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March 31, 2006

March 16-31 2006

March 31, 2006

Bartlett: Same Old Administration

Prudent Bear Visitors: This is an incorrect link. Click here for the Shiller article.

Bruce Bartlett is not impressed with President Bush's choice of Josh Bolten to replace Andrew Card as White House Chief of Staff:

Bush Plays the Same Old Hand, by Bruce Bartlett, Commentary, New York Times: Washington is still atwitter over the resignation of Andrew Card as White House chief of staff and the appointment of his replacement, Josh Bolten... Much of the buzz comes from the belief that President Bush may be listening to the Washington establishment, which has been urging him to reinvigorate his administration and lift his lowly poll ratings. ...

The problem is that only one part of Mr. Bush’s team ever gets shaken up. Whenever things are not working, the economic advisors seem to take most of the blame, while even dramatic failures by other staff members cause no repercussions. No one was fired for the prewar intelligence failures in Iraq ... George Tenet, the former Director of Central Intelligence, was given a medal. Michael Chertoff is still Secretary of Homeland Security even though his agency was responsible for many of the screw-ups related to Hurricane Katrina.

In contrast, in 2002, Treasury Secretary Paul O’Neill was publicly fired — along with Larry Lindsey, Director of the National Economic Council — in a fashion that suggested there was more to it than a mere desire to change staff. Why Bush could not have told the two men privately that he wanted to make a change and allow them to leave with their dignity intact has never been explained. Instead, Vice President Dick Cheney phoned Mr. O’Neill to tell him he was out — this after Mr. O’Neill had personally asked Bush if he wanted him to leave and was told no. ...

The firings sent a message to everyone in the administration that they were expendable... They would not even be permitted the face-saving gesture of quitting for “personal reasons” ... The effect was to dampen what little initiative and independence might have existed ... Mr. O’Neill’s replacement, John Snow, got the message ... His only job seems to be greeting every new economic statistic as if the nation had won the lottery. The economic news has been fairly good. But ... Mr. Bush apparently still believes he has not gotten enough credit, and that this is the primary reason for his low poll ratings.

I have no doubt that Mr. Bolten will do his job with ruthless efficiency, for he is the truest of Mr. Bush’s true believers. I know this because ... Josh Bolten and I often worked together during the George H.W. Bush administration... We weren’t pals, but we were always on friendly terms. Then, a couple of years into the current administration, I saw him at a reception. I had just started writing some mildly critical things about some of Mr. Bush’s policies, like the Medicare drug program... Up until that time, I had been almost entirely positive in my writings about the administration.

So I was taken aback when I went up to Mr. Bolten to say hello and he pointedly turned his back on me and walked away. I guess he thought he was punishing me for my criticism. All this did was confirm my growing belief that Mr. Bush would ultimately be a disaster ...

The funny thing is that I was treated far better by Bill Clinton’s people ... even though I almost never had a good word to say about their positions. To their credit, they really believed in what they were doing and were almost evangelical in their desire to explain why it was right... I have no doubt that if I had come across Gene Sperling ... at such a reception, he would have come straight at me with a laundry list of facts and arguments for why I was wrong... I would have been invited to the White House mess to carry on the conversation, and I would have left with an armful of studies and statistics explaining the virtues of whatever Clinton program I was attacking.

By contrast, the Bush administration never provides its supporters with any ammunition to defend its positions, beyond the endless repetition of the day’s talking points. ... So I see no reason to believe that anything substantive will change in this White House, no matter how many staff changes are made. ...

    Posted by Mark Thoma on Friday, March 31, 2006 at 06:57 PM in Economics, Politics

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    Baker: Government Should Preemptively Burst the Housing Bubble

    Dean Baker is worried, very worried, about a fall in housing prices. So much so, he is calling for a preemptive strike to prevent even larger problems down the road, something I'll comment on at the end. His opening paragraph sets the stage in this piece from Economists' Voice:

    The Menace of an Unchecked Housing Bubble, by Dean Baker, Economists' Voice: An unprecedented run-up in the stock market propelled the U.S. economy in the late nineties and now an unprecedented run-up in house prices is propelling the current recovery. Like the stock bubble, the housing bubble will burst. Eventually, it must. When it does, the economy will be thrown into a severe recession, and tens of millions of homeowners, who never imagined that house prices could fall, will likely face serious hardships.

    The incredible increase in house prices The basic facts on the housing market are straightforward: Quality-adjusted house prices ordinarily follow the overall rate of inflation. However, in the last eight years house prices have risen by almost 50 percent in real terms... The run-up has not been even. In large parts of the country (most of the South and Midwest) there has been little real appreciation in house prices. In contrast, the run-ups in the bubble areas (the West Coast, the East Coast north of DC, and Florida) have been close to 80 percent in real terms.

    The housing bubble spurs the economy directly by increasing home construction, renovation, and sales and indirectly by supporting consumption. The run-up in house prices has created more than $5 trillion in real estate wealth compared to a scenario where prices follow their normal trend growth path. The wealth effect from house prices is conventionally estimated at 5 cents on the dollar, which means that annual consumption is approximately $250 billion (2 percent of GDP) higher than it would be in the absence of the housing bubble.

    Fundamentals or a speculative bubble Nobody doubts that there has been a sharp increase in house prices, the question is why: Is it because of fundamentals or a speculative bubble?

    A quick examination of the fundamentals should remove any doubts on this issue. On the demand side, neither income nor population growth has been especially rapid. Real per capita income has grown at a respectable rate of 2 percent annually since 1997, but this is considerably slower than the 2.8 percent annual rate from 1953 to 1973, a period which saw no run-up in house prices. Furthermore, the median family income has actually been falling since 2000.

    Population trends also would not suggest a surge in demand for housing. The number of households grew by an average of 1.4 million a year from 1995 to 2004. This is far slower than the 2.8 million annual growth rate in the 1970s when the baby boomers were first forming their households. The age distribution is also not consistent with a surge in demand for housing. The rapidly rising house prices come at a time when the baby boomers are moving out of their years of peak housing demand.

    There also is no obvious supply-side story. While there are environmental restrictions on building, this is not a new phenomenon, and there is no reason to believe that these have become more restrictive in a period of Republican ascendancy. Moreover, the near record pace of housing construction the last few years indicates that these restrictions have not been an impediment to construction.

    The best evidence that fundamentals are not the cause of the run-up in housing prices is the fact that there has been no comparable increase in rental prices. While rental prices did rise somewhat more rapidly than the overall rate of inflation during the first part of the house price run-up..., in the last couple of years they have been falling behind inflation. If the run-up in home sale prices was being driven by fundamentals in the supply and demand for housing, then there should be substantial price increases in both the rental and ownership markets. ...

    The bubble will break eventually If housing prices are a speculative bubble, then eventually prices will return to normal levels reflecting the value of housing services. The country has been building houses at a near record pace ... At the moment, this oversupply has been absorbed by speculators and by a record vacancy rate in the rental market, but eventually excess supply will put downward pressure on sale prices (part of this story is the conversion of rental property to ownership units), which will cause speculative demand to evaporate. ... How fast this happens depends on how quickly mortgage interest rates rise from what are still extraordinarily low levels.

    The adjustment process will not be pretty. Residential construction accounts for more than 6 percent of GDP ... In addition, with a correction in housing prices, the loss of bubble wealth will lead to a sharp decline in consumption. ... the implied drop in consumption would be $250 billion annually, or 2 percent of GDP.

    Another consequence of the collapse of the housing bubble will be the financial fallout from an unprecedented wave of defaults. Nationwide, homeowners’ ratio of debt to equity is at a near record high. This is itself a startling fact given all the equity created by recent appreciation. ... When the downturn in house prices occurs, many homeowners will have mortgages that exceed the value of their homes, a situation that is virtually certain to send default rates soaring. This will put lenders that hold large amounts of mortgage debt at risk, and possibly jeopardize the solvency of Fannie Mae and Freddie Mac...

    Breaking the bubble sooner is better than later Given the prospect for a collapse of the housing bubble and its impact on the economy and the financial system, there is a strong case for a preemptive strike. ... The government should have taken steps to prevent the bubble from ever getting this large. Having failed ..., the best it can do at this point is to burst the bubble before it gets even larger, creating the conditions for an even bigger disaster down the road.

    The best and simplest way to burst a bubble is talk. If the Fed and top treasury officials simply made the basic data available and explained to the public about the inconsistency of current housing prices with long-term trends (as they have done with budget deficits), their warnings would almost certainly be widely reported in the media. Every real estate pusher in the country would have to deal with buyers armed with this information. ... the fact that people in positions of authority are issuing warnings about future house prices would almost certainly dampen their enthusiasm for home ownership.

    Whether talk would be sufficient to burst a financial bubble is an open question—it has never been tried—but since talk is cheap, there seems little reason not to use ... information as the first weapon ... If this fails, the Fed has a second weapon: higher interest rates. ... If mortgage rates were pushed back to more normal levels (e.g., 7 to 8 percent), it would almost certainly lead to a sharp reduction in housing prices.

    Deliberately destroying trillions of dollars of wealth may seem like perverse policy, but ... [t]he longer the bubble persists, the more overbuilding takes place, and the more resources will eventually have to be diverted from homebuilding to some other sector of the economy. Similarly, the amount of bubble-induced debt, and subsequent defaults, will also grow larger as long as the bubble persists. The recession following a housing collapse will likely be more severe the longer the bubble persists....

    In addition, tens of millions of baby boomers are approaching retirement with plans based on the assumption that the value of their home will hold steady, or even continue to rise. As a result, they are saving very little. The decision not to save because of the wealth created by the housing bubble (and previously the stock bubble) will leave this huge cohort ill-prepared for retirement, a problem that worsens each month the bubble persists.

    The fed needs to step up the plate The Fed has taken the view that bubbles come and go and that this is not their business—a view that seems difficult to justify given the enormous consequences from the growth and collapse of financial bubbles. These consequences certainly seem much larger than the impact of modest upticks in the inflation rate, which has been the Fed’s driving concern over the last two decades.

    The decision to ignore financial bubbles also seems inconsistent with the Fed’s past decisions, where it has made the stability of the financial system a central concern. ... there seems little justification for sitting on the sideline when financial bubbles that pose enormous threats dominate the economy. It is unfortunate that it might require the collapse of the housing bubble, and the enormous damage it will entail, to finally prompt some new thinking on this issue among the nation’s policymakers.

    I like Dean Baker's work, but I have to disagree a bit on this one. For me, language such as "preemptive strike" and "breaking the bubble sooner" is too strong. The air does need to be let out of the bubble, but slowly so as not to create the very catastrophe tighter policy, warnings from public officials, and increased regulation is attempting to avoid. There is no reason to "burst the bubble" if letting the air out slowly accomplishes the same rebalancing task in the end, and there are additional questions about trying to identify bubbles and the effectiveness and the ability of the government to target particular sectors of the economy. I agree with his call for more communication on this issue from public officials, though economists don't fully agree on the degree of the problem, but not with a policy involving a strong and immediate change in interest rates. A measured pace rather than a "shock and awe" strategy ought to dictate policy.

    Posted by Mark Thoma on Friday, March 31, 2006 at 02:07 PM in Economics, Housing, Monetary Policy, Policy

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    Marriage Market Decisions of Black, Hispanic, and White Women

    Having raised the issue of differences in marriage rates for whites and blacks in Marriage is for White People in a post based upon a Washington Post column, I thought I'd follow up with the abstract and part of the introduction to recent academic research on this issue for those who want to probe a bit deeper into these issues:

    The Role of Labor and Marriage Markets, Preference Heterogeneity and the Welfare System in the Life Cycle Decisions of Black, Hispanic and White Women, by Michael P. Keane and Kenneth Wolpin, PIER WP 06-004: Abstract Using data from the NLSY79, we structurally estimate a dynamic model of the life cycle decisions of young women. The women make joint and sequential decisions about school attendance, work, marriage, fertility and welfare participation. We use the model to perform a set of counterfactual simulations designed to shed light on three questions: (1) How much of observed minority-majority differences in behavior can be attributed to differences in labor market opportunities, marriage market opportunities, and preference heterogeneity? (2) How does the welfare system interact with these factors to augment those differences? (3) How can new cohorts that grow up under the new welfare system (TANF) be expected to behave compared to older cohorts?

    I. Introduction

    The large differences in economic and demographic characteristics of majority (white) vs. minority (black and Hispanic) women are well documented. To get a picture of the extent of these differences, consider data drawn from the 1990 survey year of the NLSY79, when respondents were between the ages of 25 and 33. At the time of that survey, (i) the mean schooling of white women (13.4 years) exceeded that of black women by .6 years and that of Hispanic women by 1.3 years, (ii) 65 percent of white women, but only 32 percent of black women, and 55 percent of Hispanic women, were married and living with their spouse, (iii) the white women had borne, on average, 1.2 children, while blacks and Hispanics both had 1.7 children on average, (iv) 74 percent of the white women, 66 percent of the black women and 67 percent of the Hispanic women were employed, and (v) in the year prior to the survey, 4 percent of the white women, 20 percent of the black women and 11 percent of the Hispanic women had received some AFDC payments.

    In this paper, we provide quantitative estimates of the relative importance of labor market opportunities, marriage market opportunities and preference heterogeneity in explaining these large minority-majority differences. We also ask whether government welfare programs interact with these three factors to augment these differences. Finally, we provide estimates of how recent major changes in welfare rules, such as the major expansion of the Earned Income Tax Credit (EITC) in 1994-96, and the 1996 welfare reform legislation establishing the Temporary Aid for Needy Families (TANF) program can be expected to alter the life cycle behavior of women entering adulthood in the new regime. In order to perform these assessments, we develop and estimate a life-cycle model that incorporates all the key behaviors of interest: welfare participation, labor supply, marriage, fertility and schooling.

    Our work builds on a number of distinct literatures. One set of studies is concerned with the incentive effects of welfare programs. ... The bulk of these studies are based on static models of behavior, although the behavioral model underlying the statistical work is not always made explicit. Attention to the role of government welfare programs in accounting for minority-majority differences in labor supply and marital status is surprisingly rare.

    A distinctly different literature, spanning both economics and sociology, has focused on minority-majority differences in rates of marriage, usually without considering the specific role of welfare. Wilson (1987) postulated that the much steeper decline since the 1960's in the marriage rate of black women relative to that of white women was due to a fall in the pool of marriageable, i.e, employed, black men. Since then, numerous empirical studies based on economic models of marital sorting have attempted to determine the importance of marriage market opportunities, including the availability and characteristics of potential spouses, in explaining the minority-majority difference in marriage rates.

    Finally, we contribute to the literature on structural estimation of dynamic discrete choice models of female labor supply (see Blundell and MaCurdy (2004) for a recent survey). Almost all of that literature treats labor supply as the only choice, assuming that schooling, children and marital status are predetermined states. And, unlike here, welfare participation is generally ignored. ...

    The model that we estimate significantly extends these diverse literatures. We augment the choice set to include schooling and fertility in addition to work, marriage and welfare participation. This extension enables a more complete analysis of existing anti-poverty programs. For instance, the EITC not only provides a subsidy to low earners, but, because the subsidy is much larger if one has children, is also strongly pronatalist. Thus, the program may have important effects on fertility, effects that would interact with decisions made jointly about marriage, schooling, work, and welfare participation.

    In addition to considering a larger set of choices, the modeling framework with respect to these choices is generally richer. In our model, women make sequential decisions in each 6 month period, starting at age 14, about school attendance, work, fertility, and, starting at age 16, marriage. Employment may be either part- or full-time. In each period, with some probability a woman receives a part-time wage offer and, likewise, with some probability a full-time wage offer. In modeling fertility, it is assumed that a woman receives utility from children, but bears a time cost of rearing them that depends on their current age distribution. Sequential decisions about school attendance are governed by direct preferences and by the additional human capital, and thus wages, gained from schooling.

    The marriage market is modeled in a search context. In each period a woman receives a marriage offer with some probability that depends on her current characteristics and on her past welfare participation. ... If the marriage offer is accepted, the husband’s actual earnings evolve over time stochastically. The woman receives a fraction of the total of her earnings and her husband’s earnings. If a woman is not married, there is some probability, determined by current characteristics, that she co-resides with her parents. In that case, she receives a fraction of her parents’ income that also depends on her characteristics.

    Finally, we allow for unobserved permanent components of preferences and endowments that are person specific, as well as differences in preferences and endowments between minority and white women and across U.S. State of residence. Differences in labor market opportunities arise due to both differential skill “endowments” (at age 14) and discrimination against minorities. Minority women face different distributions of husband earnings than do white women, as well as different preferences for marriage (which may reflect, in part, differences in characteristics of the available men other than earnings capacity). And, there are also differences in preferences for leisure, school, fertility and welfare participation.

    It is worth emphasizing that the welfare system could not by itself create differences between minority and white women in behavior (barring explicit differences in how the system treats them), unless there exist differences in preferences and constraints of the type that we allow for. But, if differences in preferences and constraints do exist, the welfare system can either enhance or mitigate their role in generating outcome differences. ...

    Our estimates reveal that there are important differences among white, black and Hispanic women in their structural parameters. For example, black women value marriage the least and Hispanic women the most, but both of them draw from potential husband’s earnings distributions with lower means than white women. Minority women also receive lower wage offers for given schooling and employment histories than do white women. Black women are estimated to have the lowest welfare stigma, followed in order by white women and Hispanic women.

    We perform a number of counterfactual experiments to determine the extent to which differences in the behaviors of minority women can be accounted for by differences in structural parameters. As an example, we find that if minority-majority wage offer distributions were equalized (eliminating differences in both age 14 endowments and wage discrimination), the black-white gap in employment would disappear. However, while marriage rates would also rise for black women, due the increase in their desirability as mates, only about 20 percent of the gap in the marriage rates would be eliminated.

    We also consider the behavioral impact of counterfactual experiments in which welfare benefits and rules are altered. For example, eliminating all welfare (for women, based on their estimated type, that are most prone to be on welfare) would increase employment of minorities much more than of whites, essentially equalizing employment among the three groups. Thus, it appears that welfare exaggerates the differences in employment between whites and minorities that would arise solely due to differences in labor and marriage market opportunities and in preferences. ...

    Posted by Mark Thoma on Friday, March 31, 2006 at 11:42 AM in Academic Papers, Economics, Unemployment

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    A Defense of Outsourcing

    This article from Economists' Voice argues that concerns over the loss of jobs in the service sector due to outsourcing are overstated, and that with the appropriate change in policy the costs to workers displaced by globalization can be minimized:

    U.S. Offshoring: Small Steps to Make It Win-Win, by Diana Farrell: Companies from the United States lead the world in offshoring white-collar jobs to low-wage countries. Today they employ more than 900,000 service workers overseas. But widespread concern about the effects on the U.S. job market has prompted policymakers to call for curbs on offshoring... Trying to protect jobs this way is a mistake. For one thing, fears of job losses ... are greatly exaggerated. ... In addition, curbs on offshoring would deprive the United States of its many benefits and impose new costs instead. ...

    Policymakers should let offshoring continue. But that doesn’t mean they should ignore its consequences. None of the benefits of offshoring currently flow directly to those who suffer most directly, namely US workers whose jobs move overseas. Companies can and should ... use some of their gains from offshoring to help their displaced employees... Wage loss insurance ... would cost only a fraction of the savings that offshoring will bring. Governments too, must work ... to increase retraining, provide life-long learning programs, and ensure portable health and pension benefits...

    Job loss will be limited According to our research, the maximum number of U.S. service jobs that could in theory be performed offshore is 11 percent of total service employment. ... In reality, we project that less than 2 percent of all U.S. service jobs actually will be done offshore by 2008. We expect that U.S. companies will create some 200,000 to 300,000 offshore jobs per year over the next 30 years.

    Why will so few service jobs go overseas?

    Only a small fraction of service jobs could ever go offshore mostly because a much larger percentage require face-to-face customer interactions or a worker’s physical presence, for example, to stock shelves, provide nursing care, or install networks. In two of the largest service sectors—health care and retail—only 8 percent and 3 percent of jobs ... could be performed remotely... And the industries in which the highest percentage of jobs could be performed remotely—packaged software (49 percent) and IT services (44 percent)—represent only 1 or 2 percent of overall employment.

    Even fewer jobs actually will migrate for several reasons. About one third of U.S. workers work for companies too small to justify the costs of offshoring. Even larger companies ... find the major changes ... that offshoring requires to be a significant deterrent. ... Furthermore,... [c]ompanies consider a host of factors beyond labor cost when deciding where to place an activity, including each potential location’s risk profile, infrastructure, domestic market, non-labor costs, business and living environment, and the availability of vendors. Against these criteria, the U.S. remains a logical choice for the many companies that do not rank labor cost far above other factors...

    A new offshore job does not always represent a job lost at home, because many offshore jobs would not be viable at higher wage levels. ... Mounting evidence confirms that offshoring is not what lies behind mass layoffs. The U.S. Bureau of Labor Statistics confirms that only 1 percent of service layoffs involving more than 50 employees in the first quarter of 2004 was associated with offshoring.

    Imperceptible impact on wages Because offshoring has such a limited impact on the U.S. jobs market, its effect on U.S. wages will also be negligible, even in the computer and data-processing industry ... Although many programming jobs have moved offshore, more positions for systems analysts and software engineers have been created in the U.S. Average wages have actually grown at a faster pace than elsewhere in the economy, since the new jobs have higher productivity... These findings confirm what other research has found. A new study by Mary Amiti and Shang-Jin Wei, two economists at The IMF, confirms that U.S. and UK service sectors subject to offshoring are creating as many — or more — new jobs than the ones that move offshore. ...

