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January 31, 2006

January 2006

January 31, 2006

FOMC Raises Target Rate: Policy No Longer Measured

The FOMC decided to raise the target federal funds rate from 4.25% to 4.50%. Here are the differences from the previous statement:
  1. The Fed still sees the expansion as solid, but altered its statement to indicate a bit more uncertainty going forward due to recent data. The phrase "Despite elevated energy prices and hurricane-related disruptions, the expansion in economic activity appears solid" was replaced by "Although recent economic data have been uneven, the expansion in economic activity appears solid."
  2. The long awaited removal of the word measured has been occurred. The phrase "some further measured policy firming is likely to be needed" is replaced by "some further policy firming may be needed." The change from "likely" to "may" is notable.
  3. The voting representatives on the Committee have changed, but the vote was still unanimous. San Francisco, Cleveland, Richmond, and Atlanta replace Dallas, Chicago, Philadelphia, and Minneapolis as voting members.
  4. Finally, and worthy of attention, Minneapolis did not request an increase in the discount rate potentially signaling the Minneapolis Fed was not in favor of further rate increases. We won't know for sure until the minutes are released.

Thus, it's likely that rates will go up again, but by no means assured. The December 13 FOMC statement is in italics. Here's the January 31st FOMC statement with substantive changes in bold:

For immediate release

The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 4-1/2 percent.

[No substantive change from previous statement]

Although recent economic data have been uneven, the expansion in economic activity appears solid. Core inflation has stayed relatively low in recent months and longer-term inflation expectations remain contained. Nevertheless, possible increases in resource utilization as well as elevated energy prices have the potential to add to inflation pressures.

Despite elevated energy prices and hurricane-related disruptions, the expansion in economic activity appears solid. [After the first sentence, the statement is identical].

The Committee judges that some further policy firming may be needed to keep the risks to the attainment of both sustainable economic growth and price stability roughly in balance. In any event, the Committee will respond to changes in economic prospects as needed to foster these objectives.

The Committee judges that some further measured policy firming is likely to be needed to keep the risks to the attainment of both sustainable economic growth and price stability roughly in balance. [Second sentence identical]

Voting for the FOMC monetary policy action were: Alan Greenspan, Chairman; Timothy F. Geithner, Vice Chairman; Susan S. Bies; Roger W. Ferguson, Jr.; Jack Guynn; Donald L. Kohn; Jeffrey M. Lacker; Mark W. Olson; Sandra Pianalto; and Janet L. Yellen.

Voting for the FOMC monetary policy action were: Alan Greenspan, Chairman; Timothy F. Geithner, Vice Chairman; Susan S. Bies; Roger W. Ferguson, Jr.; Richard W. Fisher; Donald L. Kohn; Michael H. Moskow; Mark W. Olson; Anthony M. Santomero; and Gary H. Stern.

In a related action, the Board of Governors unanimously approved a 25-basis-point increase in the discount rate to 5-1/2 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Kansas City, Dallas, and San Francisco.

[No substantive change in first sentence]. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco.

News Reports: WSJ, New York Times, Washington Post, Bloomberg, Financial Times, CNN/Money.

    Posted by Mark Thoma on Tuesday, January 31, 2006 at 11:51 AM in Economics, Monetary Policy

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    The Ownership Society is Still for Sale

    "For Mr. Bush, the ownership society initiative is temporarily gone -- but hardly forgotten.":

    We Are What We Own, by Fred Barnes, Commentary, WSJ: When running for re-election in 2004, and again last year as he campaigned for Social Security reform, President Bush repeatedly advocated an "ownership society." ... But "ownership society" is not a phrase you're likely to hear from him tonight in his State of the Union address. ...

    At best, there will be faint echoes. ... But after failing in his drive for Social Security reform last year, Mr. Bush has now gone incremental, hoping small steps will lead to bigger ones later. For 2006, however, he's reconciled himself to the fact that overhauling Social Security is an impossibility. And since Social Security reform is a necessary element of an ownership society, that idea is off the table this year, too.

    But that's not the end of the matter. For Mr. Bush, the ownership society initiative is temporarily gone -- but hardly forgotten. ... Where the phrase "ownership society" came from, nobody knows, not even Mr. Bush or political adviser Karl Rove. Nor did the program emerge in full form. Rather, it was patched together, ... from a handful of programs. By 2004, it consisted of five separate proposals: Social Security private accounts, flexible "lifetime" IRAs, HSAs, tax reform and home ownership assistance. ...

    Mr. Bush still yearns to modernize Social Security and create private investment accounts funded by payroll taxes. When informed last year that congressional Republicans wouldn't "scout" the political terrain ahead of him, he went ahead with his campaign for reform -- alone. Now, an aide insists, "If the president sees a political opportunity [for Social Security reform], he'll seize it in an instant." He brought it up again in a private White House meeting last week. ... Indeed, he's likely to keep talking about Social Security and private accounts and perhaps even an ownership society. But not tonight, when he addresses the nation.

      Posted by Mark Thoma on Tuesday, January 31, 2006 at 01:09 AM in Economics, Politics, Social Security

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      Milton Friedman: Greenspan Ruled with Discretion

      Milton Friedman is impressed that Alan Greenspan was able to achieve price stability without committing to a strict money rule:

      'He Has Set a Standard', by Milton Friedman, Commentary, WSJ: Over the course of a long friendship, Alan Greenspan and I have generally found ourselves in accord on monetary theory and policy, with one major exception. I have long favored the use of strict rules to control the amount of money created. Alan says I am wrong and that discretion is preferable, indeed essential. Now that his 18-year stint as chairman of the Fed is finished, I must confess that his performance has persuaded me that he is right -- in his own case.

      His performance has indeed been remarkable. There is no other period of comparable length in which the Federal Reserve System has performed so well. It is more than a difference of degree; it approaches a difference of kind. For the first 70 years after it opened in 1914, the Fed did far more harm than good... We would clearly have been better off for those 70 years if the Federal Reserve System had never been established.

      In 1979, Paul Volker was named chairman of the Fed... The great inflation of the 1970s was still raging ... Supported by President Reagan, Mr. Volker broke the back of inflation, in the process producing a recession. The recession produced a public reaction that seriously lowered the president's popular standing. Fortunately, President Reagan did not waver in his support, reappointing Mr. Volker to a second term. He later appointed Alan to succeed him as chairman. ...

      Inflation averaged 3.7% per year from the end of World War II to the Volker era, but only 2.4% per year during the Greenspan era. Even more important, inflation was much less variable. ... Greater price stability had far-reaching effects. By greatly reducing the uncertainties, enterprises could use their resources more efficiently and steadily. Price stability fostered innovation and supported a high level of productivity. ...

      It has long been an open question whether central banks have the technical ability to maintain stable prices. Their repeated failures to do so suggested that they did not -- whence, in part, my preference for rigid rules. Alan Greenspan's great achievement is to have demonstrated that it is possible to maintain stable prices. He has set a standard. Other central banks around the world, whether independently or by following his example, are following suit. The timeworn excuses for central bank failure to stem inflation will no longer do. They will have to put up or shut up.

        Posted by Mark Thoma on Tuesday, January 31, 2006 at 12:26 AM in Economics, Monetary Policy

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        Who Would Cross the Bridge of Death Must Answer Me These Questions Three!

        The chairman of Intel, Craig Barrett, joins Gary Becker in saying we need to open our doors to the “best and brightest”:

        America should open its doors wide to foreign talent, by Craig Barrett, Commentary, Financial Times: America is experiencing a profound immigration crisis but it is not about the 11m illegal immigrants... The real crisis is that the US is closing its doors to immigrants with degrees in science, maths and engineering – the “best and brightest” ... who flock to the country for its educational and employment opportunities. ... This is not a new issue; the US has been partially dependent on foreign scientists and engineers ... for several decades. After the second world war, an influx of German engineers bolstered our efforts in aviation and space research. During the 1960s and 1970s, a brain drain from western Europe supplemented our own production of talent. In the 1980s and 1990s, our ranks of scientists and engineers were swelled by Asian immigrants who came to study in our universities, then stayed to pursue professional careers.

        The US simply does not produce enough home-grown graduates in engineering and the hard sciences to meet our needs. ... So while Congress debates how to stem the flood of illegal immigrants across our southern border, it is actually our policies on highly skilled immigration that may most negatively affect the American economy.

        The US does have a specified process for granting admission or permanent residency to foreign engineers and scientists. The H1-B visa programme sets a cap – currently at 65,000... But the programme is oversubscribed because the cap is insufficient to meet the demands of the knowledge-based US economy. The system does not grant automatic entry to all foreign students who study engineering and science at US universities. I have often said, only half in jest, that we should staple a green card to the diploma of every foreign student who graduates from an advanced technical degree programme here.

        At a time when we need more science and technology professionals, it makes no sense to invite foreign students to study at our universities, educate them partially at taxpayer expense and then tell them to go home and take the jobs those talents will create home with them. ... Certainly ... security must always be a foremost concern. But that concern should not prevent us from having access to the highly skilled workers we need. ..

        In a global, knowledge-based economy, businesses will naturally gravitate to locations with a ready supply of knowledge-based workers. ... Deciding to compete means reforming the appalling state of primary and secondary education, ... and urgently expanding science education in colleges and universities – much as we did in the 1950s after the Soviet launch of Sputnik gave our nation a needed wake-up call. ...

        At a minimum the US should vastly increase the number of permanent visas for highly educated foreigners, streamline the process for those already working here and allow foreign students in the hard sciences and engineering to move directly to permanent resident status. Any country that wants to remain competitive has to start competing for the best minds in the world. Without that we may be unable to maintain economic leadership in the 21st century.

        If they had a 95 mph fastball or the talent to play in the NBA, we'd find a way to let them in.

          Posted by Mark Thoma on Tuesday, January 31, 2006 at 12:18 AM in Economics, Policy, Unemployment

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          January 30, 2006

          Mom, and the Tax Code, Always Liked You Best

          Gene Sperling looks at inefficiencies and inequities in our tax system by comparing twin brothers, one with labor income, the other with investment income, and looking at how the tax code treats each:

          How to reform a winner-takes-all economy, by Gene Sperling, Financial Times: ...Lawrence Katz, the Harvard economist, has documented the increasing polarisation in the US labour market as earnings grow at the high end while opportunities for middle-class jobs dry up. Such extreme gains and losses are often due to significant differences in education or skill but as Robert Shiller ... has written, the unpredictability, speed and vastness of global markets have also enhanced the role of luck ... in determining who falls into the winners’ or losers’ circles.

          Consider twin brothers with [identical] ... histories, who each took good jobs six years ago – one, fortunately, with Google, the other, less fortunately, with Lucent. Since the investment community was still betting on Lucent in early 2000 and Google was just getting established, it is hard to say that skill led one worker to $2m in stock options and the other to a pink slip and a job retraining programme.

          Even though such differential outcomes can seem unfair ..., this is a price we gladly pay for a free market economy. Our progressive tax system has been part of the way the US has balanced the desire for a free economy with the values of equity. Yet, eliminating taxation on investment income exacerbates – not moderates – winner-takes-all outcomes. Consider our brothers. If the one at Lucent finds a new, $60,000 a year job, he could pay about 25 per cent in federal taxes (including payroll taxes). Yet, ... if his twin at Google can find a solid 6 per cent return investing his $2m, he can make at least $120,000 a year while paying a lower 15 per cent tax rate. If we move closer ... to zero taxes on dividends, capital gains and inheritances, the Google twin could watch his gains accumulate tax-free year after year and then pass on his wealth to an heir, tax free.

          Moving the US tax code in this direction is wrongheaded on both economic growth and value grounds. ... [A] tax system that eases the Googler’s tax-free wealth accumulation but forces his brother to pay higher taxes on income earned through labour betrays American values that honour the hard work of the middle class... A better tax reform plan would prevent the most privileged Americans from paying lower taxes on their investment than typical families pay on their wages...

            Posted by Mark Thoma on Monday, January 30, 2006 at 04:22 PM in Economics, Income Distribution, Taxes

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            Ed Lazear to be Nominated to Head the CEA

            As I reported here in early November when his name first came up, Bush will nominate Edward P. Lazear to replace Ben Bernanke as head of the White House Council of Economic Advisers. The link has a picture, links to his website, and covers his background. To me, the important factor to note is that he is a microeconomist, not a macroeconomist, an indication that issues such as tax reform will be on the future agenda. Here's a link to the Washington Post story, the Bloomberg report, and to Brad Delong's favorable comments on Lazear's selection from November.

              Posted by Mark Thoma on Monday, January 30, 2006 at 11:55 AM in Economics, Politics

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              The Human Costs of China's Industrialization

              We've heard a lot about the environmental costs of China's industrialization, and of social unrest in rural areas and other problems, but less about how industrialization affects the army of migrant workers who come from the country to the cities in search of work:

              In China, a Rare Return , by Peter S. Goodman, Washington Post: On almost every other day, Cai Weilan wakes up hundreds of miles away in a cramped factory dormitory, facing another long shift making sweaters... On this day, she wakes up at home. She ... lifts a pair of knitting needles and a ball of green wool to begin making a single sweater for her 2-year-old daughter... For one brief stretch -- this week's Chinese Lunar New Year festival -- mother and daughter are reunited. "Of course I miss her," says Cai, 23, who has been gone for a full year, leaving her daughter behind in the care of her mother-in-law while she endures the factory life for $80 a month. "At home, there is nothing for me to do. My family needs this money."

              In this village ... as throughout most of China, migrant workers are heading home this week on packed overnight trains and buses for the most important holiday of the year. They are carrying home to their families things they did not have before -- televisions, sacks of clothing and cooking pots. They are bringing along glimpses of China's burgeoning urban wealth and tales of street hustlers and bosses who cheat them out of wages. They are bearing new expectations for their own lives and those of their children.

              In this rapidly industrializing country ..., these workers send home nearly $80 billion a year... Many villages in bitterly poor interior regions have seen their incomes doubled and tripled by this flow of wages. ... "In many counties, as long as there is one migrant worker in the family, the whole family is lifted out of poverty."

              But not without wrenching social costs. Migration has separated families, delivering a generation of rural children raised largely by grandparents. For many migrants, round-trip bus and train fare home can exceed $60 -- more than some monthly wages. ... The New Year is typically the only time workers go home. ... Wherever they sleep the rest of the year, migrant workers are clear that home remains home -- a concept laden with significance in Chinese culture. ...

              Cai has been working in Guangdong province since she was 14, returning only to get married, give birth to her daughter and celebrate the Lunar New Year. She speaks of forced unpaid overtime and wages that have stayed flat for almost a decade in factories without air conditioning. But her eyes light up when she speaks of how her income has kept her younger sister in high school and how she and her husband are saving about $1,200 a year to build a brick home in the village. Some day. They figure they need $12,000.

              Next door, Huang Meiyun, 28, and his father have returned from their jobs as carpenters in Guangzhou, where they occupy plywood bunks in a shed with seven other men. Huang's wife works at a factory in another city ... Their son, 6, stays here in the village with Huang's mother. "I will definitely return," Huang said... He will come back changed. In the city, Huang has grown accustomed to reading news and communicating with people all over China on chat boards at Internet cafes ... He wants a computer at home now... He graduated from high school. He wants his son to make it to university. "We see the other villagers going out to the city and their houses getting better, more money in their pockets," Huang said. "We need to keep up."

                Posted by Mark Thoma on Monday, January 30, 2006 at 12:42 AM in China, Economics

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                The Fed Debates via Encrypted Email

                Will the Fed will become more democratic under Bernanke?:

                New Chairman Will Take Over An Increasingly Democratic Fed, by Greg Ip, WSJ: ...An early glimpse of this democracy in action unfolded ... in the run up to the Fed's Dec. 13 policy meeting. Virtually all ... economists expected the Fed to raise interest rates ... Still unclear, however, was whether the Fed would signal a change in the future course of rates. For FOMC members, most of the suspense ended long before they gathered ... at Fed headquarters ..., according to people familiar with the process. About a week earlier, the five Fed governors and 12 regional reserve bank presidents ... had received three drafts of the statement from the Fed's staff. A debate ensued... Several presidents circulated extensive comments via encrypted email. By the day of the meeting, the FOMC had largely agreed on what the statement should say. The key point: it would no longer call interest rates "accommodative"...

                This is not at all unusual, but the formal process is still evolving. It grew out of protests by Reserve Bank presidents that they did not have enough input on the wording of the statement. Initially, the process was:

                Before meetings, Mr. Greenspan drafted the statement with a handful of advisers, primarily Donald Kohn... Governors sometimes discussed the draft the Monday before an FOMC meeting. At the midmorning coffee break on the day of the meeting, Mr. Greenspan huddled in his office with Mr. Kohn, along with the president of the New York Fed, the Fed board's vice chairman and its director of public affairs to decide if the morning discussion required changing the draft. The final statement was distributed to FOMC members after they voted on rates and released to the media at 2:15 p.m.

                But that has changed:

                Beginning in 2004, the presidents would receive drafts of the statement a few days before a meeting. Typically, there were three versions. Version A was dovish, version C hawkish, and version B ... somewhere in the middle. ... The consultation last December was the most extensive so far. ... December's process went smoothly in part because FOMC members broadly agreed on what to say. But if their views diverge, the process may take longer. ... Another big unanswered question is how Mr. Bernanke will deal with this ... process. ...

                On the editorial page, Robert Barro says goodbye to Greenspan and congraulates him on a great overall job. He also says:

                Despite Mr. Greenspan's strengths, there is something akin to Peter Sellers's Chance the Gardener in the exaggerated popular view of his economic prowess. ... Fortunately, setting interest rates to ensure low and stable inflation does not require much economic sophistication.

                This is as Barro is noting that his strength as a policy maker was his leadership ability, not his abilities as a research econmist.

                If you just can't get enough of Greenspan farewells, here's John M. Berry defending his record. He says "...a cottage industry has sprung up questioning the strength of [Greenspan's] legacy. Most of the criticism is off base..." Kevin Hassett weighs in too with advice for Bernanke. The NY Times has a piece here. Update: William Polley has more on the Greg Ip WSJ story...

                  Posted by Mark Thoma on Monday, January 30, 2006 at 12:33 AM in Economics, Monetary Policy

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                  Paul Krugman: A False Balance

                  Paul Krugman wonders why some members of the media find it necessary to paint the Abramoff scandal as bipartisan when there is no evidence that it is:

                  A False Balance, by Paul Krugman, Media Imbalance, Commentary, NY Times: How does one report the facts," asked Rob Corddry on "The Daily Show," "when the facts themselves are biased?" He explained to Jon Stewart, who played straight man, that "facts in Iraq have an anti-Bush agenda," and therefore can't be reported. Mr. Corddry's parody of journalists who believe they must be "balanced" even when the truth isn't balanced continues, alas, to ring true. The most recent example is the peculiar determination of some news organizations to cast the scandal surrounding Jack Abramoff as "bipartisan." ...

                  Here's how a 2004 Washington Post article described Mr. Abramoff's background: "Abramoff's conservative-movement credentials date back more than two decades to his days as a national leader of the College Republicans." In the 1990's, reports the article, he found his "niche" as a lobbyist "with entree to the conservatives who were taking control of Congress. He enjoys a close bond with [Tom] DeLay." ...

                  Mr. Abramoff is a movement conservative whose lobbying career was based on his connections with other movement conservatives. His big coup was persuading gullible Indian tribes to hire him as an adviser; his advice was to give less money to Democrats and more to Republicans. There's nothing bipartisan about this tale, which is all about the use and abuse of Republican connections.

                  Yet over the past few weeks a number of journalists, ranging from The Washington Post's ombudsman to the "Today" show's Katie Couric, have declared that Mr. Abramoff gave money to both parties. In each case the journalists or their news organization, when challenged, grudgingly conceded that Mr. Abramoff himself hasn't given a penny to Democrats. But in each case they claimed that this is only a technical point, because Mr. Abramoff's clients ... gave money to Democrats as well as Republicans...

                  But the tribes were already giving money to Democrats before Mr. Abramoff entered the picture; he persuaded them to reduce those Democratic donations, while giving much more money to Republicans. ... donations to Democrats fell by 9 percent after they hired Mr. Abramoff, while their contributions to Republicans more than doubled. So in any normal sense of the word "directed," Mr. Abramoff directed funds away from Democrats, not toward them. ... Bear in mind that no Democrat has been indicted or is rumored to be facing indictment in the Abramoff scandal, nor has any Democrat been credibly accused of doing Mr. Abramoff questionable favors.

                  There have been both bipartisan and purely Democratic scandals in the past. Based on everything we know so far, however, the Abramoff affair is a purely Republican scandal. Why does [this] matter? For one thing, the public is led to believe that the Abramoff affair is just Washington business as usual, which it isn't. The scale of the scandals now coming to light, of which the Abramoff affair is just a part, dwarfs anything in living memory.

                  More important, this kind of misreporting makes the public feel helpless. Voters who are told, falsely, that both parties were drawn into Mr. Abramoff's web are likely to become passive and shrug their shoulders instead of demanding reform. So the reluctance of some journalists to report facts that, in this case, happen to have an anti-Republican agenda is a serious matter. It's not a stretch to say that these journalists are acting as enablers for the rampant corruption that has emerged in Washington over the last decade.

                  I wish the media would show more courage and stand up to the pressure that brings this about. Reporting the unpleasant truth will bring howls of protest, cries of bias, the usual chorus of voices attacking the credibility of the messenger. By some measure, some count of the number of words on the topic assessed subjectively as favorable or unfavorable, the number of guests on certain T.V. or radio programs, the particular page in the newspaper that stories appear on, how many minutes were devoted to reporting this or that, bias will be found in most any direction one is looking. I have the impression that fear of being attacked by the smear machine, fear of being labeled as biased or of some other tactic, has affected the way the news gets reported.

                  Previous (1/26) column: Paul Krugman: Health Care Confidential Next (2/3) column: Paul Krugman: State of Delusion

                    Posted by Mark Thoma on Monday, January 30, 2006 at 12:15 AM in Economics, Politics, Press

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                    January 29, 2006

                    Fed Watch: Now It Gets Interesting...

                    Tim Duy with a Fed Watch:

                    For the Fed watcher, the 4Q05 GDP report is a real brainteaser. The central focus of the many, many blogs covering Friday’s news was the disappointing growth numbers (see William Polley’s and James Hamilton’s views, the latter including a long list of similar concerns). To be sure, the weak headline number deserved attention. But I was surprised by the relatively little attention placed on the inflation reading. I doubt the Fed is going to let that number slip by so lightly. Weak growth and higher inflation? Now that’s interesting.

                    But before I get ahead of myself on the inflation topic, we need to think about how rattled the Fed will be by the growth decline. For this slice of the data, I will concentrate on the contributions to GDP, following in Hamilton’s footsteps with a closer look at the underlying numbers. Let’s toss out the consumption side of the story:

                    Pctg. pts. (annual):  2004  2005  05Q3  05Q4 Personal Cons. Exp.   2.71  2.49  2.85  0.79  Durable goods......  0.51  0.37  0.76 -1.56    Motor veh./parts.  0.06 -0.04  0.45 -2.06    Furniture and                     household equip.  0.34  0.28  0.37  0.35    Other............  0.10  0.13 -0.06  0.14  Nondurable goods...  0.94  0.90  0.73  1.04    Food.............  0.48  0.49  0.61  0.51    Clothing/shoes...  0.17  0.17  0.08  0.28    Gas, fuel oil, and              energy goods....  0.03  0.04 -0.11  0.07    Other............  0.26  0.20  0.15  0.17         Services...........  1.27  1.22  1.36  1.32    Housing..........  0.30  0.24  0.20  0.18    Household oper...  0.07  0.11  0.17  0.08      Elect./gas.....  0.03  0.06  0.10  0.02      Other..........  0.05  0.05  0.08  0.06    Transportation...  0.03  0.04  0.05  0.11    Medical care.....  0.49  0.56  0.66  0.61    Recreation.......  0.11  0.06  0.02  0.08    Other............  0.26  0.21  0.26  0.26

                    The end of the consumer? Oh, don’t get me wrong, the household spending slowdown will be coming. I am not sure how else the imbalances in the economy, summarized by the current account deficit, are resolved. But I am not so confident I see that adjustment in these numbers. No, seriously – the only component that looks out of whack is motor vehicles and parts. And none of us are really surprised too much here. Moreover, the Fed will look at that and note that if car sales simply stabilize in 1Q06, they will contribute nothing to GDP growth, about what they contributed in 2004 and 2005. This is not a make it or break it issue for Greenspan & Co.

                    For a very different perspective on the importance of the auto industry, see Jim Hamilton. I will only add that if you think it important that some rebalancing of economic activity occur to resolve the US current account deficit, then some category of household spending is going to have to take a hit. Perhaps others see a different way out, but I tend to think any rebalancing is going to involve some…how does one put it?...unpleasantness.

                    Much more important is the investment side of the story. Conventional wisdom, which I believe the Fed shares, is that investment swings drive business cycle fluctuations. And Fedspeak has clearly revealed policymaker’s expectation that investment spending will hold strong in 2006. They will be surprised if a different story evolves. More specifically, nonresidential fixed investment is the key here – the expectation at the Fed is that residential investment will ease this year. On to the tables:

                    Pctg. pts. (annual):  2004  2005  05Q3  05Q4  Fixed investment...  1.47  1.28  1.31  0.51    Nonresidential...  0.92  0.87  0.88  0.30      Structures.....  0.06  0.05  0.06  0.02      Equip./soft....  0.86  0.82  0.82  0.28        Info. proc.                   equip./soft.  0.49  0.48  0.42  0.34        Comp./equip.   0.19  0.24  0.11  0.26               Software...  0.11  0.17  0.14  0.13          Other......  0.19  0.08  0.17 -0.05        Ind. equip.... 0.04  0.08  0.20  0.13        Trans. equip.  0.15  0.16  0.18 -0.27        Other equip.   0.18  0.09  0.02  0.07    Residential.....   0.55  0.42  0.43  0.21

                    I suspect this will puzzle policymakers more than the consumption figures. Is the weakness in nonres investment a fluke? The weakness is not widespread, and not like the massive swing in 3Q00 (was it that long ago?) in the equipment and software category. What about the transportation component? Is that related to the auto fallout we saw in consumption? Note that the Beige Book reported tight transportation markets, and expectations of more capital spending. Also, the story in the GDP report is just not consistent with last Thursday’s durable goods release, which revealed strong shipments of capital goods in 4Q and, bolstering the expectation that this was a one off event, a solid 3.5% gain in non defense, non aircraft capital goods orders in December. All in all, I think the Fed will be cautiously optimistic that the weak investment figure was an aberration. Given the other data, it won’t put them on hold this week, but they will be watching a bit more closely during the run up to the March meeting.

                    I will refrain from a long analysis on the inventory adjustment. If you are bearish, the inventory gain signals that the end is near with firms seriously misjudging demand. If you are more on the optimistic side, firms are confident about the future. The Fed will not likely place much emphasis on either story; instead, they will simply note that inventories were drawn down the previous two quarters, and many expected that trend would be reversed in the fourth quarter – nothing ominous, nothing exciting.

                    The swing in defense spending was hurricane related – see Gerald Prante via Mark Thoma. Not much policymaking meat here.

                    For some analysis of the trade figures, see Brad Setser and Menzie Chinn. At least one policymaker, New York Fed President Timothy Geithner, views the current situation as unsustainable (others do as well), but notes that it is not an appropriate focus of monetary policy. The solutions lie outside, far outside, those hallowed halls on Constitution Ave:

                    For global growth to be sustained at a reasonably strong pace during this period of adjustment, the desirable increase in U.S. savings, and the necessary slowing in U.S. domestic demand growth relative to growth of U.S. output, would have to be complemented by stronger domestic demand growth outside the United States, absorbing a larger share of national savings. Exchange rate regimes, where they are currently closely tied to the dollar, will have to become more flexible, allowing exchange rates to adjust in response to changing fundamentals. Reforms to financial systems and to social safety nets over time would help reduce the need for exceptionally high levels of domestic saving we see in many countries.

                    The global nature of these requirements does not imply that the United States can put the principal burden for adjustment on others. If we focus adequate political capital on the factors within our control, we will have more credibility internationally in encouraging policy changes outside the United States that might reduce our collective risks in the adjustment process ahead.

                    Is that all?

                    Monetary policy doesn’t have a direct role in addressing this imbalance, according to Geithner. Of course, the Fed needs to be aware that the globalization of capital flows may be holding longer term interest rates lower than normal, complicating efforts to calibrate monetary policy (read as: the yield curve is no longer an accurate predictor of recessions). But that’s about it – policymakers are left with the chore of maintaining credibility in the event the US current account adjusts in a disruptive fashion. And maintaining credibility means keeping your eye on the prize, a focus on low and stable inflation.

                    (I know that many feel the Fed had a role in the creating role in creating the deficit by flooding the world with cheap money, and Geithner’s speech leaves the Fed unaccountable. I am only the messenger.)

                    Ah yes, it all comes down to inflation. And now, after two quarters of declining core-PCE inflation, we pop back up to an annualized 2.2% rate. If you saw weak growth in this GDP report, you should be especially unhappy with this inflation reading – it suggests that visions of a Fed pause are not quite as simple as a disappointing headline number. As Greg Ip at the WSJ notes, this is “around the top of incoming Fed chairman Ben Bernanke's comfort zone of 1% to 2%.” Are we seeing some pass through of this summer’s high energy costs? Very possibly, and policymakers will not like this, especially with oil within striking distance of $70. Firms that thought this summer’s energy surge a temporary phenomenon may start thinking that it is time to get more forceful about pushing higher prices onto customers. So far, pushing higher prices down the line hasn’t been easy, and the Fed will want to keep it that way – especially with signs that some firms, like Proctor & Gamble (WSJ subscription) are getting away with it.

                    I think the bond markets summed this up nicely on Friday. Interest rates ended just about where they began. Yes, headline GDP was weak, and red flags were raised, particularly in investment spending. But, from the Fed’s perspective, no smoking gun, especially when placed in light of higher frequency data. Couple that with higher inflation and the combination suggests little change in the course of policy – one more tomorrow, with slightly better than even odds on a March hike.

                    Hopefully the final statement of the Greenspan era will provide a clearer path to March. But I tend to think they will be waiting on data to guide them, just like the rest of us. [All Fed Watch posts.]

                      Posted by Mark Thoma on Sunday, January 29, 2006 at 02:11 PM in Economics, Fed Watch, Monetary Policy

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                      Structural Change in Monetary Policy

                      Here are scatter plots of monthly non-borrowed reserves (horizontal axis) and the monthly federal funds rate (vertical axis) for the full sample from 1959-2005 and before and after 1982:

                      I was looking for a dummy variable and piecewise linear regression example for my introductory econometrics course. This ought to do the trick, though piecewise might be a bit of a stretch. I can also ask about potential problems with the approach, e.g., for one, ask how the presence of a trend in NBR might affect the conclusions. For example, here's what happens with a very quick, very simple (and crude) linear detrending of NBR:

                      Looks like two different policy regimes to me. Finally, here's the last diagram with the observations connected through time:

                      The one obvious outlier (FF=3.07, NBR=6.68) is September 2001 when reserves were increased following the terrorist attacks.

                        Posted by Mark Thoma on Sunday, January 29, 2006 at 02:52 AM in Economics, Monetary Policy

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                        Junk Medicaid ... and Replace it With Universal Health Insurance

                        Alex Gerber, M.D., clinical professor of surgery emeritus at the University of Southern California, adds his voice to those calling for universal health insurance, the only viable replacement he sees for a Medicaid program in danger of "meltdown":

                        Junk Medicaid, by Alex Gerber, Commentary Washington Times: Medicaid, the government health-care plan for low-income people, has been targeted ... as a prime source for savings in a bloated federal budget. ... A lowering of Medicaid costs by $6.9 billion is proposed over the next five years, which will decrease benefits and raise out-of-pocket expenses for the 47 million Americans... The nonpartisan Congressional Budget Office predicts an appreciable number of Medicaid recipients ... will join the ranks of the medically uninsured. The adverse morbidity and mortality statistics of the uninsured are well documented...

                        Few are happy with Medicaid today. Patients are unhappy with eligibility red tape and the declining number of doctors willing to treat them. Doctors are unhappy with the mountains of paper work and unrealistically low fees. Most hospitals are unhappy because Medicaid's reimbursement doesn't cover the cost of patient care.... But unhappiest of all are government agencies struggling to control costs... Meanwhile, the public hospitals are alive but not well. ... After 40 years, we must reluctantly conclude Medicaid has been a well-intentioned program that has fallen short of expectations....

                        The great majority of Americans ... believe health care should be a fundamental right and a public rather than a private good. A single standard of health care, regardless of ability to pay... What, then, should replace Medicaid? ...

                        Our outmoded, employer-based, privately financed, multipayer health-care system ... is an anachronism in the 21st century. The world's richest and most powerful nation is unique in not sponsoring government-controlled Universal Health Insurance (UHI) other industrialized nations have enjoyed for decades. Unlike Medicaid, Medicare -- UHI for the elderly -- has been a resounding success. Medicare, though also targeted by Congress for budget cuts by increasing patient-out-of pocket payments, is indeed widely recognized as the most important advance of the last century in our health-care socioeconomics. Medicare for our entire population is probably the most likely answer to Medicaid's "meltdown."

                        I have previously advocated on these pages a change to the Canadian, single-payer health-care plan funded by national health insurance. ... Canada's medical results equal ours at a huge savings. Perhaps the superiority of Canada's health-care system was best expressed by a Harris Interactive Poll among the leading industrial societies that evaluated patient satisfaction with their system: Canada ranked first and the U.S. last. ... Significantly, The new Conservative government in Canada did not advocate major changes in the UHI program.

                        Of interest is a comparison of prescription drug prices in the U.S. and Canada. ... The attempt to constrain skyrocketing drug prices was hamstrung ... by President Bush's insistence there be no price negotiations with pharmaceutical companies. Thus, our Medicare population, ... has been denied the advantage of bulk-buying economies of scale. Imagine the uproar if Hertz and Avis were, by law, denied discounted prices on autos they purchased in huge lots. ...

                        The future for national health insurance looks bleak. The issue has never been on President Bush's agenda. ... A major reform of our wasteful health-care system will help put the brakes on an inexorably rising national debt that will eventually fall on our children and grandchildren. It would be well to recall an admonition from George Washington's 1796 Farewell address: "by vigorous exertion to discharge the debt" -- not ungenerously throwing upon posterity the burden which we ourselves ought to bear.

                          Posted by Mark Thoma on Sunday, January 29, 2006 at 02:06 AM in Economics, Health Care

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                          Corporate Wealth Share Rises for Top Income Individuals

                          Following up on "The Evolution of Top Incomes" which Brad DeLong comments on here, new government statistics show that the concentration of corporate wealth at the high end of the income distribution is continuing to increase:

                          Corporate Wealth Share Rises for Top-Income Americans, by David Cay Johnston, NY Times: New government data indicate that the concentration of corporate wealth among the highest-income Americans grew significantly in 2003, .. a trend that began in 1991 [and] accelerated in the first year that President Bush and Congress cut taxes on capital. In 2003 the top 1 percent of households owned 57.5 percent of corporate wealth, ... The top group's share ... has grown ... since 1991, when it was 38.7 percent. ... according to a Congressional Budget Office analysis of the latest income tax data. ... In 2003, incomes in the top 1 percent of households ranged from $237,000 to several billion dollars. For every group below the top 1 percent, shares of corporate wealth have declined since 1991. ...

                            Posted by Mark Thoma on Sunday, January 29, 2006 at 01:59 AM in Economics, Income Distribution

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                            Another follow up, this time to Technology and Class Attendance:

                            Apple Offers College Lectures Via Podcasts, AP/NYT: In its latest move to broaden its iPod and iTunes franchises, Apple Computer Inc. has introduced ''iTunes U,'' a nationwide expansion of a service that makes course lectures and other educational materials accessible via Apple's iTunes software. The company ... had been working with six universities on the pilot project for more than a year and expanded the educational program this week, inviting other universities to sign up. ... Apple's service offers universities a customized version of the iTunes software, allowing schools to post podcasts, audio books or video content on their iTunes-affiliated Web sites. ...

                            I *guess* this is a good thing...

                              Posted by Mark Thoma on Sunday, January 29, 2006 at 01:24 AM in Economics, Universities

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                              The Demand for Business Ethics

                              Do customers care about business ethics? They say they do, mostly anyway:

                              A Company's Ethics Do Concern Shoppers (or So They Say), by Hubert B. Herring, NY Times: ...[D]o more modest ethical taints affect buying behavior? On the eve of the biggest Enron trial, that's an intriguing question — and one asked in a survey by Opinion Research for LRN, which consults on business ethics and governance. ... Nearly three-quarters of shoppers said they would prefer to buy stuff from a company with ethical practices, even if it meant paying more [graph]. That's what they said, at any rate. Given Americans' passion for rooting out bargains, their resolutions just might teeter when spying an alluring price tag. Shaky ethics seem far from rare. Nearly half of working Americans say that at some point they've had to choose between what a supervisor ordered and what they thought was right...

                                Posted by Mark Thoma on Sunday, January 29, 2006 at 01:01 AM in Economics, Market Failure

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                                You in 1905

                                On the PBS web site is "You in 1905," part of Manor House:

                                You in 1905 Get a snapshot of your life as it might have been had you been living in Britain 100 years ago. Just enter your gender and your fathers profession.

                                So I entered:

                                Are you: Male Your father's occupation: Academic And his job: Professor

                                Here's what it gave me:

                                You are a Schoolmaster! A Snapshot of your life as it might have been in 1905

                                Education You go to the local school in the village and then to Durham University. You're the first person in your family to go to university. Career Prospects Through a mixture of hard work and intelligence you do well in your work as a schoolmaster. You receive a pension but don't live to enjoy it as you're killed in the First World War. Leisure Time You enjoy inviting neighbours in for tea but you have your main meal (meat and vegetables) in the evening. You go to church regularly and are on the parochial Church Council, as well as being an active supporter of the local Conservative club. You go to theatre and musical concerts in the local market town when there is something worth seeing and you always buy the best seats. Living Conditions You live in a village and employ three domestic servants who live with you: a cook, a maid and a scullery maid. You believe that your wife has better things to do than household chores. Marital Relations You marry your wife when you're 25 - she is a friend of your family and goes to the local church. World War One At the outbreak of World War One you feel it's your duty to join the army as a non-commissioned officer. You rise quickly to the rank of company sergeant major. You're killed in the trenches at Ypres in 1917. Other Possible Occupations Farmer, Bank clerk, Army officer, Clergyman, Book keeper

                                I also entered something closer to my father's actual occupations and got:

                                You are an Engine Fitter! A Snapshot of your life as it might have been in 1905

                                Education You go to school until you're thirteen. Career Prospects You follow your father into your job as an engine fitter. You join the army in 1914 as a Private Officer and are promoted to become Lance Corporal. Leisure Time You enjoy watching cricket on Saturday afternoons. On the way home from work you read the Daily Mail to learn about strikes, crimes and sporting results or Tit Bits magazine which keeps you up to date on scandal, jokes and stories. You enjoy exchanging gossip with your friends at the music hall on a Friday night. Living Conditions You live in a small terraced house with your parents, wife and two of your children. You have four children but two will be servants living with their employers and sending money back when they can. As a treat you buy fish and chips from one of the shops on the parade near your home. Your family share an allotment by the railway line where you grow potatoes, carrots and sweet peas. Marital Relations You marry twice, due to the death of your first wife. World War One You're killed on the beaches at Gallipoli in 1915. Other Possible Occupations Engine fitter, Mechanic, Policeman, Coachman, Wheelwright, Cutler (knife-maker)

                                Going up and down the income ladder brings up all the possible outcomes:

                                Position in Society Your life as it might have been further UP or DOWN society's ladder

                                General Statistics

                                • In 1910, there were only 1000 divorces a year
                                • A married couple would not normally share a bedroom
                                • There was no NHS or social security service


                                Posted by Mark Thoma on Sunday, January 29, 2006 at 12:15 AM in Economics, Miscellaneous

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                                January 28, 2006

                                Kill the Messenger

                                The administration does not like the results of greenhouse gas and global warming research from a leading researcher in the area and, according to this report, is attempting to control what he is allowed to say in public:

                                Climate Expert Says NASA Tried to Silence Him, by Andrew C. Revkin, Washington Post: The top climate scientist at NASA says the Bush administration has tried to stop him from speaking out since he gave a lecture last month calling for prompt reductions in emissions of greenhouse gases linked to global warming. The scientist, James E. Hansen, longtime director of the agency's Goddard Institute for Space Studies, said ... officials at NASA headquarters had ordered the public affairs staff to review his coming lectures, papers, postings on the Goddard Web site and requests for interviews from journalists. Dr. Hansen said he would ignore the restrictions. "They feel their job is to be this censor of information going out to the public," he said. ...

                                Dr. Hansen said that nothing in 30 years equaled the push made since early December to keep him from publicly discussing ... clear-cut dangers from further delay in curbing carbon dioxide. ... He said he was particularly incensed that the directives affecting his statements had come through informal telephone conversations and not through formal channels, leaving no significant trails of documents. Dr. Hansen's supervisor, Franco Einaudi, said there had been no official "order or pressure to say shut Jim up." But Dr. Einaudi added, "That doesn't mean I like this kind of pressure being applied."

                                The fresh efforts to quiet him, Dr. Hansen said, began in a series of calls after a lecture he gave ... and the release of data ... showing that 2005 was probably the warmest year in at least a century, officials at the headquarters of the space agency repeatedly phoned public affairs officers, who relayed the warning to Dr. Hansen that there would be "dire consequences" if such statements continued, those officers and Dr. Hansen said in interviews.

                                Among the restrictions, according to Dr. Hansen and an internal draft memorandum he provided to The Times, was that his supervisors could stand in for him in any news media interviews. In one call, George Deutsch, a recently appointed public affairs officer at NASA headquarters, rejected a request from a producer at National Public Radio to interview Dr. Hansen, said Leslie McCarthy, a public affairs officer responsible for the Goddard Institute.

                                Citing handwritten notes taken during the conversation, Ms. McCarthy said Mr. Deutsch called N.P.R. "the most liberal" media outlet in the country. She said that in that call and others Mr. Deutsch said his job was "to make the president look good" and that as a White House appointee that might be Mr. Deutsch's priority.

                                But she added: "I'm a career civil servant and Jim Hansen is a scientist. That's not our job. That's not our mission. The inference was that Hansen was disloyal." ... Mr. Acosta, Mr. Deutsch's supervisor, said that when Mr. Deutsch was asked about the conversations he flatly denied saying anything of the sort. ... Ms. McCarthy, when told of the response, said: "Why am I going to go out of my way to make this up and back up Jim Hansen? I don't have a dog is this race. And what does Hansen have to gain?" ...

                                "He's not trying to create a war over this," said Larry D. Travis, an astronomer who is Dr. Hansen's deputy at Goddard, "but really feels very strongly that this is an obligation we have as federal scientists, to inform the public, and this kind of attempted muzzling of the science community is really rather dangerous. If we just accept it, then we're contributing to the problem." ...

                                "He really is one of the most productive and creative scientists in the world," Dr. Cicerone said. "I've heard Hansen speak many times and I've read many of his papers, starting in the late 70's. Every single time, in writing or when I've heard him speak, he's always clear that he's speaking for himself, not for NASA or the administration, whichever administration it's been." ...

                                Many people who work with Dr. Hansen said that politics was not a factor in his dispute with the Bush administration. "The thing that has always struck me about him is I don't think he's political at all," said Mark R. Hess, director of public affairs for the Goddard Space Flight Center in Greenbelt, Md... "He really is not about concerning himself with whose administration is in charge, whether it's Republicans, Democrats or whatever," Mr. Hess said. "He's a pretty down-the-road conservative independent-minded person. "What he cares deeply about is being a scientist, his research, and I think he feels a true obligation to be able to talk about that in whatever fora are offered to him."

                                The administration is set to reveal a new science education initiative soon to encourage more people to enter science related fields. Showing more respect for science and the dedicated scientists behind it would be a good way to begin.

                                  Posted by Mark Thoma on Saturday, January 28, 2006 at 12:51 PM in Economics, Environment, Science

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                                  The Tax Policy Blog: Hurricanes, Government Spending, and GDP

                                  Gerald Prante at the The Tax Policy Blog looks at the difference between GDP and net domestic product growth rates (in levels, NDP=GDP-CFC, where CFC is the consumption of fixed capital, i.e. a measure of depreciation, see the BEA for more). He also notes that much of the spending on hurricane Katrina is reflected in defense spending which rose in the 3rd quarter but fell in the 4th leading to corresponding swings in the GDP figures:

                                  Gerald Prante, The Tax Policy Blog, Hurricanes, Government Spending, and GDP: The Bureau of Economic Analysis today released GDP numbers for the 4th quarter and it showed GDP rising at only 1.1 percent, down significantly from the 4.1 percent growth witnessed in the 3rd quarter of 2005. ... There are two main factors associated with the high volatility of recent GDP growth: (1) Hurricane Katrina and (2) defense spending.

                                  Remember that GDP is Gross Domestic Product, meaning that if our economy is just replacing capital destroyed by Katrina, gross production will increase. But also during Katrina, federal defense spending—part of the government portion of GDP—rose dramatically. Defense spending includes much of the costs to government from hurricane relief ... Specifically, defense spending rose 10 percent in the 3rd quarter, only to fall 13.1 percent in the 4th quarter. That means the 3rd quarter GDP number was “artificially” high thanks to these added costs of rebuilding and spending, and the percent change in the 4th quarter was “artificially” low as spending and rebuilding subsided.

                                  If, on the other hand, we examine Net Domestic Product (NDP)—which accounts for huge capital stock losses from natural disasters—one can see a much different picture of the recent economy. NDP fell dramatically in the 3rd quarter—an 8.4 percent annualized decline—but rose dramatically in the 4th quarter by 12 percent. Contrast that with GDP, which increased at a rapid pace of 4.1 percent in the 3rd quarter, yet only rose by 1.1 percent in the 4th quarter.

                                  Take a look at the chart below of the quarterly growth rates in GDP and NDP since 2003 and the timing of when the two indicators diverge. The first large divergence comes in the 3rd quarter of 2004 ... when we saw the destruction caused by Hurricanes Ivan and Charley. During the 3rd quarter of 2004, defense spending rose by 13.8 percent, spiked by the hurricane relief expenses, and then only increased by 0.8 percent in the 4th quarter.

                                  The second large divergence between the two indicators appeared in the 3rd quarter of 2005 with Hurricanes Katrina and Rita. Notice too from the chart that this phenomenon does not occur in 2003 as its hurricane season was very light relative to other years. Hurricane Isabel was the only big storm of the 2003 season and only struck land as a Category 2 storm.

                                  Click on figure to enlarge

                                  Here's the same two series for a slightly longer time period, since 1990:

                                  The magnitude of the changes in NDP growth recently look unusually large, but a longer view of the two series shows that changes of this magnitude are not unprecedented:

                                  However, though subsequent data revisions may change this, the difference between the two series is unusually large:

                                  I'm not sure what to make of the inceasing volatility in the difference between the two growth rates.

                                    Posted by Mark Thoma on Saturday, January 28, 2006 at 01:05 AM in Economics

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                                    Wal-Mart Dons the Environmental Red Cape and Uses its Monopsony Powers to Promote Truth, Justice, and the American Way

                                    Or is it really Wal-Mart's evil super-store twin up to its old profit maximizing tricks?

                                    Wal-Mart fishes for eco-friendly profile, by Jonathan Birchall and Fiona Harvey, Financial Times: Wal-Mart has committed itself to taking most of the fish it sells in North America from environmentally sound sources, in its latest initiative to improve its much criticised record on environmental and social issues. The world’s largest retailer has pledged that all of its US fresh and frozen fish, excluding farmed fish, will eventually come from fisheries certified as being “sustainable” by the Marine Stewardship Council... Wal-Mart, which operates 900 fish counters, joins a small group of US retailers, including Whole Foods Market and Wild Oats, which source salmon, pollock, lobster and hoki fish from MSC-certified fisheries. ...

                                    Wal-Mart has also established “sustainability networks” that bring its suppliers and its buyers together with concerned non-profit groups, covering products including agricultural products, seafood, and gold and jewellery. Rupert Howes, head of the Marine Stewardship Council, said: “It is hugely significant that Wal-Mart is doing this, and setting a real example to the rest of the industry.”

                                    However, only a small number of fisheries have been certified as sustainable. This means it will take between three and five years for Wal-Mart to achieve its goal. The company has also been showing new interest in improving conditions in garment and footwear factories – another area highlighted by Mr Scott.

                                    But it is still struggling to persuade many of its critics that it is serious about its conversion to the cause of corporate social responsibility. ... However, David Schilling, of the Interfaith Center on Corporate Responsibiity, which has co-ordinated numerous shareholder resolutions critical of Wal-Mart, said critics would watch for genuine changes that went beyond its current propaganda war. ...

                                    Wal-Mart faces considerable challenges if it is to adapt its operations to the range of standards now embraced by some of its rivals. Unlike Nike or Gap, both of which have been active in developing supply chain monitoring, it sells a vast range of merchandise ranging from bananas to diamonds; its supply chain uses 60,000 factories worldwide for its own brand products alone, compared to around 700 at Nike.

                                      Posted by Mark Thoma on Saturday, January 28, 2006 at 12:16 AM in Economics, Environment

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                                      January 27, 2006

                                      Krugman's Money Talks: The V.H.A. ... Not Wealthy, but Sometimes Wise

                                      Paul Krugman responds to comments on his recent column Health Care Confidential:

                                      The V.H.A.: Not Wealthy, but Sometimes Wise, Paul Krugman, Money Talks: C.J. Stimson, Nashville, Tenn.: ...[We] often find ourselves debating the V.A. and its tremendous advances. The quality and cost figures reported over the last decade do seem to paint a very optimistic picture. But ... I often wonder whether it's actually replicable. The patient base for the V.A. makes it very unique and lends itself to improved outcomes and increased efficiency. The V.A. is a closed system where variables in the delivery of care, the most important of which is the patient, can be well controlled. If this degree of control could be exercised over a broader population, perhaps U.S. Health Care, Inc., would be feasible. I am afraid, however, that the American psyche is not ready to cede such control. ...

                                      Paul Krugman: As you say, the V.A. is a closed population, which is what makes it work. Big plans like Kaiser share some of the same advantages, and have partially matched the V.A.'s achievement. But to replicate the achievement nationwide, we'd need a nationwide health system - which is sort of a "well, duh" conclusion.

                                      I am highly skeptical of claims that the obstacle to such a system lies in something deep about the American psyche. After all, people tell us that even the more limited goal of single-payer health care is deeply unacceptable to Americans, yet every American over 65 benefits from Medicare, which is single-payer pure and simple, and it's highly popular. So I think the problem is politics, not national character. ...

                                      Jennifer C. Jaff, Farmington, Conn.: Your view of the Veterans Administration as a model of successful single-payer healthcare ignores the daily reality of patients -- especially those with chronic illness. Veterans Administration doctors routinely cut off all medication -- no tapering even where normal protocol is to taper, ... without reason, disregarding long-standing diagnoses ... of other Veterans Administration doctors. If you talk to patients with chronic conditions, you will find that the Veteran's Administration vastly under-treats, withholding medication and treatment that are used routinely in the private sector... In theory, you may be right. In practice, unless those engaging in this important debate about health care financing focus on the real experience of patients with chronic diseases -- those patients whose health care is the most expensive, and who have the most contact with the health care system -- these sorts of misimpressions of how things really work will lead to disastrous outcomes. ...

                                      Health care policy that is made only for the healthy will jeopardize the care and financial stability of millions of Americans with chronic diseases. I, for one, am terrified when even the well-intentioned like you get this wrong. I see bankruptcy court in my future, and the future of fully half of Americans who suffer from at least one chronic disease, unless our needs and the cost of our care is addressed in any plan to reform the health care system in America.

                                      Donna Whaley, Tennessee Colony, Tex.: I feel compelled to comment that this Op-Ed is obviously written by someone who is not dependent on the V.A. for health care. Someone who is not waiting for MONTHS for follow-up to a heart attack and a subsequent failed stress test, wondering if you will last until they can work you in. Or who discovered that her recent kidney stone procedure was done with outdated equipment and no anesthesia unnecessarily causing excruciating pain that could have been avoided. The V.A., I believe, does the best they can with what they have, but it is far from good enough. ... What I ask is that you please address the problems, too -- your article makes it sound utopian. ...

                                      Paul Krugman: The V.A. does have some waiting time issues; as you say, they're due to lack of funds. The fact remains, however, that despite its shoestring budget the V.A. by all accounts does a better job in many dimensions than private health care.

                                      Still, you've touched on my biggest worry about the V.A., which is that it will be starved for funds by politicians who prefer to use the money for, say, tax cuts. That's what happened to Britain's National Health Service, which is better than Americans think, but was nickel-and-dimed by successive British governments down to the point where it currently spends only about 40 percent as much per capita as the U.S. system.

                                      Robert Feinberg, Chicago: Enjoyed your article on the V.A. My own experience as a retired naval officer differs. While I have had some positive experiences with V.A. care, on the whole, I have found the system still reflective of the old stereotypes. ... The fact is, among the retired officer community, most of us will do almost anything not to use the V.A. system .... But I am glad that it exists to provide care for those less fortunate ... By the way, did you know that the V.A. treats service-connected conditions only and that an entire generation of vets have no carte blanche access to the system? ...

                                      Tom Lewis, Colebrook, Conn.: You missed one important point about the VHA. It emphatically does not serve all veterans. It means-tests them and serves generally the oldest, sickest and poorest. This makes its mission far harder because it does not cherry-pick the way the privatized, insured health care system does. With that in mind, it is an even more interesting model for a national health care system. On the other hand, all of its statistics are self-reported. I'm told that some V.H.A. institutions cook their statistics. There is no federal health care oversight agency for any of the federal health care agencies: D.O.D., prisons, V.H.A., etc. Bear in mind also, that the V.H.A. is very bureaucratic. Patients get bumped around a lot in the course of care. And access and quality of care vary considerably. The south and southwest are underbedded. The northeast and rust belt are wrongly bedded. Many vets do not have access to V.H.A. medical centers or clinics. Inpatient mental health care, for example, can be very uneven. (The writer is the former director of the New York State Division of Veterans Affairs.)

                                      Ben Hadad, Houston: Please don't wax too poetic on V.A. health care unless you like most appointments three to four hours late and six months or more to make an appointment. Once they get you in they are great. Prescription drugs flow seamlessly by mail, certainly at an affordable cost. ...

                                      Paul Krugman: The comments on the V.A. have been greatly informative ... Let me say something about how to interpret what you're reading.

                                      First, experiences with the V.A. are by no means uniformly positive. That's what you'd expect. We're talking about a real-world system run by fallible human beings. So negative stories don't condemn the system, just as positive stories don't validate it. For that you need careful, systematic quality assessments - and these give the V.A. system very high marks.

                                      Second, waiting times are a bit of an issue. This reflects the tightness of the V.A.'s budget. And there is, to be honest, some reason to think that this is always a risk with government-run health care: politicians see an opportunity to squeeze a bit, to make funds available for their pet projects, then to squeeze a bit more, and after a decade or two quality has really suffered. That's what happened to the British system, although that system remains much better than Americans have been told.

                                      But - and this is my last point - consider the alternative. Out here in the non-veteran world, corporations are reacting to rising health care costs by dropping insurance; states are reacting by throwing people off Medicaid; and people without health insurance are leaving chronic problems untreated, then ending up in emergency rooms - or dead. Meanwhile, the V.A. is containing costs while providing excellent if not always perfect care.

                                        Posted by Mark Thoma on Friday, January 27, 2006 at 07:31 PM in Economics, Health Care

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                                        Yellen Says the New Guy is Right

                                        This Fed Letter from the FRBSF is based upon Janet Yellen's speech last week. She reviews the Greenspan years, looks ahead the the Fed under Bernanke, and talks about how Bernanke and Greenspan differ on explicit inflation targets:

                                        2006: A Year of Transition at the Federal Reserve, Economic Letter, FRBSF: At the end of this month, Alan Greenspan will bring to a close his 18 years of distinguished service as Chairman of the Board of Governors of the Federal Reserve System. ... With such a significant transition for the Fed just days away, this seemed like a natural time to spend a few moments looking back at the Greenspan Fed and offering some of my own views on what may lie ahead under a "Bernanke Fed." ...

                                        Alan Greenspan has won many plaudits for skillfully managing monetary policy—and deservedly so. During the Greenspan years, the U.S. economy has been extraordinarily stable, with just two mild and short recessions (Figure 1), and with low and stable inflation for over a decade ... Clearly, in the short time I have today, I cannot do justice to all the accomplishments.... So I'll focus on two aspects of policy that I believe have been especially important... a systematic, and therefore understandable and predictable approach to policy, and a growing emphasis on communication and transparency.

                                        I will focus first on what I mean by a systematic approach to policy. While the Fed does not follow a policy rule, it has been consistent in its approach to achieving its dual mandate—keeping inflation low and stable and promoting maximum sustainable employment. ...

                                        This systematic, consistent approach has enhanced the ability of financial markets to anticipate the Fed's response to economic developments and to respond themselves in advance of the Fed. Such market responses strengthen and speed the transmission of policy to the economy and conceivably enhance economic stability. Moreover, such an approach helps build the public's confidence in the Fed's commitment to low and stable inflation; this, in turn, may well make it easier for the Fed to respond to fluctuations in labor and product markets, because there is less risk that an easing of policy will unleash a wave of inflation fears. As successful as this systematic approach ... has by no means been a straitjacket for policy during the Greenspan years. Rather, policy also has been flexible when unusual circumstances called for it. ...

                                        Now let me turn to the second aspect of policy, namely, the increased emphasis on communication and transparency. One of the first steps in this direction occurred in 1994, when the FOMC first started issuing press releases after its meetings that explicitly announced changes in the federal funds rate target. Over the decade or so since then, the press release has come to include a statement about the balance of risks to the attainment of its dual mandate, and at least some indication of where policy may go in the future. This enhanced transparency works in tandem with the systematic approach ... because it ... helps the markets anticipate the Fed's response to economic developments...

                                        Of course, there have certainly been other developments in policy during the 18 years of Greenspan's chairmanship that have contributed to its success in achieving its dual mandate. But I believe these two—a systematic approach to policy and more communication and transparency—are particularly noteworthy. ...

                                        Looking ahead to the "Bernanke years"

                                        These achievements provide a great foundation for the new Chairman, Ben Bernanke. Having observed him when he was a member of the Board of Governors from 2002 to 2005, and being familiar with his remarkable body of research on macroeconomic policy, I feel pretty confident that he places an equally high value on a systematic approach as well as on transparency and communication. ... And any of you who have read the speeches he gave while he was a Governor will know that he is a consummate communicator and teacher.

                                        One area where he has differed with Chairman Greenspan is on how to define "price stability." Of course, both see price stability as a prime objective of policy. But for Chairman Greenspan, the definition has been behavioral—that is, he would say that we have achieved price stability when inflation is low enough that it does not materially affect people's economic decisions. In contrast, ... Bernanke ... said that he would like to see the establishment of a numerical objective for price stability... Since his nomination, he has said that he would not institute such an approach without a consensus among FOMC members.

                                        For my part, I'm sympathetic to the idea of a quantitative objective for price stability, as I agree that it enhances both Fed transparency and accountability. ... I see an inflation rate between 1% and 2%, as measured by the core personal consumption expenditures price index, as an appropriate price stability objective for the Fed. However, I also think it is critically important that a numerical inflation objective not weaken our commitment to a dual mandate that includes full employment. ... I believe that a numerical long-run objective for inflation will enhance our ability to maintain that success even in the face of the significant challenges that may come up. ...

                                          Posted by Mark Thoma on Friday, January 27, 2006 at 06:08 PM in Economics, Monetary Policy

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                                          Revisions to Real and Nominal GDP

                                          With today's disappointing advance GDP report which will be revised as new data arrive, I thought it might be worthwhile to look at typical revisions in recent years to see if there is any particular pattern.
                                          I went to the Philadelphia Fed web site where they have vintage data stored and clicked on the Core Variables/ Quarterly Observations/ Quarterly Vintages link. I then used this Excel macro to extract the earliest release and the latest revisions of the real and nominal GDP data. I am not fully confident in these data since they do not match up exactly with the vintage data series extracted from the Alfred archive at the St. Louis Fed. But assuming the data from the Philadelphia Fed are accurate, here is what they show.

                                          First, the table of initial values, the latest revised values, and percentage changes since 2003:Q4:

                                          Initial RGDP Revised RGDP Initial NGDP Revised NGDP
                                          2003:04 10597.1 10502.6 11246.3 11236.0
                                          2004:01 10708.6 10612.5 11447.8 11457.1
                                          2004:02 10778.0 10704.1 11649.3 11666.1
                                          2004:03 10883.4 10808.9 11803.5 11818.8
                                          2004:04 10975.7 10897.1 11967.0 11995.2
                                          2005:01 11078.2 10999.3 12182.7 12198.8
                                          2005:02 11092.0 11089.2 12376.2 12378.0
                                          2005:03 11193.2 11202.3 12589.6 12605.7
                                          Real Adjustment Nominal Adjustment % Change Real % Change Nominal
                                          2003:04 -94.5 -10.3 -0.89% -0.09%
                                          2004:01 -96.1 9.3 -0.90% 0.08%
                                          2004:02 -73.9 16.8 -0.69% 0.14%
                                          2004:03 -74.5 15.3 -0.68% 0.13%
                                          2004:04 -78.6 28.2 -0.72% 0.24%
                                          2005:01 -78.9 16.1 -0.71% 0.13%
                                          2005:02 -2.8 1.8 -0.03% 0.01%
                                          2005:03 9.1 16.1 0.08% 0.13%

                                          In general, over the last two years, real GDP has been revised downward while nominal GDP has been revised upward. The average adjustments from 1983 - 2002, a time period not covered in the tables above, according to today's GDP report from the BEA is (these are not directly comparable as the figures below are for adjustments to growth rates - thanks to William Polley for noting that - see his post on the same issue from a year ago):

                                             Revisions Between Quarterly       Percent Changes of GDP:         Vintage Comparisons           [Annual rates]    Current-dollar GDP  Average  Advance to preliminary......0.1  Advance to final............ .2  Preliminary to final........ .0  Advance to latest........... .4   Real GDP   Average  Advance to preliminary......0.1 Advance to final............ .1 Preliminary to final........ .0   Advance to latest........... .4  NOTE -- These comparisons are based  on the period from 1983 through 2002.

                                          We'll know more with the preliminary report which comes about a month after the advance numbers, and even more yet with the final report about a month later. The latest estimates also incorporate comprehensive revisions occurring at about five year intervals.

                                          Posted by Mark Thoma on Friday, January 27, 2006 at 03:45 PM in Economics

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                                          Bush is Moving to Fill Two Slots at the Federal Reserve

                                          News from Greg Ip and John McKinnon at the Wall Street Journal on Bush's choice to fill the two open seats on the Federal Reserve Board of Governors:

                                          Bush Is Moving To Fill Two Slots At Federal Reserve, by Greg Ip and John D. McKinnon, WSJ: With leadership at the Federal Reserve about to change, the White House is moving to fill two vacancies on the central bank's seven-member board of governors. President Bush plans to soon nominate Kevin M. Warsh, a White House adviser on domestic finance and capital markets, to fill one of the two vacancies, two people familiar with the matter said. Mr. Bush aims to fill the other seat with an academic economist, and the likeliest candidate is Randall S. Kroszner, who teaches at the University of Chicago's Graduate School of Business, one of these people said...

                                          The nominations would tilt the board's composition toward financial-industry expertise rather than macroeconomics. Mr. Warsh, a lawyer by training, was an investment banker at Morgan Stanley before joining the White House National Economic Council. He has been the White House's point person on financial-industry issues. Mr. Kroszner, who served on the Council of Economic Advisers during Mr. Bush's first term, specializes in banking, banking regulation, international-financial crises and monetary economics...

                                          From Brad DeLong on Randall Kroszner [photo/web page, color photo]:

                                          I know I'm proud to have played a (alas, very small) part in the education of Randy Kroszner and Robin Hanson, both far to my right.

                                          From Institutional Economics:

                                          Both Clarida and Kroszner would be excellent appointments. Appointing non-specialists with financial market backgrounds would be a mistake in my view, increasing the risk of ... regulatory capture by Wall Street...

                                          That doesn't sound like a strong endorsement of Warsh [photo, photo with Bush]. I know little about him. BusinessWeek Online has a bit more, but not much:

                                          Warsh is the NEC's point man for contact with the financial-services industry. He has recently sought to raise his public profile by speaking to more industry groups and was mentioned as a candidate for chairman of the Securities & Exchange Commission before Bush tapped Rep. Christopher Cox (R-Calif.) for the job.

