 applications. Political donations are reported. It would not be difficult to statistical estimate the probability of receiving an exemption for those making donations to the Obama campaign and comparing it to the probability of receiving an exemption for those making donations to the McCain campaign. Until I see more rigorous evidence, I will not consider the allegation of corruption.

The other charges are more difficult to dismiss. By prohibiting insurers from limiting coverage the cost the amount of claims paid must stay the same or increase. They will only stay the same if the caps on coverage were set so high that they were never reached. I believe that this hit low wage earners hardest. Suppose your job is worth $10.00 per hour to your employer and that you receive this wage in the form of wages at $7.25 per hour and a healthcare benefit valued at $2.75 per hour. If the cost of healthcare now rises to $3.50 per hour, the employer will either cancel the policy or fire the worker because the cost of the wages and benefits exceed the value of the job.

At best, the lack of transparency is bad government. I don’t know what the legal requirements of transparency are, and without additional information, I assume that the administration meets them. Wolf writes that more than 500 waivers were granted in December but not reported until after the State of the Union. That is not a high level of transparency from an administration promising new levels of openness.

Romer and Samuelson on the Deficit

2011-01-31T12:59:00.000-06:00

Greg Mankiw (Greg Mankiw’s Blog) linked to two articles concerning the State of the Union that support contentions that I have made in class: economists are at least in part guided by their economic science, that economic consensus often transcends politics, and that economics is more important than politics. The issue is the deficit; both economists, Robert Samuelson from the political right and Christina Romer from the political right, agree that burgeoning deficits and mounting debt that threaten the financial stability of the United State government and the economy.

At this point, I must be careful about any consensus that may exist between economists on the importance of the deficits and the debts they cause. Without the advantage of surveys or polls of economists, I can only write that I believe that a consensus exists on the issue and that it is widely held. At the least I can write that two economists with different political views agree on many of the problems caused by the deficits. On the size and budgetary challenges of the deficit, Samuelson writes (“A Missed Opportunity On the Budget”),

Americans think deficits are someone else's problem that can be cured by taxing the rich (say liberals) or ending wasteful spending (conservatives). Obama indulged these fantasies.

If deficits stemmed mainly from the recession, this wouldn't matter. They would shrink as the economy recovered; tax collections would rise and spending (on unemployment insurance, food stamps) would fall. Unfortunately, this isn't the case. In fiscal 2010, the deficit - the gap between government spending and revenue - was $1.3 trillion. Of that, about $725 billion was a "structural" deficit, says Mark Zandi of Moody's Analytics. That is, it would exist even if the economy were at full employment (5.75 percent by Zandi's estimate).

Even this arithmetic may be misleading. Falling interest rates - reflecting the recession and Federal Reserve policy - have lowered the government's interest payments despite ballooning debt. In 2010, federal interest costs were $197 billion, down from $253 billion in 2008. But as the economy strengthens, interest rates will rise, offsetting some of the recovery's beneficial effect on the deficit. By 2020, annual interest payments could approach $800 billion, projects the Congressional Budget Office.

If anything, Romer views the deficits as presenting a bigger challenge (“What Obama Should Say About the Deficit”).

President Obama should embrace the reality that his re-election may depend on facing up to the budget problem.

The economic need is also pressing. The extreme deficits of the last few years are largely a consequence of the terrible state of the economy and the actions needed to stem the downturn. But even with a strong recovery, under current policy the deficit is projected to be more than 6 percent of gross domestic product in 2020. By 2035, if the twin tsunami of rising health care costs and the retirement of the baby boomers hits with full force, we will be looking at deficits of at least 15 percent of G.D.P.

Such deficits are not sustainable. At some point — likely well before 2035 — investors would revolt and the United States would be unable to borrow. We would become the Argentina of the 21st century.

The root cause of the growing deficits and debt is growing expenditures on Social Security, Medicare and Medicaid. Samuelson writes,

Myth: The problem is the deficit. The real issue isn't the deficit. It's the exploding spending on the elderly - for Social Security, Medicare and Medicaid...