    Offshoring benefits the United States Past MGI research found that for every $1 of cost on services that U.S. companies move offshore, the U.S. economy gains at least $1.14. The companies doing the offshoring reap 58 cents of these gains. This gives companies scope to invest in new opportunities that create jobs both at home and abroad... Offshoring also gives companies access to distinctive skills abroad, making them more competitive...

    The U.S. also benefits as a destination for offshoring companies. In 2004, it received $121 billion of direct investment ..., more than any other country. Foreign subsidiaries provided jobs for 5.4 million U.S. workers in 2002. ... U.S. trade negotiators are arguing for freer trade in services precisely because so many companies in financial services, accounting, law, consulting, and IT services would gain.

    Helping displaced workers is better than protectionism

    Continuing to allow offshoring and free trade in services will benefit the United States as a whole. But one undeniable corollary is less job security: there will be more jobs, but a higher level of job turnover. Workers need help ... So rather than trying to prevent offshoring, governments and companies should ease the transition for those workers it displaces, and prepare all workers for more frequent job changes.

    Ease the transition Not all workers who lose their jobs find new ones quickly, and many that do suffer pay cuts. More than 75 percent of U.S. service workers who lose their jobs due to trade find new jobs within six months; however, the median wage of those re-employed is 11 percent below its level for their previous jobs.

    The U.S. already has two ... programs targeting workers displaced by trade, the Trade Adjustment Assistance and the Alternative Trade Adjustment Assistance, but neither has been particularly effective. U.S. spending on policies to assist displaced workers, at 0.5 percent of GDP, is low compared with other developed nations ...

    U.S. policymakers should invest in additional measures to help workers move between jobs, especially job retraining credits for employers, to encourage them to hire displaced workers, and on-the-job training, demonstrably the most effective kind. Continuing education grants will help workers to build skills in ... growing areas of the economy such as healthcare, education, and social services. Portable medical insurance plans and pension benefits are also essential to a workforce changing jobs more frequently.

    Companies benefiting from offshoring can ease the plight of displaced workers too. More generous severance packages would help. Companies could also fund wage insurance programs to help fill the gap between workers’ previous wages and their new ones... Companies may not volunteer to do this on their own, suggesting that some kind of public policy intervention may be warranted.

    Indeed, policy makers might consider extending wage insurance to all displaced workers... Globalization and advances in technology require a more flexible and fluid workforce than ever before. But there is no reason that individual workers should bear the full cost of that flexibility. Robert Litan and his colleagues found that a wage insurance program that insures 30-70 percent of wage loss for two years for all involuntarily displaced full-time workers with two years or more of tenure would cost only $1.5 billion to $7 billion (depending on the program design), or $12 to $50 per worker per year.

    Forward-looking labor unions are beginning to push for similar approaches, rather than trying to protect jobs. ... This kind of response to offshoring gives union members a better chance of long-term future employment than struggling to preserve existing jobs.

    Prepare people for more job changes Changes to the U.S. educational system are also needed to prepare future workers for more changes of job in their working lives. As well as technical skills, which may become obsolete, students will need business knowledge, and teamwork and communication skills, to be more broadly employable. Engineering, computer science, and other science programs at U.S. universities should adapt their curriculums accordingly... Life-long learning should be an aspiration for all workers in the economy.

    At the same time, industry associations, unions and companies can collaborate to help workers anticipate job changes. They could, for example, monitor occupations where employment demand is rising—in healthcare, business services, communications and leisure—and plot potential career paths for workers switching into them. Software programmers may need to become systems analysts; information specialists may need to move into analysis. But companies and unions can identify future employment opportunities and help workers prepare for them.

    Conclusion Fears about job losses and wage cuts in the U.S. due to offshoring are vastly overstated. Protectionism may save a few jobs for a while, but it will stifle innovation and job creation in the longer term. Rather than trying to stop globalization, the goal must be to let it happen, while easing the transition for workers who lose out.

    Posted by Mark Thoma on Friday, March 31, 2006 at 12:33 AM in Economics, International Trade, Politics

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    Paul Krugman: The Road to Dubai

    Paul Krugman continues with the subject of his last column, immigration, and then explains an additional concern with proposals to increase immigration, the effect of creating a large class of workers without political representation, something contrary to our basic democratic principles:

    The Road to Dubai, by Paul Krugman, Commentary, NY Times: For now, at least, the immigration issue is mainly hurting the Republican Party, which is divided between those who want to expel immigrants and those who want to exploit them. The only thing the two factions seem to have in common is mean-spiritedness.

    But immigration remains a difficult issue for liberals. Let me say a bit more about the ... uncomfortable economics of immigration, then turn to what really worries me: the political implications of a large nonvoting work force. About the economics: the crucial divide isn't between legal and illegal immigration; it's between high-skilled and low-skilled immigrants. High-skilled immigrants ... are, by any criterion I can think of, good for America.

    But the effects of low-skilled immigration are mixed at best. ... All of these effects, except for the gains for the immigrants themselves, are fairly small. Some of my friends say that's the point I should stress: immigration is a wonderful thing for the immigrants, and claims that immigrants are undermining ... workers and taxpayers are hugely overblown — end of story. But it's important to be intellectually honest, even when it hurts. Moreover, what really worries me ...[is] the effects of having a disenfranchised labor force.

    Imagine ... a future in which America becomes like Kuwait or Dubai, a country where a large fraction of the work force consists of illegal immigrants or foreigners on temporary visas — and neither group has the right to vote. Surely this would be a betrayal of our democratic ideals, of government of the people, by the people. Moreover, a political system in which many workers don't count is likely to ... have a weak social safety net and to spend too little on services like health care and education.

    This isn't idle speculation. Countries with high immigration tend ... to have less generous welfare states... U.S. cities with ethnically diverse populations — often the result of immigration — tend to have worse public services...

    Of course, America isn't Dubai. But we're moving in that direction. As of 2002, ... 14 percent of U.S. workers, and 20 percent of low-wage workers, were immigrants. Only a third ... were naturalized citizens. So we already have a large disenfranchised work force, and it's growing rapidly. The goal of immigration reform should be to reverse that trend.

    So what do I think of the Senate ... proposal ... derived from a plan sponsored by John McCain and Ted Kennedy? I'm all in favor of ... offering those already here a possible route to permanent residency and citizenship. ... we aren't going to deport more than 10 million people ... But I'm puzzled by the plan to create a permanent guest-worker program, one that would admit 400,000 more workers a year (and you know that business interests would immediately start lobbying for an increase...). Isn't institutionalizing a disenfranchised work force a big step away from democracy?

    For a hard-line economic conservative like Mr. McCain, the advantages to employers of a cheap work force may be more important than the violation of democratic principles. But why would someone like Mr. Kennedy go along? Is the point to help potential immigrants, or is it to buy support from business interests?

    Either way, it's a dangerous route to go down. America's political system is already a lot less democratic in practice than it is on paper, and creating a permanent nonvoting working class would make things worse. The road to Dubai may be paved with good intentions.

    Previous (3/27) column: Paul Krugman: North of the Border Next (4/3) column: Paul Krugman: John and Jerry

      Posted by Mark Thoma on Friday, March 31, 2006 at 12:15 AM in Economics, Politics

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      March 30, 2006

      Selling Public Infrastructure to Fund Government

      Daniel Gross has a nice column in Slate on "the foolish plan" to sell public infrastructure:

      Lost Highway - The foolish plan to sell American toll roads to foreign companies, by Daniel Gross, Slate: If a governor told you there were a way to spread pork, raise funds for infrastructure investment, promote jobs, avoid raising taxes, and put a dent in the trade deficit—all in one fell swoop—you might think he had a bridge to sell you. And you'd be right. Only in this case, it's a toll road. And instead of a sale, how about a long-term lease?

      Earlier this month, in a triumph for Gov. Mitch Daniels, Indiana's House narrowly approved his proposal to lease the 157-mile Indiana Toll Road ... for $3.85 billion to a joint venture of Cintra, a Spanish company, and Australia's Macquarie Bank. The two companies have been active in the U.S. road business. In 2004, the two inked a 99-year lease for the 7.8-mile elevated Chicago Skyway. Last year, Macquarie completed its acquisition of the Dulles Greenway outside Washington, D.C. And Cintra, ... is a strategic partner to the Texas state government in the planned Trans-Texas Corridor. There are likely more such deals to come.

      For Daniels ... the 75-year lease is an elegant solution. The state needs billions of dollars to invest in new roads. Getting the cash upfront will allow Daniels to speed up construction on needed infrastructure projects, create new jobs, and fund his ... Major Moves initiative. ... And by raising the cash from foreigners, he's doing his part to rein in the pernicious current-account deficit. "Too often in Indiana, we see Hoosier dollars and jobs leaving the state. Major Moves is an exciting opportunity to recapture U.S. dollars by attracting foreign investment, and use them to create jobs for Hoosiers," he said.

      What's in it for the foreign companies? Huge potential profits. Gigantic, steady profits. Toll roads are an incredible asset class. They're often monopolies. They can support debt, since they provide a recurring guaranteed revenue stream that is likely to rise over time... The heavy lifting has already been done: The state or federal governments have acquired the land and rights of way, built the roads and maintained them for years, and enacted toll increases. All the private companies have to do is deliver cash upfront, maintain the roads, and collect the windfall. The buyers can also increase their profits by making toll roads run more efficiently with technology. ...

      This easy money for foreigners makes the locals uneasy. ... I think the uneasiness has ... to do with what it says about the peculiar fiscal climate in the United States. How is it that in the richest nation on the earth, localities simply don't have the cash to do necessary maintenance on basic infrastructure, the political will to raise such funds, or the competence to run such easily profitable operations? Why are they being forced to sell off long-term cash cows for short-term cash?

      Leasing or selling a public asset is a classic one-shot—a short-term measure that bolsters the balance sheet today but that can't be repeated. While politicians ... focus on getting through the next few fiscal years with minimum pain, .... [f]rom Gov. Daniels to his former boss, President Bush, there's a troubling unwillingness to align governmental resources with the express goals and responsibilities of government. At the federal level, we rely on China's central bank to buy our bonds and fund basic operations. As a result, our tax revenues wind up in Beijing—as interest payments. At the state level, Indiana is relying on foreign companies to lease public infrastructure like toll roads. And under these arrangements, tolls—taxes people pay for driving—are being paid to foreign shareholders of foreign companies.

      Of course, by selling public infrastructure at high prices, state governments could be taking foreigners for a ride. The Japanese famously overpaid for Rockefeller Center, after all. It's possible that Indiana just ripped off the Spaniards and Aussies. But I doubt it.

      I want to repeat that selling off assets to pay the bills "is a classic one-shot—a short-term measure." It's like a household selling a car to pay the month's bills. If income and expenditures don't change, what do you do next month?

      Posted by Mark Thoma on Thursday, March 30, 2006 at 11:58 AM in Budget Deficit, Economics

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      Shiller: Long-Term Perspectives on the Current Boom in Home Prices

      Robert Shiller and Dean Baker have articles in the latest Economists' Voice about the housing boom and its sustainability in the near and longer terms. Here's Shiller with a long-term perspective gained from looking at over 100 years of housing data in a variety of countries. I cut quite a bit, but it's still fairly long as it has lots of interesting things to say:

      Long-Term Perspectives on the Current Boom in Home Prices, by Robert J. Shiller, Economists' Voice: Homeowners want to know: Is the current boom in home prices temporary? Is a crash possible? And if prices do fall, will they come back up fairly soon, or will they stay down for many years? Some have written reassuringly, downplaying concerns about possible price falls... Angell and Williams, for example, concluded that “In over 80 percent of the metro-area price booms we examined between 1978 and 1998 the boom ended in a period of stagnation… the expectation would be that metro-area home price busts will continue to be relatively rare.” But they reach their conclusion based only on a twenty-year period of United States data.

      Indeed, all these studies confined themselves to no more than a few decades’ recent data. Such data simply cannot provide useful insights to homeowners planning to occupy homes for thirty or forty years, and wondering whether a general uptrend in home prices will inevitably carry them over any possible price declines.To answer the important questions, we first need to find out if there have been other booms similar to this one, and what happened after such booms ended. Until now long-term price indexes have not been generally available to allow us to do this. I have constructed one... The news is not good for homeowners. According to our data, homeowners face substantial risk of much lower prices that could stay low for a long time after. Luckily, though, derivatives products, notably a futures market, are being developed that they will soon be able to use to insure against this risk.

      The data show no long-term uptrend in real home price Figure 1 shows three long-term series of real home prices. All attempt to control for changing size and quality of homes; all are corrected for inflation in consumer prices.

      I constructed the United States series 1890-2005 ... Piet Eichholtz constructed the Amsterdam series 1628-1973, ... based on selling prices of homes along the Herengracht canal, a small region of Amsterdam which was originally zoned for large lots and expensive homes and for which data have been carefully maintained. Homes are thought to have remained relatively unchanged there for centuries. Øyvind Eitrheim and Solveig Erlandsen constructed the Norway series 1819-1989, ... this time based on individual home sales data for Bergen ..., Oslo ..., Kristiansand ..., and Trondheim.... Note the enormous current boom in home prices in the United States since 1997. The magnitude of the current boom is practically unique in history, making it difficult to predict what comes next based on historical examples. Amsterdam and Norway have also seen sharp upswings since 1997, but these price indexes terminate before 1997, and so are not visible on Figure 1.

      Figure 1. Real home price indexes for the United States 1890-2005 (Shiller 2005), Amsterdam 1628-1973 (Eichholtz 1997) and Norway 1819-1989 (Eitrheim and Erlandsen 2004)

      Do real home prices have a substantial long-term uptrend? The chart suggests not. First, what about the United States? It’s notable that until the recent explosion in home prices, real home prices in the United States were virtually unchanged from 1890 to the late 1990s. The Amsterdam data show lots of ups and downs, but only the slightest hint of an uptrend. Prices approximately doubled, but it took nearly 350 years to do so, implying an annual average price increase of only 0.2% a year. The Norway data do suggest such an uptrend, but viewed from the longer perspective of the Amsterdam data, that uptrend seems to be merely part of a long cycle from the early 19th century to the late 19th century. And even leaving the context added by Amsterdam aside, Norway’s real price growth is, on average, negligible: only 1.3% a year.

      Accounting for the current boom: an historical comparison If the current boom doesn’t reflect a long-term uptrend in real home prices, when will the market correct for this short-term discrepancy? And will the correction be smooth or drastic? The only other time the United States has experienced a large home price boom was around the end of World War II. According to these data, real home prices went up 60% from 1942 to 1947, and then leveled off into a “soft landing,” ... The current boom is of a similar and even greater magnitude. From the first quarter of 1997 to the first quarter of 2005, real home prices went up 71% according to the Case-Shiller index, and by 52% according to the OFHEO repeat sales index. Will this boom end in a soft landing as the prior boom did? Possibly...

      Recession: only way current boom can end? Not necessarily. Many think that only a recession can end a home price boom, and no recession is on the horizon: therefore, a soft landing is most likely. But this comforting syllogism is an over-extrapolation from the last two real estate cycles. The magnitude of the current boom is much greater than past booms, and so the way the boom ends, may be more unpredictable and dramatic. Figure 2 shows a longer view, giving unemployment rates and home prices since 1890. Two things stand out: first, the current boom is far more dramatic than its predecessors, and second, even prior booms do not necessarily track the unemployment rate such that their ends are signaled by recessions.

      Figure 2. U. S. real home price index 1890-2005 (Shiller, 2005, updated) and U.S. unemployment rate 1890-1930, source: Bureau of Labor Statistics, Current Population Survey, and, before 1930, Romer (1986).

      Granted, the real estate boom-bust in the late 1970s and early 1980s does match up roughly with fluctuations in the unemployment rate. And so does the boom-bust of the late 1980s and early 1990s. But that is not true if we look at a longer time span. ... Although the last two real estate boom cycles did end in recession, that is not the rule historically.

      Real rents, the rent-price ratio, and real interest rates It is striking that, while there does not seem to be a genuine long-term uptrend in real house prices, there does seem to be a genuine long-term downtrend in real rents.

      Indeed, according to BLS data, real housing rents have been in decline—falling about 50% in total—ever since the Consumer Price Index was created in 1913. See Figure 3. ...

      Figure 3. U.S. real rent of primary residence, January, 1913-2005 (Bureau of Labor Statistics) and real home price, 1913-2005, Shiller 2005.

      It is thus surprising that the real price of American housing, also shown in Figure 3, has had an uptrend since 1913—although, as noted above, there is no long-term uptrend if pre-1913 years are taken into account. ...

      In theory, real rents and real home prices might be expected to track each other In theory, one might expect real home prices to represent the present discounted value of future rents. After all, people can move from renting to owning with relative ease. And while there’s an obvious tax advantage to owning..., that advantage could be easily valued and taken into account in the calculations. If [so]..., then prices should closely track rents. ... In practice, however, the situation is very different: Not only do real home and rent prices fail to track each other, but the rent-price ratio has shown a remarkable downtrend since 1913. (See Figure 4). But why?

      Figure 4. Real interest rate is defined as long-term government bond yield described in (Shiller 2005), minus the rate of change of the consumer price index for the preceding year. The index of the rent/price ratio is defined as the U.S. consumer price index for rent of primary residence, 1982-4=100, divided by the Shiller [2005] U.S. home price index, and the result rescaled to 1980=1.

      Interest rates are not the explanation, as some have suggested... The rent-to-price-ratio downtrend is not matched by a downtrend in real long-term interest rates, ... Also, real rates today, while much lower than in 1980, do not appear low by historical standards. The recent divergence between real interest rates and real rental-price ratios suggests the possibility of an irrational overpricing today and a huge fall in home prices in coming years. However, more study of these series in association with present value models and other data would be warranted before drawing strong conclusions ...

      The character of the current boom: a glamour city boom more than a land boom Nationwide, there is something of a land price boom going on too. Using data from the United States Department of Agriculture, the U.S. real (CPI inflation-corrected) estimated market value of cropland per acre rose a total of 29% between 1997 and 2005. Over the same period, real average cash rents per acre for cropland were virtually constant, so the agricultural land boom shows up in the price-rent ratio as well.

      But, the 29% increase in real agricultural land prices is a lot less than the 71% increase we saw in Figure 1 in real home prices. Moreover, some of this land price boom is from acreage that is in the immediate vicinity of urban areas, and so some of this boom is just the same urban real estate boom that we have already seen.

      The cause of the home price boom does not seem to be an unsatisfied hunger for land services or housing services, above other goods and services: We saw in the preceding section that rents have not been increasing as much as consumer prices. Expenditure on housing services in the United States as a share of GDP has been relatively constant at about 15% since 1929. Expenditures have kept up with rising incomes not because rents or prices have been increasing but because we have increased the amount of real housing services that we buy. ... the average size of new houses increased from 1100 square feet in the 1940s to 2150 square feet in 1997 as the number of people per household dropped from 3.67 in 1940 to 2.64 in 1997. ...

      We appear to be seeing growth in a different kind of hunger: a hunger for investments in real estate that can be expected to do extremely well. The home price boom is in large measure a boom in investments in glamorous urban areas and vacation spots that appear to investors to have sharp appreciation potential. According to the National Association of Realtors, 36% of all homes purchased in 2004 were second homes: investment properties or vacation homes. ...

      Particular examples bear out the general thesis that the boom is very strong in desirable cities and vacation spots. Consider that the Case-Shiller Indexes show that from the first quarter of 1997 to the first quarter of 2005, when nationwide real home prices went up 71%, real home prices rose 93% in Boston, the home of universities and intellectuals, and 151% in Los Angeles, the home of movie stars. Over this same interval, real home prices went up 137% in Barnstable County, Massachusetts—the elite area of Cape Cod summer homes, and 114% in Collier County, Florida, one of the most exquisite vacation areas in the United States, and with the beautiful Ten Thousand Islands.

      A “soft landing” after all? The safety-valve hypothesis The variance across regions of home prices, relative to construction costs, has increased over this interval in the United States, and is very high by world standards.

      Goldman-Sachs chief economist Jan Hatzius believes this variance creates a greater safety valve in the United States: homeowners can move to lower-priced land to build their houses. ... The process takes time: businesses have to move with people, and new urban areas have to be planned and built. If he is right, then the housing boom, if it cools, may have a “slow crash,” instead of a “soft landing.”

      Figure 5 shows that residential investment has tended to be high when the home price index that I constructed for 1890-2005 has been high. That conclusion makes sense: When houses seem to be a good investment, more is spent on them. This investment is essential to the process that brings home prices back down when they are high.

      Figure 5: Residential investment as a share of GDP 1929-2004 from National Income and Product Accounts, Table 1.1.10, and real home price index for the United States, Shiller [2005].

      High prices in some cities appear to be related to local zoning restrictions that inhibit construction in those cities. ... Zoning changes can be intentionally used by local governments to slow a potential bust in the housing market. On the other hand, zoning changes could inadvertently accelerate the bust: If such changes make big cities less desirable, owing, for instance, to more of the type of high-rise apartment buildings disliked by wealthy residents – then we may see price declines in the boom cities.

      It seems likely that some neighborhoods of unique value will see their value protected by zoning laws, even into the distant future. The neighborhoods of Georgetown, in Washington DC, of Beacon Hill, in Boston, ... The beautiful cities of Aspen Colorado or Santa Fe New Mexico have unique ambience that would be disrupted by high-density housing or high rises, and voters there know that. ...

      But, these are rare places. Most neighborhoods are not so unique or special that they will necessarily encounter resistance from residents if an economically advantageous offer is made. Studies of zoning laws, such as that by Fischel (2004), show that we have only imperfect understanding of the political forces that shape zoning laws, and we cannot make a case that there is any fundamental force that will keep zoning very tight in the future.