                                          Update: Bloomberg reports that Al Hubbard, director of the White House's National Economic Council, says:

                                          "They're going to fit very, very well'' at the Fed, said Al Hubbard ... in an interview. Warsh, who works for Hubbard, "has terrific business experience, having worked on Wall Street.'' Kroszner is "one of the great economists in our country,''...

                                          The same report notes that a former Fed vice Chairman is not sold on Warsh:

                                          Preston Martin, who was Fed vice chairman from 1982 to 1986. called Kroszner "a brilliant choice because he has served in many categories around and in the Federal Reserve system.'' "If I were on the Senate committee, I'd vote yes for Kroszner and no for Warsh,'' said Martin. "I have great reservations about Warsh because he just doesn't have the background.''

                                          Brad DeLong has questions too.

                                            Posted by Mark Thoma on Friday, January 27, 2006 at 01:45 AM in Economics, Monetary Policy, Politics

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                                            The Economist Opposes Bush's Health Care Proposal

                                            The Economist swallows hard, and then talks sensibly about health care reform:

                                            America's headache, The Economist: Everyone , it seems, has a health problem. ... But nowhere has a bigger health problem than America. ... Pushed by polls that show health care is one of his main domestic problems ..., George Bush is expected to unveil a reform plan in next week's state-of-the-union address.

                                            America's health system is unlike any other. The United States spends 16% of its GDP on health, around twice the rich-country average, equivalent to $6,280 for every American each year. Yet it is the only rich country that does not guarantee universal health coverage. ...[M]ost Americans receive health insurance through their employer, with the government picking up the bill for the poor (through Medicaid) and the elderly (Medicare).

                                            This curious hybrid certainly has its strengths. Americans have more choice than anybody else, and their health-care system is much more innovative. Europeans' bills could be much higher if American medicine were not doing much of their R&D for them. But there are also huge weaknesses. The one most often cited ... is the army of uninsured. ... In many cases that is out of choice and, if they fall seriously ill, hospitals have to treat them. But it is still deeply unequal. And there are also appalling inefficiencies: by some measures, 30% of American health spending is wasted.

                                            Then there is the question of state support. Many Americans decry the “socialised medicine” of Canada and Europe. In fact, ... around 60% of America's health-care bill ends up being met by the government (thanks in part to huge tax subsidies that prop up the employer-based system). Proportionately, the American state already spends as much on health as the OECD average, and that share is set to grow... America is, in effect, heading towards a version of socialised medicine by default.

                                            Is there a better way? ...[T]here is no such thing as a perfect health-care system: every country treads an uneasy compromise between trying to harness market forces and using government cash to ensure some degree of equity. Health care is also ... where market forces have ... the most limited success: it is plagued by distorted incentives and information failures. To begin with, most health-care decisions are made by patients and doctors, but paid for by someone else. There is also the problem of selection: private-sector insurers may be tempted to weed out the chronically ill and the old, who account for most of the cost of health care.

                                            In the longer term, America, like this adamantly pro-market newspaper, may have no choice other than to accept a more overtly European-style system. In such a scheme, the government would pay for a mandated insurance system, but leave the provision of care to a mix of public and private providers. Rather than copying Europe's distorting payroll taxes, the basic insurance package would be paid for directly by government...

                                            Such a system would not be perfect but it could mitigate the worst inequities in America's health-care system, while retaining its strengths. In practice, however, it will not happen soon. American politicians are still scarred by the failure of Hillary Clinton's huge health-care plan .... Incremental change ... looks the only way forward...

                                            [T]here is a flaw at the heart of his proposal. Mr Bush goes straight to one of the biggest distortions in American health care—the generous tax subsidies doled out to firms providing insurance. These help to promote a culture where costs do not matter. ...[T]he president wants to even things out by doling out yet more tax subsidies to others—for instance, letting individuals set more of their out-of-pocket medical expenses against taxes. Such hand-outs may have political appeal, but they will worsen the budget deficit and, most probably, drive up the pace of medical spending. America's health-care system could be improved in small steps. But those steps need to be in the right direction.

                                            See The Economist's companion article "Desperate Measures" [free link] for more detail on these and other issues. It ends with:

                                            Mr Bush's health-care philosophy has a certain political appeal. It suggests incremental change rather than a comprehensive solution. It reinforces existing industry trends. And it promises to be pain-free. Unfortunately, it will not work. The Bush agenda may speed the reform of American health care, but only by hastening the day the current system falls apart.

                                              Posted by Mark Thoma on Friday, January 27, 2006 at 01:19 AM in Economics, Health Care

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                                              Paul Krugman: Health Care Confidential

                                              Paul Krugman continues the health care theme from recent columns and in the post below this one with ideas on how to reform the health care system. He says there are lessons to be learned from a government run program that is not too far away:

                                              Health Care Confidential, by Paul Krugman, On Health Care Commentary, NY Times: American health care is desperately in need of reform. But what form should change take? Are there any useful examples we can turn to for guidance? Well, I know about a health care system that has been highly successful in containing costs, yet provides excellent care. And the story of this system's success provides a helpful corrective to anti-government ideology. For the government doesn't just pay the bills ... it runs the hospitals and clinics.

                                              No, I'm not talking about some faraway country. The system in question is our very own Veterans Health Administration, whose success story is one of the best-kept secrets in the American policy debate. In the 1980's and early 1990's, says ... The American Journal of Managed Care, the V.H.A. "had a tarnished reputation of bureaucracy, inefficiency and mediocre care." But reforms beginning in the mid-1990's transformed the system, and ... "have allowed it to emerge as an increasingly recognized leader in health care." Last year customer satisfaction with the veterans' health system ... exceeded that for private health care for the sixth year in a row. This high level of quality (which is also verified by objective measures ...) was achieved without big budget increases. ... How does the V.H.A. do it?

                                              The secret of its success is the fact that it's a universal, integrated system. Because it covers all veterans, the system doesn't need to employ legions of administrative staff to check patients' coverage and demand payment from their insurance companies. Because it's integrated, ... it has been able to take the lead in electronic record-keeping and other innovations that reduce costs, ensure effective treatment and help prevent medical errors.

                                              Moreover, the V.H.A., as Phillip Longman put it in The Washington Monthly, "has nearly a lifetime relationship with its patients." As a result, it "actually has an incentive to invest in prevention and more effective disease management. ..." Oh, and one more thing: the veterans health system bargains hard with medical suppliers, and pays far less for drugs than most private insurers.

                                              I don't want to idealize the veterans' system. In fact, there's reason to be concerned about its future: will it be given the resources it needs to cope with the ... wounded and traumatized veterans from Iraq? But the ... V.H.A. is clearly the most encouraging health policy story of the past decade. So why haven't you heard about it?

                                              The answer, I believe, is that pundits and policy makers ... can't handle the cognitive dissonance. (One prominent commentator started yelling at me when I tried to describe the system's successes in a private conversation.) For the lesson of the V.H.A.'s success story ... runs completely counter to the pro-privatization, anti-government conventional wisdom that dominates today's Washington.

                                              The dissonance ... is one reason the Medicare drug legislation looks as if someone went down a checklist of things the veterans' system does right, and in each case did the opposite. For example, the V.H.A. avoids dealing with insurance companies; the drug bill shoehorns insurance companies into the program... The V.H.A. bargains effectively on drug prices; the drug bill forbids Medicare from doing the same.

                                              Still, ideology can't hold out against reality forever. Cries of "socialized medicine" didn't, in the end, succeed in blocking the creation of Medicare. And farsighted thinkers are already suggesting that the Veterans Health Administration, not President Bush's unrealistic vision of a system in which people go "comparative shopping" for medical care the way they do when buying tile, represents the true future of American health care.

                                              Previous (1/22) column: Paul Krugman: Iraq's Power Vacuum Next (1/29) column: Paul Krugman: A False Balance

                                                Posted by Mark Thoma on Friday, January 27, 2006 at 12:33 AM in Economics, Health Care

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                                                January 26, 2006

                                                Gifts from Medical Companies and Health Care Costs

                                                I am told by a cardiac nurse that she gets taken out to lunch once a week or so by medical and pharmaceutical device reps. She orders stents and a few other things so they treat her well. This spring, she is going to an all expenses paid conference in Las Vegas. There are a few classes you can attend if you want, she says they always make sure to have at least one, but attendance is not required and she doubts she will bother. There are plenty of places to cut costs for health care that don't involve cutting benefits to patients:

                                                In Article, Doctors Back Ban on Gifts From Drug Makers By Gardiner Harris, NY Times: The gifts, drugs and classes that makers of pharmaceuticals and medical devices routinely give doctors undermine medical care, hurt patients and should be banned, a group of influential doctors say in ... The Journal of the American Medical Association. ... Broadly adopted, the recommendations would ... shut off the focus of drug makers' biggest expenditures. But Dr. David Blumenthal, an author of the article, said it was "not very likely" that many in medicine would listen to the group. ...

                                                Federal law forbids companies from paying doctors to prescribe drugs or devices, but gifts and consulting arrangements are almost entirely unregulated. Voluntary professional guidelines suggest that doctors refuse gifts of greater than "modest" value. Sanctions against doctors who accept gifts of great value are extremely rare. The drug industry spends tens of billions of dollars a year to woo doctors, far more than it spends on research or consumer advertising. Some doctors receive a significant part of their income from consulting arrangements with drug and device makers. Others take regular vacations and golfing trips that are paid for by companies. ...

                                                Surveys show that most doctors do not believe that these gifts influence their medical decisions, although most believe that they do affect their colleagues' medical judgment. But even small gifts can lead to profound changes in doctors' prescribing behavior, with "negative results on clinical care," the article states. As a result, all gifts should be banned...

                                                Ken Johnson, a spokesman for the Pharmaceutical Research and Manufacturers of America, said the drug industry had a voluntary code of marketing conduct. "Only practices that do not compromise independent judgments of health providers - such as modest working meals, gifts of minimal value that support the medical practice, and distribution of free samples - are permitted," ... Dr. Duane M. Cady, board chairman of the American Medical Association, said in a statement that "drug and medical device makers can play a role in educating physicians about new products." He said the organization was "in the process of examining and updating its policy on gifts to physicians from industry." ...

                                                Kaiser Permanente, the California-based managed-care group, is one of the few medical organizations in the United States that have enacted nearly all of the recommendations suggested by the journal article. Kaiser physicians prescribe heavily marketed medicines far less frequently than doctors nationally. ...

                                                The article also argues that "no strings attached" consulting arrangements should be banned... Doctors should refuse free drug samples, the article states, because they are "a powerful inducement for physicians and patients to rely on medications that are expensive but not more effective." Such a refusal would also eliminate one of the principal reasons for which drug salespeople are routinely allowed to enter doctors' offices... While the article does not suggest that salespeople be refused entry into offices, it states that such visits have few useful functions. ...

                                                Dr. Troy A. Brennan, former chairman of the American Board of Internal Medicine and the other principal author of the article, said he was looking forward to reading responses to it. "I don't think there are a lot of good answers as to why it's O.K. to accept these gifts and contracts," Dr. Brennan said.

                                                Advertising and product differentiation can play a role in providing information, but this goes far beyond any socially useful function.

                                                  Posted by Mark Thoma on Thursday, January 26, 2006 at 05:56 PM in Economics, Health Care, Market Failure

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                                                  The Quiet Revolution that Transformed Women's Employment, Education, and Family

                                                  Another interesting looking paper I haven't had a chance to read:

                                                  The Quiet Revolution that Transformed Women's Employment, Education, and Family, by Claudia Goldin, NBER WP 11953, January 2006: Abstract The modern economic role of women emerged in four phases. The first three were evolutionary; the last was revolutionary. Phase I occurred from the late nineteenth century to the 1920s; Phase II was from 1930 to 1950; Phase III extended from 1950 to the late 1970s; and Phase IV, the "quiet revolution," began in the late 1970s and is still ongoing. ... The evolutionary phases are apparent in time-series data on labor force participation. The revolutionary phase is discernible using time-series evidence on women's more predictable attachment to the workplace, greater identity with career, and better ability to make joint decisions with their spouses. Each of these series has a sharp break or inflection point signifying social and economic change. ... The paper concludes by assessing whether the revolution has stalled or is being reversed... [Open AEA web link, Author web site link - both have sharper figures than the copies below]

                                                  Here are a few graphs from the paper:

                                                    Posted by Mark Thoma on Thursday, January 26, 2006 at 03:58 PM in Academic Papers, Economics

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                                                    Technology and Class Attendance

                                                    Guess what? If you lower the cost of missing class, less students show up. This article notes that when more material is posted for classes, attendance is lower. I've noticed the same thing. There is a very clear association between how much I post and class attendance and because of this, I have stopped posting as much review material. I thought it gave students a false sense of security. They would skip class thinking they could make up what was lost with web-based material later, then find out when the test time arrives that the posted material is not an effective substitute for coming to class, or that they have waited too long to get started making up missed material. That's when I start getting frantic email. It appears to me that it is the students on the margin who most easily fall victim to this temptation.

                                                    On the other side, though, are the students who make effective use of the posted material. They show up to class as always, and use what I post as a complement, not a substitute, to lectures. I am reluctant to allow class policy to be dictated by the students who are more interested in obtaining a piece of paper than learning, so I am rethinking my policy about posting material. I don't think my classes should be less effective for the best students just because other students cannot resist the temptation to sleep in on a cold and rainy morning knowing that lecture materials will be posted to make the sleep less costly. This isn't high school where it's the state's job to make sure every student is educated. In college, students must begin learning to take responsibility for their own education and I should not let some students to be held back in an attempt to force those at the other end of the spectrum to come to class, read, ask questions, and learn the material. Still, it's hard not to structure incentives so as to get the most out of every student rather than just the subset who are most interested in learning the course material:

                                                    Skip class? You've got online pal, Detroit Free News/LA Times, by Stuart Silverstein: Skipping classes, particularly big lectures where an absence can go undetected, is a tradition among college undergraduates who party late or swap notes with friends. These days, professors are witnessing a spurt in absenteeism as an unintended consequence of adopting technologies originally envisioned as learning aids.

                                                    One of Azevedo's Classes

                                                    Last semester, Americ Azevedo's class on "Introduction to Computers" at the University of California, Berkeley, featured some of the hottest options in educational technology. By visiting the course's Web sites, the 200 students could download audio recordings or watch digital videos of the lectures, as well as read the instructor's lecture notes and participate in online discussions.

                                                    But there was one problem: So many of the undergraduates relied on the technology that, at times, only 20 or so actually showed up for class. "It was demoralizing," Azevedo said. "Getting students out of their media bubble to be here is getting progressively harder."

                                                    Even as many academics embrace electronic innovations, others are pushing back. To deter no-shows, professors are reverting to low-tech tactics such as giving more surprise quizzes or slashing online offerings.

                                                    "Too much online instruction is a bad thing," said Terre Allen, a communication studies scholar at California State University, Long Beach.

                                                    Last term, Allen posted extensive lecture notes online for her undergraduate course, "Language and Behavior." One goal was to relieve students of the burden of scribbling notes, freeing them to focus on the lectures' substance. Yet the result, Allen said, was that only about one-third of her 154 students showed up for most of the lectures. In the past, when Allen put less material online, 60 percent to 70 percent of students typically would attend. ...

                                                    Kelly A. Rocca, an assistant professor of communication at St. John's University in New York and one of the few scholars who has recently studied American college absenteeism, said she suspects that skipping class has reached an all-time high because of off-campus jobs and reliance on technology. To combat ditching in her own classes, Rocca refuses to post notes online. With undergraduates, she said, "the more reasons you give them not to come to class, the less likely they are to come." ...

                                                    Other research supports the common-sense belief that skipping class hurts a student's grades. Lee Ohanian, a UCLA economics professor, said he notices that frequent skippers often "are the ones who are doing just enough to get by. The ones who are getting the A's are in the front row at every lecture." Ohanian said "too much technology really leads to a passive learning environment" and spurs absenteeism. He has cut back on posting lecture materials online and now provides extensive notes only for the most complicated topics.

                                                    Despite concerns about absenteeism, schools increasingly are experimenting with ways to let students watch or listen to lectures on their computers or digital music players, ... Likewise, online, or "distance," education programs -- premised on students' not needing to be in class -- are growing.

                                                    Advocates of the new technologies say they give schools an effective, low-cost way to deliver instruction while freeing students to review material at their own pace. The online options also let students participate in discussions electronically and allow instructors the flexibility to make quick changes.

                                                    Update: Brief follow up at iLecture.

                                                      Posted by Mark Thoma on Thursday, January 26, 2006 at 09:56 AM in Economics, Universities

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                                                      Smarter than the Average Bearish Investor?

                                                      "Even when it ... hurts you on average to take the gamble, the smart people ... actually like it more":

                                                      Would You Take the Bird in the Hand, or a 75% Chance at the Two in the Bush?, By Virginia Postrel, Economic Scene, NY Times: Would you rather have $1,000 for sure or a 90 percent chance of $5,000? A guaranteed $1,000 or a 75 percent chance of $4,000? In economic theory, questions like these have no right or wrong answers. Even if a gamble is mathematically more valuable ... someone may still prefer a sure thing. People have different tastes for risk, just as they have different tastes for ice cream... The same is true for waiting: Would you rather have ... $3,400 this month or $3,800 next month? Different people will answer differently. Economists generally accept those differences without further explanation... Shane Frederick, a management science professor at the Sloan School of Management at the Massachusetts Institute of Technology, ... discovered striking systematic patterns in how people answer questions about risk and patience, including those above. This short problem-solving test, he found, predicts a lot:

                                                      1) A bat and a ball cost $1.10 in total. The bat costs $1 more than the ball. How much does the ball cost?

                                                      2) If it takes five machines five minutes to make five widgets, how long would it take 100 machines to make 100 widgets?

                                                      3) In a lake, there is a patch of lily pads. Every day, the patch doubles in size. If it takes 48 days for the patch to cover the entire lake, how long would it take for the patch to cover half the lake?

                                                      The test measures not just the ability to solve math problems but the willingness to reflect on and check your answers. (Scores have a 0.44 correlation with math SAT scores, where 1.00 would be exact.) The questions all have intuitive answers — wrong ones. Professor Frederick gave his "cognitive reflection test" to ... students... Participants also answered a survey about how they would choose between various financial payoffs, as well as time-oriented questions like how much they would pay to get a book delivered overnight.

                                                      Getting the math problems right predicts nothing about most tastes, including whether someone prefers apples or oranges, Coke or Pepsi, rap music or ballet. But high scorers — those who get all the questions right — do prefer taking risks. "Even when it actually hurts you on average to take the gamble, the smart people, the high-scoring people, actually like it more," ... They are also more patient, particularly when the difference, and the implied interest rate, is large. Choosing $3,400 this month over $3,800 next month implies an annual discount rate of 280 percent. Yet only 35 percent of low scorers ... said they would wait, while 60 percent of high scorers preferred the later, bigger payoff. ...

                                                      The connection between cognition and risk preferences challenges some of the "prospect theory" developed [by] Daniel Kahneman and Amos Tversky. They observed that people would accept larger risks to avoid losses than to achieve gains, even when the two choices were mathematically equivalent. The same person might take a sure $100 instead of a 50 percent chance of $300, yet prefer a 50 percent chance of losing $300 rather than a sure $100 loss. This result, which has implications for investment and insurance, is one of the major findings of behavioral economics. Although prospect theory "is spectacularly true" for the low-scoring group, Professor Frederick writes, high scorers treat potential gains and potential losses about the same. ...

                                                      The correct answers, by the way, are 5 cents, 5 minutes, and 47 days.

                                                        Posted by Mark Thoma on Thursday, January 26, 2006 at 01:18 AM in Economics

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                                                        Greenspan Opposes Wal-Mart's Banking Plans

                                                        There are limits to Greenspan's free-market tendencies after all:

                                                        Greenspan Opposes Bank Loophole, by Bernard Wysocki Jr., WSJ: Federal Reserve Chairman Alan Greenspan is opposing a regulatory loophole that allows corporations to own banks, [Icon]thrusting himself into the middle of an effort by Wal-Mart Stores Inc. to establish a bank. Mr. Greenspan's salvo, outlined in a 12-page letter to Congress ..., is the latest in a controversy over the separation of commerce and banking. ...

                                                        Wal-Mart officials say the Utah bank would be a back-office processing center, handling debit-card, credit-card and electronic check-transfer payments ... A third party currently processes the transactions ... and bringing the work in-house would save Wal-Mart money. Company officials repeatedly have said they don't plan to establish bank branches. Under current law, these state-chartered banks, many incorporated in Utah, may open branches in more than 20 states...

                                                        In his letter, sent Jan. 20 in response to questions from Rep. Jim Leach, ... Mr. Greenspan doesn't single out Wal-Mart's application for criticism but mentions it along with the names of other big companies that have established industrial-loan corporations -- or industrial banks, as these state-chartered financial institutions are sometimes called. ...

                                                        "The ILC exemption is now the primary means by which commercial firms may control an FDIC-insured bank engaged in broad lending and deposit-taking activities and thereby breach the general separation of banking and commerce," Mr. Greenspan's letter said. He warned that the growing use of the loophole is "undermining the prudential framework that Congress has carefully crafted and developed" to oversee financial institutions. ...

                                                        In uncharacteristically blunt language, Mr. Greenspan urged Congress to close the loophole, which he said "provides the corporate owners of exempt ILCs a significant competitive advantage over other types of banking institutions, and creates an unlevel competitive playing field among banking organizations."

                                                        In an interview, Mr. Leach, the former chairman of the House banking committee, said he considered Mr. Greenspan's letter significant. "It's ... a stark warning to the Congress" about the need to separate commerce and banking, Mr. Leach said. "This is not primarily a Wal-Mart issue. It is a 'nature of the American economy' issue."...

                                                        In coming out against the ILC loophole, and by implication against Wal-Mart's bid for a bank, Mr. Greenspan has parted company with some free-market advocates who believe that a Wal-Mart bank, if it did turn into a retail-banking powerhouse, would encourage competition in the financial-services field, and would ultimately lower costs to consumers....

                                                        A spokesman for the Fed said it couldn't comment on whether incoming Fed Chairman Ben Bernanke would endorse every word of Mr. Greenspan's comments. However, the spokesman said other Fed officials have made similar comments, as official Fed positions, during the time Mr. Bernanke was a Fed official...

                                                        [The Full Letter: Read Greenspan's letter to Congress.]

                                                          Posted by Mark Thoma on Thursday, January 26, 2006 at 12:36 AM in Economics, Financial System, Monetary Policy, Regulation

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                                                          January 25, 2006

                                                          The Evolution of Top Incomes

                                                          I haven't had a chance to read this yet, but I hope to:

                                                          The Evolution of Top Incomes: A Historical and International Perspective, by Thomas Piketty and Emmanuel Saez, NBER WP 11955, January 2006: Abstract This paper summarizes the main findings of the recent studies that have constructed top income and wealth shares series over the century for a number of countries using tax statistics. Most countries experience a dramatic drop in top income shares in the first part of the century due to a precipitous drop in large wealth holdings during the wars and depression shocks. Top income shares do not recover in the immediate post war decades. However, over the last 30 years, top income shares have increased substantially in English speaking countries but not at all in continental Europe countries or Japan. This increase is due to an unprecedented surge in top wage incomes starting in the 1970s and accelerating in the 1990s. As a result, top wage earners have replaced capital income earners at the top of the income distribution in English speaking countries. We discuss the proposed explanations and the main questions that remain open. [Open link]

                                                          Here are some figures from the paper:

                                                            Posted by Mark Thoma on Wednesday, January 25, 2006 at 04:34 PM in Academic Papers, Economics, Income Distribution

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                                                            Best Science Available?

                                                            The administration has no comment regarding the use of Mickey Mouse science:

                                                            Mouse frustrates endangered species policy, by John Heilprin, AP: An acrobatic mouse is threatening Bush administration efforts to give Western developers an upper hand over endangered species. The Preble's meadow jumping mouse is in fact a distinct creature, according to a U.S. Geological Survey study presented ... to senior Interior Department officials.

                                                            That finding contradicts research touted by Interior Secretary Gale Norton last February when she proposed removing the mouse from the government's endangered species list. Critics say it also undercuts the administration's claim that it uses the best science available in promoting fewer protections for imperiled wildlife.

                                                            The previous study, which was done by a biologist since hired by Norton's department, concluded there was no genetic difference between the Preble's meadow jumping mouse and the much more common Bear Lodge meadow jumping mouse. Listed by the government as a threatened species since 1998, the Preble's meadow mouse stands in the way of any project that could damage its habitat, a broad swath of Colorado and Wyoming ...

                                                            The 3-inch mouse uses its 6-inch tail, and strong hind legs to launch itself a foot and a half into the air, where it can abruptly switch directions in mid-flight. It prefers to roam by night, scurrying and jumping along streams through undisturbed grasslands. There it dines on insects, spiders, fungus, moss, willow, sunflower, grasses and seeds, hibernating each winter from mid-October to early May.

                                                            A year ago, developers welcomed the findings of biologist Rob Roy Ramey ... and the Interior Department's conclusion, based on his findings, that the Preble's meadow mouse no longer needed federal protections. Ramey was later contracted as a science adviser to the Interior Department in its attempt to reclassify several species whose endangered status is blocking developers.

                                                            The new study was conducted by Tim King, a USGS conservation geneticist based in West Virginia, and peer-reviewed by academic experts outside government. One of the reviewers, Eric Hallerman, a professor of fisheries and wildlife science at Virginia Tech, said King's study debunks Ramey's work. "It contradicts it fairly strongly," Hallerman said. ... Hallerman said Ramey's work reflects the Bush administration's intrusion of politics in its scientific research. "It seemed to me from the get-go, he wanted to find that this was not a taxonomically valid subspecies," Hallerman said.

                                                            After others raised similar doubts, Interior officials agreed to revisit Ramey's work by commissioning King's study. They had no immediate comment Wednesday. ... King said it probably would be a few more months before officials decide whether his study justifies continued federal protections for the high-flying mouse. "I would think that would be one of the options," he said.

                                                            Though I would not want the present poltical environment to tackle such a task, I could be convinced that the Endangered Species Act needs reexamination. But there is no role for shoddy or comissioned science in such a process, and no role for anything that blurs the distinction between true science in search of the truth and work designed to reach or support a predetermined conclusion.

                                                              Posted by Mark Thoma on Wednesday, January 25, 2006 at 03:07 PM in Economics, Environment, Politics, Regulation, Science

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                                                              Privatization of Roads

                                                              Should the allocation of transportation services - driving on roads - be allocated by the price system? If we continue on the road to privatization, will we be satisfied that it is equitable for the haves to be able to drive on roads closed by resource constraints to the have nots?:

                                                              Indiana Sells Road for Billions; Prepare for Deluge, by Joe Mysak, Bloomberg: On Monday, Governor Mitch Daniels said a Spanish-Australian consortium had bid $3.85 billion to run the Indiana Toll Road, a 157-mile highway across northern Indiana that runs from the Illinois to Ohio, for 75 years. The legislature still has to approve the proposal...

                                                              A Merrill Lynch & Co. report published last July on the subject of U.S. toll road privatization asked whether sales like the Skyway were one-offs, "or do they represent the beginning of a sweeping trend that will spread to other tolled bridges, tunnels, expressways and long-distance toll roads?'' Let's bet on the sweeping trend. The money is just too big to resist...

                                                              Merrill Lynch estimates that at least 18 states from California to Massachusetts have state-, county-, or city-owned toll roads that might lend themselves to privatization. ... What you need is an established road, and the flexibility to increase tolls. ... We are going to see more of these transactions, and the numbers are going to get bigger and bigger. It was estimated last year that New Jersey might get $30 billion for the state's Turnpike and Parkway... That would cure a lot of Governor Jon Corzine's headaches. Merrill Lynch estimated that the New York State Thruway Authority might be worth something like $20 billion. ... So now the cry will go up: Sell the roads! ...

                                                              The sticky matter for Governor Daniels is selling the state's lawmakers, and everyone else in Indiana, for that matter, on the idea. But we've come a long way from the days where people felt bad about selling assets like landmark buildings and other property to foreign investors. ... The money is just too big.

                                                              Selling Yellowstone Park to private developers would raise a lot of money too, but that doesn't mean we should do it. There are arguments both ways here, and some of my concern is redued by recent research showing that toll lanes are used predominantly by people pressed for time, people late for daycare pickups, that sort of thing, not just higher income individuals. Still, equity considerations are a concern.

                                                                Posted by Mark Thoma on Wednesday, January 25, 2006 at 07:40 AM in Economics, Market Failure, Regulation

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                                                                Hausman on Wal-Mart and Welfare


                                                                Econ professor illustrates benefits of Wal-Mart, PressZoom: Economics Professor Jerry Hausman placed the cooling hand of numbers on ... notions about Wal-Mart's economic impact in an IAP session titled, "The Consumer Benefits From Increased Competition in Shopping Outlets: Measuring the Effect of Wal-Mart," ... Hausman's ... hourlong talk ... focused on the direct and indirect effects for consumers when one of Wal-Mart's ... super centers comes to town. ... Hausman focused on ... grocery prices and shopping data for 10,000 families who buy food in Wal-Mart super centers.

                                                                The direct effect for consumers is easy to spot, he said: Wal-Mart brings in lower food prices. Cereal, for example, costs 17 percent less at Wal-Mart than at a traditional supermarket. The indirect effect of Wal-Mart occurs "even if you never enter a Wal-Mart," Hausman said, since supermarkets tend to drop their prices in competitive response to Wal-Mart's. In addition, Wal-Mart does not raise its prices after it has driven out the competition, he said. "The indirect price effect is 5 percent even if you never go into a Wal-Mart,"...

                                                                Hausman presented graphs to show that Wal-Mart's impact on consumers varies by income category: For families with incomes less than $10,000 annually, a super center makes a 30 percent difference in what they can buy. "The marginal utility on the poor is greater," he noted. The rate of overall improvement in consumer welfare [from] a Wal-Mart super center's direct and indirect effects on the cost of food in a community averages 3.75 percent, Hausman said.

                                                                "Getting a 3.75 percent improvement in consumer welfare is greater than any tax reform or other policies. And while Wal-Mart pays its employees less -- which does affect local wages -- you still can't beat that 3.75 percent. If economists could improve consumer welfare by that much, we'd all be heroes," Hausman said.

                                                                Hausman said the U.S. Bureau of Labor Statistics ( BLS ) is taking a puzzlingly inaccurate measure of Wal-Mart's economic role, especially for lower-income families: According to the BLS, consumers are no better off when a Wal-Mart enters their community. But that's not what the numbers show. According to Hausman's research, excluding Wal-Marts from local markets creates a "large loss" to consumer welfare, he said.

                                                                Hausman is co-author, with Ephraim Leibtag, of "Consumer Benefits From Increased Competition in Shopping Outlets: Measuring the Effect of Wal-Mart" ... and "CPI Bias From Supercenters: Does the BLS Know that Wal-Mart Exists?" .... Slides from Hausman's presentation are available on his web site.

                                                                The last part refers to bias in the way the CPI is calculated by the BLS. See the second paper below on how the BLS does not account for the fall in the price of the reference basket of goods when consumers purchase goods at lower price from Wal-Mart after a store enters a market. Here are the papers:

                                                                Consumer Benefits from Increased Competition in Shopping Outlets: Measuring the Effect of Wal-Mart, Jerry Hausman and Ephraim Leibtag, NBER WP 11809, December 2005: Abstract Consumers often benefit from increased competition in differentiated product settings. In this paper we consider consumer benefits from increased competition in a differentiated product setting: the spread of non-traditional retail outlets. In this paper we estimate consumer benefits from supercenter entry and expansion into markets for food. We estimate a discrete choice model for household shopping choice of supercenters and traditional outlets for food. We have panel data for households so we can follow their shopping patterns over time and allow for a fixed effect in their shopping behavior. We find the benefits to be substantial, both in terms of food expenditure and in terms of overall consumer expenditure. Low income households benefit the most. [AEA web link] [Link on Hausman's page]

                                                                CPI Bias from Supercenters: Does the BLS Know that Wal-Mart Exists?, Jerry Hausman and Ephraim Leibtag, NBER WP 10712, August 2004: Abstract Hausman (2003) discusses four sources of bias in the present calculation of the CPI. ... We discuss economic and econometric approaches to measuring the first order bias effects from outlet substitution bias. ... the current BLS procedure does not treat correctly outlet substitution bias and acts as if Wal-Mart does not exist. Yet, Wal-Mart offers identical food items at an average price about 15%-25% lower than traditional supermarkets. The BLS links out' Wal-Mart's lower prices. ... We find a significant difference between our approach and the BLS approach. Our estimates are that the BLS CPI-U food at home inflation is too high by about 0.32 to 0.42 percentage points, which leads to an upward bias in the estimated inflation rate of about 15% per year. [Link on Hausman's page - June 2005 revision]

                                                                For a different perspective, see Paul Krugman: Wal-Mart's Excuse.

                                                                  Posted by Mark Thoma on Wednesday, January 25, 2006 at 01:59 AM in Academic Papers, Economics

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                                                                  Why is U.S. Productivity Strong Relative to Europe?

                                                                  Hal Varian argues that a primary factor in explaining the U.S. productivity advantage in recent years is more effective use of information technology. Chris Giles of the Financial Times follows up with a discussion of this and other influences on the difference between the U.S. and European productivity rates. He says resistance to change and tougher management practices has forestalled the adoption of productivity enhancing technology:

                                                                  How US productivity pulled away, by Chris Giles, Financial Times: You could call it the productivity myth. It goes like this. European economies trail behind the US because their citizens would rather people-gaze from a pavement cafe than labour loyally in the corporate salt mines. Americans, on the other hand, are a bunch of stakhanovites so preoccupied with boosting their nation’s gross domestic product they take just a week’s vacation a year.

                                                                  The conveniently simple notion that Europeans are poorer because they prefer leisure to work can no longer be supported by the data, however. ... One fact is indisputable. Over the past decade the US has stolen a march on its competitors so marked that it can no longer be dismissed as a statistical blip. ... The trend had been obvious for some time before that. ... The US has not always held so unassailable a lead. In the 1950s and 1960s, European per capita incomes steadily rose towards US levels, spurred on by the rapid recovery from the devastation of the second world war and the successful integration of European economies. ...


                                                                  But the good times in Europe and Japan are long gone. In the past decade, the gap between US living standards and those in other leading countries widened again. ... the relative position of Europe’s economy has declined since 2000.

                                                                  For much of that period, economists have grasped at sociological and cultural straws as they sought to explain the continued disparity in living standards. They have argued it had much to do with Europeans’ determination not to work themselves into the ground like their unfortunate US counterparts. Part of this is true. Europeans do work fewer hours than US employees... Most of this difference is indeed a conscious choice. The decline in European weekly working hours has been a consistent feature since 1950. In the US, in contrast, hours worked stopped falling in the early 1980s and since then, while US citizens have become richer, they have not chosen to “buy” additional leisure time.


                                                                  Europeans accept that lower incomes are the price of spending more time at home. If they worked US hours, ... European GDP per capita would increase from 73 per cent of US levels to 86 per cent. ... A second drag on European living standards is the share of its population that is working. Unemployment dogs Germany, France and Italy ... because European economies are worse at getting the young into employment and keeping older people at work. For the 30 to 50 age group, there is almost no difference between the participation rates of the US and Europe...

                                                                  The Conference Board, the global business organisation, has found that the differences between the two can be found in just three industries: retail, wholesale and finance. Take retail, where research ... indicated that the US’s advantage is almost entirely due to the building of new shops and the closure of existing stores that had become uncompetitive. The Wal-Mart effect, in other words, transformed the US economy as much as it transformed the US landscape.

                                                                  By contrast, in Europe planning laws and a reluctance to allow old establishments to fail have prevented productivity growth from taking off. Prof Robert Gordon of Northwestern University thinks the outcome reflects the power of existing producers in Europe at the expense of poorer consumers. This, he believes, is a high price for Europeans to pay for the preservation of small and unproductive shops. The idea that European economies are bad at exploiting new technology is supported by detailed research ... Management differences and the use of technology explains Europe’s poor performance... US companies use technology better and their hire-and-fire culture keeps workers on their toes.

                                                                  If Europe wants to improve its productivity levels, it seems, it must accept tougher management, the emergence of new and much more productive shopping centres and the death of many companies. The same lessons apply to Japan. For the US, the lesson of the past decade is that it should avoid complacency ... If Europe were to rediscover its competitive spirit and close the gap, it could disappear as quickly as it came...

                                                                    Posted by Mark Thoma on Wednesday, January 25, 2006 at 12:33 AM in Economics, Technology

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                                                                    January 24, 2006

                                                                    Spying on Professors

                                                                    This is a post from my daughter, Amy, at Flash Report on the recent story about students spying on their professors at UCLA:

                                                                    Weighing in on the UCLA Story, Flash Report, by Amy Thoma

                                                                      Posted by Mark Thoma on Tuesday, January 24, 2006 at 11:40 AM in Politics, Universities

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                                                                      What Explains the Decline in the Volatility of Real GDP Growth?

                                                                      This is a graph of quarter to quarter growth rates for real GDP in the U.S. since 1947:

                                                                      Does anything catch your eye? In the mid-1980s (some narrow it down to first quarter of 1984), the variance of GDP growth declines substantially, by 50%. The source of the decline is not completely clear. This NBER paper uses cross-country evidence to help to settle whether it was from better technology, better policy, a run of good luck where no big shocks hit the economy, financial innovation, or some other explanation:

                                                                      Assessing the Sources of Changes in the Volatility of Real Growth, Stephen G. Cecchetti, Alfonso Flores-Lagunes, and Stefan Krause, NBER WP 11946, January 2006: Abstract In much of the world, growth is more stable than it once was. Looking at a sample of twenty five countries, we find that in sixteen, real GDP growth is less volatile today than it was twenty years ago. And these declines are large, averaging more than fifty per cent. What accounts for the fact that real growth has been more stable in recent years? We survey the evidence and competing explanations and find support for the view that improved inventory management policies, coupled with financial innovation, adopting an inflation targeting scheme and increased central bank independence have all been associated with more stable real growth. Furthermore, we find weak evidence suggesting that increased commercial openness has coincided with increased output volatility. [Open link to paper]

                                                                        Posted by Mark Thoma on Tuesday, January 24, 2006 at 10:19 AM in Academic Papers, Economics, Macroeconomics

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                                                                        'We Must Change Policy Direction'

                                                                        Former Treasury Secretary Robert E. Rubin says it's time for politicians to stop playing games and deal with our mounting economic challenges. He urges both sides to set aside differences and hammer out effective bi-partisan solutions. I will just note that one party is in power, the other isn't, and the party in power has shown few signs of a willingness to seek political solutions that will allow these problems to be addressed through negotiatied, compromise solutions:

                                                                        'We Must Change Policy Direction', by Robert E. Rubin, Commentary, WSJ Online: ...[T]he leaders of Asia's emerging market economies... are making tough decisions ... The result is large numbers of well-educated workers in low-wage and increasingly market-based environments (especially in China and India)... This has created a competitive challenge of historic proportions which encompasses manufacturing and virtually all services electronically communicable. We can meet this challenge and enjoy a bright future. Our economy has great strengths ... However ... to avoid the real possibility of great economic difficulty, we must re-establish our own seriousness of purpose about economic policy, and we must change policy direction on many fronts.

                                                                        Some would argue that our reasonably healthy GDP growth ... indicates that we can stick with the economic policy status quo. I believe this would be a serious mistake. Median real wages ... have been roughly stagnant for the past five years -- and many Americans have had falling real incomes. Private sector job growth has been the lowest of any recovery since the '30s. ...

                                                                        Re-establishing seriousness of purpose regarding economic policy ... will require ... making choices that are very difficult politically, compromising among divergent views ..., and putting aside ideology in favor of facts and analysis. There is ... widespread agreement that our future economic well-being is threatened by large ... fiscal deficits, huge increases in entitlement costs ..., personal savings rates of approximately zero, public school system inadequacies, and high health care costs. But our political system is failing to mediate differing views on how to address these issues, and failing to make the difficult decisions required. ...

                                                                        To move forward, serious policy advocates from all perspectives should start by agreeing on two basic bedrock principles: that there is no free lunch; and that a strong future requires incurring costs now for benefits later. We should then put everything on the table. Our strategy should have four components:

                                                                        (1) We should re-establish sound fiscal conditions for the intermediate term ... and put in place a real plan to get entitlements on a sound footing ... (2) We need a strong public investment program -- paid for, not funded by increased public borrowing -- to promote productivity growth, to help those dislocated by technology and trade, and to equip all citizens to share in our economic well-being and growth. (3) We must pursue an international economic policy that continues global integration, ... (4) We should work toward a regulatory regime that meets our needs and sensibly weigh risks and rewards.

                                                                        Our strategy should reaffirm market-based economics as the most effective organizing principle for economic activity, while recognizing the critical role of government in providing the many requisites for economic success that markets, by their very nature, will not provide.

                                                                        Broad participation in economic well-being and growth is critical ... to realize our economic potential. ... Broad-based participation is also the best antidote to protectionism, and to pressures for undue restrictions on our economic flexibility and immigration. For these same reasons, measures to increase security for the growing number of people dislocated in our rapidly changing economy may well be wise economically. This can be done without creating the rigidities and excessive social benefits that have led to chronically slow growth and high unemployment in Continental Europe. ... Our economy is not working for too many of our people, and that is a problem for all of us...

                                                                        The proponents of supply-side theory who assert that tax cuts will wholly -- or even significantly -- pay for themselves (through increased growth and federal tax revenues), appear to be no more accurate now than they were in the '90s. ... Virtually all mainstream economists take the view that sustained long-term deficits will crowd out private investment, increase interest rates, reduce productivity and reduce growth. ... The adverse impact on interest and currency rates has not yet occurred, partly because business has had relatively low levels of demand for capital -- but most importantly because of vast capital inflows from abroad ... This is not indefinitely sustainable; at some point, which could be near in time or still some years out, continued imbalances, increasing fiscal debt levels and ever-greater overweighting of dollar holdings abroad are highly likely to lead to loss of confidence, and trouble.

                                                                        The fiscal and entitlement holes are now so deep that measures adequate to address them would be exceedingly difficult politically... And, even more importantly, the proposals themselves would likely be so sharply attacked as to become politically toxic. Thus, I believe that the most realistic way forward is for the president to bring together the leaders of both parties and both houses to make these decisions with joint political responsibility. Everything should be on the table... Finding the balance that best promotes economic growth in this context could well call for revenue increases as well as spending discipline... None of this is easy, but our economy could well be at a critical juncture... To realize our bright future and to minimize the risk of serious difficulty, we urgently need our own sense of mission to meet the challenges facing our economy.

                                                                          Posted by Mark Thoma on Tuesday, January 24, 2006 at 12:17 AM in Budget Deficit, Economics, Policy, Politics

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                                                                          January 23, 2006

                                                                          What China Can Learn from India

                                                                          Yasheng Huang from the MIT Sloan School of Management says China could learn a thing or two from India about economic development. He believes India will outperform China in the next few decades unless "China embarks on bold institutional reforms":

                                                                          China could learn from India’s slow and quiet rise, by Yasheng Huang, Financial Times: In an article published in 2003 called “Can India overtake China?” Tarun Khanna of Harvard Business School and I argued that India’s domestic corporate sector – strengthened by the country’s rule of law, its democratic processes and relatively healthy financial system – was a source of substantial competitive advantage over China. At that time, the notion that India might be more competitive than China was greeted with wide derision.

                                                                          Two years later, India appears to have permanently broken out of its leisurely “Hindu rate of growth” ... and its performance is beginning to approach the east Asian level. ... More impressively, India is achieving this result with just half of China’s level of domestic investment in new factories and equipment, and only 10 per cent of China’s foreign direct investment. ...

                                                                          Why, then, is India gaining strength? Economists and analysts have habitually derided India’s inability to attract FDI. This single-minded obsession with FDI is as strange as it is harmful. Academic studies have not produced convincing evidence that FDI is the best path to economic development compared with responsible economic policies, investment in education and sound legal and financial institutions.

                                                                          An economic litmus test is not whether a country can attract a lot of FDI but whether it has a business environment that nurtures entrepreneurship, supports healthy competition and is relatively free of heavy handed political intervention. In this regard, India has done a better job than China. From India emerged a group of world-class companies... This did not happen by accident.

                                                                          Although it has many flaws, India’s financial system did not discriminate against small private companies the way the Chinese financial system did. Infosys benefited from this system. ... It is unimaginable that a Chinese bank would lend to a Chinese equivalent of an Infosys. With few exceptions, the world-class manufacturing facilities for which China is famous are products of FDI, not of indigenous Chinese companies. ...

                                                                          Pessimism about India has often been proved wrong. Take, for example, the view that India lacks Chinese-level infrastructure and therefore cannot compete with China. This is another “China myth” – that the country grew thanks largely to its heavy investment in infrastructure. ... China built its infrastructure after – rather than before – many years of economic growth and accumulation of financial resources. The “China miracle” happened not because it had glittering skyscrapers and modern highways but because bold economic liberalisation and institutional reforms – especially agricultural reforms in the early 1980s – created competition and nurtured private entrepreneurship.

                                                                          For both China and India, there is a hidden downside in the obsession with building world-class infrastructure. As developing countries, if they invest more in infrastructure, they invest less in other things. Typically, basic education, especially in rural areas, falls victim to massive investment projects... China made a costly mistake in the 1990s: it created many world-class facilities, but badly under-invested in education. Chinese researchers reveal that a staggering percentage of rural children could not finish secondary education. India, meanwhile, has quietly but persistently improved its ­educational provisions, especially in the rural areas. For sustainable ­economic development, the quality and quantity of human capital will matter far more than those of physical capital. ...

                                                                          Unless China embarks on bold institutional reforms, India may very well outperform it in the next 20 years. But, hopefully, the biggest beneficiary of the rise of India will be China itself. It will be forced to examine the imperfections of its own economic model ... China was light years ahead of India in economic liberalisation in the 1980s. Today it lags behind in critical aspects, such as reform that would permit more foreign investment and domestic private entry in the financial sector. The time to act is now.

                                                                          Update - New Economist adds:

                                                                          MIT's Yasheng Huang writes ... that China could learn from India's slow and quiet rise ... Huang's claims are, I think, exaggerated - India's poor infrastructure is a problem, and its education system has major shortcomings. Nonetheless, it is refreshing to read a piece these days that doesn't extoll the virtues of China, and which demonstrates that "pessimism about India has often been proved wrong"

                                                                            Posted by Mark Thoma on Monday, January 23, 2006 at 06:03 PM in China, Economics, India

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                                                                            Global Imbalances and Monetary Policy

                                                                            NY Fed president Tim Geithner gave a speech today on the implications of global imbalances for the conduct of monetary policy. Here's the speech. Brad Setser comments here. I'll update this post later today.

                                                                            Update: Here's a follow up from the Financial Times. President Geithner believes the trajectory for the current account deficit is unsustainable, and it's not necessarily self-correcting in a smooth, non-disruptive fashion, but we just don't know for sure how rocky the road might be. In his view, the longer the trade gap builds, the larger the risks. Because of this, policies such as reductions in the federal budget deficit are needed to mitigate the risk:

                                                                            US current account deficit ‘unsustainable’ – NY Fed chief, by Christopher Swann, Financial Times: Timothy Geithner, president of the New York Federal Reserve, on Monday dismissed the view that the US current account deficit was sustainable, suggesting the risk of a sudden fall in the dollar would grow the longer the trade gap widened. ... Mr Geithner said the problem could not necessarily be expected to solve itself. “Time does not necessarily help. The longer these gaps continue to build, the greater the ultimate adjustment required, and the greater the risks that accompany that process,” he said.

                                                                            “The plausible outcomes range from the gradual and benign to the more precipitous and damaging,” he said. “The size and duration of these [global] imbalances, perhaps the most visible of which is the US current account deficit, present challenges – and risks – for the world economy.” His warning came as Raghuram Rajan, chief economist at the International Monetary Fund, repeated his concern over the risk of a run on the dollar. “You cannot discount a run on the dollar. But you cannot fully quantify that risk at the moment,” he said ...

                                                                            Mr Geithner ... does not see a role for monetary policy in responding to the current account by raising interest rates to slow domestic demand growth and so the demand for imports. Rather, he believes the risks on the external side make it more important for the Fed to keep inflation under control, to avoid adding to the problems and to preserve the Fed’s flexibility in a crisis.

                                                                            Many economists have argued that the risks to the dollar from the bloated current account deficit are mitigated by support for the currency from Asian central banks... However, Mr Geithner said this should provide little comfort over the long term. “A prolonged continuation of the exchange rate arrangements that have given rise to the large increase in foreign official investments in US financial assets is unlikely to be consistent with the domestic requirements of those economies and for this reason many are already in the process of change,” he said.

                                                                            “Even if we could be confident that the world would be comfortable financing the US on these terms for some time, that fact alone does not mean that it is prudent for the US to continue borrowing on this scale.” Mr Geithner repeated his call for US politicians to reduce the budget deficit. The fact that the US is using much of the money borrowed from abroad to finance public spending, he said, increased the dangers. If it was being invested in the productive capacity of the US tradeable goods industries, this would at least help the US to pay back its foreign obligations.

                                                                              Posted by Mark Thoma on Monday, January 23, 2006 at 07:29 AM in Economics, Fed Speeches, Monetary Policy

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                                                                              "Bitter Conflict" at the World Bank

                                                                              It's hard to argue with the goal of reducing corruption, but this hardly seems like the best way to go about it. It's so surprising to hear that Paul Wolfowitz is creating controversy as president of the World Bank:

                                                                              Wolfowitz triggers graft storm at World Bank, by Andrew Balls and Edward Alden, Financial Times: Paul Wolfowitz, president of the World Bank, has triggered a bitter conflict with the bank’s senior career staff by empowering a group of close political advisers to pursue aggressively what he sees as widespread corruption surrounding bank projects. The dispute has come to a head with the appointment ... of Suzanne Rich Folsom, a counsellor to Mr Wolfowitz with close ties to the Republican party, as the new director of the Department of Institutional Integrity, the internal bank watchdog that investigates suspected fraud and staff misconduct.

                                                                              Her appointment has raised objections that a person close to Mr Wolfowitz, and with a political background, has been put into a senior position at a unit that was seen as independent of the president’s office since it was set up in 2001. Robert Hindle, previously the senior manager of the unit and a long-time World Bank employee, resigned ... largely as a result of ... concern at the targeting of employees who had worked on projects that developed corruption problems... A number of senior bank staff and executive directors representing member countries ... complain of a lack of consultation by Mr Wolfowitz’s advisers, and an atmosphere of suspicion. Roberto Dañino, the bank’s general counsel and a former prime minister of Peru, this month also announced his resignation because, friends said, he was unhappy at the way the bank was being run by Mr Wolfowitz... Mr Wolfowitz’s appointment last year was greeted with apprehension by some long-time staff. Many Republicans believe the bank is plagued by corruption. Ms Rich Folsom was hired ... with the task of improving the bank’s relations with Congressional Republicans.

                                                                              Brad DeLong has more.

                                                                                Posted by Mark Thoma on Monday, January 23, 2006 at 01:08 AM in Economics, Politics

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                                                                                Paul Krugman: Iraq's Power Vacuum

                                                                                Infrastructure is essential in allowing an economy to reach its potential, a fact Paul Krugman illustrates with Iraq. He explains how the failure to develop Iraq's infrastructure through effective reconstruction efforts has undermined the chance of a successful outcome:

                                                                                Iraq's Power Vacuum, by Paul Krugman, Commentary, NY Times: In the State of the Union address, President Bush will assert ... that he has a strategy for victory in Iraq. I don't believe him. ... To explain myself, let me tell you some stories about electricity.

                                                                                Power shortages are a crucial issue for ordinary Iraqis, and for the credibility of their government. As Muhsin Shlash, Iraq's electricity minister, said ..., "When you lose electricity the country is destroyed, nothing works, all industry is down and terrorist activity is increased." ... In today's Iraq, blackouts are the rule rather than the exception. ... Baghdad and "much of the central regions" - in other words, the areas where the insurgency is most active and dangerous - currently get only between two and six hours of power a day.

                                                                                Lack of electricity ... prevents businesses from operating, destroys jobs and generates a sense of demoralization and rage that feeds the insurgency. So why is power scarcer than ever...? Sabotage by insurgents is one factor. But as ... The Los Angeles Times ... showed, the blackouts are also the result of some incredible missteps by U.S. officials. Most notably, ... U.S. officials ... decided to base their electricity plan on natural gas: ...American companies were hired to install gas-fired generators in power plants across Iraq. But ... "pipelines needed to transport the gas" - ... to the new generators - "weren't built because Iraq's Oil Ministry, with U.S. encouragement, concentrated instead on boosting oil production." Whoops.

                                                                                Meanwhile, ... U.S. officials chose not to raise the prices of electricity and fuel, which had been kept artificially cheap under Saddam, for fear of creating unrest. But as a first step toward their dream of turning Iraq into a free-market utopia, they removed tariffs and other restrictions on ... imported consumer goods. The result was that wealthy and middle-class Iraqis rushed to buy imported refrigerators, heaters and other power-hungry products, and the demand for electricity surged ... This caused even more blackouts.

                                                                                In short, U.S. officials thoroughly botched their handling of Iraq's electricity sector. They did much the same in the oil sector. But the Bush administration is determined to achieve victory in Iraq, so it must have a plan to rectify its errors, right? Um, no. ... all indications are that the Bush administration ... doesn't plan to ask for any more money for Iraqi reconstruction.

                                                                                Another Los Angeles Times report ... contains some jaw-dropping quotes from U.S. officials, who now seem to be lecturing the Iraqis on self-reliance. "The world is a competitive place," declared the economics counselor at the U.S. embassy. "No pain, no gain," said another official. "We were never intending to rebuild Iraq," said a third. We came, we saw, we conquered, we messed up your infrastructure, we're outta here.

                                                                                Mr. Shlash certainly sounds as if he's given up expecting more American help. ... Yet he also emphasized the obvious: partly because of the similar failure of reconstruction in the oil sector, Iraq's government doesn't have the funds to do much power plant construction. In fact, it will be hard pressed to maintain the capacity it has, and protect that capacity from insurgent attacks.

                                                                                And if reconstruction stalls, as seems inevitable, it's hard to see how anything else in Iraq can go right. ...[T]he Bush administration... doesn't have a plan; it's entirely focused on short-term political gain. Mr. Bush is just getting by from sound bite to sound bite, while Iraq and America sink ever deeper into the quagmire.

                                                                                Previous (1/19) column: Paul Krugman: The K Street Prescription Next (1/26) column: Paul Krugman: Health Care Confidential

                                                                                Update: From the Washington Post:

                                                                                Professionals Fleeing Iraq As Violence, Threats Persist: Exodus of Educated Elite Puts Rebuilding at Risk: ... Iraq's top professionals -- doctors, lawyers, professors -- and businessmen have been targeted by shadowy political groups for kidnapping and ransom, as well as murder, some of them say. So many have fled the country that Iraq is in danger of losing the core of skilled people it needs most ... "It's creating a brain drain," said Amer Hassan Fayed, assistant dean of political science at Baghdad University. "We could end up with a society without knowledge. How can such a society make progress?" Professionals and businessmen with the means to escape are going to Jordan, Syria, Egypt or, if they have visas, to Western countries...

                                                                                  Posted by Mark Thoma on Monday, January 23, 2006 at 12:31 AM in Economics, Iraq, Politics

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                                                                                  January 22, 2006

                                                                                  Fed Watch: Ready to Invert

                                                                                  Tim Duy with his latest Fed Watch:

                                                                                  I had previously believed that the Fed would not purposefully invert the yield curve (in this case, the spread between the 10 year and the Fed Funds rates). I had thought that whatever economic environment would drive tighter Fed policy would drive long rates higher. But it looks like inversion day is coming, barring some near term changes in the bond market. Moreover, the Fed looks to be sending a very specific signal: Even if we do pause at the March meeting, our bias remains tilted toward inflation. A solid economy and rising energy prices means it is too early to call off the dogs. In my opinion, policymakers do not want investors to get the idea that a pause in rates signals an imminent rate cut. Instead, they are signaling that without a more dramatic change in the economic environment, the odds remain tilted toward more tightening in the post-Greenspan era.

                                                                                  As this post kept getting longer and longer, a quick outline of my take on the Fed’s position is in order:

                                                                                  1. Overall, economic activity is quite healthy.
                                                                                  2. Consumer spending cooled at the end of last year, but Fed officials don’t seem particularly worried.
                                                                                  3. Housing is cooling as well, but not uniformly, and not in such a way as to suggest a crash is coming.
                                                                                  4. The expectation continues to be that firms will step up capex spending.
                                                                                  5. Resource utilization continues to be a concern.
                                                                                  6. A cessation in rates hikes should not be interpreted as the first step toward cutting rates.

                                                                                  The Beige Book was, in my opinion, somewhat hard to get a handle on. Mixed messages were common, leaving open the possibility of cherry picking little bits and pieces to support whatever story you want to tell. With that in mind, I concluded that the anecdotal message was that despite some cooling in housing and consumer spending, economic activity continued its solid expansion. And while prices pressures remain contained, there are enough signals of potential inflationary pressures to keep policymakers on their toes.

                                                                                  I was somewhat surprised by the benign impressions of consumer spending given wide expectations that Q4 GDP will look soft due to a weak household spending component. Moreover, the slowdown in the housing market appears to be evolving as planned, with pockets of cooling somewhat offset by pockets of heating up – including an acceleration in Oregon (Oregon is relatively inexpensive compared to other West Coast states). This pattern will support the underlying contention at the Fed that the housing “bubble” is not likely to pop with the same consequences as the burst of the technology bubble. The auto industries woes are still evident – no surprise here. But outside of that, not much of concern to policymakers and reflective of the quiescence we see in FedSpeak.

                                                                                  Consistent with the December employment and industrial production reports, manufacturing activity looked solid:

                                                                                  Increases in manufacturing activity were widely reported across the country. Only the St. Louis District characterized industrial activity as mixed. Elsewhere, robust expansion was reported in the San Francisco, Dallas, Kansas City, Minnesota, Chicago, New York, and Boston Districts. More moderate expansion was indicated in the Cleveland, Richmond, Philadelphia, and Atlanta Districts.

                                                                                  So it looks like, via both anecdotal and data evidence, that resource utilization from the physical capital side of the equation is on the rise – this is evidently important to at least one governor, as we will see a bit later. What about the labor side of the equation? Here it is worth repeating the relevant section from the Beige Book overview:

                                                                                  Most Districts reported signs of continued, if generally moderate, increases in employment. Cleveland, Minneapolis, and Richmond all cited moderate employment gains, with Richmond noting that its rate represented a slowdown. New York, Atlanta, Kansas City, and Dallas reported evidence of stronger employment growth. However, Boston noted that output growth had generally not translated into higher employment, while St. Louis reported a widely mixed pattern of layoffs and hiring. Hiring at financial and legal services firms is boosting the New York District's employment growth, although New York also reported some hiring in manufacturing. Atlanta reported strong demand for both skilled and unskilled labor, in part boosted by storm-recovery efforts.

                                                                                  Atlanta reported several locations with tight labor market conditions, while Boston, New York, Philadelphia, Chicago, Kansas City, Dallas, and San Francisco all reported specific occupations in which jobs have been difficult to fill. Several of these Districts cited trucking jobs. Skilled construction workers are relatively sought after in Dallas and San Francisco, and skilled manufacturing jobs were mentioned by Boston, Chicago, and Dallas. Atlanta listed a variety of specialties in "extreme shortage." New York and San Francisco noted that finance-industry labor markets were relatively tight. Despite reports of labor market tightness, Boston, Philadelphia, Minneapolis, Kansas City, and San Francisco all noted that wage increases have been generally moderate. However, New York, Chicago, and Dallas all reported some acceleration in compensation.

                                                                                  Mixed messages here – St. Louis and Atlanta appear to be on opposite ends of the spectrum – but the story seems to point to a strengthening labor market with accelerating wage gains in some locals. Will this acceleration spread? In the current environment, I would say this is a good bet. Note that jobless claims, a leading indicator, have fallen to a six year low. Will the Fed be unhappy, from an inflation perspective? Maybe. As always, the answer to this question depends on pass through. The Fed will be most concerned if they sense that pricing power is emerging that will allow firms to raise prices to offset higher wages. If not, then rising wages would reflect productivity gains. Nothing bad about that – it would simply indicate that the short run data is catching up to the long run theory.

                                                                                  On, then, to the inflation story. Note that the report on trucking and shipping has the feel of emerging transportation bottlenecks:

                                                                                  Trucking and shipping demand remained strong across the country, but companies were constrained by continuing driver shortages in the Atlanta, Cleveland, Chicago, and Philadelphia Districts. In addition, despite the ongoing use of fuel surcharges, contacts in Cleveland, Dallas, and Atlanta noted that margins tightened because of fuel-cost increases. Cleveland and Dallas reported plans for increased capital spending in the trucking industry. Dallas also reported that both railroads and airlines saw rising demand.

                                                                                  Would such bottlenecks, rather than the overall capacity utilization rate, both Fed officials? I think we will see the answer is yes. Moreover, the Fed appears confident that firms are in fact trying to pass on higher costs – leading one to believe that tighter labor markets would only add to such pressure. In the end, though, the inflation line is holding. For now, at least:

                                                                                  However, in the remaining nine Districts, nonlabor-input-cost increases continued to concern companies, particularly those in the manufacturing sector. Producers were reported to have attempted to recoup these costs, although, according to the Atlanta, Boston, San Francisco, and Dallas Districts, intense competition was thought to be holding down price increases in parts of the supply chain further "downstream."

                                                                                  In addition, keep watching the energy market. It is looking like the easing in the energy prices early this winter is being reversed, especially with regards to oil. It is easy to write this off to the tension with Iran, but note that commodities in general have continued to be strong – suggesting a common underlying dynamic is in play. Given the solid economic environment, the Fed will likely continue to see oil as an inflationary, not recessionary, threat.

                                                                                  For the FedSpeak, I want to first draw attention to Fed Governor Susan Bies speech. Notably, she touches on the bottleneck concern I alluded to earlier:

                                                                                  Futures markets currently expect only limited increases in the price of crude oil this year. Nevertheless, tight resource utilization is likely to put pressure on prices. The unemployment rate, at 5 percent in the second half of 2005, was down about 1 1/4 percentage points from its recent peak in early 2003 and at its lowest level in four years. Meanwhile, the factory operating rate--a measure of resource utilization in the manufacturing sector--was 79.6 percent in December, a rate that is approaching its 1972-2004 average of 79.8 percent. Within manufacturing, industries operating at utilization rates above their long-run averages include plastics and rubber products, iron and steel products, machinery, electronic products (excluding computers), and electrical equipment, appliances, and components. And although the overall high technology aggregate is below its long-run average rate of utilization, the operating rate at firms making computers and peripherals is above average, and the rate at manufacturers of communications equipment has risen significantly over the past year. As in the mid- to late-1990s, resilient productivity growth appears to be helping contain the inflationary pressures that might otherwise be expected to accompany a narrowing margin of resource slack. That said, we at the Federal Reserve will remain vigilant for any sign of a deterioration in the inflation outlook.

                                                                                  Clearly, she remains focused on the unemployment rate rather than other measures of the labor market, and concludes that it is sufficiently tight to keep inflation worries on the front burner. Moreover, the identification of specific industries in the speech is an important insight into Bies thinking. She is effectively saying that while overall manufacturing is just approaching its average utilization rates, specific sectors are already above average – suggesting the possibility of bottlenecks. Is overall utilization the important variable, or can bottlenecks in the supply chain be the inflationary trigger? You be the judge, but I bet the Bies shares the latter interpretation. Also note that in her speech, Bies remains optimistic that while bottlenecks imply inflationary pressures, rising utilization and healthy cash flow will support capex spending in the months ahead.

                                                                                  Bies appears to share the same outlook for healthy growth next year as Richmond Fed President Jeffery Lacker in his speech last week

                                                                                  It is a pleasure to be with you today to discuss the economic outlook for 2006 and beyond. It is a pleasure, in part, because the economic outlook is fairly encouraging. Growth is on a solid footing, despite this year’s run-up in energy prices and the disruptions of a devastating hurricane season. And after a brief pause this fall, employment is expanding again at a healthy pace, consumer spending continues to grow briskly, and business investment spending is robust. Granted, housing activity seems to be softening, and at least some potential price level pressures remain, so it may be too soon to break out the champagne. But inflation expectations remain contained, and we at the Fed are well-positioned to resist inflation pressures, should they emerge.

                                                                                  So all in all, it is quite a good outlook.