Myth: Eliminating wasteful or ineffective programs will close deficits. The Republican Study Committee - 176 House members - recently proposed $2.5 trillion of cuts over a decade in non-defense, non-elderly programs. This plan would kill dozens of specific programs…The Republicans' cuts are huge, about 35 percent. Even so, they would reduce projected deficits by at most a third. Over the next decade, those deficits could easily total $7 trillion to $10 trillion.

Myth: The elderly have "earned" their Social Security and Medicare by their lifelong payroll taxes, which were put aside for their retirement. Not so. Both programs are pay-as-you-go. Today's taxes pay today's benefits; little is "saved." Even if all were saved, most retirees receive benefits that far exceed their payroll taxes. Consider a man who turned 65 in 2010 and earned an average wage ($43,100). Over his expected lifetime, he will receive an inflation-adjusted $417,000 in Social Security and Medicare benefits, compared with taxes paid of $345,000, estimates an Urban Institute study.

Romer writes,

By 2035, if the twin tsunami of rising health care costs and the retirement of the baby boomers hits with full force, we will be looking at deficits of at least 15 percent of G.D.P…

Respected analysts across the ideological spectrum agree that rising health care spending is the biggest source of the frightening long-run deficit projections. That is why the president made cost control central to health reform legislation. He should vow not just to veto a repeal of the legislation, but to fight to strengthen its cost-containment mechanisms.

One important provision of the law was the creation of the Independent Payment Advisory Board, which must propose reforms if Medicare spending exceeds the target rate of growth. But the legislation exempted some providers and much government health spending from the board’s purview. The president should work to give the board a broader mandate for cost control.

The fiscal commission recommended that military spending — which has risen by more than 50 percent in real terms since 2001 — grow much more slowly in the future. It also proposed thoughtful ways to slow the growth of Social Security spending while protecting the disabled and the poor. And it recommended caps on nonmilitary, non-entitlement spending.

Both economists explicitly criticize the party with which they are commonly associated. Samuelson writes,

Americans think deficits are someone else's problem that can be cured by taxing the rich (say liberals) or ending wasteful spending (conservatives).

Romer’s criticism is more subtle. She wrote her article, (“What Obama Should Say About the Deficit,” before the State of the Union. If President Obama had broadly addressed the issue of the deficits and the ensuing debt, it would not have been a criticism, but he did not.

Romer and Samuelson will disagree on many issues. Economics is not easily subject to controlled experimentation, models are complex and statistical inference testing is less conclusive than it might otherwise be. With more room to wander from the scientific path, personal biases might be more important than in a science such as chemistry in which controlled experimentation is the rule, but these difficulties obfuscate an important point; their guiding light will be the economic science.

Krugman on Competitiveness

2011-01-27T14:48:00.000-06:00

In the State of the Union Address President Obama spoke of building America’s competitiveness as a theme. Paul Krugman, a Nobel prize and John Bates Clark medal recipient, explains why the new buzzword is the old buzzword in “The Competition Myth.”

Meet the new buzzword, same as the old buzzword. In advance of the State of the Union, President Obama has telegraphed his main theme: competitiveness. The President’s Economic Recovery Advisory Board has been renamed the President’s Council on Jobs and Competitiveness. And in his Saturday radio address, the president declared that “We can out-compete any other nation on Earth.”

This may be smart politics. Arguably, Mr. Obama has enlisted an old cliché on behalf of a good cause, as a way to sell a much-needed increase in public investment to a public thoroughly indoctrinated in the view that government spending is a bad thing.

But let’s not kid ourselves: talking about “competitiveness” as a goal is fundamentally misleading. At best, it’s a misdiagnosis of our problems. At worst, it could lead to policies based on the false idea that what’s good for corporations is good for America.

About that misdiagnosis: What sense does it make to view our current woes as stemming from lack of competitiveness?

…ultimately, we’re in a mess because we had a financial crisis, not because American companies have lost their ability to compete with foreign rivals.

Krugman’s current article echoes his classic work, “Pop Internationalism.”