      Zoning laws do appear to have become gradually more effective over the course of the twentieth century, according to the research of Edward Glaeser and Joseph Gyourko 2005. But still they are local, and still there is an incentive for communities somewhere to welcome economic development. Even if the rare places can’t be built up more, upward pressure on their prices can be relieved by new construction elsewhere, even far away. ...

      The history of world real estate has been like this for centuries. Zoning laws have not stopped new construction and newly-valuable urban areas keep appearing. We still see the glamour areas persist indefinitely ... but we will see more and more of such places appearing ... The glamour areas are likely to be like ever expanding and replicating mesas of value rather than ever-rising mountains of value as the conventional urban land model is often taken to suggest.

      At some point, with prices high relative to construction costs in big cites, and construction proceeding quickly outside the cities, a decline seems likely to follow. Whether the landing will be hard or soft, remains to be seen.

      Fads can fade fast The preceding discussion did not touch upon behavioral economics. I argued in Irrational Exuberance that there is substantial evidence that there is a strong psychological element to the current housing boom. While the boom may continue for some time, the psychological element is likely to die away as thinking changes and current folk expectations for further price increases are lost. I argued that the current home price boom is best thought of as a social epidemic: a fad of sorts. And yet social epidemics are not even mentioned by most of those who say reassuringly that there is no reason to worry about home prices. Social epidemics can unwind sharply as psychology changes, suggesting the worrisome possibility of a rather hard landing.

      With the housing market riskier than it seems, hedging instruments are invaluable The outlook for home prices is not so certain ... The “fundamentals” ... are surprisingly weak ... The market for homes is a very risky place. The recent tremendous boom in home prices shows that there are risks on the upside: people who are underexposed to real estate may miss out on a rising market. And, the historical tendency for booms to be reversed eventually shows that there are risks on the downside: people who are overexposed to real estate may suffer when prices collapse.

      It is vitally important that vehicles be created to hedge these risks and to allow people to manage their exposure to the real estate market. Creating hedging vehicles that will protect agents from such major risks will enable them to act without the hindrance of idiosyncratic risk... There have been a number of efforts over the years to create hedging instruments for real estate price risk, but none of these has really caught on to date. ... But one failure, and other failures or half successes, do not disprove the concept of real estate risk management. The Chicago Mercantile Exchange ... has announced plans to create futures markets for home prices in ten U. S. metropolitan areas. ... The contracts will be launched spring, 2006 ...

      There is a basic principle here: there really are substantial risks to the market value of homes, and so major risk management tools will be central mechanisms of our future economy. When home value risk management is finally made possible, we will see some fundamental economic transformations as a result.

      Update: See also Dean Baker: Government Should Preemptively Burst the Housing Bubble, also from Economists' Voice.

      Update: Michael Mandel at BusinessWeek Online's blog Economics Unbound adds:

      By my calculations, a drop of 10% in national housing prices over the next few years would put home values back on the long term trend line. See my piece here.

      Posted by Mark Thoma on Thursday, March 30, 2006 at 05:28 AM in Economics, Housing

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      True Time Management

      Scientists have this productivity thing all figured out. Just slow down your internal clock to allow more information to be absorbed in the same amount of real time, get your work done in this hyper-state, then turn the clock back to normal and go home:

      The Future of Time, by Alan Burdick, Discover: In the future, perhaps all too soon, time will slow down. Certainly that is not what most of us experience now. Time seems to be speeding up: Our computers run faster, ... our cell phones make communication immediate and ubiquitous. Yet all these ingenious "labor-saving" devices have only made us labor more. ... An entire time-management industry rushes to save us: best-selling books, software packages, and other "productivity solutions" designed to improve the conversion of our time units into dollar units .... But they've got the equation all wrong. Productivity is the amount of work done in a given amount of time: P = W/t.

      Traditionally, time management has consisted of increasing productivity (P) by increasing the work (W)—squeezing more out in the same lump of time. By this math, time (t) never decreases. That's not time management, that's work management.

      There is a better way: What if we could increase productivity by leaving W alone and making t smaller? What if we could slow down time, make each moment seem to last longer so more work could be extracted from it? ... Neurobiologists are slowly coming to realize that "real time" is just a convention foisted upon us by our brains. In any given millisecond, all kinds of information—sight, sound, touch—pours into our brains at different speeds and is reprocessed as hearing, speech, and action. Our perception of time can be manipulated in ways that researchers have already begun to exploit.

      To understand how fundamentally your brain bends time ... Tap your finger on the table once. Because light outraces sound, the audio tap should register a few milliseconds after the sight of it; yet your brain synchronizes the two to make them seem simultaneous. A similar process occurs when you see someone speak to you from several feet away—thankfully so, or our days would unravel like a badly dubbed movie. Your mind is messing with the time, editing out the parts that distract you. Woody Allen once said, "Time is nature's way of keeping everything from happening at once." He was right.

      "The brain lives just a little bit in the past," says David Eagleman, a neurobiologist at the University of Texas at Houston. "The brain collects a lot of information, waits, then it stitches a story together. 'Now' actually happened a little while ago." ... "Time is one of the many, many illusions that the brain bestows upon us," says Dean Buonomano, a neuroscientist at UCLA. How it does that is not yet clear, he says. Researchers long believed the brain was ruled by a single clock that kept all its disparate activities in sync... But scientists are learning that there is no central clock. Instead, the brain contains lots of little clocks all running at independent rates yet linked by a network.

      At this point the future begins to take shape. If scientists gained a better understanding of how neural timing works, we could employ that timing to better use. In the productivity equation, we could effectively make t smaller by making the same amount of time last longer.

      Weird as it seems, it can be done. Not long ago, Eagleman became intrigued by the stories one hears of people who experience time slowing—during a car crash, say. (Eagleman himself entered slo-mo briefly as a child, when he fell off a roof.) He wondered: What's really going on? Does the experience gain added vividness only afterward, as it's being recalled? Or does a person's perception of time truly slow down enough to absorb extra information?

      Eagleman designed a test. He built a small LED screen that flashed a series of numbers too quickly to comprehend. He attached the screen to his subjects' wrists, clipped a bungee cord to their legs, and had them jump backward, one by one, off a 150-foot tower—a fairly terrifying experience for the uninitiated. To his surprise, his jumpers (all two of them; the experiment is ongoing and the results preliminary) were able to read the flashing numbers on the way down—evidence that a brain under duress can warp time. "It's like the brain has a reserve capacity," he says. "But like everything, it works as slowly as it can get away with." ...

      "[When] your perception of time is more acute, ... that doesn't necessarily mean you're getting more done. You can make decisions faster. But are they the best decisions?" The choices one faces in an adrenaline rush are fairly binary: Run from the bear, or freeze. In contrast, the choices one makes in an office often require discriminating thought: Paper clip or staple? Jelly doughnut or chocolate glazed? "You're sacrificing the optimal decision for speed," Buonomano says. "If you think about it, most things are a trade-off between time and quality. You can write your article faster, but will it be better?"

      For anyone keen to bring on the future of customized time sooner, Meck suggests an alternative. In November ... the Dalai Lama ... encouraged researchers to study the brains of meditating monks. Different states of meditation are thought to alter time perception... Well, OK, maybe. A future office worker is willing to consider that he might create more time for himself, maybe even get more done, through a regimen of mental calisthenics. However, a future office manager can't help but notice that a monk in deep meditation looks distinctly . . . unproductive.

        Posted by Mark Thoma on Thursday, March 30, 2006 at 02:52 AM in Economics, Science, Technology

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        Okun's Law Then and Now

        I was curious to see if the relationship between unemployment and output has changed in recent years, so I took a very quick look at the issue through the lens of Okun's law (and used a simple textbook version of Okun's law as well). Recall that Okun's law is the negative relationship between unemployment and GDP. One way to look at this is to graph the growth of real GDP against changes in the unemployment rate. The data are quarterly, the sample period is 1948:Q2-2005:Q4, and the changes are expressed in annual rates:

        The equation for the fitted line is (GDP Growth) = 3.40 - 1.78ΔUN, not too far from the equation in, say, Mankiw's textbook where (GDP Growth) = 3 - 2ΔUN is used as a rough approximation (e.g. see page 35 in his 5th edition as well as the graph that is very similar to the one above).

        The next step is to break the sample into two pieces. I chose 1982 as the break point. You will either like that or you won't, but it's what I chose for a first cut. The individual sub-sample graphs are similar to the total sample:

        Here are the fitted lines for the two sub-samples:

        And finally, here are the two estimated equations for the sub-samples:

        (GDP Growth) = 3.73 - 1.87ΔUN for 1958:Q2-2005:Q4

        (GDP Growth) = 2.99 - 1.49ΔUN for 1983:Q1-2005:Q4

        The last set of results is close to (GDP Growth) = 3 - 1.5ΔUN if you like round numbers.

        So what does this mean? Here are two observations:

        • For the full sample, unemployment will be stable (ΔUN=0) when GDP growth is 3.4%. For the sub-samples, the figures are 3.73% for sample through 1982, and 2.99% for the sample after 1982. Thus, rate of output growth producing stable employment has fallen according to these estimates.
        • For every percentage point unemployment increases in the early sample (i.e. an additional 1% increase over the last period), GDP growth falls by 1.87%. But in the later sample it falls less, by 1.49%.

        I need to think through this more, but the decreased sensitivity of GDP growth to unemployment changes seems to be consistent with technological change allowing firms to replace people with machines more flexibly than in the earlier time period, with technological change allowing work to be digitized and performed elsewhere so that domestic unemployment can rise without output falling, and through the outsourcing of intermediate stages of production.

          Posted by Mark Thoma on Thursday, March 30, 2006 at 01:26 AM in Economics, Unemployment

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          March 29, 2006

          The Economic Costs and Benefits of Invading Iraq

          In his last Economic Scene column for the New York Times, Alan Krueger examines a difficult but important issue, the costs and benefits of invading Iraq. Krueger uses estimates on both sides of the issue, those that find net benefits and those that do not, to illustrate the high degree of uncertainly present in all of these estimates:

          The Cost of Invading Iraq: Imponderables Meet Uncertainties, by Alan B. Krueger, Economic Scene, NY Times: The question of whether it was worth invading Iraq is being asked with increasing frequency and fervency. ... Fundamentally, deciding whether war is worth it involves weighing the benefits and costs, both tangible and intangible. The many estimates of the cost of the Iraq war that are available are uninformative absent a comparison with the likely benefits, or a comparison with the costs and benefits of the best alternative to invasion. Unfortunately, cost-benefit comparisons of such weighty issues are more art than science. One problem is that the ... outcomes that would have occurred had another policy been pursued ... cannot be known for sure. In addition, it is often unclear how to value the outcomes of the policy that is pursued.

          One of the earliest cost-benefit comparisons was done by Steven J. Davis, Kevin M. Murphy and Robert H. Topel of the University of Chicago on the eve of the invasion in 2003. They explicitly considered a continued policy of containment ... as an alternative to invasion and regime change. Assuming that containment and invasion would protect the United States equally well, the question of whether invasion is worth it turns on which policy is less costly, after discounting all likely future costs.

          Allowing for a 3 percent chance that the Iraqi regime would evolve into a benign government in any future year and a 2 percent real interest rate, the economists reckoned that the cost of pursuing a containment strategy was $258 billion to $380 billion. "This dwarfs any reasonable estimate of U.S. war costs," they wrote at the time. Their anticipated price tag for the war, which they considered conservative, was $125 billion. Professors Davis, Murphy and Topel have revised their figures in a new National Bureau of Economic Research working paper... Their estimated war costs have increased to a range of $410 billion to $630 billion, reflecting reality there.

          William D. Nordhaus, an economist at Yale ... said the updated work is "economics at its best and worst — quantifying the almost-unquantifiable." In the fog of war accounting, one thing is clear: all costs and benefits can be contested as wildly inaccurate — in either direction. Consider what the cost of containment would have been had the United States not gone to war. The University of Chicago study now says it is in "the range of $350 billion to $700 billion."

          This range is arguably grossly inflated because it counts virtually all of the American military forces in the Middle East as dedicated to containing Iraq. While containing Iraq was a central focus, these troops also served many other purposes. They conducted rescue operations in Somalia; performed humanitarian missions in Nigeria, Ethiopia, Eritrea and Jordan; responded to terrorist bombings in Nairobi and Tanzania; and were responsible for military activities in the five Central Asian republics of the former Soviet Union.

          Additionally, Iran was considered a greater potential long-term threat than Iraq... It is hard to believe that the United States would not have a substantial military presence in the region even if Iraq was not regarded as a threat. Ideally, only incremental costs would be counted in deciding whether something was worth it...

          Another study of Iraq war costs, by Linda J. Bilmes of Harvard and Joseph E. Stiglitz of Columbia, comes up with an eye-catching estimate of $2.2 trillion, assuming the United States is no longer in Iraq in 2015. This is arguably too high for several reasons. First, it counts future interest payments on the debt created by military spending as well as the direct expenditures. (This is analogous to counting both the sale price of a house and the cost of future mortgage payments as the cost of buying the house.)

          Second, it counts elevated military recruitment costs that incorporate a premium for higher risk of death or injury ... as well as the predicted direct cost of the deaths and injuries; this is double counting if the risk premium is adequate. Finally, it ascribes a big increase in the price of oil to the war, and, as a result, a loss to the American economy of almost half a trillion dollars.

          A menu of cost estimates is thus available, depending on the counterfactual situation that one chooses. "The question of whether the war was worth it hinges not on ... economic costs," said Douglas Holtz-Eakin, ... "but on what do we gain in the way of genuine security and international standing." The costs, he said, were manageable.

          The benefits, however, are much harder to quantify than the costs. To Zbigniew Brzezinski, President Jimmy Carter's national security adviser, "the benefits have been, in fact, very few, beyond the obvious one: the removal of Saddam Hussein." Offsetting that, he said the war "undermined our international legitimacy," "destroyed our credibility" and "tarnished our morality with Abu Ghraib and Guantánamo."

          The Chicago economists argue that anticipated improvements in Iraq's living standard, once the country stabilizes, tip the balance in favor of invasion over containment, which in their view had costs that were "in the same ballpark." They also argue that the number of Iraqi fatalities since the invasion is probably no greater than would have been the case under Mr. Hussein.

          But even if one accepts all of their estimates, their results implicitly raise another question: Why intervene in Iraq and not a country like Sudan, where genocide and oppression are at least as much an affront as they were in Iraq, and where the cost of intervention and prospects for improving lives may offer a better benefit-to-cost ratio than is likely in Iraq?

          Credible estimation of counterfactual outcomes of alternative policies for cost-benefit comparisons has been a hallmark of modern economics. When it comes to judging whether war is worth it, however, cost-benefit analysis is little more than educated guessing by other means. But at least it provides a framework for where to put the guesses.

            Posted by Mark Thoma on Wednesday, March 29, 2006 at 07:10 PM in Economics, Iraq

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            Increased U.S. Productivity from the Outsourcing of Services

            Just when you thought it was safe to go back into the workplace and exploit your "skill premium" in the service sector, we learn:

            Service Offshoring Raises U.S. Productivity, by Mathew Davis, NBER Reporter: ...In "Service Offshoring and Productivity: Evidence from the United States" (NBER Working Paper No. 11926), co-authors Mary Amiti and Shang-Jin Wei note that service outsourcing is doing more than fueling an economic boom in ... India. It is also playing a major role in ... the surging productivity of American manufacturing firms. They find that American firms are getting bigger boosts in productivity from outsourcing services to overseas providers than from the more familiar practice of turning to foreign concerns for manufacturing materials, such as parts and packaging.

            Amiti and Shang-Jin find that from 1992 to 2000, "service offshoring" accounted for around 11 percent of the productivity growth in U.S. manufacturing industries compared to the 3 to 6 percent gain attributable to imported material inputs." Their analysis is the first comprehensive study to find a link between service offshoring and productivity. ... [T]hey observe "Although the level of service offshoring is still low compared to material offshoring, this business practice is expected to grow as new technologies make it possible to access cheaper foreign labor and different skills." ...

            Amiti and Shang-Jin note that additional research is needed to understand more precisely how buying services from foreign providers boosts domestic productivity. They also are interested in how the rise in service offshoring might affect U.S. incomes. Economists have long linked the rise of material outsourcing to the fact that for the last twenty years, wages for skilled workers have been increasing faster than wages for unskilled workers, a gap often referred to as the "skill premium." The authors observe that "service offshoring is likely to be more skill intensive than material offshoring" so, "it will be interesting to see what effects, if any, service offshoring has on the wage skill premium.

              Posted by Mark Thoma on Wednesday, March 29, 2006 at 05:21 PM in Academic Papers, Economics, Technology, Unemployment

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              Valuing Women in India

              What happens when the value of a woman in society is determined such that "she can raise her value by becoming the mother of sons"? In Indian Punjab, "There are districts in the state where only one girl child has been born in the past six months":

              Meanwhile: India's women battle the 'bad luck' label, by Manreet Sodhi Someshwar, International Herald Tribune: Growing up in my hometown in Indian Punjab, I often heard people remarking to my father, "You are very fortunate." It seemed a reasonable statement: In the hothouse of the Indian middle class, ... were we five siblings, each intent on surpassing the excellent scholarship of the others.

              How much better could it get for my parents? ... It was only later, when I moved out of Punjab to study engineering, that I began to comprehend, little by little, the nature of my father's "fortune." In a land where people do away with newborn girls, my father had four daughters. "Kuree maar" (daughter- killer) is a common pejorative in Punjab, yet my father was not only raising four girls, but also educating them and sending them to professional colleges. To add to the strangeness of it all, the girls began to graduate and earn handsome salaries. ...

              When their child reaches marriagable age, parents who have sired a son (often with considerable help from a sex-determination test) can command a Honda car, a house, a flat- screen television, cash, even foreign trips - all in the name of the dowry that the hapless parents of the bride are obliged to provide. In a patriarchal society like Punjab, women are defined by matrimony. Before marriage, a Indian woman is a cipher. Marriage simply confers the decimal point. Thereafter, she can raise her value by becoming the mother of sons. It is in her hands, and she understands the situation all too well.

              The tools are readily available: tin- roofed clinics ... provide prenatal diagnostic testing and subsequent "medical termination of pregnancy," also known as abortion; traveling laboratories that conduct on- the-spot ultrasound tests; midwives who scour the countryside for pregnant women in need of "help." For some, it is never too late to smother a newborn girl under a sack of grain, strangle her, or bury her alive.

              Punjab, India's granary and its most prosperous state, has added another claim to its record: it's the state with the worst child sex ratio: 776 girls for every 1,000 boys. There are districts in the state where only one girl child has been born in the past six months.

              This is giving rise to a whole new breed of women, known as Draupadis. In the great Indian epic, the Mahabharata, Draupadi was married to five Pandava brothers, and played a central role in the story. But she is no heroine, no role model; the regard Indians hold for her is apparent in the fact that seldom is a girl named after her. ...[I]n the upside- down world that India's women inhabit, ... fraternal polyandry is flourishing, institutionalizing violence against women: one woman is forced to marry her husband's brothers, and is expected to produce sons for each of them.

              My father managed to astound his community with his counterintuitive act: In a culture that regards the birth of a girl as bad luck, he decided that his daughters would be in charge of their destinies. He empowered us. ...

              Laws exist in India to safeguard women's rights: polyandry, seeking dowry and sex selection all are prohibited. These laws, however, need to be publicized and enforced so that women know a legal recourse exists for them and that when facing a bully, the first step might just be to stand up for their rights.

              In one recent instance, a new bride was daily nagged by her mother-in-law for more dowry. One day she wrenched open a can of kerosene, splashed it on herself and declared she was proceeding to the nearest police station to complain that her in-laws' were threatening to set her on fire. The burning of brides after dowry disputes has forced the police to sit up. The mother-in-law, chastened, stopped her nagging. ...

                Posted by Mark Thoma on Wednesday, March 29, 2006 at 03:51 PM in Economics, India

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                The Continuing Search for Links between Saddam and Al Qaeda...

                Vice President Cheney suggests it's only a matter of time before strong links between Saddam Hussein and Al Qaeda are discovered now that the search is being conducted by researchers outside of the administration:

                The Case for Iraq, by John McKinnon, WSJ's Washington Wire: Seeking to buoy public support for the Iraq war, the Bush administration hopes tens of thousands of boxes of captured Iraqi documents now being made public will buttress their case for invading. On Fox News Talk’s Tony Snow Show today, Vice President Cheney predicted that over the next few months, as researchers comb through the records, “we’ll see a pretty complete picture that Saddam Hussein did, in fact, deal with some pretty nefarious characters out there there. And he was legitimately labeled by our State Department as a state sponsor of terror.” That likely includes dealings with Osama bin Laden, Cheney suggested, while adding that he wasn’t making a “hard and fast prediction.”

                In the past, the administration has been embarrassed over suggestions that Iraq aided the 9/11 attackers. Cheney conceded yesterday that an early report that lead hijacker Atta met with Iraqi intelligence officials in Prague “has been pretty well knocked down.” But he said that “that’s a separate proposition from the question of whether or not there was some kind of a relationship between the Iraqi government, Iraqi intelligence services and the al Qaeda organization.” Conservatives also hope to find evidence that Iraq was actively pursuing development of various weapons of mass destruction.