                                                                                  Wait a second, it might be too soon to break out the champagne, but he doesn’t sound too concerned about inflation. By the way, where is the inflation? David Altig’s colleague, Michael Bryan at macroblog, appears to be breathing a sigh of relief regarding the inflation outlook. And policymakers keep talking about inflation pressures (Lacker reiterates it is too early to conclude that the inflation risk is behind us), but don’t they need some evidence that the genie is actually getting out of the bottle to justify higher rates now that we are near neutral? Not so, according to Lacker:

                                                                                  As I have emphasized elsewhere, a real interest rate is a relative price — the price of current resources relative to the future resources one either forgoes by borrowing or obtains by investing. Real interest rates need to respond to changes in the relative pressure on current versus future resources.

                                                                                  Unpredicted movements in economic fundamentals, to the extent that they affect the relative pressure on current and future resources, thus will have implications for policy rates, even in situations in which inflation and inflation expectations are low and well-contained.

                                                                                  He reiterates this point in his conclusion

                                                                                  Thus, whenever the current sequence of tightening moves reaches completion, short-term interest rates should not be expected to remain constant for an extended period of time. Instead, they will likely move from time to time during the expansion ahead.

                                                                                  Policymakers will need to be alert for movements in economic fundamentals that shift the relative pressure on current versus future resources in ways that require changes in real interest rates, even if inflation pressures subside.

                                                                                  Read that again if you didn’t catch it the first time – even if inflation keeps under the radar, we need to be concerned the that future resources not be excessively drained to satisfy current wants. The Fed thus needs to keep policy aligned with the real economy even if inflation is in check. In other words, don’t expect the Fed to just sit still if rates are near “neutral” and inflation is in the target range.

                                                                                  Now, if all that doesn’t convince that the Fed holds an internal inflationary bias, just ask San Francisco Fed President Janet Yellen, via Mark Thoma’s report of her January 19th speech:

                                                                                  ''I'm pretty comfortable with the inflation outlook,'' Yellen said today in response to an audience question after a speech to economists in Los Angeles. The risk of it speeding up is ''skewed slightly to the upside.'' She didn't elaborate on the risks.

                                                                                  More directly:

                                                                                  ''Given what I know and what I've seen about the economy'' and ''based on the data that I'm looking at, probably, yes,'' the Fed is near the end of its current series of rate increases, Yellen said in response to a question. At the same time, she said the Fed is ''not finished'' with rate increases.


                                                                                  Yellen said yesterday that ''we have an economy that's operating somewhat above trend.''

                                                                                  Skewed slightly to the upside indeed, sounds like macroblog’s probabilities, are pretty accurate (traditionally, we get a new reading on Mondays). Next week another hike looks like a lock, and with policymakers holding the view that the economic is solid and inflation somewhat more likely than not, the risk remains better than even that Bernanke & Cos. first move is another hike. At a minimum, the Fed wants market participants to believe that even if the first Bernanke move is a pause, don’t be surprise if a hike does occur at a later meeting. From their perspective, they are not yet seeing conditions that justify sending an all’s clear signal. [All Fed Watch posts.]

                                                                                  Posted by Mark Thoma on Sunday, January 22, 2006 at 05:08 PM in Economics, Fed Watch, Monetary Policy

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                                                                                  Burning Bridges To and From the World Bank

                                                                                  Following up on the topic of economic and political ties between Africa and China in the post below this one, the World Bank and Chad are having troubles over oil revenues from a World Bank sponsored project intended to ease poverty, and there are indications this may result in Chad abandoning the World Bank agreement and forging deals with China instead:

                                                                                  Why a World Bank oil project has run into the sand, by David White, Financial Times: It was touted as the formula all future projects of its kind would follow. The conditions put in place for an oil development and pipeline project in central Africa were hailed by the World Bank as a pioneering breakthrough, a way of tracking where the money went and making sure it helped the people who needed it most. Yet two and a half years since oil for export started pumping ... the triumph rings hollow.

                                                                                  The deal, which obliged Chad to account for most of its direct revenues from the $4.2bn (£2.4bn, €3.5bn) project, was meant to overcome the sorry history of mineral exploitation in developing countries – the “resource curse” that, instead of bringing development, gets in the way of it, favouring corruption, self-serving elites, waste, poverty and unrest.

                                                                                  But the World Bank took a gamble setting its test case in a fragile country held back by war, with no record of good governance and little experience of budget management. Always questionable, the experiment is now at an impasse, a victim of mutual misunderstanding and the desperation of a shaky regime needing to shore up its rotting power base.

                                                                                  The breakdown is a significant early test for Paul Wolfowitz, who took over as World Bank president last June... Chad had defied the bank by changing its law on managing petroleum revenues, to gain more freedom in spending its money. ...[T]he outcome will have important implications. It could demonstrate how any country can bypass international attempts to impose standards on it. It could also leave one of the world’s poorest countries ... even worse off than before.

                                                                                  The government seems not to have reckoned with the full consequences. For the moment it has no access to further funds either from its main creditor or from its oil. A cornerstone international institution is sticking to its principles but at a potential cost, both to the people the scheme was supposed to benefit and to its reputation.

                                                                                  “It’s a paradox, when the World Bank is an organisation that presents itself as the high priest of the fight against poverty, and its first reflex is to close down projects of social benefit,” says Mahamat Ali Hassan, Chad’s economy minister. Chadian officials’ charge of “blackmail” has a resonance in other developing countries. ...

                                                                                  The differences between Chad’s new legislation and the 1999 original would seem to leave room for negotiation but both sides have dug in. ... In an exercise in brinkmanship, Idriss Déby, Chad’s president, had the law approved by parliament in late December. A week later ... he had a two-hour telephone conversation with Mr Wolfowitz. Next morning, the World Bank chief called in board members. The bank’s loans to Chad, destined mostly for non-oil projects, were suspended...

                                                                                  Chad’s government received the notification only five days later. Mr Déby, who still had the possibility of sending the law back to parliament, immediately signed it. The bridges were now burnt. Each side appears to have underestimated the other’s determination.

                                                                                  The freezing of funds has created bewilderment in Chad’s government, which by its spokesman’s admission “has its back to the wall”. ... “If it’s crunch time, Chad could turn its back on the international community,” warns Chris Melville of Global Insight... Officials hint at alternative oil deals with China, already the dominant client for oil from neighbouring Sudan. Chad may seek bridging finance from other African oil producers – possibly Gabon or Equatorial Guinea – or elsewhere. That could sustain the regime for a year until taxes from the oil venture begin flowing in. Chad may be able to cancel its World Bank debt on the oil project and go its own way. ...

                                                                                  Chad was supposed to establish a model of good practice. But, as a western observer in the country puts it: “The risk is that it will become an example for the worst pupils.” ...

                                                                                    Posted by Mark Thoma on Sunday, January 22, 2006 at 12:39 PM in China, Economics

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                                                                                    Africa and China

                                                                                    As the economic ties between China and Africa grow stronger, there are questions about the nature of the evolving relationship:

                                                                                    A match made in Beijing, by Lyal Whi, Mail & Guardian Online, South Africa: Africa needs China. ...China’s insatiable appetite for natural resources is creating unprecedented demand for commodities, pushing prices to new highs and fuelling economic growth across the continent. But China’s relations with Africa have stirred a polarised debate from Cape to Cairo. China is either the next big thing, usually in the view of business and some governments. Or it is the red peril, the new coloniser...

                                                                                    In terms of political ideology and approaches to socio-economic development, China is closely aligned to countries of the south. This has ... shaped China’s relations with countries in Africa and elsewhere and created a somewhat idealistic impression of the distant partner or big brother in the East ... Many Africans still believe that relations with China are of an altruistic nature. They tend to forget the hardnosed commercial reality that now determines international relations -- and relations with China in particular.

                                                                                    They are seemingly unaware of the fact that China’s relations with Africa are merely part of a broader strategy of engagement with the developing world, focused on the search for natural resources. Reliable access to resources is essential for ongoing growth and development and is at the core of China’s national interests. In this respect, China and Africa are ideal partners. Africa is a treasure trove of metals and minerals and has huge agricultural potential. ...

                                                                                    But China’s relations with Africa have faced criticism. Firstly, trade imbalances are increasingly in China’s favour and large-scale dumping of cheap manufactured products are undercutting local industries. ... The South African clothing and textile sector has lost more than 100 000 jobs since 1995 due largely to the influx of cheaper products from China. Trade with China has, if anything, worsened unemployment and poverty in South Africa, which are two of the most pressing problems facing the country today.

                                                                                    Secondly, the slow trickle of long-term fixed investments from China indicates a lack of commitment in Africa. ... Finally, the nature of Chinese activities on the continent ... are often accused of undermining the principles of good governance and human rights, is a source of controversy both on the continent and abroad. The use of Chinese labour on many of the African based contracts is also a point of contention. ... China’s so-called “respect for sovereignty” carries little resonance among human rights groups ...

                                                                                    China needs Africa. Apart from Latin America, Africa is probably the richest diversified source of metals, minerals, fuel and agricultural produce in the world. ... China is also seeking greater international recognition and leverage in multilateral organisations. Africa is able to provide such support and assist China in improving its “soft power” of influence and acceptance worldwide.

                                                                                    China-Africa relations are first and foremost commercial in nature. But China’s pursuit of business interests in Africa should not disregard the principles associated with political good governance. ... Finally, Africa can learn from China’s process of economic development and liberalisation, which has turned it into an investment magnet and one of the most competitive markets in the world. An improved investment climate in Africa will guarantee a reliable supply of resources and unlock vast potential in the labour market.

                                                                                      Posted by Mark Thoma on Sunday, January 22, 2006 at 01:56 AM in China, Economics

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                                                                                      Health Savings Accounts: Krugman vs. Feldstein

                                                                                      Last year, the administration promoted Social Security privatization. This year, the push is for Health Savings Accounts. Here's president Bush in his radio address today:

                                                                                      President's Radio Address: ...For the sake of America's small businesses, workers, and families, we must also make health care more affordable and accessible. A new product known as Health Savings Accounts helps control costs by allowing businesses or workers to buy low-cost insurance policies for catastrophic events and then save, tax-free, for routine medical expenses. This year, I will ask Congress to take steps to make these accounts more available, more affordable, and more portable...

                                                                                      I thought it would be useful to review the debate over these accounts. Here's Martin Feldstein's arguments in support of Health Savings Accounts:

                                                                                      Health and Taxes, by Martin Feldstein, WSJ, 1/19/04: ...Health Savings Accounts ... may well be the most important piece of legislation of 2003. These new tax and medical insurance rules have the potential to transform health-care finances, bringing costs under control and making health care reflect what patients and their doctors really want. It is remarkable that this legislation has received so little public attention.

                                                                                      Today's high cost of health care reflects the way that the tax law has subsidized the use of insurance to pay for health care. ... Because out-of-pocket payments at the time of care are only a small fraction of the total cost of producing that care, individuals naturally want "the best care" that medical science can provide. And the demand for that high-tech care drives medical innovation toward new and more expensive modes of treatment.

                                                                                      The demand for the typical health-insurance policy reflects the tax provision that allows employees to exclude payments for health insurance from their taxable income. ...[T]he resulting tax saving is a very large subsidy for the purchase of the kind of comprehensive, low-deductible insurance policy that drives up health-care costs ... essentially a $120 billion subsidy for purchasing the wrong kind of insurance. ...

                                                                                      The new HSA law (a part of the recent Medicare reform bill) eliminates the preferential subsidy... Anyone under the age of 65 can establish a Health Savings Account if they have a "qualified" health-insurance plan. A "qualified" plan is an insurance policy that has a minimum deductible of $2,000 for a family and a $10,000 limit on the family's annual out-of-pocket expenses. The deductible is designed to make individuals more cost-conscious in their consumption of health care, and the annual limit on out-of-pocket expenses is there to prevent financial hardship... An individual can withdraw funds from his HSA without paying tax if the money is used for any kind of health bills...

                                                                                      High-deductible policies give individuals and their doctors an incentive to avoid wasteful health spending. When spending comes from the individuals' own Health Savings Accounts, individuals and their doctors have a strong reason to balance the costs of medical procedures against the potential favorable impact on health. ...

                                                                                      Here's Paul Krugman with a different view:

                                                                                      Medical Class Warfare, by Paul Krugman, NY Times, 7/16/04: The ... main component of the Bush plan involves "health savings accounts." ...[H]ealth savings accounts don't seem to have much to do with the needs of the families likely to find themselves without health insurance. For one thing, such families need more protection than a plan with a $2,000 deductible provides. Furthermore, the tax advantages of health savings accounts would be small for those families most at risk of losing health insurance, who are overwhelmingly in low tax brackets.

                                                                                      But for people whose income puts them in high tax brackets, these accounts are a very good deal; making the premiums deductible turns them into a great deal. In other words, health savings accounts will offer the already affluent, who don't have problems getting health insurance, yet another tax shelter. Meanwhile, health savings accounts, in the view of many experts, will actually increase the number of uninsured.

                                                                                      This perverse effect shouldn't be too surprising: unless they are carefully designed, medical policies often have side consequences that worsen the problems they supposedly address. ... In the case of health savings accounts, the key side consequence is a reduced incentive for companies to insure their workers. When companies provide group health insurance, healthier employees implicitly subsidize their sicker colleagues. They're willing to do this largely because the employer's contributions to health insurance are a tax-free form of compensation, but only if the same plan is offered to all employees.

                                                                                      Tax-free health savings accounts and premiums would provide healthier and wealthier employees an incentive to opt out, accepting higher paychecks instead, and would lead to higher insurance premiums for those who remain in traditional plans. This would cause some companies to stop providing health insurance, or raise employee contributions to a level some workers can't afford. ...

                                                                                      And, from another column:

                                                                                      America's Failing Health, by Paul Krugman, NY Times, 8/27/04: ...Clearly, health care reform is an urgent social and economic issue. But who has the right answer? ... George Bush's economists think ... health costs are too high because people have too much insurance and purchase too much medical care. What we need, then, are policies, like tax-advantaged health savings accounts tied to plans with high deductibles, that induce people to pay more of their medical expenses out of pocket. (Cynics would say that this is just a rationale for yet another tax shelter for the wealthy, but the economists who wrote the report are probably sincere.) ...

                                                                                      [Others] believe that health costs are too high because private insurance companies have excessive overhead, mainly because they are trying to avoid covering high-risk patients. What we need, according to this view, is for the government to assume more of the risk, for example by picking up catastrophic health costs, thereby reducing the incentive for socially wasteful spending, and making employment-based insurance easier to get. A smart economist can come up with theoretical justifications for either argument. The evidence suggests, however, that the [second] position is much closer to the truth. ...

                                                                                      Does this mean that the American way is wrong, and that we should switch to a Canadian-style single-payer system? Well, yes. ... My health-economist friends say that it's unrealistic to call for a single-payer system here: the interest groups are too powerful, and the antigovernment propaganda of the right has become too well established in public opinion. All that we can hope for right now is a modest step in the right direction... I bow to their political wisdom. ...

                                                                                      I'm with Krugman on this one.

                                                                                        Posted by Mark Thoma on Sunday, January 22, 2006 at 01:38 AM in Economics, Health Care

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                                                                                        January 21, 2006

                                                                                        Global Competition and Changes in the Structure of the U.S. Economy

                                                                                        Daniel Altman talks about the decline in manufacturing and other changes in the U.S. economy driven by technological change and globalization:

                                                                                        Exporting Expertise, If Not Much Else By Daniel Altman, Economic View, NY Times: Want to understand what's really happening in the American economy? ...[T]he sea of numbers that pour out of ... statistical agencies... describe some disturbing changes. You can look at the economy in two ways: by production, or by people. The two aren't always the same... This is clear when you look carefully at the biggest long-term trend in the economy: the decline of manufacturing.

                                                                                        Both of manufacturing's two big categories, durable goods (like cars and cable TV boxes) and nondurable goods (like pastrami and pantyhose), have plunged, but the exact trends have differed. From 1965 to 2005, the percentage of payroll employees devoted to durable goods dropped to 8 percent, from 19 percent; over the same period, the share of the economy they represent shrank by just four percentage points. In other words, workers in these industries became a lot more productive as their numbers dwindled.

                                                                                        The picture was different for nondurable goods. In that category, the employees' share of the nation's labor force also declined steeply, by nine percentage points, to just 5 percent of the total. But nondurables' share of the economy dropped by even more, by 10 percentage points. ... Most of the losses in nondurable production had already occurred by the early 1990's. That's not too surprising, when you think about it: the nation's agriculture had become about as efficient as it could be, and clothing imports from developing countries like China, Bangladesh and Mauritius were in full swing.

                                                                                        The story for durable goods is more troubling. Half of the decline in production has been a legacy of the last recession: sales went down, and they have stayed down. The situation is a first, and it has been reflected in the labor market, too. ...[A]fter the 2001 recession, [employment] sank below nine million and hasn't picked up. ... The explanation may lie ... in the world's emerging economies. They saturated the American market with nondurables in the 1980's and early 90's, using the profits to move onto higher-value, durable items.

                                                                                        The change in the trend for durable goods was not the only worrisome legacy of the last recession. In the information sector, which had been among the most steadily growing areas of the labor market, growth has completely stalled ... The relatively small industries of broadcasting and Internet publishing have started upward ... But in print publishing, telecommunications and Internet services, the trend has been absolutely flat, despite the economy's return to regular growth.

                                                                                        Of course, there have been winners, too. The share of the economy devoted to medical care services has grown by eight percentage points in the past four decades, with commensurate changes in employment. But this isn't necessarily great news for the economy. ...

                                                                                        The leisure and recreational industries have also expanded, with the share of employment up by four percentage points. Here, too, exporting is difficult: after all, gambling, artistic performances and restaurant dinners usually take place on site. More promising, management and professional services like law and finance resumed their strong growth after taking a hit in the recession. These areas are the ripest for exporting. Need some business advice? No problem. Want some derivatives structured? Great. ...

                                                                                        We are becoming a nation of advisers, fixers, entertainers and high-tech engineers, with a lucrative sideline in treating our own illnesses. ... The change is being forced on us by global competition and our own aptitudes. The first step in dealing with it is to realize what's happening. The second, most likely, is to prepare for more of the same.

                                                                                          Posted by Mark Thoma on Saturday, January 21, 2006 at 04:43 PM in Economics, International Trade, Technology, Unemployment

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                                                                                          Whale of a Job

                                                                                          It's too bad that the whale they were trying to rescue from the Thames did not survive the ordeal. It reminded me of this story of "A whale that ... will always have the last laugh":

                                                                                          Bob Welch: Tale of flying blubber keeps bubbling up, by Bob Welch Columnist, The Register-Guard, November 10, 2005: Saturday marks the 35th anniversary of the funniest thing that ever happened in Oregon: the exploding whale. Like you needed reminding, right? ... [E]ach year at this time, [we] pay tribute to the ... Oregon Department of Transportation ... for bringing us the laugh heard 'round the world.

                                                                                          Who can we thank for helping keep the spirit alive? An otherwise unassuming Eugene man, Steve Hackstadt, mastermind of the ever-popular "" Web site. It receives about 10,000 hits a day ... "There are still people who don't believe," says Hackstadt, a 35-year-old software engineer who works for NASDAQ. "Some think it's an urban legend." No, it's too perfect for legend.

                                                                                          In 1970, an 8-ton sperm whale washed ashore dead - this is an important fact, this "dead" part - just south of Florence. After considering ways to get rid of the stinking, rotting remains, the Highway Division gathered its finest minds to noodle a solution.

                                                                                          Being guys, they naturally figured a half-ton of dynamite would do the job. Most of the ex-whale, they figured, would blow out to sea as mist and any small pieces would be cleaned up by the gulls. ... As KATU's Paul Linnman says while narrating film footage: "The humor of the situation gave way to a run for survival as huge chunks of whale blubber fell everywhere." A woman can be heard saying, "Here come pieces of ... ." The hood of a car is crunched like a pop can.

                                                                                          Nobody was hurt. "However," reported Linnman, "everyone on the scene was covered with small particles of dead whale." Oregon rain - with a ... twist.

                                                                                          For most people, the story faded. But .... In 1990, columnist Dave Barry saw the video and called the explosion "the most wonderful event in the history of the universe." Then, in the mid-'90s, along came Hackstadt, a graduate student in the University of Oregon's computer information science department. He saw the video and slapped it on his personal Web page. "It's a classic," he says. ... Eight tons of whale blubber, splattered up to a quarter-mile from the ex-whale, attest to that.

                                                                                          If engineers thought the idea of burying the whale to be impractical, the story itself refuses to be buried. It has a cult following, ... "I've received death threats. Some people don't understand that the whale was dead when this happened. A lot of people are confused. It's like: 'You killed Keiko.' "

                                                                                          No, no, no. This story isn't about death. It's about a whale that refuses to die. A whale that lives on. A whale that, thanks to man's stupidity, will always have the last laugh.

                                                                                            Posted by Mark Thoma on Saturday, January 21, 2006 at 04:23 PM in Oregon

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                                                                                            For Whom the Benefit Tolls

                                                                                            According to this geriatric medicine specialist, it's not for thee:

                                                                                            It's a benefit, but for whom?, by Daniel J. Stone, Commentary, Los Angeles Times: As a geriatric medicine specialist, I am confronted daily by the chaos and confusion of Medicare's Part D drug benefit. The program should reflect President Bush's ideals of "compassionate conservatism." Compassion would mean user-friendliness and easy access to affordable drugs. And a conservative plan would maximize "bang for the buck." Instead, the priorities of the insurance and pharmaceutical companies have trumped these objectives.

                                                                                            Economics 101 tells us that the largest purchasers have bargaining power to get the best prices... Similar national bargaining entities in Canada and Europe allow foreign consumers to pay a third to one-half of U.S. drug prices. A single Medicare bargaining entity, however, threatened to place unprecedented price pressures on drug companies and might have reduced or eliminated the role of private insurers.

                                                                                            So Congress sacrificed Medicare's bargaining power in favor of a system in which multiple private insurers offer competing plans. This decision will ultimately transfer billions of dollars from seniors and the government to insurers and drug companies. Some claim the industry needs these resources to finance tomorrow's drug breakthroughs. Although the need for research dollars is real, it seems unfair for Medicare seniors to shoulder costs that also subsidize Canadian and European consumers.

                                                                                            One of my patients, Betty L., is already feeling the pinch. A low-income senior on Medi-Cal, Betty was automatically enrolled in a Medicare Part D program on Jan. 1. ...[H]er new Healthnet plan requires small co-payments. ... [and] it omits coverage for ...[drugs] Medi-Cal covered. To get those medicines, and cover her new co-pays, Betty will be charged ... extra ... We all have a right to question a prescription drug program that will cost $700 billion over 10 years and yet increases drug payments for some of the poorest.

                                                                                            George A. and Mary S., two other patients in my practice, have "Medi-Gap" drug coverage policies, and they are less financially vulnerable... In order to find the right Part D coverage, they must sort though ... about 80 different plans ... George A., an 85-year-old bachelor with multiple medical problems, knows that Medicare Part D might save him money... he just hasn't had the motivation to make an informed choice. Given his advanced age and relative financial security, George would rather pay more and worry less about the prospect of change.

                                                                                            Mary S., a relatively healthy 80-year-old, has Internet access, and she's sophisticated about medication issues. I've explained that it would be relatively easy to use Medicare's interactive website to input her medications and find plans that would cover her current prescriptions. "When you get old," she countered, "nothing is that easy." As Mary's comments suggest, Part D's congressional architects seemed to think that seniors would be utterly at ease when it comes to using the Internet and reading the fine print in insurance plans. Unfortunately, that description doesn't fit most Americans in any age range, much less seniors.

                                                                                            The Department of Health and Human Services is proclaiming that 21 million seniors have enrolled in the program. Conveniently, this statistic ignores the fact that the vast majority ..., like Betty L., were ... automatically enrolled them in Part D. About 22 million more seniors still need to make a choice, and many of them, like George A. and Mary S., remain too uninformed, confused or wary to make up their minds.

                                                                                            How did American seniors and AARP, their powerful watchdog, permit Congress to approve a complex and confusing drug benefit program that squanders its bargaining power? The answer is that it was better than nothing. That abysmal standard appeared sufficient... But seniors have a right to expect those in power to adhere to principles rather than corporate interests when their health and financial welfare are at stake. Saddling seniors with a flawed program that prioritizes special interests rather than seniors' interests can be considered neither compassionate nor conservative.

                                                                                              Posted by Mark Thoma on Saturday, January 21, 2006 at 12:43 PM in Economics, Health Care, Policy

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                                                                                              The Decline in Workplace Provided Health Coverage

                                                                                              This is from Table 132 of this report from the CDC web site. It's a graph of the percentage of people with workplace provided private health coverage from 1984-2003. There's quite a bit of detail in the table including breakdowns of coverage by age, sex, race, and income level. For example, here's coverage by age:

                                                                                              The numerical overall changes by age are:


                                                                                              1984 2003 Change
                                                                                              Under 18 years 66.5 58.6 -7.9
                                                                                              18-44 years 69.6 62.2 -7.4
                                                                                              45-64 years 71.8 70.0 -1.8

                                                                                              Thus, the largest decline is for those under 45.

                                                                                              Here are the numerical endpoint data by sex along with the overall changes. Given the standard errors in the table (not shown here), there is little difference between males and females:


                                                                                              1984 2003 Change
                                                                                              Male 69.8 63.3 -6.5
                                                                                              Female 68.4 63.3 -5.1

                                                                                              There are, however, big differences by income level, and the changes are larger for those under 18. As the following table shows, the decline in workplace provided health care coverage has been largest among those earning between 100% and 200% of the poverty level, a change of over 20%, while the change for those outside this range is less than 10%:

                                                                                              Age and Percent of Poverty Level

                                                                                              All ages 1984 2003 Change
                                                                                              Below 100 % 24.1 19.9 -4.2
                                                                                              100-149 % 52.4 31.8 -20.6
                                                                                              150-199 % 69.5 46.8 -22.7
                                                                                              200 % or more 85.0 78.6 -6.4
                                                                                              Under 18 years
                                                                                              Below 100 % 23.0 14.0 -9.0
                                                                                              100-149 % 58.3 30.1 -28.2
                                                                                              150-199 % 75.8 47.0 -28.8
                                                                                              200 % or more 86.9 79.9 -7.0

                                                                                              These data show that middle income families have been affected most by the decline in employer provided private health care coverage.

                                                                                              Update: A colleague writes to tell me:

                                                                                              The explanation for the decline in coverage (at least through the late 90s) is also quite interesting. David Cutler has a paper (NBER WP #9036), arguing that the reason for the decline was not a decrease in employers offering HI, but a decrease in employees choosing to purchase insurance from their employers, primarily due to rising premiums.

                                                                                                Posted by Mark Thoma on Saturday, January 21, 2006 at 01:02 AM in Economics, Health Care

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                                                                                                Changes in the Economic Tide

                                                                                                The Economist says that the share of world output coming from developing countries exceeds fifty percent for the first time since the early 1800s, and the share will continue to increase in the future:

                                                                                                Climbing Back, The Economist: Since their industrial revolutions in the 19th century, the rich countries of the “first world” have dominated the global economy. By one measure at least, that era may be over. According to estimates by The Economist, in 2005 the combined output of emerging (or developing) economies rose above half of the global total. This figure has been calculated from the International Monetary Fund's World Economic Outlook database. We ... include the newly industrialised Asian economies (South Korea, Taiwan, Hong Kong and Singapore). These countries might well now be classed as developed, but should surely be counted in any estimate of the long-term success of developing countries. ... We have used the IMF's method of converting national GDPs into dollars using purchasing-power parities (PPPs) instead of market exchange rates. The latter can distort the relative size of economies, not only because currencies fluctuate, but also because prices are lower in poorer economies...

                                                                                                But even when measured by market exchange rates emerging economies are flexing their muscles. Last year, their combined GDP grew in current dollar terms by $1.6 trillion, more than the $1.4 trillion increase of developed economies. And there is more to this than just China and India: these two countries together accounted for only one-fifth of the total increase in emerging economies' GDP last year.

                                                                                                Of course, with half the world's output but five-sixths of its population, emerging economies still have incomes per head far lower than the rich world. But by a wide range of gauges they are looming larger (see chart 1). Their share of exports has jumped to 42%, from 20% in 1970. Over the past five years, they have accounted for more than half of the growth in world exports. Emerging economies are now sitting on two-thirds of the world's foreign-exchange reserves and they consume 47% of the world's oil. On the other hand, their stock markets still account for only 14% of global capitalisation. ...

                                                                                                The growing clout of emerging economies is in fact returning them to the position they held for most of history. Before the steam engine and the power loom gave Britain its industrial lead, today's emerging economies dominated world output. Estimates by Angus Maddison, an economic historian, suggest that in the 18 centuries until 1820 they produced, on average, around 80% of the total. But they were then left behind by Europe's technological revolution. By the early 20th century their share had fallen to 40% (see chart 2). ...

                                                                                                In the past three years, their growth has averaged more than 6%, compared with 2.4% in rich economies. The IMF forecasts that in the next five years they will roll along at just under 6%, twice as fast as developed economies. ...

                                                                                                The future expansion of emerging economies will not follow a straight line. ... However, the long-run prospects for emerging economies as a whole look excellent... Confirmation that emerging economies are grabbing a bigger slice of global output will frighten many people in the rich world. It shouldn't... Emerging economies' spurt is boosting global output, not substituting for growth elsewhere. ...

                                                                                                  Posted by Mark Thoma on Saturday, January 21, 2006 at 01:01 AM in Economics

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                                                                                                  Zero Down Payment Housing Loans

                                                                                                  Following up on the note at the end of the post after this one on the costs and benefits of financial deregulation and innovation, a larger and larger percentage of housing purchases are being financed with zero down payment loans:

                                                                                                  Down Payments' Downward Trend, by Tomoeh Murakami Tse, Washington Post: More than four out of every 10 recent first-time home buyers financed their purchases with no-down-payment loans, according to a study ... by the National Association of Realtors... That's an increase of about 54 percent over the past two years. Analysts say the upsurge means more buyers have entered the market who have a greater risk of defaulting on their mortgages. "That is a very big increase. ... almost certainly due to ... a lot of people feeling very stretched," said economist Dean Baker of the Center for Economic and Policy Research. They can't afford traditional mortgages, "prices are going through the roof and this is how they're responding."... Because those who apply for zero-down loans often have little or no savings, analysts say they are more likely to let mortgage payments lapse. In a worst-case scenario, such borrowers might be forced to sell, potentially flooding the market with homes and driving down values, which would affect all owners in an area. ... The median down payment -- the point at which half of the down payments were smaller and half larger -- for first-time buyers was just 2 percent. For all buyers, it was 13 percent, lower than the traditional 20 percent down payment...

                                                                                                    Posted by Mark Thoma on Saturday, January 21, 2006 at 12:59 AM in Economics, Housing

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                                                                                                    January 20, 2006

                                                                                                    Financial Market Deregulation Under Greenspan: Did It Go Too Far?

                                                                                                    Steven Pearlstein of the Washington Post talks about an area of Greenspan's tenure that hasn't received as much press at it might, his penchant for financial deregulation:

                                                                                                    The Laissez-Fairest of Them All, by Steven Pearlstein, Washington Post: ...Perhaps Greenspan's most important contribution has been as the policymaker who... engineered the wholesale deregulation of the U.S. banking and financial system. In this respect, his most enduring legacy is an American economy that is not only more prone to assets bubbles, corporate scandal and financial crises, but robust enough to absorb such shocks while continuing to deliver long-term economic growth.

                                                                                                    A determination to substitute the wisdom of markets for the heavy hand of government runs through the Greenspan story. ... There was, for example, his work on behalf of Lincoln Savings and Loan seeking permission for thrifts to branch out from boring old home loans to invest directly in commercial real estate ventures. Greenspan told Congress such powers were "essential for the financial stability and survival of the savings and loan industry." Congress agreed, but this first bit of financial deregulation spawned a crisis that nearly wiped out the industry, cost taxpayers more than $100 billion and landed Lincoln's top executive in prison.

                                                                                                    Once installed at the Fed, Greenspan immediately began pushing Congress to repeal the Depression-era law that prevented banks from competing with investment banks in underwriting stocks and bonds. When Congress dallied, he used the Fed's supervisory authority to allow banks to circumvent the law and usher in the era of the megabank. ...

                                                                                                    When crisis struck, Greenspan was quick on the scene with liquidity to prevent it from spreading. But he almost never saw in such episodes a reason for new regulation. Even after derivatives trading bankrupt Orange County, Calif., and the venerable Barings investment house, Greenspan fought efforts to regulate these newfangled financial instruments. And while the near collapse of Long-Term Capital required the Fed's jawboning to prevent a global financial meltdown, Greenspan opposed efforts by the Securities and Exchange Commission to initiate even modest regulation of the $1 trillion hedge fund industry.

                                                                                                    After the Enron scandal, accounting regulators set out to draft rules to prevent companies and their lenders from using "special purpose entities" to hide indebtedness from investors. Objections from the Fed stalled adoption of the new rules, and eventually watered them down. And just yesterday came Greenspan's latest salvo in his campaign to dismantle Fannie Mae and Freddie Mac. In a letter to Sen. John E. Sununu (R-N.H.), he reprises his view that there's nothing the government-sponsored mortgage lenders do that private banks couldn't do at less cost to taxpayers, with less threat to the financial system.

                                                                                                    As you can probably tell, I didn't much like most of these decisions. There was, and is, plenty of evidence that skillful regulation and intervention can help deter corporate fraud, protect investors from Wall Street sharpies and reduce the frequency and severity of assets bubbles and financial crises.

                                                                                                    At the same time, Greenspan is probably right that deregulation sparked a flurry of financial innovation that has made capital cheaper and more readily available, done a better job of pricing and spreading risk and shielded the economy from the impact of financial crises. ... Greenspan summed up the trade-offs behind his deregulatory philosophy in a series of unusually lucid speeches in London in 2002, on the eve of being knighted by Queen Elizabeth. "The extent of government intervention in markets to control risk-taking," he said, "is a trade-off between economic growth and its associated potential instability, and a more civil but less stressful way of life with a lower standard of living."...

                                                                                                    I have the same reaction. Compared to twenty years ago, there has been remarkable transition and innovation in the financial services industry driven by competition. So far, so good. But I also worry that deregulation has gone too far and made us more vulnerable to financial meltdown in the face of large and unexpected shocks. Housing markets are a good example of this. The promotion of home ownership though creative financing allows many to purchase homes that could not have done so not that long ago. But have people taken on excessive risk and thereby increased our vulnerability to a crash?

                                                                                                      Posted by Mark Thoma on Friday, January 20, 2006 at 09:43 AM in Economics, Financial System, Housing, Monetary Policy, Regulation

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                                                                                                      Milton Friedman: "I Think the Austrian Business-Cycle Theory Has Done the World a Great Deal of Harm"

                                                                                                      This is from a 1998 interview with Milton Friedman:

                                                                                                      EPSTEIN You were acquainted with the Austrian economist Friedrich Hayek and also are familiar with the work of Ludwig von Mises and his American disciple, Murray Rothbard. When you were talking about bad investments, you were alluding to Austrian business-cycle theory. A certain concept that has pretty much gone into our parlance and understanding fits in with what you said about what happened in Asia. There can be times and conditions in which the stage can be set for malinvestment that leads to recession.

                                                                                                      FRIEDMAN That is a very general statement that has very little content. I think the Austrian business-cycle theory has done the world a great deal of harm. If you go back to the 1930s, which is a key point, here you had the Austrians sitting in London, Hayek and Lionel Robbins, and saying you just have to let the bottom drop out of the world. You’ve just got to let it cure itself. You can’t do anything about it. You will only make it worse. You have Rothbard saying it was a great mistake not to let the whole banking system collapse. I think by encouraging that kind of do-nothing policy both in Britain and in the United States, they did harm.

                                                                                                        Posted by Mark Thoma on Friday, January 20, 2006 at 01:32 AM in Economics

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                                                                                                        ''We're Not Manipulating the Yuan''

                                                                                                        Ma Delun says the trade balance is not China's fault, it's just the market doing what markets do:

                                                                                                        China Central Bank's Ma Denies Manipulation of Yuan (Update1), Bloomberg: People's Bank of China Assistant Governor Ma Delun said the market is determining the yuan's exchange rate, rejecting U.S. criticism that the government keeps the currency artificially weak to spur exports. Ma said currency policy wasn't to blame for the U.S. trade deficit. ''Workers' pay in China is 1/33rd of that of a U.S. worker,'' Ma said ... ''The U.S. has to accept this global reallocation of industries.'' ... ''We're not manipulating the yuan,'' Ma said. ''The U.S. trade deficit is not caused by the yuan. It's easy to explain this to an economist, but those who don't know about finance don't understand this. They should go back to university.'' ...

                                                                                                        ''The Chinese government would never look as if it bows to international pressures in its currency reform, even if it actually does, because that would make China lose face,'' said Gao ]Shanwen], chief economist at Everbright Securities Co...

                                                                                                        ''The small appreciation is decided by the market,'' Ma said, when asked about the currency's movement since July 21. ''Market participants have different views than some outsiders.'' .... In August, [Ma] was named executive vice president of the central bank's Shanghai office, which carries out market operations under guidance from Beijing headquarters.

                                                                                                        Questioned on what his forecast for the yuan is this year, Ma responded: ''You need to ask the market.''... ''Some people may think the yuan should appreciate rapidly, but, in fact, it may not,'' the central bank's Ma said. ''It's important to let U.S. politicians understand the currency and what the currency's mechanism is,'' he said, without naming the lawmakers concerned. ... Ma described as ''all rumor'' reports that China might switch its reserves out of U.S. dollar assets. ''We're satisfied with our management of foreign currency reserves,'' he said.

                                                                                                          Posted by Mark Thoma on Friday, January 20, 2006 at 01:12 AM in China, Economics, International Finance, International Trade

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                                                                                                          Paul Krugman: The K Street Prescription

                                                                                                          Paul Krugman continues his discussion of health care reform with a look at how the influence of lobbyists corrupted the Medicare reform process:

                                                                                                          The K Street Prescription, Medicare on Drugs, by Paul Krugman, Commentary, NY Times: The new prescription drug benefit is off to a catastrophic start. Tens of thousands of older Americans have arrived at pharmacies to discover that their old drug benefits have been canceled... More than two dozen states have taken emergency action. ...

                                                                                                          [T]his was a drug bill written by and for lobbyists. Consider the career trajectories of the two men who played the most important role in ... the Medicare legislation. Thomas Scully was a hospital industry lobbyist before President Bush appointed him to run Medicare. ... Mr. Scully had good reasons not to let anything stand in the way of the drug bill. He had received a special ethics waiver from his superiors allowing him to negotiate for future jobs with lobbying and investment firms - firms that had a strong financial stake in the form of the bill - while still in public office. He left public service, if that's what it was, almost as soon as the bill was passed, and is once again a lobbyist, now for drug companies.

                                                                                                          Meanwhile, Representative Billy Tauzin, the bill's point man on Capitol Hill, quickly left Congress once the bill was passed to become president of Pharmaceutical Research and Manufacturers of America, the powerful drug industry lobby. Surely both men's decisions while in office were influenced by the desire to please their potential future employers. And that undue influence explains why the drug legislation is such a mess.

                                                                                                          The most important problem with the drug bill is that it doesn't offer direct coverage from Medicare. Instead, people must sign up with private plans offered by insurance companies. This has three bad effects. First, the elderly face wildly confusing choices. Second, costs are high, because the bill creates an extra, unnecessary layer of bureaucracy. Finally, the fragmentation into private plans prevents Medicare from using bulk purchasing to reduce drug prices. It's all bad, from the public's point of view. But it's good for insurance companies ... and it's even better for drug companies... So whose interests do you think Mr. Scully and Mr. Tauzin represented?

                                                                                                          Which brings us to the larger question of cronyism and corruption. Thanks to Jack Abramoff, the K Street project orchestrated by Tom DeLay is finally getting some serious attention in the news media. ... But most reports on the project still miss the main point by emphasizing the effect on campaign contributions. The more important effect of the K Street project is that it allows the party machine to offer lavish personal rewards to the faithful. If you're a congressman, toeing the line on legislation brings you free meals in Jack Abramoff's restaurant, invitations to his sky box, golf trips to Scotland, cushy jobs for family members and a lavish salary once you leave office. The same rewards are there for loyal members of the administration...

                                                                                                          I don't want to overstate Mr. Abramoff's role ... he doesn't seem to have been involved in the Medicare drug deal. It's interesting, though, that Scott McClellan has announced that the White House, contrary to earlier promises, won't provide any specific information about contacts between Mr. Abramoff and staff members. So I have a question for my colleagues in the news media: Why isn't the decision by the White House to stonewall on the largest corruption scandal since Warren Harding considered major news?

                                                                                                          Previous (1/15) column: Paul Krugman: First, Do More Harm Next (1/22) column: Paul Krugman: Iraq's Power Vacuum

                                                                                                            Posted by Mark Thoma on Friday, January 20, 2006 at 12:15 AM in Economics, Health Care, Politics

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                                                                                                            FedSpeak Links

                                                                                                            There have been four speeches over the last two days by Fed officials, two yesterday by Fed Governor Susan Bies, Productivity and Economic Outlook, and Richmond Fed President Jeffrey M. Lacker, The Economic Outlook for 2006. Both were discussed very briefly here.

                                                                                                            Today, there were two more speeches (Bloomberg reports Atlanta Fed president Guynn also spoke today, but I haven't found his remarks posted yet):

                                                                                                            San Francisco Fed President Yellen: 2006: A Year of Transition at the Federal Reserve

                                                                                                            Bottom line: As in the two speeches yesterday, she is comfortable with current economic conditions, but expresses concern that inflation risks are weighted towards the upside. She also says about inflation targets:

                                                                                                            I'm sympathetic to the idea of a quantitative objective for price stability, as I agree that it enhances both Fed transparency and accountability. ... I see an inflation rate between 1 and 2 percent, as measured by the core personal consumption expenditures price index, as an appropriate price stability objective for the Fed. However, I also think it is critically important that a numerical inflation objective not weaken our commitment to a dual mandate that includes full employment. Therefore, I would see the numerical objective as a long-run goal, and would want the Committee to have a flexible timeframe within which to maintain it.

                                                                                                            Dallas Fed President Fisher also spoke today:

                                                                                                            Dallas Fed President Fisher: Excerpts from Remarks on the Process of Creative Destruction

                                                                                                            Bottom line: He discusses economic transition, but does not mention U.S. policy in his posted remarks.

                                                                                                            Here's the Bloomberg report on Yellen's speech:

                                                                                                            Fed's Yellen Says Inflation Risks 'Skewed Slightly' to Upside

                                                                                                            Update: Bloomberg reports additional comments by Yellen:

                                                                                                            Federal Reserve May Be Near Ending Interest-Rate Increases, Yellen Says

                                                                                                            Update: Comments from Lacker:

                                                                                                            Lacker says Fed not done yet on raising rates

                                                                                                              Posted by Mark Thoma on Friday, January 20, 2006 at 12:06 AM in Economics, Fed Speeches, Monetary Policy

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                                                                                                              January 19, 2006

                                                                                                              Should People be "Totaled Out"?

                                                                                                              Robert Frank says using cost-benefit analysis does not make one a moral monster:

                                                                                                              Economic Scene Weighing the True Costs and Benefits in a Matter of Life and Death, by Robert Frank, Economic Scene, NY Times: Do the poor deserve life support?" asks the economist Steven E. Landsburg in an article ... in Slate this month ( The subtitle says: "A woman who couldn't pay her bills is unplugged from her ventilator and dies. Is this wrong?" Mr. Landsburg invokes "economic considerations" to suggest that the answer is "no." Many commentators have attacked his argument as morally preposterous. Well, yes. But it is also economically preposterous. ...[H]ere are some details of the case...:

                                                                                                              The patient was Tirhas Habtegiris, a 27-year-old legal immigrant being kept alive by a ventilator as she lay dying of cancer last month in the Baylor Regional Medical Center in Plano, Tex. Physicians offered no prospect for her recovery. She was hoping, however, to hang on until her East African mother could reach her bedside. Ms. Habtegiris had little money and no health insurance. On Dec. 1, hospital authorities notified her brother that unless another hospital could be found to treat his sister, Baylor would be forced to discontinue care after 10 days. But ... the family was unable to find a willing hospital. True to its word, Baylor disconnected her ventilator on Dec. 12, invoking a law signed in 1999 by George W. Bush, then governor of Texas. ...

                                                                                                              Unlike the comatose Terri Schiavo, Ms. Habtegiris was fully conscious and responsive when she was disconnected, according to her brother. She wanted to continue breathing. Her brother and several other family members have described the agonizing spectacle of her death by suffocation over the next 16 minutes. Her mother never got there. ...

                                                                                                              In Baylor's defense, Mr. Landsburg argues that Ms. Habtegiris's treatment would have failed the economist's basic cost-benefit test... The cost of care is relatively easy to calculate, but measuring its benefit is more difficult, and it is here that Mr. Landsburg stumbles. In general, ... the benefit of an action as what its beneficiaries would be willing to pay to see it taken. To place a rough upper bound on the benefit ..., Mr. Landsburg asks us to imagine that before her illness, she had been given a choice between free ventilator insurance and $75 in cash (his ... estimate of the cost of providing ... such insurance). He assumes, plausibly, that she would have chosen the cash. The implication, he believes, is that the benefit of extending Ms. Habtegiris's care must be less than its cost.

                                                                                                              He is mistaken for multiple reasons. For one thing, he ignores the economically compelling reasons for having social safety nets... [C]atastrophe is only one unlucky break away. One might lose one's job and be unable to afford health insurance, for example, or be stranded by a mountain blizzard and unable to afford a helicopter rescue. With such prospects in mind, most people favor collectively financed rescue efforts. That a poor person would not, or could not, buy private insurance against such contingencies is entirely beside the point.

                                                                                                              Even more troubling, Mr. Landsburg completely ignores moral emotions like sympathy and empathy. As economists since Adam Smith have recognized, economic judgments are often tempered by these emotions. ... Had the opportunity presented itself, many would have eagerly contributed to Ms. Habtegiris's care. But organizing an endless series of individual private fund-raisers for such cases is impractical. So, we empower government to step in when the need arises.

                                                                                                              Mr. Landsburg's argument finesses the important distinction between a "statistical life" and an "identified life." The concepts were introduced by the economist Thomas C. Schelling, who observed the apparent paradox that communities often spend millions of dollars to save the life of a known victim - someone trapped in a mine, for example - yet are often unwilling to spend even $200,000 on a highway guardrail that would save an average of one life each year. This disparity is not economically irrational, Mr. Schelling insisted, because the community values what it is buying so differently in the two cases. It is one thing to risk one's own life in an unlikely automobile accident, but quite another to abandon a known victim in distress.

                                                                                                              By offering a transparently unsound economic argument in defense of the Habtegiris decision, Mr. Landsburg unwittingly empowers those who wrongly insist that costs and benefits have no legitimate role in policy decisions about health and safety. Reducing the small risks we face every day is expensive. The same money could be spent instead on other pressing needs. We cannot think intelligently about these decisions without weighing the relevant costs and benefits. But using cost-benefit analysis does not make one a moral monster. In the wealthiest nation on earth, a genuine cost-benefit test would never dictate unplugging a fully conscious, responsive patient from life support against her objections. Mr. Landsburg's argument to the contrary is wrongheaded, not just morally, but also economically.

                                                                                                                Posted by Mark Thoma on Thursday, January 19, 2006 at 12:29 AM in Economics, Health Care

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                                                                                                                New Support for Friedman's Plucking Model

                                                                                                                Milton Friedman's "plucking model" is an interesting alternative to the natural rate of output view of the world. The typical view of business cycles is one where the economy varies around a trend value (the trend can vary over time also). Milton Friedman has a different story. In Friedman's model, output moves along a ceiling value, the full employment value, and is occasionally plucked downward through a negative demand shock. Quoting from the article below:

                                                                                                                In 1964, Milton Friedman first suggested his “plucking model” (reprinted in 1969; revisited in 1993) as an asymmetric alternative to the self-generating, symmetric cyclical process often used to explain contractions and subsequent revivals. Friedman describes the plucking model of output as a string attached to a tilted, irregular board. When the string follows along the board it is at the ceiling of maximum feasible output, but the string is occasionally plucked down by a cyclical contraction.

                                                                                                                Friedman found evidence for the Plucking Model of aggregate fluctuations in a 1993 paper in Economic Inquiry. One reason I've always liked this paper is that Friedman first wrote it in 1964. He then waited for almost twenty years for new data to arrive and retested his model using only the new data. In macroeconomics, we often encounter a problem in testing theoretical models. We know what the data look like and what facts need to be explained by our models. Is it sensible to build a model to fit the data and then use that data to test it to see if it fits? Of course the model will fit the data, it was built to do so. Friedman avoided that problem since he had no way of knowing if the next twenty years of data would fit the model or not. It did. I was at an SF Fed Conference when he gave the 1993 paper and it was a fun and convincing presentation. Here's a recent paper on this topic that supports the plucking framework (thanks Paul):

                                                                                                                Asymmetry in the Business Cycle: New Support for Friedman's Plucking Model, Tara M. Sinclair, George Washington University, December 16, 2005, SSRN: Abstract This paper presents an asymmetric correlated unobserved components model of US GDP. The asymmetry is captured using a version of Friedman's plucking model that suggests that output may be occasionally "plucked" away from a ceiling of maximum feasible output by temporary asymmetric shocks. The estimates suggest that US GDP can be usefully decomposed into a permanent component, a symmetric transitory component, and an additional occasional asymmetric transitory shock. The innovations to the permanent component and the symmetric transitory component are found to be significantly negatively correlated, but the occasional asymmetric transitory shock appears to be uncorrelated with the permanent and symmetric transitory innovations. These results are robust to including a structural break to capture the productivity slowdown of 1973 and to changes in the time frame under analysis. The results suggest that both permanent movements and occasional exogenous asymmetric transitory shocks are important for explaining post-war recessions in the US.

                                                                                                                Let me try, within my limited artistic ability, to illustrate further. If you haven't seen a plucking model, here's a graph to illustrate (see Piger and Morley and Kim and Nelson for evidence supporting the plucking model and figures illustrating the plucking and natural rate characterizations of the data). The "plucks" are the deviations of the red line from blue line representing the ceiling/trend:

                                                                                                                Notice that the size of the downturn from the ceiling from ab (due to the "pluck") is predictive of the size of the upturn from bc that follows taking account of the slope of the trend. I didn't show it, but in this model the size of the boom, the movement from bc, does not predict the size of the subsequent contraction. This is the evidence that Friedman originally used to support the plucking model. In a natural rate model, there is no reason to expect such a correlation. Here's an example natural rate model:

                                                                                                                Here, the size of the downturn ab does not predict the size of the subsequent boom bc. Friedman found the size of ab predicts bc supporting the plucking model over the natural rate model.

                                                                                                                  Posted by Mark Thoma on Thursday, January 19, 2006 at 12:18 AM in Academic Papers, Economics, Macroeconomics

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                                                                                                                  Will Recent Trends Toward Increasing Inequality Persist?

                                                                                                                  David Wessel of the WSJ takes a look at inequality:

                                                                                                                  Is Inequality Over Wages Worsening?, Capital, by David Wesel, WSJ (Free Link): A distinguishing feature of the U.S. economy of the past quarter-century is a sharp increase in economic inequality. No matter how you slice the data, very well-paid folks have done better than the rest. But what changed the U.S. economy around 1980? Do those forces persist? Can or should government resist? Is computer technology the culprit? Is better education the answer? Start with a couple of facts:

                                                                                                                  About 11% of income (and that's not counting capital gains) went to the best-off ½% of Americans in 2002; 25 years earlier, they got 5.25%, according to ... Berkeley economist Emmanuel Saez. Workers at the 90th percentile ... earned 4.5 times as much as those in the 10th percentile in 2004; 25 years earlier, they were earning 3.5 times as much, according to ... Harvard economist Lawrence Katz. ...Although economic growth in the past few years has been robust and productivity has surged, wages of typical workers in the middle aren't rising. Where's the money going?

                                                                                                                  The big story isn't that capital and profits are squeezing labor and wages, say Northwestern University economists Robert Gordon and Ian Dew-Becker. Labor's share has been shrinking ..., but its slice of the pie hasn't changed much in the past 20 years. ... For the past 40 years, they conclude, "only the top 10% of the income distribution enjoyed a growth rate of real ... income ... above the average rate of economy-wide productivity growth."

                                                                                                                  There's more than one puzzle here. One is at the very top, where CEOs, rap stars and ballplayers work. Why do team owners and companies pay so much? ...[S]uperstars make more than ever because, as a result of technology and globalization, they play on a larger stage, and the value of employing No. 1 or No. 2, instead of No. 25 or No. 30, has soared.

                                                                                                                  But few Americans are in that economic stratosphere. Roughly 90% of full-time workers earn less than $90,000 a year. What about them? In the 1980s, wages of $90,000-a-year workers ... pulled away from workers at the middle, and wages of those in the middle pulled away from workers at the bottom. The consensus diagnosis: Computer technology changed the workplace and made employers prize and pay more for skill and education.

                                                                                                                  The 1990s were different. Nearly all workers did better than they did in the 1980s -- even those at the bottom... And inequality wasn't as simple to diagnose. The $90,000-a-year crowd continued to do better than men and women in the middle, but the gap between the middle and the bottom didn't keep widening. Looking at all that, the best minds in labor economics differ on whether the 1990s and early 2000s are best seen as a continuation of the 1980s inequality trend (Harvard's Mr. Katz) or an end to it (Berkeley's David Card.) ...

                                                                                                                  Mr. Card and like-minded scholars say: The ... widening of inequality in the 1980s reflected a one-time change in attitudes and rules, and isn't going to get wider. ... If their analysis is right, the only way to restrain inequality is to tamper with the market by raising the minimum wage or lifting taxes at the top (which isn't to say all these scholars advocate either).

                                                                                                                  Mr. Katz and his crowd counter ... In the 1980s, technology whacked ... those at the bottom whose jobs were easily automated or shipped overseas. And it helped those who leveraged computers to be more productive. In the 1990s, ... those whose work was made more valuable by computers saw wages and job prospects grow. But the same goes for many low-wage workers who work for those at the top -- janitors, waiters, gardeners, home-health aides and massage therapists. The losers are in the middle, those ... threatened by the increasing sophistication of computers and workers overseas. If these scholars are right, then the answer is to restructure American schools so they prepare workers for jobs for which technology is either a wage booster or irrelevant ...

                                                                                                                    Posted by Mark Thoma on Thursday, January 19, 2006 at 12:12 AM in Economics, Income Distribution

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                                                                                                                    Fed Links

                                                                                                                    There were two speeches today by Fed officials. First, there was a speech by Fed Governor Susan Bies:

                                                                                                                    Productivity and Economic Outlook

                                                                                                                    Bottom line: Likes current situation, but worried about capacity and resource constraints driving up input prices and causing in inflationary pressure.

                                                                                                                    There was also a speech by Richmond Fed President Jeffrey M. Lacker:

                                                                                                                    The Economic Outlook for 2006

                                                                                                                    Bottom line: Likes current situation, but not sure that the pass-through risk from high energy prices to core inflation is over. One more rate hike, then assess incoming data to see where to go next.

                                                                                                                    Here's the Bloomberg write-up of the speeches:

                                                                                                                    Fed Officials See Inflation Risks From Oil, Rising Factory Use

                                                                                                                    And also from Bloomberg, Gene Sperling assesses Greenspan's record. He has quarrels with particular episodes such as the 2001 tax cut, but overall sees Greenspan's record in a positive light:

                                                                                                                    Time to Judge the Whole Record of Alan Greenspan

                                                                                                                    Update: Speeches by Yellen and Fisher

                                                                                                                      Posted by Mark Thoma on Thursday, January 19, 2006 at 12:06 AM in Economics, Fed Speeches, Monetary Policy

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                                                                                                                      January 18, 2006

                                                                                                                      Money Can't Buy Me Love

                                                                                                                      Andrew Oswald from the University of Warwick says there's plenty of evidence that economic growth and prosperity doesn't make us any happier:

                                                                                                                      The hippies were right all along about happiness, by Andrew Oswald, Financial Times: Politicians mistakenly believe that economic growth makes a nation happier. ... because they were taught to do so. But today there is much statistical and laboratory evidence in favour of a heresy: once a country has filled its larders there is no point in that nation becoming richer. The hippies, the Greens, the road protesters, the downshifters, the slow-food movement – all are having their quiet revenge. Routinely derided, the ideas of these down-to-earth philosophers are being confirmed by new statistical work by psychologists and economists.

                                                                                                                      First, surveys show that the industrialised nations have not become happier over time. ... UK citizens today report the same degree of psychological well-being and satisfaction with their lives as did their (poorer) parents and grandparents. In the US, happiness has fallen over time. White American females are markedly less happy than were their mothers. Second, using more formal measures of mental health, rates of depression in countries such as the UK have increased. Third, measured levels of stress at work have gone up. Fourth, ... In the US, even though real income levels have risen six­fold, the per-capita ­suicide rate is the same as in the year 1900. In the UK, ... the suicide rate has fallen in the last century, although among young men it is far greater than decades ago. Fifth, global warming means that growth has long-term consequences few could have imagined in their undergraduate tutorials.

                                                                                                                      None of these points is immune from counter-argument. But ... [s]ome of the world’s most innovative academics have come up with strong evidence about why growth does not work. One reason is that humans are creatures of comparison. ... happiness levels depend inversely on the earnings levels of a person’s neighbours. Prosperity next door makes you dissatisfied. It is relative income that matters: when everyone in a society gets wealthier, average well-being stays the same.

                                                                                                                      A further reason is habituation. Experiences wear off. ... Some researchers believe that after a pay rise people get used to greater income and eventually return to their original happy or unhappy state. Such hedonic flexibility also works downwards. Those who become disabled recover 80 per cent of their happiness by three years after an accident. ... A final reason is that human beings are bad at forecasting what will make them happy. In laboratory settings, people systematically choose the wrong things for themselves. ...

                                                                                                                      Economists’ faith in the value of growth is diminishing. That is a good thing... Happiness, not economic growth, ought to be the next and more sensible target for the next and more sensible generation.

                                                                                                                        Posted by Mark Thoma on Wednesday, January 18, 2006 at 02:43 PM in Economics

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                                                                                                                        China's Growing Pains

                                                                                                                        Macroblog notes a few of China's growing problems:

                                                                                                                        Macroblog, by David Altig, Growing Pains: Amid stories that the Chinese economy is showing few signs of slowing down...

                                                                                                                        China's tax chief said on Tuesday the economy had grown by 9.8 percent in 2005, but comments by a senior commerce ministry official and analysts suggested the pace of expansion could slow this year, if only slightly...

                                                                                                                        That would make 2005 the third consecutive year in which China's economy had grown by around 10 percent. The economy expanded by 10.1 percent in 2004 and 10.0 percent in 2003.

                                                                                                                        ... and that China's accumulation of foreign reserves barrels on...

                                                                                                                        News that China's foreign exchange reserves rose sharply in the final quarter of 2005 and are on course to overtake those of Japan as the largest in the world by the end of 2006, caused a predictable ripple of excitement in the currency market on Monday.

                                                                                                                        The knee-jerk reaction was that the continuing growth in Chinese reserves, which rose by a further $50bn to $819bn in the last quarter, would maintain pressure on the Chinese authorities to allow faster appreciation of the renminbi, thereby reducing the need to intervene in the currency market, building up yet more reserves in the process...

                                                                                                                        Julian Jessop, economist at Capital Economics, argued that reserve growth is actually slowing, with the increase in each of the past four months lower than that in the same month a year earlier as hot money inflows have "slowed sharply".

                                                                                                                        But Stephen Jen, global head of currency research at Morgan Stanley, swam against the tide, claiming China's reserves are now so large that this could be the "year of the renminbi".

                                                                                                                        ... comes this news, from the Wall Street Journal (subscription required):

                                                                                                                        The second violent protest reported in China's Guangdong province within weeks is sparking concern among some investors based in the country's manufacturing heart.

                                                                                                                        A protest near the city of Zhongshan in southern China turned violent over the weekend after police moved in to clear away demonstrators, local residents and officials said yesterday. The protesters had blocked a main road to demand more compensation for land taken from them to build a factory...

                                                                                                                        Protests have grown increasingly common in China, a side effect of economic restructuring that has improved the fortunes of many Chinese but left others disgruntled over a widening wealth gap. The weekend's protest follows another violent episode last month in Guangdong, which borders the financial hub of Hong Kong and is one of China's wealthiest provinces. Local officials said three people were killed in that incident, but some villagers said the number of dead was higher.

                                                                                                                        So far, the growing number of large-scale, violent protests across the country hasn't directly hit operations of most foreign and Chinese investors. But some are starting to express concern over growing social unrest...

                                                                                                                        A manager at Foxconn, a unit of Taiwan-based Hon Hai Precision Industry Co., said that while the company hasn't felt any impact from protests or other social unrest in the area so far, he was concerned about the possibility. "If there is a problem with social order, it would, of course, affect our investment," he said. Hong Hai Precision is a prominent computer peripherals company and one of China's biggest exporters.

                                                                                                                        Other businesses in the area said the protest caused road blockages that did impede work. Road closures could "make some trouble for our customers visiting our company," said a salesman of Mingkang Packaging Machinery Factory in nearby Sanjiao Township, who identified himself only by his surname, Yang.

                                                                                                                        In the China Daily article on Chinese economic growth linked above, Vice Minister of Commerce Yi Xiaozhun was quoted as saying "we will not see a relaxed year for 2006." He was talking about pressures on export demand from potential yuan appreciation, but the applicability of that sentiment may be much broader than Mr. Yi intended.

                                                                                                                          Posted by Mark Thoma on Wednesday, January 18, 2006 at 06:54 AM in China, Economics

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                                                                                                                          Household Debt Payments and Unemployment

                                                                                                                          Here is a graph of household debt service payments as a percent of disposable personal income from 1980Q1-2005Q3, the latest period for which consistent data exist (total financial obligations show a similar pattern):

                                                                                                                          I wanted to see how the debt load related to economic downturns, so the shaded areas are NBER dated recessions. It's hard to see a strong association between the recessions and changes in debt. The next graph plots the same series along with the negative of the unemployment rate. The association appears much stronger:

                                                                                                                          To see if regression confirms the association, I ran OLS on

                                                                                                                          %Debtt = β0 + β1%Debtt-1 + β2%Debtt-2 + β3UNt + et

                                                                                                                          and it does (debt data described here). The coefficient on UN is significant at the 5% level:

                                                                                                                               Linear Regression - Estimation by Least Squares      Dep Var PERCENTDEBT      Quarterly Data:  1980:03 To 2005:03      Usable Observations             101      Degrees of Freedom               97      Durbin-Watson Statistic    2.014351       Variable        Coeff          T-Stat     Signif      ***************************************************         β0        0.468304856      1.49629   0.13782438         β1        1.125298228     11.06370   0.00000000         β2       -0.150035410     -1.48249   0.14145135         β3       -0.024721984     -2.01484   0.04668936

                                                                                                                          As you interpret the second graph, remember that it's the negative of the unemployment rate. Thus, when the blue line is rising, unemployment is falling. In the regression results the actual unemployment rate, not the negative of it, is used. This is a fairly broad brush and it may hide detail such as differences by income class, and omitted variables are a concern, but in general these data and this model suggest unemployment and the debt percentage are negatively related.

                                                                                                                            Posted by Mark Thoma on Wednesday, January 18, 2006 at 12:01 AM in Economics, Unemployment

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                                                                                                                            January 17, 2006

                                                                                                                            Vested Interests and Economic Development

                                                                                                                            Martin Wolf summarizes The Power of Productivity: Wealth, Poverty and the Threat to Global Stability by William Lewis. He makes a good point about developing economies. For capitalism to live up to its promises, the assumptions behind those promises must be satisfied. If competition is suppressed by special interests, then development will be thwarted:

                                                                                                                            Overthrowing the tyranny of vested interests, by Martin Wolf, Commentary, Financial Times: Why are some countries rich and many others so poor? Why has it proved so difficult for those mired in poverty to catch up with the prosperous? These are the most important questions in economics. Adam Smith addressed them. Many have followed in his footsteps. Few, however, have recently done so with more insight than William Lewis, founding director of the McKinsey Global Institute. His answer would have pleased the author of The Wealth of Nations: remorseless, pervasive, fair and open competition. ...

                                                                                                                            Investors are ... desperately seeking opportunities for profitable investment across the globe. Yet they cannot find them in many countries where existing producers are grotesquely inefficient. How can this be? The answer is that the people with power – incumbent businesses, corrupt bureaucrats and politicians, possessors of sinecures, protected workers in formal employment and beneficiaries of government subsidies – combine to oppose the competition that would force uncomfortable economic changes. Anti-market intellectuals also laud this recalcitrance. The result is a pervasive bias against competition.