Many people who know that "competitiveness" is a largely meaningless concept have been willing to indulge competitive rhetoric precisely because they believe they can harness it in the service of good policies. An overblown fear of the Soviet Union was used in the 1950s to justify the building of the interstate highway system and the expansion of math and science education. Cannot the unjustified fears about foreign competition similarly be turned to good, used to justify serious efforts to reduce the budget deficit, rebuild infrastructure, and so on?

A few years ago this was a reasonable hope. At this point, however, the obsession with competitiveness has reached the point where it has already begun dangerously to distort economic policies.

As an aside, I may owe Krugman an apology. In the past I have criticized him for supporting less than truthful statements by politicians to achieve policy he deems beneficial because of statements like those bolded above, but maybe I have misunderstood his meaning. Perhaps he just has more tolerance for this political behavior.

Ethanol and the Production Possibilities Frontier

2011-01-24T13:49:00.000-06:00

People acting through their government face trade-offs. The production possibilities frontier is a simple model showing food and ethanol production that illustrates some trade-offs. In the United States, ethanol is made from corn. To get more ethanol, resources have to move from the production of food and into the production of ethanol.

Markets are usually the best way to organize economic activities. The graph shows the market production combination point. Economic agents, acting through markets, buy a great deal of food and little ethanol. People acting through markets do not consume much ethanol.

Governments can sometimes improve market outcomes. In the light of rising oil prices, a warming climate, and the war in Iraq, some suggested that oil production is associated with three significant negative externalities that contributed to each problem. Economists usually recommend that negative externalities be taxed.

This is not the course the government took. At the urging of almost all corn growers and a few environmentalists, the Congress passed and President Bush signed legislation that subsidized the production of ethanol in three ways: consumers must buy blended gasoline containing 10% ethanol, blenders received a 45 cent per gallon subsidy for mixing the gasoline and ethanol, and importers must pay a 54 cent per gallon tariff (taxes on imports) on foreign ethanol. In response to these incentives, farmers took resources from food production and put it into ethanol production. Forty percent of corn production in the United States is now used to make ethanol. This is shown in the graph at the point “Production Combination with Ethanol Subsidies.”

Environmentalist no longer support ethanol production. The EPA believes that corn production has a minimal to negative impact on the environment. David Pimentel, a Cornell University scientist, estimates that the United States would achieve only a 4% reduction in oil consumption if the entire corn crop were devoted to ethanol production. Let me suggest that, at the margin, such a small reduction in oil consumption would not significantly reduce the odds of entering a war to protect oil production.

At a time of slow growth, lingering high unemployment from the Great Recession, and budget deficits that threaten the financial stability of the government, ethanol subsidies should be ended. Instead, protection has been extended and expanded. When consumers did not buy the mandated level of ethanol, the Obama administration lifted the cap on how much ethanol could be blended into gasoline from 10% to 15% and increased the number of car models that are approved to use the 15% blend. The Congress also extended subsidies to ethanol production.

A Review of Rajan’s and Zingales’ “Saving Capitalism for the Capitalists”

2011-01-22T15:34:00.000-06:00

Raghuram Rajan and Luigi Zingales make an excellent contribution to economic literature in “Saving Capitalism for the Capitalists.” Their writing style is crisp and animated even as they maintain scientific precision. The authors’ seem to write as concerned but detached outsiders looking into various national economies. Perhaps that is the perspective they gained by living, studying and working in many countries. Anyone with an interest in economics could benefit by reading it including the professional economist; the notes are clear and the authors reference a great deal of economic literature.

Economists have long observed that the laws and institutions within a country determine the level of wealth. If a country is not wealthy, it has bad institutions and those institutions should be changed. This approach treats an economy like a building or a machine to be constructed or fine tuned. Rajan and Zingales approach is almost biological. They theorize that a country’s economic and political institutions grow symbiotically in the same national environment and they offer two types of relationships or capitalisms.

Relationship capitalism is the most common and produces the least wealth. The relationship between economic and political institutions is parasitic. Because economic laws and institutions do not protect property rights, the ability of an entrepreneur to produce goods and services depends on her political and business relationships. A political regime’s power is also derived from relationships with incumbent firms, unions and other special interests. The political regime protects incumbents’ economic status by limiting competition from internal and external forces. This exposes an internal weakness of relationship capitalism. The ability to protect incumbents is in part dependent on the economic efficiency of the incumbents the political regime protects from efficiency promoting competition.