                  Posted by Mark Thoma on Wednesday, March 29, 2006 at 03:04 PM in Iraq, Politics

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                  Disposable American Workers

                  Brad DeLong reviews Louis Uchitelle's new book "The Disposable American":

                  Americans Idle, Review by Brad DeLong, NY Times: Louis Uchitelle has long been one of The New York Times's best economics reporters. ... Now he has written his first book, "The Disposable American," about large-scale layoffs and the harm he sees them doing to the country. Uchitelle believes Americans have acquiesced in permanent mass layoffs because of three myths: (1) that they are a necessary step to make companies better, stronger, more efficient and more productive; (2) that it is the laid-off workers' own fault if they fail to find near-equivalent new jobs in the modern economy; and (3) that layoffs are primarily an economic affair that ought to be decided upon by managers looking at their corporation's dollars-and-cents bottom line.

                  To Uchitelle's attack on these three myths I want to say yes, yes and yes. There are numerous costs associated with layoffs that are not measured by their effects on the corporation's bottom line: it's not only workers who get a great deal of the cash flow from a highly efficient productive operation; so do national, state and local governments, as well as businesses in the region that live off the purchases of the workers who are about to be laid off.

                  Moreover, older workers have a particularly hard time starting over, turning the skills and experience that made them a good fit at their old jobs into something valuable to a new employer. ... White-collar middle managers in their early 50's have next to no chance of finding remotely equivalent jobs. Layoffs destroy what is ... a valuable meshing of worker skills and experience... A huge amount of human capital disappears when businesses close down.

                  And Uchitelle is right when he says mass layoffs do not make the companies that undertake them better. Mass layoffs make them different. Consider one of his major examples: the Stanley Works, which found itself under increasing pressure from countries like Japan, Taiwan, Korea and China. "Customers for Stanley's hand tools were defecting in alarming numbers. The lure was Asian tools . . . indistinguishable in quality from Stanley's offerings, and at 60 percent of the price." ...

                  So Stanley's directors found a new chief executive, John Trani, to change the Stanley Works from a tool-making manufacturing company into a service-providing money-making machine. ... As Uchitelle explains: "Selling hand tools was not a favored market. ... Automatic entrance doors . . . were a different matter. . . . What set the doors apart was the need to service the various electronic components." ... Stanley now had a chance to survive as it gradually shifted into a high-margin service-sector market niche where foreigners could not compete, but where its corporate tool-making assets still gave it an edge. Meanwhile, Stanley's longtime workers were left high and dry. ... Stanley's workers are increasingly electronics maintenance and repair technicians, not blue-collar assembly-line tool makers.

                  For Uchitelle, this transformation of Stanley — this use of corporate assets to find new market niches where the old workers do not fit — is a bad thing. In his eyes, Stanley's bosses were morally obligated, and in a better world would be legally obligated, to invest the company's resources in directions that promised a chance of preserving the jobs of longtime workers — even if such investments were, in the judgment of Wall Street, unlikely to succeed, and so would depress the stock price.

                  Uchitelle's diagnosis that mass layoffs are a serious national problem is convincing. But for this card-carrying economist, his desired prescription is not. I see no examples ... of economies that have taken steps in the direction he desires without severe side-effects. In Western Europe, unions bargained fiercely for job security, and governments enacted "no firing without cause" laws... Yet this did not lead to a happy labor market. Instead, high overall unemployment, extra-high long-term unemployment and extra-extra-high youth unemployment appear to be the consequences ... Companies that know they cannot lay off groups of workers if demand goes sour are very likely to be companies that hesitate to hire workers when demand is strong.

                  Indeed, Uchitelle does not want to forbid all mass layoffs. "Some," he writes, "are inevitable as American companies adjust to the growing competition from abroad." His real wish is for managers to treat their workers as partners and fellow human beings, rather than as potentially obsolete and disposable parts in the corporate money-making machine. But when demand and industrial structure are shifting rapidly, there is a great deal of money to be made by treating workers as disposable parts rather than as partners.

                  Uchitelle wants the government to help. But the government's powers and competence are limited: it can do much more at cleaning up the mess afterward — in the form of unemployment compensation, education support and job search assistance — than it can at getting managers, directors and shareholders to "play nice" when the financial stakes are high.

                    Posted by Mark Thoma on Wednesday, March 29, 2006 at 12:40 PM in Economics, Policy, Unemployment

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                    Beauty and the Sleeping Sickness Beast

                    The fate of people in poor countries afflicted with serious diseases depends not only on the cost of treatment, but also upon whether the disease also afflicts people in wealthier countries, or, in the case of sleeping sickness, whether the cure is also an effective beauty treatment:

                    The Scandal of 'Poor People's Diseases', by Tina Rosenberg, Commentary, NY Times: It's hard to imagine how a Rwandan woman with AIDS might be considered lucky, but in a way, she is. Effective drugs exist to treat her disease, and their price has dropped by more than 98 percent in the last six years. ... [T]he world takes AIDS seriously: rich countries provide money, drug companies have lowered their prices and accepted generic competition, and poor countries like Rwanda are scrambling to provide free treatment to all who need it. None of this is true for people who suffer from malaria, tuberculosis, or a host of other diseases ... like kala azar, sleeping sickness and Chagas disease... Most of these diseases are easily preventable and completely curable. Saving the lives of their sufferers is much cheaper and easier than treating AIDS. Yet millions of people die of them. Why the difference?

                    As fatal illnesses go, AIDS is the best one for a poor person to catch because rich people get it, too. The other diseases might as well hang out a sign: "Poor People Only." They offer researchers no profitable market. They have little political constituency. ... People with AIDS all over the world are fortunate to have fellow sufferers in America and Europe. They are even more fortunate that many are middle-class gay men. These men have lots of education, leisure time and income ... They are predominantly urban, well-connected and ultra-sophisticated. Their buying power provided pharmaceutical companies with a lucrative market for AIDS drugs. And they lobby. ... Today, contracting a serious disease that affects only poor people is the worst luck of all.

                    I. How a Beauty Regime Salvaged a Cure for Sleeping Sickness ...After malaria, sleeping sickness is the most deadly parasitic disease. It is endemic in 36 African countries and is always fatal if it is not treated. The cure used in most places is melarsoprol – an arsenic-based drug so toxic that it collapses each vein into which it is injected and kills between two and eight percent of those who take it. There is another cure, eflornithine, so effective that it is called the "resurrection drug" – it makes people in comas get up and walk.

                    Eflornithine is an old anticancer drug that turned out to be not very effective against cancer. In the mid-1990's, the company that made the drug stopped making it. The fact that it was extraordinarily effective at treating sleeping sickness didn't matter, because victims of that disease had little money to pay for it. ... [B]y 2000, the existing stocks of eflornithine were dwindling and no other manufacturer was interested. It looked as though the miracle cure would disappear. Then lightening struck. Eflornithine reappeared in a six-page ad in Cosmopolitan magazine as the active ingredient in the Bristol- Myers Squibb product ... that impedes the growth of women's facial hair. Doctors Without Borders ... seized the opportunity to launch a publicity campaign. Christiane Amanpour went to southern Sudan to report on eflornithine for "60 Minutes."

                    The [company] which still controlled the rights to the drug, eventually agreed to donate a five-year supply, plus money for research, surveillance and training of health care workers, in a package totaling $25 million. The donation runs out this year, but there is a good chance it will be renewed. A Bristol-Myers Squibb spokesman inadvertently summed up the plight of sleeping sickness in 2001: "Before Vaniqa came on the scene, there was no reason to make eflornithine at all. Now there's a reason." The market agrees with him. Saving American complexions is a reason. Saving African lives, apparently, is not. ...

                    III. Why One Million Africans a Year Die of Malaria Malaria used to be common as far north as Canada and Britain. ... Shakespeare refers to it, as "ague," in eight of his plays. But today, ... Malaria is all but invisible despite the fact that it is one of the world's top killers... It is the leading cause of death for children under five in Africa. ...

                    International organizations and aid agencies talk a lot about malaria. But they have not backed their talk with money. The solutions they push have been things poor people can buy for themselves, because most donors are unwilling to finance more effective measures. All over Africa, a main cure for malaria is chloroquine. The great advantage of chloroquine is that it costs only a few pennies, so even poor African families can buy it. It just has one small problem – in most places it doesn't work. The parasite has become resistant to it. There is a new, effective cure, called artemisinin-based combination therapy. Countries should be switching to it rapidly, but they are not, because it's much more expensive – around $1.40 for an adult cure, 40 cents for a child. ... more than most malaria-stricken families can afford. That means rich-country donors would have to pay. Until recently, they haven't. ...

                    The hot prevention tool today is an insecticide-treated net to hang over a bed. These bed nets are very effective, if people can get them. But people can't... Even at the subsidized price of three dollars, the cost is high enough so that people living on a dollar a day do not buy them. One survey asked rural Africans what they would buy if they had the money. A bed net was sixth on the list. The first three items were a radio, a bicycle and, heartbreakingly, a plastic bucket. ...

                    The truth is that many malaria victims would be better off if America still had the disease. If malaria still existed in America, we would be attacking it with DDT . In fact, we did exactly that. ... This was extremely irresponsible and did terrible environmental harm. But now we know that DDT can beat malaria without environmental damage, if it is ... sprayed in tiny amounts inside houses. DDT, however, is banned in the United States and Europe. That means that Washington has not, until the last few months, financed its use anywhere else and it has blocked the World Health Organization from issuing recommendations to use DDT. American officials maintained it was hypocritical to push an insecticide overseas that is banned at home.

                    Americans are beginning to realize, however, that it is more hypocritical to deny Africa the ability to use responsibly the tools we used irresponsibly to beat malaria. Last year, President Bush announced a new program to ... provide an additional $1.2 billion over the next five years. ... It will give away bed nets, buy malaria drugs that work and finance indoor spraying. Eight countries in Africa are due to start spraying this year, and three will use DDT as their primary insecticide. ...

                      Posted by Mark Thoma on Wednesday, March 29, 2006 at 12:50 AM in Economics, Health Care, Market Failure

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                      The Sky Isn't Falling Yet, But Stay Indoors

                      Martin Wolf says far too much blame is placed on the U.S. for global imbalances. The source of the problem, and hence the source of the solution, is the exchange rate policies of countries such as China. He believes changes need to be made soon or there will be a painful adjustment process to relieve the pressures arising from accumulating global imbalances:

                      We should still worry about imbalances, by By Martin Wolf, Financial Times: ...Why should we remain concerned about global imbalances? The answer is that they are undesirable, cannot continue indefinitely and the longer they last, the bigger and more painful the adjustment will be. Worse still, as recent US congressional threats to China ... demonstrate, much damage can be done along the way to the world economy and international relations.

                      Yet if we are to understand the dangers, we need first to recognise what is happening. ... If only, critics argue, the US government had a smaller fiscal deficit and US households were less profligate, the current account deficits would disappear. These people are right: if the US had an economic depression, the trade deficit would certainly dwindle. Yet this cure would be vastly more painful than the disease. ... As Lawrence Summers ... noted ... “There is one striking fact about the global economy that belies a predominantly American explanation for the pattern of global capital flows: real interest rates globally are low, not high.” ...

                      A superpower’s place may always be in the wrong. But, ... the driving force behind the global imbalances is Asia’s structural savings surplus, with China playing an increasingly significant role. .... If one accepts ... that the US domestic spending and current account deficits are a ... response to the excess of desired savings over investment in the rest of the world, why should we worry? ...

                      First, the imbalances are the results of bad policies in the capital exporting countries. The global accumulation of ... foreign currency reserves ... was the result of decisions to intervene in currency markets... China’s reserves alone are now $600 for every man, woman and child – and rising. Cannot a government ... concerned about persistent mass poverty do something more intelligent with this money than lend it to the US, at very low interest rates, only to have the latter both complain and ultimately, in all likelihood, depreciate its currency and so partially default on its liabilities?

                      Second, the scale of US foreign borrowing has ... allowed George W. Bush ... to offer guns and butter. But the adverse impact on sectors producing tradable goods and services has also exacerbated protectionist sentiments. When the economy next slows down, the expression of these sentiments could become both deafening and dangerous.

                      Third, strange things are happening to the US economy. ... Since the bursting of the equity bubble, the corporate sector has moved into surplus. The government and, above all the household sector, are in huge deficit. ... As a result, household indebtedness and debt service are both soaring (graph 1, graph 2).

                      Finally, the counterpart of the huge capital inflow is not increased investment, but increased consumption and falling national savings. ... Investment is also tilted towards real estate and the non-traded sector, which will not pay the foreign debts. ...

                      Yes, there are economists who argue that the huge US current account deficits are a mirage or, if not that, indefinitely sustainable... Over the past 15 years, US imports at constant prices grew at a trend rate of 8.3 per cent a year, while exports grew at 5.1 per cent. Today, as a result, imports are 60 per cent bigger than exports. It would take a substantial turnround in these relative rates of growth for the current account deficit merely to stabilise as a share of GDP, let alone fall. ...

                      What is undesirable ought to change. What is unsustainable will change. What is dangerous must change. Yet, if the world is to avoid a serious recession, adjustment must start in the surplus countries. The fate of the world economy does not lie predominantly in US hands. It is comforting for many – both American and non-American – to disbelieve this. It is true, all the same.

                        Posted by Mark Thoma on Wednesday, March 29, 2006 at 12:33 AM in Budget Deficit, Economics, International Finance, International Trade, Policy

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                        The Best Tax Ever

                        I'm going to follow Brad DeLong who notes:

                        Brad DeLong: Bruce the Apostate: Fewer conservative--well, not "conservative," fewer Bush-loyal--websites are printing Bruce Bartlett's columns. So it is only fair that more reality-based websites do so.

                        So here's Bruce Bartlett on the need to raise taxes and, given the need, the optimal tax strategy to employ:

                        The Best Kind of Tax, by Bruce Bartlett, Commentary, NY Times: In my previous post, I tried to show that the magnitude of growth in government spending already in the pipeline is so great that it cannot be contained just by cutting. ... So we are left with the need for a new revenue source. When confronted by the need to pay for health and other spending programs, every other major country has turned to the value-added tax, or V.A.T. This is the best strategy tax economists have ever devised for raising revenue without investing a lot in enforcement and economic incentives.

                        The V.A.T. is a kind of sales tax embedded in the price of goods. A farmer who grows wheat, for example, pays, say, 10 percent on the sale. The miller buys the wheat ..., makes flour, and when that is sold, he also pays 10 percent, but gets a credit for the taxes the farmer paid. The baker who makes bread from the flour also pays 10 percent when he sells to the food store, but gets credit for the taxes paid by the farmer and the miller. Since taxes must be paid in order to claim credits for the taxes embedded in the bread at earlier stages of production, the tax is largely self-enforcing. And because the tax is applied only to consumption, its impact on incentives is minimal. ...

                        According to the International Monetary Fund, the tax base for the V.A.T. is about 37 percent of G.D.P. in industrialized countries. With our G.D.P. close to $13 trillion, that means about $5 trillion would be available for taxation. A 10-percent V.A.T. would raise $500 billion in new annual revenue ... The average V.A.T. rate is 18 percent, according to the Organization for Economic Cooperation and Development, ranging from a low of 5 percent in Japan to a high of 25 percent in Sweden, Denmark and Hungary.

                        We should bite the bullet and put in a V.A.T. For now, the revenue could be used to fix glaring problems in the tax code, such as the Alternative Minimum Tax. In the longer run, it could be raised gradually to pay for Medicare and other programs. The burden is on those who oppose a V.A.T. to spell out how spending could ... be cut or taxes raised by the order of magnitude I have outlined.

                          Posted by Mark Thoma on Wednesday, March 29, 2006 at 12:06 AM in Budget Deficit, Economics, Politics, Taxes

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                          March 28, 2006

                          Poor Measurement of Poverty Raises Concerns

                          The Center on Budget and Policy Priorities has concerns about the limited set of poverty measures the Bureau of Census is considering as replacements for existing measures of poverty. Here are sections of the introduction and conclusion from the report issued today:

                          Poor Measurement: New Census Report On Measuring Poverty Raises Concerns, by Jared Bernstein and Arloc Sherman, CBPP: On February 14, the Bureau of the Census released its latest report on alternative measures of poverty. ... The Census Bureau has consistently produced important and insightful work in this area, carrying on the mission set forth by a 1995 National Academy of Sciences (NAS) report, Measuring Poverty: A New Approach. The NAS report has been widely viewed in the research community as the leading blueprint for future improvements in measuring poverty.

                          The latest Census release, however, departs in some respects from this tradition. Unlike past reports in recent years, this release is limited to a set of new measures that are flawed. ... This is of particular concern because the alternative measures ... all incorporate features that both the NAS panel and past Census reports warned were faulty and that reduce the poverty rate substantially. ...

                          The cumulative effect of the changes in poverty measurement that are presented in the new report is to lower the poverty rate ... by 4.4 percentage points, or more than one-third, to 8.3 percent, from 12.7 percent ... By contrast, the more balanced and complete approach ... represented by the NAS-guided estimates included in last yearâ??s Census analysis resulted in a range of estimates that were between 0.1 percentage points and 2.0 percentage points higher than the official measure...

                          The Census Bureau says its new report is meant to provide â??a more complete measure of economic well-being,â? but ... by not following some of the key recommendations made by the National Academy of Sciences regarding improved poverty measurement ... and by not including or discussing the NAS-guided measures of poverty, the new report presents an overly positive view of the extent of poverty in America. ...

                          There's much more on this issue in the report. One thing we should avoid to the extent that we possibly can is the politicization of our economic statistics. I have always trusted that the people producing the statistics do their utmost to produce an unbiased picture of the economy, an independent view free of political bias. Anything, real or perceived, that undermines the faith we have in those statistics would be a huge step backward for those interested in learning how the economy operates and how policy interacts with the economy's operation, or for anyone wishing to view the economy through an unbiased statistical lens.

                            Posted by Mark Thoma on Tuesday, March 28, 2006 at 03:11 PM in Economics, Income Distribution, Politics

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                            Is Talking on Airplanes Noise Pollution?

                            The social rules for appropriate cell phone use in confined spaces such are still developing. Jagdish Bhagwati, professor of economics and law at Columbia University, has a clear opinion of what the rules should be on airplanes:

                            Fight the mobile phone invasion at 30,000ft, by Jagdish Bhagwati, Financial Times: Our right to peace and quiet is guaranteed by fining taxi drivers from India who honk as they drive: a habit acquired through years of dodging cycles, cows, cars and the carefree in the crowded streets of Calcutta and Karachi. Flights are not allowed to land in Washington DC beyond late evening... Yet, noise pollution, practised with abandon in your face and in your ears, is tolerated in enclosed spaces in buses, trains, restaurants and cinemas and is spreading like bird flu...

                            The final straw in the US ... is the impending decision to allow the use of mobile phones on flights. In this way, loud passengers will be free to jabber away in a closed cabin, saying “hi” to Joey, Joel and Josie at home just for the heck of it, or conducting their business, which is no concern of yours, by public declamation. What can be done if the US Federal Aviation Administration allows this madness to happen...? [W]e are not out of remedies.

                            Consider what you can do in the aircraft cabin itself. Before the Good Samaritans came down on smoking, I had a friend who was so annoyed by the smoke getting into his eyes in restaurants... that he carried a little Sanyo fan that would blow the smoke back into their startled faces. While the stewardesses would not let you turn on a CD player at loud volume to drown out the mobile phone users, how about screaming into your own phone (without, of course, actually dialing and paying) ... This is worth a try. But frankly, how long and how often can such ridicule and retaliatory noise-making be sustained, without unleashing a competition in steadily higher octaves, one which the vulgar freaks you are trying to drown out are likely to win? A more effective remedy has to be a collective, legal response. How about encouraging environmental and human rights groups to file lawsuits against the agencies that grant the permission for the use of mobile phones in flight, and against the airlines when they act on such permission? ...

                            But what of the rights of the mobile phone users? These are more frivolous than those of the fellow passengers on whom they impose. Besides, the airlines can readily accommodate their desire to talk ... Mobile phone users should be provided, at an extra cost charged to their tickets, with a phone booth at which they can queue for their turn. That would protect their rights without invading ours.

                            The smoking ban on all flights came along when the science behind the problem of secondary harm from smoking became well-established. But this harm ... can also be mental. The stress of ... an enclosed space with continuous noise is sufficient to produce high blood pressure, fatigue and other ailments... It is still not completely clear whether continual emission of radiation from the use of mobile phones on flights could cause secondary brain damage to fellow passengers. If providence were just, it would surely affect the brains of the users. But who believed at first that cigarettes could hurt the smoker’s own family?

                            So, perhaps the compelling answer may be to threaten the mobile phone companies themselves with ultimate liability, reminding them of the cigarette manufacturers who eventually faced huge financial damages. Eventual retribution could be the most powerful deterrent to the rising spectre of cellular noise.

                            It would be hard to work, sleep, etc. with the person next to me jabbering on the phone, but what is different about them talking on a cell phone as opposed to talking to the person in the seat next to them or to someone across the aisle? I don't see the distinction. [dual post]

                              Posted by Mark Thoma on Tuesday, March 28, 2006 at 01:46 PM in Economics, Environment

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                              The FOMC Raises the Target Rate to 4.75%

                              As expected, the FOMC decided to raise the target federal funds rate from 4.5% to 4.75%. Here is the statement along with the previous statement (released 3/31/06 1/31/06) in italics for comparison:

                              For immediate release

                              The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 4-3/4 percent.

                              [No substantive difference from previous press release on 1/31/06].

                              The slowing of the growth of real GDP in the fourth quarter of 2005 seems largely to have reflected temporary or special factors. Economic growth has rebounded strongly in the current quarter but appears likely to moderate to a more sustainable pace. As yet, the run-up in the prices of energy and other commodities appears to have had only a modest effect on core inflation, ongoing productivity gains have helped to hold the growth of unit labor costs in check, and inflation expectations remain contained. Still, possible increases in resource utilization, in combination with the elevated prices of energy and other commodities, have the potential to add to inflation pressures.