                                                                                                                            Mr Lewis and his colleagues were able to demonstrate the significance of competition ... by ... linking microeconomics to the overall macroeconomic outcomes ... So, what are the chief conclusions? First, ... the development effort of the last half-century has largely failed. Second, two and only two successful routes to development have been discovered: the high productivity, low input-intensity path of the US and the low productivity, high input-intensity path of Japan and South Korea (see chart)...

                                                                                                                            Third, huge numbers of workers produce services or work in construction, even in developing countries. Thus, the productivity of these industries plays a big part in determining overall output per person. ... Fourth, neither education or lack of capital is a binding constraint on productivity. Illiterate Mexican workers reach world-class productivity levels in building houses in Houston. Similarly, Toyota has succeeded in raising productivity to close to Japanese levels in its plants around the world. ... Finally, undistorted competition in product markets is the most important long-run determinant of productivity and so prosperity. Competition is how the more productive companies win out. ...

                                                                                                                            It is in developing countries ... that competition is most systematically thwarted. Just read the chapters on Brazil, Russia and India and weep. In many developing countries ... legitimate companies compete with businesses that pay no taxes, ignore regulations and steal intellectual property. ... Big government, which is also almost always interfering and corrupt in poor countries, is a curse.

                                                                                                                            What is to be done? ... Policymakers need to understand that the aim of policy must not be to nurture specific producers, but to promote the interests of consumers and, so, competition. Openness to the world economy matters most for this reason. International competition explains, for example, why the export sectors of Japan and South Korea are so productive, while the rest of their economies are not.

                                                                                                                            Unfortunately, what is required is also a revolt against the conspiracy of predatory vested interests. Almost everybody would be better off, and quite quickly, if these interests could be disarmed simultaneously. But this is always hard to achieve. In a democracy with well-entrenched interest-group politics, it is almost impossible. ...

                                                                                                                            Free and fair competition sounds simple to achieve. Nothing is further from the truth: competition upsets intellectuals who glory in the notion of state benevolence, bureaucrats who administer government programmes, businesses that receive state favours and, in short, all those who gain, directly or indirectly, from distortions. Competition benefits often-despised outsiders against those who are well-connected and entrenched. It also requires the courts and government to work honestly. The surprise may rather be that some countries became rich than that so many are poor. ...

                                                                                                                            There is a debate about market-based versus directed paths to development that can wait for another day. With the focus on distribution lately in the U.S. and questions about why worker income has stalled in this recovery, this quote caught my eye: "distorting competition ... is a damaging route to cherished distributional goals." The article is intended as a guide for developing countries, but it applies to developed economies too. It is not just any market, it is competitive markets that produce the desired gains and reward factors of production according to their productivity. Those who promote markets above all else sometimes forget that not all markets have this feature.

                                                                                                                            With globalization, has there been a net shift in market power away from workers and towards owners of capital that might explain some of the shift in the income distribution in recent years? Is the shift in power reflected in tax and other recent legislation? I'm not sure how much of the change in income distribution shifts in market power can explain, but it's something to think about.

                                                                                                                              Posted by Mark Thoma on Tuesday, January 17, 2006 at 06:33 PM in Economics, Market Failure

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                                                                                                                              It's an Option

                                                                                                                              I'm not sure how to price the value of this option precisely, I suppose I could give Black-Scholes a try, but I'm glad I have it:

                                                                                                                                Posted by Mark Thoma on Tuesday, January 17, 2006 at 09:14 AM in Economics, Health Care, Oregon, Politics, Regulation

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                                                                                                                                Robert Solow: An Economy That Doesn't Distribute Gains Widely is ''Poorly Performing''

                                                                                                                                Bloomberg says there is friction between the administration and the Fed over how far unemployment can be reduced without creating inflation, and Robert Solow says the unusually small share of income going to workers during the recovery indicates an economy that is not performing optimally:

                                                                                                                                Bush's Expansion Leaves Workers Behind, Sparking Fed Friction, Bloomberg: American workers have rarely taken home a smaller share of the nation's prosperity, a condition that is undermining bipartisan support for free trade and creating friction between President George W. Bush's administration and the Federal Reserve. After 16 consecutive quarters of economic growth, pay is rising at a slower rate than in any similar expansion since the end of World War II. ...

                                                                                                                                Such a disparity, partly the result of globalization of the labor market, helps explain why the Bush administration is struggling to muster support for lower trade barriers even with the jobless rate at a four-year low. The imbalance has also triggered a debate between Bush's Treasury Department and the Fed about how low unemployment can go without kindling inflation.

                                                                                                                                ''There is no doubt that something is happening'' to reduce labor's share of income, says Robert Solow, a Nobel Prize- winning economist ... An economy that doesn't distribute its gains widely is ''poorly performing,'' he says.

                                                                                                                                From the final quarter of 2001 through last year's third quarter, total compensation paid to employees ... rose at a 4.3 percent average annual rate... That's the slowest growth for any similar period in post-war expansions lasting at least four years. ... Treasury Secretary John Snow said Jan. 6 that wage growth will pick up. ''We are at that tipping point where labor's share of national income will be rising,'' he said. That may require further declines in the unemployment rate, something the Fed is likely to resist... as an inflation risk. ...

                                                                                                                                Treasury officials object to that idea. ''Nobody knows what the full employment, non-inflationary number is,'' Snow said after the government published a 4.9 percent unemployment rate for December. ''I'm confident it's considerably lower. We have room to bring it down.'' ...

                                                                                                                                This is not an explicit dispute as far as I'm aware, at least from the Fed's point of view, but in any case I'm glad the Fed is independent.

                                                                                                                                  Posted by Mark Thoma on Tuesday, January 17, 2006 at 01:35 AM in Economics, Inflation, Monetary Policy, Unemployment

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                                                                                                                                  John M. Berry Says Administration, Congress Lack the Courage to Fix Entitlements

                                                                                                                                  Bloomberg's John M. Berry is a more pessimistic about the fiscal problems from entitlement spending in the years ahead than the authors of the article discussed here. He says the only hope of dealing with the nation's long-term fiscal challenges is to appoint a bi-partisan commission to study the problem and recommend solutions both sides can accept, solutions that will involve both increases in taxes and cuts in spending:

                                                                                                                                  Bush, Congress Lack Courage to Fix Entitlements, John M. Berry, Bloomberg: -- The irony was stark. On Jan. 1, the new Medicare drug program began. It is the most costly addition to federal entitlements in decades and was enacted with full backing by President George W. Bush. Then on Jan. 6, Bush issued another call for spending restraint to slow the growth of entitlements.

                                                                                                                                  Where are we on the costs of entitlements? The estimated cost of the drug program is almost three- quarters of a trillion dollars over the next 10 years. ... And the unfunded liability associated with the Medicare drug program is at least twice as large as that for Social Security, which is about $11 trillion, according to administration estimates. ...

                                                                                                                                  This yawning gap between budget rhetoric and reality is only going to get worse in coming weeks as Bush and administration officials try in advance to put the right spin on the fiscal 2007 budget ... There is going to be a lot of talk about how tough the 2007 budget is, how many programs are going to be cut or eliminated. The budget ''is going to call for sacrifices, no doubt about it,'' Treasury Secretary John Snow told reporters. ''The growth rate of things will be slowed. There will be some outright reductions.''

                                                                                                                                  In the meantime, the fiscal 2006 budget deficit is soaring as a result of spending on hurricane relief, Afghanistan and Iraq and other programs. The administration said ... that the deficit is likely to top $400 billion, up from $319 billion last year. Any spending reductions in the 2007 budget are sure to be small ones... There are already leaks about proposed cuts in Medicare, NASA and agriculture. In this election year the chances of significant reductions are close to zero.

                                                                                                                                  Most of all, Bush has no plans to do what he himself said in his speech is necessary: tackle the long-term budget implications of soaring health-care costs. The unfunded liability for Social Security is small enough that it could be dealt with using relatively small changes in benefits and taxes. Instead of dealing with entitlements, Bush continues to push for extending a number of expiring income tax breaks ...

                                                                                                                                  In his speech, Bush said of the unfunded liabilities, ''We can solve this problem, it just takes political will, political courage.'' Indeed, unfortunately will and courage in this regard are singularly lacking both in the White House and on Capitol Hill. ... For all practical purposes, time has run out for the Bush administration to lay the groundwork for dealing with the nation's long-term fiscal challenges. Because of the magnitude of the changes needed in both spending and taxes, any plan will have to have true bipartisan support.

                                                                                                                                  Probably the place to start is to create a bipartisan commission to study the complex issues and make recommendations. That means bipartisan in the sense that members would be appointed, in the current context, by a Republican president and the Democratic congressional leaders. And the commission's writs should run to dealing with the problem, not to come to some preconceived conclusion.

                                                                                                                                  That sort of approach worked in the early 1980s when Social Security literally was about to be unable to write monthly benefit checks. President Ronald Reagan appointed Alan Greenspan to head the commission and named several other members. Congressional Democrats named the rest. And when a plan was proposed, it had built-in bipartisan backing.

                                                                                                                                  In contrast, when Bush created commissions to study Social Security and tax reform, he appointed all the members and laid out some of the things they could and couldn't include in their recommendations. Bush isn't about to create such a commission at this late point in his presidency. He hasn't even been able to bring himself to veto a single piece of legislation, even appropriation bills that have been many billions of dollars more than he had requested or said he would accept.

                                                                                                                                  Furthermore, he and administration officials have worked hand in glove with members of Congress to understate the true amount of revenue likely to be lost through some tax cuts and to understate the cost of new programs such as the Medicare drug benefit. ... One can only hope that Bush's successor, whether Republican or Democrat, will tackle the problem. The alternative eventually would be a federal debt spiraling out of control.

                                                                                                                                    Posted by Mark Thoma on Tuesday, January 17, 2006 at 12:57 AM in Budget Deficit, Economics, Health Care, Social Security

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                                                                                                                                    Portraits of Famous Historical Economists

                                                                                                                                    From The Warren J. Samuels Portrait Collection at Duke:

                                                                                                                                    Jean-Baptiste Say

                                                                                                                                    Thomas Robert Malthus

                                                                                                                                    Nassau William Senior

                                                                                                                                    John Stuart Mill

                                                                                                                                    David Ricardo

                                                                                                                                    Jeremy Bentham

                                                                                                                                    Adam Smith

                                                                                                                                      Posted by Mark Thoma on Tuesday, January 17, 2006 at 12:09 AM in Economics

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                                                                                                                                      January 16, 2006

                                                                                                                                      Demography Is Not Destiny

                                                                                                                                      In the debate over Social Security and health care reform we often hear about how many workers per retiree there will be in the future as compared to the past. Paul Krugman summarizes:

                                                                                                                                      How big is the demographic challenge? Pundits who want to sound serious love to contrast Social Security as it was in 1950, when sixteen workers were paying in for every retiree drawing benefits, with Social Security as it will be once the baby boomers have retired, with only two workers per retiree. But most of the transition from sixteen to two happened a long time ago. Since the mid-1970s there have been about three workers per retiree —and Social Security has been running a surplus. The real issue is what happens when three goes to two. How big a problem is that?

                                                                                                                                      How did we go from sixteen workers per retiree to three workers without disaster? Will going from three to two in the future be a budget breaker? Here's one view:

                                                                                                                                      FromHold off on the boom-and-doom talk, by Julie Kosterlitz and Marilyn Werber Serafini, Los Angeles Times: For many budget experts, 2006 brings with it a prominent milestone on the road to fiscal doom. This month, the first of the baby boomers ... will turn 60. That leaves a mere two years before they are eligible to start collecting Social Security, and just five years before they can flash their Medicare cards in the doctor's office...

                                                                                                                                      But the graying of America may not be the fiscal disaster that the deficit hawks project. The nation may age a good deal more gracefully than advertised, thanks to American ingenuity, adaptability and an increasingly hardy group of elderly, say a diverse group of demographers and public policy experts. The nation has continued to prosper despite a doubling in the share of the nation's elderly population since 1960, said Robert Friedland, director of Georgetown University's Center on an Aging Society. Thanks to leaps in worker productivity, the nation's income has nearly quadrupled during the same time period.

                                                                                                                                      Friedland, coauthor of the 2005 study "Demography Is Not Destiny, Revisited," argues that the straight-line projections of the budget experts paint too dour a picture because of their conservative assumptions about many variables, including economic growth. He also contends that the projections are being misused by conservative advocates of small government to advance their ideological agenda. "I don't want people to get away with the notion that it is simply the number of people" that dictates our future, he says.

                                                                                                                                      Hand-wringing scenarios tend to ignore the myriad ways in which people, technology and political processes respond to changed circumstances. For starters, baby boomers are likely to work longer than preceding cohorts. A decades-long trend toward earlier exit from the workforce appears to have ended... When age-related ailments do stop people from working, new technologies, medical advances and innovative living arrangements could allow baby boomers to live independently longer — potentially avoiding the projected explosion of nursing home costs. The AARP's John Rother ... was optimistic about the health front. "By 2030, I have to believe that Alzheimer's is no longer a threat and neither are urinary incontinence and osteoarthritis. Take these three away, and the nursing homes will be empty."

                                                                                                                                      In the end, the nation will likely avoid the scariest budget scenarios and adjust to its new, grayer population in fits and starts. "We'll ... adapt," said Robert Reischauer, president of the Urban Institute and a former head of the Congressional Budget Office. "...[T]he 'Chicken Little' view of history isn't correct. Changes take place gradually, and people and institutions adapt."

                                                                                                                                        Posted by Mark Thoma on Monday, January 16, 2006 at 05:55 PM in Economics, Health Care, Social Security

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                                                                                                                                        Paul Krugman: First, Do More Harm

                                                                                                                                        Paul Krugman continues his series on health care reform. This column focuses on diabetes to illustrate some of the bad incentives built into our current health care system and the administration's health care reform proposals:

                                                                                                                                        First, Do More Harm, by Paul Krugman, Commentary, NY Times: It's widely expected that President Bush will talk a lot about health care in his State of the Union address. He ... probably will tout proposals for so-called "consumer driven" health care. So it's important to realize that the administration's idea of health care reform is to take what's wrong with our system and make it worse. Consider ... the rising tide of diabetes. Diabetes is a horrifying disease. It's also an important factor in soaring medical costs. ... And the problem of dealing with diabetes is a clear illustration of the real issues in health care.

                                                                                                                                        Here's what we should be doing: since the rise in diabetes is closely linked to the rise in obesity, we should be getting Americans to lose weight and exercise more. We should also support disease management: people with diabetes have a much better quality of life and place much less burden on society if they can be induced to monitor their blood sugar carefully and control their diet.

                                                                                                                                        But ... the U.S. system of paying for health care doesn't let medical professionals do the right thing. There's hardly any money for prevention... And even disease management gets severely shortchanged. ... insurance companies "will often refuse to pay $150 for a diabetic to see a podiatrist, who can help prevent foot ailments associated with the disease. Nearly all of them, though, cover amputations, which typically cost more than $30,000." ... The point is that we can't deal with the diabetes epidemic in part because insurance companies don't pay for preventive medicine or disease management...

                                                                                                                                        Which brings us to the Bush administration's notion of health care reform. The administration's principles ... were laid out in the 2004 Economic Report of the President. The first and most important of these principles is ... insurance policies - "that focus on large expenditures that are truly the result of unforeseen circumstances," as opposed to small or predictable costs. ...

                                                                                                                                        The ... administration is saying that we need to make sure that insurance companies pay only for things like $30,000 amputations, that they don't pay for $150 visits to podiatrists that might have averted the need for amputation. To encourage insurance companies not to pay for podiatrists, the administration has turned to its favorite tool: tax breaks. The 2003 Medicare bill ... allowed people who buy high-deductible health insurance policies - policies that cover only extreme expenses - to deposit money, tax-free, into health savings accounts that can be used to pay medical bills. Since then the administration has floated proposals to make the tax breaks bigger and wider...

                                                                                                                                        Critics of health savings accounts have mostly focused on two features of the accounts Mr. Bush won't mention. First, such accounts mainly benefit people with high incomes. Second, they encourage wealthy corporate employees to opt out of company health plans, further undermining the already fraying system of employment-based health insurance.

                                                                                                                                        But the case of diabetes and other evidence suggest ... a third problem with health savings accounts ... in practice, people who are forced to pay for medical care out of pocket don't have the ability to make good decisions about what care to purchase. ... The bottom line is that what the Bush administration calls reform is actually the opposite. Driven by an ideology at odds with reality, the administration wants to accentuate, not fix, what's wrong with America's health care system.

                                                                                                                                        Previous (1/2) column: Paul Krugman: No Bubble Trouble? Next (1/19) column: Paul Krugman: The K Street Prescription

                                                                                                                                          Posted by Mark Thoma on Monday, January 16, 2006 at 12:21 AM in Economics, Health Care

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                                                                                                                                          IT and the British National Health Service

                                                                                                                                          The British National Health Service is implementing an information technology program that is the largest civic project in the world according to the article below. The goal is to have digital records and systems for all aspects of patient care such as booking, prescriptions, and medical records. While expensive, the promised savings are even larger.

                                                                                                                                          This is the type of project that has the potential to increase health care efficiency substantially and to hold down costs, but due to information technology system coordination and other issues, is difficult to bring about in the U.S. through the private sector alone. The U.S. has very advanced information systems in individual hospitals, but not between hospitals or between hospitals and other health care providers such as pharmacies. Hopefully, ideology will not get in the way of the U.S. government taking a leadership role and pushing beyond current roadblocks to its 10-year program to produce electronic patient records, and to broaden the effort to allow all segments of the health care provision network to communicate effectively:

                                                                                                                                          World’s biggest civil technology project comes alive, by Nicholas Timmins, Public Policy Editor, Financial Times: Robin Kantor, a consultant radiologist at Hillingdon Hospital on the western outskirts of London, clicks on a mouse – and offers a glimpse into the future of healthcare across the country. Alongside him, on two costly flat screens, before-and-after scans of the head of a woman who has been treated for a brain tumour pop into view. Another mouse click and the two Pictures are locked together side by side. Dr Kantor scrolls them down in parallel. Even a layman can see how far the tumour has regressed. ...

                                                                                                                                          In truth, there is nothing very special about what he is doing. Thousands of radiologists in some 1,500 hospitals around the world have digital systems ... although not all are as modern as the one just installed at Hillingdon. The significance lies in it being part of the British National Health Service’s £6.2bn ($11bn) information technology programme, which is the biggest civil IT project in the world.

                                                                                                                                          The goal, over a decade, is to provide 50m patients in England with an electronic care record – along with the ability to book hospital appointments on the day and online, with electronic transfer of everything from prescriptions to digital images and entire medical records as well as, in time, allowing patients access via their own internet “health space”.

                                                                                                                                          Taking full advantage of the potential that IT offers has finally – many would say belatedly – become the next big thing in health. In the US, President ... Bush has announced a 10-year programme to produce electronic patient records, although the most basic pre-condition – agreement on standards so that different systems can talk to each other, in a country where healthcare is fragmented – has yet to be met. ... The USA and Scandinavia have the most advanced systems in individual hospitals although they are rarely connected to one another. But in terms of sums committed to a national programme, England is in the lead.

                                                                                                                                          According to its advocates, the potential gains are huge. It should provide quicker, safer and more cost-effective treatment. ... David Brailer, Mr Bush’s health IT co-ordinator, has estimated that it will cost between $100bn and $200bn to achieve electronic patient records across the entire US. But the potential gains have been put at $700bn a year.

                                                                                                                                          Installing such systems, however, is a mighty challenge. And three years in, the NHS’s programme, like most big IT projects, has its troubles. ... But if at national level the programme remains a source of controversy, on the ground it is taking shape. The path it is following is that taken by many IT projects: beset by problems but getting better as it evolves. .... At the moment this is all small-scale and very partial. But the key infrastructure is being put in place. ... Further difficulties, some of them substantial, are guaranteed. Yet already a future is hoving into view. ... It is far from trouble-free. But, essentially, it works. ... Yet the three main issues – what goes on the electronic record, how secure it is and who has official access – remain clouded.

                                                                                                                                          Richard Granger, the programme’s director, has been fervent about security. Access to the system comes via smart card and password. And there are different levels. Doctors can see more than nurses; nurses more than administrators. Access is on a “need to know” basis – with actions logged to show who viewed what. Mr Granger is equally adamant that patient records are anything but secure now. He has a favourite slide of a public corridor in a West Midlands hospital, with files on patients scattered across the floor, lined up against the walls and piled high in a laundry trolley. Anyone could get at them ...

                                                                                                                                          [W]hat goes on the record? The National Health Service will insist patients have a minimal demographic record ... necessary for hospitals, general practitioners and pharmacists to be paid. Beyond that, there will be tiers. Patients will be given the right (beyond the basic data) not to have an electronic record at all. They will alternatively be able to exclude what they see as sensitive: past mental illness, an abortion or HIV status, for example. ... Plans also envisage a “sealed envelope” into which these details could be put, to be opened only in an emergency. ...

                                                                                                                                            Posted by Mark Thoma on Monday, January 16, 2006 at 12:17 AM in Economics, Health Care, Technology

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                                                                                                                                            Black and White Unemployment Over Time

                                                                                                                                            Here are monthly unemployment rates for whites and blacks since 1972. The green line is the gap between the two rates to see if there has been any systematic changes over time. The shaded areas are NBER dated recessions:

                                                                                                                                            Here is the rate for men only:

                                                                                                                                            For women only:

                                                                                                                                            And for teens:

                                                                                                                                            Some observations:

                                                                                                                                            1. The rate is always higher for blacks than for whites.
                                                                                                                                            2. In most, but not all, cases the gap between whites and blacks is larger than the rate for whites.
                                                                                                                                            3. There does appear to be a long-run decline in the gap since the early 1980s, but recently the decline has been reversed.
                                                                                                                                            4. The gap follows the trend. When unemployment rises, for example, the gap rises indicating that the black unemployment rate rises faster than the white rate during recessions. This will also mean that the black rate will fall faster in recoveries. [Update: graph of black to white ratio: smaller, larger]
                                                                                                                                            5. There is a clear difference in volatility. The series for whites is much smoother than the series for lacks.

                                                                                                                                            A more general observation: In the first graph, notice how the unemployment rate stops rising at the end of the recessions in the early 1970s and 1980s, but the recession in the early 1990s is different. Even after the recession ended, unemployment continued rising, than begins a long-term decline. In the most recent recession, unemployment continued rising after it officially ended as well. This is even more evident in the rates for men in the second graph, black men in particular.

                                                                                                                                            Update: I was asked about participation statistics. These are in the continuation frame.

                                                                                                                                            First, the overall rates for blacks and whites:

                                                                                                                                            Here is the rate for men only:

                                                                                                                                            For women only:

                                                                                                                                            And for teens:

                                                                                                                                            And here are the gaps. The only gap that is positive (black-white) is for women:

                                                                                                                                            This is the black to white ratio:

                                                                                                                                            Posted by Mark Thoma on Monday, January 16, 2006 at 12:15 AM in Economics, Income Distribution, Unemployment

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                                                                                                                                            January 15, 2006

                                                                                                                                            Shifting the Risk Burden to Workers

                                                                                                                                            Jacob Hacker talks about the shift of risk from employers to workers as health and retirement benefits are redefined and wonders, as we all do, what system will emerge to replace the old and restore economic security:

                                                                                                                                            There goes the rug, by Jacob S. Hacker, Commentary, LA Times: The announcement by IBM that it would freeze its traditional pension plan, shifting all workers into 401(k) plans by 2008 ... was ... the latest in a string of increasingly desperate attempts by companies as diverse as GM, United and Verizon to get out from under mounting pension and healthcare burdens. ... We are seeing the death throes of a corporate insurance system that, for decades, set the United States apart from other rich capitalist nations. And with this system's slow but steady demise comes a massive shift of risk from employers onto workers and their families.

                                                                                                                                            Contrary to conservative complaints about an unrestrained government, the United States has one of the smallest public welfare states in the advanced industrial world. Yet many times more is spent on private benefits than in any other nation — almost a tenth of the nation's economy. And benefits offered by employers are extensively subsidized and regulated by government. ... Indeed, if America's tax code and private benefits are taken into account, U.S. social spending is slightly higher than average compared with other rich countries — higher, in fact, than the spending of Denmark.

                                                                                                                                            Yet this distinctive private system is in peril. ... Employers once championed private benefits as an alternative to overbearing public programs. The editors of Life magazine described them in 1949 as "ransom devices to buy off the welfare state." Today, however, the workplace welfare system that once stood as a shining beacon of America's singular path looks more like a dimming light on a failed byway. Take retirement pensions. In 1975, the vast majority of pensions looked like mini-Social Security systems. .... These were the kinds of pensions for which the federal government created a backstop insurance program in 1974, the Pension Benefit Guaranty Corp.

                                                                                                                                            Twenty-five years later, almost all pensions are of the "defined-contribution" variety ... such as 401(k)s, that are voluntary, uninsured and have no guarantees. Much ink has been spilled comparing the investment returns of 401(k)s and old-style pensions (according to a study of returns from 1985 to 2001 by economist Alicia Munnell, the dinosaurs have actually won, outperforming their upstart competitors by about 1% a year). But the central issue for economic security isn't the return but volatility. Some people do well with 401(k)s; others do poorly. The difference, in a word, is risk.

                                                                                                                                            Employers also want to cut back health insurance coverage, which they say hurts their competitiveness. In 1979, nearly 70% of workers received health insurance coverage from their employer. Twenty years later, the proportion had dropped to just over 50%, and it continues to fall. Among workers earning roughly $8.50 an hour, the drop has been even steeper: from 46% coverage to 26% coverage. Even companies that have retained coverage have made workers pay a larger share of the costs — in essence shifting some of the risk from their own balance sheets to employees' checkbooks. Not surprisingly, the ranks of the medically uninsured have expanded steadily ... and health costs and crises are now a factor in nearly half of America's 1.5 million personal bankruptcies a year.

                                                                                                                                            Still, faith in America's unique system lives on, whether in calls for corporate responsibility by the left or paeans to spontaneous market solutions by the right. The harsh truth suggested by IBM's pension freeze, however, is that no amount of hectoring or tax breaks will resurrect the old bargain that once provided tens of millions of American workers with a private umbrella of economic protection. The unanswered question, in an age of growing economic insecurity, is what, if any, bargain will take its place.

                                                                                                                                            Update: Here's a good follow-up piece in the Financial Times about similar problems in Britain along with a proposal to solve them (it's free). Also, devs ad - good comments. I think some of your answers are here. After experience with insured private retirement programs in Britain, and noting the demise of employer provided defined benefit programs, Ros Altmann from the London School of Economics calls for "decent basic state pensions for all" and explains how to pay for them:

                                                                                                                                            Use wasted billions to reform our state pensions, by Ros Altmann, Commentary, Financial Times: The British pension model is unique and it has failed. The crisis in UK pension provision is worsening and the demise of traditional final salary pensions is throwing the inadequacy of our state pension system into stark relief. The reason Britain has just about the least generous state pension system in the industrialised world is because it has relied on employers shouldering ever-increasing responsibility for old-age income support with generous final salary pension schemes.

                                                                                                                                            Our system of contracting-out encouraged millions of people to swap their state pension rights for private pension promises they were led to believe were guaranteed. However, the regulatory framework to protect these privatised social welfare benefits was inadequate and the costs and risks of private pensions have proved too high to be relied on. Both employers and governments are guilty of raiding these funds, leaving many mature schemes with huge deficits, members with no pension and hampering corporate competitiveness. ...[A]s lifelong employment disappears, average job tenure declines, global competitive pressures intensify and corporate ownership changes frequently, managers cannot justify continuously trying to run down the up escalator in an attempt to provide long-term welfare benefits.

                                                                                                                                            As traditional pensions disappear, radical overhaul of the UK pension model is vital. However, state pensions are so complex that most people cannot predict what they will receive and have no sound basis on which to plan. The low level and coverage of state pensions forces millions into means-testing to escape poverty. But this mass means-testing discourages the private savings needed to top up a poverty-level state pension, so the whole pension system has become unstable. ...

                                                                                                                                            The Pensions Commission highlighted the unsustainability of our current system, but shied away from the most radical reforms, such as abolishing contracting out or providing better incentives, for fear of destabilising defined benefit pensions. If these schemes are changing anyway, why allow such concerns to hold up reform?

                                                                                                                                            Adair Turner, the commission’s chairman, says a decent universal state pension, which lifts the elderly out of poverty and recognises women in their own right, would be too expensive... However, there are obvious sources of pension-related funding in the existing budget that could be diverted to finance such much-needed reform.

                                                                                                                                            We are wasting billions of pounds which could be redeployed to provide decent basic state pensions for all. Pension tax relief costs £21bn a year – over half of which goes to top-rate taxpayers (mostly men) ... [I]f we need to find extra money to fund a decent, fair state pension, giving a sound basis upon which individuals can plan their later life finances, there are many ways to do so. This may require slaying some sacred cows and entail measures that will be unpopular with certain groups. However, holding up reforms out of a desire to slow the demise of defined benefit pension schemes seems a great shame because they are changing anyway. It is time for a radical overhaul of our pension system, to provide a minimum state pension to prevent poverty, offer fairer incentives for private sector workers to save more or work longer part-time and ensure a higher standard of living in old age.

                                                                                                                                              Posted by Mark Thoma on Sunday, January 15, 2006 at 10:39 AM in Economics, Health Care, Social Security

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                                                                                                                                              The Post Office Gets the Email Message

                                                                                                                                              The internet is making it difficult for industries that rely on delivery of the printed word such as newspapers and, as this article describes, the post office. Where the Postal Service is headed in the future is not completely clear:

                                                                                                                                              Saving the Post Office As Mail Usage Drops, USPS Faces a Whirlwind of Change, by Margaret Webb Pressler, Washington Post: There are, in many ways, two U.S. Postal Services. There is the one that people love to hate, ... the Postal Service that made Mark Tornga, 24, hold his head in disbelief as he walked out of a post office ... last week. "Fifty-two minutes I spent in line -- 52 minutes!" the College Park resident fulminated after sending a certified letter ... Then there is the Postal Service that has made huge strides in on-time delivery, runs one of the most impressively automated operations in the world and, for now, is bringing in a huge profit. This is the Postal Service that ... moves 580 million pieces of mail a day with remarkable speed and accuracy to every address in the nation, six days a week.

                                                                                                                                              The first Postal Service is the one that executives are trying to fix... The other Postal Service is the one they are trying to save. "Am I optimistic or pessimistic? I'd have to say I'm anxious," said John M. Nolan, who retired last year as deputy postmaster general... The structural problems facing the Postal Service are monumental. Despite a tiny uptick last year, first-class mail volume is slowly but steadily eroding as people pay more bills online ... and shoot off e-mails rather than write letters. The agency also is facing massive and escalating personnel costs, especially for health care... And finally, there is the federal government's attempt to change the structure of Postal Service regulation, an effort that postal officials regard as riddled with problems and with favors to private industry.

                                                                                                                                              "It doesn't give us nearly the flexibility we believe we need," said Tom Day, senior vice president of government relations for the Postal Service. Without making some hard decisions ... in the near term, Nolan and others say, the Postal Service "is on a crash course with cataclysmic change." What kind of change and when is unclear. Privatization? Shuttered post offices? Dramatically more expensive mail? Less frequent delivery? It could be any of those things -- or none of them. It just depends on how things go...

                                                                                                                                              At its most basic level, the Postal Service needs to keep as many customers as it can, and a good place to start is by tackling its legendary customer-service problems. ... In the meantime, postal officials keep coming up with ways to keep people -- happily -- out of the post office. There are the post office's retail partners, grocers in particular, that sell books of stamps, which has become one of the most common ways people buy stamps. ... There's the ... Click-N-Ship service: Go online and find out the rates, print the postage at home, then schedule a free pickup. The problem has been getting out the word that Click-N-Ship even exists ... Day says even his own nephew was using UPS to ship things he sells on eBay. ... 2,000 postal offices nationwide [have] ... new Automated Postal Centers, which can ... dispense stamp sheets, sell postage..., look up rates and Zip codes, provide certified mail receipts, and so on. To encourage people to use the mail more, the post office has been aggressively advertising some of its newer services on television. ...

                                                                                                                                              Since 2000, the agency has gone through an astonishing makeover of automation and efficiency; reducing staffing by 100,000 to just over 700,000, all through attrition; while delivering more mail to more delivery points. ... What postal officials find most gratifying is that on-time delivery has improved, too: Today, 96 percent of mail is delivered on time ... Eight years ago, that figure was 92 percent...

                                                                                                                                              But these results belie an underlying erosion in the most important type of the Postal Service's business. About two years ago, first-class mail fell below the 50 percent threshold of mail volume for the first time. It now accounts for about 46 percent of all mail, while direct-mail marketing items represent 49 percent. The rest is packages. The package-delivery business is so dominated by UPS and FedEx that the Postal Service now partners with these private carriers... The theory is that it's cost-effective for both if only one delivery person has to walk up to a house. There are even FedEx boxes in some post offices.

                                                                                                                                              The decline in first-class mail is partly because people are writing fewer letters, but it's also closely tied to the banking industry. The more people pay bills online, the more money banks save, so they're making it easier to do. Financial remittances represent about $17 billion of the Postal Service's $70 billion operating revenue, so it's a big chunk to lose. "My concern would be . . . there comes a tipping point ... where ... they may get more aggressive in providing incentives to customers to get them out of the mail," Day said.

                                                                                                                                              To deal with the expected decline in revenue, the Postal Service needs to raise money in other ways and cut costs, and that means several looming battles, Day said. Rates will likely rise again for first-class stamps and for direct mail, perhaps as early as next year, he said. Later this year, the agency will also begin renegotiating contracts with four major unions in hope of winning concessions on some high-cost benefits such as health care. Union leaders are ready for a fierce fight. ... For all the dire predictions mail-industry experts make about the Postal Service, though, there remains an underlying feeling that somehow it will get worked out. It's like this: You just can't let the post office -- the one we feel so connected to -- go away. ...

                                                                                                                                                Posted by Mark Thoma on Sunday, January 15, 2006 at 01:12 AM in Economics, Technology

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                                                                                                                                                Em-Pyrrhic-al Research

                                                                                                                                                How to value the costs and benefits of war?:

                                                                                                                                                When Talk of Guns and Butter Includes Lives Lost, by Louia Uchitelle, Economic View, NY Times: As the toll of American dead and wounded mounts in Iraq, some economists are arguing that the war's costs, broadly measured, far outweigh its benefits. Studies of previous wars focused on the huge outlays for military operations. That is still a big concern, along with the collateral impact on such things as oil prices, economic growth and interest on the debt run up to pay for the war. Now some economists have added in the dollar value of a life lost in combat...

                                                                                                                                                Through the cold war, economists generally avoided calculations of the cost of a human life. Even during Vietnam, the focus of economic studies was on guns and butter - the misguided insistence of the Johnson administration that America could afford a full-blown war and uncurtailed civilian spending. The inflation in the 1970's was partly a result of the Vietnam era. Cost-benefit analysis, applied to war, all but ceased after Vietnam and did not pick up again until the fall of 2002 ... [William D. ] Nordhaus is the economist who put the subject back on the table with the publication of a prescient prewar paper that ... warned that "if the United States had a string of bad luck or misjudgments during or after the war, the outcome could reach $1.9 trillion," once all the secondary costs over many years were included.

                                                                                                                                                So far, the string of bad luck has materialized, and Mr. Nordhaus's forecast has been partially fulfilled. In recent studies by other economists, the high-end estimates of the war's actual cost, broadly measured, are already moving into the $1 trillion range. For starters, the outlay just for military operations totaled $251 billion through December, and that number is expected to double if the war runs a few more years. The researchers add to this the cost of disability payments and of lifelong care in Veterans Administration hospitals for the most severely injured - those with brain and spinal injuries, roughly 20 percent of the 16,000 wounded so far. ...

                                                                                                                                                In a war that has lost much public support, the costs stand out and the benefits ... are harder to pinpoint. In a paper last September, for example, Scott Wallsten, a resident scholar at the conservative American Enterprise Institute, and Katrina Kosec, a research assistant, listed as benefits "no longer enforcing U.N. sanctions such as the 'no-fly zone' in northern and southern Iraq and people no longer being murdered by Saddam Hussein's regime." Such benefits, they found, fall well short of the costs. "Another possible impact of the conflict, is a change in the probability of future major terrorist attacks," they wrote. "Unfortunately, experts do not agree on whether the war has increased or decreased this probability. Clearly, whether the direct benefits of the war exceed the costs ultimately relies at least in part on the answer to that question."

                                                                                                                                                The newest research was a paper posted last week on the Web ( by ... Joseph E. Stiglitz of Columbia University and Linda Bilmes, now at the Kennedy School of Government at Harvard. Their upper-end, long-term cost estimate tops $1 trillion... They assumed an American presence in Iraq through at least 2010, and their estimate includes the war's contribution to higher domestic petroleum prices. They also argue that while military spending has contributed to economic growth, that growth would have been greater if the outlays had gone instead to highways, schools, civilian research and other more productive investment. The war has raised the cost of Army recruiting, they argue, and has subtracted from income the wages given up by thousands of reservists who left civilian jobs to fight in Iraq at lower pay.

                                                                                                                                                Just as Mr. Wallsten and Ms. Kosec calculated the value of life lost in battle or impaired by injury, so did Mr. Stiglitz and Ms. Bilmes - putting the loss at upwards of $100 billion. That is more than double the Wallsten-Kosec estimate. Both studies draw on research undertaken since Vietnam by W. Kip Viscusi, a Harvard law professor. The old way of valuing life calculated the present value of lost earnings, a standard still used by the courts to compensate accident victims, generally awarding $500,000 a victim, at most. Mr. Viscusi, however, found that Americans tend to value risk differently. He found that ... the cost to society adds up to $7 million for each life lost...

                                                                                                                                                  Posted by Mark Thoma on Sunday, January 15, 2006 at 12:45 AM in Economics, Iraq

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                                                                                                                                                  Open-Source Kryptonite?

                                                                                                                                                  The Economist wonders if patents are being issued too freely, in part because the patent office is overwhelmed:

                                                                                                                                                  Innovation and its enemies, The Economist: ...A rough league table of the world's most intellectually creative firms was published this week, when the United States Patent Office issued its annual rankings of who received the most patents in 2005. IBM claimed the top spot for the 13th consecutive year (but with 307 fewer patents than in 2004). As in previous years, American firms were the minority on the top-ten list, with Japanese computer and electronics firms dominating—in part because of their tradition of filing many applications with narrow claims.

                                                                                                                                                  Strikingly, half of the firms in the top ten were absent from the list a decade ago, showing that the world of innovation is fluid... Topping the patent list can be a badge of pride. But garnering a plethora of patents does not necessarily mean that a firm is hugely innovative: the brute number says nothing about the value of the inventions. Fewer than 10% of patents have economic worth. In fact, an increasing number of patents are of dubious merit...

                                                                                                                                                  While the European Union frequently berates itself because EU companies register few patents compared with their American peers, many Americans now believe that patents—which let the holders exclude rivals from using a technique for around 20 years—are being issued too freely. ... even many of the technology firms that rely most on intellectual property have come to believe that the system needs thorough reform.

                                                                                                                                                  Part of the reason for the increase in seemingly illegitimate patents is that America's patent office ... is flooded with applications. It now takes around three years for a patent to be approved, and today's backlog of 500,000 is expected to double by the end of the decade... Annual legislative proposals by Congress stall. ... In 2005 the number of patents issued declined by 12% from a year earlier, though it is unclear if this is a sign that the patent office is working more slowly, or getting stricter.

                                                                                                                                                  In an attempt to limit questionable patents, America's patent office said this week it would co-operate with open-source software firms and IBM on an initiative to improve the examination process. It will make it easier for the public to submit materials related to pending patent applications... Open-source relies on intellectual property—but uses copyrights, not patents, to stipulate sharing rather than keeping things proprietary. Software patents are to open-source projects what kryptonite is to Superman. Protecting against them is one of the main motivations for revising the General Public Licence for free and open-source software, a task that formally begins on January 16th at the Massachusetts Institute of Technology...

                                                                                                                                                    Posted by Mark Thoma on Sunday, January 15, 2006 at 12:40 AM in Economics, Market Failure, Regulation

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                                                                                                                                                    When Will China Revalue Further?

                                                                                                                                                    China will revalue when it's good and ready, and not a moment sooner:

                                                                                                                                                    Beijing Says 2005 Trade Surplus May Not Warrant Revaluing Yuan, by Victoria Ruan: China isn't purposefully chasing a trade surplus, and a record-high surplus in 2005 doesn't necessarily mean the yuan should appreciate further, said a senior official at the country's top economic-planning agency. China's major trading partners ... have been pressing the government to allow a stronger yuan to help curb a rapid growth in exports, which has created a huge trade imbalance. "We aren't chasing a trade surplus on purpose," National Development and Reform Commission Vice Chairman Zhu Zhixin said in an interview. ... When asked if the record-high surplus would push the government to revalue the yuan more rapidly, Mr. Zhu said "not necessarily." ... "China should follow its own pace" in reforming its foreign-exchange mechanism, rather than bowing to pressure from trade partners...

                                                                                                                                                      Posted by Mark Thoma on Sunday, January 15, 2006 at 12:12 AM in China, Economics, International Finance

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                                                                                                                                                      January 14, 2006

                                                                                                                                                      The Chinese Auto Export Industry

                                                                                                                                                      "It's a matter of time":

                                                                                                                                                      China's Fast-Moving Vehicles, by Daren Fonda, Time: ... Slide over Hyundai -- the next automotive upstart ... in the U.S. will probably be Chinese. In Detroit this week, a small company called Geely (pronounced Jee-lee) will be the first Chinese automaker to display a car at the North American International Auto Show. ... Geely may be a couple of years away from shipping products to the U.S. Yet the company has big plans, aiming to export 1.3 million vehicles worldwide, including small sedans for less than $10,000 and a sports car, the Beauty Leopard, which sells for $15,125 in China. Other Chinese manufacturers, with varying levels of sophistication, are developing export models too, notably Chery, which is being promoted by Malcolm Bricklin, ... who made his fortune importing Subarus and his name importing the ill-fated Yugo. ... [S]ays Mike Hanley, global director of Ernst & Young's automotive practice. "Everybody recognizes that Chinese cars will end up in North America. It's a matter of time."

                                                                                                                                                      And what a lousy time for U.S. automakers, struggling under competitive pressures ... Yale Zhang, an industry analyst in Shanghai ... says he expects Chery to begin exporting a minivan and a four-door sedan next year. Chery recently cleared two hurdles: settling a law-suit with GM over charges that it ripped off a design from GM's Daewoo subsidiary, and agreeing to find a new name for North American models -- since Chery sounds like Chevy ... Chery plans to sell cars up to 40% below current market prices. That will help buyers get past the jokes that their Chinese cars may not make it off the lot, the same jokes once aimed at Japanese brands.

                                                                                                                                                      With production workers earning $2 an hour, China is pressing its labor advantage, luring foreign automakers to both supply its domestic market and develop export programs. Almost all the big names -- GM, Ford, Honda, Volkswagen -- have joint ventures that assemble vehicles for the local market.... [But] low wages don't make China a low-cost producer. The country has an inefficient supply chain, high component costs (many parts are slapped with import tariffs) and nonwage expenses like housing for factory workers. CSM's Zhang estimates that materials account for 80% to 85% of a vehicle's cost (vs. 65% in Detroit), eroding much of the labor savings. "It's not particularly cheap to produce a car in China," notes Steven Blackman, head of Ernst & Young's automotive practice in Europe.

                                                                                                                                                      Yet while China may not be the cheapest place to build cars, it's growing more attractive. Tariffs on parts have declined lately, and logistics costs should decrease as China's transport infrastructure improves. Last year Honda became the first foreign automaker to set up a major export operation, shipping a compact to Europe... Chrysler plans to build its 300-model sedan in Beijing for domestic sale and possible export (although not to North America, where autoworkers would probably object). GM and Volkswagen export small quantities too, such as Chevy Venture minivans to the Philippines and Polo compact cars to Australia. ...

                                                                                                                                                      [A]lthough Chinese vehicle quality is improving, it lags Western standards by wide margins. Chery's QQ model, for instance, had an average 391 problems per 100 vehicles, according to J.D. Power's latest initial-quality survey. For U.S. models, the average is 118. Chinese manufacturers must also redesign cars to meet tougher U.S. emissions and safety standards, a cumbersome, costly process. And they must build distribution and sales networks, which will take time and money. The manufacturer that gets to market first carries China's automotive reputation on its shoulders. ... John Harmer, vice president of marketing at Geely-USA, vows that Geely isn't rushing into production at the expense of solid engineering. "We'll make sure Geely doesn't become a member of the group of manufacturers that came to the U.S. prematurely and failed," he says...

                                                                                                                                                        Posted by Mark Thoma on Saturday, January 14, 2006 at 12:14 PM in China, Economics, International Trade

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                                                                                                                                                        High-Tech Scalping

                                                                                                                                                        The St. Petersberg Times does quite a bit more than just list ticket prices for upcoming concerts, it gives a glimpse of the underlying economics:

                                                                                                                                                        Internet's golden tickets, Helen Huntley contributed to this Wall Street Journal story, St. Petersberg Times: If you want really good seats to see Bon Jovi at the St. Pete Times Forum next month, be prepared to shell out big bucks. Fifth-row seats were listed for $1,250 a pair Friday afternoon on the ticket exchange Web site That's about six times their face value. On eBay, the bidding on a similar pair was up to $736 ...

                                                                                                                                                        The Internet has forever changed the economics of rock concerts. Legions of high-tech scalpers snap up seats when they go on sale. Then they flip the tickets on Web sites like StubHub, where the markup can reach many multiples of the face value. The result is that buying concert tickets is becoming akin to getting in on a hot initial public offering of stock: Scrappy insiders get them at face value, often with an eye on reselling them at a premium.

                                                                                                                                                        Indeed, the number of people buying tickets the old-fashioned way - at a ticket outlet, on the phone or when they first go on sale online - is low. At a U2 concert ... at New York's Madison Square Garden, at least 29 percent of the fans said they bought their seat on the Internet at a source other than Ticketmaster, the authorized ticket agent, according to a survey conducted by Alan Krueger, a Princeton University economics professor.

                                                                                                                                                        This isn't just rock concerts. Tickets for everything from Broadway shows to sporting events are increasingly resold online. Super Bowl seats can be bought on StubHub ... the prices start at upwards of $2,000. Classical and opera performances can be found, too, though the offerings usually aren't nearly as numerous...

                                                                                                                                                        But reselling has become particularly widespread in the concert business, bringing scalping out from the shadows and into the mainstream. Anyone with a computer and a broadband connection these days can become a ticket scalper. And the ease with which tickets can be flipped creates tremendous incentives for enterprising resellers to snap up tickets before concertgoers can get their hands on them.

                                                                                                                                                        From an economic perspective, some argue the markups seen on Web sites are making the market for tickets more efficient by letting prices fluctuate with supply and demand. With eBay and countless other Web sites reselling and auctioning tickets, it's making scalped prices less arbitrary. "It would be very hard to charge something that's far out of line," said Princeton's Krueger, who has studied the rock-concert business.

                                                                                                                                                        And while some ... argue that real fans with limited resources are priced out in this new ticket economy, ... StubHub's chief executive, says: "I would argue that the true fans are the ones who are willing to pay the most for the tickets."

                                                                                                                                                        But getting seats at face value has become far more difficult. Shows for big-name acts like U2, Paul McCartney and the British band Coldplay sell out in minutes on, while many of the best seats aren't offered to the public. Instead they're held back for highly priced auctions and so-called presales, available through fan clubs, some of which charge membership fees. ...

                                                                                                                                                        In a bid to capture some reselling revenue, Ticketmaster ... conducts auctions for premium seats - for Coldplay, Nine Inch Nails, country-music star Martina McBride and others. "The ones putting on the event should be the ones who benefit from this increase in price," said David Goldberg, Ticketmaster's executive vice president for strategy and business development.

                                                                                                                                                        For fans intent on getting tickets at face value for sold-out concerts, it is possible, although it can take a lot of effort and some luck. ... Online ticket-buying through unauthorized sources isn't without risk. Many states, including Florida, ban scalping or limit ticket markups, although the laws often are unenforced.

                                                                                                                                                        Tickets for these upcoming bay area concerts are a hot commodity. Here's what sellers were asking Friday for a pair of tickets on three popular Web sites. Prices are for two tickets and do not include shipping fees:

                                                                                                                                                        BON JOVI, FEB. 17 & 18 ST. PETE TIMES FORUM StubHub: $162 to $1,250 eBay: $169.99 to $355 "buy it now"* Ticketmaster: Feb. 17 sold out; $124 for the Feb. 18 (3rd level only)

                                                                                                                                                        KEITH URBAN, FEB. 24 ST. PETE TIMES FORUM StubHub: $198 to $824 eBay: $250 "buy it now"* Ticketmaster: $100.70 (3rd level only)

                                                                                                                                                        COLDPLAY, MARCH 5 FORD AMPHITHEATRE StubHub: $130 to $590 eBay: $89 to $150 "buy it now"* Ticketmaster: $83.40 (lawn only)

                                                                                                                                                        *Other tickets available on eBay through bidding process. [Last modified January 14, 2006, 01:38:14]

                                                                                                                                                          Posted by Mark Thoma on Saturday, January 14, 2006 at 12:21 AM in Economics

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                                                                                                                                                          "The Fetters of Ignorance, Self-Deception and Intemperance"

                                                                                                                                                          Does the “consumer ... need to be coaxed and wheedled into responding to market choices with sufficient diligence”?:

                                                                                                                                                          The aggro of the agora, Consumers fail to measure up to economists' expectations, The Economist: “We must accept the consumer as the final judge,” wrote Frank Taussig, a former president of the American Economic Association (AEA), in 1912. ... The AEA's latest annual meeting ... made one thing abundantly clear: this ritual deference to consumer sovereignty is slipping. ... John Campbell, president of the American Finance Association (AFA), dwelt on the failure of households to hold enough shares, diversify their assets fully or refinance their mortgages promptly. Meanwhile, Daniel McFadden, the AEA president, argued that the unshackling of markets, which has proceeded apace since the 1980s, would fall short of its promise if consumers were not similarly freed from the fetters of ignorance, self-deception and intemperance.

                                                                                                                                                          Mr McFadden's speech leaned on the work of neuroeconomists, who claim to prove what Adam Smith long ago asserted: man's “propensity to truck, barter and exchange” runs deep in our nature. According to brain scans, it lurks in the same primitive, limbic vaults of the cerebrum as our instinct to fight, flee and feed ourselves. Indeed, “shopping and sex share the same neurotransmitters and receptors,” Mr McFadden jokes.

                                                                                                                                                          But if trading turns some people on, it puts others off. Markets can be “rough, murky, tumultuous places”. Consumers may doubt themselves, the products on display and the people flogging them. Losing out—paying too much—is an ever-present danger. This can be character-building, of course. By punishing a consumer's mistakes and inconsistencies, the market may whip him into shape, so that he more closely resembles the rational actor an efficient market deserves. But Mr McFadden worries that consumers may instead develop an aversion to markets: “Opportunities for choice may be interpreted as opportunities for mistakes, embarrassment and regret.” He calls this agoraphobia. In common parlance, this is a fear of open spaces; translated literally from Greek, it means “fear of the marketplace”. ... “Consumers find trade an edgy experience...and resist trading for small gains.” ...

                                                                                                                                                          Mr McFadden takes ... this a step further. The “consumer may need to be coaxed and wheedled into responding to market choices with sufficient diligence,” he says. For his predecessors, such as Taussig, this is heresy. The consumers' choices are the data—the given things—of economics. It is only by observing a consumer's choices that economists can infer his preferences. Thus to argue that we know what's best for consumers, independent of what they have chosen for themselves, is a failure of logic as well as the height of presumption. If our theory fails to explain their behaviour, it is our problem, not theirs. Mr McFadden seems tempted by the opposite conclusion. If economic theory fails to reflect consumer behaviour, perhaps consumers can be remoulded, better to serve the theory.

                                                                                                                                                            Posted by Mark Thoma on Saturday, January 14, 2006 at 12:15 AM in Economics

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                                                                                                                                                            Money or Morals?

                                                                                                                                                            Last time the question of why college presidents have fallen silent came up, I noted that the role of a college president today is largely one of fund raising and thus it was no mystery why they would be unwilling to risk offending potential donors by speaking out on controversial issues. This commentary by Margaret A. McKenna, president of Lesley University, explores the question further:

                                                                                                                                                            The silencing of college presidents, by Margaret A. McKenna, Boston Globe: When I became president of Lesley University 20 years ago, I was attracted to the college because of its mission and beliefs that individuals can and should make a difference. ... I ... believed that we had an opportunity, in fact a responsibility, to make the world a better place. I knew, though may have underestimated, the demands of a university presidency: the pressures of fund-raising and enrollment numbers, the toll on personal time, and the economic challenges of tuition dependent institutions. ...

                                                                                                                                                            In the 19th century, presidents taught their college's course in moral philosophy and ethics. Moral leadership was the centerpiece of the college president's role. In the 20th century, that tradition began to ebb, but some college presidents still provided very public models of moral leadership. ... Much has changed in a few decades. The president's role as fund-raiser has grown. The university system and its expectations are stacked against any president providing the kind of public moral leadership that once characterized our profession. Too much risk is involved. Prospective students, donors, trustees, and alumni could be offended. Faculty may fear that a president's opinion too forcefully expressed might impinge on academic freedom.

                                                                                                                                                            And since 9/11, dissent of almost any kind has been labeled as unpatriotic, and even reasoned debate on hot button social issues is viewed as dangerously controversial. Thus, while many of my colleagues will state positions on issues clearly affecting their campuses, like financial aid, they are loath to venture an opinion outside of academe. Who can blame them? ... But I wonder what it would take for more of us to speak out?

                                                                                                                                                            We will defend our students' right to financial aid, but what about basic human rights like those trampled at Guantanamo and Abu Ghraib? We can respond to college students displaced by Katrina, but are we willing to speak on behalf of children of undocumented immigrants? We might write our congressman to protect charitable deductions for nonprofits, but what of tax reform that disproportionately aids the rich and ignores the poor? We are eloquent advocates of academic freedom, but what of freedom to communicate free from government surveillance?

                                                                                                                                                            The country is sorely in need of new voices of courage and conviction. Thank God for John McCain, Ted Kennedy, and more recently John Murtha. Others who speak from less formal roles: George Will, Dan Schorr, Cindy Sheehan, Bono, and Pat Buchanan on his more rational days. Whether you agree with them or not, you can believe they say what they mean and mean what they say. Regardless of ideological position, we need more voices in public dialogue like that.

                                                                                                                                                            The punditry of Sunday morning talk shows is not an answer. On the other hand, I am convinced moral leaders can be found at all levels of society. Their formal roles matter less than the power of their ideas, vision, and voices. But university presidents, in particular, have a unique historical tradition, and strong educational reason, to reassert their voices in their historical role of moral leadership.

                                                                                                                                                            Many college students are increasingly cynical about politics. They are willing to serve as volunteers, but less willing to be part of the political process. I believe that if we want our students to be engaged in civic life, to be leaders, to speak out on issues, we need to provide them with the models for doing so. ...

                                                                                                                                                              Posted by Mark Thoma on Saturday, January 14, 2006 at 12:15 AM in Politics, Universities

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                                                                                                                                                              Fuel Prices in 1856, What You Don't Know, and Washington's Corset

                                                                                                                                                              A few tidbits from Scientific American:

                                                                                                                                                              I wonder if there were worries about peak wood and peak coal during the energy crisis in '56:

                                                                                                                                                              FEBRUARY 1856 FUEL PRICES—“The fuel required to cook a dinner in Paris costs nearly as much as the dinner itself. Fuel is very scarce, and the American is surprised to find shops all over the city, fitted up with shelves like those in shoe stores, upon which is stored wood, split in pieces about the size of a man’s finger, and done up in bundles, like asparagus. Larger sticks are bundled up in the same way, and sell at a frightful price. Hard coal being nearly as expensive as wood, can be bought in the smallest quantity at any of these fuel shops.”

                                                                                                                                                              Brad Delong has more on the next one, including a more extensive explanation and an interpretation in terms of risk versus uncertainty:

                                                                                                                                                              BEHAVIOR, The Devil You Know: Experimental economists know that people prefer games involving known risks, not ambiguous ones. Now they have a better idea why. Researchers from the California Institute of Technology had volunteers play two games while undergoing brain-imaging scans. In one game, subjects could take a small sum of money or potentially win a larger sum by guessing the color of a card drawn from a deck they knew was split evenly between two colors. The second game was identical except that subjects did not know the proportions of the cards. This more ambiguous game activated the amygdala and orbitofrontal cortex, brain areas associated with emotion processing, whereas the game of known risk did not. The result lends credence to a model in which people caution themselves to avoid the worst possible outcome, as opposed to coolly identifying the best strategy, according to a commentary in the December 9, 2005, Science.

                                                                                                                                                              Males were corseted? I did not know that. This is from an article on reconstructing George Washington's face and full body shape at various ages:

                                                                                                                                                              Constructing the Body: ...both the statue and the paintings portrayed a form somewhat different from what we expect to see in a 20th or 21st-century male physique. I discovered that in keeping with an 18th-century custom common among English families of status, Washington’s body had been corseted until about the age of five. I have not been able to find an example or even description of such a corset, but it would have differed from that used on girls and women to pull in the waist, because the effect altered the male body to look like a ballet dancer’s. The shoulders were pulled back, puffing out the chest and flattening the area across the shoulder blades, as well as down, creating a long slope from the neck on each side; the natural inward curvature of the lower back was further accentuated, which then pushed the belly out. (As I also learned, Washington had been a fabulous ballroom dancer. In fact, he kept meticulous notes on each type of dance.) Once the growth trajectory of the body had been changed in the boy, the new shape would have persisted throughout life, which is why portraits of 18th-century English gentlemen, including the signers of the Declaration of Independence, have a distinctly different look to them than portraits of important men of later centuries. [picture - you may need to click on lower right corner to enlarge and make the print legible.]

                                                                                                                                                                Posted by Mark Thoma on Saturday, January 14, 2006 at 12:07 AM in Economics, Science

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                                                                                                                                                                January 13, 2006

                                                                                                                                                                Greg Mankiw Returns to Teaching

                                                                                                                                                                First, from The Washington Wire in the WSJ:

                                                                                                                                                                Minor Memos: As Bernanke prepares to succeed Fed chair Greenspan, fellow academic economist Greg Mankiw admits, "I will not miss you as a competitor in the textbook market."

                                                                                                                                                                Next, from the Harvard Crimson online edition, a story about Greg Mankiw and his return to teaching. In one class he is teaching, Ec 10, Mankiw hopes to overcome the complaints of conservative bias that occurred when Feldstein was teaching it:

                                                                                                                                                                After D.C., Mankiw Resumes Teaching, by Alex M. McCleese, Harvard Crimson: For Beren Professor of Economics N. Gregory Mankiw, the leader of one of Harvard’s largest courses, economics is not just a day job. The Ec 10 professor typically wakes up in his 1930s brick colonial in Wellesley between 5:30 and 6:00 a.m. to take his border terrier Tobin for a walk. Tobin, who is named after Nobel Prize-winning economist James Tobin, is the brown-furred successor to Keynes, Mankiw’s last dog. The real-life Tobin was a follower of economist John Maynard Keynes, as well....

                                                                                                                                                                Mankiw’s first conversation with his wife was about public policy. “We were both grad students. I was at MIT, and she was at Harvard at the Kennedy School,” he recalls ... “We started chatting at the train platform at South Station, and I sat next to her and we chatted on the Amtrak train, and that’s how we met,” he says. “We had sort of a natural common interest, because we both had policy interests, and then we started dating and got married.” Mankiw pursued his interest in public policy in Washington from 2003 to 2005, serving as chair of President Bush’s Council of Economic Advisors. But he says he is glad to be back ... trying to help hundreds of Ec 10 students become “economically literate citizens.” “I’m first and foremost an academic, and always viewed myself as spending my life in a university,” Mankiw says. “I viewed [the time in Washington] as a temporary period of public service.”

                                                                                                                                                                A NATURAL TEACHER Mankiw’s love affair with economics began during his freshman year at Princeton, when he took an introductory course that he says “had such a big impact on my life.” “What I liked about economics was the combination of, on the one hand, very rigorous scientific thinking with an application to important public policy problems,” he says. “I was always very interested in policy and politics, but I liked the scientific approach, the idea of mathematical models, separating out analysis from value judgements. Economics did that in a way that I thought was very clean and very compelling.”

                                                                                                                                                                When Mankiw was given the chance to teach the 680-person behemoth Social Analysis 10, “Principles of Economics,” beginning this past fall, he says he leapt at the opportunity, partly because his own introductory economics class had made such an impression on him. The move was a logical one: he had been an Ec 10 Teaching Fellow in the mid-1980s when ... Martin S. Feldstein ’61 was teaching the course, and he had written the course’s textbook, “Principles of Economics.” “I love teaching, and obviously anybody who volunteers for a big course like Ec 10 has to love teaching, because it’s a big course and a big responsibility,” he says. ... Mankiw says that Ec 10 is a course with an especially important mission. “I’m a big believer that you can really teach a lot of economics at the basic level, at a non-technical level. I think those are tremendously important ideas for citizens,” he says. “Being an intelligent voter, or an intelligent reader of the newspaper requires a basic knowledge of economics.” ... Some students criticized Ec 10 under Feldstein’s leadership for what they considered a conservative bias. Social Analysis 72, “Economics: A Critical Approach,” has been offered since the fall of 2003, after students circulated a petition calling for an alternative introductory course. Mankiw says that he tries for balance in assembling the syllabus and readings for Ec 10. He acknowledges that economists are often viewed as conservative because of their emphasis on market efficiency, but says that the relative importance of market efficiency remains an open question. “Embracing the tools of economics does not mean embracing a particular political view,” he says.

                                                                                                                                                                During his tenure in Washington, Mankiw sparked political controversy when he said ... that outsourcing of jobs by U.S. companies “is probably a plus for the economy in the long run.” Democratic leaders, as well as House Speaker Dennis Hastert, R-Illinois, criticized this statement. Mankiw later wrote in a letter to Hastert that his comments were misconstrued and that he believes the loss of U.S. jobs is “regrettable.” Inspired by his experience in Washington, Mankiw recently published a paper about outsourcing. ... “I’m very much an advocate of free trade.” THE MAN IN ACTION In an Ec 10 lecture on Monday, Dec. 12, Mankiw addressed the disputes between liberal and conservative economists. ... He roamed on all sides of the podium as he outlined competing viewpoints on taxes, externalities, anti-trust policy, the rationality of individuals, and the role of government, the main points of contention in economics. He enlivened this discussion ... with an anecdote about ice cream to illustrate a theory of voting. ... Mankiw delivered a total of six lectures in the fall semester of Ec 10, which is taught largely in section. “I think he’s a good professor,” says John D. Cella ’08, ... “He does actually try to get kids interested in economics, besides just the equations and the mundane stuff you have to learn in introductory economics.” Cella says that Mankiw frequently e-mails students to point out articles in the Economist or the New York Times. Students do receive replies from Mankiw if they e-mail him, Cella says. After he lectures, Mankiw says he usually waits after class to respond to students’ questions. “I’m happy to hang out as long as they want to talk,” he says. “They can come see me during office hours, though not enough do.” After his lecture on “Market Success and Market Failure,” Mankiw crouched down on Sanders’ wooden stage to address a student’s question about economic growth during the Clinton administration... BEYOND ECONOMICS In his life outside of teaching economics, Mankiw is still a student. He reads widely—from Steven Pinker’s psychology tomes to history to the entire Harry Potter series, which he has read out loud to his three children—and he takes statistics courses when he has free time. But he says that free time has been hard to come by recently. “Lately, my main outside activity is raising my three children, which is a pretty time-consuming task,” he says. In addition to his 14-year-old daughter, Mankiw has two sons, ages 11 and 7. ...

                                                                                                                                                                Mankiw says that he plans to continue teaching Ec 10 for the “foreseeable future,” adding that he finds it especially rewarding to teach an introductory course. “Freshman year people are very open to news ways of thinking about the world, which economics is,” Mankiw says. “It certainly was for me when I was a freshman.”

                                                                                                                                                                  Posted by Mark Thoma on Friday, January 13, 2006 at 11:46 AM in Economics

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                                                                                                                                                                  The Changing Social Contract

                                                                                                                                                                  This is a bit hurried, but here's more on social insurance and the changing social contract:

                                                                                                                                                                  America's welfare dilemma, by Dan Roberts, Financial Times: Few gulfs between the US and Europe run deeper than their approach to insuring people against life's vicissitudes. One side of the Atlantic clings to the notion of a welfare state - if not the cradle-to-grave version beloved of postwar socialists, then at least one where governments mandate some form of universal healthcare and pension provision. In the US, meanwhile, the more basic social security and medical safety net provided by the government is dwarfed by generous health and retirement benefits offered by large employers - a voluntary paternalism long ago dubbed "welfare capitalism".