Change to a commensal symbiotic relationship or arms-length capitalism, comes in two phases beginning with the “taming of the government.” In general, the government is not tamed by a great leader working for the masses but an incumbent politician attempting to solidify his position or eliminate political rivals. To do so, political incumbents must attract new allies and they can only do so with a credible commitment to protect their property. The second phase, the “taming of the incumbents,” comes by exposing incumbents to internal and external competition. Rajan and Zingales see finance as a vital agent of change making competition in capital markets as important as competition in trade. Economic challengers can grow faster when the financial industry is strong because they do not have to rely on profits to fund growth.Arms-length capitalism produces political challengers. Schumpeter’s “winds of creative destruction” blow hard, challenging weak economic incumbents in good times, and spawning more political opponents during downturns. Rajan and Zingales suggest that challenged incumbents will combine with the economically displaced to politically threaten arms-length capitalism using protection of the masses as a pretext to protect the interests of the wealthy owners of the incumbent firms.

The authors propose a set of policies that protect arms-length capitalism and the dispersed wealth that it creates by reducing incumbents’ incentives to appeal to political markets. My review is incomplete but highlights some of the proposals I find most interesting. They begin with a property tax to replace or augment the income tax. An income tax is inefficient, favoring businesses and individuals with extravagant expenditures and resultant lower profits or savings over the efficient who produce large profits or savings. The property tax favors the efficient over the extravagant by subjecting both to the same taxes. They also propose an inheritance tax on transfer of control not on wealth. Because heirs typically do not have the entrepreneurial talents of their progenitors, transfer of controlling interest would increase inefficiency. The tax could be avoided by transferring wealth in diversified portfolios.

Rajan and Zingales also propose an enhanced safety net that insures people directly and not through firms. The presence of the expanded safety net reduces the incentive of those displaced by innovation to act in political markets. Their safety net would concentrate on health and education to allow people to protect themselves through permanent changes in the economy rather than cyclical changes.

As an economist who appreciates the wealth creation of arms-length capitalism and the higher standard of living that it engenders, I find their proposals intriguing. They decrease incentives for malignant action in political markets, protecting economic innovation. They protect the poor and other displaced with minimal disruption of markets and create economic mobility for the motivated and talented of all economic classes.

Didn’t See It Coming

2011-01-19T13:35:00.000-06:00

In response to the post, “Markets and Government,” a student asked, ”I would like to know if economist knew that we were going to suffer from the financial crisis? If so, why didn't they do anything about it? I find it kind of interesting that nothing was done to keep us out of the financial situation we are in now....or was it just too late?”

The answer to the first question is a little embarrassing, few economists saw the financial crisis coming. Although not a satisfying answer, the main reason so few recognized the danger is that the vast majority of economists have expertise and interests outside of the housing market and finance. The answer is not satisfying for a second reason, few financial economists saw it coming either and their warnings were largely ignored. Raghuram Rajan, who I quoted in “Markets and Government,” was one economist who saw the writing on the wall. Others included Nouriel Roubini, and Nassim Taleb. The financial crisis was the confluence of many problems, most of which were seen and understood. Government officials carefully created a system of regulation to deal with these problems and economists added a great deal of insight into these regulations. This implies that my student’s assumption in framing the second question is probably wrong, it wasn’t that the government did nothing; it was that the steps it took were ineffectual or inadequate. As Seabright wrote in Foreign Policy, “The Imaginot Line,”

There are important lessons to be learned from the [financial] crisis. But we'll learn them better if we realize that the intellectual and political architects of the system that failed us were not naive at all, but immensely clever and subtle; it was their cleverness and subtlety that undid them. And that is bad news for all of us, for naivete can give way to learning, but cleverness has no obvious higher state.

Seabright explains the regulatory philosophy that guided the government and why it failed. His article is a good place to start, but the issue of what caused the financial crash is so enormous that economists will debate its root causes for a century.

Markets and the Government

2011-01-18T14:12:00.000-06:00

I read the articles by President Obama and Paul Seabright today. They speak to the relationship between a market economy and the government. The remaining three quotes are by very good economists on the same topic; they are presented in alphabetical order.