                              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.

                              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.

                              [Identical to previous press release].

                              Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Susan S. Bies; Jack Guynn; Donald L. Kohn; Randall S. Kroszner; Jeffrey M. Lacker; Mark W. Olson; Sandra Pianalto; Kevin M. Warsh; and Janet L. Yellen.

                              [Ferguson is not participating, so the vote was unanimous. No substantive difference from previous press release].

                              In a related action, the Board of Governors approved a 25-basis-point increase in the discount rate to 5-3/4 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, Minneapolis, Dallas, and San Francisco.

                              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.

                              It is worth noting that Kansas City did not request an increase in the discount rate, just as Minneapolis did not request an increase at the last meeting. This may indicate dissent on the rate increase, but until the minutes are released, we won't know for sure.

                              The main difference in the two statements comes in the second paragraph. The uneveness discussed in the previous statement is attributed to special, temporary factors. The committee notes that growth has rebounded strongly, but appears likely to moderate to a sustainable pace indicating that the end of rate increases may be near. However, the bottom line is identical to the last press release, "possible increases in resource utilization, in combination with the elevated prices of energy and other commodities, have the potential to add to inflation pressures," indicating that although future moves are clearly data dependent, the committee remains wary of inflationary pressures. [See also Bloomberg, NY Times, Washington Post, Wall Street Journal, Financial Times, CNN/Money, WSJ's 'Economists React', Big Picture, William Polley]

                                Posted by Mark Thoma on Tuesday, March 28, 2006 at 11:39 AM in Economics, Monetary Policy

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                                Just Close Friends

                                Karl Rove expresses his love for Joshua Bolten, President Bush's choice to replace Andrew Card as chief of staff:

                                Rove on Bolten, by Peter Lattman, WSJ Law Blog: ...Karl Rove’s assessment of President Bush’s new chief of staff:

                                “He’s soft-spoken but very clear thinking,” said Karl Rove, Bush’s chief political adviser. “I love him in an entirely appropriate way. ...”

                                Since he felt the need to make this distinction, people must make this mistake often. I'm glad he cleared up that he's not one of those "inappropriate" people. Calculated Risk fills us in on the source of Rove's love:

                                Joshua Bolten: "Budget Deficit Falling Fast", by CalculatedRisk: Joshua Bolten, the Master of the Budget Disaster on July 14, 2005:

                                "The U.S. budget deficit is falling, and it is falling fast."

                                Meanwhile back in the real world, the US General Fund deficit will set a new record this year of close to $600 Billion. More Bolten:

                                "...the budget deficit is forecast to continue to fall, to $162 billion in 2009, or 1.1 percent of GDP - less than half the size of the average deficit over the last 40 years."

                                This statement isn't just wrong, its dishonest. Until about 20 years ago, the Unified budget deficit and the General Fund deficit were about the same size. When Reagan (following the advice of the Greenspan Commission) upped the SS payroll tax, SS started running huge surpluses. These surpluses are not included in the General Fund. But Bolten is using the Unified Budget - and masking the General Fund deficits with SS surpluses. Over a period of 40 years Bolten should be comparing to the General Fund deficit as a percentage of GDP, not the Unified Budget deficit. That is dishonest.

                                Besides, Bolten was also wrong. The way things are going, the US might have a $1 Trillion General Fund budget deficit in 2009 (probably more like $800 Billion).

                                Boltie, you're doing a heck of a job!

                                Update: Brad DeLong has more. He discusses Vox Baby's comments on Bolten.

                                  Posted by Mark Thoma on Tuesday, March 28, 2006 at 10:12 AM in Budget Deficit, Economics, Politics

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                                  Adam Smith on Relative Poverty

                                  Many fans of Adam Smith make the following argument concerning poverty statistics:

                                  Treasury Secretary John Snow ... says ... How the average family is doing in absolute terms is more important than how it is doing relative to others...

                                  Here's a Wall Street Journal commentary by Douglas Besharova from a few days ago that is cited by Donald Luskin in his claim that "The official poverty statistics just can't be right -- showing that the same percentage of Americans lives in poverty as did in 1968":

                                  Each year the Census Bureau calculates the nation's poverty rate, based on the number of people with incomes below the official poverty line... But many analysts ... have pointed out that ... poor people's physical and material well-being is considerably better now than in the late '60s. How else to explain why so many poor now have color TV (93%) ... Millions of low-income Americans are living better lives than they did before. Period.

                                  Adam Smith had something to say on this topic. This is from an article about Mollie Orshansky's development of poverty statistics (long, but worth it) appearing in The New Yorker:

                                  Relatively Deprived, by John Cassidy, The New Yorker: ...The concept of relative deprivation was first described by Adam Smith in “The Wealth of Nations,” in a passage on the “necessaries” of daily life:

                                  By necessaries I understand not only the commodities which are indispensably necessary for the support of life, but what ever the customs of the country renders it indecent for creditable people, even the lowest order, to be without. A linen shirt, for example, is, strictly speaking, not a necessary of life. The Greeks and Romans lived, I suppose, very comfortably, though they had no linen. But in the present times, through the greater part of Europe, a creditable day-laborer would be ashamed to appear in public without a linen shirt, the want of which would be supposed to denote that disgraceful degree of poverty which, it is presumed, nobody can well fall into, without extreme bad conduct. Custom, in the same manner, has rendered leather shoes a necessary of life in England.

                                  Let's use the TV example. A TV, is, "strictly speaking, not a necessary of life." Suppose a family cannot afford a color TV (a 20" flat screen is less than $100). Would the presumption be that the family is living in a "degree of poverty which ... nobody can well fall into, without extreme bad conduct"? Would a parent "be ashamed" to have their children's friends find out they cannot afford a color TV when they come over to visit? If the answer is yes, then Smith would say they are impoverished.

                                    Posted by Mark Thoma on Tuesday, March 28, 2006 at 02:46 AM in Economics, History of Thought, Income Distribution

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                                    Tax Advantages for Foreign Firms in China

                                    Foreign companies locating in China have the advantage of low labor costs. They also pay very low taxes, much lower than domestic Chinese firms, a source of growing political discontent. To solve the problem, taxes on foreign firms located in China must be raised, or taxes on domestic firms must be lowered. The problem is that raising taxes on foreign firms endangers FDI, an important source of growth, and lowering taxes on domestic firms reduces needed tax revenues. Thus, for now, the decision is being postponed:

                                    Beijing's 'separate but unequal' tax dilemma, by Frederick W Stakelbeck Jr, Asian Times: At the ... National People's Congress held in Beijing early this month, NPC spokesman Jiang Enzhu announced that the implementation of the much-anticipated Law on Enterprise Income Tax and the Property Law, designed to unify the income tax rates for domestic entities and foreign-invested enterprises (FIEs), would be postponed. ...

                                    The current Chinese income-tax rate structure has been the subject of intense debate over the past several years. A growing number of Chinese economists, government officials and business leaders have openly criticized the tax policies as being unfair to domestic entities, while at the same time providing competitive advantages to FIEs. ... FIEs pay an average 15% tax rate and Chinese entities pay an average 33%. As a result, FIEs operating in China currently enjoy one of the lowest tax rates in the world.

                                    The generous tax policy has allowed FIEs to reap tremendous annual profits and has facilitated the expansion of their China-based operations. FIEs have flocked to China and taken full advantage of the tax incentives offered by special economic zones (SEZ) and coastal open economic zones (COEZs) to grow their businesses.

                                    In 2001, Beijing pledged to rectify the glaring disparity in the country's income-tax rate structure when it joined the World Trade Organization. The communist government promised to replace the present rate structure with a unified income-tax rate structure that would range from 24-28%. But the proposed changes never materialized, provoking frustration in the Chinese business community and raising fears that preferential income-tax rates would become permanent.

                                    Sources close to the recent NPC summit noted that Beijing's procrastination concerning income-tax reform has been primarily based on fears of catastrophic and permanent foreign direct investment (FDI) losses. Generous FIE tax incentives have fostered foreign investment, which has steadily grown over the past few years... An increasing amount of foreign investment has gone into high-technology sectors such as telecommunications and computers, which are crucial to China's global competitiveness...

                                    Several alternatives have been proposed by various groups to address the country's income-tax-rate dilemma. ... The most likely scenario, and the most controversial, involves Beijing delaying a decision on tax reform indefinitely. Instead, the government would call for additional industry input, cooperative empirical research and independent studies before any broad tax-unification plan commenced...

                                    In 2005, more than 44,000 foreign-funded enterprises were established in mainland China - a tremendous accomplishment by any measure. But few observers would deny that some type of income-tax reform is now needed. ... FIEs [a]re using tax loopholes to evade about $3.75 billion in taxes annually. This, coupled with serious misgivings by the Chinese business community about the fairness of the current dual income-tax system, will eventually force Beijing to take action. ...

                                    If you add up the social services such as health care that the government provides to workers in foreign firms, and also add in government expenditures on roads, police and fire protection, port facilities, legal protection, and so on used by these firms, will 15% minus tax breaks for locating in special economic zones cover the total costs foreign firms impose on China, or is there an implicit subsidy for locating in China built into the tax rates, tax rates that are "one of the lowest tax rates in the world"?

                                    While I can't say for sure, I would guess that an average rate of 15% does not fully cover the costs. At the 24%-28% rate China promised the WTO, tax revenues and costs would be closer to alignment and this would reduce or eliminate the competitive advantage the implicit subsidy provides to foreign firms located in China.

                                      Posted by Mark Thoma on Tuesday, March 28, 2006 at 12:15 AM in China, Economics, International Trade

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                                      Jeffrey Sachs: Depoliticize Development Aid

                                      Jefferey Sachs argues that development aid and political goals should be separated, aid should not be contingent upon the attainment of political objectives set by donor countries:

                                      Development Aid for Development’s Sake, by Jeffrey D. Sachs, Project Syndicate: Almost daily, the United States and Europe brandish threats to impose economic sanctions or cut off development assistance unless some vulnerable government accepts their political strictures. The most recent threats are towards the new Hamas-led government in Palestine. Other recent examples include threats vis-à-vis Chad, Ethiopia, Haiti, Kenya, Bolivia, Uganda, and long-standing sanctions against Myanmar.

                                      To understand why requires taking a long-term view of geopolitics, particularly the gradual decline of US and European global domination. Technology and economic development are proliferating across ... the developing world, while the spread of literacy and political awareness ... made national self-determination by far the dominant ideology of our age... Nationalism continues to produce powerful political “antibodies” to American and European meddling in other countries’ internal affairs.

                                      The failure to understand this lies behind repeated US foreign policy debacles in the Middle East... The US naively continues to view the Middle East as an object of manipulation, whether for oil or for other purposes. In the Middle East, the Iraq war is widely interpreted as a war for US control of Persian Gulf oil – a rather plausible view... Only incredible hubris and naiveté could bring US (and UK) leaders to believe that Western troops would be greeted as liberators rather than as occupiers.

                                      The politicization of foreign aid reflects the same hubris. Even as the US rhetorically champions democracy in the Middle East, its first response to Hamas’s victory was to demand that the newly elected government return $50 million in US aid. Hamas’s doctrines are indeed unacceptable for long-term peace... But cutting aid is likely to increase turmoil rather than leading to an acceptable long-term compromise between Israel and Palestine. ... An aid cutoff should be a policy of last resort, not a first strike.

                                      Aid cutoffs regularly fail to produce desired political results for at least two reasons. First, neither the US nor European countries have much standing as legitimate arbiters of “good governance.” Rich countries have long meddled, often with their own corruption and incompetence, in the internal affairs of the countries that they now lecture. The US preaches “good governance” in the shadow of an unprovoked war, congressional bribery scandals, and windfalls for politically connected companies like Halliburton.

                                      Second, US and European threats to cut off aid or impose sanctions are in any case far too weak to accomplish much besides undermining already unstable and impoverished countries. Consider the recent threats to cut Ethiopia’s aid, which is on the order of $15 per Ethiopian per year – much of it actually paid to US and European consultants. It is sheer fantasy to believe that the threat of an aid cutoff would enable the US and Europe to influence the course of Ethiopia’s complex internal politics. ...

                                      Indeed, the track record of on-again-off-again aid is miserable. Stop-and-go aid has left Haiti in an unmitigated downward spiral. The decade-long sanctions against Myanmar have not restored Aung San Suu Kyi to power, but have deepened the disease burden and extreme poverty... None of this is to suggest that the US and Europe should abide every move by every corrupt dictator. But realism in international economic affairs requires accepting that ... most reliable path to stable democracy is robust and equitable economic progress over an ample period of time.

                                      The overwhelming standard for supplying official development assistance should therefore be whether official assistance actually promotes economic development. ... Can the aid be monitored and measured? Is it being stolen? Is it supporting real development needs, such as growing more food, fighting disease, or building transport, energy, and communications infrastructure?

                                      If development aid can be directed to real needs, then it should be given to poor and unstable countries, knowing that it will save lives, improve economic performance, and thus also improve the long-term prospects for democracy and good governance.

                                        Posted by Mark Thoma on Tuesday, March 28, 2006 at 12:06 AM in Economics, Policy

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                                        March 27, 2006

                                        Krugman's Notes on Immigration

                                        Paul Krugman follows up on his column on immigration:

                                        Notes on Immigration, by Paul Krugman, Money Talks, NY Times: Immigration is an intensely painful topic for a liberal like myself, because it places basic principles in conflict. Should migration from Mexico to the United States be celebrated, because it helps very poor people find a better life? Or should it be condemned, because it drives down the wages of working Americans and threatens to undermine the welfare state? I suspect that my March 27 column will anger people on all sides; I wish the economic research on immigration were more favorable than it is.

                                        In writing this piece I drew mainly on three sources, research papers by economists I know and trust. First is a paper, “Immigration Policy,” by Gordon H. Hanson (pdf) of the University of California at San Diego. Mr. Hanson is one of my former students, and a leading expert on all matters having to do with U.S.-Mexican economic relations, especially issues having to do with income distribution. This paper gives a good overview of the (small) gains from immigration and the fiscal impacts.

                                        Second is a paper by George Borjas and Lawrence Katz of Harvard, “The Evolution of the Mexican-Born Workforce in the United States." (pdf). Mr. Borjas is a leading expert on immigration issues; Mr. Katz is one of America’s leading labor economists.

                                        Third is a paper by Mr. Hanson, Matthew Slaughter of Dartmouth (another former student) and Kenneth Scheve (pdf) of the University of Michigan. This paper alerted me to the way immigration penalizes more generous states.

                                        Like all research results, the conclusions of these papers may have to be revised in the light of future research. But I’m afraid that the three negative conclusions I stressed in the column are fairly robust.

                                        First, the benefits of immigration to the population already here are small. The reason is that immigrant workers are, at least roughly speaking, paid their “marginal product”: an immigrant worker is paid roughly the value of the additional goods and services he or she enables the U.S. economy to produce. That means that there isn’t anything left over to increase the income of the people already here.

                                        You might ask why, in that case, there are any gains from immigration. The answer is that when a country receives a lot of immigrants, the wage paid to immigrants reflects the marginal product of the last immigrant, which is less than that of earlier immigrants. So there is some gain. But as Mr. Hanson explains in his paper, reasonable calculations suggest that we’re talking about very small numbers, perhaps as little as 0.1 percent of GDP.

                                        There is, by the way, a possible out from this argument in the case of high-skill immigrants. You could argue that, say, South Asian engineers who move to Silicon Valley add to the dynamism of the region, generating benefits much larger than their wages. (Economists know that I’m talking about “positive externalities.”) But that’s not an argument you can easily make about Mexican migrants who haven’t completed high school.

                                        My second negative point is that immigration reduces the wages of domestic workers who compete with immigrants. That’s just supply and demand: we’re talking about large increases in the number of low-skill workers relative to other inputs into production, so it’s inevitable that this means a fall in wages. Mr. Borjas and Mr. Katz have to go through a lot of number-crunching to turn that general proposition into specific estimates of the wage impact, but the general point seems impossible to deny.

                                        Finally, the fiscal burden of low-wage immigrants is also pretty clear. Mr. Hanson uses some estimates from the National Research Council to get a specific number, around 0.25 percent of G.D.P. Again, I think that you’d be hard pressed to find any set of assumptions under which Mexican immigrants are a net fiscal plus, but equally hard pressed to make the burden more than a fraction of a percent of G.D.P.

                                          Posted by Mark Thoma on Monday, March 27, 2006 at 06:48 PM in Academic Papers, Economics, Unemployment

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                                          Marriage is for White People

                                          I received an email saying:

                                          There is a lot of economics in this article: 'Marriage Is for White People'. You need to be somewhat brave to post it.

                                          Here it is. As we contemplate immigration policy, it would be helpful to know how much of this problem can be attributed to falling wages and employment opportunities for low-skill labor. The large difference in college attendance between black men and black women is also a factor to consider:

                                          'Marriage Is for White People', by Joy Jones, Commentary, Washington Post: I grew up in a time when two-parent families were still the norm, in both black and white America. Then, as an adult, I saw divorce become more commonplace, then almost a rite of passage. Today it would appear that many -- particularly in the black community -- have dispensed with marriage altogether...

                                          [S]ome 12-year-olds enlightened me ... when I taught a career exploration class. ... I was pleasantly surprised when the boys in the class stated that being a good father was a very important goal to them, more meaningful than making money or having a fancy title. "That's wonderful!" I told my class. "I think I'll invite some couples in to talk about being married and rearing children." "Oh, no," objected one student. "We're not interested in the part about marriage. Only about how to be good fathers." And that's when the other boy chimed in, speaking as if the words left a nasty taste in his mouth: "Marriage is for white people." ...

                                          He's right. At least statistically. ... African Americans ... have the lowest marriage rate of any racial group in the United States. In 2001, according to the U.S. Census, 43.3 percent of black men and 41.9 percent of black women in America had never been married, in contrast to 27.4 percent and 20.7 percent respectively for whites. African American women are the least likely in our society to marry. ... I was stunned to learn that a black child was more likely to grow up living with both parents during slavery days than he or she is today..

                                          Traditional notions of family, especially the extended family network, endure. But ... in an era of brothers on the "down low," the spread of sexually transmitted diseases and the decline of the stable blue-collar jobs that black men used to hold, linking one's fate to a man makes marriage a risky business for a black woman. ...

                                          "Women don't want to marry because they don't want to lose their freedom." Among African Americans, the desire for marriage seems to have a different trajectory for women and men. ... As men mature, and begin to recognize the benefits of having a roost and roots ..., they are more willing to marry and settle down. By this time, however, many of their female peers are satisfied with the lives they have constructed and are less likely to settle for marriage to a man who doesn't bring much to the table. Indeed, he may bring too much to the table: children and their mothers from previous relationships, limited earning power, and the fallout from years of drug use, poor health care, sexual promiscuity. In other words, for the circumspect black woman, marriage may not be a business deal that offers sufficient return on investment.

                                          In the past, marriage was primarily just such a business deal. Among wealthy families, it solidified political alliances or expanded land holdings. For poorer people, it was a means of managing the farm or operating a household. Today, people have become economically self-sufficient as individuals, no longer requiring a spouse for survival. African American women have always had a high rate of labor-force participation. "Why should well-salaried women marry?" asked black feminist and author Alice Dunbar-Nelson as early as 1895. But now instead of access only to low-paying jobs, we can earn a breadwinner's wage, which has changed what we want in a husband. ...

                                          Most single black women over the age of 30 whom I know would not mind getting married, but acknowledge that the kind of man and the quality of marriage they would like to have may not be likely, and they are not desperate enough to simply accept any situation just to have a man. A number of my married friends complain that taking care of their husbands feels like having an additional child to raise. ...

                                          By design or by default, black women cultivate those skills that allow them to maintain themselves (or sometimes even to prosper) without a mate. "If Jesus Christ bought me an engagement ring, I wouldn't take it," a separated thirty-something friend told me. "I'd tell Jesus we could date, but we couldn't marry."

                                          And here's the new twist. African American women aren't the only ones deciding that they can make do alone. Often what happens in black America is a sign of what the rest of America can eventually expect. In his 2003 book, ... Andrew Hacker noted that the structure of white families is evolving in the direction of that of black families of the 1960s. In 1960, 67 percent of black families were headed by a husband and wife, compared to 90.9 percent for whites. By 2000, the figure for white families had dropped to 79.8 percent. Births to unwed white mothers were 22.5 percent in 2001, compared to 2.3 percent in 1960. So my student who thought marriage is for white people may have to rethink that in the future. ...

                                          But human nature being what it is, if marriage is to flourish -- in black or white America -- it will have to offer an individual woman something more than a business alliance, a panacea for what ails the community, or an incubator for rearing children...

                                          Update: See also "The Role of Labor and Marriage Markets, Preference Heterogeneity and the Welfare System in the Life Cycle Decisions of Black, Hispanic and White Women" for recent academic work on this issue.

                                            Posted by Mark Thoma on Monday, March 27, 2006 at 11:50 AM in Economics

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                                            Should High-Skill Labor Immigration Be Limited?