                                                                                                                                                                  Both models lend themselves to easy caricature. ... Yet in truth, the challenges facing rich economies are remarkably similar. Ageing populations and rising medical costs are straining twentieth-century welfare systems to their limit. Just as Europe's social model is creaking under the weight of German unemployment or the runaway budget of Britain's National Health Service, so the US model is being tested to destruction in industries such as carmaking and airlines...

                                                                                                                                                                  Employees, too, are realising the limitations of relying on one source for both their salary and welfare insurance. The shortfall in many corporate pension funds has left some US workers doubly penalised when their companies go bankrupt. Other companies are choosing to shift much of the risk from uncontrollable costs back to employees, either by switching from guaranteed pensions towards defined-contribution saving schemes or by encouraging individual responsibility for health insurance though high deductions on claims and flexible health savings accounts. ...

                                                                                                                                                                  If welfare capitalism is dying away, what will replace it - a more self-reliant individualism or creeping state intervention? The irony of the second scenario is not lost on those who study the history of US corporate benefits. Since American Express launched the first employer-provided retirement plan in 1875, through the Great Depression and the postwar boom, part of the reason the business community has been willing to provide such benefits was to guard against the dread accretion of big government. "Employers had reasons for doing this other than paternalism," says Sanford Jacoby, a UCLA management professor who wrote a book on welfare capitalism. "One reason schemes were more elaborate than in Europe was companies wanted to avoid the creeping social insurance." ...

                                                                                                                                                                  Signs that employers are reconsidering their unwritten social contract with Americans are everywhere. Last week, IBM ... announced it would freeze this defined-benefit scheme ... A similar sharing of burdens is taking place in healthcare. Many of the newer health insurance plans offer greater flexibility to employees. As with defined-contribution pensions, employers are encouraging people to open health savings accounts that put patients in charge of their own spending but can leave them with nasty surprises if the money runs out. Yet supporters of this so-called "consumer-driven healthcare" movement argue it is overly simplistic to say this is just about saving money or shifting risk. ...

                                                                                                                                                                  Certainly, the days when employers would simply pick up every medical bill are nearly gone. Only 28 per cent of US employees worked at businesses offering health plans that require no employee contribution in 2003, compared with 35 per cent in 1998 ... A still bigger problem lies with companies that offer no health cover at all. Since 2000, the number of Americans without health coverage has increased by 6m to reach 45.8m, according to the US Census Bureau - an increase many attribute to a decline in employer- sponsored coverage. ...

                                                                                                                                                                  For this reason, pressure is growing for legislation to force large employers to spend at least 8 per cent of their payroll on health insurance or pay the rest toward a state-run scheme. Business groups fear that could be the thin end of the wedge in allowing states to dictate how they offer benefits. The union-backed campaign hopes this year to introduce bills in 20 state legislatures, the first of which may come in Maryland, where it is aimed mainly at Wal-Mart. The legislation - which may pass as early as today ...

                                                                                                                                                                  John Sweeney, president of the AFL-CIO umbrella group, argues: "It is nothing short of immoral that big, rich companies are shirking their responsibilities." But in spite of the heated partisan language, replacing the old model of welfare is something both ends of the political spectrum are beginning to worry about. With the number of Americans aged over 65 set to more than double from 35m in 2000 to 81m by 2050, few can ignore the issue.

                                                                                                                                                                  "All countries rely on a mix of insurance provided by individuals, employers, insurers and governments," says Prof Jacoby. "In the US, there has traditionally been a relatively large role provided by companies. The real difficulties [in the new model] will arise for those employees who are unable to afford health insurance or save for their retirement. This in turn may put pressure on governments. It would be back to the future."...

                                                                                                                                                                  The decline of welfare capitalism in the US has yet to prompt a broad public backlash ... So far, the strongest response has come from affected workers... Mr Bush's failure last year to reform Social Security, the federal pension programme, serves as a reminder of how politically charged such important economic programmes are. But ... "Republicans are hearing from their friends in business." Mr Nichols says he has been called in to talk to two Republicans considering bids for the 2008 presidential nomination. He declines to name them but says one asked for advice on how he could discuss universal coverage in a way that was consistent with Republican principles such as low taxation and limiting the size of government. The second asked about what Mr Nichols calls the "moral case" for healthcare....

                                                                                                                                                                  Politicians, employers, employees and activists with a range of views - from those who favour universal health coverage to backers of individual health savings accounts - have begun to communicate. "There are people talking to each other on this issue who wouldn't have returned each other's phone calls eight years ago," he says.

                                                                                                                                                                  Opinion polls suggest most Americans believe the government has some responsibility to ensure that everyone has healthcare coverage. But most also favour maintaining the current system, based mostly on private insurance. A lesson Mr Nichols learnt during the Clinton era is similar to one Mr Bush learnt last year during the Social Security debate: such big steps cannot be pushed through with narrow majorities. As Mr Nichols says: "It is going to have to be truly from the centre, with bipartisan support."...

                                                                                                                                                                    Posted by Mark Thoma on Friday, January 13, 2006 at 10:37 AM in Economics, Health Care, Social Security

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                                                                                                                                                                    Asymmetries, Monetary Policy, and Asset Prices

                                                                                                                                                                    There has been a lot of discussion about New York Fed president Geithner's speech (e.g., Nouriel Roubini, Angry Bear, Calculated Risk) on how monetary policy should respond to asset price changes, so let me suggest one reason to use monetary policy to respond in advance to expected changes in asset prices, the presence of asymmetries.

                                                                                                                                                                    Let's use a very simple model, perhaps too simple, to try and enlighten a few of Geithner's remarks. In this model the Fed expects two scenarios with equal probability. In the first scenario, the economy is strong and output is 10 units above the natural rate. In the second scenario, there is an housing crash and output falls below the natural rate by 10. Using a squared loss function that treats positive and negative deviations of output from the natural rate symmetrically, this gives a loss of 100 (the loss should be in utility, but I am skipping translating output changes into utility changes to keep it simple).

                                                                                                                                                                    Next, let the Fed expect the same scenarios occur with the same probabilities except this time the Fed puts stimulative policy in place in advance that lifts output by 5 units under either scenario (another simplifying assumption, this could be asymmetric). Due to lags in the effects of policy, the decision must be made prior to knowing which scenario will occur. In this case the loss is 125, larger than the loss under no policy and the Fed is better off not putting a policy in place in advance. Because of the squared loss, the positive deviation to 15 is more costly than the saving from only moving to -5 on the down side.

                                                                                                                                                                    With asymmetric expectations of deviations from the natural rate of output, policy can be justified. To see this, let the Fed expect two scenarios with equal probability as before, a recession of -20 from the natural rate from an housing crash, and a positive deviation of 10 with no crash. With no policy in advance, the loss is 250:

                                                                                                                                                                    But with stimulative policy put in place in advance that raises output by 5 under either scenario as before, the loss is smaller:

                                                                                                                                                                    Asymmetric probability will give the same result, as will an asymmetric loss function. So, the presence of asymmetries around the natural rate of output is one way to justify intervention in advance (because overshooting, e.g., is less costly than a recession), as are other types of asymmetries. Note that this model does not account for inflation, etc., and is thus very incomplete, the goal is to demonstrate that asymmetries can justify policy action in advance when there is an anticipation of an asset price crash.

                                                                                                                                                                    In his speech, Geithner expressed the worry that:

                                                                                                                                                                    Even in circumstances where asset prices may appear to have moved away from fundamentals, and it seems reasonable to consider the implications of some deceleration in the pace of future increase or some decline, central banks need to be very cautious about adjusting policy in anticipation of that event ... If it turns out that the anticipated fall in asset prices does not materialize, the policy constructed under the assumption of a decline will likely have been too easy...

                                                                                                                                                                    and as shown above under symmetry, or nearly so, such worries can justify inaction. In the second graph, policy was too easy on the upside resulting in a deviation of +15 and that was the reason for the larger loss relative to no policy option shown in the first graph. Geithner also notes one potentially important asymmetry that can justify policy action:

                                                                                                                                                                    Although the potential case for adjusting policy applies in both directions, the implications for policy may differ. Because some asset prices may fall more abruptly than they rise, and because the effects of downward moves in asset prices on demand may be larger ... the case for adjusting monetary policy in response to negative asset price shocks is commonly considered more compelling than in the alternative context. But this does not mean that monetary policy should generally ignore the effects of increases and only respond to observed declines in asset prices. The test should be the size and circumstances of the asset price moves and their impact on the forecast relative to the central banks’ objectives, not the direction of the asset price move.

                                                                                                                                                                      Posted by Mark Thoma on Friday, January 13, 2006 at 12:33 AM in Economics, Monetary Policy

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                                                                                                                                                                      Price as a Signal of Quality in Foreign Exchange Markets

                                                                                                                                                                      According to this commentary in the Financial Times, exchange rate analysts are full of . . . . good stories:

                                                                                                                                                                      The Belgian chocolate theory of the dollar, by Paul de Grauwe, Financial Times: A year ago, most analysts agreed: the dollar could only go down against the euro and the other main currencies. The huge US current account deficits had become unsustainable and called for a big decline of the dollar. A year later these analysts proved to be wrong. The dollar went up by close to 15 per cent against the euro. What went wrong? Let me answer the question by telling a story about Belgian chocolates.

                                                                                                                                                                      A few weeks ago an interesting experiment was undertaken at the Brussels food fair... A shop was put up selling boxes of Belgian chocolates. The first day the price was set at €9 for each box. Sales went well. The next day the price was raised to €15 per box. ... Demand doubled. On the third day the price was lowered to €2 for each box. Demand for chocolates collapsed. What went wrong ...?

                                                                                                                                                                      It is very difficult, if not impossible, for the consumer to find out the quality of chocolates by just looking at their appearance in the shop. When confronted with such uncertainty..., consumers use simple rules of thumb that they understand. ... Most consumers have some experience that allows them to associate high price with high quality. ... not always ... but on average ... Thus when looking at the €15 box the consumers infer ... high ... quality and they buy the chocolates. Consumers who see the boxes priced at €2 infer ... the quality ... is not to be trusted, and they do not buy them. ...

                                                                                                                                                                      Most people dealing in the foreign exchange market have no clue about the fundamental value of the dollar (the “quality” of the dollar). Specialists and professors do not know either, at least within a broad range of dollar-euro rates between say, $1.0 and $1.3. ... Faced with such uncertainty, traders in dollars and euros ... will therefore use a rule of thumb, an easy guide that they understand. ... Thus when the dollar goes up ..., the increasing dollar is a signal ... there must be some hidden economic strength driving the dollar. And they buy dollars... Conversely, when the dollar moves down for whatever reason, people interpret the decline ... as reflecting a fundamental weakness..., and they sell dollars. As a result..., the dollar moves up and down within upper and lower bounds ... determined by our lack of knowledge ...

                                                                                                                                                                      There is a difference, though, between Belgian chocolates and the dollar. The Belgian chocolate lover ... can immediately check the quality by tasting the chocolates. The buyer of dollars cannot. But he is in need of a justification of his buy as a good one. And here the analyst comes in handy.

                                                                                                                                                                      The analyst, who does not know more about the fundamental value of the dollar than the unsuspecting buyer, invents stories. Thus when the dollar goes up, the analyst goes on a search for variables that move in the right direction and that can be linked to the rising dollar, carefully eliminating ... all the other fundamental variables that move in the wrong direction. And so we are told that the strength of the dollar last year was due to interest rate differentials favouring the dollar. The further widening of the current account deficit, which in a previous analysis got centre stage, is carefully dropped from the new analysis.

                                                                                                                                                                      The honest story of why the dollar increased last year is that we simply do not know. But we do not like to admit that we do not know. ... [A]nalysts ... fulfill a psychological need to understand. Exchange rate economics ... satisfies this need by telling a new story each time the dollar goes up or down. What does that tell us about the coming year? You may now be concluding that the sceptical tone ... does not leave me much scope to say something useful. Yet I do think that the cumulated force of increasing US current account deficits and debts will be overwhelming, bringing down the dollar. But do not ask me when this will happen.

                                                                                                                                                                      New Economist has more, including a discussion of the inconsistency in the last paragraph.

                                                                                                                                                                        Posted by Mark Thoma on Friday, January 13, 2006 at 12:27 AM in Economics, International Finance

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                                                                                                                                                                        Chicago Fed's Moskow: Further Tightening May Be Needed

                                                                                                                                                                        Chicago Fed president Michaels Moskow's speech begins with an extensive review of the outlook for economic growth and inflation. Since the review is essentially along the lines of other what other FOMC members have expressed previously, after a few summary statements I'll skip forward to his statements about policy. Given the robustness of economic growth, he favors increasing the target rate so long as there is any hint of long-run inflationary pressure and thus, for him, policy depends critically on new information concerning the outlook for inflation:

                                                                                                                                                                        U.S. Economic Outlook, by Michael H. Moskow, Chicago Fed President, January 12, 2006: Over the last two years, real gross domestic product has been growing an average of 3.7 percent each year. This is somewhat faster than potential, or the rate of GDP growth that can be sustained without creating inflation pressures. ... The unemployment rate has fallen to 4.9 percent; at the Chicago Fed, we think that this rate is roughly consistent with an economy operating at potential. In addition, the capacity utilization rate in manufacturing has nearly reached its historical average. ... Finally, core inflation has changed only modestly in recent months. ... According to the Blue Chip consensus, real GDP growth is expected to average about 3-1/4 percent over the next two years—close to recent estimates for potential. And Blue Chip projects the unemployment rate will stay a bit below 5 percent through the end of next year. ... Given the fundamentals, I think the Blue Chip forecast is reasonable. But there certainly are some risks. ...

                                                                                                                                                                        The latest readings on the core price index for personal consumer expenditures ... have been favorable.... Still, for most of this past year, core PCE inflation has been running close to 2 percent, which is at the upper end of the range that I feel is consistent with price stability. ... Fortunately, current financial market data and consumer surveys suggest that long-run inflation expectations remain contained. Nonetheless, it will take appropriate monetary policy to keep inflation and inflation expectations contained. For me, this likely entails some further policy action. Whatever actions are taken, however, will depend on economic conditions. ...

                                                                                                                                                                        Conceptually, it's easiest to think about the neutral—or equilibrium—rate as being the rate consistent with an economy growing steadily along its potential growth path over a long period of time. ... By such measures, we're currently in the bottom end of this range. Of course, this is a rough estimation. ... But there is another very important point to emphasize. Even if the funds rate were at neutral, further changes in policy might be appropriate. ...[A]s I mentioned earlier, there are risks to the inflation outlook—namely, the potential for energy cost pass through, pressures from increases in resource utilization, or rising inflationary expectations. ... My views about policy will depend importantly on how various cost factors play out and affect the outlook for inflation. ... if inflation or inflation expectations were to rise persistently, then policy clearly would have to be tightened further. Of course, other events could transpire that result in prospects for inflation and growth that would be consistent with a less firm policy stance. ... policy will not be a mechanical reaction to the next number on inflation or employment. ...

                                                                                                                                                                        There is quite a bit more in the speech on these and other topics such as national savings and education.

                                                                                                                                                                          Posted by Mark Thoma on Friday, January 13, 2006 at 12:15 AM in Economics, Fed Speeches, Monetary Policy

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                                                                                                                                                                          January 12, 2006

                                                                                                                                                                          The Economic and Social Costs of Unemployment

                                                                                                                                                                          When economists teach about unemployment, they are careful to point out that the costs of unemployment go beyond the loss of GDP from having unemployed resources, there are also the human and social costs to consider. Here's a good example of this from Japan:

                                                                                                                                                                          We have heard quite a bit lately about job tenure and worker security. The implication drawn by some from recent research showing that job tenure hasn't changed substantially in recent decades is that worker insecurity has not changed either (more discussion at TPM Cafe and in The New Yorker both of which note the broader costs).

                                                                                                                                                                          But this research does not examine the costs of being unemployed. If the economic or social costs of unemployment rise, then worker insecurity will rise even if job tenure is unchanged.

                                                                                                                                                                          For example, suppose that relative to the past it is more likely that job loss is due to structural rather than cyclical factors or competition, but average job tenure is unchanged. If the job loss is cyclical, the worker has a good chance of being rehired later. If the loss is due to competition, then a competitor will have jobs. But if it is structural and the loss is permanent, i.e. that particular job no longer exists anywhere, then it will be much more costly to be unemployed and worker anxiety will rise even though job tenure is unchanged, particularly if such workers are often rehired later in different occupations at much lower incomes. The point is that there is much more to worker insecurity then simply examining statistics on job tenure. For example, this research shows that income volatility has increased over time:

                                                                                                                                                                          [S]cholars have concluded that incomes are much less stable - i.e., much more volatile - today than they have been in the past. 'There has unequivocally been general upward-trend income volatility since at least 1975,' ... [I]ncome volatility can wreak greater havoc now than it did in the past. ... It was generally thought that when families' incomes fell sharply and unexpectedly, they would borrow, tap into savings or send a second adult (frequently a mother) into the work force rather than sharply reduce consumption. But, Professor Chetty said, 'that no longer seems to be the case today.' Why? Many families already rely on two incomes.... THE factors that functioned as internal shock absorbers for families have weakened. And so, too, have external buffers. Over the last three decades, the percentage of workers covered by defined-benefit pension plans and employer-provided health insurance - guarantees that provide ballast for fluctuating incomes - has declined. Add this to the trend of rising volatility - especially for people in the lower and middle income levels - and it's easy to understand ... 'The real issue lurking behind this debate is whether we should have a program that provides the bedrock protection against economic risk.'

                                                                                                                                                                          [Note: The graph is from Miracle to Malaise: What’s Next for Japan? in an Economic Letter from the Dallas Fed. I hope to have more on that paper later.]

                                                                                                                                                                            Posted by Mark Thoma on Thursday, January 12, 2006 at 11:21 AM in Economics, Social Security, Unemployment

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                                                                                                                                                                            Fairness and Productivity

                                                                                                                                                                            Tax and regulatory changes in Britain have had few discernible positive effects on productivity. This commentary offers an explanation for the failure of productivity to respond to tax cuts and other changes:

                                                                                                                                                                            Britain overlooks productivity factor, by Michael Prowse, Financial Times: After Labour transferred responsibility for price stability to the independent monetary policy committee in 1997, raising productivity growth ... became the Treasury’s central preoccupation. Gordon Brown, the chancellor, attacked the new microeconomic agenda with an almost religious zeal, unveiling dozens of tax and regulatory changes... His quest resembled that of a medieval knight in search of the grail...

                                                                                                                                                                            Yet after nearly nine years, the results look meagre. The Treasury claims that output per worker has grown slightly faster since 1997 ... But other experts cannot discern any change. Output per hour worked is arguably a better measure of productivity ... And on this measure, figures ... show ... UK output per hour grew faster ... during the 1970s, a decade of labour unrest and macroeconomic instability. After allowing for differences in purchasing power, output per hour worked remains lower in Britain than in France, Germany, Belgium, the Netherlands and Ireland... In supposedly sclerotic France, productivity is still about 20 per cent higher than in Britain. ...

                                                                                                                                                                            Mr Brown’s strategy may yet be proved right because time lags on the supply side are notoriously long. Yet he may also be failing to allow sufficiently for cultural and social factors. Productivity depends on work effort – but that of all employees rather than just that of a few highly remunerated board members. ...

                                                                                                                                                                            Market theory suggests the key to productivity lies in performance-related pay ... Yet this just reflects its assumption that people are motivated solely by their command over goods and services. Modern behavioural economics and evolutionary psychology suggest ... that people’s response depends on how they are doing relative to others, and how fairly they believe they are treated – which ought not to be surprising. ...

                                                                                                                                                                            So, within reason, a productive workplace is likely to be one in which the average band member feels justly treated as a member of a social group. But this implies that reforms ... which enhance businesses’ capacity to treat people like commodities to be bought and sold as market conditions fluctuate, may sometimes be counter-productive. The dramatic widening of differentials between boardroom and shop floor pay may have boosted the work effort of directors, although this is unproven. But what has it done for rank-and-file morale? And why should the average employee work his heart out for an employer who refuses to contribute to decent pensions and sacks staff in downturns? ...

                                                                                                                                                                            What neo-Darwinian biology and behavioural economics suggest is a direct link between fairness and productivity. People give their best when they feel justly treated relative to others. It is as simple – and difficult – as that.

                                                                                                                                                                              Posted by Mark Thoma on Thursday, January 12, 2006 at 12:33 AM in Economics, Policy

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                                                                                                                                                                              Varian: Information Technology and Productivity Growth

                                                                                                                                                                              Hal Varian explains the recent increase in productivity and the difference in productivity between the U.S. and Europe. The difference is explained by the efficient integration of computers into the production process to optimize the flow of information, an area where the U.S. has taken the lead:

                                                                                                                                                                              American Companies Show an Edge in Putting Information to Work, by Hal R. Varian, Economic Scene, NY Times: Productivity just keeps humming along. ... From 1974 to 1995, productivity grew at around 1.4 percent a year. Productivity growth in the United States accelerated to about 2.5 percent a year from 1995 to 2000. Since then, productivity has grown at a bit over 3 percent a year, with the last few years looking particularly strong. Unlike the United States, European countries have not seen the same surge in productivity growth in the last 10 years. Why the difference?

                                                                                                                                                                              The answer, according to Nick Bloom, Raffaella Sadun and John Van Reenen, researchers at the Center for Economic Performance at the London School of Economics, is that American companies make much more effective use of information technology than European companies. (A selection of their studies can be downloaded from

                                                                                                                                                                              Nowadays, most economists agree that information technology is a significant part of the explanation for the post-1995 productivity surge in the United States. ... The story is quite different in the European Union. In the late 1990's, ... productivity growth in Europe was static. But Europe has access to the same information technology that the United States does, at more or less the same prices. Why didn't those countries get the same increase in productivity?

                                                                                                                                                                              To answer the question, we have to move away from macroeconomics and look at the experience of individual companies. Work by the economist Erik Brynjolfsson and his colleagues at M.I.T. suggests that organizational factors are quite important. Just dropping a bunch of new personal computers on workers' desks is unlikely to contribute to productivity. A company has to rethink how business processes are handled to get significant cost savings.

                                                                                                                                                                              As the Stanford economic historian Paul A. David has pointed out, the productivity effects from the electric motor did not really show up until Henry Ford and other industrialists figured out how to use it effectively to create the assembly line. The same is true for computers: ... companies today must learn how to use information technology to optimize the flow of information in their organizations.

                                                                                                                                                                              It appears that United States companies are much farther up the learning curve than European companies. ...[T]he authors suggest that information technology capital may be a big part of the productivity difference: American companies in Britain use a whopping 40 percent more information technology capital per worker than the average company. Not only did American companies use more information technology, they used it more effectively. ...

                                                                                                                                                                              Why the difference in effective use of information technology? This is still something of a mystery, but part of the answer seems to be managerial practices. ... Personally, I have found that American managers are much more comfortable with computers than their European counterparts. Until a few years ago, a typical European manager could not even type. This is no longer true of the younger generation of European managers, and ... as they move up in their organizations, managerial comfort with information technology in European companies will broaden.

                                                                                                                                                                              As a business school professor, I sometimes worry whether we are giving our students the right skills in finance, accounting, marketing and leadership. But the one thing I never worry about is their skills in PowerPoint and Excel... Perhaps the comfort of young American managers in using computers and other sorts of information technology contributes more than we realize to productivity growth.

                                                                                                                                                                                Posted by Mark Thoma on Thursday, January 12, 2006 at 12:21 AM in Economics, Technology

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                                                                                                                                                                                Taxes and Disposable Income of Workers in OECD Countries

                                                                                                                                                                                OECD in Figures - 2005 Edition (data for 2002) Disposable Income of the Average Production Worker (% of Gross Pay)
                                                                                                                                                                                Total Tax as % of GDP Highest Personal Tax Rate Highest Corporate Tax rate Single Married with Two Children
                                                                                                                                                                                Australia 31.5 48.5 30.0 76.0 84.4
                                                                                                                                                                                Austria 44.0 42.9 34.0 71.4 91.1
                                                                                                                                                                                Belgium 46.4 47.4 40.2 58.8 79.0
                                                                                                                                                                                Canada 33.9 46.4 38.6 75.6 85.7
                                                                                                                                                                                Czech Republic 39.3 28.0 31.0 77.1 101.9
                                                                                                                                                                                Denmark 48.9 54.4 30.0 57.7 70.3
                                                                                                                                                                                Finland 45.9 51.8 29.0 68.5 77.2
                                                                                                                                                                                France 44.0 40.0 35.4 73.2 85.4
                                                                                                                                                                                Germany 36.0 51.2 38.9 59.0 81.7
                                                                                                                                                                                Greece 35.9 33.6 35.0 83.7 83.2
                                                                                                                                                                                Hungary 38.3 56.0 18.0 70.6 91.5
                                                                                                                                                                                Iceland 38.1 44.0 18.0 74.9 95.3
                                                                                                                                                                                Ireland 28.4 42.0 16.0 83.6 120.7
                                                                                                                                                                                Italy 42.6 41.4 36.0 71.7 85.1
                                                                                                                                                                                Japan 25.8 47.2 40.9 80.7 84.9
                                                                                                                                                                                Korea 24.4 36.7 29.7 91.1 91.7
                                                                                                                                                                                Luxembourg 41.8 33.9 30.4 77.9 103.0
                                                                                                                                                                                Mexico 18.1 35.0 35.0 96.3 96.3
                                                                                                                                                                                Netherlands 39.2 52.0 34.5 71.4 82.9
                                                                                                                                                                                New Zealand 34.9 39.0 33.0 79.9 81.2
                                                                                                                                                                                Norway 43.5 47.5 28.0 71.2 82.0
                                                                                                                                                                                Poland 32.6 26.2 28.0 68.9 70.8
                                                                                                                                                                                Portugal 33.9 35.6 33.0 83.5 94.6
                                                                                                                                                                                Slovak Republic 33.1 33.1 25.0 81.3 99.1
                                                                                                                                                                                Spain 35.6 48.0 35.0 80.7 89.5
                                                                                                                                                                                Sweden 50.2 55.5 28.0 69.6 79.2
                                                                                                                                                                                Switzerland 30.3 34.0 24.4 78.6 91.4
                                                                                                                                                                                Turkey 31.1 40.6 33.0 69.9 69.9
                                                                                                                                                                                United Kingdom 35.8 40.0 30.0 76.8 90.1
                                                                                                                                                                                United States 26.4 45.2 39.3 75.7 88.5
                                                                                                                                                                                EU average 40.6 44.6 32.4 72.5 86.2
                                                                                                                                                                                OECD average 36.3 42.6 31.2 75.2 86.9

                                                                                                                                                                                Notes: International comparisons should also take into account differences among countries in the length of tax brackets, the amount of tax relief and rates of social security contributions. The highest rate of income tax includes temporary special surcharges. All rates include rates of state and local income taxes as reported in the OECD Tax Database. Family income is one-earner family. Takes account of family allowances and/or tax reliefs.

                                                                                                                                                                                  Posted by Mark Thoma on Thursday, January 12, 2006 at 12:15 AM in Economics, Taxes

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                                                                                                                                                                                  New York Fed's Geithner on the Fed's Response to Asset Price Movements

                                                                                                                                                                                  New York Fed president Geithner discusses the development of global asset markets and the impact of the development on monetary policy. The speech begins with a review of the past year which echoes many previous reviews from the Fed, so I will skip forward to his remarks on how asset prices should affect monetary policy. He believes that asset price movements must be considered in setting policy, but only if changes in asset prices affect forecasts of inflation and output. Asset prices should not be the goal of policy. He also explains why negative asset price movements should command more attention from policy makers than positive movements.

                                                                                                                                                                                  Bottom line: We don't know as much as we'd like about how asset prices are determined or how changes in asset values affect inflation and output, but these markets are increasing in importance so we need to learn more. In cases where we are confident we understand how an event in asset markets will affect forecasts of inflation and output, policy should respond:

                                                                                                                                                                                  Some Perspectives on U.S. Monetary Policy, by Timothy F. Geithner, New York Fed Chair: ... There is a well established, and I believe fundamentally correct, case against directing monetary policy at specific objectives for asset values or the future path of those values. ... [A]sset values should be neither a target nor a goal of monetary policy. ... Because we know so little about how to assess the appropriateness of asset values against fundamentals, ... [m]onetary policy does not today and is unlikely in the future to offer us an effective tool for directly reducing the incidence of large or sustained deviations of asset values from ... their fundamental values...

                                                                                                                                                                                  That said, monetary policy still has to take into account the impact of significant movements in asset values on output and inflation. ... History provides us with numerous examples in which significant movements in asset prices have had sizable effects on the path of output relative to potential and on price stability. And experience suggests that asset values can be very sensitive to ... perceptions of future policy moves. The challenge for central banks is to determine how movements in asset values and expected asset values affect the evolution of the economy. ...

                                                                                                                                                                                  The incorporation of asset price movements into monetary policy formation is hard to do, in part, because we don’t know that much about the transmission mechanism from movements in asset values to the underlying economic fundamentals we care about. ... And successfully integrating asset prices into monetary policy formulation is also hard to do because of the difficulty of assessing how ... monetary policy will ... affect asset values. ... But to acknowledge these complexities does not weaken the case for ... trying to make sensible judgments about how monetary policy should respond to asset price developments. Here are some considerations:

                                                                                                                                                                                  First, in circumstances where the central bank observes a large realized movement in asset prices and is confident in its knowledge of the impact ... on ... aggregate demand, monetary policy may need to follow a different path than might have seemed appropriate in the absence of those developments. .... Of course central banks must always be prepared to respond when factors threaten to push aggregate demand away from aggregate supply and impact the inflation outlook. Movements in asset prices certainly have the potential to be one of those factors...

                                                                                                                                                                                  Because some asset prices may fall more abruptly than they rise, and because the effects of downward moves in asset prices on demand may be larger due to the greater negative impact of deflation on the net worth of borrowers—witness the United States in the 1930s or Japan in the 1990s, the case for adjusting monetary policy in response to negative asset price shocks is commonly considered more compelling than in the alternative context. ...

                                                                                                                                                                                  More generally, despite the fact that policymakers can’t be completely confident in their assessment of the future path of asset prices, it seems unavoidable that these assessments will factor into policy decisions. ... [P]olicy, in some circumstances, will need to respond to asset price movements when those movements alter the central bank’s assessment of the risks to its outlook...

                                                                                                                                                                                  This leaves us with no simple or clear doctrine for the role of asset prices in monetary policy regimes. Asset prices probably matter more than they once did, but what that means for monetary policy necessarily depends on the circumstances. ...

                                                                                                                                                                                  Update: See Nouriel Roubini's extensive comments on the significance of these remarks.

                                                                                                                                                                                    Posted by Mark Thoma on Thursday, January 12, 2006 at 12:07 AM in Economics, Fed Speeches, Monetary Policy

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                                                                                                                                                                                    January 11, 2006

                                                                                                                                                                                    China's Green Ambitions

                                                                                                                                                                                    Green China?, posted at Environmental Economics, summarizes an article from the Financial Times "A prescription to advance China’s green ambitions" on the steps China can take to achieve its goal of environmentally sustainable growth.

                                                                                                                                                                                      Posted by Mark Thoma on Wednesday, January 11, 2006 at 04:05 PM in China, Economics, Environment

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                                                                                                                                                                                      Will Wages Grow Faster?

                                                                                                                                                                                      How low can unemployment go before wages begin growing at a faster rate? It depends upon whether discouraged workers return to the labor force as conditions improve and hold down wage pressure, and the extent to which labor available in other countries can be used when the U.S. labor market tightens. Here's a quick summary of these issues from the Financial Times:

                                                                                                                                                                                      Decline in US jobless figures, by Christopher Swann, Financial Times: ... After several years of rising unemployment following the bursting of the high technology bubble in 2000, the jobless level nationwide has fallen from 6.3 per cent in June 2003 to 4.9 per cent last month, with more than 4m jobs created over the past two years. There are growing concerns that unemployment is now falling to levels that are bringing faster wage growth and inflation... But how tight is the US labour market? Many economists believe conditions are still far less rosy for jobseekers than the improved unemployment figures suggest. There is good evidence that many potential workers who gave up looking for employment when the economy turned down have still not re-entered the workforce.

                                                                                                                                                                                      The participation rate ... is still far from its peak. In the middle of 2000 it reached 67.3 per cent of the population and now stands at just 66 per cent, close to its cycle low of 65.8 per cent. ... The question for economists is whether these marginal workers have left the labour market for good. “If they are waiting in the wings and will come back to work as conditions improve further, then we might not need to be quite so worried about accelerating wage growth,” says Paul Ashworth, US analyst at Capital Economics. “If, on the other hand, they have retired and moved to Florida, there is a greater risk that wages and inflation will start to pick up.”

                                                                                                                                                                                      So far the decline in unemployment has done little to help workers extract higher wages. ... But some fear that the level of unemployment may be reaching tipping point. ... Federal Reserve policymakers have expressed concerns that capacity constraints will soon start to heighten inflationary pressures.

                                                                                                                                                                                      One hope for the Fed and businesses is that even if the US is running out of spare workers, the rest of the world can step into the breach. Some economists believe that the threat of moving production overseas has made it easier for companies to keep a lid on wage growth. “Companies have been able to tap not just cheap labour but also smart labour from abroad,” said Ian Morris, US economist at HSBC. “This may help explain why wage growth has remained weak and profits at S&P 500 companies have been surprisingly strong.”

                                                                                                                                                                                      ... This raises the possibility that US unemployment can now fall much lower before sparking high wage growth and inflation. “With so much extra international labour available, it may be that we can now get down to a 4 per cent unemployment rate before we see wage growth really taking off,” says Mr Morris.

                                                                                                                                                                                      Just one question for Mr. Ashworth about his choice of words concerning what we should worry about. Should workers be "worried about accelerating wage growth" from a tight labor market that might redistribute the "suprisingly strong" profits to wages?

                                                                                                                                                                                        Posted by Mark Thoma on Wednesday, January 11, 2006 at 02:04 PM in Economics, Unemployment

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                                                                                                                                                                                        Are Reports of Housing's Demise Premature?

                                                                                                                                                                                        Mortgage applications are up:

                                                                                                                                                                                        Mortgage applications rebound MBA: Applications increased 9.9% following five-week slump; interest rates fall to a two-month low, CNN/Money: U.S. mortgage applications rose for the first time in five weeks as interest rates on fixed loans fell to more than a two-month low, spurring a surge in demand for home loans... The Mortgage Bankers Association said its seasonally adjusted index of mortgage application activity for the week ended Jan. 6 increased 9.9 percent to 600.1 from the previous week's 545.9.

                                                                                                                                                                                        The group's seasonally adjusted index of refinancing applications increased 9.9 percent to 1,497.5, compared with 1,363.2 the previous week. The index moved higher for a second consecutive week. ... The MBA's seasonally adjusted purchase mortgage index increased 9.3 percent to 457.4 from the previous week's 418.3. The index is considered a timely gauge on U.S. home sales.

                                                                                                                                                                                        There are signs the market is moderating as well. This report is encouraging in that it indicates that the chance of a crash rather than a gradual slowdown is less likely. But if housing demand is as responsive to changes in interest rates as is implied by the article, what will happen if long-term rates rise suddenly as many fear they might in response to global imbalances and changes in foreigner's willingness to hold dollar denominated assets?

                                                                                                                                                                                          Posted by Mark Thoma on Wednesday, January 11, 2006 at 07:19 AM in Economics, Housing

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                                                                                                                                                                                          Why is the Yield Curve Flat?

                                                                                                                                                                                          Is this the answer?:

                                                                                                                                                                                          Goldman Sachs Economist May Just Have THE Answer, by John M. Berry, Bloomberg: Why have long-term interest rates hardly budged in the face of 13 increases in the Federal Reserve's target for the overnight lending rate? Economist Bill Dudley of Goldman Sachs has an answer -- maybe THE answer. And if Dudley's view is correct, the flattening of the yield curve over the past 18 months isn't signaling a significant slowdown in U.S. economic growth, much less a near- term recession. Dudley's explanation ... is straightforward:

                                                                                                                                                                                          -- Historically, longer-term interest rates usually have been higher that short-term rates because investors required compensation for expected future inflation, which was likely to be volatile.

                                                                                                                                                                                          -- That calculus has changed because of the Federal Reserve's success in keeping core inflation both low and less volatile.

                                                                                                                                                                                          ''The bond risk premium on the 10-year Treasury note is unusually low -- around zero -- when the 10-year yield is compared to expected future short-term interest rates,'' he said. ''Many explanations have been offered to explain the conundrum --including central bank buying of Treasuries and pension fund duration extension. ''But the collapse in the volatility of inflation relative to the volatility of real rates is a much more compelling explanation,'' Dudley said.

                                                                                                                                                                                          Over the past 15 years, volatility of the core personal consumption price index consistently has been much lower than that of inflation-adjusted short-term interest rates. According to Dudley's estimates, inflation volatility last year was less than a fourth of that of real rates. ''This change makes investing in longer-dated fixed-income assets more attractive,'' Dudley said. ''Investors can lock in a stable real rate of return and are subject to little inflation risk.''

                                                                                                                                                                                          On the other hand, buying a series of short-term securities isn't likely to provide a similarly stable real rate of return because the Fed, in an on-going effort to keep inflation low, will raise or lower its short-term rate target as needed. ...

                                                                                                                                                                                          Of course, such an investment decision requires investor confidence that the Fed will continue to control inflation more or less indefinitely. Dudley said he and his colleagues ... believe that the Fed's success under Chairman Alan Greenspan will continue when his successor, Ben S. Bernanke, ... takes over next month.

                                                                                                                                                                                          One consequence of the central bank's success is that it takes a higher Fed target for the overnight lending rate to offset the stimulus flowing from a lower bond risk premium. ''If the bond risk premium falls by 75 basis points, then the average level of short-term interest rates will have to be about 50 basis points higher to offset this,'' Dudley said. And that could mean that the current long string of rate increases ... ''could go somewhat further than anticipated.'' ...

                                                                                                                                                                                          Also ..., two Deutsche Bank economists, Torsten Slok and Christine Dobridge at Deutsche Bank, published a similar explanation for the unusual behavior of long-term rates. Unlike Dudley though, Slok and Dobridge said they expect enough of an increase in inflation that later this year the yield curve would steepen again. ... Their formal modeling also indicated that the yield curve would have to drop much further before it would be pointing to a significant probability of a recession...

                                                                                                                                                                                          I suppose I should note that I said something similar here, but I don't think that this is the whole story for the flattening of the yield curve. Widely cited factors such as the pattern of global saving and investment incentives are also a consideration.

                                                                                                                                                                                            Posted by Mark Thoma on Wednesday, January 11, 2006 at 12:42 AM in Economics, Monetary Policy

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                                                                                                                                                                                            Saving Capitalism from Catastrophic Meltdown

                                                                                                                                                                                            The University of Chicago's Raghu Rajan says the free market pendulum is in danger of swinging too far and that government regulation is needed to reduce the chances of a catastrophic meltdown:

                                                                                                                                                                                            U. of C. star economist says risks call for, yes, regulation, Raghu Rajan, on loan to IMF, says likelihood of meltdown grows, by Greg Burns, Chicago Tribune [Note: We have link rot, this is the best alternative]: These are quiet times in the global economy, just the sort of lull that worries Raghu Rajan, one of the University of Chicago's leading stars. On loan to the International Monetary Fund, ... the 42-year-old native of India sees risks on the rise in housing markets, hedge funds, pensions ... Difficult to track and often disguised, the steady accumulation of risks has increased the odds of what Rajan cautiously terms "a greater (albeit still small) probability of a catastrophic meltdown."

                                                                                                                                                                                            A sharp decline in home prices, for instance, could cripple the job market, trigger loan defaults, hurt anyone invested in mortgage securities, and eventually undermine every moving part of the interconnected financial system. "When you've let down your defenses, things can come and smack you," Rajan explained ...

                                                                                                                                                                                            Rajan is no Dr. Doom. His sophisticated ideas have won him the respect of the world's most rigorous financial experts. Yet he is convinced that years of easy credit and the rapid expansion of financial markets have left little cushion if things go wrong. "We haven't had a real storm in the financial markets since 1987," he said. "The cost of this thing could be tremendous if it turned out the wrong way."

                                                                                                                                                                                            What to do? Surprisingly for a dedicated advocate of free markets in the University of Chicago tradition, Rajan believes more government regulation is needed. After decades of deregulation and laissez-faire policies, "We are in danger of the pendulum swinging too far," he said. "The times have changed." ...

                                                                                                                                                                                            There is quite a bit more in the original article.

                                                                                                                                                                                              Posted by Mark Thoma on Wednesday, January 11, 2006 at 12:33 AM in Economics, Market Failure, Regulation

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                                                                                                                                                                                              Growth is Good

                                                                                                                                                                                              Robert Samuelson uses a discussion of Benjamin Friedman's book "The Moral Consequences of Economic Growth" as an excuse to tack a paragraph onto the end of his column making the same the same point he's made again and again recently, that the welfare state will drag us under:

                                                                                                                                                                                              Even Good Growth Can't Satisfy Welfare's Appetite By Robert J. Samuelson, The Washington Post (from the WSJ): ...[E]economic growth ... is widely seen -- especially in wealthy societies -- as morally corrupting: the mindless pursuit of materialism (do flat-panel TVs make us better off?) that drains life of spiritual meaning and also wrecks the environment. Exactly wrong, says Benjamin Friedman.

                                                                                                                                                                                              Mr. Friedman, a Harvard economist, has written a hugely provocative book ("The Moral Consequences of Economic Growth") arguing that rapid growth is morally uplifting. "Economic growth -- meaning a rising standard of living for the clear majority of citizens -- more often than not fosters greater opportunity, tolerance of diversity, social mobility, commitment to fairness, and dedication to democracy," he writes. Further, the opposite is true. Poor growth feeds prejudice, class conflict and anti-democratic tendencies.

                                                                                                                                                                                              Look at history, he says. In the United States, exploding economic growth after World War II coincided with a broad expansion of rights for women, blacks and the poor. In 1919, it passed the 19th Amendment giving women the vote. Good times often played out similarly in Europe. ... People, Mr. Friedman argues, compare themselves to "two separate benchmarks: their own (or their family's) past experience, and how they see people around them living." When living standards rise rapidly, more people feel optimistic, unthreatened and tolerant. Economic growth isn't mainly about greed.

                                                                                                                                                                                              Case closed? Well, not exactly. Mr. Friedman mostly misses the real growth predicament facing most advanced societies. The immediate dilemma involves the welfare state. It requires fast economic growth to generate the income and government revenues to pay all the promised benefits. But the mounting costs of those benefits ... may stifle growth through higher taxes and budget deficits. If so, the welfare state may cause the stagnation and strains against which Mr. Friedman warns.

                                                                                                                                                                                              Saying that well-being is lower when growth is lower, as Friedman does, but not covering every single way one can imagine growth slowing as Samuelson wants him to do, isn't missing the point. Friedman's goal isn't to list the ways growth might slow, the point is to examine how growth affects well-being.

                                                                                                                                                                                                Posted by Mark Thoma on Wednesday, January 11, 2006 at 12:21 AM in Budget Deficit, Economics, Health Care, Social Security

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                                                                                                                                                                                                No Change in White House and Fed Relationship Under Bernanke

                                                                                                                                                                                                According to administration officials, there won't be any change in the relationship between the White House and the Fed chair after Bernanke takes over:

                                                                                                                                                                                                Continuous Loop, by John D. McKinnon, Washington Wire, WSJ: Administration officials expect to pick up with new Federal Reserve Chairman Ben Bernanke where they leave off with retiring Alan Greenspan, in a seamless transition. The relationship between the White House and the incoming Fed chairman "will continue just the way we are with Chairman Greenspan," White House chief economic adviser Allan Hubbard tells The Wall Street Journal. Bush, Cheney, Chief of Staff Card and Hubbard have lunch with Greenspan every six weeks or so, he says. And Hubbard himself maintains "continuous communication" with Greenspan, who visited the White House 12 times in the first half of 2005. Cheney, who has been a Greenspan buddy since the Ford administration, speaks with him "quite frequently." "I would anticipate that that will be the way the relationship continues," Hubbard says, adding that "the president lets the Fed do its job without any attempt to influence it. ..." ... The White House has yet to fill two vacancies on the seven-member Fed board.

                                                                                                                                                                                                  Posted by Mark Thoma on Wednesday, January 11, 2006 at 12:15 AM in Economics, Monetary Policy, Politics

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                                                                                                                                                                                                  Your Tax Dollars at Work Servicing the Debt

                                                                                                                                                                                                  With interests rates rising, the debt rising, and payments on inflation indexed bonds rising, guess what? Interest on the debt increased sharply:

                                                                                                                                                                                                  Interest Grows, Washington Wire, WSJ: Federal spending to cover net interest on the public debt surged ... to $58 billion in the first quarter of fiscal 2006 from $43 billion a year earlier, according to the Congressional Budget Office. That means $1 of every $11 in federal spending in the September-to-December quarter went to interest "Costs were driven up by higher rates of inflation (which affect the amount paid on inflation-indexed securities), higher short-term interest rates, and growing debt," CBO said in a monthly budget report....

                                                                                                                                                                                                    Posted by Mark Thoma on Wednesday, January 11, 2006 at 12:12 AM in Budget Deficit, Economics

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                                                                                                                                                                                                    January 10, 2006

                                                                                                                                                                                                    Chile Confronts Problems Caused by Social Security Privatization

                                                                                                                                                                                                    Remember when Chile's private account system was hailed as a model for Social Security reform? As this article notes, the Chilean system was endorsed by President Bush, who has called it "a great example" from which the United States can "take some lessons." So what are the lessons?:

                                                                                                                                                                                                    Chile's Candidates Agree to Agree on Pension Woes, by Larry Rohter, NY Times: Michelle Bachelet is a pediatrician and a Socialist, while Sebastián Piñera is a billionaire businessman and a conservative. They may agree on little as the opposing candidates in Chile's election for president, but they concur on one important point: the country's much vaunted and much copied privatized pension system needs immediate repair. ... [D]issatisfaction with the system has emerged as one of the hot-button issues in the election...

                                                                                                                                                                                                    "Most people perceive the costs of pensions and the pensions themselves as unfair," said Patricio Navia, a political science professor at New York University and at Diego Portales University here. "Many of those who started work when the system was first adopted are realizing that they have not been able to contribute enough to get a significant pension," ... they resent "overhead costs that are so high" and that have led to record profits for the pension funds that manage contributions automatically deducted from workers' paychecks. ...

                                                                                                                                                                                                    "There are two big issues, coverage and costs," Andrés Velasco, Ms. Bachelet's economic adviser, said ... "Too many people are outside the system," he said, adding that too many of those in the system have found that "saving via the pension funds is quite expensive." ...

                                                                                                                                                                                                    [S]skeptics point to another developing problem: many young people, who should be enrolling in the system early to accrue maximum benefit, are staying out or paying in very little. Some cannot afford to contribute beyond the obligatory minimum payment, which is 10 percent of wages, while others are either self-employed or have been hired by companies as low-paid independent contract workers and therefore do not have to contribute at all. ...

                                                                                                                                                                                                    [E]ven advocates of an untrammeled free market, like Mr. Piñera, the conservative candidate, are jumping in with criticisms, to the surprise of some here. Mr. Piñera is the brother of José Piñera, the former labor minister who imposed the personal account system during the dictatorship of Gen. Augusto Pinochet. [and co-chairman of the Project on Social Security Choice at the conservative Cato Institute] ... "Chile's social security system requires deep reforms in all sectors, because half of Chileans have no pension coverage, and of those who do, 40 percent are going to find it hard to reach the minimum level," Mr. Piñera said ... "This has to be confronted now..." ...

                                                                                                                                                                                                      Posted by Mark Thoma on Tuesday, January 10, 2006 at 10:42 AM in Economics, Social Security

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                                                                                                                                                                                                      Heckman: Investing in Disadvantaged Children is Fair and Efficient

                                                                                                                                                                                                      James Heckman, Nobel laureate in economics in 2000 and a professor at the University of Chicago makes the case for early childhood intervention:

                                                                                                                                                                                                      Catch 'em Young, by James J. Heckman, Commentary, WSJ: It is a rare public policy initiative that promotes fairness and social justice and, at the same time, promotes productivity in the economy... Investing in disadvantaged young children is such a policy. The traditional argument for providing enriched environments for disadvantaged young children is based on ... fairness and social justice. But another argument can be made that ... is based on economic efficiency, and it is more compelling than the equity argument, in part because the gains from such investment can be quantified -- and they are large.

                                                                                                                                                                                                      There are many reasons why investing in disadvantaged young children has a high economic return. Early interventions ... promote schooling, raise the quality of the work force, enhance the productivity of schools, and reduce crime, teenage pregnancy and welfare dependency. They raise earnings and promote social attachment. Focusing solely on earnings gains, returns to dollars invested are as high as 15% to 17%. ...

                                                                                                                                                                                                      Families are the major source of inequality in American social and economic life. The accident of birth has substantial lifetime consequences. Adverse early environments are powerful predictors of adult failure on several social and economic dimensions. ... Experimental interventions that enrich early childhood environments ... produce more successful adults by raising both cognitive and noncognitive skills. At current levels of spending, early interventions targeted toward disadvantaged children have much higher economic returns than later interventions, such as reduced pupil-teacher ratios, public job training, convict rehabilitation programs, tuition subsidies or expenditure on police. ...

                                                                                                                                                                                                      Moving persons from the bottom to the top of either cognitive or noncognitive distributions has equally strong effects on many measures of social and economic success. Gaps in rankings of both cognitive and noncognitive ability by socioeconomic status emerge early in the life of the child, widen slightly in the early years of schooling, and stay constant after age eight. Research shows that schooling and school quality play only a small role in accounting for these gaps ... Controlling for early family environments narrows the gaps greatly. Family environments are major predictors of adult cognitive and noncognitive abilities. ...

                                                                                                                                                                                                      Although much public policy discussion focuses on the failings of schools, a major finding from the research literature is that schools ... contribute little to the emergence of test-score gaps among children. By the second grade, gaps ... across socioeconomic groups are stable ... [T]he abilities and motivations that children bring to school play a far greater role ... than do the traditional schooling input measures that receive so much attention in public policy debates. ...

                                                                                                                                                                                                      Many politicians and citizens place their faith in adolescent and young-adult remediation programs. ... However, the track records of criminal rehabilitation programs, adult literacy programs and public job-training programs are poor. ... Studies ... show that later compensation for deficient early family environments is very costly. ... If society waits too long to compensate for the accident of birth, it is economically inefficient to invest in the skills of the disadvantaged. A serious trade-off exists between equity and efficiency for ... adolescents and young adults. There is no such trade-off for policies targeted toward disadvantaged young children.

                                                                                                                                                                                                      Important operational details of investment programs for disadvantaged children remain to be determined. Children from advantaged environments, by and large, receive substantial early investment, while children from disadvantaged environments more often do not. There is little basis for providing universal programs at zero cost, although some advocate such a policy. While there is a strong case for public support for funding interventions in the early childhood of disadvantaged children, there is no reason for the interventions to be conducted in public centers. Vouchers that can be used in privately run programs would promote competition and efficiency in the provision of early enrichment programs. They would allow parents to choose the venues and values offered in the programs that enrich their child's earliest years.

                                                                                                                                                                                                      We have school choice here. You can send your child to any elementary, middle, or high school in town, any immersion or magnet school, charter school, and so on (rules for school choice, there are lotteries for some schools). This has caused a heated debate as to whether the program should continue unmodified as there is evidence that schools are now more segregated economically due to school choice. Children with resources tend to leave neighborhood schools more often than students with fewer resources, but even within the same school where there is an immersion and traditional school residing in the same building, such separation exists.

                                                                                                                                                                                                      After seeing something resembling a voucher system in action here (private schools are not part of it, but it does set up competition through choice and it's been in place a long time), I am not sold on the virtues of vouchers for those from lower income households. If the few students in poorer neighborhoods with resources use their vouchers to leave in disproportionate numbers, the stratification becomes worse, not better. When I first moved here, my kids were in the second poorest school in town by state demographic measures, though they didn't stay long. It had an alternative school and a regular school housed in separate wings of the same building and the disparity between the two schools in almost every dimension was very evident. The kids knew the difference. The steps involved in enrolling a student in the alternative school seemed to be enough to allow the enclave to develop.

                                                                                                                                                                                                      We need to do more, and I think Heckman may be right, perhaps it is a problem of being from a disadvantaged family - around here one disadvantage is parents who do not or cannot take action to find better schools for their kids (resource constraints restrict choice for some families, e.g. transportation to school and after school care, etc., though that is less of an excuse in the co-habitating programs).

                                                                                                                                                                                                      How will we get those parents who define disadvantaged families to use the vouchers? That vouchers "allow parents to choose the venues ... that enrich their child's earliest years" sounds good, but that is not how I've observed it working in practice. Allowing parents to do something does not mean they will actually do it. It may be necessary to do more than hope that children, through the vouchers in their parent's hands, will find their way to the programs they need.

                                                                                                                                                                                                      Update: Cleveland Fed president Sandra Pianalto gave a speech today on "Early Childhood Education and Our Economic Future."

                                                                                                                                                                                                        Posted by Mark Thoma on Tuesday, January 10, 2006 at 12:33 AM in Economics, Income Distribution, Policy

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                                                                                                                                                                                                        Health Care Costs Consume Record Share of the Economy

                                                                                                                                                                                                        Health care costs as a percentage of GDP set a new record:

                                                                                                                                                                                                        Record Share Of Economy Is Spent on Health Care, by Marc Kaufman and Rob Stein, Washington Post: Rising health care costs ... now consume 16 percent of the nation's economic output -- the highest proportion ever, the government said yesterday ... The nation's health care bill continued to grow substantially faster than inflation and wages, increasing by almost 8 percent in 2004... Spending for physicians and hospitals shot up considerably faster than in recent years, while drug costs grew at a slower rate than over the past decade. ...

                                                                                                                                                                                                        Did the quality of care increase due to the increased spending? Not much:

                                                                                                                                                                                                        ...[A] different agency ... released two new annual reports mandated by Congress on the quality of health care and disparities in care. Officials called them the most comprehensive assessments of their kind. ... The researchers concluded that the overall quality of care in 2005 had improved at a rate of 2.8 percent from 2003. That was the same increase as the year before, and many measures showed no improvement or even decreases. ... In the second report, the National Healthcare Disparities Report, researchers found more measures on which the quality gap between whites and racial minorities was shrinking than widening. But the report found that major disparities remained for all groups and that the gap had widened for Hispanics. ...

                                                                                                                                                                                                          Posted by Mark Thoma on Tuesday, January 10, 2006 at 12:24 AM in Economics, Health Care

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                                                                                                                                                                                                          Fed Presidents Hoenig and Guynn: Changes in Funds Rate Becoming Increasingly Data Dependent

                                                                                                                                                                                                          Thomas M. Hoenig, president of the Kansas City Fed said today that future moves in monetary policy are becoming increasingly data dependent:

                                                                                                                                                                                                          The National Economy and Monetary Policy in the New Year, Thomas M. Hoenig, Kansas City Fed President: ...Implications for monetary policy ...Over the course of the last year and a half, the FOMC gradually has raised its target for the federal funds rate... As a result ..., the funds rate now has returned to a more normal level and is within at least the lower range of ... neutrality. Whether the funds rate is now precisely at the point within the neutral range where it needs to be is a question I cannot answer with any degree of certainty. This depends on possible increases in resource utilization as well as elevated energy prices, and whether other factors add to inflation pressures.

                                                                                                                                                                                                          More generally, when the funds rate is within the neutral range, as I believe it is now, changes in the funds rate target become more dependent on incoming economic data and on anecdotal information... If such evidence were to suggest that core inflation was increasing above the level associated with price stability, it might be necessary to move the funds rate target higher within the range of neutrality. Or, depending on the extent of upward price pressure, it might be necessary to move the funds rate above the neutral range to offset the tendency for inflation to rise. One indicator that would be of particular concern to me would be any upward movement in long-run inflation expectations....

                                                                                                                                                                                                          In contrast, if incoming evidence suggested the expansion were faltering, it might be necessary to adjust the funds rate downward. As I suggested earlier, the burden of high energy prices or a desire by consumers to curtail their spending could lead to a slower-growth scenario. Depending on the outlook for inflation in such a scenario, it might be appropriate to move the funds rate lower within the neutral range or, potentially, below neutral to help stimulate spending and production.

                                                                                                                                                                                                          On balance, while the current setting of monetary policy may be close to where it will ultimately need to be, we won't know this until new data are reported. The point is that we still must monitor closely incoming information as we seek to calibrate our policy in the months ahead.

                                                                                                                                                                                                          Atlanta Fed president Guynn said much the same thing in his speech today. He also says he is not worried about the yield curve, he is worried about debt monetization, and he's open to explicit inflation targets. Here's Bloomberg's report:

                                                                                                                                                                                                          Fed Policy Makers Scaling Back Rate Guidance, Watching Data, Guynn Says, Bloomberg: Federal Reserve policy makers are scaling back guidance on future interest-rate decisions because they don't know the "full economic effect'' of the 13 increases since June 2004, Atlanta Fed President Jack Guynn said. "Many of you may be wondering when enough is enough?'' Guynn said in a speech to the Rotary Club of Atlanta today. "The closer we get, the less explicit we can be on that point.'' ... "We don't know yet the full economic effect of the policy moves that we have already made,'' said Guynn, ... "In the months ahead, we'll have to watch the data very carefully to make sure that growth is still on track and inflation expectations are well anchored.'' ...

                                                                                                                                                                                                          "While our policy direction has been quite clear over the past 18 months, in the less certain period ahead it's my personal opinion that as policy makers we should resist the temptation to say more than we know in any given time,'' said Guynn...

                                                                                                                                                                                                          Guynn told reporters afterward that he is "not terribly concerned'' about the ... flattening yield curve. ... Guynn listed three longer-term economic risks: energy costs, workforce issues including job security and "strong downward pressure on wage growth,'' and the federal budget deficit. "It's hard to prove empirically that fiscal deficits cause inflation,'' Guynn said. "But history -- and I think common sense -- tells us that most inflation problems arise in economies with large fiscal deficits.''

                                                                                                                                                                                                          Guynn said after the speech he would consider supporting a specific inflation goal for the Fed, a practice advocated by ... Ben Bernanke ... "I continue to be open to discussing whether some form of inflation targeting can improve our policy process,'' Guynn told reporters. "It has been implemented in many different ways in other economies. I think we should continue to talk about it.'' ...

                                                                                                                                                                                                          Guynn said he is "very much attuned to potential inflationary pressures that I think are still at work in the economy,'' citing the desire of businesses to pass through higher energy costs to customers.

                                                                                                                                                                                                          [Text of Guynn's speech] For some reason, The Kansas City Fed does not provide president Hoenig's speeches in digital format, only as a pdf. Here's the entire text:

                                                                                                                                                                                                          The National Economy and Monetary Policy in the New Year, Thomas M. Hoenig, Kansas City Fed President: I'm pleased to be back at the Central Exchange to speak with you about the outlook for 2006 and implications for monetary policy. With the start of the New Year, it's a particularly opportune time to reflect on the past year and to anticipate the opportunities and challenges that the current year might bring. Some of you might recall that I spoke here a year ago, providing my perspective on the U.S. economy for 2005. Fortunately, last year, my crystal ball proved reliable, and the year unfolded largely as I expected.

                                                                                                                                                                                                          Today, I would like to review the performance of the economy in 2005 and take a look at some of the fundamental forces that will be shaping the outlook in 2006. I also would like to give you my perspective on monetary policy over the period ahead I hope-but can't guarantee-that my crystal ball will prove as reliable this year as it did last year.

                                                                                                                                                                                                          Looking back at 2005

                                                                                                                                                                                                          Let me begin by taking a look back at the year just ended. While we don't yet have GDP data for the fourth quarter, it appears the economy experienced solid growth throughout the year. In the first three quarters of the year, the economy grew at an annual rate of 3.7 percent. This strong growth-which is above most estimates of the economy's long-run growth potential-largely closed the output gap and returned the economy close to fall resource utilization. For example, the unemployment rate fell from 5.4 percent in December of 2004 to 4.9 percent in December of last year, and capacity utilization in manufacturing edged up. This growth rate was also close to the forecast of 3'/z to 4 percent that I gave here last year.

                                                                                                                                                                                                          All major components of domestic demand contributed to this performance. Consumer and business spending remained robust, and residential investment spending actually accelerated a bit relative to the previous year. The only major sector not contributing significantly to overall growth was the foreign trade sector, where we continued to see large deficits. But, depending on what happened in the fourth quarter, even that sector likely has been less of a drag on growth than in previous years.

                                                                                                                                                                                                          On the inflation front, the news was also reasonably good. Although there was a significant impact of higher energy prices on overall inflation, the core inflation rate remained relatively low and stable. On a year-over-year basis, the overall CPI rose by 3'/z percent in November of last year. But, the CPI excluding food and energy prices rose a more modest 2.1 percent. This outcome was consistent with what I expected last year at this time. Although last year I mentioned a number of factors that made me cautious about the outlook for inflation, my expectation was that core inflation would remain stable.

                                                                                                                                                                                                          Now, before I get carried away with my forecasting ability, let me acknowledge that last year I obviously was not anticipating the disruption to economic activity caused by hurricanes Katrina and Rita or the spike in energy prices they precipitated. Indeed, the long-run outlook for oil and gas prices has changed dramatically since this time last year. Had the hurricanes not struck, I suspect economic growth might have come in even stronger than I was anticipating last year, and, certainly, overall inflation would have come in lower.

                                                                                                                                                                                                          One of the factors that contributed to the solid economic performance last year was the accommodative stance of monetary policy. Although the Federal Open Market Committee (FOMC) raised the target for the federal funds rate by 25 basis points at each of our eight meetings last year, for most of the year, the rate remained below the level most analysts would describe as neutral. A neutral funds rate is one that neither over-stimulates nor restrains overall economic activity. Although no one knows exactly what level of the funds rate is consistent with neutrality, we clearly did not approach the neutral range until late in 2005. Recall that at the beginning of the year, the funds rate was just 2'/4 percent in nominal terms and zero percent after adjusting for inflation. Today, it is 4'/ percent in nominal terms and just over 2 percent after inflation. So, throughout most-if not all-of 2005, monetary policy remained accommodative.

                                                                                                                                                                                                          Looking ahead at 2006

                                                                                                                                                                                                          Looking ahead, I expect the favorable performance of the economy to continue. Most private forecasters expect the momentum from the solid growth in 2005 to continue into 2006. Although monetary policy has become less accommodative, it will continue to support economic activity. Because of the lags with which monetary policy affects the economy, monetary policy accommodation over the past year will continue to act as an economic stimulant, though clearly far less so than in the past several years. My sense is that most forecasters expect growth of around 3'/2 percent (Q4/Q4) for 2006, which is just slightly above most estimates of trend GDP growth. My own view is that we will see growth in the 3'/4 to 3%2 percent range, which encompasses the consensus estimate.

                                                                                                                                                                                                          As in 2005, consumer spending is expected to be a primary contributor to growth in 2006. In recent months, consumer confidence measures have sharply rebounded from the hurricane-related decline last fall. More importantly, consumer expectations of the future are positive. One possible drag on consumption lies in the persistence of high energy prices, especially for natural gas. High utility prices for heating are expected to constrain spending somewhat during the winter months. This drag should diminish by spring as heating demands decline and production in the Gulf region is more fully restored. Overall, I expect to see consumption growth of around 3 percent for 2006.

                                                                                                                                                                                                          Despite the upheavals in several sectors of the economy, such as the auto industry, business investment is also expected to contribute to growth in 2006. Strong growth of corporate earnings combined with low borrowing costs over the past two years have led to marked improvement in firms' balance sheets. In the first three quarters of 2005, corporate profits were nearly 15 percent higher than the year-earlier period. Looking ahead, while there may be some slowing from recent performance, most private sector forecasters expect profit growth of around 8 percent in 2006. Together, improved balance sheets and strong profit growth will provide fundamental support for investment spending.

                                                                                                                                                                                                          In the international sector, continued strong growth in the rest of the world will slow the growth of the trade deficit. An expanding world economy is expected by many economists to generate increasing demand for U.S. exports. Such growth, however, is also likely to further increase global demand for natural resources. This implies that prices for commodities such as oil may remain at elevated levels for an extended period.

                                                                                                                                                                                                          The solid growth forecast for the economy also should translate into steady growth in employment. The increases will be somewhat less than employment gains seen in the past two years due to two factors. First, as growth slows and converges toward the economy's trend growth rate, fewer additional workers will be needed. And second, strong productivity growth over the past few years is expected to continue, suggesting that the existing workforce will be able to produce a sizeable portion of the projected increase in output. Based on these factors, I would expect that employment will grow between 1.5 and 2 million in 2006.