President Barak Obama. Wall Street Journal, “Toward a 21st-Century Regulatory System.”

For two centuries, America's free market has not only been the source of dazzling ideas and path-breaking products, it has also been the greatest force for prosperity the world has ever known. That vibrant entrepreneurialism is the key to our continued global leadership and the success of our people.

But throughout our history, one of the reasons the free market has worked is that we have sought the proper balance. We have preserved freedom of commerce while applying those rules and regulations necessary to protect the public against threats to our health and safety and to safeguard people and businesses from abuse.

Paul Seabright, Foreign Policy, “The Imaginot Line.”

There are important lessons to be learned from the [financial] crisis. But we'll learn them better if we realize that the intellectual and political architects of the system that failed us were not naive at all, but immensely clever and subtle; it was their cleverness and subtlety that undid them. And that is bad news for all of us, for naivete can give way to learning, but cleverness has no obvious higher state.

Daron Acemoglu, ("The Crisis of 2008: Structure Lessons for and from Economics,").

A deep and important contribution of the discipline of economics is the insight that greed is neither good nor bad in the abstract. When channeled into profit-maximizing, competitive and innovative behavior under the auspices of sound laws and regulations, greed can act as the engine of innovation and economic growth. But when unchecked by the appropriate institutions and regulations, it will degenerate into rent-seeking, corruption and crime. It is our collective choice to manage the greed that many in our society inevitably possess. Economic theory provides guidance in how to create the right incentive systems and reward structures to contain it and turn it into a force towards progress.

F.A. Hayek, “The Fatal Conceit.”

The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.

Raghuram Rajan and Luigi Zingales, “Saving Capitalism From the Capitalists.”

We do not believe that capitalism is fundamentally flawed, because we believe that markets can be given the political support to remain free. Much of this book has been about why that support is necessary: markets cannot flourish without the very visible hand of the government, which is needed to set up and maintain the infrastructure that enables participants to trade freely and with confidence. But who has an interest in pushing the government to support the market? For even though everyone collectively benefits from the better goods, the services, and the equality of access that competitive markets make possible, no one in particular makes huge profits from keeping the system competitive and the playing field level. Thus, everyone has an incentive to take a free ride and let someone else defend the system. A competitive market is a form of public good (a good, like air, that is useful but hard to charge for), and somewhat paradoxically, collective action is needed for its maintenance.

Given its dependence on political goodwill, democratic capitalism’s greatest problem is not that it will destroy itself economically, as Marx would have it, but that it may lose its political support. Capitalism’s biggest political enemies are not the firebrand trade unionists spewing vitriol against the system but the executives in pin-striped suits extolling the virtues of competitive markets with every breath while attempting to extinguish them with every action.

The Circular Flow Diagram and Home Finance

2011-01-17T14:00:00.001-06:00

The circular-flow diagram is a simple model used by economists to explain how households and business are connected through markets. It assumes that households who own all resources and businesses produce all goods and services.

Households interact with businesses through two markets: the market for factors of production and the market for goods and services. The arrows that circle the diagram illustrate a physical flow and a financial flow. The inner arrows represent the physical flow. Resources or inputs are taken to the market for factors of production. Use rights to these factors are acquired by businesses that use them to make goods and transport them to the market for goods and services where they are acquired by households. The outer arrows represent the financial flows which move in the opposite direction. Households pay businesses for the goods and services they acquire in the market for goods and services. These revenues to the firm are used to pay their expenses in the market for goods and services. These expenses are the wages, rents, interest, and profit earned by households. Wealth is created through specialization. Markets allow households and businesses to specialize (Principle 8: A country’s standard of living depends on its ability to produce goods and services.). And (Principle 7) “governments can sometimes improve market outcomes” with good law.

Rajan and Zingales explain in “Saving Capitalism for the Capitalist” how households benefit from businesses ability to take ownership of collateral pledged to cover a loan.