                                            This editorial in the Wall Street Journal arguing for increased immigration of high-skill labor, along with the commentary by Krugman on the need to limit low-skill immigration that follows, illegal immigration in particular, completes an immigration daily double. While discussing the impact of immigration on domestic low-skill workers, Krugman highlights research by Borjas and Katz showing that immigration of low-skill labor lowers wages for workers in those markets. Following up on Krugman's statement that "a review of serious ... research reveals some uncomfortable facts about ... immigration... If people like me are going to respond effectively to anti-immigrant demagogues, we have to acknowledge those facts," a recent paper by Borjas, "Immigration In High-Skill Labor Markets: The Impact of Foreign Students on The Earnings of Doctorates," shows that high-skill immigration has lowered wages as well. Thus, the argument made below that wages are not undercut because "it's illegal to pay these high-skill immigrants less than the prevailing wage" misses how the prevailing wage is affected by immigration:

                                            The Other Immigrants, Review and Outlook, Wall Street Journal: Lost in the heated debate about the future of millions of illegal laborers in the U.S. is that our system for admitting foreign-born professionals is also in tatters. While globalization has increased the competition for international talent, U.S. businesses are frustrated by processing delays, long backlogs and especially the failure of Congress to increase the annual limits on visas for skilled immigrants. The Senate Judiciary Committee is scheduled to resume its mark-up of Arlen Specter's immigration bill today. And the good news is that it contains long-overdue provisions for hiring more of the foreign professionals who help keep our economy competitive.

                                            Under Mr. Specter's proposal, the annual cap on H-1B guest worker visas for immigrants in specialty fields like science and engineering would rise to 115,000 from 65,000. Moreover, the new cap would not be fixed but would fluctuate automatically in response to demand for these visas. ...

                                            Another important reform addresses foreign students who want to work here after graduating from U.S. colleges and universities. It doesn't make a lot of sense in today's global marketplace to educate the best and brightest and then send them away ... to start businesses and develop new technologies for U.S. competitors. But that's exactly what current U.S. policy encourages by limiting the employment prospects of foreign students who would rather stay here.

                                            Mr. Specter would let more foreign students become permanent residents by obtaining an advanced degree in math, engineering, technology or the physical sciences and then finding work in their field. .... The reality today is that the U.S. ... and our economy will suffer if bad policy limits industry's access to intellectual capital.

                                            Anti-immigration groups and protectionists want to dismiss these market forces, arguing that U.S. employers seek foreign nationals only because they'll work for less money. But it's illegal to pay these high-skill immigrants less than the prevailing wage. ...

                                            According to a new study by the National Foundation for American Policy, our broken system for admitting foreign professionals also contributes to outsourcing. Since 1996 the 65,000 annual cap on H-1B visas has been reached in most years, sometimes only weeks into the new year. This leaves employers with the choice of waiting until the next fiscal year to hire workers in the U.S. or hiring people outside the country.

                                            "Many companies concede," says the report, "that the uncertainty created by Congress' inability to provide a reliable mechanism to hire skilled professionals has encouraged placing more human resources outside the United States to avoid being subject to legislative winds." ...

                                            [T]he U.S. labor market has ... long been a magnet for highly skilled and educated foreigners, many of whom attend school in America at some time in their lives. In a world where these brains have more options than ever in Asia and Europe, we drive them away at our economic peril.

                                              Posted by Mark Thoma on Monday, March 27, 2006 at 12:33 AM in Economics, Policy, Politics

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                                              Paul Krugman: North of the Border

                                              Paul Krugman says we need to face up to the facts on immigration:

                                              North of the Border, Immigration Facts, by Paul Krugman, Commentary, NY Times: "Give me your tired, your poor, your huddled masses yearning to breathe free," wrote Emma Lazarus, in a poem that still puts a lump in my throat. I'm proud of America's immigrant history, and grateful that the door was open when my grandparents fled Russia.

                                              In other words, I'm instinctively, emotionally pro-immigration. But a review of serious, nonpartisan research reveals some uncomfortable facts about the economics of modern immigration, and immigration from Mexico in particular. If people like me are going to respond effectively to anti-immigrant demagogues, we have to acknowledge those facts.

                                              First, the net benefits to the U.S. economy from immigration, aside from the large gains to the immigrants themselves, are small. Realistic estimates suggest that immigration since 1980 has raised the total income of native-born Americans by no more than a fraction of 1 percent.

                                              Second, while immigration may have raised overall income slightly, many of the worst-off native-born Americans are hurt by immigration — especially immigration from Mexico. Because Mexican immigrants have much less education ... they increase the supply of less-skilled labor, driving down the wages of the worst-paid Americans. The most authoritative recent study ... by George Borjas and Lawrence Katz of Harvard, estimates that U.S. high school dropouts would earn as much as 8 percent more if it weren't for Mexican immigration.

                                              That's why it's intellectually dishonest to say, as President Bush does, that immigrants do "jobs that Americans will not do." The willingness of Americans to do a job depends on how much that job pays — and the reason some jobs pay too little to attract native-born Americans is competition from poorly paid immigrants. Finally, ... our social safety net has more holes in it than it should — and low-skill immigrants threaten to unravel that safety net. ... Unfortunately, low-skill immigrants don't pay enough taxes to cover the cost of the benefits they receive. ...

                                              We shouldn't exaggerate these problems. Mexican immigration, says the Borjas-Katz study, has played only a "modest role" in growing U.S. inequality. And ... the disastrous Medicare drug bill alone does far more to undermine ... our social insurance system than the whole burden of ... illegal immigrants. But modest problems are still real problems, and immigration is becoming a major political issue. What are we going to do about it?

                                              Realistically, we'll need to reduce the inflow of low-skill immigrants. ... But the harsh anti-immigration legislation passed by the House... legislation that would, among other things, make it a criminal act to provide an illegal immigrant with medical care — is simply immoral.

                                              Meanwhile, Mr. Bush's plan for a "guest worker" program is clearly designed by and for corporate interests, who'd love to have a low-wage work force that couldn't vote. Not only is it deeply un-American; it does nothing to reduce the adverse effect of immigration on wages. And because guest workers would face the prospect of deportation after a few years, they would have no incentive to become integrated into our society.

                                              What about a guest-worker program that includes a clearer route to citizenship? I'd still be careful. ... it could all too easily ... create a permanent underclass of disenfranchised workers. We need to do something about immigration, and soon. But I'd rather see Congress fail to agree on anything this year than have it rush into ill-considered legislation that betrays our moral and democratic principles.

                                              Previous (3/24) column: Paul Krugman: Letter to the Secretary Follow up (3/27): Krugman's Money Talks: Notes on Immigration Next (3/31) column: Paul Krugman: The Road to Dubai

                                                Posted by Mark Thoma on Monday, March 27, 2006 at 12:15 AM in Economics, Policy, Politics, Unemployment

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                                                Falling Real Wages and Widening Inequality

                                                Greg Ip summarizes the data and debate on real wage growth and changes in inequality since 2000:

                                                Wages Fail to Keep Pace With Productivity Increases, Aggravating Income Inequality, by Greg Ip, Wall Street Journal (free): Since the end of 2000, gross domestic product per person in the U.S. has expanded 8.4%, adjusted for inflation, but the average weekly wage has edged down 0.3%. That contrast goes a long way in explaining why many Americans ... don't believe the Bush administration when it trumpets the economy's strength. What is behind the divergence?...

                                                Some factors aren't in dispute. Since the end of the recession of 2001, a lot of the growth in GDP per person ... has gone to profits, not wages. This reflects workers' lack of bargaining power in the face of high unemployment and companies' use of cost-cutting technology. ... Another factor holding down wages is that employer-paid health benefits, pensions and payroll taxes have risen almost 16% since 2000, making employers less generous with wages. Also ..., people at the top -- executives, managers and professionals -- are widening their lead on the rest.

                                                The role of inequality is contentious. Treasury Secretary John Snow... says, "Since the early 1980s on, we've seen a rise in inequality but we've also seen ... a continuous rise in living standards." How the average family is doing in absolute terms is more important than how it is doing relative to others ... Still, the gap between the wages of the highest- and lowest-paid workers has continued to widen. Based on Labor Department data, ... the weekly wage of the worker at the 10th percentile ... fell 2.7% from 2000 to 2005, adjusted for inflation. The wage of the worker at the 90th percentile rose 5.3%.

                                                Many economists predict that with the U.S. unemployment rate below 5% now, workers will regain their leverage. Indeed, wages have picked up recently. Still, wage inequality may continue to rise. Lawrence Katz, an economist at Harvard University ... says the wage gap has been growing for the past 25 years, particularly between the top and the middle. He believes the biggest factor is technology, which has complemented the skills of the well-educated while rendering redundant routine skills of many in the middle.

                                                "The factors that seem to be driving it are continuing: the broad span of the computer revolution," he says. "For people in the middle the big question is: Will our education system give them ... skills that are very valuable?..." Mr. Snow, a Ph.D. economist, says income equality ultimately reflects "equality of educational opportunities," and if the U.S. can "reduce the variability of educational opportunities," it will also reduce the income gap.

                                                History suggests that with unemployment low and growth steady, the typical family will see its income rise noticeably. As that happens, Americans' spirits will rise, as well.

                                                  Posted by Mark Thoma on Monday, March 27, 2006 at 12:06 AM in Economics, Income Distribution

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                                                  March 26, 2006

                                                  Dobbsism

                                                  Is Lou Dobbs bad for America?:

                                                  Dobbsism, unintelligently designed for our times, By Benn Steil, Commentary, Financial Times:

                                                  Even if the result is more profits for multinational corporations, do we truly believe that exporting those jobs will lead to a better life in this country, for our workers?...Or should we rely on public policy, regulation, tariffs, and quotas to protect our standard of living? Or should we share the blind faith of many in corporate America and Washington, in the power of a free market to resolve these questions? - Lou Dobbs, Exporting America, 2004

                                                  Faith is required in all views regarding the beginning of life, whether scientific, so-called, or whether religious...The fact is that evolution, Darwinism, is not a fully explained or completely rigorous and defined science that has testable results within it. - Lou Dobbs, CNN, May 12, 2005

                                                  As an economist, I feel a communal and curmudgeonly kinship with evolutionary biologists. We are ... in a seemingly endless ... struggle to persuade others that impersonal and unseen forces shape our world in predictable ways which, though far from obvious, are eminently demonstrable. The resistance we are up against I will call Dobbsism. Dobbsism is ... exemplified by crusading American television anchor Lou Dobbs... It is the consciousness behind belief in intelligent design, according to which biological life must have been designed by a creator, given its complexity. It is likewise behind the belief that a complex social construct like a “national economy” must be deliberately designed by enlightened policymakers, lest joblessness, poverty and mass bankruptcy result from the neglect.

                                                  To be clear, no biologist would claim that conscious design cannot improve on unguided evolution. Thousands of years of deliberate human genetic modification of animals and plants attest otherwise. Likewise, no economist would claim that economic outcomes cannot be improved by policy interventions. ... However, it is exceptionally well established that enormous and highly adaptive biological complexity can emerge, and has emerged, over periods of time that are well beyond what humans can intuitively grasp, through processes that are entirely unguided by a deliberate, thinking force. Evolution is indeed “just a theory”. Gravity is as well. But evolution is a theory strongly supported by the fossil record, comparative anatomy, the distribution of species, embryology and molecular biology.

                                                  Likewise, the foundation of the doctrine of free trade, that there is an inherent gain in production specialisation along the lines of comparative competence, is far from obvious but logically impeccable and empirically sound. Of this theory of comparative advantage, Nobel Prize winner Paul Samuelson wrote: “That it is logically true need not be argued before a mathematician; that it is not trivial is attested by the thousands of important and intelligent men who have never been able to grasp the doctrine for themselves or to believe it after it was explained to them.”

                                                  Why should we care? Well, Dobbsism ... can be dangerous. Take President George W. Bush’s imposition of tariffs on imported steel in 2002, on which Mr Dobbs commented enthusiastically that: “It appeared that the president had decided he had a far more important constituency to serve than the members of the World Trade Organisation, the European Union, and the so-called free traders: namely, working men and women in this country”. Powerful stuff. But is it true that Mr Bush faced down foreigners and free traders to the benefit of American workers?

                                                  It is a simple task to count the number of American steel workers at two different points in time, even if it is less straightforward to determine the portion of any decline that resulted from foreign competition (as opposed to, for example, new technology). Unfortunately for economists however, they must apply considerably more data and higher maths in order to estimate the effect of steel tariffs on American workers, the vast majority of whom do not work in the steel industry. Studies have found that the tariffs produced tens of thousands of job losses in steel-using industries. Yet since statistical estimation techniques are not nearly as comforting as counting steel workers, Dobbsism would dismiss such an exercise as “just theory”...

                                                  But this leaves the hard question unanswered. Even if "no economist would claim that economic outcomes cannot be improved by policy interventions," there is considerable disagreement about how much policy intervention is optimal. How much "genetic alteration" should we do in an attempt to make the economy yield higher welfare returns?

                                                    Posted by Mark Thoma on Sunday, March 26, 2006 at 12:06 PM in Economics, International Trade, Policy, Regulation

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                                                    Geopolitics and Geoeconomics

                                                    This article argues that many proponents of free trade and globalization do not pay enough attention to the conflict between economics and geopolitics that globalization brings about and that, though globalization in some form is inevitable, it will be guided and limited by political realities:

                                                    Globalization 2.0, by David Rieff, NY Times Magazine: Globalization is both unavoidable and of great benefit to the world as a whole. At least that has been the conventional wisdom..., except at the far fringes of the radical, antiglobalization left and the xenophobic, protectionist right. But is it true? Is the march toward economic interdependence, open markets and the weakening of national identity really as unstoppable as all that?

                                                    Two recent controversies — the sale of port facilities to a company owned by the government of Dubai and the negotiation of a controversial nuclear cooperation deal with India — underscore the tensions and contradictions between America's commitment to economic globalization and its political priorities in a post-9/11 world.

                                                    In part, these controversies pitted desirable outcomes — political stability and national security on the one hand; economic dynamism on the other — against one another. In the ports case, the principles of globalization demanded that the Dubai company be allowed to take over the management of the six ports in question. But advocates of globalization never really took into account ... that even as nations become interdependent..., political difficulties may continue to separate them.

                                                    Globalization is a coherent theory for times of comparative peace and economic expansion like the 1990's. It is less persuasive in times of conflict and fear like those we live in today. Although ... Karl Rove has insisted that Democrats live in a pre-9/11 world and Republicans do not, the Bush administration's defense of the ports deal seems like a classic case of pre-9/11 thinking. The administration argued that the deal had to go forward if Americans were to remain true to their commitment to open markets... But add the threat of terrorism and the specter of weapons of mass destruction to the equation, and suddenly the words "free movement" seem more like a threat than a harbinger of a more prosperous economic future.

                                                    Bush's deal with India also illustrates the new and unexpected conundrums of globalization. The administration pledged to help India develop nuclear power plants despite that country's refusal to sign the Nuclear Nonproliferation Treaty and its maintenance of an atomic-weapons arsenal. An implicit argument was this: Because India is so important a strategic partner and, prospectively at least, a major economic power, Washington is no longer in a position to insist, even rhetorically, that New Delhi abide by the established rules of the nuclear game.

                                                    U.S. officials made little effort to deny that they were making an exception in India's case — an exception they were at pains to point out they would never make for Iran. Rather, as Bush made clear ... the cementing and deepening of the U.S.-Indian alliance were simply too important to allow a mere international legal regime to get in the way. ... Better to accept an India that uses more civilian nuclear power (and offers U.S. companies the chance to benefit from the sector's expansion) than to vainly chastise an India that is not going to abandon its nuclear arsenal anyway, whatever the effect on nonproliferation globally.

                                                    In retrospect, globalization's most fervent partisans and critics were both naïve to imagine that geopolitics would play second fiddle to geoeconomics... The Achilles heel of that "inevitabilist" vision of globalization, so dominant in the 1990's, was its rigid ... economic determinism. Today's globalization — inseparable from political concerns, no longer able to overrule nationalist sentiments or national security objections, increasingly marked by the phenomenon of Asian companies buying European and North American assets — is most likely to be far more controversial and far less orderly.

                                                    In all likelihood, Asians will complain about Western hypocrisy. After all, when globalization meant Western companies buying one another and acquiring assets in Asia, the U.S. and the countries of the European Union were unstinting advocates of globalization. Now it may seem that Western nations were never committed to ... globalization in the true sense of the word — but simply to opening new markets for their own corporations and exporting political and legal norms coined in Washington or Brussels. But could it have been otherwise? As both the Indian nuclear agreement and the furor over the Dubai ports deal demonstrate, imagining that nations could not politicize international trade and economic issues or legal norms is as vain a hope as expecting them to act against their own self-interest in any other sphere of public life. Doubtless, some form of globalization is unavoidable. It will just not be the globalization we had been led to expect.

                                                      Posted by Mark Thoma on Sunday, March 26, 2006 at 01:38 AM in Economics, International Trade, Politics

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                                                      Why is the Trade Gap So Persistent?

                                                      This article asks why the trade gap appears stickier, i.e. is not moving back towards zero, as quickly as it did in the past. Several reasons are cited, the most prominent being the increased proportion of total trade with countries that peg their exchange rate and interfere with the automatic adjustment mechanism:

                                                      A Stickier Trade Gap By Daniel Altman, Economic View, NY Times: ...Last year was the eighth in a row with a record-setting deficit in the nation's current account, which includes the trade balance and other income from abroad. Yet once upon a time, that big deficit turned around, and it took a mere five years. Could that, too, happen again this time? ... From 1987 to 1991, the annual current account deficit fell from a peak of almost $161 billion — equivalent to about 3 percent of the domestic economy — to less than $3 billion. This time, however, the challenge is bigger: the deficit of $805 billion for 2005 was about 6 percent of the domestic economy. And there are other factors that could make a turnaround much more difficult.

                                                      First, consider what took place in the late 1980's and early 1990's. The dollar was falling rapidly against foreign currencies, partly as a result of coordination by the governments of the world's five biggest economies. As the dollar fell, American investments became less attractive to foreign investors; the same returns would be worth less when converted into their home currencies. The returns themselves were falling, too. ...

                                                      Clearly, the United States was becoming a relatively less attractive place to invest. The value of the dollar and investment returns held hands as they jumped off a cliff. At the same time, the current account deficit narrowed. Americans couldn't afford as many foreign goods, and foreigners could afford more American goods.

                                                      Now things are heading in the same direction — sort of. While long-term interest rates remain stubbornly low ... in the United States, they are finally starting to rise in Japan and Germany. Those changes may be starting to make a difference in foreign investors' preferences, said Maury N. Harris, chief United States economist at UBS Securities. "When you look at the monthly Treasury international capital flows data, your capital inflows aren't as strong as they were, let's say, six months ago," he said. Mr. Harris said he also expected to see the dollar's value decline this year, by about 9 percent relative to the euro.

                                                      But even if exchange rates change with the euro and Japanese yen, it probably won't solve the problem the way it did from 1987 to 1991. The big difference is the "changing shares of who we import from, and very few changes in who we export to," said Catherine L. Mann, a senior fellow at the Institute for International Economics... "It's important, because who we import from increasingly is from countries that have exchange rates that have not moved very much."

                                                      Back in 1987, the nation's current account deficit with Japan and Europe, which had fairly flexible currencies, was 62 percent of the total deficit. Last year, it was just 32 percent. In 1987, the current account deficit with the rest of Asia, Africa and Latin America was about 50 percent of the total. In 2005, the share of the deficit for those regions, where many countries link their currencies to the dollar, was an enormous 71 percent. (The numbers in each year don't add up to 100 percent because of surpluses with other countries and international organizations.) These changes matter, because countries like China protect their currency links by keeping plenty of dollar-denominated securities in reserve in their central banks. ...

                                                      "The U.S. capital markets are where people want to invest their money right now," [Columbia] Professor [Robert] Hodrick said, "and the performance of our economy has been really extraordinary, so there's no reason to think that that's a bad idea." ... For the current account deficit to turn around in a hurry in this climate ... the United States economy would have to become genuinely weak while that of the rest of the world was strong. Some forecasters do see growth slowing here in the next year or two, while Germany and Japan pick up, and ... the current account deficit could start to shrink by the end of next year. But ... without really big differences in economic growth, a return to balance in the current account could take a decade — not just five years, as before. Given the alternative, that might not be so bad.

                                                      Echoing a point Brad Setser also makes, since the investment in the U.S. is largely from foreign central banks, the focus on business conditions and asset returns as an explanation for the trade balance misses a point Larry Summers was trying to make in his speech. Summers believes "an international facility in which countries could invest their excess reserves without taking domestic political responsibility for the process of investment decision and ultimate result" is needed to allow foreign central banks to diversify their reserve holdings.

                                                        Posted by Mark Thoma on Sunday, March 26, 2006 at 01:17 AM in Economics, International Trade

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                                                        Putin Accused of Plagiarizing His Dissertation

                                                        Vladimar Putin is accused of copying a large part of his dissertation from a management text:

                                                        Researchers peg Putin as a plagiarist over thesis, by David R. Sands, Washington Times: Vladimir Putin -- KGB spy, politician, Russian Federation president, 2006 host of the Group of Eight international summit -- can add a new line to his resume: plagiarist. Large chunks of Mr. Putin's mid-1990s economics dissertation on planning in the natural resources sector were lifted straight out of a management text published by two University of Pittsburgh academics nearly 20 years earlier ... "Somebody was cutting corners," said Mr. Gaddy, "whether it was Mr. Putin or whoever cut-and-pasted the work for him." ... Mr. Putin's effort should be seen in a Russian, post-Soviet context, some scholars said. E. Wayne Merry ... at the American Foreign Policy Council, said dubious academic credential building was common in Eastern Europe and especially the old East Germany... "It was really quite common for an up-and-coming apparatchik to get a ghostwritten work done to obtain a degree," he said. "It's probably an open question whether Putin even read his dissertation until shortly before he had to defend it."...