                                                                                                                                                                                                          Turning to inflation, I expect the core inflation rate to remain low. Thus far, the impact of higher energy prices on the core measure of CPI inflation has been moderate. However, the longer energy prices remain at elevated levels, the greater the probability that these higher costs will be passed on from producers to consumers. For 2006, I expect these energy price pressures to result in a modest increase of care inflation in the first half of the year before diminishing in the second half.

                                                                                                                                                                                                          Risks to the outlook

                                                                                                                                                                                                          With the general performance of the economy outlined, let me next discuss what I see as the major risks for the US economic outlook. Over the past year, the economy again has displayed its resilience to economic shocks. In first half of 2005, we experienced a sharp run-up in energy prices. In the second half, we faced the devastating impacts of hurricanes Katrina and Rita, which led to an additional increase in energy prices. Throughout these events, the economy has continued its robust growth, and related inflation pressures appear to have been temporary. Despite the excellent performance of the economy in the wake of these events, it is important that we continue to be on the lookout for potential problems ahead.

                                                                                                                                                                                                          The primary near-term concern pertains to the upside risks for the economy and inflation. If global demand continues to accelerate, total resource demands could increase as well. As mentioned earlier, the increase in energy prices may lead to higher core inflation if higher energy costs are passed on by businesses to consumers. In addition, if the U.S. economy continues expanding at a rate faster than underlying trend growth, the pool of available workers will shrink. Such expansion eventually should result in higher labor costs. Thus far, we have yet to see rapid growth in wages. Over the past year, unit labor costs have increased by only 2 percent. But looking forward, measures of wage pressures and total resource demands will require careful monitoring as the economy continues to grow.

                                                                                                                                                                                                          A second, longer-term concern relates to the current low savings rate in the United States. For seven of the past eight months, the personal savings rate has been negative. So while businesses have been improving their balance sheets as a result of strong earnings growth, consumer debt has been increasing as consumers have spent in excess of their incomes. The picture for government savings is not any better due to the current large federal budget deficit. Combined, strong consumer and government demand have caused imports to exceed exports, resulting overtime in the large U.S. trade deficit. To finance this trade deficit, foreigners have acquired large holdings of U.S. securities. At some point, the domestic savings rate must increase to reduce this trade imbalance. Many economists expect that the transition to a higher savings rate will occur smoothly, but with an imbalance of this magnitude, there is the low probability that a rapid transition could lead to a downturn in the economy through a sharp falloff in consumption.

                                                                                                                                                                                                          A third concern relates to a possible imbalance in asset prices. Over the past several years, there has been a rapid increase in the value of housing in the United States fueled by low mortgage interest rates. This has increased household wealth and contributed to strong growth in household consumption during the current economic expansion. If housing prices have risen above levels dictated by economic fundamentals, there is a chance that prices could fall. With the current low savings rate and high debt level of consumers, such a drop in household wealth would have negative implications for the economy. While I do not think there is much risk of a significant housing price decline on a nationwide basis, we could see a decline in prices in certain markets.

                                                                                                                                                                                                          These three factors present both upside and downside risks to the economy. As the economy nears the point of full utilization of resources, it will become more challenging to set a course for monetary policy that appropriately balances these risks.

                                                                                                                                                                                                          Implications for monetary policy

                                                                                                                                                                                                          That brings me to the final part of my presentation: the role of monetary policy in fostering sustainable economic growth with price stability. Over the course of the last year and a half, the FOMC gradually has raised its target for the federal funds rate from an unusually low level of 1 percent in 2004 to 4'/4 percent today. As a result of these actions, the funds rate now has returned to a more normal level and is within at least the lower range of what most analysts associate with neutrality. Whether the funds rate is now precisely at the point within the neutral range where it needs to be is a question I cannot answer with any degree of certainty. This depends on possible increases in resource utilization as well as elevated energy prices, and whether other factors add to inflation pressures.

                                                                                                                                                                                                          More generally, when the funds rate is within the neutral range, as I believe it is now, changes in the funds rate target become more dependent on incoming economic data and on anecdotal information on economic activity and inflation. If such evidence were to suggest that core inflation was increasing above the level associated with price stability, it might be necessary to move the funds rate target higher within the range of neutrality. Or, depending on the extent of upward price pressure, it might be necessary to move the funds rate above the neutral range to offset the tendency for inflation to rise. One indicator that would be of particular concern to me would be any upward movement in long-run inflation expectations. It is essential for long-run inflation expectations to remain well anchored if price stability is to be maintained.

                                                                                                                                                                                                          In contrast, if incoming evidence suggested the expansion were faltering, it might be necessary to adjust the funds rate downward As I suggested earlier, the burden of high energy prices or a desire by consumers to curtail their spending could lead to a slower-growth scenario. Depending on the outlook for inflation in such a scenario, it might be appropriate to move the funds rate lower within the neutral range or, potentially, below neutral to help stimulate spending and production.

                                                                                                                                                                                                          On balance, while the current setting of monetary policy may be close to where it will ultimately need to be, we won't know this until new data are reported. The point is that we still must monitor closely incoming information as we seek to calibrate our policy in the months ahead.


                                                                                                                                                                                                          Let me conclude by saying that I expect we will continue to enjoy solid economic growth with low inflation throughout 2006. Output will likely grow at or slightly above the economy's long-run growth potential. With the possibility of increased resource utilization and the pass-though of higher energy prices to core inflation, there is a risk that inflationary pressures could build. In this environment we will need to monitor carefully incoming data and take necessary actions to keep the risks to the attainment of both sustainable economic growth and price stability roughly in balance.

                                                                                                                                                                                                            Posted by Mark Thoma on Tuesday, January 10, 2006 at 12:15 AM in Economics, Fed Speeches, Monetary Policy

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                                                                                                                                                                                                            January 09, 2006

                                                                                                                                                                                                            Martin Feldstein: Capital Inflows Primarily from Foreign Governments, not Private Investors

                                                                                                                                                                                                            Martin Feldstein says the optimistic view that capital inflows to the U.S. are the result of the attractiveness of investment is wrong and arises from a misinterpretation of the data. A proper interpretation of the data reveals that the source of capital inflows is primarily foreign governments, not foreign private investors. Furthermore, Feldstein says, "If they decide to buy fewer dollar bonds, the US current account deficit could not continue to be financed at current exchange rates and interest rates." He believes a 30% decline in the dollar is necessary to get the current account down from 6% of GDP to a more sustainable level of 3% and that much larger changes are possible. Finally, he says the only thing holding up the dollar currently is the belief that interest differentials that make U.S. financial investment attractive will persist. He adds, "That sanguine belief may, however, reflect a serious misunderstanding of the magnitude and nature of the capital flow to the US.":

                                                                                                                                                                                                            Uncle Sam’s bonanza might not be all that it seems, by Martin Feldstein, Commentary, Financial times: A major reason for the dollar’s current overvaluation is the widespread misunderstanding of the nature of capital flows to the US. The business press and many financial analysts provide the reassuring message that the flow of capital to the US substantially exceeds the amount needed to finance the US current account deficit, and that that inflow is coming primarily from private investors who are attracted by the strength of the American economy.

                                                                                                                                                                                                            This optimistic analysis of the capital inflow is wrong. It results from a misinterpretation of the data provided by the US Treasury... It is easy to see why analysts reach this wrong conclusion. Recent ... press releases stated that the capital inflow was $278bn in the third quarter of last year, or $82bn more than the current account deficit for that quarter. The Treasury also reported that $257bn of this capital inflow came from private buyers.

                                                                                                                                                                                                            In reality, there is no excess capital inflow and private investors are almost certainly not the primary source of the funds coming to the US. The figures..., while technically correct, are misleading for two reasons. First, the .. release refers only to transactions in long-term securities... It excludes bank deposits and bank lending, and flows of foreign direct investment into the US and by American investors to the rest of the world. A comprehensive measure of the capital inflow and outflow would show that the total net inflow is almost exactly equal to the amount needed to finance the current account deficit. ... If the total net inflow were larger than the current account deficit, the US would be accumulating large reserves of foreign exchange. In fact, reserves are virtually unchanged from year to year and are actually lower than they were two years ago. So it is wrong to conclude that the net capital flow to the US substantially exceeds the current account deficit. ...

                                                                                                                                                                                                            A second source of confusion in the ... report is an easily misunderstood classification of whether the funds coming to the US are from governments or private sources. The ... measure of inflows from “private” sources overstates the actual private investment because it does not distinguish between a purchase by a private buyer for its own account and a purchase executed by a private institution on behalf of a foreign government. For example, if the Chinese government purchases US bonds through JPMorgan or another private bank, these funds will be recorded in the ... data as a private purchase. ...

                                                                                                                                                                                                            My own belief, based on widespread conversations with officials and with private bankers, is that the inflow of capital that now finances the US current account deficit is coming primarily, perhaps overwhelmingly, from governments and from institutions acting on behalf of those governments. ...

                                                                                                                                                                                                            The very large current account deficits are now being financed by bonds and shorter term fixed-income funds. Some of this has recently come from OPEC governments and other oil producers that are temporarily placing revenue in dollar bonds and bank deposits until they can spend those funds on investment or consumption. Much of the inflow in recent years has come from Asian governments that wanted to accumulate foreign ex-change to eliminate the risk of speculative attacks of the sort that hurt those countries in the late 1990s. A large amount is coming from China and other Asian governments to stop a falling dollar reducing their net exports. If they decide to buy fewer dollar bonds, the US current account deficit could not continue to be financed at current exchange rates and interest rates.

                                                                                                                                                                                                            The US current account deficit increased ... in the first three quarters of last year and is widely predicted to move much higher in 2006. This unprecedented level is equal to 6.4 per cent of US gross domestic product. Experts estimate that the real trade-weighted value of the dollar must fall by at least 30 per cent just to shrink the trade deficit to a more sustainable level of 3 per cent of GDP. Much larger dollar declines are also possible. ...

                                                                                                                                                                                                            The current small interest rate differences in favour of US bonds are not nearly enough to compensate investors for the fall in the dollar that is likely over the next few years. ... The dollar must fall faster than these small interest differentials in order to prevent the current account deficit from increasing more rapidly than GDP. ... At some point, that will trigger a shift away from the dollar. Private investors and the governments ... will inevitably shift at some time from dollars to euros or yen ... That that has not happened already reflects investors’ belief that it is still possible to benefit from the interest differentials before the dollar depreciates. That sanguine belief may, however, reflect a serious misunderstanding of the magnitude and nature of the capital flow to the US.

                                                                                                                                                                                                            [Update: PGL at Angry Bear has more.]

                                                                                                                                                                                                              Posted by Mark Thoma on Monday, January 9, 2006 at 02:01 PM in Economics, International Finance, International Trade

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                                                                                                                                                                                                              Should Bernanke Attend the January FOMC Meeting?

                                                                                                                                                                                                              Should Bernanke be allowed to attend the January 31st FOMC meeting to smooth the transition? Most FOMC members said no, particularly since he is still part of the White House. There are arguments on both sides, but I agree with the decision:

                                                                                                                                                                                                              Bernanke quietly begins to prepare for transition at the Fed, Greg Ip, WSJ Washington Wire: While awaiting Senate confirmation, the Fed chairman nominee meets one-on-one or talks by telephone with members of the Federal Open Market Committee, the Fed's policy panel. They talk more about running the Fed and long-range economic issues, less about monetary policy. More formal consultations between Bernanke and the FOMC before his swearing-in are unlikely. Some Fed officials thought the transition would be smoother if Bernanke were given input on the policy decision at the Jan. 31 meeting, Alan Greenspan's last one. But more officials object to admitting a non-member into confidential FOMC deliberations, especially one who is still part of the White House. It might also tread on Greenspan's authority in his final weeks. Meanwhile, Greenspan is dragging his feet on sitting for an official portrait. The artist has yet to be chosen and the work could take about a year.

                                                                                                                                                                                                                Posted by Mark Thoma on Monday, January 9, 2006 at 11:55 AM in Economics, Monetary Policy

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                                                                                                                                                                                                                Graphs Gathered from Blogs (December 2005)

                                                                                                                                                                                                                The collection of graphs is at Optimetrica:

                                                                                                                                                                                                                Graphs Gathered from Blogs (December 2005).

                                                                                                                                                                                                                There is also a directory of links to graphs from other months.

                                                                                                                                                                                                                  Posted by Mark Thoma on Monday, January 9, 2006 at 11:45 AM in Economics, Graphs

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                                                                                                                                                                                                                  Going Nuclear

                                                                                                                                                                                                                  Europe, like the U.S., is attempting to secure stable and environmentally sustainable energy sources for the future. To accomplish this goal, Wolfgang Munchau of the Financial Times says that Europe needs to consider nuclear energy as part of the answer. But the politics won't be easy:

                                                                                                                                                                                                                  EU must grasp the nuclear nettle, by Wolfgang Munchau, FT: The two overriding objectives of the European Union’s future energy policy should be to secure supplies and ensure environmental sustainability. It is currently in danger of failing in both. ... If Europe is serious about meeting both goals, it will need a new energy mix – one that would include both nuclear and alternative energy sources, combined with policies to encourage energy efficiency. While nuclear energy is not the answer to all our energy problems, it has to be part of any answer. The scientific and strategic case for a return to nuclear energy in the EU is overwhelming. ...

                                                                                                                                                                                                                  Nuclear energy is not risk-free. In the 1970s and 1980s, the debate was about whether we would be prepared to accept this new technology at the expense of what we were told would be a small accident risk. Today’s debate is different. For one, the accident risk is considerably smaller. But there are also equally grave risks attached to going non-nuclear, the biggest of which is an increase in greenhouse gas emissions. Scientists have been warning about the effects of phasing out nuclear energy on future greenhouse emissions. ...[If the energy] gap were filled by traditional power stations, the UK would almost certainly miss its greenhouse gas targets. ...

                                                                                                                                                                                                                  But it is far from clear whether the EU’s political classes are ready for a change in nuclear policy. ... For the present political generation, the anti-nuclear movement was one of the defining moments in their early political careers. It not only gave rise to green parties all over Europe but heavily influenced the political left – though, interestingly, this was never true of France ... Elsewhere in continental Europe, opposition to nuclear energy is so deep-rooted that even a dangerous rise in greenhouse gas emissions cannot change the views of a seasoned anti-nuclear campaigner. ... There are big differences among EU countries. Finland, for example, has been alone in commissioning a new power station at a time when others are decommissioning. ... Europe needs a common energy policy and it also needs a rethink on nuclear power. I am not holding my breath: there is too much political resistance. But let the debate commence.

                                                                                                                                                                                                                  Is it time for the U.S. to rethink its position too? I would listen to the arguments, but I'm not sold on nuclear. Here's a related story that points to reasons to reconsider:

                                                                                                                                                                                                                  Shell’s Sakhalin shows an industry its daunting future, by Thomas Catan, FT: On a remote island off the eastern coast of Russia, encased in ice for nearly half the year, the future of the world oil and gas industry is beginning to take shape. And judging by the scale of the project ... around the bleak shores of Sakhalin, that future will be expensive, complex and, above all, big. Off Sakhalin’s north coast, two of the largest concrete structures ever built in Russia have been installed in the sea. As large as football fields and as tall as 15-storey buildings, the offshore platform bases have been towed in from 1,000 nautical miles away. Some 6,000 construction workers labour in temperatures that can reach minus 40 degrees laying 800km pipelines down the length of the island.

                                                                                                                                                                                                                  On the south side, Russia’s first liquefied natural gas plant is being built in Aniva Bay. There the natural gas will be super-cooled into liquid form and shipped to Japan, South Korea and the US – markets that have never before had access to Russia’s massive gas reserves. Europe came to realise just how dependent it had become on Russia for energy after a new year spat between the Kremlin and Ukraine briefly threatened its gas supply. Now Asia and the US are about to join the club. After decades of false starts, the big push is under way to transform Sakhalin into the world’s latest oil and gas province. ... “This is the biggest single project certainly that Shell has and, by most measures, that anybody has,” says Chris Finlayson, Shell’s Russia country manager. ... The project is burning through $100 a second and occupying 60m person-hours a year. ... the scale of the technical task that has led Shell managers to call it “the Mother of all Projects”. ... The list of obstacles faced by Shell and its partners is daunting. ...

                                                                                                                                                                                                                  Sakhalin’s pristine environment has ... made Shell the target of campaigners around the world. An endangered population of only 100 western gray whales feed on Sakhalin’s north-eastern shore during the summer months. ... Environmental groups also fear that the construction of the twin pipelines, which cross 1,000 rivers and streams, will interfere with salmon spawning and harm the island’s fishing industry. ... The company is drilling under rivers that are held to be particularly sensitive and has sought to allay fears about its impact on the island’s fishing industry. ... A bigger concern is that the company does not have a plan for what to do in the event of an oil spill under ice. It says it is working hard to come up with one. ...

                                                                                                                                                                                                                    Posted by Mark Thoma on Monday, January 9, 2006 at 12:42 AM in Economics, Environment, Oil

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                                                                                                                                                                                                                    Bush Plan to Bomb al-Jazeera Leaked to Influence U.S. Election

                                                                                                                                                                                                                    This isn't about economics, it's a report from the Guardian about how the Bush plan to bomb the Arabic TV station al-Jazeera became public through leaks in Britain. After the leaks, the information was passed to the U.S. in an attempt to influence the 2004 U.S. election. The information was known prior to the election (by a Democrat), but was not released:

                                                                                                                                                                                                                    MPs leaked Bush plan to hit al-Jazeera, by David Leigh and Richard Norton-Taylor, Guardian: Two Labour MPs have defied the Official Secrets Act by passing on the contents of a secret British document revealing how President George Bush wanted to bomb the Arabic TV station, al-Jazeera. The document, a transcript of a meeting between Mr Bush and Tony Blair in April 2004 ... is already the subject of an unprecedented official secrets prosecution in Britain, against an aide to one of the MPs and another man.

                                                                                                                                                                                                                    David Keogh, a Cabinet Office employee, is charged with leaking information damaging to international relations to Leo O'Connor, researcher to Tony Clarke, former MP for Northampton South. ... The information was then acquired by Mr Clarke, who in turn consulted his parliamentary colleague, Peter Kilfoyle. The two politicians decided to pass on the information to a contact in the US.

                                                                                                                                                                                                                    Mr Kilfoyle, MP for Liverpool Walton and a former defence minister, said last night: "It's very odd we haven't been prosecuted. My colleague Tony Clarke is guilty of discussing it with me and I have discussed it with all and sundry." Asked if he had broken the act in the same alleged way as Mr Clarke's aide who is facing charges, he said: "I don't know. But I'd be very pleased if Her Majesty's finest approached me about it."

                                                                                                                                                                                                                    The two MPs decided in October 2004 to reveal the contents of the transcript of the Blair-Bush meeting to John Latham, a Democrat supporter living in San Diego, California. They hoped to influence the impending 2004 US election, Mr Kilfoyle said. In San Diego, Mr Latham, ... a "contributing member" to the Democrat National Committee, told the Guardian that the MPs also wanted him to send letters with the information to newspapers in Los Angeles and New York...

                                                                                                                                                                                                                    Mr Latham said he had never met Mr Clarke before. He added: "He mentioned that the document was a transcript of a meeting in Washington DC between Bush and Blair. There had been a proposal to take military action against al-Jazeera at their headquarters in Qatar. This was defused by Colin Powell, US secretary of state, and Tony Blair."

                                                                                                                                                                                                                    Mr Latham decided not to write to US newspapers at the time, in October 2004. As a result, details of the Washington meeting between Mr Bush and Mr Blair remained secret for more than a year. Within days of the charges being brought against Mr Keogh and Mr O'Connor, the contents of the memo were, however, passed on again, this time to the Daily Mirror, which put them on its front page...

                                                                                                                                                                                                                    The Bush-Blair meeting took place when Whitehall officials, intelligence officers, and British military commanders were expressing outrage at the scale of the US assault on the Iraqi city of Falluja, in which up to 1,000 civilians are feared to have died. Pictures of the attack shown on al-Jazeera had infuriated US generals. London was also arguing with Washington about the number of extra British troops to be sent to Iraq...

                                                                                                                                                                                                                      Posted by Mark Thoma on Monday, January 9, 2006 at 12:33 AM in Politics

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                                                                                                                                                                                                                      You're On Your Own

                                                                                                                                                                                                                      Here's another story on the changing social contract between firms and workers (see 401(k) Street Gets a New Resident). The point of this story from the NYT is that even strong firms who are not in financial trouble as a result of pension fund promises are switching to 401(k) type plans now in a bid to retain or increase competitiveness: More Companies Ending Promises for Retirement

                                                                                                                                                                                                                        Posted by Mark Thoma on Monday, January 9, 2006 at 12:30 AM in Economics, Social Security

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                                                                                                                                                                                                                        Did an Appeal to Patriotism Increase the Demand for Bonds During World War I?

                                                                                                                                                                                                                        The effort to generate increased demand for government bonds during World War I by appealing to patriotism was not effective:

                                                                                                                                                                                                                        Capitalizing Patriotism: The Liberty Loans of World War I , by Sung Won Kang, Hugh Rockoff, NBER WP 11919, January 2006: Abstract In World War I the Secretary of the Treasury, William Gibbs McAdoo, hoped to create a broad market for government bonds, the famous Liberty Loans, by following an aggressive policy of "capitalizing patriotism." He called on everyone from Wall Street bankers to the Boy Scouts to volunteer for the campaigns to sell the bonds. He helped recruit the nation's best known artists to draw posters depicting the contribution to the war effort to be made by buying bonds, and he organized giant bond rallies featuring Hollywood stars such as Douglas Fairbanks, Mary Pickford, and Charlie Chaplin. These efforts, however, enjoyed little success. The yields on the Liberty bonds were kept low mainly by making the bonds tax exempt and by making sure that a large proportion of them was purchased directly or indirectly by the Federal Reserve. Patriotism proved to be a weak offset to normal market forces.

                                                                                                                                                                                                                          Posted by Mark Thoma on Monday, January 9, 2006 at 12:24 AM in Academic Papers, Budget Deficit, Economics, Politics

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                                                                                                                                                                                                                          Dollar on the Decline?

                                                                                                                                                                                                                          The Wall Street Journal sees prospects for a weaker dollar ahead, but as The Economist notes while coming to a similar conclusion, the conditions looked ripe for a decline in the dollar last year as well, but the dollar appreciated to the surprise of many analysts (graph):

                                                                                                                                                                                                                          Dollar Prospects Look Weak for '06 As Hurdles Loom, by Craig Karmin, WSJ: ...After a surprisingly strong performance in 2005, when the U.S. currency rose 15% against the euro and the yen, the dollar has stumbled out of the gate in what some worry may be an ominous sign for 2006. In the first two trading days ..., the dollar suffered its largest two-day decline against the euro in five years as it tumbled 2.5%. While the stock market shrugged off weaker-than-expected employment numbers released Friday, the dollar didn't. The currency fell again on heightened fears of an economic slowdown ...

                                                                                                                                                                                                                          [T]he release Tuesday of the Federal Reserve minutes -- which suggested that the central bank is nearing an end to its campaign to raise interest rates -- hit the dollar hard. The Fed's steady rate increases last year widened the gap between U.S. debt yields and those in Europe and Japan, luring foreign investors and boosting the dollar. Once the Fed stops raising rates, that advantage is expected to diminish. Other factors also may be conspiring against the dollar. Domestically, there are signs that the housing market is cooling, and a lobbying scandal in Washington could bog down efforts to pass new laws. Legislation that allowed U.S. companies to repatriate earnings at a discounted tax rate expired for most companies at the end of 2005.

                                                                                                                                                                                                                          China's central bank, meanwhile, last week said it will allow foreign banks to trade yuan with each other directly... This is seen as a liberalizing step toward a more open, market-based currency regime... Separately, Chinese officials also indicated ... they were looking to further diversify the country's rapidly expanding foreign reserves, a move that ... is seen as part of a gradual shift away from the dollar. ...

                                                                                                                                                                                                                          [T]he gap between U.S. rates and those in Europe is already narrowing. ... since the European Central Bank raised rates last month...

                                                                                                                                                                                                                            Posted by Mark Thoma on Monday, January 9, 2006 at 12:15 AM in Economics, International Finance

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                                                                                                                                                                                                                            January 08, 2006

                                                                                                                                                                                                                            Do I Make Myself Perfectly Clear?

                                                                                                                                                                                                                            Not exactly - according to this research, we get the direction of interest rate changes wrong more often than not after Fed speeches:

                                                                                                                                                                                                                            Fed Speeches Send Investors Wrong Way, Reinhart Says, Bloomberg: ...Interest rates after a Fed speech tend to move in the opposite direction from where they are eventually headed, according to research by Vincent Reinhart, director of the Fed's monetary affairs division, and Brian Sack, a former Fed economist who is now a private forecaster. ... Speeches by individual members of the Fed's policy-setting Open Market Committee cumulatively pushed down the yield on the two-year Treasury note during the first half of 2005, while the committee's official statements lifted it, the authors said ...

                                                                                                                                                                                                                            ''Speeches are the least accurate form of communication,'' wrote Reinhart and Sack .... ''On average, the initial market reaction to speeches reversed over subsequent weeks.'' The paper's sample included 1,042 speeches since November 2001. That includes interviews by Fed members, which were classified in the same category. The Fed communicates with the public in four ways: FOMC statements ... released after each interest-rate meeting; minutes of those meetings, released three weeks later; semi- annual testimony to Congress on monetary policy; and speeches by individual committee members, of which there are about 250 a year.

                                                                                                                                                                                                                            ''Statements were quite successful at pushing the yield in the appropriate direction, while speeches appear to have given the market a head fake'' the authors wrote. Congressional testimonies had the ''most accurate'' effects, ahead of statements, the research showed. Minutes of meetings were third. ...

                                                                                                                                                                                                                            The financial market reaction to Fed speeches, while often wrong, was the smallest of the four methods of communication studied by the authors. Testimonies produced the biggest moves, followed by statements and minutes. Speeches may have a small effect because ''the market realizes that the communications by any individual Committee member are a less accurate predictor of the Committee's actions than communications that have been sanctioned by the Committee as a whole,'' Reinhart and Sack wrote.

                                                                                                                                                                                                                            Fed Chairman Alan Greenspan's speeches moved the two-year Treasury yield more than 3 basis points, ''well above the effect attributable to other FOMC members,'' according to the research...

                                                                                                                                                                                                                              Posted by Mark Thoma on Sunday, January 8, 2006 at 01:08 AM in Economics, Fed Speeches, Monetary Policy

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                                                                                                                                                                                                                              Shanghai's Bubble Pops

                                                                                                                                                                                                                              This is what we are hoping to avoid:

                                                                                                                                                                                                                              A Home Boom Busts, by Don Lee, LA Times: ...Once one of the hottest markets in the world, sales of homes have virtually halted in some areas of Shanghai, prompting developers to slash prices and real estate brokerages to shutter thousands of offices. For the first time, homeowners here are learning what it means to have an upside-down mortgage ... Recent home buyers are suing to get their money back. Banks are fretting about a wave of default loans.

                                                                                                                                                                                                                              "The entire industry is scaling back," said Mu Wijie, a regional manager at Century 21 China, who estimated that 3,000 brokerage offices had closed since spring. Real estate agents, whose phones wouldn't stop ringing a year ago, say their incomes have plunged by two-thirds. Shanghai's housing slump is only going to worsen and imperil a significant part of the Chinese economy, says Andy Xie, Morgan Stanley's chief Asia economist in Hong Kong.

                                                                                                                                                                                                                              Although the city's 20 million residents represent less than 2% of China's population of 1.3 billion, Xie says, Shanghai accounts for an astounding 20% of the country's property value. About 1 million homes in Shanghai alone — about half the number of housing starts for the entire United States in 2004 — are under construction. "They'll remain empty for years," Xie said, adding that a jolting comedown also was in store for other Chinese cities with building booms — including Beijing, Chongqing and Chengdu — though other analysts say the problem is largely confined to Shanghai.

                                                                                                                                                                                                                              Shanghai's housing bust comes after ... a run-up fueled by massive speculation. .... At least 30% to 40% of homes sold were bought by speculators... "Ordinary people had no option but to follow the trend," Zhang said. "Worrying that prices would be even more unaffordable tomorrow, many of them borrowed from relatives and banks to buy as soon as possible." ...

                                                                                                                                                                                                                              Some still see promise in the Shanghai market. Incomes are rising and droves of people are relocating from the inner city to outlying areas... What's more... the Shanghai government — which owns all the land — has auctioned off few lots in the last two years, which will limit the number of housing units in the future. But that's little solace for homeowners who have seen inventories rise even as buyers show no hurry to come back into the market.

                                                                                                                                                                                                                              In Shanghai, people blame the popping of the housing bubble on the central government, which has applied one measure after another in the last year to quash excessive speculation and price increases. Banks were ordered to raise their best rate on home loans to 5.5% from 5%. Home buyers were required to make down payments of at least 30%, up from 20%. A 5.5% capital gains tax on home sellers' profits was imposed. Beijing also levied a 5% tax on the sale price of homes sold before two years of ownership. "It's killed the speculators," said David Pitcher, a Shanghai developer and former head of CB Richard Ellis' office here. ...

                                                                                                                                                                                                                              But it's not just speculators who have bailed out of the market. A lot of potential Shanghai buyers have been scared off by numerous reports of sinking home prices and desperate action by some owners. ... Few analysts are betting on a quick turnaround. Yin Zhongli, an economist at the Chinese Academy of Social Sciences in Beijing, says a housing crash takes time to clean up. He worries that the financial sector will be crippled by the real estate fallout. Last year, he said, 76% of all bank loans in Shanghai were in real estate. ...

                                                                                                                                                                                                                                Posted by Mark Thoma on Sunday, January 8, 2006 at 12:33 AM in China, Economics, Housing

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                                                                                                                                                                                                                                Clamping Down on Risky Mortgage Loans

                                                                                                                                                                                                                                Federal regulators are planning to tighten the standards on risky home loans to make the loans more difficult to get. Here's the story from CNN/Money: Risky home loan standards tightening - Federal regulators proposed guidance to make it harder to qualify for exotic home loans.:

                                                                                                                                                                                                                                  Posted by Mark Thoma on Sunday, January 8, 2006 at 12:15 AM in Economics, Housing, Regulation

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                                                                                                                                                                                                                                  Liberals and Conservatives Have Beef in Common

                                                                                                                                                                                                                                  Conservatives supply a liberal demand and in the process love - or at least the market - brings them together:

                                                                                                                                                                                                                                  In Oregon, Thinking Local, by Marian Burros, Eating Well, NY Times: Six years ago "organic" was the next big thing in grocery shopping, but the term has begun to lose its luster. It has been co-opted by agribusiness, which has succeeded in watering down the restrictions of the definition. Today "local" and "sustainable" are the new culinary buzzwords. ...

                                                                                                                                                                                                                                  "I think there is a gathering sense that organic and local are not the same," said Michael Pollan, the author of a forthcoming book, "The Omnivore's Dilemma,"... "Buying national organic products does very little for the local economy. ... Organic has important values having to do with pesticides and how land is treated, but now that it is industrialized, buying organic doesn't necessarily support living in a place that still has farmers consuming less energy." He added: "Moving organic food across the country uses just as much energy as conventional. I think this is becoming more important."

                                                                                                                                                                                                                                  Kristen Crittenden ...[said] "It's nice to know where our food is coming from because you know how it was raised," she said. "It makes you feel good about supporting your local farmer and your local fishing industry." ...

                                                                                                                                                                                                                                  The opportunity to sell locally has kept some area ranchers from going out of business in Oregon and nearby states. Doc and Connie Hatfield, who founded the Country Natural Beef cooperative in 1986, said the co-op now has 70 ranchers, who raise beef on a vegetarian diet free of hormones, antibiotics and genetically modified feed. "Nineteen years ago we were going broke," Mr. Hatfield said. "Now we are paying income taxes."

                                                                                                                                                                                                                                  Mr. Hatfield was just as pleased about an unexpected byproduct of selling locally: the bond forged between rural and urban residents. "Most of the ranchers are rural, religious, conservative Republicans," Mr. Hatfield said. "And most of the customers are urban, secular, liberal Democrats. When it comes to healthy land, healthy food, healthy people and healthy diets, those tags mean nothing. Urbanites are just as concerned about open spaces and healthy rural communities as people who live there. When ranchers get to the city, they realize rural areas don't have a corner on values. I think that's what we are most excited about."...

                                                                                                                                                                                                                                    Posted by Mark Thoma on Sunday, January 8, 2006 at 12:06 AM in Economics, Oregon

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                                                                                                                                                                                                                                    January 07, 2006

                                                                                                                                                                                                                                    The Social Experiments: Labor Supply, Housing Allowances, and Health Insurance

                                                                                                                                                                                                                                    An NBER paper by Sanbonmatsu, Kling, Duncan, and Brooks-Gunn looks at the Moving to Opportunity Program, a program that distributes housing vouchers to low-income households:

                                                                                                                                                                                                                                    Neighborhoods and Academic Achievement: Results from the Moving to Opportunity Experiment, by Lisa Sanbonmatsu, Jeffrey R. Kling, Greg J. Duncan, Jeanne Brooks-Gunn, NBER WP 11909, January 2006: Abstract Families originally living in public housing were assigned housing vouchers by lottery, encouraging moves to neighborhoods with lower poverty rates. Although we had hypothesized that reading and math test scores would be higher among children in families offered vouchers (with larger effects among younger children), the results show no significant effects on test scores for any age group among over 5000 children ages 6 to 20 in 2002 who were assessed four to seven years after randomization. Program impacts on school environments were considerably smaller than impacts on neighborhoods, suggesting that achievement-related benefits from improved neighborhood environments are alone small.

                                                                                                                                                                                                                                    I want to talk about the Moving to Opportunity experiment more including earlier econometric results by Katz, Kling, and Liebman (and many others) on the program's effectiveness. But before talking about the Moving to Opportunity experiment in particular (and its earlier version, the Gautreaux experiment) , I thought it would be useful to talk in general about three large-scale social experiments that have been conducted to evaluate voucher programs in housing and health insurance, and to evaluate the effect a minimum income guarantee for low-income households has on work effort. Fortunately, there is a nice discussion of this topic in Michael Murray's new econometrics text. I will try to follow this up over the next few days with more on the Moving to Opportunity and other programs. From reading comments, etc., I have the impression that many think that economists simply fight ideological battles over social programs and other government policies without regard to actual evidence. Hopefully this discussion will help to uncover some of the evidence behind policy debates. Here's the discussion from Murray (pgs. 649-651):

                                                                                                                                                                                                                                    The Social Experiments: Labor Supply, Housing Allowances, and Health Insurance

                                                                                                                                                                                                                                    In the 1970s and 1980s, the U.S. government sponsored three large social science experiments. First were a series of four negative-income tax experiments that sought to understand how American households would alter their work effort if given a guaranteed minimum income. Second were two housing allowance experiments that probed into how low-income American households would respond to housing vouchers that work much like food stamps. Third was a national health insurance experiment that examined how American households would respond to universal health insurance.

                                                                                                                                                                                                                                    These randomized social experiments all randomly sampled U.S. households in the subpopulations of interest. Selected households were then randomly assigned to treatment and control groups. In each instance, the experiments focused on potential public policies of great scope. Many conservative and liberal social analysts hoped that the patchwork quilt of American social welfare programs could be replaced by a single program, a guaranteed minimum income that would be slowly taxed away as one's income rose (the benefit a household received would be based on a formula: benefit = minimum income - [tax rate]·[earned income]). Others, skeptical about the prospects for a guaranteed income and dissatisfied with public housing projects as a solution to the housing needs of the poor, hoped for a system of housing vouchers that would pay part of the rent of low-income families as they found their homes in the private housing market. Still others saw health insurance as a national need that could be provided best by a universal, subsidized insurance program. Before such complex programs could garner the political support they would need, the most serious doubts about the programs had to be addressed, which was the goal of the experiments.

                                                                                                                                                                                                                                    Would a guaranteed minimum income cause millions of people to go on the dole and abandon work? Would housing vouchers increase the demand for housing, only, to see rents skyrocket and low-income households made no better off by the allowances? Would a free national health plan bankrupt government? Would national health insurance improve health outcomes in the United States? The available economic and medical evidence on all these questions was too fragile to serve as the basis for vastly expensive public policies. The hope was that randomized experiments, freed of the biases that threaten the validity of most social science empirical work, could provide the informational basis for sound policy making.

                                                                                                                                                                                                                                    The experiments were complex undertakings. In the four negative-income tax (NIT) experiments, more than 8,000 households received guaranteed incomes, some receiving guaranteed incomes for up to 20 years. One housing allowance experiment, called the supply experiment, offered housing allowances to all income-eligible households in two small cities, South Bend, Indiana, and Green Bay, Wisconsin. The other housing allowance experiment offered allowances to a random sample of income-eligible households in two larger cities, Phoenix and Pittsburgh. The health insurance experiment sampled some 5,000 people across six cities. Each experiment lasted a minimum of several years.

                                                                                                                                                                                                                                    The NIT experiments established that a guaranteed minimum income would have nonnegligible, but also noncatastrophic, effects on work effort. Male heads of two-parent households would not react much to the minimum income guarantee itself, but would cut their work hours because of the tax rate on earnings that draws down the subsidy as income rises. Men in the program who faced the highest marginal tax rates decreased their hours worked by about 11%. Single female household heads who participated would cut their hours worked by as little as nothing or as much as 15%; these women would react to both the guarantee itself (an income effect that increases the consumption of leisure, which is a normal good) and to the tax rate (a substitution effect that follows on a decrease in the opportunity cost of leisure). Participating women in two-parent households would cut their hours of work most dramatically, by as much as 20% to 30%. (Because married women have become more attached to market work in the past 30 years, this last result might prove different today; married women might behave more like their husbands now.)

                                                                                                                                                                                                                                    Despite these results, the political will for a guaranteed minimum income did not materialize. When Richard Nixon proposed his Family Assistance Plan, a variant on guaranteed minimum income, it fell to a coalition of conservatives who disliked the idea altogether and liberals who found the plan insufficiently generous.

                                                                                                                                                                                                                                    The experimental data from the NIT experiments did, however, provide labor economists with a rich trove of information to explore with economic models and econometric tools. The division of reductions in work effort into income and substitution effects required econometric estimates of labor supply models that went well beyond comparing the mean hours worked of treatment groups and controls. The sophistication of labor economics grew dramatically during the 1970s and 1980s as a direct result of analyzing the experiment.

                                                                                                                                                                                                                                    The housing allowance supply experiment established that a city-wide housing allowance program need not drive up rents. Four factors contributed to keeping prices in check in South Bend and Green Bay. First, eligible households only slowly took advantage of their vouchers, giving the market time to adjust to increased demands. Second, housing vacancies served as a buffer, absorbing new demands for better housing. Third, landlords upgraded units to provide additional housing that met the requirements of the allowance program. Fourth, among those who used their vouchers, the program subsidies spurred housing demand less than anticipated. Much doubt remained, nonetheless, about whether housing market experiences in small places such as South Bend and Green Bay told us enough about large-city markets such as New York or Los Angeles.

                                                                                                                                                                                                                                    The housing allowance demand experiment rigorously established that price and income elasticities of demand for housing are smaller than had been previously believed. Voucher plans that would pay a percentage of households' rents would spur demand less than anticipated. Program requirements that insisted on housing units meeting specific physical standards (such as treads on the building's stairways) did increase the proportion of households meeting those standards, but the correlation among standards met was rather low, so the only way to ensure a standard would be met was to set the standard explicitly. Unfortunately, physical standards discouraged substantial numbers of otherwise eligible households from finding compliant housing. Perhaps the most important finding of the experiment was that housing allowances enabled households to obtain housing as good as that found in public housing at a much lower cost to government.

                                                                                                                                                                                                                                    In the years since the housing allowance experiment, federally subsidized housing programs have increasingly used voucher programs, and less and less used subsidized construction for the poor. Because the voucher programs are cheaper, more households are getting housing subsidies today than in the past, while the quality of the housing that subsidized households receive has not been adversely affected.

                                                                                                                                                                                                                                    The National Health Insurance Experiment (NHIE) established that income has a positive effect on outpatient services and a negative effect on Inpatient services for insured households, leading to a shallow U-shaped relationship between income and total expenditures. Furthermore, the experimental results imply that changes in insurance coverage over time accounted for only a small fraction of the rise in health care costs since World War II. But perhaps the most important finding of the NHIE was that modest cost sharing by patients (with a cap on maximum out-of-pocket expenditures) reduces medical expenditures but does not measurably change health outcomes.

                                                                                                                                                                                                                                    The NHIE did not lead to a national health insurance program. The lesson about cost sharing seems to have changed insurance practices in the United States, however. The fraction of major companies with cost-sharing insurance plans rose from 30% to 63% in the years immediately following the publication of the experimental results. Within a decade of the experiment, the resulting cost savings on the consequent avoided medical expenses was about $7 billion.

                                                                                                                                                                                                                                    Final Notes

                                                                                                                                                                                                                                    All of the large social experiments had to grapple with serious logistical and statistical problems. Do short-duration experimental programs tell us much about actual long-term programs? Do attrition bias and nonreporting bias invalidate the inferences from the experiments? Are the locations chosen for the experiments representative of the nation as a whole - can we generalize from South Bend to New York or from Seattle to Atlanta? Researchers overcame enough of these problems by applying well-known statistical methods and by inventing new methods, so that all the experiments added richly to our understanding of the social policies they addressed.

                                                                                                                                                                                                                                    The great social experiments of the 1970s and 1980s did not lead to the vast new programs that their sponsors had hoped for, but each has had a lasting positive impact on social policy. Despite this success, few additional social experiments have followed in the wake of these first efforts. The cost of social experiments is high-the NHIE cost almost $150 million-and government seldom funds such big ticket items in times of fiscal distress. But if we compare the $150 million cost of the NHIE with the $7 billion cost savings from knowing to use modest cost sharing in health insurance policies, we might conclude that additional social experiments can be worthwhile social Investments.

                                                                                                                                                                                                                                    If that is accurate, if a $150 million investment yielded a $7 billion saving, or anything remotely close, then we should do a lot more of these experiments. It would save money and give our policy debates a much better empirical foundation.

                                                                                                                                                                                                                                      Posted by Mark Thoma on Saturday, January 7, 2006 at 01:22 PM in Academic Papers, Economics, Health Care, Housing, Policy

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                                                                                                                                                                                                                                      "Boys dying in Vietnam, and Bill Martin doesn’t care!"

                                                                                                                                                                                                                                      Dallas Fed president Richard Fisher tells economists gathered at the ASSA meetings in Boston that their econometric models aren't much help. He also stresses the importance of Fed independence by recounting a story from the 1960s about president Johnson and William Martin, Fed president at the time:

                                                                                                                                                                                                                                      Coping with Globalization's Impact on Monetary Policy, by Richard W. Fisher, Dallas Fed President,January 6, 2006: Many of my fellow Federal Reserve Bank presidents are economists ... I am not. ... I do not mind admitting to some apprehension about speaking to an audience of economists on an economic topic. But I am very comfortable with ... one of the biggest challenges my colleagues and I must cope with: globalization’s impact on ... the economy and the making of monetary policy.

                                                                                                                                                                                                                                      The literature on globalization is large. The literature on monetary policy is vast. But the literature examining the combination of the two is surprisingly small. ... The word “globalization” does not appear in the index of Michael Woodford’s influential Interest and Prices: Foundations of a Theory of Monetary Policy. Nor do the words “international trade” or “international finance.” What gives? Is the process of globalization disconnected from monetary policy? Is central banking totally divorced from globalization? I think not. I believe globalization and monetary policy are intertwined in a complex narrative that is only beginning to unfold. ...

                                                                                                                                                                                                                                      There are many convoluted definitions of globalization. Mine is simple: Economic potential is no longer defined or contained by political and geographic boundaries. ... Where does monetary policy come into play in this world? One of the first books I read as I prepared for my new job as Dallas Fed president was A Term at the Fed... by former Federal Reserve Governor Larry Meyer. ... Meyer’s book is a real eye-opener because it describes in great detail the learning process of the FOMC ... as the U.S. economy morphed into the new economic environment of the second half of the 1990s. At the time, economic growth was strong and accelerating. ... The prevailing views ... pointed to rising inflation. That is precisely what the Federal Reserve’s models were saying, as was Meyer himself, joined by nearly all the other Fed governors and presidents ... Under the circumstances, they concluded that monetary policy needed to be tightened to head off the inevitable.

                                                                                                                                                                                                                                      They were frustrated by Chairman Greenspan’s insistence on postponing rate hikes, yet ... inflation ... kept falling. If the conventional wisdom had prevailed, the Fed would have caused the economy to seriously underperform. ... Greenspan ... was ... constantly talking ... to business leaders. And what they were telling him jibed with what he knew ... new technologies ... enhanced productivity. ... It is important to listen to our economy’s business operators. ... Our business managers are the nerve endings in Adam Smith’s invisible hand...

                                                                                                                                                                                                                                      The ... creation of vast new sources of inputs and production have upset all the calculations and equations of the very best economics minds. How can economists quantify with precision what the United States can produce with existing labor and capital when we do not know the full extent and elasticity of the global labor pool? Or the totality of the financial and intellectual capital that can be drawn on to produce a nation’s GDP? How do we measure the inventory-to-sales ratio in a technologically advanced, hyper-interconnected world where offshore sources are expanding geometrically, if not exponentially? ...

                                                                                                                                                                                                                                      The old models simply no longer apply in our globalized, interconnected and expanded economy. ... the economics profession needs to rejigger its econometric equations to better inform our understanding of the maximum sustainable levels of U.S. production and growth.

                                                                                                                                                                                                                                      There are, of course, those who will argue, at least from a theoretical perspective, that globalization should not matter much in a world of flexible exchange rates. They contend that a central bank can tailor monetary policy to domestic objectives alone when it is not obliged to defend a specific value for the currency. ... The proposition, however, holds only under assumptions I do not think apply in the world we live in today. ... To be sure, not everyone buys into my proposition ... Even so, as a practical matter, globalization has important implications for monetary policymakers, flexible exchange rates or no. ...

                                                                                                                                                                                                                                      Will the tailwinds stay with us? Left to their own devices, I think they would ..., but we have to take into account the political dimension. I have expressed my concern about the implications of our fiscal deficits, vowing never to use my vote on the FOMC to monetize excess spending. I have also warned of the dangers of protectionism...

                                                                                                                                                                                                                                      As a Texan, I am mindful of the story about William McChesney Martin, Fed chairman from 1951 to 1970. President Johnson invited him down to his Texas ranch for what turned out to be a one-on-one meeting. The president wanted a more accommodating monetary policy, and Martin, a strong advocate of Fed independence, tried to explain to him the consequences of that course of action. Johnson would have none of it and advanced on Martin, shoving him around the room and shouting, “Boys dying in Vietnam, and Bill Martin doesn’t care!” Years later, Martin expressed his regrets about shifting policy to suit the president. “To my everlasting shame,” he said, “I finally gave in to him.”[1]

                                                                                                                                                                                                                                      Presidents Clinton and Bush have allowed the Fed to operate with a high degree of political independence from the administration. On the whole, Congress has also wisely refrained from interference. Without its independence from political interference, I doubt the Fed could have so successfully set the interest rates that have led to today’s favorable economic circumstances. Just as I doubt that, without independence from rigid econometric dicta, monetary policy could have so adroitly harnessed, and in turn lubricated, the forces of globalization.

                                                                                                                                                                                                                                      "Boys dying in Iraq and Ben Bernanke doesn't care!" I trust Bernanke will withstand any such pressure.

                                                                                                                                                                                                                                        Posted by Mark Thoma on Saturday, January 7, 2006 at 12:32 AM in Economics, Fed Speeches, Monetary Policy

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                                                                                                                                                                                                                                        Where the Boys Aren't

                                                                                                                                                                                                                                        From Andrew Leigh of Imagining Australia:

                                                                                                                                                                                                                                        Imagining Australia, Sororities Up, Frats Down: A fascinating paper by Claudia Goldin and Larry Katz looks at why women outnumber men in US universities (as they do in Australia). For every man graduating from a 4-year college in the US, 1.35 women graduate.* Their abstract:

                                                                                                                                                                                                                                        Women are currently the majority college students and those receiving a B.A., but were 35 percent of undergraduates in 1960. Although the relative increase progressed steadily from the 1950s large changes occurred in the late 1960s and 1970s. Using three longitudinal data sets of high school graduates in 1957, 1972, and 1992 we show that the new gender gap in college was produced in several stages. From 1957 to 1972 high school girls increased their college going, however their high school course taking changed only slightly. But from 1972 to 1992 girls took substantially more math and science courses and showed greatly improved math and reading test scores relative to boys. These changes can account for one-third to one-half of the increase in women’s college completion rate relative to men’s. The expectations of young women about their future work were rapidly brought in line with reality between 1968 and 1979, enabling them to invest more appropriately in skills.

                                                                                                                                                                                                                                        The most interesting fact-ette:

                                                                                                                                                                                                                                        In all three surveys girls achieved higher grades in high school than did boys. In the WLS (graduating 1957) the high school rank of the median girl was 21 percentile points above the median boy. In the NLS (graduating 1972) the median girl was 16 percentile points above the median boy and the difference was almost 15 percentile points in the NELS (graduating [from high school] 1992).

                                                                                                                                                                                                                                        * Apparently in some colleges in the US south, the ratio is now nearly 2 women for every man, which makes one wonder whether soon men will start attending university just so they can find a high-flying mate.

                                                                                                                                                                                                                                        Some of the difference between male and female attendance can also be explained by a much larger fraction of women from low income homes attending college than low income men. As this report notes:

                                                                                                                                                                                                                                        Black, Hispanic, and low-income students have lagged behind their peers for years. ... the growing gender gap within these groups has been well-documented ... There is little evidence to suggest that white, middle-class males are falling behind their female peers.

                                                                                                                                                                                                                                        Here are some data from the report. The figures are a bit dated, and it is only one of many statistics examined, but it gives a sense of the findings:

                                                                                                                                                                                                                                        I wonder if income level and college enrollment are related similarly in Australia?

                                                                                                                                                                                                                                          Posted by Mark Thoma on Saturday, January 7, 2006 at 12:25 AM in Economics, Universities

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                                                                                                                                                                                                                                          January 06, 2006

                                                                                                                                                                                                                                          Fed Watch: A Little Something for Everyone

                                                                                                                                                                                                                                          Tim Duy looks through the eyes of monetary policymakers at today's employment report and its impact on the course of monetary policy:

                                                                                                                                                                                                                                          What better way to return from a long winter break than to tackle a muddled labor report! I suspect that we will find many stories told about this report, and I will try to summarize all of them (Kash at Angry Bear was out of the gates early with the pessimist’s take). But what is most important – from a FedWatch perspective – is the view at Constitution Ave. I tend to think that despite a few setbacks in the details, policymakers will walk away with a relatively upbeat perspective on the labor markets. And that means it may be premature to think the Fed will shortly be done for good.

                                                                                                                                                                                                                                          But first, a quick look back at the Fed minutes. Wall Street’s stamp of approval implies a wide expectation of “one and done” for this tightening cycle. That’s not quite my interpretation, although I can’t blame traders for looking for good news after a dreary December. Instead, I left the minutes with the sense that another rate hike at the end of the month is in the bag, but beyond that, future changes in policy are not automatic but instead data dependent. That is decidedly not the same thing as “done.” “Done” means you are betting against the economy – and I doubt the Fed is ready to make that call just yet.

                                                                                                                                                                                                                                          As far as the labor report goes, the headline payroll gain of 108,000 was clearly a disappointment. But optimists will point to the revision that pushed the October gain to 305,000 jobs, which yields a respectable two-month average of just over 200,000. Optimists will point to the decline in the unemployment rate to 4.9%; pessimists will focus on the decline in the labor force participation rate. Pessimists will focus on the slight fall in aggregate hours worked; optimists will point to the 5 cent wage gain.

                                                                                                                                                                                                                                          Some other details popped out at me. The 18,000 gain in manufacturing employment should be happy news to many, although my initial scan of the blogs does not show a focus on this number. In contrast, the decrease in construction employment could reflect cooling housing markets. While many expect those jobs will eventually show up in Gulf Coast rebuilding efforts, only in macroeconomic textbooks does a worker move from San Diego to New Orleans instantaneously and at zero cost.

                                                                                                                                                                                                                                          So, what will policymakers make of all of this? First of all, it is always important to remember that one month of a single data report is not likely to fundamentally alter the perceptions on Constitution Ave. We will have two more of these reports – not to mention dozens of other data points – by the time the March meeting rolls around. If, then, the overall trends are what is important, can we find some consistency in the data of the optimists and pessimists? For this I turn to Table A12 of the employment report, a personal favorite of mine. Table A12 reports different measures of labor underutilization. The most optimistic measure is:

                                                                                                                                                                                                                                          Percent of Civilian Labor Force Unemployed 15 Weeks & Over

                                                                                                                                                                                                                                          The most pessimistic measure is:

                                                                                                                                                                                                                                          Total Unemployed, Plus All Marginally Attached Workers Plus Total Employed Part Time For Economic Reasons, As A Percent Of All Civilian Labor Force Plus All Marginally Attached Workers

                                                                                                                                                                                                                                          The headline unemployment rate at 4.9% basically splits the difference.

                                                                                                                                                                                                                                          What do both of these pictures have in common? Both measures place labor market utilization near the rates seen prior to the great boom of the late 1990’s. Do policymakers believe that the late 1990’s can be repeated? Or was that period an aberration, and attempts to recreate that environment will only lead to higher inflation expectations?

                                                                                                                                                                                                                                          I tend to believe that policymakers favor the latter interpretation. That implies if overall economic data points to stabilization in these measures, the Fed will be content to sit back after this next hike and wait to see how their medicine works. But if these measures continue to decline in concert with strong coincident and leading data, the Fed will feel obligated to move rates higher in March and possibly beyond. I believe this interpretation will not be well received by the labor market pessimists.

                                                                                                                                                                                                                                          What about the employment to population ratio? PGL an Angry Bear points to a decline over the past five years as a sign of a weak labor market. This short run view of the data raises the same question: Was the push higher in the late 1990’s a reflection of a once-in-a-generation stock market boom? Do we really want the Fed to recreate those conditions? Do we really expect them to? And a longer run view raises another batch of questions:

                                                                                                                                                                                                                                          Employment to Population Ratio

                                                                                                                                                                                                                                          Here you are stuck with disentangling the cyclical behavior with the secular trends. If we attribute rising employment participation to increased female participation in the labor force, and if that trend has pretty much been maxed out while male labor force participation continues to slide, and we believe the boomers are starting to retire, then I am not sure we can expect much higher employment to population numbers short, again, of 1990’s style boom.

                                                                                                                                                                                                                                          Similar thoughts can be said of Mark Thoma’s questions regarding stagnant numbers among marginally attached workers in the post below this one. You have to raise the question of what type of environment is necessary to draw these workers back into the labor force, and will the Fed attempt to do so?

                                                                                                                                                                                                                                          Truth be told, I honestly don’t know the “correct” level for any of these measures of the labor market. Nor would I, or anyone at the Federal Reserve, say the job market is as strong as in the late 1990s. My point is that from a policy perspective, the last cycle may not be the relevant reference point. Pointing to the Clinton Era might be like pointing to the 1980’s in Japan – remember when Tokyo had all the answers? It was fun while it lasted, but it isn’t likely to happen again. If instead, we assume that the Fed sees labor markets as relatively healthy, and that they see this view as supported by rising wages (accelerating to 3.1% over the past year), then the next step for the Fed is to determine the impact on the inflation outlook. And that again raises enough questions to keep a central banker awake at night:

                                                                                                                                                                                                                                          • To what extent do rising wages reflect productivity gains, tight labor markets, and pass through from this summer’s surge in headline inflation?
                                                                                                                                                                                                                                          • How much of the wage gain will firms be able to pass through to core prices?
                                                                                                                                                                                                                                          • Has past monetary policy already put enough tightening into the system to head off any pass through to core prices?
                                                                                                                                                                                                                                          • What about the pressure exerted through rising commodity prices? Note that oil prices are creeping upward toward $70 again. Also watch metals (copper and gold).
                                                                                                                                                                                                                                          • Is the housing market slowdown turning into a full blown bust?

                                                                                                                                                                                                                                          With so many variables in play, it is not surprising that the Fed wants to change the game plan. To date, policy has been driven by the desire to normalize interest rates. But now that we are at a more neutral level, the next policy steps aren’t so clear. This is why policy is now data dependent, and why anything beyond Greenspan’s final move is fuzzy. [All Fed Watch posts.]

                                                                                                                                                                                                                                          [Update from Mark Thoma: Dallas Fed president Richard Fisher and Boston Fed president Cathy Minehan gave speeches today (1/6/06) at the ASSA meetings in Boston. From Bloomberg:

                                                                                                                                                                                                                                          "We may be entering a period in which policy changes are even more dependent than they have been on current readings of the economy, with all the uncertainty such readings can bring,'' Minehan said. "As the Committee's minutes have suggested and its recent policy statement confirms, its communication is evolving.''

                                                                                                                                                                                                                                          And also:

                                                                                                                                                                                                                                          Fisher didn't speak in any detail about the near-term course of interest-rate policy. Minehan said policy makers will have to watch economic data to determine their next steps now that the Fed has removed most of the "accommodation'' from the economy. Investors should understand that Fed statements aren't going to give them a clear road map of future rate moves in that environment, Minehan said.]

                                                                                                                                                                                                                                            Posted by Mark Thoma on Friday, January 6, 2006 at 03:52 PM in Economics, Fed Watch, Monetary Policy, Unemployment

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                                                                                                                                                                                                                                            And Never is Heard a Discouraging Word?

                                                                                                                                                                                                                                            The Labor Department reported today that employment increased by 108,000 over November, a number that is lower than expected, and the unemployment rate held steady at 4.9%. This is a brief follow-up to PGL's post at Angry Bear on the unemployment, labor force participation, and discouraged worker numbers (Kash has more). A sign of an improving labor market is a fall in discouraged workers. However, according to today's report from the BLS:

                                                                                                                                                                                                                                            Persons Not in the Labor Force (Household Survey Data)

                                                                                                                                                                                                                                            The number of persons marginally attached to the labor force was 1.6 million in December, about the same as a year earlier. (Data are not seasonally adjusted.) These individuals wanted and were available to work and had looked for a job sometime in the prior 12 months. They were not counted as unemployed, however, because they did not actively search for work in the 4 weeks preceding the survey. Among the marginally attached, there were 451,000 discouraged workers in December, essentially the same as a year earlier. Discouraged workers were not currently looking for work specifically because they believed no jobs were available for them. The other 1.1 million marginally attached persons had not searched for work for reasons such as school attendance or family responsibilities. (See table A-13.)

                                                                                                                                                                                                                                            It's puzzling why the number of marginally attached discouraged workers isn't falling if the labor market is strengthening. The news is a bit better relative to a year ago for part-time workers wanting to work full-time:

                                                                                                                                                                                                                                            Total Employment and the Labor Force (Household Survey Data)

                                                                                                                                                                                                                                            Total employment, at 142.8 million in December, was little changed over the month but was 2.6 million higher than a year earlier. The employment- population ratio held at 62.8 percent in December, 0.4 percentage point higher than a year earlier. The labor force participation rate, at 66.0 percent, was unchanged over the year. (See table A-1.)

                                                                                                                                                                                                                                            The number of persons who work part time for economic reasons, at 4.1 million, was about unchanged in December but was down by 327,000 over the year. This category includes persons who indicated that they would like to work full time but were working part time because their hours had been cut back or because they were unable to find full-time jobs. (See table A-5.)

                                                                                                                                                                                                                                            See PGL's post for a look at these figures over a longer time period. With both employment and real income behaving sluggishly by historical standards, the labor market is not as robust as would be expected in a recovery.

                                                                                                                                                                                                                                              Posted by Mark Thoma on Friday, January 6, 2006 at 11:00 AM in Economics, Unemployment

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                                                                                                                                                                                                                                              401(k) Street Gets a New Resident

                                                                                                                                                                                                                                              More evidence of the changing social contract between firms and workers:

                                                                                                                                                                                                                                              IBM Adds Its Name to List Of Firms Freezing Pensions, by Albert B. Crenshaw and Amy Joyce, Washington Post: International Business Machines Corp. said yesterday that it will freeze the pension plans of some 120,000 employees in the United States, effective at the end of next year, and will offer instead an improved 401(k) plan. IBM's move is part of a corporate stampede away from traditional pension plans. IBM officials called the change essential to remain competitive with foreign and domestic information-technology rivals. ... IBM's action adds the company to a growing list of U.S. employers that have frozen or terminated pension plans to cut costs or, in some cases, to emerge from bankruptcy. ...

                                                                                                                                                                                                                                              [T]he full benefits of the new 401(k) plan will closely match those that employees would have gotten under the cash-balance plan. However, ... a consequence of dropping the plans is less guaranteed money for all workers. Under a traditional pension ... the employer bears the investment risk, and the pension ... is insured by the PBGC. With 401(k) plans, no matter how generous the company match, the worker's ultimate benefit depends substantially on the performance of his or her investments. "We're looking at very large companies who have had traditional pension plans for a very long time getting rid of them," ... "This is corporate America ... saying to workers 'you're on your own.' "

                                                                                                                                                                                                                                                Posted by Mark Thoma on Friday, January 6, 2006 at 03:15 AM in Economics, Social Security

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                                                                                                                                                                                                                                                Scenes from China's Industrial Revolution

                                                                                                                                                                                                                                                I received this by email (thank you). It's a long article, but worth taking the time to read. It's a description of China's industrial revolution with looks inside factories, at worker's lives, at the movement from the countryside to the city, and at the social, political, and environmental consequences of industrialization told through the eyes of a visitor:

                                                                                                                                                                                                                                                Letter from China: The Great Leap: Scenes from China's industrial revolution, by Bill McKibben, Harper's Magazine (December 2005): On the flight from Newark to Beijing, I read the following small item in the China Daily:

                                                                                                                                                                                                                                                According to media reports, several air conditioner installers have fallen to their deaths in the last couple of days in Beijing alone. As the sweltering summer heat sweeps the country, sales of air conditioning units are booming. This has naturally led to strong demand for installation services. The spurt in installation service demand has left many firms under staffed, so some are temporarily recruiting untrained installers to cash in ... [Some] even refuse to provide safety belts to installers in order to save costs.

                                                                                                                                                                                                                                                The article - evoking as it did a hazy urban sky filled with plummeting air-conditioner installers - coincided perfectly with my mental image of China, so I tore it out and filed it away. I'd done the same thing a hundred times before, creating for myself a carefully imagined China full of smog-blackened cities where people wore gas masks against the clouds of coal smoke; savagely Dickensian factories where young women were paid slave wages; a heedless and rapidly expanding consumer class hell-bent on buying cars and appliances with no regard for the environmental costs of their consumption. I wanted to see it for myself, to indulge in the kind of disaster tourism that makes one gaze agape at the sheer can't-take-your-eyes-off spectacle of it all, like the visitors who flocked to Niagara to watch boats filled with zoo animals wash over the falls. And then come home with head-shaking cautionary tales about what this combination of heedless growth and ecological unconcern meant for the future of the world. That was the plan, anyhow.

                                                                                                                                                                                                                                                The "watch out for China" narrative offers something to every American. Liberals can be repulsed by China's destruction of the environment and conservatives can portend the rising hegemon of the East. Americans from across the political spectrum can frown upon China's dismal disregard for personal freedom - jails filled with Falun Gong devotees, always Tiananmen hovering in the background. The problem with actually reporting about a place, however, is that you start collecting stories, and they never quite fit. It's not that any of these angles are wrong - there are countless well documented stories of nightmarish factory conditions, human-rights violations, local corruption, and environmental folly - but even taken together they don't come close to adding up to China. And they allow us to ignore what might be most crucial about the emerging nation: the ways it is starting to resemble our own.

                                                                                                                                                                                                                                                On my third day in China, still slightly jet-lagged, I piled into a VW Jetta driven by a Beijing software designer named Wen Jie and headed for the "Rongcheng Industry Zone" about 100 miles southwest of Beijing - one of hundreds of such zones spread along China's coastline. We took an empty new highway out of the city. That highway joined another, and another, till finally we exited the toll-road system altogether and plunged into Third World rural chaos: overloaded trucks, flocks of sheep wandering across the street, a landscape scarred by tiny brickworks whose owners had mined out the top few feet of much of the surrounding landscape. And, covering every other bit of available land, the underlying green order of corn and rice fields, punctuated at irregular intervals by men and women, straw-hatted, backs bent, hoeing under the hot sun.