Study after study has shown that the easier it is for a financier to seize collateral, the more lending takes place. The ease with which a creditor can collect on pledged collateral differs amoung countries. In England, or instance, it takes a lender on average a year and a sum of approximately 4.75 percent of the cost of the house to repossess a house from an insolvent borrower. Mortgage loans amount to 52 percent of gross domestic product (GDP) in England. In Italy, a country with roughly the same GDP per capita as England, it takes between three and five years at a cost of between 18 and 20 percent of the value of a house to foreclose on it. Mortgage loans amount to a far lower 5.5 percent of GDP.

Likewise, businesses benefit from the bankruptcy code expands credit markets aiding both households and businesses as Rajan and Zingales offer this evidence.

The economic role of the bankruptcy law is not just to provide a mechanism for creditors to collect their money but also to offer a form of insurance to debtors, relieving them from some of their debt burden when it becomes overly oppressive. When a borrower owes so much that he has small hope of repaying it, he will have little incentive to exert effort to earn money, because any extra dollar earned, while requiring his blood and toil, will simply go to repay creditors. Both debtors and creditors may be better off in such situations if some of the debt is forgiven or renegotiated down in a bankruptcy proceeding. Debtors will have an incentive to work harder if they know there is some chance of repaying their debt and keeping their businesses, while creditors will get something back instead of nothing at all.

Our laws governing collateral and bankruptcy may not be perfect, but they have improved credit opportunities for households and businesses. Good law creates wealth by creating opportunities for trade and specialization through markets.

Fox Shoots Hunter

2011-01-17T10:12:00.001-06:00

Mankiw’s principle four is that “people respond to incentives.” Apparently foxes do as well (“Fox shoots man during animal-human hunting scuffle”).

MOSCOW - A wounded fox shot its would be killer in Belarus by pulling the trigger on the hunter's gun as the pair scuffled after the man tried to finish the animal off with the butt of the rifle, media said on Thursday.

Oil and Two of Mankiw’s Ten Principles of Economics

2011-01-14T10:01:00.001-06:00

Greg Mankiw’s seventh principle of economics is that “governments can sometimes improve market outcomes.” Modifying “can” with “sometimes” is common economic analysis built on tons of experience. The production and consumption of oil exemplifies the problems that even government with the best of intentions faces. We often associate oil production and consumption with two market failures: market power and negative externalities (pollution), and they are partially offsetting. A government response to market power is to create more competition which would increase output, decrease price, and increase the negative externalities. A government response to negative externalities is to impose a tax that would decrease production and consumption and drive up prices.

The issue of oil production and consumption is more complex still. Oil, and the products derived from it, add greatly to our national wealth. At present, it does not have good substitutes. In addition to directly creating wealth, it also creates positive externalities as do all market based transactions. Because it is the cheapest form of energy for many uses, someone else’s use of oil benefits me because its consumptions leaves them wealthier and more able to buy the goods and services that I produce. We know that steeply rising oil prices can act stop economic growth or even throw it into reverse. (HT Drudge Report) That is why our eyes are on OPEC as the price per barrel of crude oil approaches $100 (Gene Ramos, “Oil off on U.S. data but OPEC eyed as $100 in sight”).

Mankiw’s sixth principle is that “markets are usually a good way to organize economic activity.” How do markets help? In response to higher prices, consumers will shift consumption to energy efficient products. Companies that make products that are not energy efficient will lose business unless they can modify their products to use less energy. Markets even help solve market failures. Pollution is often a sign of inefficient production. Learning from BP’s example, oil companies will be more careful when drilling, not just to avoid cleanup costs, but to not waste a valuable resource. The internal combustion engine has grown more efficient in part by polluting less. A fuel efficient car in 1972 got about 25 miles per gallon on the highway, less than most modern minivans. Firms exercising market power by withholding product to raise prices will face new competition from firms that want to grab part of the high profit market power creates. Schumpeter referred to innovation threatening existing producers as the “winds of creative destructions.” Are these winds sufficient to blow away oil’s twin market failures of market power and negative externalities?

Energy Source	USA Cents/Kwh
Natural Gas	8
Coal	9
Nuclear	11
Hydro-electric	12
Wind	14
Wind offshore	23
Solar thermal	26
Solar voltaic	40