                                                          Posted by Mark Thoma on Sunday, March 26, 2006 at 12:43 AM in Economics

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                                                          The Velocity of Money and Recessions

                                                          Here's a brief follow-up to the post on velocity. The graphs show the percentage change (year over year rather than month to month as before) in M1, M2, and M3 income velocity, and add NBER dated recessions:

                                                            Posted by Mark Thoma on Sunday, March 26, 2006 at 12:33 AM in Economics, Monetary Policy

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                                                            March 25, 2006

                                                            What Jobs Should Laid-Off Workers Be Retrained To Do?

                                                            This article is an attempt to address an often repeated, but hard to answer question, what jobs to target when designing education and retraining programs for displaced workers. However, the article is more successful at identifying the problems than it is at finding a recipe for solving the displaced worker problem:

                                                            Retraining Laid-Off Workers, but for What?, by Louis Uchitelle, NY Times: Layoffs have disrupted the lives of millions of Americans over the last 25 years. The cure that these displaced workers are offered — retraining and more education — is heralded as a sure path to new and better-paying careers. But often that policy prescription does not work, as this book excerpt explains. It is adapted from "The Disposable American: Layoffs and Their Consequences" by Louis Uchitelle, an economics writer for The New York Times...

                                                            JO GOODRUM, a thin, energetic woman older than her audience of aircraft mechanics ... got their attention with a single, unexpected sentence... Her husband, she said, had been laid off six times since the late 1980's. And yet here she was, standing before them, in one piece, cheerful, apparently O.K., giving survival instructions to the mechanics, who would be laid off themselves in 10 days.

                                                            They were, in nearly every case, family men in their 30's and 40's who had worked for United Airlines since the mid-1990's. ... Confrontation had brought on the layoffs. Influenced by militants in their union local, Hoosier Air Transport Lodge 2294 of the International Association of Machinists, the 2,000 mechanics at the center had engaged in a work slowdown for many months, and then a refusal to work overtime. But rather than give ground, United responded by outsourcing, sending planes to nonunion contractors elsewhere in the country. That scared the mechanics. They quieted down and, in effect, authorized the leaders of Lodge 2294 to make peace. ... In this state of mind, the union was helping to usher the 60 laid-off mechanics quietly away. It had rented the conference room on this cold January evening in 2003 to introduce the men to what amounted to a boot camp for recycling laid-off workers back into new, usually lower-paying lines of work.

                                                            SIMILAR federally subsidized boot camps, organized by state and local governments, often in league with unions, have proliferated in the United States since the 1980's, and now many cities have them. Unable to stop layoffs, government has taken on the task of refitting discarded workers for "alternate careers." ... The presumption — promoted by economists, educators, business executives and nearly all of the nation's political leaders, Democrats and Republicans alike — holds that in America's vibrant and flexible economy there is work, at good pay, for the educated and skilled. The unemployed need only to get themselves educated and skilled and the work will materialize...

                                                            If the workers were already trained, as the mechanics certainly were, then what they needed was additional training and counseling as a transition into well-paying, unfilled jobs in other industries. If the transition failed to function as advertised, ... the accepted wisdom suggested that it was the fault of the workers themselves. Their failure to land good jobs was due to personality defects or a resistance to acquiring new skills or a reluctance to move where the good jobs were...

                                                            You cannot be an engineer or an accountant without a degree; in that sense, education and training certainly do count. Furthermore, in the competition for the jobs that exist, the educated and trained have an edge. That advantage shows up regularly in wage comparisons. But you cannot earn an engineer's or an accountant's typical pay if companies are not hiring engineers and accountants...

                                                            For the mechanics at the Days Inn, the retraining process would begin in a few days with workshops in résumé writing and interviewing skills, personality evaluations and job counseling — and, for a lucky few, tuition grants to go back to school. The mechanics were being "counseled out" of their well-paying trade, as some of them wryly put it...

                                                            In the blue-collar world, aircraft mechanics are at the top, and these were painful economies for them. They are the highly skilled people who repair and overhaul the nation's airliners. Each mechanic in the room had completed two years of college like schooling to qualify for the exacting ... work carried out at the maintenance center. Several compared their role proudly to that of a pilot, claiming as much credit as the pilots for the safety of air travel.

                                                            Now they were falling out of this high-level world, in most cases for good. They were unlikely to match or come close in their next jobs to the level of pay that would soon cease. They would be newcomers again in the work force. They must learn how to get a foot in the door... Their careers were gone, and the grief at this loss must be absorbed in order to move on. ...

                                                            Three months later, in April 2003, United abruptly laid off the 1,100 remaining mechanics... Outsourcing had won, hands down...

                                                            IN an earlier era, the two sides would have tried to settle their differences through negotiation and would probably have succeeded. There was really no other alternative. The outsourcing of maintenance did not exist before the 1980's; airlines did their own maintenance. But now layoffs and outsourcing had become an easy and acceptable option. Everywhere in America, the barriers to layoffs came down one after another starting in the late 1970's, and by the turn of the century there was acquiescence. ...

                                                            What had started as an escape from a unionized, often militant work force took on a second function. The outsourcing of heavy maintenance became a means for the airlines to cut costs, and nearly every major airline gradually moved that way...

                                                            The 60 mechanics gathered at the Days Inn that January evening were in the fourth wave to lose their jobs, bringing the total to 1,200. The recycling of former mechanics into new lines of work was now in full swing... Tori E. Bucko... turned out to be the main speaker, the chief of the boot camp that the mechanics were being encouraged to enter.

                                                            Given her responsibilities, Ms. Bucko was surprisingly young — only 30. But ... she would soon play a more important role in the lives of many of the mechanics than ... the union they were leaving behind. The program that Ms. Bucko directed was sponsored by the Indianapolis Private Industry Council, a coalition of companies, unions, government agencies and civic groups. Virtually all of the funding comes from Washington, which sends less than $7 billion a year to the states to recycle laid-off workers back into jobs. ... Ms. Bucko's task, in this initial presentation at the Days Inn, was to encourage the 60 mechanics to take the next step. There would be no help for them if they failed to show up at the AIR Project's center, in an industrial park not far from the airport. There, they would be asked to fill out a detailed enrollment application and submit to a series of workshops and evaluations.

                                                            What Ms. Bucko did not mention was the pressure on her employer, Goodwill Industries, and on herself, to meet the employment goals specified in the federal grant — to get most of the mechanics re-employed at 90 percent of their previous wage. Meeting this goal was a condition for getting more federal money once the initial grant expired. ... But the employment goals were not met. They could not be met; they were too optimistic, mythically optimistic. Ms. Bucko knew that as she struggled to meet the standard. ...

                                                            Job training, as a result, became a channeling process, channeling the unemployed into the unfilled jobs that do exist, with a veneer of training along the way. Yet job training is central to employment policy. It has been since 1982, when Congress passed the Job Training Partnership Act at the urging of President Ronald Reagan. President Bill Clinton took job training ... further, making it available to higher-income workers — including the aircraft mechanics in Indianapolis.

                                                            Saying that the country should solve the skills shortage through education and training became part of nearly every politician's stump speech, an innocuous way to address the politics of unemployment without strengthening either the bargaining leverage of workers or the federal government's role in bolstering labor markets.

                                                            But training for what? The reality, as the aircraft mechanics discovered, is painfully different from the reigning wisdom. Rather than having a shortage of skills, millions of American workers have more skills than their jobs require. That is particularly true of college-educated people, who make up 30 percent of the population today, up from 10 percent in the 1960's. They often find themselves working in sales or as office administrators, or taking jobs in hotels and restaurants, or becoming carpenters, flight attendants and word processors.

                                                            The number of jobs that require a bachelor's degree has indeed been growing, but more slowly than the number of graduates... The Labor Department's Bureau of Labor Statistics offers a rough estimate of the imbalance in the demand for jobs as opposed to the supply. ... On average, there were 2.6 job seekers for every job opening over the first 41 months of the survey. That ratio would have been even higher, according to the bureau, if the calculation had included the millions of people who stopped looking for work because they did not believe that they could get decent jobs.

                                                            So the demand for jobs is considerably greater than the supply, and the supply is not what the reigning theory says it is. Most of the unfilled jobs pay low wages and require relatively little skill, often less than the jobholder has. From the spring of 2003 to the spring of 2004, for example, more than 55 percent of the hiring was at wages of $13.25 an hour or less: hotel and restaurant workers, health care employees, temporary replacements and the like.

                                                            That trend is likely to continue. Seven of the 10 occupations expected to grow the fastest from 2002 through 2012, according to the Labor Department, pay less than $13.25 an hour, on average: retail salesclerks, customer service representatives, food service workers, cashiers, janitors, nurse's aides and hospital orderlies.

                                                            The $13.25 threshold is important. More than 45 percent of the nation's workers, whatever their skills, earned less than $13.25 an hour in 2004, or $27,600 a year for a full-time worker. That is roughly the income that a family of four must have in many parts of the country to maintain a standard of living minimally above the poverty level. Surely lack of skill and education does not hold down the wages of nearly half the work force.

                                                            Something quite different seems to be true: the oversupply of skilled workers is driving people into jobs beneath their skills and driving down the pay of jobs equal to their skills. Both happened to the aircraft mechanics laid off by United.

                                                              Posted by Mark Thoma on Saturday, March 25, 2006 at 02:00 PM in Economics, International Trade, Policy, Unemployment

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                                                              The Relationship Between Manufacturing Production and GDP

                                                              After posting this graph showing the relationship between industrial production (IP) and GDP, I was made aware of research on this topic by Charles Steindel appearing in the New York Fed's August 2004 issue of Current Issues in Economics and Finance. In examining the graph I posted, it is difficult to see any change in the relationship between IP and GDP over time. This paper shows that a change in the trend relationship between the two series since 2001 is detectable when the series are put into a comparable basis (basically, manufacturing IP vs. the goods component of GDP) and offers reasons for the break in the relationship:

                                                              The Relationship between Manufacturing Production and Goods, by Charles Steindel, NY Fed: The sharp divergence in the 2001 recession between two key economic indicators—manufacturing production and goods output—could suggest that one indicator is flawed, casting doubt on the reliability of its overall series. This analysis finds no evidence of error. Rather, the strength of spending on consumer—relative to capital—goods and the growth of merchandising services in the sale of consumer goods more likely explain the recent deviation.

                                                              A curious phenomenon of the 2001 recession was the sharp divergence between two arguably similar economic indicators: the manufacturing component of industrial production and the goods output component of GDP.1 Adding to the peculiarity is the fact that the indicators’movements were much more alike in the previous recession, 1990-91.

                                                              Beginning in mid-2000, manufacturing, or "factory," production experienced significant declines. ... In the year and a half that followed, production grew very little. ... The GDP data tell a different story. The 2001 downturn witnessed virtually no drop in overall GDP, and there has been substantial growth since then. ... GDP encompasses more than just manufacturing activity, so it may not necessarily move in step with manufacturing production.2 Within the GDP data, however, is a series—goods output—that measures U.S. production of goods. The ... series, which accounts for about 40 percent of GDP, measures the same type of activity as manufacturing production does. Yet this series, like overall GDP, has behaved quite differently than the factory output numbers in recent years...

                                                              The recent divergence of these two sets of data raises a pertinent question... Namely, are manufacturing production and goods output measuring the same type of activity? If they are, their separate paths could suggest that one indicator has been in error and thus cast doubt on the reliability of the overall industrial production or GDP number.

                                                              In this edition of Current Issues, we investigate the reasons for the varying paths of manufacturing production and goods output during the most recent recession—and the possibility that one series has missed the mark. ... Our investigation yields no evidence of error in either series. ...

                                                              Having rejected the possibility of indicator error, we argue that the divergence between goods output and manufacturing production in the 2001 recession and subsequent recovery stems largely from two interrelated trends: the strength of spending on consumer goods relative to spending on capital goods, and the growing importance of merchandising services... Since the output of service sector workers ... is counted in goods output but not in manufacturing production, these trends very likely helped buoy the goods output figure during the recession and beyond.

                                                              Manufacturing Production and Goods Output Manufacturing production is a robust measure of the value-added of factories. ... The other measure we examine, goods output, cumulates spending on goods in the United States by households, businesses, and governments ... plus exports of goods less imports of goods. At first glance, this concept appears quite similar to manufacturing production: U.S. spending on goods other than imports seems much the same as spending on goods produced in the United States, which in turn should be equivalent to the output of American factories.

                                                              In truth, however, there is a striking difference between the two measures (see box). ... a major distinction between the two indicators is the inclusion in goods output of the domestic service content of retail spending, whether the consumer good is made in a U.S. factory or abroad. ...

                                                              Long-Run and Cyclical Behavior of the Two Measures Although manufacturing production and goods output differ conceptually, the two series may typically grow and shrink together. If so, the divergence in recent years may have been ephemeral...5 To explore this possibility, we study the relative behavior of the two aggregates over the long run and during key business cycles. Since the aggregates do not encompass the same menu of products, we begin by making the two series as comparable as possible...

                                                              We can now compare movements in the two adjusted series over the long term (Chart 1). Since 1972, goods output has consistently grown more strongly than manufacturing production—at an average rate of 3.5 percent, compared with 2.6 percent...

                                                              Chart 1 Goods Output and Manufacturing Production over the Long Run

                                                              Sources: U.S. Department of Commerce, Bureau of Economic Analysis; Board of Governors of the Federal Reserve System; author’s calculations.

                                                              The adjusted data suggest that in the typical cycle, manufacturing production drops more rapidly than goods output in a recession and rebounds more slowly in a recovery—with the major exception being the early 1990s. We illustrate this point in Chart 2, which shows the cyclical movement of the two series with their values at cyclical peaks (the 1980:1 peak is omitted). ...

                                                              Chart 2 Goods Output and Manufacturing Production in Cyclical Downturns

                                                              Sources: U.S. Department of Commerce, Bureau of Economic Analysis; Board of Governors of the Federal Reserve System; author’s calculations.

                                                              Note: The shaded areas indicate periods designated national recessions by the National Bureau of Economic Research.

                                                              This cyclical comparison suggests that the more peculiar experience is not that of 2001 but that of 1990-91, because the swing in goods output was then comparable to the swing in manufacturing production. In view of the other episodes, it was unusual for a manufacturing cycle of the magnitude seen in the early 1990s to have been associated with such a significant swing in goods output; goods output is typically much more stable than manufacturing production. ...

                                                              The Role of Service Inputs Goods output incorporates all of the service sector activity associated with the sale of goods. The higher long-run trend of goods output compared with manufacturing production suggests that the relative importance of the service inputs to the sale of goods has been growing. In this part of our analysis, we consider two factors that may have combined to account for this growth: a shift in spending to goods whose purchase price incorporates a higher fraction of U.S. service input and an increase in the service inputs to goods in general.

                                                              As we have observed, an imported good requires some U.S. service sector inputs in order to be sold. Thus, the growth of trade and, in particular, the rising significance of imports have, all things equal, likely elevated goods output relative to manufacturing production,7 Although the greater importance of trade does not by itself represent a change in the fundamental service intensity of goods sold—imported shirts, for example, do not require more selling effort by retailers than do domestic products—the trade factor can be viewed as a spending shift to more service-intensive goods.

                                                              One can also argue that there has been some increase in the underlying service intensity of a major portion of goods output. ... Since the early 1980s, retail output has grown more rapidly than consumer spending on goods (Chart 3). This phenomenon suggests that the service component of goods output over the long run has increased for reasons other than the mere rise in the import share of purchases.8

                                                              Chart 3 Retail Output and Consumer Spending on Goods

                                                              Source: U.S. Department of Commerce, Bureau of Economic Analysis.

                                                              Notes: The data do not incorporate the recent benchmark revisions to the National Income and Product Accounts because the longer term GDP by-industry data have not been updated; thus, they end in 2002. The revisions appear to have had little effect on the consumer goods data.

                                                              The Role of Spending As we have suggested, the divergence of manufacturing production and goods output over recent decades likely stems from long-run forces such as the increasing importance of foreign trade and the growth in service inputs to the sale of consumer goods. Yet such long-run forces may not play a role in a sharp short-term divergence like the one in 2001. In particular, trends in the fundamental service intensity of the marketing of individual products seem unlikely to vary much with short-term swings in the economy. ... The cyclical divergences may owe more to swings in the composition of goods demand and to differences in the sale and production of major categories of goods.

                                                              In particular, as Table 3 shows, recessions see greater declines in capital spending than in consumer spending. Indeed, in two of the last four recessions of any length (we exclude the extremely brief 1980 downturn), consumer spending on goods was higher at the end of the downturn than at the beginning. In addition, in three of the recessions, the drop in real spending on capital goods was at least 5 percentage points deeper than the change in spending on consumer goods. The exception is 1990-91...

                                                              Table 3 Changes in Consumer Goods Spending and Capital Goods Spending during and after Recent Recessions

                                                              Period Consumer Goods Capital Goods
                                                              Recession
                                                              1973:4-1975:1
                                                              -2.2
                                                              -9.5
                                                              1981:3-1982:4
                                                              0.6
                                                              -9.7
                                                              1990:3-1991:1
                                                              -1.5
                                                              -3.4
                                                              2001:1-2001:4
                                                              4.2
                                                              -8.4
                                                              First year of expansion
                                                              1975:1-1976:1
                                                              5.9
                                                              1.8
                                                              1982:4-1983:4
                                                              7.5
                                                              20.3
                                                              1991:1-1992:1
                                                              2.4
                                                              1.5
                                                              2001:4-2002:4
                                                              2.5
                                                              1.6

                                                              Source: U.S. Department of Commerce, Bureau of Economic Analysis.

                                                              Why should the relative strength in consumer spending affect the relative performance of goods output and manufacturing production? As we have observed, consumer goods appear to require a higher fraction of service inputs to bring to market than do capital goods. A decline in production associated with a drop in spending on capital goods may involve less of a drop in related service sector inputs (and thus in overall goods output) than does a comparable decline in spending on consumer goods. ... the 1990-91 recession was atypical because the consumer share of the spending decline was unusually high.

                                                              Chart 4 Goods Output, Manufacturing Production, and the Composition of Private Demand for Goods

                                                              Chart 4 - Goods Output, Manufacturing Production, and the Composition of Private Demand for Goods

                                                              Sources: U.S. Department of Commerce, Bureau of Economic Analysis; Board of Governors of the Federal Reserve System; author’s calculations.

                                                              Note: The shaded areas indicate periods designated national recessions by the National Bureau of Economic Research.

                                                              a Excludes software.

                                                              Chart 4 illustrates the performance of goods output relative to manufacturing production and consumer spending relative to private goods spending (spending on consumer and capital goods) during the periods around the last four recessions. ... it appears that in periods around recessions, gains in goods output relative to manufacturing production may be connected to gains in consumer spending relative to capital spending.

                                                              Conclusion Despite their apparent similarity, manufacturing production as an indicator of U.S. factory output is a different measure than goods output... Goods output has been growing relative to manufacturing production for many years. We attribute the growth in part to the rising significance of imported goods as well as to increased service inputs to the sale of all goods, whether manufactured in domestic or foreign plants.

                                                              The two indicators have also been affected by the relationship between spending on capital goods and on consumer goods. Compared with capital goods, consumer goods appear to require a larger share of post-factory ... service inputs to bring to market. Recessions generally result in much larger declines in spending on capital goods—and in manufacturing production of these goods—than on consumer goods, and goods output typically is more stable than manufacturing production in cyclical downturns...

                                                              The differences between the two most recent downturns suggest that the relationship between the overall economy and these two key indicators of economic activity can fluctuate, reflecting changes in the nature of demand and in the corresponding magnitude of the inputs outside the factory gates used to produce goods. Accordingly, while goods production is a crucial part of the economy, much of this output takes place outside the factory gates. Researchers who analyze only the manufacturing production data therefore have a limited view of the overall goods production process.

                                                                Posted by Mark Thoma on Saturday, March 25, 2006 at 11:54 AM in Economics

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                                                                Selling the Tree Farm

                                                                Suppose the government were to sell off all of its assets, the national parks, the White House, dams, tanks, government buildings, desks, chairs, the miles of ocean front land between Los Angeles and San Diego used as a military base, every bit of government property sold to the highest bidder. If the government completely liquidated, would it have enough to pay off the national debt? While it's an interesting exercise to think through, and the (highly speculative) estimates I've seen place the total value of government assets somewhat close to the value of the debt, I didn't expect the government would actually try to pay the debt this way:

                                                                Selling the Forests, Editorial, NY Times: It's rarely a good idea to sell off assets to pay normal operating expenses. It's an even worse idea when the assets are chunks of national forest. But that's exactly what the Bush administration wants to do. Washington has long sent money to isolated local communities surrounded by national forests. The communities cannot tax federal property, so the money helps pay for schools. The grants were calculated as a percentage of timber sales. When the annual harvest declined, partly as a result of court rulings in favor of various endangered species, the money was taken from general revenues. President Bush's 2007 budget proposes to raise the money by auctioning off about 300,000 acres of federal forest in 41 states, at an anticipated price of $800 million. The administration recently sent a bill to Congress that would give the Forest Service the authority to conduct the sales. ... In addition to the forest sale, the administration also proposes to sell a half-million acres managed by the Interior Department, not for any purposes related to stewardship of the public lands, but simply to reduce a national deficit already bloated by tax cuts...