                                                                                                                                                                                                                                                The Rongcheng Industry Zone turned out to be less grand than it sounded - a rural district with a higher density of factories and (another) brand-new highway, this one leading directly to Tianjin, the largest manmade port in China. We stopped at the Hebei Rongcheng LeJia shower-curtain factory to pick up its owner, Bao Jijun, who wanted to show us his and some of his friends' operations.

                                                                                                                                                                                                                                                Now, given what I'm going to say, it matters how I came across Bao. I had avoided registering as a reporter with the Chinese government, and so I was spared a tour of some showpiece installation. On the other hand, the owner of any dark satanic mill or prison-slave-labor operation was surely bright enough to keep an American with a notepad away. In fact, I found Bao in as random a way as I could imagine: a friend in Vermont, where I live, introduced me to Wen (the software designer), who in turn introduced me to Bao, a kind of shirtsleeve cousin, who'd been making shower curtains since 2002.

                                                                                                                                                                                                                                                Before showing me his factory, Bao wanted us to visit the Hua Xin Li Dress Co, Ltd, which was by Chinese standards a venerable firm. It had opened its doors in 1987, right around the time that Deng Xiaoping had begun to allow any such enterprise. From a home factory with five or six employees, it had grown into a medium-sized enterprise with several hundred workers. "'First Quality and Prestige Supreme' is our aim", says the company's brochure; on the day we visited they were churning out slightly garish yellow dress shirts for the Eastern European market. The factory was three stories tall, and on each floor young women, and a few young men, in white company T-shirts sat, four abreast, in front of new sewing machines imported from Japan. It was a hot day, but big fans moved plenty of air around. There was a busy hum, but not a din. The women worked fast, especially the button-sewers at the end of the room, but not frantically. A large red banner hung over the middle of each room reading, in Chinese, "The Customer Is God and the Market Decides Everything".

                                                                                                                                                                                                                                                What "the market" had decided was that these women would earn about 10,000 yuan a year (fifty cents an hour).{1} Two thirds of them commuted from the surrounding villages. The rest came from the provinces and lived behind the factory, in a dormitory with a water pump and a clothesline out in the courtyard. I cannot tell you if this was a hard life or even an acceptable life, but later, as we drove away from the factory, we did pass field after field of those men and women with bent-over backs.

                                                                                                                                                                                                                                                After our tour of the Hua Xin Li Dress Co, Ltd, we got back in the Jetta and headed down the road to the Gold Pioneer Cow shirt factory, where in similar (although smaller) rooms young women and some men were sewing track suits for Germans, black vests for hotel waiters, and - under the Tact Squad label - dark blue uniforms for American cops. Gold Pioneer Cow also makes men's suits for the Chinese market. "In China, the requirement is that if you get married you need to have a wedding suit", the owner explained happily.

                                                                                                                                                                                                                                                And then, at the end of a dusty road, we returned to the shower-curtain plant. Bao Jijun is in his early forties, tall, lean, and vigorous. He'd started his business three years before in a Beijing apartment with his wife and two other workers; within six months he was renting space at another factory; within a year he had leased this place. Now he had a hundred employees. We wandered through the workrooms, watching kids - almost everyone was between eighteen and twenty-two, as if the place were some kind of shower-curtain college - smooth long bolts of polyester onto huge tables, sew hems and grommets, fold the finished curtains into plastic bags, pack them into cartons. It's hard to imagine a much simpler product than a shower curtain.

                                                                                                                                                                                                                                                Because of the summer heat, everyone worked from 7:30 to 11:30 and then again from 3:00 to 7:00. We'd been there for only a few minutes, in fact, when all labor ceased and everyone poured down the stairs into the cafeteria for lunch. Rice, green beans, eggplant stew, some kind of stuffed dumpling, and a big bowl of soup: 1.7 yuan, or about twenty cents. While people ate, we wandered into one of the dormitory rooms for girls (the boys were off a separate hall). Each room had four bunk beds, one of which was for storing suitcases and clothes. The others were for sleeping, six girls to a room. There were stuffed animals, posters of boy bands, stacks of comic books, little bottles of cosmetics. One desk to share, one ceiling fan. Next to the dormitory was a lounge with a giant TV and twenty or thirty battered chairs; the room next door had a Ping-Pong table. "Any of my workers who can beat me", Bao said, "gets a bottle of beer".

                                                                                                                                                                                                                                                Virtually all of Bao's employees come from the province where he grew up, a couple hundred miles to the south. He let me interview as many as I wanted, with Wen acting as interpreter. He was especially pleased with my first pick, Du Peitang, a nervous twenty-year-old with a goofy grin and very bright eyes. His father had died and his mother had remarried and moved away, so he'd grown up with his grandparents. His first job had been as a guard at an oil company in Shandong province, but it paid only a few hundred yuan a month and there was no room or board. One of his relatives introduced him to Bao, who had the reputation of being nice to his workers, so he'd come to work, earning about 1,000 yuan a month. From that salary, he'd been able to save 12,000 yuan in a little less than two years - a pretty big stake. In another year or two, he said, he'd have enough to build a small house back home and get married. For fun, Du said, he played Ping-Pong and watched TV - a good plan, because, as Bao pointed out, buying a single Coke every night would come near to halving Du's savings.

                                                                                                                                                                                                                                                The next worker I talked to was Liu Xia, eighteen years old, a lovely young woman nervous as hell about talking to a strange American who inexplicably and impertinently wanted to know about her life. "There are four people in my home. My parents, my elder brother, and me. My parents aren't healthy. They do farm work, but my father has a bad knee, so my mother carries most of the load. I really wanted to help her. And my brother could go to college, but it would cost a lot. He is in the Shandong University of Science and Technology, studying mechanical engineering." In fact, it turns out, he had graduated just a week before, thanks to her earnings here at the curtain factory. I asked her if she had a stuffed animal on her bed like everyone else. Her eyes filled ominously. She likes them very much, she said, but she has to save all her earnings for her future.

                                                                                                                                                                                                                                                I could tell stories about this one factory for a long time. It was hot the night before we came, for instance, and so everyone had slept on the roof, and Bao had told them the old Chinese story about the spinning girl and the cowboy and the creation of the Milky Way. But I'll desist - for all I know, I'd stumbled into the one decent factory in all of China. After all, Chinese workers reportedly lose 40,000 arms, hands, and fingers to industrial accidents every year.

                                                                                                                                                                                                                                                For his part, Bao says he thinks he's in the seventieth or eightieth percentile of factories, judging by working conditions. One reason his factory is decent is because he's a good guy. Another is that he sells some of his shower curtains to Ikea. The company sends an inspector, unannounced, several times a year to check on the living spaces and the number of toilets and so on, and slowly these inspectors have been checking off the improvements. "It adds to the cost, but I appreciate it. I regard the requirements as help to reach the level of a factory in a developed country", Bao says with a kind of Rotarian pride.

                                                                                                                                                                                                                                                TENS OF MILLIONS OF CHINESE ARE LEAVING THEIR FARMS EVERY YEAR. IT'S THE BIGGEST MIGRATION IN THE HISTORY OF THE PLANET

                                                                                                                                                                                                                                                Depending on the model, Bao can make a shower curtain for about 21 yuan. He can sell one for about 24 yuan. When you buy a similar shower curtain in an American big-box store it retails for about $30, or about 240 yuan. But Bao doesn't do much business directly with American-owned retailers. When a pair of buyers from the States came to visit a few months earlier, they had told him they could sell millions of curtains. But he would somehow have to drive the price down to 18 yuan. Which would mean, say, getting rid of the Ping-Pong table, or adding a few hours to the workday, or doubling the price of the soup.{2}

                                                                                                                                                                                                                                                Seeing the sheer volume of industrious labor in those few factories began my education. But it was only toward the end of my four-week visit, in the city of Yiwu, that I really began to understand not only the scale of China's manufacturing enterprise but the force of the momentum behind it.

                                                                                                                                                                                                                                                I'd taken a packed and sweltering train from Shanghai to Yiwu, which despite being home to more than a million people didn't even appear in my 900-page tourist guide to China. Yiwu is home to the International Trade City, where you can see sights every bit as awesome as the terracotta warriors of Xian or even the Great Wall. The place is only two-fifths complete, but the two huge buildings already standing - they each look like the Empire State Building laid on its side and mated with a fleet of aircraft carriers - demonstrate the unavoidable truth that anything that can be made can be made cheaper in China.

                                                                                                                                                                                                                                                Take, for instance, the "Suit cases and Bags, Including School Bags" section of the International Trade City. There are about eight hundred 10 x 12 stalls, each representing a different factory, each showing its wares to buyers in the hope they'll order lots of ten or twenty or thirty thousand. There are stalls with duffel bags, change purses, wallets of every kind. Fanny packs, metal lunchboxes, jewelry cases. It's a kind of headquarters of dubious English: "I dream of being the best basketballer in the town". "Durable Performance Based on the 58's 123-45 Vintage Spirit". "My grandfather has white hair like snow". I stared for a long time at a backpack that said "All Things Grow with Love" before I figured out that it looked weird because it was grammatically correct.

                                                                                                                                                                                                                                                "Suitcases and Bags, Including School Bags", took up only half a floor. The story above was entirely devoted to "Hardware Tools and Fittings", which is another way of saying pretty much everything on earth: knife blocks, car jacks, chaise longues, surge protectors, lint rollers, jumper cables, carabiners, bike pumps, rubber bands, cheese graters. One stall had thousands of those Lance Armstrong "Livestrong" bracelets in a rainbow of colors. Lucky rabbit's feet, singing birthday cards, nail clippers, safety pins, ratchet sets, thigh exercisers, bathroom scales, toilet-bowl deodorizers, plaid wheelchairs, feather dusters, meat-pounding mallets. Dozens of models of magnetic patriotic ribbons for the backs of American cars ("Freedom Is Not Free"). Pruning shears, putty knives, carafes, egg cups, cake-decorating nozzles, depilatory machines, giant martini glasses, immersion heating coils, disposable cameras, hip flasks, sake sets, mortar and pestles, cereal dispensers (like you see on the buffet at the Motel 6), rolling pins, exit signs, sander belts, key rings, rubber gloves.

                                                                                                                                                                                                                                                In the "Regular Toys" section of Building 1 there are hundreds of stalls offering variations on those weird squishy rubber balls: skull-shaped balls whose eyes pop out when you squeeze, "yucky maggot balls". Not to mention boogie boards, plastic hand grenades, squeaky mallets, bow-and-arrow sets, toy pianos, "small chef" ovens. After twenty minutes of walking you emerge into the "Electric Toys" section. ("Does thinking the son and daughter become the scientist? Then start growing from the electronic toy bricks! Train pilot! Look for the Bill Gates!") And then the "Inflatable Toys" section, and then, biggest of all, the "Fabric Plush Toys". The next floor is divided between artificial flowers and hair ornaments - you suddenly realize that there are three billion women on this planet, many of whom would probably be happy to have ribbons in their hair. And above that, miles of kitsch - the "Tourism Crafts" section, which could stock every gift shop on earth, with light-up Virgin Marys, "African" carvings, novelty bottle openers, refrigerator magnets by the millions. And on the top floor, the stalls that bring the world Christmas. Groves of artificial trees blinking with LEDs, squads of Santas playing electric guitars and riding exercycles and spinning hula hoops. Tinsel tinsel tinsel.

                                                                                                                                                                                                                                                Once I'd been to Yiwu, sights I'd seen earlier made more sense. Chunming, for instance, was a tiny rural town in the hills of Sichuan. We'd spent the night before in Chengdu, the provincial capital, which is larger than New York City. Chunming was an hour's drive away, but it was the usual world apart. Most of the men worked up the hill at a makeshift coal mine, trying to avoid the cave-ins and explosions that claim a hundred miners a week around the country. The place was pretty bleak.

                                                                                                                                                                                                                                                With my translator, a young environmental journalist named Zhao Ang, I wandered up to the first house we came to. The place was actually pretty big, a series of interlinked and crumbling courtyards. It had belonged to the local landlord until 1949, when it was expropriated in the wake of the Communist victory and given to seven or eight families to share. A few pigs slept in the room next to the kitchen. There was one girl we could talk to here, Zhao Lintao (no relation). She was twelve years old, and proudly spoke the English she'd learned in the overcrowded village school. When we asked her about her life, though, she was soon in tears: her mother had gone to the city to work in a factory and never returned, abandoning her and her sister to her father, who beat them regularly because they were not boys. The government was taking care of her school fees until ninth grade, but after that there would be no more money. Her sister had already given up and dropped out.

                                                                                                                                                                                                                                                Multiply that story by half a billion and you will begin to understand why the biggest migration in the history of the planet is underway in China, why there are always more bodies to sit behind those sewing machines. Tens of millions of people leave desperately poor farms every year to work at the factories that feed Yiwu. By one estimate the country needs to add an urban infrastructure equivalent to Houston every month just to keep pace. More than a hundred cities in China have populations that top a million. And even so, the countryside still bulges.

                                                                                                                                                                                                                                                What struck me about China, in fact, was not so much the teeming cities as that teeming countryside. China has a third of the planet's farmers and one fourteenth of its farmland. In places, the average farm plot is a sixth of an acre - smaller than many American houses. About 800 million people, roughly 65 percent of China's population, are crowded onto those tiny farms. And on average they are earning one third the income of city dwellers. It is easy to see why the United Nations predicts that by 2030, sixty percent of Chinese will live in the cities. With a massive effort, that number might be held down to fifty percent. But since about one percent of Americans currently work as farmers, down from 39 percent a century ago, we should be able to understand this tide.

                                                                                                                                                                                                                                                Not that the path to the city is easy. The gulf between urban and rural Chinese is as profound as the racial gulfs that plague our own country. Here, for instance, is a small item that appeared one day in the section of the China Daily that runs down comical stories from around the country, tales like "Widowed Swan Finds Love During Treatment" or "Princely Sum Offered for Return of Umbrella" or "Man Dislocates Chin in Laughing Incident".

                                                                                                                                                                                                                                                MIGRANT WORKERS TOLD TO ZIP UP IN ZHENGZHOU

                                                                                                                                                                                                                                                Migrant workers are fresh out of luck if nature calls and they're anywhere near one public toilet in Zhengzhou, Henan province ... The female guard of the toilet is on a campaign to keep migrant workers from using her lavatory. She's even been known to yank any one suspected of being a migrant labourer out of the restroom no matter what state of undress they're in. The toilet's management said the practice was to keep the facilities clean. But it means a long trek to relieve themselves for workers at a construction site near the toilet, as the only other spot they can squat in is wasteland 500 metres away.

                                                                                                                                                                                                                                                A teacher I met in Beijing said he had been appalled at the discrimination he faced when he moved to the city from his village in Inner Mongolia ten years ago. He joined a guerrilla-theater troupe that performed at factory gates and construction sites. One of their most popular plays was the tale of a girl from the country who came to the city and crossed the road in front of a bus, forcing it to slam on its brakes. "Someone in the bus had a cake and it smashed and the man was angry", the teacher said. "The bus driver said the girl was at fault. So the people taking the bus dragged her into the bus and yelled and screamed at her. She got very scared and jumped out the bus window and died."

                                                                                                                                                                                                                                                The teacher, who taught the children of other new arrivals, and who was scared to give his name, said he and his colleagues thought calling those new arrivals "peasants" was "impolite" - he proposed "the people who come to the city for a job" or "the workers" or "new citizens" - but many such new arrivals will never become citizens of Shanghai or Beijing or anywhere other than the villages from which they came. Internal migration being such a major factor in Chinese politics, moving officially requires new papers, and those papers are hard to come by. It was considered a sign of great progress, in fact, when China's premier, Wen Jiabao, went on TV to announce that contractors would no longer be allowed to get away with their usual fraud - turning workers away from construction sites without their last month's pay, a scam that costs workers billions of yuan annually.

                                                                                                                                                                                                                                                If you wanted to slow down the tide of people, you'd need to do something to raise rural incomes. And there are people trying. Ren Xuping, for instance, who lives about an hour outside of Chengdu, in the village-turned-city of Dayi. He was a poor peasant in 1987 when Heifer International, the Arkansas-based rural-development charity, gave him forty-eight rabbits and some instruction on how to breed them. "At first I didn't really believe it was something free", he said. "It was like some pie dropping down from heaven". Within a few years, aided by the well-known reproductive success of bunnies, he was a millionaire. But Ren was a particular kind of millionaire, one who'd become obsessed with Heifer's credo of passing on the wealth. He'd soon delivered up the requisite 100 animals for other farmers to use, but that was barely the beginning: he has since built a training school that, according to Heifer, has trained some 300,000 would-be rabbit farmers.

                                                                                                                                                                                                                                                I spent an afternoon with Ren deep in the Chinese countryside, visiting poor farmers with new consignments of Heifer rabbits. The man can talk for a very long time (over stewed rabbit, spicy sauteed rabbit, deep-fried rabbit) about the advantages of bunnies. (They eat mostly grass, for instance, which can be harvested from recovering eroded hillsides. And every part of them can be used: Ren was opening a factory to make clothing and stuffed animals from rabbit fur.) But he was even more passionate about what rabbit income might mean for poor farmers. "You can make 10,000 yuan a year after two or three years", he said. "This can resolve the problem of supporting the old people and educating the children". The trick, he said, in full power-of-positive-thinking mode, "is to make a family become positive instead of passive. They can say, 'Oh, I live in a remote area, I'm illiterate, I'm poor'. That's a passive attitude, and it can be changed through things like Heifer. You want to make them become a bigger farmer, then an enterpriser. The key is they have to have a dream for the future, develop a mission. In so many cases, they don't have a dream, they just live day to day."

                                                                                                                                                                                                                                                But the truth is, programs like Heifer's will help only so much. The push of the crowded countryside and the pull of urban opportunity are simply too strong. One sweaty night, I drove with Wen out beyond Beijing's fifth ring road, past a huge new condo development with its own McDonald's, and into a totally different world - a once-rural village now surrounded by city, soon to be swallowed up itself, but for the moment serving as home to tens of thousands of migrant families. At the north end of town, down a dark alley, we came to the home of Cao Zhonglong, fifty-seven years old, who came from Jiangxi province in 1987. "Our village didn't have enough food", he said. "There was not any meat, not any alcohol".

                                                                                                                                                                                                                                                Cao's cousin had started a construction team, and so Cao went to work peddling a tricycle full of materials around job sites. Before long he'd learned ceramic tiling, then plastering and painting. He went into business on his own. He, his wife, and their three daughters shared a tiny room, one third of which was occupied by a tinier store. They slept in one bed. Throughout the night, people would stop in to buy beer from the cooler. And yet Cao was not a poor man. He'd saved enough to build two homes back in his village, one two stories tall and the other three. His mother lived in one, and he rented the other.

                                                                                                                                                                                                                                                In Beijing, Cao had only enough money to live in a slum. But if he lived in his house in the countryside he'd have no way to make money. In any case, he had other things to accomplish in the city. His second daughter had, the spring before, graduated from university. She was now working for a joint-venture pharmaceutical company, at a starting salary of 2,400 yuan a month. I asked him if when she was born it had occurred to him she might someday go to university. He just looked at me and laughed.

                                                                                                                                                                                                                                                We drove to Cao's first daughter's hut, a few slums away. She lives there with her husband, Wang Zhihua, who is also from the countryside, and who makes his money enclosing Beijing apartment balconies with glass. "I go to the apartment buildings", he said, "and I note the units where the balconies aren't yet enclosed, and I send them letters". With the money he's saving he plans to move back to the capital city of Jiangxi and start some business safer than fooling around on unenclosed balconies. In the meantime, he's putting his brother through college. The brother, who happened to be visiting the day I was there, speaks excellent English, even though he'd met only one other foreigner in his life. He's getting his degree in electronic-information-systems engineering and plans to start an Internet company.

                                                                                                                                                                                                                                                I'd been in Beijing just a few days when I was invited to the monthly meeting of the Environmental Journalists Salon. I went with an American environmentalist, Randy Kritkausky, whose small nonprofit organization, ECOLOGIA, had helped launch the salon five years before. More than eighty people jammed into a hot and sweaty conference room off the main newsroom of the China Youth Daily.

                                                                                                                                                                                                                                                Which was impressive: in the still tightly controlled political environment, this group was not precisely dissident, but some of its members skated closer to the edge than most Chinese would want to go. One of the day's presenters, for instance, was a retired teacher, Yun Jianli, who'd traveled from Hubei province in the south to rouse among these writers interest in the problems of the Han River. She showed photos of her brigade of activists walking more than a hundred miles along the water - which was gruesomely polluted by effluvia flowing from a hundred small factories - and of campaigners waving a huge green flag with "Save Our River" written in Chinese. She had a lot of pictures of herself at huge meetings, shouting into a megaphone, and of a riverside village of 300 people, 110 of whom she said had cancer. "We complain to the provincial officials, but we get no response", she said. Watching her was almost exactly like watching Lois Gibbs talk about Love Canal two decades ago.

                                                                                                                                                                                                                                                Yun was typical of the kind of environmental activists who have arisen in China in the last few years. Chinese activists tend to focus on pollution in particular rivers and particular cities, as opposed to the more global concerns that increasingly worry Western environmentalists. By some accounts, there may be 70,000 protests a year in China, many of them over particular factories spewing out toxins. While I was there, Howard French wrote a remarkable story in the New York Times about a crowd of 15,000 who rioted to close a pharmaceutical plant at Xinchang. They said the plant had poisoned waterways for miles downstream.

                                                                                                                                                                                                                                                The Chinese authorities, who value stability above all else, are attempting to respond. The Party, for instance, under the influence of European environmentalists, has pledged its commitment to what it calls a "circular economy". In, say, Denmark this would mean organizing industrial parks such that a power company, a drug plant, a wallboard producer, and an oil refinery would be located near one another so that they could use one another's wastes as raw materials. In China it's so far meant a large number of conferences and pledges and confident announcements - pilot projects to turn sulphur slag into fertilizer, promises that, say, Guangdong province would, since round numbers are big in China, "introduce standard clean production systems to 100 industrial enterprises, turn 100 heavy polluting enterprises into more clean and efficient operations and promote 100 types of new clean production skills and techniques". Given that there are millions of plants across China, it's hard to tell what any of this means, though the World Bank is ready to start spending and the restaurant next to the best hotel in Guiyang has an impressive list of German beers for the Teutonic experts who are arriving to dispense advice.

                                                                                                                                                                                                                                                As it happened, I later visited a village near Guiyang devoted to another oddly green enterprise: organic peaches, each one individually wrapped in brown paper to prevent insects from causing trouble. China actually has a pretty good market for organic food, in part because consumers have good reason to worry about food safety. In one supermarket, I watched women wait in line for organic pork and saw mountains of eggs with individual "no harm" stickers. Demand is high enough to have blunted some of the momentum toward factory farming.

                                                                                                                                                                                                                                                But the peaches, while delicious, were only half the story. Every house in the village had a biogas digester, a pit where manure and green waste rotted and gave off methane that in turn heated the wok and warmed the shower. (I even saw rice cookers converted to use the biogas.) According to local officials, forty percent of the 400,000 farm families in the Guiyang metro area will have biogas pits of their own within the next five years. That would be a good thing. Meanwhile, the small cement operations that squat beneath the limestone hills are slowly being closed down and consolidated, the better to control their emissions. That will be a good thing, too. And the local head of the Circular Economy office is signing contracts, buying (German) pollution-control equipment, training factory managers.

                                                                                                                                                                                                                                                Such progress, however, is on the surface. Forget pollution for a minute - the bigger problem is that almost every natural system in China shows the effects of thousands of years of hard use and, especially, of the last half century of ideologically inspired misuse.

                                                                                                                                                                                                                                                To get a sense of the burden the Chinese face, I got in a Chinese-made SUV one day in Beijing with Zhao Ang and a telecom programmer, Zhang Junfeng, who volunteers with a local environmental group that is monitoring the capital's water supply. Our goal was to follow the Chao River, the main source of Beijing's chief reservoir, as far upriver as we could. It was a trip none of us had taken before, and revealing in - well, in a hundred ways.

                                                                                                                                                                                                                                                Each village we passed - and the villages essentially ran together without end - had one building with a long blackboard nailed to a wall. The blackboards turned out to contain the town records - the corn-planting schedule, the electricity fees. And a list of each of the recent births: name, date, whether it was the first or the second child for the couple in question, and whether it was legal or not. (Under certain circumstances, rural families can have two kids).{3}

                                                                                                                                                                                                                                                Although the lowlands were covered in corn (and when you walked the rows you discovered that they were carefully interplanted with potatoes, something that doesn't happen on a tractor-planted Iowa industrial farm), the hills were essentially bare - without trees, eroding, a mess. In 1958, the Great Helmsman declared the Great Leap Forward. The people were to stop raising crops and start making steel in their back yards. Making steel required heat, which required wood, which required deforestation, and since not making steel would have been a bad idea, the hills were soon bare. The chaos of the Cultural Revolution led to a lot of tree-cutting too, and even the recovery from Mao took its toll - in 1979, when the "household responsibility system" was inaugurated and authorities divided communal land into individual plots, some people were afraid their neighbors would cut down "their" trees and so they axed them first.

                                                                                                                                                                                                                                                Grasslands disappeared like forests. With newly prosperous urban markets for meat, the number of livestock swelled. American environmentalist Lester Brown, a longtime student of China, says that there are 339 million goats and sheep in the country, compared with seven million in the United States. "I've been in areas where the farmers have to put human clothes on their mohair goats to keep them from grazing one another", he told me. "There's nothing to eat". Without roots to hold the soil, much of the countryside has simply turned to sand. Deserts advance by hundreds of miles annually, and the dust storms of April and May are now a recognized Beijing season, just like spring and fall. Think Dust Bowl circa 1934 - only in Pennsylvania and New Jersey, and with no vacant California left for the refugees.

                                                                                                                                                                                                                                                The government has responded with tree-planting campaigns. On my way up to the Chao River, I was confronted with a grand vista - hundreds of brown hills that seemed to have broken out in a kind of acne. As I got closer, I saw that each white spot was in fact a small semicircular niche, maybe three feet round and two feet high, built of carefully stacked whitewashed stones - they were planters for trees, designed to catch water and nurture individual seedlings. I could see hundreds of thousands of them, the work of almost unimaginable man-hours. Pile all the rocks in one place and you'd have the pyramids.

                                                                                                                                                                                                                                                When it comes to trees and erosion, the government seems also to have replaced the classic Communist sloganeering with stuff that sounds like it was written by bureaucratic Greenpeacers. One huge billboard I saw said, "Carefully operate the policy of the central government on forest management". Carved in ten-foot-tall chalk letters on one mountainside: "Keep the sand here and the water clean to make our area wealthy and serve Beijing!" The point, I guess, is that they've noticed they have a problem.

                                                                                                                                                                                                                                                Which is not to say that they're necessarily solving it. Just as the Great Leap Forward produced great heaps of utterly useless pig iron, Maoist-style tree-planting has its critics. I'd earlier watched a Powerpoint presentation by Jiang Gaoming of the Chinese Academy of Sciences demonstrating that in one project after another three out of four trees had perished. "It's a foolish policy", Jiang had said. "It emphasizes construction, not protection". On the other hand, Jiang's solution to the dust storms was to speed up the migration to the cities so there'd be fewer peasants out grazing their stock on fragile soil.

                                                                                                                                                                                                                                                Certainly all the activity had yet to make much difference to the Chao River, which was dry in spots and a narrow, sudsy channel across a wide, empty bed in others. We drove through one small town where farmers had hung a banner across the road: "For our children, give us back our clean water. Stop the gold mine!" Soon after was the mine itself. Farmers had clearly rioted there the day before, barricading the entrance with paving stones and splashing paint across the walls.

                                                                                                                                                                                                                                                Still, the farther up the winding river we ventured the greener things got. We were climbing now - five, six, seven thousand feet up. The road was petering out, into rutted dirt and then into tracks, and then - well, at some point Zhao and I got out to walk while Zhang looked for some way to get through. We reached a village so remote that I was rewarded with a shriek from a small girl unused to tall white guys wandering around. We talked with an old man smoking a handmade pipe. Seven years ago, he said, the sand was very bad in this valley. Then the government paid them 4,000 yuan to fence a lot of it off from the animals. The grass had come back within a year or two, he said - and indeed now it was a sea of grass, worked entirely by men on horseback.

                                                                                                                                                                                                                                                It's questionable, though, whether such changes will make any real difference to the encroaching desertification. Although the country's south is saturated, always trying to fend off flood, China's north is simply parched. As the flow of the Chao and other rivers has been siphoned off by the cities growing alongside them, Beijing has been drawing more and more of its own water from an underground aquifer - half or more of the water it uses comes from underground, and as a result the water table is sinking by meters every year. "Some northern cities will simply be out of water in eight or ten years", Ma Jun, author of China's Water Crisis, the one great environmental book China has yet produced, told me over lunch in Beijing one day. The earth subsides into sinkholes in dozens of places every year now, and fissures yards wide suddenly appear like earthquake faults. National Geographic recently came for a look and decided the country was committing "ecological suicide". To deal with the crisis, China's leaders have dusted off a plan that Mao dreamed up in 1952: construct 800-mile-long canals to carry water from the south to the north. That's an almost unimaginable idea, roughly comparable to putting Lake Superior in an aqueduct in order to let Phoenix keep watering its lawns. But it's a sign of the depth of the challenge that environmentalists, like Ma cross their fingers and hope for the best. "People in the north have been using water in a crazy way for the last fifty years because they knew it would someday flow from the Yangtze", he said. "Now the time has come for the promise to be realized".

                                                                                                                                                                                                                                                But the problem, he quickly added, is that the extra water will probably just be used to fuel a new round of rapid growth. One of the million reasons the Chao has run dry is that Beijing has thirteen ski slopes in the surrounding mountains, all of them relying on manmade snow. And they've just opened a fourteenth, this one entirely indoors.

                                                                                                                                                                                                                                                When we'd reached the head-waters of the Chao, we crossed a few valleys and drove back to Beijing along the equally dry White River - another of the city's main tributaries. But this time we were more interested in power than in water. Along the way we passed one new high-tension line after another. These massive, still-shiny steel towers crossed the mountains in the same lovely undulating ripples as the Great Wall; indeed we hiked to one ruined section of the wall to get a better look at the power lines, which represent an engineering feat on the same heroic/insane scale. In 2004, China added fifty billion watts of generating capacity to its electric grid. In 2005, it will have added another 65 billion watts. You can do the math any number of ways - they're adding two New Englands to their electric system annually, or half of India, or a Brazil. No power grid on earth has ever grown anywhere near that fast. Almost all of the new power comes from coal, which China has in cheap abundance; Party officials have announced ambitious plans to build two nuclear reactors every year until 2020, but even if they manage to pull it off, only about four percent of their electricity will come from atomic reactors. Essentially, China is going to burn coal - it will have passed the two-billion-ton mark this year. And even with that utterly unprecedented growth in supply, the country is stretched to the breaking point - twenty-four of thirty-one provinces had power shortages in 2004. "In some provinces plants operate only three or four days a week", said Yang Fuqiang, the Beijing-based vice president of the Energy Foundation. "You get five or six or seven percent loss in local GDP". In late July the Beijing authorities announced that the 4,689 local factories "will arrange week-long summer vacations for their employees in the coming four weeks" to save power, and then offset the holidays by "adopting a temporary six-day week schedule in the coming fall".

                                                                                                                                                                                                                                                The explanation for this surge is relatively simple, and it has everything to do with those farmers streaming into the city: Yang, hunched over his computer in a Beijing office where the thermostat is turned to 82 to save energy, says the best guess is that more than twenty million people come to the cities every year. There they make enough money to start consuming power - in the city people get, say, small refrigerators or even air conditioners. And they get jobs making shower curtains and spatulas and suitcases, which also take some energy. And building even simple concrete huts for them requires all sorts of resources - five percent of China's fuel may go to producing cement alone. China makes more steel than any nation on earth - not primitively, a la Mao, in the back yard, but it still takes energy.

                                                                                                                                                                                                                                                Oh, and cars. Ten years ago there weren't any. "Driver" was an occupation - you took Party officials around in a big black sedan. Today, China is the world's number-three car market. Demand is surging - vehicle sales grew ten percent in the first half of 2005 - and automakers expect to sell 5.6 million vehicles by year's end. Visiting the big car markets in Beijing is like going to a ball game in the United States - you park blocks away at a gas station where attendants wave you in; sidewalk vendors sell Cokes to the gawkers. (And teams of young men with big wooden clubs roam the car lot, looking for criminals.) It's a fascinating place to drive, because almost everyone is a tyro. The traffic patterns are unlike anywhere else in the world - people weave in and out constantly, merging from side streets without stopping - but crashes are relatively uncommon because speeds are low. Five years ago, you suddenly realize, these people were riding bikes.

                                                                                                                                                                                                                                                Again, it's not as if the Chinese haven't noticed there are big problems that come with this kind of growth. By some estimates, eight or ten percent of the country's GDP is wasted dealing with pollution and the health effects it causes. In an interview of rare candor, Pan Yue, the country's deputy environment minister, told Der Spiegel that the country's economic "miracle will end soon because the environment can no longer keep pace. Five of the ten most polluted cities worldwide are in China; acid rain is falling on one third of our territory; half of the water in China's seven largest rivers is completely useless." But without that level of growth, there'd be no way to absorb the endless influx from the countryside. How are you going to keep people down on their sixth of an acre once they've heard that city dwellers eat meat!

                                                                                                                                                                                                                                                Only with a level of repression that the post-Mao Chinese probably wouldn't tolerate, a level of repression that would shake the country's power structure. (And if that power structure fell, the democracy that replaced it would have many virtues, but controlling migration wouldn't be one of them.) That's why the country is busy building cars - because automaking, road-building, tire-patching, bumper-fixing, and gas-pumping are ways to build an economy. What's good for Shanghai Automotive, or so the thinking goes, is good for China.

                                                                                                                                                                                                                                                And so the country is trying to muddle through. On the one hand, it must keep growing fast enough to absorb all that restless labor - the newspapers are already full of reports about college graduates unable to find jobs, and then there are those people pushed out of work in the vast and useless state heavy industries. And on the other hand, it must keep resource and energy use enough in check that China doesn't simply crash and burn. The official goal is to quadruple the size of the economy by 2020 while only doubling energy use - a target that's probably unattainable due to the huge growth in electric generation in the last couple of years. But devoted teams of Western planners arrive regularly with new schemes. Yang Fuqiang, whose Energy Foundation is funded primarily by the Hewlett and Packard fortunes, has managed to assemble an advisory council that includes twelve of the country's most senior officials. A vice premier comes to council meetings, listening carefully as plans are outlined for new building codes that would make apartments fifty percent more efficient than in the past, or price reforms that would end energy subsidies for heavy industry, or appliance standards - by 2030, according to Yang, "better household appliances alone would mean thirty fewer coal-fired power plants".

                                                                                                                                                                                                                                                And the government has adopted most of these schemes, at least on paper. It has pledged to provide ten percent of the power with renewable resources in the next fifteen years - windmills are being built left and right, which is more than we can say. And some of what the Chinese are doing we couldn't even begin to imagine. In Shanghai, for instance, if you want a new car you not only have to go buy it, you have to bid for a license plate - in an effort to control the growth in autos, the city allows only about 6,000 new plates a month, and in June's auction they went for more than $4,000 apiece. Not only that, but they've built a remarkably good subway system, designed to persuade people to hold off buying cars. "Look, if you have a cheap, low-end metro, then the people who need to wear business clothes to the office simply won't take it", Ma Jun said. "And those are exactly the people with enough money to buy a car". The Shanghai metro has plasma screens on every car, delivering a continuous English lesson; the weekend I was riding the metro the screens were endlessly explaining the phrase "home field".

                                                                                                                                                                                                                                                In 1997, when the world was negotiating the Kyoto Protocol, the US Senate, by a vote of 95-0, passed a resolution that forbade any American involvement in a pact that limited American emissions - "unless the protocol or other agreement also mandates new specific scheduled commitments to limit or reduce greenhouse gas emissions for Developing Country Parties within the same compliance period". Although the resolution didn't cite China in particular, the testimony made it clear that China (and to a lesser extent India) was the nation everyone had in mind. Kyoto would give them a "free pass". Their economy would be allowed an "advantage" if the Chinese didn't sign on. It's an argument still in circulation - John Kerry, who voted for the original resolution, said during last year's presidential campaign that he thought Kyoto should be renegotiated to make the Chinese start reducing their energy use. More than any other argument, this idea of "fairness" has derailed American participation in the only international attempt to do anything about the biggest environmental problem our species has yet faced.

                                                                                                                                                                                                                                                It used to be said that the point of travel was to see your own home more clearly. So let's look. When you're standing in Shanghai, at the city's urban-planning exhibition, admiring the basketball-court-sized model of the city's future plan, with every skyscraper and apartment complex carefully detailed, you just viscerally know that there are two countries that really count right now. You just viscerally know that this is the story that will define the future. China and the United States are now the world's biggest consumers of raw material, and of food, and of energy. Are they therefore morally equivalent?

                                                                                                                                                                                                                                                That's not just a rhetorical question - it's a deeply practical one. And answering yes has a certain straightforward appeal. Sometime between 2025 and 2030, China will pass the United States as the largest carbon emitter in the world - already it produces sixteen percent of the world's CO2 compared with our 25 percent. That is, they are now joining us in the task of undermining the planet's physics and chemistry.

                                                                                                                                                                                                                                                The longer I looked, however, the less alike the two nations seemed. Take cars, for instance. Cars define America - their proliferation is the single physical item that makes our continent's civilization unique. We have nearly the same number of cars as we have people. In China the number of automobiles is growing fast. But if the Chinese sell six million cars this year, that will be eleven million less than the United States - in a population more than four times as large.

                                                                                                                                                                                                                                                In fact, the size of China's population queers every discussion of numbers. If you're interested in global warming, it doesn't make moral sense to divide up the atmosphere by nations - if it did, then there'd be nothing wrong with Luxembourg producing as much waste as America. If you think about it for even a minute, the only unit that works is people - Zhao Ang, my translator, has as much right to the sky as I do, which is to say as much right to a car or a big house. And measuring by people, in 2025 or 2030, when China passes the United States as the world's largest carbon emitter, the average Chinese will still be producing only a quarter as much carbon as the average American. And of course it goes deeper than that - the reason the atmosphere is filled to the danger point with carbon is because we've already been filling it for two centuries, burning coal and oil to get rich while the Chinese have been staying poor. As Ma Jun - a daring environmentalist who's taken big risks to write his books - told me one day, "Nearly eighty percent of the carbon dioxide has come from 200 years of the industrial world. Let's be realistic. Those historic burdens have to be shouldered by those countries that have enjoyed the benefits." In any just scheme, it's not morally required of the Chinese to help solve global warming, any more than it's your kids' responsibility to work out the problems in your marriage.

                                                                                                                                                                                                                                                This does not mean that the Chinese should burn all their coal. (After all, they'll have to deal with a wrecked world, just like your kids will have to deal with a broken home.) What it means is that we face an actual tragedy. The world, as it turns out, cannot afford two countries behaving like the United States. It lacks the atmosphere (and it also may lack the resources, as this summer's scramble for control over oil makes clear. We can't let the Chinese buy Unocal, because we need its reserves for us). And the reason it's an actual tragedy is because, right now, a rapidly growing China is actually accomplishing some measurable good with its growth. People are enjoying some meat, sending their brothers to school, heating their huts. Whereas we're burning nine times as much energy per capita so that we can: air-condition game rooms and mow half-acre lots, drive SUVs on every errand, eat tomatoes flown in from Chile. I understand that our country has people living in poverty, some of whom are now losing their jobs to Chinese competition, but that's simply our shame - we have all the money on earth, and we haven't figured out how to spread it around. China has hundreds of millions of people too poor to have clean water, and they sense that a few decades of burning coal might do something about that.

                                                                                                                                                                                                                                                Which is why it seems intuitively obvious when you're in China that the goal of the twenty-first century must somehow be to simultaneously develop the economies of the poorest parts of the world and undevelop those of the rich - to transfer enough technology and wealth that we're able to meet somewhere in the middle, with us using less energy so that they can use more, and eating less meat so that they can eat more. (Indeed, baby steps toward such transfers of technology and wealth are enshrined in the Kyoto formula.)

                                                                                                                                                                                                                                                One name for this kind of statistical mean is "Europe" or "Japan", whose citizens use half the energy of Americans. (And indeed the Chinese would almost certainly be willing to head in that direction. While I was there, for instance, they adopted new mileage standards for cars based on European standards - their showrooms are filling fast with tiny cars, like the Chery QQ, that come with 0.8-liter engines. ) But try to imagine the political possibilities in America of taking Chinese aspirations seriously - of acknowledging that there isn't room for two of us to behave in this way, and that we don't own the rights to our lifestyle simply because we got there first. The current president's father announced, on his way to the parley in Rio that gave rise to the Kyoto treaty, that "the American way of life is not up for negotiation". That's what defines a tragedy.

                                                                                                                                                                                                                                                Here's another way to say it. On my last night in Shanghai, after about a month of touring the country, I ended up strolling the Bund, the strip of old European banking houses that faces the Huangpu River. On the other bank, in the Pudong District that China has made its great urban showpiece, huge towers rose in neon splendor - the Jinmao Tower, with the highest hotel on earth taking up its top thirty-four floors; the Oriental Pearl TV tower, its great kitschy globes glowing pink against the sky, the Aurora building, with its vast outdoor TV screen showing ad after ad. The vista was a little less grand than usual - the temperature had topped 95 degrees that day, so the government had decreed a power cut - but it was still enough to draw tens of thousands of spectators, content just to stand there in the dark and look. Many, perhaps most, were new arrivals from the countryside, in shabbier clothes and with ruddier faces than the city folk; they posed for pictures along the railing with the promise of the country glowing behind them.

                                                                                                                                                                                                                                                I don't think in the end it's a real promise - I'm not sure China can escape the horrible environmental contradictions of its own growth (the soil is subsiding even in Pudong as Shanghai overpumps groundwater). I'm not sure globalization makes sense for the globe even if makes sense for China (in fact, I'm almost sure it doesn't - that 95-degree day was not unique; both China and the planet were suffering through the hottest year on record while I was there). I'm not sure that if the Chinese someday got as rich as we are they'd be any happier than us. That's why meeting in the middle makes so much sense. But in moral terms I am completely sure that that vista across the Huangpu River is filled with a kind of hope for the people who nightly drink it in, and that that hope is, for now, essentially innocent.

                                                                                                                                                                                                                                                The only neon spectacle I've ever seen that compares is Vegas, with its pyramids and dancing waters. But what is Vegas? It's the search for some kind of new stimulus for the jaded. Some thicker meat and pricier alcohol, for people who've been packing away meat and alcohol for decades. Some attempt to figure out what more might mean when you've already had too much. Whatever else it is, China's not like that at all.


                                                                                                                                                                                                                                                {1} At the moment, the exchange rate is at around eight yuan to the dollar. But for an approximate number, it works to just drop the last digit - 10,000 yuan is something like a thousand dollars.

                                                                                                                                                                                                                                                {2} Ikea's slogan, which in the modern economy almost passes as humane, is "Low Price, But Not at Any Price".

                                                                                                                                                                                                                                                {3} No one knows for sure how effective the one-child policy has been. One demographer estimates that China has as many as 37 million uncounted children, hidden at least in part because local officials don't like to report bad news. But total population growth is not the main force driving China's problems. And however cruel the legislation was, most people I talked to, in the cities anyhow, seem to have internalized it as an indisputable fact of life.

                                                                                                                                                                                                                                                Bill McKibben, a scholar-in-residence at Middlebury College, is the author of many books, including The End of Nature and Wandering Home. His last article for Harper's Magazine, "The Christian Paradox", appeared in the August issue.

                                                                                                                                                                                                                                                Posted by Mark Thoma on Friday, January 6, 2006 at 01:27 AM in China, Economics

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                                                                                                                                                                                                                                                Will the Dollar Depreciate in 2006?

                                                                                                                                                                                                                                                The Economist sees signs pointing to a weaker dollar in the coming year:

                                                                                                                                                                                                                                                The greenback’s sinking feeling, The Economist: For ... many Wall Street number-crunchers, the dollar supplied one of the nastiest surprises of 2005. ... Although America’s current-account deficit headed towards $800 billion in 2005, the dollar rose. It was up by 3.5% against a broad trade-weighted basket of currencies, the first rise in four years (see chart). Against the euro and yen, the greenback did even better. It ended the year at $1.18 per euro, up by 14%. Despite a wobble in December, the dollar made a similar advance against the yen.

                                                                                                                                                                                                                                                Not surprisingly, the pundits are more cautious about 2006. Although most expect the dollar to end this year weaker than it began it, the typical forecast is that any decline will be fairly modest and take place mainly in the latter part of 2006. That is because most analysts attribute the dollar’s recent strength to widening differences between American, European and Japanese interest rates. These gaps are expected to grow for a few more months before closing slightly later in the year. ...

                                                                                                                                                                                                                                                Oil exporters may prove more fickle dollar buyers than many expect. In 2005, as oil prices shot up, exporting countries saw their external surpluses soar. A good slice of these petro surpluses found their way into dollar-denominated assets. That led some analysts to conclude that oil exporters were a safe and lasting source of dollar support. An alternative view is that the exporters, like others, were attracted by rising American interest rates. ... China is yet another cause of uncertainty. ... This year ... the Chinese [may allow]... a bigger move in the yuan than markets expect. This week China introduced a system of market making in spot yuan trading that could permit faster appreciation. But the biggest shadow remains America’s huge and rising current-account deficit. Reducing this will, at some point, require a much cheaper dollar. ... The result could be a sharp drop for the dollar.

                                                                                                                                                                                                                                                Here's more from the Financial Times on how China's announcement that it may begin diversifying its foreign exchange reserves to reduce the share of dollars in its portfolio might affect exchange rates:

                                                                                                                                                                                                                                                China signals reserves switch away from dollar, by Geoff Dyer and Andrew Balls, Financial Times: China indicated on Thursday it could begin to diversify its rapidly growing foreign exchange reserves away from the US dollar and government bonds – a potential shift with significant implications for global financial and commodity markets. Economists estimate that more that 70 per cent of the reserves are invested in US dollar assets, which has helped to sustain the recent large US deficits. If China were to stop acquiring such a large proportion of dollars with its reserves ... it could put heavy downward pressure on the greenback. ... although the language was “vague”, Thursday's statement was the first time Safe has publicly indicated a shift away from dollar assets. ...

                                                                                                                                                                                                                                                [Update: Brad Setser has more.]

                                                                                                                                                                                                                                                  Posted by Mark Thoma on Friday, January 6, 2006 at 12:27 AM in Economics, International Finance

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                                                                                                                                                                                                                                                  Thomas Friedman: Living Green

                                                                                                                                                                                                                                                  Thomas Friedman continues to push for increased energy efficiency and independence:

                                                                                                                                                                                                                                                  The New Red, White and Blue, by Thomas L. Friedman, Commentary, NY Times: ...What's so disturbing about President Bush and Dick Cheney is that they talk tough about the necessity of invading Iraq, torturing terror suspects and engaging in domestic spying - all to defend our way of life and promote democracy ... But when it comes to what is actually the most important issue in U.S. ... policy today - making ourselves energy efficient and independent ... - they ridicule it as something only liberals, tree-huggers and sissies believe is possible or necessary.

                                                                                                                                                                                                                                                  Sorry, but being green, focusing the nation on greater energy efficiency and conservation, is not some girlie-man issue. It is actually the most tough-minded, geostrategic, pro-growth and patriotic thing we can do. Living green is not for sissies. Sticking with oil, ... saying that a country that can double the speed of microchips every 18 months is ... incapable of innovating its way to energy independence - that is for sissies, defeatists and people who are ready to see American values eroded at home and abroad. ...

                                                                                                                                                                                                                                                  The biggest threat to America and its values today is not communism, authoritarianism or Islamism. It's petrolism. Petrolism is my term for the corrupting, antidemocratic governing practices - in oil states from Russia to Nigeria and Iran - that result from a long run of $60-a-barrel oil. Petrolism is the politics of using oil income to buy off one's citizens with subsidies and government jobs, using oil and gas exports to intimidate or buy off one's enemies, and using oil profits to build up one's internal security forces and army to keep oneself ensconced in power - without any transparency or checks and balances. ...

                                                                                                                                                                                                                                                  Our energy gluttony fosters and strengthens various kinds of petrolist regimes. .... Most of these petrolist regimes would have collapsed long ago, ... but they were saved by our energy excesses. No matter what happens in Iraq, we cannot dry up the swamps of authoritarianism and violent Islamism ... without also ... bringing down the price of crude. A democratization policy in the Middle East without a different energy policy at home is a waste of time, money and, most important, the lives of our young people. That's because there is a huge difference in what these bad regimes can do with $20-a-barrel oil compared with the current $60-a-barrel oil. ...

                                                                                                                                                                                                                                                  We need a president and a Congress with the guts not just to invade Iraq, but to impose a gasoline tax and inspire conservation at home. That takes a real energy policy with long-term incentives ... - rather than the welfare-for-oil-companies-and-special-interests that masqueraded last year as an energy bill. Enough of this Bush-Cheney nonsense that conservation, energy efficiency and environmentalism are some hobby we can't afford. I can't think of anything more cowardly or un-American. Real patriots, real advocates of spreading democracy around the world, live green.

                                                                                                                                                                                                                                                  Green is the new red, white and blue.

                                                                                                                                                                                                                                                    Posted by Mark Thoma on Friday, January 6, 2006 at 12:11 AM in Economics, Environment, Oil, Politics

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                                                                                                                                                                                                                                                    January 05, 2006

                                                                                                                                                                                                                                                    Cross the River by Groping the Stone Under Foot

                                                                                                                                                                                                                                                    What is the best approach to economic development in the transition to a more market-based economy?:

                                                                                                                                                                                                                                                    "Mo zhe shi tou guo he", or cross the river by groping the stone under foot, has, for a long time, been a pet phrase of Chinese policy-makers. The gradualism they think has helped China avoid the sometimes destructive impact following the bold shock remedy taken by, for example, Russia.

                                                                                                                                                                                                                                                    Here's a view of the ideological struggle between the U.S. and Chinese models of economic development from the Japan Times:

                                                                                                                                                                                                                                                    U.S.-China ideological rivalry heats up, by Eric Teo Chu Cheow, Special to The Japan Times: ...[E]vents in Asia have again directly underscored the "ideological" tussle between Washington and Beijing, which is increasingly seen as a benevolent power ... offering a model for socioeconomic development. ... At a recent conference on Asian economic integration held in New Delhi, a professor from Jawahral Nehru University spoke of a socially oriented "Beijing Consensus," contrasting it with the liberal "Washington Consensus" that emerged in the 1990s.

                                                                                                                                                                                                                                                    The professor reminded the audience that as Asian countries ... establish an East Asian Community, they must reflect on the type of society they ... want to establish: a liberal Anglo-Saxon model or a more socialist model that places ... stability before development and reforms. In fact, China's political and economic presence and influence have become overwhelming, as Beijing has largely convinced its smaller Asian neighbors that it presents an opportunity rather than a threat, and a model for socioeconomic development. ...

                                                                                                                                                                                                                                                    The Washington Consensus emerged from the neoliberal revolution that swept the globe with the arrival of the Thatcherite and Reaganite schools of thought and power. It marked the beginning of the ... credo that formed the basis of the globalization wave, which in turn has laid the foundation of the present socioeconomic and political movement toward "free markets, free societies."

                                                                                                                                                                                                                                                    This movement has manifested itself in U.S. President George W. Bush's push for democracy and freedom in the Middle East, as well as in British Prime Minister Tony Blair's vision of a European Union that is based on economic competition, political democracy and social liberalism. This brand of Anglo-Saxon liberalism has since become synonymous with globalization.

                                                                                                                                                                                                                                                    China, on the other hand, has insisted on stability as the foundation of its foreign policy rather than political or social reforms. In fact, after seeing the chaos that ensued after the collapse of the Soviet Union ..., Chinese leaders came out more strongly in favor of growth-based "stability, development and reform" (in that order). Two events this year emphasized this point. In Bratislava, Chinese leaders were delighted when Putin refused to back down after Bush chastised him for not respecting and promoting democratic development in Russia. Similarly, during Bush's last visit to Beijing, Chinese President Hu Jintao accommodated him on further ... economic and financial reforms, but refused to bend on political reforms, human rights or religious freedom.

                                                                                                                                                                                                                                                    Chinese leaders will continue their socioeconomic reforms, but are determined to develop "democracy with Chinese characteristics" without outside interference. A dramatic increase in domestic unrest led Chinese leaders to decide ... in October to strengthen measures to contain social frustrations. According to a senior Chinese economist at Beijing University, China's private sector will be tasked with consolidating economic liberalization reforms (with support from financial authorities), while the public sector (state and local authorities) will spearhead social reforms to reduce "social frustrations, disparities and unrest." ... It is clear that Chinese officials refuse to view political reforms as an antidote against social unrest in China. ...

                                                                                                                                                                                                                                                    Journalist Ramo says Beijing is introducing a "new physics of development and power," instead of relying (like the U.S.) on "traditional tools of power projection." ... Just as the Washington Consensus was the "hallmark of end-of-history arrogance," the "Beijing Consensus" is centered on developmental economics, social and economic changes, and thus "a shift from power politics to moral politics" that would probably turn "traditional ideas of privatization and free trade on their heads."

                                                                                                                                                                                                                                                    He also concludes that the Beijing Consensus should be more appealing to developing countries. Unlike its Washington counterpart, the Beijing Consensus ... is "flexible enough not to be classifiable as a doctrine." In short, it is more akin to Mao Zedong's edict of "groping stones to cross the river." The ideological differences between Washington and Beijing could spark genuine competition between American and Chinese models of economic management and societal development. Although many observers say China doesn't have "real soft power" but instead is astutely "using its power softly," the stage is nevertheless set for a growing rivalry between the two giants.

                                                                                                                                                                                                                                                    Eric Teo Chu Cheow, a business consultant and strategist, is a council member of the Singapore Institute for International Affairs.

                                                                                                                                                                                                                                                      Posted by Mark Thoma on Thursday, January 5, 2006 at 01:12 AM in China, Economics, Policy, Politics

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                                                                                                                                                                                                                                                      Is the Jobs Corps Program Cost Effective?

                                                                                                                                                                                                                                                      Here is a discussion on the effectiveness of the Jobs Corps program. Carefully controlled survey data give an optimistic picture of the program's success, while data collected from tax records are not as supportive of the program's cost effectiveness. However, the program appears to work well for the 20-24 age group no matter which data are used to evaluate the program:

                                                                                                                                                                                                                                                      New (and Sometimes Conflicting) Data on the Value to Society of the Job Corps, by Alan B. Krueger, Economic Scene, NY Times: It is a cliché that good research raises more questions than it answers... Such has been the case with a long-running evaluation of the Job Corps program. Recent research challenges earlier findings that the Job Corps pays for itself in terms of the benefits to society and gain in earnings for teenage participants, although for 20- to 24-year-olds the benefits still appear to exceed the costs.

                                                                                                                                                                                                                                                      The job training budget for disadvantaged youth has been substantially cut in the last decade. The Job Corps is the largest ... of the remaining programs. Each year, it provides around 60,000 youths from age 16 to 24 with many services, including education, vocational training and counseling. Since 1993, Mathematica Policy Research Inc. has evaluated the performance of the Job Corps for the Department of Labor. Its evaluation is based on one of the most rigorous research designs ever used for a government program. ... Mathematica's initial findings from periodically surveying the ... individuals... were encouraging. Those admitted to the program had a lower crime rate, higher literacy scores and higher earnings than the control group. The benefit to society was estimated at twice the $16,500 cost to the government per participant - if the earnings gain from taking part in the program persisted.

                                                                                                                                                                                                                                                      So far, so good. But Mathematica has continued to evaluate the program, using administrative earnings data that were collected as part of the Social Security and Unemployment Insurance payroll tax systems ... On the one hand, the administrative records support a central conclusion of the survey data: ... those randomly selected for the program earned ... more than the control group, on average, according to the Social Security data... The earnings gain from the Job Corps was twice as large for 20- to 24-year-olds, who make up around a quarter of participants.

                                                                                                                                                                                                                                                      On the other hand, the new data raise several puzzles and paint a less optimistic picture over all. ... Mathematica has tried to unravel the discrepancies between the survey and tax data. The differences are partly explained by under-the-table earnings not reported in tax data, overreporting of hours worked in the survey, and - despite an 80 percent response rate to the survey - a tendency for the more successful Job Corps participants to respond to the survey. Other possible factors are mismatched tax records, incomplete reporting of taxable earnings by businesses and misleading answers to the survey.

                                                                                                                                                                                                                                                      The main cause of the discrepancies, however, remains a mystery that may never be solved. ... If the earnings patterns from the payroll records are trusted, then the earlier conclusion that the total benefits to society of the Job Corps exceed the costs no longer holds for participants as a whole. For the 20- to 24-year-old group, however, a plausible prediction based on the administrative records suggests that the increase in participants' earnings and other benefits to society, including a reduction in crime, more than offset the cost of the program. One implication is that it makes sense to admit more 20- to 24-year-olds to the Job Corps. The Job Corps is a highly effective model for them. It would be useful to learn how to more effectively apply that model to teenagers. ...

                                                                                                                                                                                                                                                      Alan B. Krueger is the Bendheim professor of economics and public affairs at Princeton University.

                                                                                                                                                                                                                                                        Posted by Mark Thoma on Thursday, January 5, 2006 at 12:42 AM in Economics, Policy, Unemployment

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                                                                                                                                                                                                                                                        The Global Environment

                                                                                                                                                                                                                                                        Posted at Environmental Economics:

                                                                                                                                                                                                                                                        Global Environmental Leadership

                                                                                                                                                                                                                                                        Alternative Approaches to Global Warming

                                                                                                                                                                                                                                                          Posted by Mark Thoma on Thursday, January 5, 2006 at 12:33 AM in Economics, Health Care

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                                                                                                                                                                                                                                                          Is There a Reasonable Chance That Rate Hikes Are Already Over?

                                                                                                                                                                                                                                                          Here's an argument that a rate hike at the next meeting is not a sure thing:

                                                                                                                                                                                                                                                          Could the Fed Take a Pass at Jan. 31 Meeting?, by Caroline Baum, Bloomberg: ...The idea itself is still in the pre-verbal stage. But there's an outside chance the Federal Reserve could pass on raising rates on Jan. 31... I didn't hatch this notion in response to the minutes from the Fed's Dec. 18 meeting, which reinforced what (I thought) most folks already believed: that, in Fed parlance, "the number of additional firming steps required probably would not be large.'' ... The idea of an early end to the rate normalization cycle isn't based on anything the Fed said, but on the interest-rate structure (the next move would put the Fed's policy rate above the long-term rate); on recent and prospective economic data, which should confirm that growth is slowing; and on the increased "uncertainty'' Fed officials always cite...

                                                                                                                                                                                                                                                          ''Previously the Fed had a reason to raise rates,'' says Joe Carson, director of economic research at Alliance Bernstein. ''There is no compelling reason to raise rates at the present time.'' Fed officials' concerns about near-term inflation pressures had eased when they met in December, with elevated energy prices having only a ''muted'' effect on core inflation. ... To the extent that the ''forward calendar will drive the decision at the next meeting,'' as the Fed itself has indicated, policy makers will struggle to justify another rate increase, Carson says. ...

                                                                                                                                                                                                                                                          Jim Glassman, senior U.S. economist at JPMorgan Chase & Co., says ''the door is open'' on what the Fed will do at the end of this month. ''If everything is data-driven, why don't the data matter?'' Glassman asks. ''The Fed raised the issue of lags. What data tell a compelling case for raising rates?'' ...

                                                                                                                                                                                                                                                          While the markets treat every word from Fed chief Alan Greenspan as if it were written in stone, it doesn't take much for him to reverse course. On Nov. 15, 2000, the Fed thought the risks to the economy were tilted toward higher inflation. ... Less than three weeks later, Greenspan talked about the economy's loss of momentum and warned community bankers against restricting loans to credit-worthy borrowers. It was a stunning about-face... This is not to suggest economic parallels between then and now. All I'm saying is that things change -- and the soon-to- retire Greenspan will be there, leading the charge, when they do.

                                                                                                                                                                                                                                                          The scenario required for a pause at the current target interest rate is not impossible, but it is, I think, improbable. In any case, both incoming data and FedSpeak will portend such a change if it does occur.

                                                                                                                                                                                                                                                            Posted by Mark Thoma on Thursday, January 5, 2006 at 12:24 AM in Economics, Monetary Policy

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                                                                                                                                                                                                                                                            January 04, 2006

                                                                                                                                                                                                                                                            Comparing the Growth in Health Care Costs in Ten OECD Countries

                                                                                                                                                                                                                                                            This paper from the NBER compares health care costs in ten OECD countries. The paper breaks the growth in health expenditures into the part due to demographic changes and the part due to benefit growth and finds that benefit growth, not demographics, is the main factor in rising health care costs. It also finds the problem is the most severe in the U.S. due to its fee for service health care payment system:

                                                                                                                                                                                                                                                            Who’s Going Broke? Comparing Growth in Healthcare Costs in Ten OECD Countries, by Laurence J. Kotlikoff and Christian Hagist, NBER WP 11833, December 2005: ABSTRACT Government healthcare expenditures have been growing much more rapidly than GDP in OECD countries. For example, between 1970 and 2002 these expenditures grew 2.3 times faster than GDP in the U.S., 2.0 times faster than GDP in Germany, and 1.4 times faster than GDP in Japan. How much of government healthcare expenditure growth is due to demographic change and how much is due to increases in benefit levels; i.e., in healthcare expenditures per beneficiary at a given age? This paper answers this question for ten OECD countries -- Australia, Austria, Canada, Germany, Japan, Norway, Spain, Sweden, the UK, and the U.S. ... Growth in real benefit levels has been remarkably high and explains the lions share - 89 percent - of overall healthcare spending growth in the ten countries. Norway, Spain, and the U.S. recorded the highest annual benefit growth rates. Norway's rate averaged 5.04 percent per year. Spain and the U.S. were close behind with rates of 4.63 percent and 4.61 percent, respectively. Allowing benefit levels to continue to grow at historic rates is fraught with danger given the impending retirement of the baby boom generation. In Japan, for example, maintaining its 1970-2002 benefit growth rate of 3.57 percent for the next 40 years and letting benefits grow thereafter only with labor productivity entails present value healthcare expenditures close to 12 percent of the present value of GDP. By comparison, Japans government is now spending only 6.7 percent of Japan's current output on healthcare. In the U.S., government healthcare spending now totals 6.6 percent of GDP. But if the U.S. lets benefits grow for the next four decades at past rates, it will end up spending almost 18 percent of its future GDP on healthcare. The difference between the Japanese 12 percent and U.S. 18 percent figures is remarkable given that Japan is already much older than the U.S. and will age more rapidly in the coming decades. Although healthcare spending is growing at unsustainable rates in most, if not all, OECD countries, the U.S. appears least able to control its benefit growth due to the nature of its fee-for service healthcare payment system. Consequently, the U.S. may well be in the worst long-term fiscal shape of any OECD country even though it is now and will remain very young compared to the majority of its fellow OECD members.

                                                                                                                                                                                                                                                              Posted by Mark Thoma on Wednesday, January 4, 2006 at 05:36 PM in Economics, Health Care

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                                                                                                                                                                                                                                                              Always Low Credit Card Fees?

                                                                                                                                                                                                                                                              Traditionally there has been, at least in principle, a strict separation between banking and commercial interests, but that separation has blurred as the industry has been deregulated. Wal-Mart seeks to blur the distinction even further:

                                                                                                                                                                                                                                                              Banking Against Wal-Mart January, Review and Outlook, Wall Street Journal: The Federal Deposit Insurance Corporation (FDIC) will soon have to make a big decision: whether to grant retail giant Wal-Mart a charter to enter the consumer banking business. You won't be surprised to learn that the idea of more banking competition is not universally popular with . . . bankers. In particular, the Independent Community Bankers Association (ICBA) is raising a ruckus ... to keep big bad Wal-Mart locked out of their game... a textbook case of a powerful corporate lobby rushing to its pals in Congress and their regulators, in this case the FDIC, and pleading for them to squash competition that might lower the prices of banking services.

                                                                                                                                                                                                                                                              At issue is whether Wal-Mart should be granted the authority to establish an Industrial Loan Company (ILC) in Utah. ILCs are state-chartered, quasi-banks that were originally designed a century ago to help low-income workers get cheap loans. ILCs can provide most banking services, such as check cashing, lending, and credit card processing. Target and General Electric have been granted an ILC with little controversy. But because Wal-Mart has been portrayed as America's latest corporate villain, its political hurdles are much higher.

                                                                                                                                                                                                                                                              If the bankers succeed in this protectionist gambit, the biggest loser won't be Wal-Mart, but rather consumers, particularly those in lower-income neighborhoods where competition in retail banking is traditionally scarce. ... Wal-Mart already performs many bank-like functions that are especially popular in poor areas -- including wire transfers, money orders, paycheck cashing, and express bill payment services. ... If they decide to regulate Wal-Mart out of the industry, the end result will be higher banking service costs for the poor constituents they claim to represent. ...

                                                                                                                                                                                                                                                              Wal-Mart's immediate banking ambitions are quite modest. ... Wal-Mart insists that in the short term it merely wants to create an in-house banking affiliate so it can lower costs on credit card transactions ... Traditionally, banks charge an interchange fee of roughly 2% on the cost of the retail credit/debit card transaction. Wal-Mart has determined that if it owns its own bank it can cut the transaction fee in half, and pass the cost-savings on to its customers who pay with Visa or MasterCard. ...

                                                                                                                                                                                                                                                              [T]he meaty policy issue at stake here [is] whether the traditional firewall between banks and commercial enterprises (i.e., the commercial lenders and the borrowers) should be officially torn down. ... Would granting Wal-Mart its ILC status impose an unnecessary financial risk on the soundness of the banking system? The Community Bankers lobby warns that "Wal-Mart's entrance into banking would constitute a dangerous over-concentration of economic power that would skew market forces." ... We suspect, however, that what really spooks the banking industry is the threat of more competition, more convenience and lower prices for financial services. ...

                                                                                                                                                                                                                                                              Most of these restrictions were put into place after the Great Depression. The massive failure of banks during that time was blamed, in part, on bank's investment activities and they were prohibited from dealing or underwriting corporate securities with the Glass-Stegall act of 1933. However, in 1999 the Gramm - Leach - Bliley Act relaxed these restrictions and blurred the distinction between banks and insurance companies consistent with the general movement towards deregulation of the financial services industry. Wal-Mart's request is another step in this direction.

                                                                                                                                                                                                                                                                Posted by Mark Thoma on Wednesday, January 4, 2006 at 01:10 AM in Economics, Financial System, Market Failure, Policy

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                                                                                                                                                                                                                                                                Data Mining for a Fool's Gold

                                                                                                                                                                                                                                                                What's the difference between economists and stockbrokers? Andrew Smithers has an answer:

                                                                                                                                                                                                                                                                There is little value in broker economics, by Andrew Smithers, Financial Times: The FT reports regularly on the views of economists and stockbrokers. Readers might be intrigued by the conflicts between them but they should not be surprised. The purposes of the two groups are completely different. Economists are in pursuit of the truth and stockbrokers of commissions.

                                                                                                                                                                                                                                                                The first principle of stockbroker economics is that all news is good. In a weak economy, interest rates tend to fall and in a strong one profits usually rise. It has therefore become an item of stockbroker faith that falling interest rates and rising profits are both good for stock markets. Neither theory, however, seems robust under testing. For example, the US stock market ... suggests a purely random relationship.

                                                                                                                                                                                                                                                                The second principle is that the stock market is always cheap. This requires more flexibility ... and is achieved by inventing meaningless measures of value, such as the bond yield ratio, and using whichever one of these absurdities happens to give the most bullish answer at the time. Data mining is the key technique for nearly all stockbroker economics. There is no claim that cannot be supported by statistics, provided that these are carefully selected. For this purpose, data are usually restricted to a limited period, rather than using the full series available. ...

                                                                                                                                                                                                                                                                The greatest single triumph yet achieved by data mining is the invention of the bond yield ratio. This claims that equities can be valued by comparing bond yields and earnings yields. These ratios showed a strong correlation in the US from 1977 to 1997. But ... [i]t is ... possible to use all the available data, thereby flattering the prejudices of economists but offending the key principle of data mining. If this is done, ... there is no relationship at all between bond yields and earnings yields.

                                                                                                                                                                                                                                                                Readers can, nonetheless, be confident that the use of the bond yield ratio will not disappear simply because it cannot be supported by either theory or experience. Claims based on data mining are not discarded simply because they do not work. They are put into the pending tray with the standard excuse that “the relationship has broken down”. ... Nonsense about value comes in many other forms. The most common is ... the current price-earnings ratio. This survives in the face of its obvious failure in the past. ... Since dog should not eat dog, I hasten to point out that, while a lot of stockbroker economics finds its way into the financial press, this is at least partly reasonable. What is widely believed may be nonsense but it can still be news... The writer is chairman of Smithers & Co, the economic consultancy

                                                                                                                                                                                                                                                                  Posted by Mark Thoma on Wednesday, January 4, 2006 at 01:05 AM in Economics

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                                                                                                                                                                                                                                                                  Dean Baker at MaxSpeak reads Thomas Friedman's column on Social Security and comes out in favor of privatization:

                                                                                                                                                                                                                                                                  MaxSpeak: Time To Privatize Social Security: Thomas Friedman’s column in the New York Times today (“Social Insecurity,” 1-4-06) convinced me that Social Security privatization might be necessary. He quoted David Walker, the head of the General Accounting Office, about how rising costs for Social Security and Medicare will bankrupt the country.

                                                                                                                                                                                                                                                                  Of course, as David Walker surely knows (perhaps not Freidman), the projected bankruptcy stems not from demographics, but from a projected explosion in health care costs. Honest people looking at these numbers would be talking about fixing the health care system, the rising cost of which threatens both the private (think GM, Ford and Delphi) and public sectors, not entitlements.

                                                                                                                                                                                                                                                                  How would privatizing Social Security help? Well, I don’t mean the personal accounts idiocy, I mean making Social Security a private corporation that does the exact same thing the current program does, except have the organization that administers the program be a private company operating on contract with the government.

                                                                                                                                                                                                                                                                  Then, when David Walker, Thomas Friedman, Peter Peterson, the Washington Post editorial board etc. make some outlandish claim about Social Security devastating the country, the company could sue them for libel, just as Microsoft would if they made an equally outlandish claim about that company’s impact. One or two lawsuits like this and these people would adhere much more closely to the truth, as would the newspapers and television stations that wholesale this tripe across the country.

                                                                                                                                                                                                                                                                  The need for the government to step in and provide economic security as traditional employer - employee relationships break down is noted in this commentary from the Washington Post, and a key part of that need is to address exploding health care costs:

                                                                                                                                                                                                                                                                  A Gentler Capitalism, by Harold Meyerson, Washington Post: On the field of ideology, 2005 was a lousy year for the American right. Twice -- in the president's proposal to privatize Social Security and in the government's failure to save New Orleans -- it confronted the public with the prospect of a radically reduced government. Twice, the public recoiled at the sight. ... Essentially Bush assumed the role of the national CEO who tells his workers he's dumping their defined-benefit pensions for some ill-defined 401(k) investment schemes. And essentially the American people responded with the same anger and anxiety that airline and auto employees have shown when their bosses reneged on their commitments of a secure retirement. The difference, of course, is that the American people have a lot more power as voters than they do as workers. ... In today's America, where business has largely abandoned the guarantees of security it used to provide its employees, a similar abdication by government was clearly not what the public sought.

                                                                                                                                                                                                                                                                  For the pervasive insecurity that is inextricably part of today's capitalism has become the dominant fact of modern life. ... Throughout most of the 20th century, the ... corporation gave the employee a place and a ladder, and in such a lifelong institution... The new workplace, by contrast, is a brave new world of short-term employment and relationships... It may be a fine place for young workers, but "as middle age looms and children, mortgages and school fees appear, the need for structure and predictability in work grows greater." ...

                                                                                                                                                                                                                                                                  [W]hat 2005 has demonstrated is that while Americans have no great love for government, they do expect it to provide a baseline of security -- the more so since the employer-provided benefits of the past 60 years are going the way of the dodo. That means that government-supported universal health insurance will soon be back on the nation's agenda. But that's the easy part. Rebuilding the kind of security that defined private-sector economic life for most of the past century, and that helped individuals define themselves, is a conundrum that's daunting even to contemplate...

                                                                                                                                                                                                                                                                    Posted by Mark Thoma on Wednesday, January 4, 2006 at 12:21 AM in Economics, Social Security

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                                                                                                                                                                                                                                                                    Robert Samuelson Looks for Cracks in His Crystal Ball

                                                                                                                                                                                                                                                                    Robert Samuelson assesses the risks to the rosy forecast he has for the coming year:

                                                                                                                                                                                                                                                                    Waiting for a Soft Landing, by Robert J. Samuelson, Washington Post: ...[A]ccording to most forecasts, we're headed for a swell year -- though a boring one. ... Could anything darken the outlook? Here are five candidates:

                                                                                                                                                                                                                                                                    Housing goes bust. Higher mortgage rates have already dampened demand and prices. ... A "bust" would involve sinking prices after some big gains: about 25 percent over the past two years. That could depress consumer confidence and spending. ... But most forecasts aren't glum. ...

                                                                                                                                                                                                                                                                    The dollar "crashes." In 2005 the U.S. trade deficit was $712 billion, ... That's up from $624 billion in 2004. The willingness of foreigners ... to invest their surplus dollars in American stocks and bonds raises U.S. share prices and reduces U.S. interest rates. A dollar sell-off could do the opposite, hurting housing ... and consumer spending. Though plausible, similar warnings in the past were never borne out.

                                                                                                                                                                                                                                                                    General Motors files for bankruptcy. Bankrupt Delphi -- GM's biggest parts supplier -- and the United Auto Workers are negotiating tensely over Delphi's demands for deep wage and benefit cuts. If the UAW were to strike, GM might also shut down and suffer massive losses. ... GM itself might file for bankruptcy. Because everyone -- GM, Delphi and the UAW -- has so much to lose, ... Delphi, the UAW and GM will settle.

                                                                                                                                                                                                                                                                    Oil jumps to $85 a barrel. Energy ... prices could rise ..., driven partly by a scramble for low-sulfur oil to meet stiffer U.S. air pollution rules ... Supply disruptions or refinery outages could also create scarcities. Still, the U.S. Energy Information Administration predicts steady prices ...

                                                                                                                                                                                                                                                                    The "yield curve" of interest rates "inverts." ...Since 1965 interest-rate inversions have occurred seven times -- and recessions have followed in five... The reason: An inversion signals tight money. ... But ... we'll escape a recession, because the overall level of rates will remain low.

                                                                                                                                                                                                                                                                    There are other potential pitfalls. Will China's surging economy produce an unpleasant surprise? Will the replacement of Alan Greenspan with Ben Bernanke go smoothly? But the larger story of the U.S. economy has been that it continually overcomes many reasons for it to falter. ... So say the standard forecasts. They're often right when predicting small shifts in the status quo. But they usually miss big changes... If something truly bad happens in 2006, you probably won't read about it first. ...

                                                                                                                                                                                                                                                                      Posted by Mark Thoma on Wednesday, January 4, 2006 at 12:14 AM in Economics

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                                                                                                                                                                                                                                                                      January 03, 2006

                                                                                                                                                                                                                                                                      Paul Krugman's Money Talks: Living in a Bubble?

                                                                                                                                                                                                                                                                      Here's more from Paul Krugman on the housing bubble:

                                                                                                                                                                                                                                                                      Living in a Bubble? Readers respond to Paul Krugman's Jan. 2 column, "No Bubble Trouble?": Stephen Distinti, Brooklyn, N.Y.: I am writing because I would like a little clarification on your comparison between the state of today's housing market and that of the early 1980's. I understand your two central claims: one, that there can be said to exist two housing sectors, which you have termed 'Flatland' and 'Zoned Zone'; and two, the high proportion of one's monthly income needed to maintain a mortgage in the Zoned Zone is indicative of a housing bubble localized to those markets.

                                                                                                                                                                                                                                                                      But ... If the proportion of monthly income demanded by a mortgage in the Zoned Zone corresponds to the levels of the early 1980's, does the bifurcated nature of the housing market correspond to the 1980's as well? ... My impression is that in the 1980's the expense of home ownership was more evenly spread across the country... So was there a Flatland and a Zoned Zone in the 1980's?...

                                                                                                                                                                                                                                                                      Paul Krugman: Today's market actually looks very little like that of the early 1980's. What happened then was that the economy was coming off a period of very high inflation. The Fed drove interest rates very high in an effort to bring inflation under control. (It succeeded, at the cost of a period of very high unemployment.) And those high interest rates made housing unaffordable everywhere. You can see this in the charts that accompanied last week's article by David Leonhardt, which provided a lot of data online. In Flatland cities like Atlanta, the cost of home ownership as a percentage of income is well below its early 80's peak. In cities like San Diego, ownership costs are at record levels. So there's no real precedent for today's situation...

                                                                                                                                                                                                                                                                      Paul Harrison, Washington: Just a thought -- to what extent does your analysis take into account the change in urban cores? Call it revitalization or gentrification, your choice. Fort Greene in Brooklyn is a perfect example; homes built by the upper class fell into slum status but have now been restored along with their neighborhood. Obviously their prices have soared... This is a trend that did not really exist during the last housing bubble.

                                                                                                                                                                                                                                                                      Paul Krugman: Gentrification is a real factor, but smaller than those of us who tend to hang around central cities might imagine. A more economistic answer is that rents in the boom cities haven't gone up all that much. This tells us that the underlying demand for housing hasn't soared, just the prices.

                                                                                                                                                                                                                                                                      Ross Grannan, Falls Village, Conn.: ...I am a real estate appraiser and geography major, so I consider myself somewhat of an expert. I like your zoned vs. flatland analysis of the housing market. I think it is a beginning, but ... what is going on much more complicated than enforcement of zoning laws. ... On the West Coast, ... a builder must prove that there is ... a minimum of water for a home. ... Many of the flatland areas — Nevada, Colorado, Arizona, Texas, Oklahoma — have promoted development that cannot be sustained ... the water issue will rear its ugly head in many places real soon. What is the value of property without water? ...

                                                                                                                                                                                                                                                                      Housing is cheap in the flatland areas for a reason. Building codes are less stringent, land use planning primarily revolves around the car and no thought is put into sustainability. I think there the reason people choose to pay more for housing in the zoned areas is quality of life, and these same people see the development in the flatland for what is cheap and disposable.

                                                                                                                                                                                                                                                                      Paul Krugman: I agree with much of this comment, and I'm a dedicated Zoned Zone resident myself. But I don't believe that the relative desirability of, say, San Francisco as compared with Atlanta has soared over the past five years. And data on housing rents don't suggest that there's been a big change in relative demand for housing. It's really interest rates plus, I believe, price speculation driving the divergence between Flatland and the Zoned Zone since 2000.

                                                                                                                                                                                                                                                                      J. Ullman, Weston, Mass.: You might wish to take your excellent analysis one step further by looking at the growing gap between rich and poor in the zoned zone population. In Manhattan, the contrast between the view looking south and that to the north from the vantage point of Park Ave and 96th St. speaks volumes, and clearly it makes no sense whatever to calculate the average housing costs of the two neighborhoods. ...

                                                                                                                                                                                                                                                                      Paul Krugman: Indeed. But you shouldn't idealize Flatland, either. At least New York's transit system allows those who can't afford to live in the glamorous parts of the city to commute to jobs. Imagine being poor in a sprawling heartland city with no rapid transit and a poor quality bus system. Central New Jersey is part of the Zoned Zone, but less expensive than the city; still, manual workers can't afford to live anywhere closer than Trenton, and I can't imagine how they get to their jobs.

                                                                                                                                                                                                                                                                      Daniel K. Cooper, New York: ...I share your perspective that local markets are what matter, and that the national data may obscure as much as they illuminate. But a question on the measure of the bubble — e.g., the proportion of median income to be paid to finance a median-priced home. If the Zoned Zone is where this proportion is highest, it is also where financially able people take second or third or fourth homes. Often ... this is the super-rich, the value of whose residences are at the upper extreme and have little if any influence on the median home value. But this pattern would also include the upper middle class who have a studio apartment in Manhattan as a pied-a-terre, or a winter condo in South Florida or southern California. In terms of value these properties would be much further from the extremes and would have a much more serious influence on the median price of a home in the region.

                                                                                                                                                                                                                                                                      To the degree that this is the case, I submit that using the median income of the region as a benchmark for measuring a housing bubble is quite imperfect ... Would you concur, or am I overlooking something? ... are you aware of any data to allow for an assessment of this?

                                                                                                                                                                                                                                                                      Paul Krugman: What great comments I'm getting here! My guess is that pied-a-terres are very rare, even though I personally know lots of people who have them. But I really don't know. And my understanding is that housing data are much less informative than we'd like.

                                                                                                                                                                                                                                                                      In my neck of the flatlands, where many dedicated flatlanders live, housing is not "cheap and disposable," if cheap is intended to mean poor quality. And as I watch the Oregon rain stream down for yet another day, I'm not all that concerned about running out of water. I can collect all I need by setting out buckets in my yard. But water issues are a concern for many on the west coast, particularly in areas like San Diego and Los Angeles and contrary to the reader comment to Krugman, I don't think those areas necessarily have a better handle on this problem than areas in the flatlands.

                                                                                                                                                                                                                                                                        Posted by Mark Thoma on Tuesday, January 3, 2006 at 03:44 PM in Economics, Housing

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                                                                                                                                                                                                                                                                        The Light at the End of the Tunnel is Getting Brighter

                                                                                                                                                                                                                                                                        But how long is the tunnel? Anyone looking for a sign of a pause in rate hikes at the next FOMC meeting in today's release of the minutes from the last meeting will have a hard time finding it. However, after that there is less certainty. Committee members aren't entirely sure how much more tightening will be required, but "the number of additional firming steps required probably would not be large." Incoming data will be important in making this determination. Here's some highlights from the minutes followed by a longer version and a link to the entire text:
                                                                                                                                                                                                                                                                        • Core consumer price inflation was moderate in recent months, although some signs of pass-through of higher energy costs were evident, especially in transportation services.
                                                                                                                                                                                                                                                                        • Both overall and core consumer price inflation were projected to move higher in the first half of next year, reflecting the effects of higher energy prices, but then to trend lower as those effects ebb.
                                                                                                                                                                                                                                                                        • The economic expansion had shown considerable resilience ... suggesting greater underlying strength than had been apparent at the time of the November meeting.
                                                                                                                                                                                                                                                                        • [W]ith growth solid and prices of energy products still well above levels earlier in the year, possible increases in resource utilization had the potential to add to pressures on prices, especially in the absence of some further firming of policy.
                                                                                                                                                                                                                                                                        • Meeting participants discussed tentative signs that activity was beginning to slow in the housing sector. ... To date, however, the national data on home prices, sales, and construction activity did not suggest a significant weakening in the sector.
                                                                                                                                                                                                                                                                        • [I]n the view of a number of participants, the economy was possibly producing in the neighborhood of its potential, and the persistent strength in spending of late suggested that resource markets could tighten further and inflation pressures build. Under these circumstances, and with policy having been accommodative for some time, inflation expectations could rise if monetary policy were not seen as responding to contain such risks.
                                                                                                                                                                                                                                                                        • Views differed on how much further tightening might be required.
                                                                                                                                                                                                                                                                        • [T]he outlook for policy was seen by most members as indicating that, given the information now in hand, the number of additional firming steps required probably would not be large.
                                                                                                                                                                                                                                                                        • Some members thought that the word "measured" was no longer necessary, but its retention for this meeting was seen as potentially useful to preclude a possible misinterpretation that the Committee now saw a significant possibility of adjusting policy in larger increments in the near future.

                                                                                                                                                                                                                                                                        The last point surprised me, but it gives some insight into how the Fed views the inflation risks. I would have thought the worry would be in the other direction, that removing the "measured" term might be interpreted as indicating the chance of a pause had risen. Here's a longer version of the minutes:

                                                                                                                                                                                                                                                                        Minutes of the Federal Open Market Committee December 13, 2005: ... The information reviewed at this meeting suggested that the economy continued to expand at a solid rate in the fourth quarter. ... Although some scattered signs of cooling of the housing sector had emerged, the pace of construction activity and sales remained brisk. ... Core consumer price inflation remained subdued, even though some of the increase in energy costs had apparently passed through to prices of final goods and services. ... The unemployment rate held steady at 5 percent, and the labor force participation rate was also unchanged. ... Activity in the housing market remained brisk despite a rise in mortgage interest rates. ... Real outlays for equipment and software posted a solid gain in the third quarter. ...

                                                                                                                                                                                                                                                                        Core consumer price inflation was moderate in recent months, although some signs of pass-through of higher energy costs were evident, especially in transportation services. ... Presumably in response to falling retail energy prices, one survey of households in November and early December showed a marked retreat in expectations for inflation over the coming year. Longer-term inflation expectations also edged down, but stayed a touch above the narrow range observed in recent years. ... overall producer price inflation remained subdued. With regard to labor costs, the ... employment cost index for private industry workers in September was well below its year-ago increase. Hourly compensation in the nonfarm business sector also appeared to have slowed a bit recently. ...

                                                                                                                                                                                                                                                                        The staff forecast prepared for this meeting suggested that growth of economic activity would slow from this year's pace, but remain solid, with output staying near the economy's potential over the next two years. ... Both overall and core consumer price inflation were projected to move higher in the first half of next year, reflecting the effects of higher energy prices, but then to trend lower as those effects ebb.

                                                                                                                                                                                                                                                                        In their discussion of the economic situation and outlook, meeting participants noted that incoming data over the intermeeting period had been encouraging with regard to both economic growth and inflation. The economic expansion had shown considerable resilience ... suggesting greater underlying strength than had been apparent at the time of the November meeting. At the same time, incoming inflation data had been benign, indicating relatively modest pass-through of higher energy prices to core inflation to date... and inflation expectations, which had jumped after the hurricanes, had fallen back. Nonetheless, with growth solid and prices of energy products still well above levels earlier in the year, possible increases in resource utilization had the potential to add to pressures on prices, especially in the absence of some further firming of policy. ...

                                                                                                                                                                                                                                                                        Meeting participants discussed tentative signs that activity was beginning to slow in the housing sector. ... To date, however, the national data on home prices, sales, and construction activity did not suggest a significant weakening in the sector.

                                                                                                                                                                                                                                                                        Business investment spending had accelerated some since midyear. ... Participants noted that the improved performance of investment suggested that the expansion was becoming more balanced, with strengthening business spending potentially offsetting some moderation in the growth of household spending ... Economic activity also could be buoyed by developments in other sectors of the economy. ...

                                                                                                                                                                                                                                                                        In their discussion of prices, participants indicated that their concerns about near-term inflation pressures had eased somewhat over the intermeeting period. ... Nonetheless, surveys and anecdotal reports suggested that some firms were successfully passing at least a portion of their increased costs on to customers, and many participants remained concerned that elevated energy prices could put pressure on core inflation. Also, in the view of a number of participants, the economy was possibly producing in the neighborhood of its potential, and the persistent strength in spending of late suggested that resource markets could tighten further and inflation pressures build. Under these circumstances, and with policy having been accommodative for some time, inflation expectations could rise if monetary policy were not seen as responding to contain such risks.

                                                                                                                                                                                                                                                                        In the Committee's discussion of monetary policy for the intermeeting period, all members favored raising the target federal funds rate 25 basis points to 4-1/4 percent. ... Committee members generally anticipated that policy would likely need to be firmed further going forward. In that process, the Committee would need to be mindful of the lags in the effect of policy firming on the economy. ... Views differed on how much further tightening might be required. ... members thought that the policy outlook was becoming considerably less certain and that policy decisions going forward would depend to an increased extent on the implications of incoming economic data for future growth and inflation.

                                                                                                                                                                                                                                                                        The Committee agreed that several changes in the wording of the announcement ... would be appropriate. ... the Committee thought that policy should no longer be characterized as accommodative. Members concurred that the statement should note that the expansion remained solid ... [T]he outlook for policy was seen by most members as indicating that, given the information now in hand, the number of additional firming steps required probably would not be large. Some members thought that the word "measured" was no longer necessary, but its retention for this meeting was seen as potentially useful to preclude a possible misinterpretation that the Committee now saw a significant possibility of adjusting policy in larger increments in the near future. ... The members agreed that the announcement should end by noting that policy will respond to changes in economic prospects as needed to foster the Committee's objectives...

                                                                                                                                                                                                                                                                        Other reports: Bloomberg, Washington Post, CNN/Money, Financial Times, Wall Street Journal, NY Times.

                                                                                                                                                                                                                                                                        Blogs: The Big Picture, William Polley. I will add more as I find them.

                                                                                                                                                                                                                                                                          Posted by Mark Thoma on Tuesday, January 3, 2006 at 12:07 PM in Economics, Monetary Policy

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                                                                                                                                                                                                                                                                          Mankiw's Guidelines for Policy Makers

                                                                                                                                                                                                                                                                          Greg Manikiw's seven guidelines for policy makers for the coming year. Nothing unexpected, but I would not have included the elimination of the penny as one of our top seven priorities:

                                                                                                                                                                                                                                                                          Repeat After Me, by N. Gregory Mankiw, Commentary, Wall Street Journal: ...Since ... economic policy makers inside the Beltway are often too busy for such introspection, my gift to them is a list of seven New Year's resolutions. Any senator, congressman or presidential wannabe is free to adopt them as his or her own. Just repeat after me:

                                                                                                                                                                                                                                                                          • #1: This year I will be straight about the budget mess. I know that the federal budget is on an unsustainable path. I know that when the baby-boom generation retires and becomes eligible for Social Security and Medicare, all hell is going to break loose. I know that the choices aren't pretty -- either large cuts in promised benefits or taxes vastly higher than anything ever experienced in U.S. history. I am going to admit these facts to the American people, and I am going to say which choice I favor.

                                                                                                                                                                                                                                                                          • #2: This year I will be unequivocal in my support of free trade. I am going to stop bashing the Chinese for offering bargains to American consumers. I am going to ask the Bush administration to revoke the textile quotas ... I am going to vote to repeal the antidumping laws... I am going to admit that unilateral disarmament in the trade wars would make the U.S. a richer nation.

                                                                                                                                                                                                                                                                          • #3: This year I will ask farmers to accept the free market. While I believe the government should provide a safety net for the truly needy, taxpayers shouldn't have to finance handouts to farmers... Farmers should meet the market test as much as anyone else. I will vote to repeal all federal subsidies ...

                                                                                                                                                                                                                                                                          • #4: This year I will admit that there are some good taxes. Everyone hates taxes, but the government needs to fund its operations, and some taxes can actually do some good in the process. I will tell the American people that a higher tax on gasoline is better at encouraging conservation than are heavy-handed CAFE regulations. ... I will tell people that tolls are a good way to reduce traffic congestion ... I will advocate a carbon tax as the best way to control global warming. Because we may well need to raise more revenue (see resolution no. 1), I'll always be on the lookout for these good taxes.

                                                                                                                                                                                                                                                                          • #5: This year I will not be tempted to bash the Fed. Ben Bernanke, soon to be the new chairman of the Federal Reserve, will not inherit Alan Greenspan's halo, and so may be a tempting target. But I will resist temptation. ... Difficult as it is, I will hold my tongue.

                                                                                                                                                                                                                                                                          • #6: This year I will vote to eliminate the penny. The purpose of the monetary system is to facilitate exchange, but I have to acknowledge that the penny no longer serves that purpose. ...

                                                                                                                                                                                                                                                                          • #7: This year I will be modest about what government can do. I know that economic prosperity comes not from government programs but from entrepreneurial inspiration. Adam Smith was right when he said, "Little else is required to carry a state to the highest degree of opulence from the lowest barbarism but peace, easy taxes, and a tolerable administration of justice." As a government official, I am not going to promise more than I can deliver. I am going to focus my attention on these three goals -- peace, easy taxes, and a tolerable administration of justice -- and I am going to trust the creativity of the American people to do the rest.

                                                                                                                                                                                                                                                                          It would have been nice to hear some of these things voiced when he was Chair of the Council of Economic Advisers.

                                                                                                                                                                                                                                                                            Posted by Mark Thoma on Tuesday, January 3, 2006 at 09:12 AM in Economics, Politics

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                                                                                                                                                                                                                                                                            Residential Investment, Non-Residential Investment, and Business Cycles

                                                                                                                                                                                                                                                                            There's been a lot of interest in housing so I thought I'd present some data. Before doing so I want to emphasize that these are correlations, I am not going to try and sort out causality with such a simple graphical approach.

                                                                                                                                                                                                                                                                            The graphs below are the I, investment, in the familiar Y = C + I + G + NX function. Investment, I, has three parts, inventories, residential fixed investment, and non-residential fixed investment. I am going to just look at two of the components of investment, residential and non-residential fixed investment. First, here are the the two series as they come "out of the box":

                                                                                                                                                                                                                                                                            However, these data can be deceptive because a decline of, say, 100 is a much larger percentage change at the beginning of the sample as compared to the end. Taking logs of the two series overcomes this problem. Here are the logged values of residential and non-residential fixed investment:

                                                                                                                                                                                                                                                                            Note the relative stability of the residential component in recent years as compared to earlier years.

                                                                                                                                                                                                                                                                            Another way to look at these data is to examine the percentage of total fixed investment accounted for by each of the two components. The following graph shows the declining share of residential fixed investment over time, though in recent years there appears to have been an increase departing from the past trend. It is too early to tell if this is a change in the trend itself, or a drawn out version of past cycles:

                                                                                                                                                                                                                                                                            The next graph shows exactly the same information, but adds the NBER recession dates. There is a general, though by no means a certain, association between declines in the share accounted for by the non-residential component of housing and economic slowdowns:

                                                                                                                                                                                                                                                                            How does this look for the individual components? Here's the log of non-residential investment along with the NBER recession dates:

                                                                                                                                                                                                                                                                            As you can see, there is a fairly close association between recessions and declines in non-residential investment. The next graph shows the log of residential investment:

                                                                                                                                                                                                                                                                            One characterization of these data is that the declines seem to be associated with the non-residential component more so than the residential component. But in the recovery, the period just after the shaded regions, there is a housing boom in every case (interestingly, the one slightly questionable episode is the most recent). There is one case around 1968 where the residential construction boom is not associated with a recovery, but in general the strongest movements in residential fixed construction are just after the troughs of cycles. Recessions are associated with the non-residential component while recoveries are associated with the residential component.

                                                                                                                                                                                                                                                                            The 1991 recession is a good one to look at to make this point. The residential construction slowdown started years before the recession, as early as 1985 according to the last graph. If this caused the recession, there was a substantial lag involved. However, the slowdown in non-residential construction shown in the second to last graph seems much more proximate to the recession. After the trough, the recovery is associated with a strong increase in residential construction, but the decline in business investment continues beyond the trough in the cycle. The 2001 recession looks similar, a fall in non-residential investment is associated with the decline in output, and the fall in non-residential investment continues past the trough of the cycle. The recovery is associated with strong residential investment, though in this case the growth is not as fast as in previous recoveries.

                                                                                                                                                                                                                                                                              Posted by Mark Thoma on Tuesday, January 3, 2006 at 12:21 AM in Economics, Housing

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                                                                                                                                                                                                                                                                              Cato: Drain the Strategic Petroleum Reserve

                                                                                                                                                                                                                                                                              Cato, in a big surprise for the new year, comes out against government intervention in markets:

                                                                                                                                                                                                                                                                              Running on Empty, by Jerry Taylor and Peter Van Doren, Commentary, NY Times: The rise in fuel prices that followed Hurricanes Katrina and Rita has prompted many members of Congress to call for ... expanded federal reserves of crude oil, diesel fuel, home heating oil, jet fuel and propane. Proponents of stockpiling claim that if the government were to hoard those commodities when prices were low, it could unleash them on the market when supplies are tight, thus dampening price increases and stabilizing the market. But the experience in this country with the strategic petroleum reserve strongly suggests that such government-managed stockpiles are a waste of taxpayers' money. ... the reserve should be emptied and closed. ...

                                                                                                                                                                                                                                                                              [A]fter adjusting for inflation, the petroleum reserve has cost federal taxpayers as much as $51 billion since it was created in 1975. ... Of course, even at that price, some would argue that the reserve is still worthwhile under certain circumstances. ... If large volumes of federal oil were released at the early stage of a supply shock, it could temper th[e] effects. But the government has never employed the reserve in this manner and probably never will. ... Another reason for the reluctance to tap the reserve is the widespread belief that it should be maintained as a hedge against an embargo like the one America experienced in 1973. But embargoes are not the powerful "oil weapon" that people think they are. Once a producer sells its oil on the world market, that oil can be bought, sold and rerouted repeatedly. ... The globalization of oil markets ensures that the United States will always have access to Persian Gulf oil whether OPEC members like it or not.

                                                                                                                                                                                                                                                                              But what if, instead of an embargo, there was a catastrophic disruption in supply, say ... in Saudi Arabia? That scenario is worrisome, but the reserve would not be able to do much. No public stockpile would ever be large enough to deal with such a huge disruption. ... Regardless, getting rid of the public petroleum reserve would not mean destroying all oil reserves. Private oil inventories are three times larger than public inventories and would be even larger if investors didn't have to worry about the government flooding the market with public oil during a price spike. ... If the reserve is thought of as an insurance policy against high prices, the cost of the policy has been more expensive than the dangers the stockpile is meant to prevent. ...[W]e should sell while the selling is good.

                                                                                                                                                                                                                                                                                Posted by Mark Thoma on Tuesday, January 3, 2006 at 12:15 AM in Economics, Oil

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                                                                                                                                                                                                                                                                                January 02, 2006

                                                                                                                                                                                                                                                                                Saving for a Rainy Day

                                                                                                                                                                                                                                                                                Ken Rogoff has some good advice:

                                                                                                                                                                                                                                                                                In the best of times, it’s wise to ponder the worst, by Kenneth Rogoff, Commentary, Financial Times: In today’s benign environment of global growth, anyone who cautions that good times might end is a heretic. What if Pharaoh had beheaded Joseph for daring to suggest higher taxes during the fat harvest years so people would not starve during the lean ones? Instead, Egypt’s leader cast his lot with the world’s first recorded business cycle theorist and the rest is, well, history. But are our leaders today preparing for the inevitable downside of the cycle? I wonder.

                                                                                                                                                                                                                                                                                Let us first acknowledge that we are indeed living in boom times. ... Moreover, under­pinning this ... are numerous positive developments. First and foremost ... is the continued rise of Asia (especially China) with huge and diverse benefits for the global economy. Second, thanks to greater independence, improved ­policy ... and ... globalisation, central banks have been enormously successful at bringing down inflation. This is a worldwide phenomenon... Third, most countries have ­experienced a clear trend decline in income volatility over the past 20 years... Fourth, long-term interest rates are back to 1950s levels, due partly to a temporary global investment shortfall.

                                                                                                                                                                                                                                                                                Low interest rates, in turn, have underpinned a worldwide housing boom. Together with reduced output ­volatility, they have helped bring down risk spreads on virtually every kind of debt, not least that of emerging ­markets. ... Still, are the risks to the fat years as low as most markets and policymakers now perceive them to be? It does not take a prophet to think of things that might go wrong.

                                                                                                                                                                                                                                                                                The number one risk to global growth ... has to be ... a terrorist incident involving weapons of mass destruction. ... Imagine, for example, that nuclear material were found in a container ship headed into New York. (Perhaps ... it might be found wrapped in one of the multitudinous bales of marijuana smuggled into the US every day.) Even if catastrophe were forestalled, governments would almost surely start treating container shipments with the same indignity now accorded to airline passengers. The ensuing delays would wreak havoc across ... global supply chains, effectively constituting a huge tax on global trade.

                                                                                                                                                                                                                                                                                Equally problematic would be a meltdown in one of the world’s many hotspots, for example in the Middle East, North Korea or the Taiwan Strait. Imagine that a military standoff led to a sustained pause in shipping from greater China. A pandemic such as avian flu could cause similar problems, by interfering with the movement of individuals both within and across ­borders.

                                                                                                                                                                                                                                                                                Markets seem to fantasise that the US Federal Reserve would simply step in in the event of a catastrophe and sharply cut interest rates as it did after September 11, 2001. But a sustained blow to the global transportation network would have far more dire economic implications than a localised disaster. Is anything being done to prepare for this risk? ...

                                                                                                                                                                                                                                                                                As good as the economic fundamentals are, it is easy to find ... vulnerabilities. Top of the list has to be global housing prices – which are not actually all that close to earth any more. ...[In] China, the leadership there still faces a delicate social, economic and political balancing act to sustain the country’s break-neck development pace. ... A pause in China’s growth would have huge global implications for commodity prices, inflation and productivity. Then there is energy. Yes, the run-up in oil prices over the past two years seems to have had a relatively modest effect on global growth. ... Still, oil has not lost its ability to sting. ... Lastly,... explosion of unregulated hedge funds and the widespread use of derivatives such as credit default swaps pose risks that are simply impossible to calibrate until the system is stress-tested. ...

                                                                                                                                                                                                                                                                                In the light of these and other risks, today’s policy climate seems marked by a discouraging level of political paralysis. The US is running a substantial budget deficit in spite of a booming economy. In Europe, reforms are at a standstill. Asia needs more flexible exchange rates to share the burden of global imbalances and, in Latin America, reform paralysis in major countries has produced tepid growth in spite of a phenomenally supportive global backdrop. The common-sense biblical wisdom of using good times to prepare for worse ones does not seem to have many adherents these days. Perhaps that complacency is the greatest risk of all.

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

                                                                                                                                                                                                                                                                                  Posted by Mark Thoma on Monday, January 2, 2006 at 04:53 PM in Budget Deficit, Economics, Monetary Policy, Policy

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                                                                                                                                                                                                                                                                                  Risks from a Slowdown in Housing

                                                                                                                                                                                                                                                                                  Here's a little more on the risk of a crash in housing explained through an example. Suppose a person purchases a new house for $250,000 (in the "Flatlands") and signs loan papers promising to pay $1,500 per month for 30 years. If I did my math right, that works out to be an interest rate of 6.01%. There is no equity initially.

                                                                                                                                                                                                                                                                                  Now let there be a housing boom driving the value of the house up to $300,000 creating $50,000 in equity. The homeowner has kids in college and decides to borrow against this increase in value. However, the bank will only allow 80% of the difference to be borrowed (but offers a lower interest rate than banks who will lend up to 100%), so the homeowner borrows $40,000 again at 6.01%. Once more, assuming I did the calculations correctly, that amounts, for a 30 year home equity loan, to $240.08 per month. The equity is the bank's collateral.

                                                                                                                                                                                                                                                                                  Now the homeowner's monthly payment for the next 30 years is $1,500 + $240.08 = $1,740.08. Assume that under normal conditions, keeping a job, no unexpected contengencies etc., the household can comfortably pay this amount for housing each month.

                                                                                                                                                                                                                                                                                  What I want to ask is how risk changes if there is a housing crash. Let's suppose the market now "crashes" and the value of the house falls from $300,000 to $275,000.

                                                                                                                                                                                                                                                                                  Do the monthly payments change? Assuming that there is no call option on the home equity loan, the answer is no. The homeowner's monthly payments on the borrowed money won't change at all (to make it simple I'm assuming fixed interest rates). There is no change in risk in this sense. All that has happened is that the collateral has fallen - now, relative to the original loan, there is only $25,000 in collateral to cover the $40,000 loan instead of $50,000 that was there before the crash. This puts both the lender and borrower at increased risk since in the case of a contingency such as a sudden loss of job, full liquidation will not cover the loan. But the uncovered gap is not large and risks of this type ought to be capitalized into the price of the loan (that's why I assumed the bank only allowed 80% of the difference, that's one way to insure against a fall in the value of the house).

                                                                                                                                                                                                                                                                                  If you think of equity in a house as insurance against future unexpected expenditures, there is an increase in risk for the homeowner here as well. Assuming the equity had never been borrowed against, initially a homeowner would have $50,000 available to cover any contingencies, but after the crash that falls to $25,000, so the homeowner is more vulnerable to financial risks - any unexpected expenditure over (80%)($25,000) = $20,000 cannot be covered in this manner whereas previously the limit was (80%)($50,000) = $40,000. Think of this as an unexpected decline in a person's collateralized credit limit.

                                                                                                                                                                                                                                                                                  And of course, the fall in the value itself represents an overall decline in household wealth, and that can lower consumption. But the main point here is that while a housing crash does increase household risk since the insurance value falls and equity may be insufficient to cover borrowed money if the homeowner is forced to sell, it does not suddenly change the monthly commitments of households and in that sense does not represent a huge change in risk.

                                                                                                                                                                                                                                                                                  Here's another scenario. Suppose a second person got started house hunting a little later and bought when the value was $300,000 and took on a 6.01% loan for 30 years. The payments for this person are $1,800.58, a little more than $1,740.08 since the loan amount is $300,000 rather than $290,000 as in the previous case. When housing values crash, this person's monthly commitments do not change at all, but risk does increase as before since the collateral will not cover the loan value.

                                                                                                                                                                                                                                                                                  The main risk arises when people start losing jobs in a recession and are forced to liquidate because at that time they may not be able to cover commitments. This is the type of risk that is the most worrisome, the risk of an overall slowdown brought about by a slowing of the housing boom or other causes and the pressure that will put on households who find themselves unemployed and unable to meet their financial commitments. But so long as you have the same job and the same income you had before, and you live in the same house, a housing crash will not change your month to month financial picture (abstracting from property taxes, etc.).

                                                                                                                                                                                                                                                                                  I don't mean to downplay the business cycle risk from a housing slowdown, the type of risk that is the subject of Krugman's column for example (worth reading if you missed it) and I'm hesitant to post this out of worry it will leave that impression. The financial difficulties that could result from higher unemployment and falling income in a recession are real and need our attention. There are many on the margin who are vulnerable, and there are those who may have been induced to take on excessive risk. My point is different and directed narrowly at some of what I've read indicating that households with the same house, the same job(s), etc. will be put into financial jeopardy by a housing crash. As I hope is clear, that is not necessarily the case.

                                                                                                                                                                                                                                                                                    Posted by Mark Thoma on Monday, January 2, 2006 at 03:05 PM in Economics, Housing

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                                                                                                                                                                                                                                                                                    Paul Krugman: No Bubble Trouble?

                                                                                                                                                                                                                                                                                    Paul Krugman says there is a housing bubble, a big worrisome bubble located in the Northeast Corridor, coastal Florida, much of the West Coast, and a few other locations:

                                                                                                                                                                                                                                                                                    No Bubble Trouble?, by Paul Krugman, Commentary, NY Times: In spite of record home prices, housing in most of America remains surprisingly affordable, thanks to low interest rates. That fact may seem to say that there's no housing bubble. But it doesn't. To see why, we need to brush up on our economic geography and economic history.

                                                                                                                                                                                                                                                                                    Let's start with the good news. A report in last week's Times ... found that for the nation as a whole, the cost of owning the median home is still only 23.7 percent of median family income, ... well below the peak of more than 30 percent reached in the early 1980's.

                                                                                                                                                                                                                                                                                    Now for the economic geography. Last summer I suggested that when discussing housing, we should think of America as two countries, Flatland and the Zoned Zone. In Flatland, there's plenty of room to build houses, so house prices mainly reflect the cost of construction. As a result, Flatland is pretty much immune to housing bubbles. ...

                                                                                                                                                                                                                                                                                    In the Zoned Zone, by contrast, buildable lots are scarce, and house prices mainly reflect the price of these lots rather than the cost of construction. As a result, house prices ... are much less tied down by economic fundamentals... By my rough estimate, slightly under 30 percent of Americans live in the Zoned Zone, which comprises most of the Northeast Corridor, coastal Florida, much of the West Coast and a few other locations. So ... results on affordability aren't surprising: most families live in Flatland, and haven't seen a big rise in the cost of home ownership.

                                                                                                                                                                                                                                                                                    But because Zoned Zone homes are much more expensive than Flatland homes, ... [b]y my estimate, more than half of the total market value of homes in the United States lies in the Zoned Zone. And ... the Zoned Zone accounts for the great bulk of the surge in housing market value over the last five years. So if we want to ask whether housing values make sense... [w]e need to focus on houses in the Zoned Zone. And there the numbers are anything but reassuring.

                                                                                                                                                                                                                                                                                    In the Zoned Zone, ... prices have risen so much that housing has become much less affordable. ... Even so, the current cost of owning a home in the Zoned Zone isn't entirely unprecedented. Roughly similar percentages of median family income were needed to afford houses in the early 1980's.

                                                                                                                                                                                                                                                                                    But that's hardly a comforting comparison, which is where the economic history comes in. You see, the unaffordability of housing in the early 1980's led to an epic collapse in the housing industry. ... And ... was one of the main factors in the worst economic slump since the Great Depression, which brought the unemployment rate to a peak of 10.8 percent at the end of 1982.

                                                                                                                                                                                                                                                                                    It's also worth noting that the reason housing was so expensive in 1981 and 1982 was that mortgage interest rates were extremely high. That made recovery easy, because all it took to make housing affordable again was for interest rates to return to normal levels. This time, with interest rates already low by historical standards, restoring affordability will require a big fall in housing prices.

                                                                                                                                                                                                                                                                                    So here's the bottom line: yes, northern Virginia, there is a housing bubble. ... Part of the rise in housing values since 2000 was justified given the fall in interest rates, but at this point the overall market value of housing has lost touch with economic reality. And there's a nasty correction ahead.

                                                                                                                                                                                                                                                                                    Post briefly discussing NY Times Housing story with link to Times story.

                                                                                                                                                                                                                                                                                    Previous (12/30) column: Paul Krugman: Heck of a Job, Bushie Next (1/15) column: Paul Krugman: First, Do More Harm

                                                                                                                                                                                                                                                                                      Posted by Mark Thoma on Monday, January 2, 2006 at 12:15 AM in Economics, Housing

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                                                                                                                                                                                                                                                                                      Pin the Party Tale on the CEO (and it Won't Help to Wear the Armor...)

                                                                                                                                                                                                                                                                                      The relative price of chief executive ability is 1 CEO to 431 workers. And that's just an average CEO, not one of those super duper ones some companies have:

                                                                                                                                                                                                                                                                                      Another Marie Antoinette Moment, Editorial, NY Times: There is no shortage of ... studies detailing the widening gap between what American companies pay workers and the millions of dollars those same companies pay top executives. But just in case anyone hasn't been paying attention, here enters David Brooks, chief executive of the bulletproof vest manufacturer DHB Industries Inc., to provide a fuller picture.

                                                                                                                                                                                                                                                                                      Mr. Brooks has made hundreds of millions of dollars ... from federal and municipal contracts for bulletproof vests. But while 18,000 of those vests were being recalled by the United States military, some from Iraq, Mr. Brooks was in the midst of throwing a private party for his daughter and her friends at the Rainbow Room at Rockefeller Center.

                                                                                                                                                                                                                                                                                      The bash was headlined by ... superstar rapper 50 Cent and the front men from the rock group Aerosmith were among the night's many performers. According to The Daily News in New York, the party's estimated $10 million price tag - a figure Mr. Brooks albeit called greatly exaggerated - culminated with guests reportedly walking out carrying gift bags valued at $1,000 each, stocked with digital cameras and video iPods.

                                                                                                                                                                                                                                                                                      Mr. Brooks is free to spend his money as he pleases, but he might have thought better than to draw added attention to his company right now. The November recall of the vests was the second by the military in 2005. The Securities and Exchange Commission is investigating the company and Mr. Brooks. And the company is also the target of several shareholder lawsuits after a material in some of its body armor failed a federal safety test.

                                                                                                                                                                                                                                                                                      Meanwhile, the party came less than three months after the release of a report on ballooning pay for chief executives that singled out Mr. Brooks for making $70 million in 2004 compared with $525,000 in pre-Iraq-war 2001. ... [plus] an additional $186 million in 2004 selling company stock. The same report, by the Institute for Policy Studies, a left-leaning research center, and United for a Fair Economy, a group seeking to narrow the gap between rich and poor, found that in 2004 the ratio of C.E.O. pay to worker pay at large companies had ballooned to 431 to 1. If the minimum wage had advanced at the same rate as chief executive compensation since 1990, America's ... working poor would be enjoying ... legal wages at $23.03 an hour instead of $5.15. ...

                                                                                                                                                                                                                                                                                      [C]orporate profits are being wrung in large part from cost cutting like reductions to worker health care and retirement, layoffs and plant closings. It would be nice to see corporate America put more effort - and money - into quality control and fair living wages for workers and less into exorbitant pay packages and bonuses for corporate chieftains. ...

                                                                                                                                                                                                                                                                                      I've heard the arguments justifying the ratio of CEO to worker pay, but I don't believe that CEO compensation approximates the outcome of a competitive market process. They're overpaid, and the usual market mechanisms fail to fix the problem.

                                                                                                                                                                                                                                                                                        Posted by Mark Thoma on Monday, January 2, 2006 at 12:11 AM in Economics, Income Distribution

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                                                                                                                                                                                                                                                                                        Economic Development in Rural America

                                                                                                                                                                                                                                                                                        This is part of a much longer article on economic development in rural America. The full article has a lot more on the politics and economic incentives involved in the development of this area than I've included here:

                                                                                                                                                                                                                                                                                        Mining Coal Country for Tech Workers Economics, Politics Send Contractors Into Southwest Virginia, by Ellen McCarthy, Washington Post: In this town of 3,300 people, cow pastures encase the local high school, churches outnumber nightclubs 14 to zero and the unemployment rate is almost twice as high as the rest of the state. This is where government contractors CGI-AMS Inc. and Northrop Grumman Corp. will ... start building multimillion-dollar technology centers and hire hundreds of software engineers at salaries far above the region's average...

                                                                                                                                                                                                                                                                                        How the companies came to build here is a tale of the economic factors shaping Northern Virginia -- towering home prices and nightmare commutes that are making it hard to hire new workers at reasonable wages. But it's also a tale of Virginia politics ... Along with cutting their costs, the companies saw ... a way to improve their chances of winning state contracts, and -- in the case of CGI-AMS -- a way to turn the promise of jobs into millions of dollars in government concessions. ...

                                                                                                                                                                                                                                                                                        In fact, the tech companies that line the overflowing roads of Northern Virginia have thousands of open jobs they can't fill. The job market in Washington is so tight, companies regularly pay bonuses and inflated salaries to recruit employees with technical skills, even though the work required to develop new software programs has become increasingly routine. Banks and insurance firms long ago cut their software development costs by shipping the work to India and China, but legal restrictions and the politics of government procurement have prevented federal contractors from following suit.

                                                                                                                                                                                                                                                                                        So they are looking at rural America instead -- to places where rents are cheap, traffic is light and, instead of companies being forced to offer bonuses or poach employees from a competitor, résumés pour in by the dozen. The area turns out plenty of résumés that the companies want to see. Local officials drafted a study to show that 4,566 computer science degrees were awarded in the past five years by colleges within 100 miles of Lebanon, including Virginia Tech, Radford University and James Madison University. Area community colleges promised to tailor their courses to fit CGI-AMS's needs, and the county said it would build a new $5 million, 53,000-square-foot facility where the company could do relatively basic software development and troubleshooting. ...

                                                                                                                                                                                                                                                                                        The contractors' move to rural America echoes a strategy that commercial tech companies made in the early 1990s. Some of them moved basic software coding jobs to small towns before they began sending such jobs overseas. Though executive and sales offices are likely to remain in Washington and on-site systems integrators will need to stay near the agencies they work with, the move of software developers and some other more routine jobs "will be a growing pattern," said Anirban Basu, an economist and chief executive of the Sage Policy Group. "The Washington-area cost structure is pushing jobs out of the region." ...

                                                                                                                                                                                                                                                                                        Executives at government contracting companies say that the boost these jobs can give rural communities is significant but that the driving factor for them is money, not altruism. ...

                                                                                                                                                                                                                                                                                        For all of [the] optimism, the long-term impact on Southwest Virginia is uncertain. Stephan J. Goetz, a Pennsylvania State University economist who studies rural areas, said an immediate boost is likely as construction workers move in to build new homes and restaurants pop up to serve residents with more disposable income. Speculation about when a Starbucks will appear is rampant on the streets of Lebanon.

                                                                                                                                                                                                                                                                                        But the change will last, Goetz said, only if other companies and subcontractors settle around the two companies and stay there for years to come. "Whenever you have a stable source of income, that can really be a boon," Goetz said. "Things like this can really change the face of a community." But the companies have to stay. ...

                                                                                                                                                                                                                                                                                          Posted by Mark Thoma on Monday, January 2, 2006 at 12:06 AM in Economics

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                                                                                                                                                                                                                                                                                          January 01, 2006

                                                                                                                                                                                                                                                                                          How Fragile is China?

                                                                                                                                                                                                                                                                                          More on China's development troubles:

                                                                                                                                                                                                                                                                                          In rural China, a time bomb is ticking, by Joshua Muldavin, International Herald Tribune: The recent police killing in China's Guangdong Province of as many as 20 villagers who were protesting the government's seizure of land for a power plant is symptomatic of an emerging pattern of rural unrest that challenges the very legitimacy of the Chinese state... China's fabulous growth since the 1980s was achieved through environmental destruction and social and economic polarization which now threaten its continuation. ... While rural strife is not new - in 1994, I witnessed thousands of peasants in Henan Province fight a local government militia over unpopular taxation and state policies - its scope and frequency have increased greatly. ... In 2004, according to official estimates, there were 74,000 uprisings throughout the country ...

                                                                                                                                                                                                                                                                                          Peasant land loss is a time bomb for the state. While avoiding full land privatization and, until recently, massive landlessness of the rural majority, Beijing still allows unregulated rural land development for new industries and infrastructure. Land seized from peasants reduces their minimal subsistence base, leaving them with what is called "two-mouth" lands insufficient to feed most families, thus forcing members of many households to join China's 200 million migrants in search of work across the country. In many areas..., some households have lost even these small subsistence lands, swelling the ranks of China's landless peasants, who number a staggering 70 million according to official estimates. ...

                                                                                                                                                                                                                                                                                          The Chinese state is very clear on the rural roots of the 1949 revolution, ones emanating from massive inequality and social insecurity. But there is a new clarity now for peasants and rural workers, who have seen the state increasingly side with the newly rich over the past two decades... This harks back to the period prior to China's 1949 revolution when enormous numbers of landless peasants formed the core of the largely rural movement led by Mao and others. Following their victory, it was the redistribution of land to the poorest peasants that gave the Communist Party its greatest enduring legitimacy in rural areas. It is the loss of this legitimacy that lies at the heart of the most recent strife.

                                                                                                                                                                                                                                                                                          Beijing could use the violence in Guangdong as an opportunity to address the structural roots of the larger unrest... Instead the state is opting to characterize the killings as the mistake of an overly zealous local police officer rather than a systematic attempt to contain rural discontent by any means. The dilemma for China is not a public relations one... Unless overall policies are altered to address the needs of China's vulnerable rural majority, Beijing will surely face more protracted and violent challenges from the victims of the country's development "success."

                                                                                                                                                                                                                                                                                          This reminds me of the enclosure movement in England:

                                                                                                                                                                                                                                                                                          Enclosure (also historically inclosure) is the process of subdivision of common land for individual ownership. There were two main processes of enclosure in England. One was the division of the large open fields which had been common in some areas of the country into individually managed plots of land, usually hedged and known at the time as "severals". All of the strips of land in these open fields had been privately owned, but communually ploughed ... and open to communal grazing after the harvest or in fallow years. ...[M]edieval manors usually had two to three large open fields, so that crops could be rotated. In the process of enclosure, these were consolidated and divided into severals, to be individually managed. ...

                                                                                                                                                                                                                                                                                          The second process of enclosure was the division and privatisation of common fens and marshes, moors and other "wastes" (in the original sense of "uninhabited places"). These enclosures created new private plots... The second form of enclosure affected particularly those areas, such as the North, the far south west and unique regions such as the East Anglian Fens, where grazing had been plentiful on otherwise marginal lands, such as marshes and moors. Access to these common resources was an essential part of the economic life in these strongly pastoral regions. In the Fens, large riots broke out both in the seventeenth century, when attempts to drain the peat and silt marshes were combined with proposals to also partially enclose them.

                                                                                                                                                                                                                                                                                          From as early as the 12th century, some open fields in Britain were being enclosed into individually owned fields. In Great Britain, the process sped up during the 15th and 16th centuries as sheep farming grew more profitable. In the 16th and early 17th centuries, the practice of enclosure was denounced by the Church and the government, particularly depopulating enclosure, and legislation was drawn up against it. However, the tide of elite opinion began to turn towards support for enclosure, and rate of enclosure increased in the seventeenth century. ... Sir Thomas More, in his 1516 work Utopia suggests that the practice of enclosure is responsible for some of the social problems affecting England at the time ... By the end of the 19th century the process of enclosure was largely complete.

                                                                                                                                                                                                                                                                                          Many believe the enclosure movement was an essential factor in England's industrialization and the emergence of capitalism as it helped to create a class of citizens with nothing but their labor to sell in order to survive, though there were many other factors such as the decline of guilds that were important as well.

                                                                                                                                                                                                                                                                                          As adults often forget their own foibles in childhood as they discipline their children, I think we often forget that we went through difficult growing pains much like those that China is experiencing. For example, we too were willing to trade environmental degradation for growth in our younger development years, and England and other European countries made the same choice as capitalism was emerging, perhaps to a much larger extent than China has. Awful working conditions, worker riots, and so on are in our past as well and we should be careful about insisting that other countries do better than we were able to do when confronted with similar economic development issues. I am not defending or excusing any of these practices, not at all, and we should continue to pressure China to do better, but remembering and acknowledging our own past as we do so could help us deliver the message in a way that is more likely to get a positive reception.

                                                                                                                                                                                                                                                                                            Posted by Mark Thoma on Sunday, January 1, 2006 at 12:09 PM in China, Economics, History of Thought

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                                                                                                                                                                                                                                                                                            That should be Nations-R-UN according to this commentary. What is the role of the nation state and what sorts of global institutions are needed to transform failed and troubled states into functioning capitalist democracies? Here's one view:

                                                                                                                                                                                                                                                                                            Rethinking Nation-Building, by Ashraf Ghani and Clare Lockhart, Commentary, Washington Post: In 1945 the future of capitalism ... and democracy ... [was] far from certain in the advanced industrialized world. Today there is a remarkable consensus on both the preferred economic and political forms. ... Yet the daily experience of so many people in poor countries is confrontation with the realities of failing or fragile states, criminalized and informal economies, and the denial of basic freedoms. It is not resentment of the West but exclusion from the right to make decisions in their own countries that feeds the resentment of the poor. ...[T]he networks of violence that have declared war on ... the developed world are making use of the territory of failed states to expand their bases of destruction. ...

                                                                                                                                                                                                                                                                                            The state is the most effective, economical way of organizing the security and well-being of a population... Thus the need for functioning states has become one of the critical issues of our times. Global political, economic and security institutions must have a new goal: to promote the emergence of states that can fulfill their necessary functions. ... It ... requires that we make clear what functions need to be performed by a state if it is to have internal legitimacy and external credibility. ...

                                                                                                                                                                                                                                                                                            For this to work, the global institutions must receive renewed attention. Despite some obvious shortcomings of the United Nations and international financial institutions, the fact remains that if they did not exist they would need to be invented. We must not succumb to calls for their abolition or further weakening. Revitalization of these organizations will require sustained attention ... It is critical to redefine their tasks and coordinate their activities. ... U.N. agencies need the resources to tackle state-building in fragile and conflict-ridden states. ... The international system needs reordering, with a new role for the United Nations, international financial institutions and security organizations. ...

                                                                                                                                                                                                                                                                                              Posted by Mark Thoma on Sunday, January 1, 2006 at 02:42 AM in Economics, Politics

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                                                                                                                                                                                                                                                                                              International Trade by Country

                                                                                                                                                                                                                                                                                              I don't know how much there is to see in these graphs that you haven't seen or read before, e.g. we know that our imports from China have increased faster than our exports to China. But since I put these graphs together I may as well pass them along. They show the value of imports and exports and the import and export shares between the U.S. and Canada, Japan, Mexico, the UK, Germany, France, and China. First, here are the imports to the U.S. and the import shares (these are not seasonally adjusted):

                                                                                                                                                                                                                                                                                              And here are the same two graphs for exports from the U.S. (again, these are not seasonally adjusted):

                                                                                                                                                                                                                                                                                              Any surprises? I had forgotten how large the trade flow is with Mexico, particularly the share of exports. For reference, NAFTA went into effect on January 1, 1994.

                                                                                                                                                                                                                                                                                                Posted by Mark Thoma on Sunday, January 1, 2006 at 01:08 AM in China, Economics, International Trade

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                                                                                                                                                                                                                                                                                                Workers are People Too

                                                                                                                                                                                                                                                                                                Ideas to improve the workplace, increase economic security, and enhance labor productivity:

                                                                                                                                                                                                                                                                                                Bring back the 40-hour workweek -- and let us take a long vacation, by Joe Robinson, Opinion, LA Times: It was a great year for labor — if you worked at a call center in India, made your living as a CEO or sold real estate to big-box stores. But deep in Cubicle Nation, the average American worker remained on a fast track to the Industrial Revolution, with soaring workweeks, declining wages and health, pension and vacation benefits vanishing ... Add ... outsourcing, cutbacks, the dismantling of ergonomics rules and forced overtime — all while business is racking up historic profits — and even a nearsighted dingo could see that the trends are unsustainable for families, personal health, company medical plans... And completely unnecessary. As ... productivity research shows, we can get the job done without finishing ourselves off. So let's ... ring in ... a "Sane Workplace in 2006":

                                                                                                                                                                                                                                                                                                • Restore the 40-hour workweek. Almost 40% of us are working more than 50 hours a week, not exactly what the Fair Labor Standards Act intended when it set the 40-hour workweek in 1938. Chronic 11- and 12-hour days result in lousy productivity, expensive mistakes, burnout, triple the risk of heart attack and quadruple the risk of diabetes — and families without a quorum for dinner. ...
                                                                                                                                                                                                                                                                                                • Establish rules for e-tools. The e-invasion is burying us alive. Human resources departments and individuals need to set ... boundaries that would determine message urgency, limit reflexive responses and establish no-send zones (i.e., no forwarding of multi-forwarded e-mails and absolutely no work e-mail at home or on vacation).
                                                                                                                                                                                                                                                                                                • Give face time the pink slip. In the knowledge/digital ages, it doesn't matter where your body is; what counts is inside your head. More telecommuting and flex schedules could save millions of dollars in office costs and hours reclaimed from gridlock, while providing workers much-needed flexibility...
                                                                                                                                                                                                                                                                                                • Legalize vacations. Almost a third of American women and a quarter of men don't get any vacation leave anymore because, unlike 96 other countries, the U.S. has no paid-leave law. Those who still get vacations seldom get to take the whole thing. ... It's barbaric. And myopic. Studies show that vacations improve performance on the job, not to mention cut the risk of heart disease and cure burnout...
                                                                                                                                                                                                                                                                                                • Provide guaranteed sick leave. No one should have to lose a job because they get ill. But across this land, hardworking people are getting fired simply because their company has no sick days and they got ill. It's time to join 139 other countries and protect those who can't protect themselves with a minimum sick-leave law. ...
                                                                                                                                                                                                                                                                                                • Support a living wage. With the skyrocketing costs of gas, food and rent, an increase in the minimum wage is long overdue. Consumers need to support companies that pay a living wage, such as Costco, and shun ones that don't.
                                                                                                                                                                                                                                                                                                • Hold the back pats. This year, make a point of not supporting workaholic martyrs ("I worked all night! I came in on the weekend!" "Really? How lame.") who don't drive productivity but stress everyone around them.
                                                                                                                                                                                                                                                                                                • Tighten the salary test. One of the main ... drivers of overwork is the expanding definition of salaried employees. When the Fair Labor Standards Act codified the salary designation, it was intended to apply only to top administrators and managers. Over the last two decades, the classification has been stretched to include more and more of us, particularly after new, elastic rules by the Bush administration that could turn everyone from chefs to preschool teachers into salaried workers. ... The explosion of salaried employees — now 40% of all workers ... — is without doubt having major repercussions on divorce rates, child care, civic responsibilities and drug sales. Wake up and smell the Paxil.
                                                                                                                                                                                                                                                                                                • Provide paid childbirth leave to all working Americans. Family values start here. Only 40% of American workers are eligible for the 12 weeks of unpaid leave under the Family Medical Leave Act, and fewer still are brazen enough to actually take the time off. There are 163 countries that offer paid family leave. The sterling bunch that doesn't includes Papua New Guinea, Burkina Faso, Swaziland and the richest nation on the planet.

                                                                                                                                                                                                                                                                                                At a time when the people who make the products and services ... are considered disposable, I'd like to see political candidates in '06 do a head count and tally the number of disaffected wage earners desperate for leadership. ... One Republican pollster has found that lack of time is the No. 1 issue for young working mothers, more of a concern than Iraq and healthcare. American workers have done their part, doubling productivity since 1969. How about producing a workplace worthy of them in 2006?

                                                                                                                                                                                                                                                                                                  Posted by Mark Thoma on Sunday, January 1, 2006 at 12:07 AM in Economics

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