                                                                  Posted by Mark Thoma on Saturday, March 25, 2006 at 02:40 AM in Budget Deficit, Economics, Environment

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                                                                  Summers: Foreign Central Banks Should Diversify Away from U.S. Debt

                                                                  Larry Summers tells foreign central banks to diversify their reserves away from U.S. debt:

                                                                  Summers Urges Diversification For Emerging-Markets' Assets, by Davud Wessel, WSJ: Lawrence Summers ... said emerging-market governments should consider diversifying their reserves away from "maximally liquid, maximally safe" short-term securities, such as U.S. Treasury debt. ... Mr. Summers said China, Taiwan, Russia, Thailand, India and other countries with significant reserves should consider "more aggressive investment -- either in support of imports that have a high social return or in a much richer menu of international assets." If India's reserves were invested in assets that performed as well as U.S. university endowments, he said, its government would have additional income equal to between 1% and 1.5% of gross domestic product each year.

                                                                  Because central banks are likely to be criticized if their investments do poorly and because of "opportunities for mischief in picking assets" and "exercising control," Mr. Summers suggested the International Monetary Fund or World Bank consider creating "an international facility in which countries could invest their excess reserves without taking domestic political responsibility for the process of investment decision and ultimate result."...

                                                                  I'd rather not have a shift away from U.S. Treasury debt and the upward pressure on interest rates that's likely to bring about. Still, it would be wise for us to prepare for that eventuality, something we are not doing now. Full text of Summer's remarks.

                                                                    Posted by Mark Thoma on Saturday, March 25, 2006 at 02:34 AM in Economics, International Finance

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                                                                    The Income Velocity of Money

                                                                    The latest issue of The Economist argues that central banks should pay more attention to monetary aggregates in the conduct of monetary policy. Nevertheless, the Fed discontinued reporting M3 on March 23. In light of this, and for those who might be interested, here's a few graphs showing velocity and velocity growth measures based upon M1, M2, and M3, where V PY/M and PY is nominal GDP:

                                                                    To decompose the velocity growth movements, recall that V PY/M. Then, in terms of percentage changes, %ΔV ≡ %ΔP + %ΔY - %ΔM where %ΔP is inflation, %ΔY is output growth, and %ΔM is money growth. For those that are interested, the components are shown in these graphs of real GDP growth, inflation, M1 growth, M2 growth, and M3 growth.

                                                                      Posted by Mark Thoma on Saturday, March 25, 2006 at 01:34 AM in Economics, Monetary Policy

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                                                                      March 24, 2006

                                                                      Amartya Sen: Democracy Isn't 'Western'

                                                                      Amartya Sen, a Nobel laureate in economics discusses the deception of using cultural differences between countries as an explanation of economic and political differences, in particular as an explanation for the emergence of democracy in some countries, but not in others:

                                                                      Democracy Isn't 'Western', by Amartya Sem, Commentary, WSJ: "The fault, dear Brutus, is not in our stars, but in ourselves, that we are underlings." Culture too, like our stars, is often blamed for our failures. Attempts to build a better world capsize, it is alleged, in the high sea of cultural resistance. The determinism of culture is increasingly used in contemporary global discussions to generate pessimism about the feasibility of a democratic state, or of a flourishing economy, or of a tolerant society, wherever these conditions do not already obtain.

                                                                      Indeed, cultural stereotyping can have great effectiveness in fixing our way of thinking. When there is an accidental correlation between cultural prejudice and social observation (no matter how casual), a theory is born, and it may refuse to die even after the chance correlation has vanished without trace. For example, labored jokes against the Irish, which have had such currency in England, had the superficial appearance of fitting well with the depressing predicament of the Irish economy when it was doing quite badly. But when the Irish economy started growing astonishingly rapidly, for many years faster than any other European economy, the cultural stereotyping and its allegedly profound economic and social relevance were not junked as sheer rubbish. Theories have lives of their own, quite defiantly of the phenomenal world that can be actually observed.

                                                                      Many have observed that in the '60s South Korea and Ghana had similar income per head, whereas within 30 years the former grew to be 15 times richer than the latter. This comparative history is immensely important to study and causally analyze, but the temptation to put much of the blame on Ghanaian or African culture (as is done by as astute an observer as Samuel Huntington) calls for some resistance. Mr. Huntington closes his contrast with a spectacular formula: "South Koreans valued thrift, investment, hard work, education, organization and discipline. Ghanaians had different values. In short, cultures count." Ghanaians, and perhaps many other Africans, seem doomed to stagnate, according to this analysis.

                                                                      In fact, that cultural story is extremely deceptive. There were many important differences, other than any differences in cultural predispositions, between Ghana and Korea in the 1960s. First, the class structures in the two countries were quite different, with a very much bigger -- and proactive -- role of business classes in Korea. Second, the politics were very different, too, with the government in South Korea eager to play a prime-moving role in initiating societal reform and economic development in a way that was not true in Ghana. Third, the close relationship between the Korean economy and Japan, on the one hand, and the U.S., on the other, made a big difference, at least in the early stages of Korean economic expansion.

                                                                      Fourth -- and perhaps most important -- by the 1960s South Korea had acquired a much higher literacy rate and a much more expanded school system than Ghana had. Korean massive progress in school education had been largely brought about in the post-World War II period, mainly through resolute public policy, and it could not be seen just as a reflection of cultural difference. This is not to suggest that cultural factors are irrelevant to the process of development, but they do not work in isolation from social, political and economic influences. Nor are they immutable.

                                                                      The temptation of founding economic pessimism on cultural resistance is matched by the evident enchantment, even more common today, of basing political pessimism, particularly about democracy, on alleged cultural impossibilities. While it is easy enough to understand the widespread -- and increasing -- doubts about armed intervention allegedly aimed at jump-starting democracy in Iraq through largely foreign and military planning, it would be quite a leap from there to become skeptical of the general possibility of the emergence of democracy in any country that is currently nondemocratic. It is worth remembering that democracy has developed well enough in many countries in Asia, Africa and Latin America, and in the case of some, such as South Africa, even foreign assistance to local democratic movements (for example through economic boycott) has positively helped.

                                                                      When it is asked whether Western countries can "impose" democracy on the non-Western world, even the language reflects a confusion centering on the idea of "imposition," since it implies a proprietary belief that democracy "belongs" to the West, taking it to be a quintessentially "Western" idea which has originated and flourished exclusively in the West. This is a thoroughly misleading way of understanding the history and the contemporary prospects of democracy.

                                                                      Democracy, to use the old Millian phrase, is "government by discussion," and voting is only one part of a broader picture (an understanding that has, alas, received little recognition in post-intervention Iraq in the attempt to get straight to polling without the development of broad public reasoning and an independent civil society). There can be no doubt at all that the modern concepts of democracy and of public reasoning have been very deeply influenced by European and American analyses and experiences over the last few centuries (including the contributions of such theorists of democracy as Marquis de Condorcet, Jefferson, Madison and Tocqueville). But to extrapolate backward from these comparatively recent experiences to construct a quintessential and long-run dichotomy between the West and non-West would be deeply misleading. There is a long history of public reasoning across the world, and while it has gone through ups and downs everywhere, the sharp priority of liberal tolerance that has emerged in the West over the past three centuries reflects how social evolution can strengthen and consolidate one tendency to the exclusion -- or near exclusion -- of other tendencies.

                                                                      The belief in the allegedly "Western" nature of democracy is often linked to the early practice of voting and elections in Greece, especially in Athens. Democracy involves more than balloting, but even in the history of voting there would be a classificatory arbitrariness in defining civilizations in largely racial terms. In this way of looking at civilizational categories, no great difficulty is seen in considering the descendants of, say, Goths and Visigoths as proper inheritors of the Greek tradition ("they are all Europeans," we are told). But there is reluctance in taking note of the Greek intellectual links with other civilizations to the east or south of Greece, despite the greater interest that the Greeks themselves showed in talking to Iranians, or Indians, or Egyptians (rather than in chatting up the Ostrogoths).

                                                                      Since traditions of public reasoning can be found in nearly all countries, modern democracy can build on the dialogic part of the common human inheritance. In his autobiography, Nelson Mandela describes how influenced he was, as a boy, by seeing the democratic nature of the proceedings of the meetings that were held in his home town: "Everyone who wanted to speak did so. It was democracy in its purest form. There may have been a hierarchy of importance among the speakers, but everyone was heard, chief and subject, warrior and medicine man, shopkeeper and farmer, landowner and laborer." Mr. Mandela could combine his modern ideas about democracy with emphasizing the supportive part of the native tradition, in a way that Gandhi had done in India, and that is the way cultures adapt and develop to respond to modernity. Mr. Mandela's quest for democracy and freedom did not emerge from any Western "imposition."

                                                                      Similarly, the history of Muslims includes a variety of traditions, not all of which are just religious or "Islamic" in any obvious sense. The work of Arab and Iranian mathematicians, from the eighth century onward reflects a largely nonreligious tradition. Depending on politics, which varied between one Muslim ruler and another, there is also quite a history of tolerance and of public discussion, on which the pursuit of a modern democracy can draw. For example, the emperor Saladin, who fought valiantly for Islam in the Crusades in the 12th century, could offer, without any contradiction, an honored place in his Egyptian royal court to Maimonides, as that distinguished Jewish philosopher fled an intolerant Europe. When, at the turn of the 16th century, the heretic Giordano Bruno was burned at the stake in Campo dei Fiori in Rome, the Great Mughal emperor Akbar (who was born a Muslim and died a Muslim) had just finished, in Agra, his large project of legally codifying minority rights, including religious freedom for all, along with championing regular discussions between followers of Islam, Hinduism, Jainism, Judaism, Zoroastrianism and other beliefs (including atheism).

                                                                      Cultural dynamics does not have to build something from absolutely nothing, nor need the future be rigidly tied to majoritarian beliefs today or the power of the contemporary orthodoxy. To see Iranian dissidents who want a fully democratic Iran not as Iranian advocates but as "ambassadors of Western values" would be to add insult to injury, aside from neglecting parts of Iranian history (including the practice of democracy in Susa or Shushan in southwest Iran 2,000 years ago). The diversity of the human past and the freedoms of the contemporary world give us much more choice than cultural determinists acknowledge. This is particularly important to emphasize since the illusion of cultural destiny can extract a heavy price in the continued impoverishment of human lives and liberties.

                                                                        Posted by Mark Thoma on Friday, March 24, 2006 at 07:12 PM in Economics, Iraq, Politics

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                                                                        Stiglitz: Bush's Bad Faith Energy Policy

                                                                        Joseph Stiglitz, a Nobel laureate in economics and a Professor of Economics at Columbia University, is not happy with Bush's energy policy. In this Project Syndicate piece, he wonders if it is "just another example of incompetence and muddle" or if the policy is the result of "bad faith and sheer ineptitude":

                                                                        Bush’s Bad-Faith Energy Policy, by Joseph E. Stiglitz, Project Syndicate: One of the more surreal sessions at this year’s World Economic Forum in Davos had oil industry experts explaining how the melting of the polar ice cap ... represents ... an opportunity: vast amounts of oil may now be accessible. Similarly, ... the fact that the United States has not signed the Law of the Sea, the international convention determining who has access to offshore oil and other maritime mineral rights, presents ...[an] upside: the oil industry ... need not beg Congress for the right to despoil Alaska.

                                                                        President George W. Bush has an uncanny ability not to see the big message. For years, it has become increasingly clear that much is amiss with his energy policy. Scripted by the oil industry, even members of his own party referred to an earlier energy bill as one that “left no lobbyist behind.” While praising the virtues of the free market, Bush has been only too willing to give huge handouts to the energy industry...

                                                                        There is a market failure when it comes to energy... The fact that Americans do not pay the full price for the pollution – especially enormous contributions to greenhouse gases – that results from their profligate energy use means that energy is under-priced, in turn sustaining excessive consumption. The government needs to encourage conservation, and intervening in the price system – namely, through taxes on energy – is an efficient way to do it. But, rather than encouraging conservation, Bush has pursued a policy of “drain America first,” leaving America more dependent on external oil in the future. ...

                                                                        Now, ... Bush appears to have finally woken up to the reality of America’s increasing dependence; with soaring oil prices, it was hard for him not to note the consequences. But, again, his administration’s faltering moves will almost surely make matters worse in the immediate future. Bush still refuses to do anything about conservation, and he has put very little money behind his continuing prayer than technology will save us.

                                                                        What, then, to make of Bush’s recent declaration of a commitment to make America 75% free of dependence on Middle East oil within 25 years. For investors, the message is clear: do not invest more in developing reserves in the Middle East, which is by far the lowest-cost source of oil in the world.

                                                                        But, without new investment in developing Middle East reserves, unbridled growth of energy consumption in the US, China, and elsewhere implies that demand will outpace supply. If that were not enough, Bush’s threat of sanctions against Iran poses the risks of interruptions of supplies from one of the world’s largest producers. With world oil production close to full capacity and prices already more than double their pre-Iraq War level, this portends still higher prices, and still higher profits for the oil industry – the only clear winner in Bush’s Middle East policy.

                                                                        To be sure, one shouldn’t begrudge Bush for having at last recognized that there is a problem. But, as always, a closer look at what he is proposing suggests another sleight of hand by his administration. Aside from refusing to recognize the importance of global warming, encourage conservation, or devote enough funds to research to make a real difference, Bush’s grandiose promise of a reduction of dependence on Middle East oil means less than it appears. With only 20% of US oil coming from the Middle East, his goal could be achieved by a modest shift of sourcing elsewhere.

                                                                        But surely, one would think, the Bush administration must realize that oil trades on a global market. Even if America were 100% independent of Middle East oil, a reduction in supply of Middle East oil could have devastating effects on the world price – and on the American economy.

                                                                        As is too often the case with the Bush administration, there is no flattering explanation of official policy. Is Bush playing politics by pandering to anti-Arab and anti-Iranian sentiment in America? Or is this just another example of incompetence and muddle? From what we have seen over the past five years, the correct answer probably contains more than a little bad faith and sheer ineptitude. [dual posted]

                                                                          Posted by Mark Thoma on Friday, March 24, 2006 at 02:25 PM in Economics, Environment, Policy

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                                                                          DeLong: Lack of Penalties for Unsound Fiscal Policy Threatens the Euro

                                                                          Brad DeLong warns that the lack of institutional and market mechanisms to penalize unsound fiscal policy among European Union members is a threat to the euro:

                                                                          Europe’s Free Riders, by J. Bradford DeLong, Project Syndicate: In the United States, individual states that follow unsound fiscal policies face a penalty. Their bonds sell at a discount... The higher debt service they must pay serves – to some degree – as a form of discipline against the temptation to spend now and pay later.

                                                                          Of course, the discipline of the market is not perfect: the bond market does not “see” implicit future liabilities (like promised pension payments) to any great degree. Nevertheless, this enforced fiscal discipline, combined with individual states’ own internal budgetary procedures, has prevented a large scale state-level fiscal crisis from occurring in the US since the Great Depression.

                                                                          Let us now turn to Europe. Before the advent of the euro, there were many fiscal crises in individual nation-states in southern Europe, which produced waves of high inflation. But, with the single currency in place, the road to solving a fiscal crisis through inflation has been closed, as the European Central Bank (ECB) now stands watch over monetary policy.

                                                                          Nevertheless, even with nation-states no longer able to rely on inflation to solve their unbalanced finances, the single currency allows them to use the debt capacity properly belonging to other members of the European Union to extend their spending sprees and postpone political accountability... To head off this possibility, the EU created the Stability and Growth Pact: government deficits had to be less than 3% of GDP.

                                                                          Last week, the government of Germany – once the most fiscally prudent and disciplined EU country – broke the pact’s rules for fiscal discipline for the fifth consecutive year... Finance Minister Peer Steinbrueck signaled that he expected the European Commission to apply some sanctions to Germany: the credibility of the pact would, he said, be at stake if no action were taken. Thus, Germany would not block sanctions ... as it did two and a half years ago.

                                                                          But Steinbrueck also made it clear that he expects any sanctions in response to Germany’s predicted 3.4%-of-GDP fiscal deficit to be largely symbolic, not penalties that would cost its government or economy anything of significance. The Stability and Growth Pact is not – or is not yet – working anywhere near the way it was intended to work.

                                                                          What about market discipline? Is the German government’s willingness to issue more debt and run bigger deficits limited because the market recognizes and penalizes nation states that allow their fiscal positions to weaken?

                                                                          In a word, no. The interest rates on the euro-denominated sovereign debt of the twelve euro-zone governments are all very similar. So the market does not seem to care that countries have different potentials to generate exports to fund the financial flows needed for debt repayments, or different current and projected debt-to-GDP ratios. ...

                                                                          In the long run, this is dangerous. Both market discipline and sound fiscal management are needed to create a reasonable chance of long-run price stability. Omit either a market penalty now for behavior that may become reckless or the institutional levers that give a voice to future generations, and you run grave risks – perhaps not today or tomorrow, but someday...

                                                                          As time passes, the coming of the single currency and the way that the euro has been implemented is generating more and more unease. .... The necessary transfers are not being made to make the common currency bearable to regions that ... are already in recession when the ECB tightens policy. The institutional foundations of stable long-run fiscal policy are being eroded. And ... the ECB is giving the market less scope to reward the thrifty and penalize the profligate than it should.

                                                                          There is no movement of the soil yet, and there will not be for some time. But the ground under the euro may well begin to shift if things don’t change.

                                                                            Posted by Mark Thoma on Friday, March 24, 2006 at 01:05 PM in Budget Deficit, Economics, Policy

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                                                                            Hunting for a Domestic Agenda

                                                                            Some notes from the Wall Street Journal's Washington Wire:

                                                                            Pay Takes Center Stage, by John Harwood, Washington Wire:

                                                                            MINIMUM WAGE EMERGES as election-year flashpoint. Treasury Secretary Snow’s remarks on income inequality fuel debate. “We’ll engage with” advocates of an increase, he says, while cautioning against pricing some workers out of labor market. The wage remains $5.15 an hour, a level set in 1997; relative to average wages, it’s at its lowest point since 1949. Commerce Secretary Gutierrez also signals openness to an increase if Congress pursues the issue “thoughtfully…and not emotionally.” With Bush and Republicans politically weakened, Democratic Sen. Kennedy plans push for floor vote this spring on an increase to $7.25. Strategist Carville advises Democrats to block pay raise for Congress until average worker’s wages rise.

                                                                            TEAM BUSH SCRAMBLES to revive domestic agenda. President’s acknowledgment of political capital spent on war reflects slipping prospects on other fronts. Senate Finance Chairman Grassley predicts uphill fight for even scaled-down version of expanded health savings accounts. A senior Bush adviser sees delay — pushing House-Senate conference until after midterm elections — as best chance for winning immigrant guest-worker program. Both chambers have sidetracked Bush’s proposed Medicare savings; extension of dividend and capital-gains tax cuts remains in doubt. Moderate Republicans, complains Heritage Foundation’s Michael Franc, are “completely untethered” from party leaders. ...

                                                                            MINOR MEMOS: …“Cheney Invites Helen Thomas on Hunting Trip” following her contentious press conference exchange with Bush, humorist Andy Borowitz reports.

                                                                              Posted by Mark Thoma on Friday, March 24, 2006 at 10:46 AM in Economics, Health Care, Press, Unemployment

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                                                                              Paul Krugman: Letter to the Secretary

                                                                              Paul Krugman sends a Dear John letter:

                                                                              Letter to the Secretary, Dear John Snow, by Paul Krugman, NY Times: Dear John Snow, secretary of the Treasury:

                                                                              I'm glad that you've started talking about income inequality, which in recent years has reached levels not seen since before World War II. But if you want to be credible on the subject, you need to make some changes in your approach.

                                                                              First, you shouldn't claim, as you seemed to ..., that there's anything meaningful about the decline in some measures of inequality between 2000 and 2003. Every economist realizes that ... "much of the decline in inequality during that period reflected the popping of the stock market bubble," which led to a large but temporary fall in the incomes of the richest Americans.

                                                                              We don't have detailed data ... yet, but the available indicators suggest that after 2003, incomes at the top ... came roaring back. ... I find it helpful to illustrate ... with a hypothetical example: say 10 middle-class guys are sitting in a bar. Then the richest guy leaves, and Bill Gates walks in. Because the richest guy in the bar is now much richer than before, the average income in the bar soars. But the income of the nine men who aren't Bill Gates hasn't increased, and no amount of repeating "But average income is up!" will convince them that they're better off.

                                                                              Now think about what happened in 2004 ... a small fraction of the population got much, much richer. ... In effect, Bill Gates walked into the bar. Average income rose, but only because of rising incomes at the top.

                                                                              Speaking of executive compensation, Mr. Snow, it hurts your credibility when you say, as you did ..., that soaring pay for top executives reflects their productivity and that we should "trust the marketplace." Executive pay isn't set in the marketplace; it's set by boards ... And executives' pay often bears little relationship to their performance. You yourself ... are often cited as an example. When you were appointed to your present job, ... the performance of the company you had run, CSX, was "middling at best." Nonetheless, you were "by far the highest-paid chief in the industry." ... So my advice on the question of executive pay is: don't go there.

                                                                              Finally, you should stop denying that the Bush tax cuts favor the wealthy. ... [U]sing the right measure — the effect of the tax cuts on after-tax income — the bias toward the haves and have-mores is unmistakable. ... once the Bush tax cuts are fully phased in, they will raise the after-tax income of middle-income families by 2.3 percent. But they will raise the after-tax income of people ... with incomes of more than $1 million, by 7.3 percent.

                                                                              And those calculations don't take into account the indirect effects of tax cuts. If the tax cuts are made permanent, they'll eventually have to be offset by large spending cuts. ... that means cuts where the money is: in Social Security and Medicare benefits. Since middle-income Americans will feel the brunt of these cuts, yet received a relatively small tax break, they'll end up worse off. But the wealthy will be left considerably wealthier.

                                                                              Of course, my suggestions about how to improve your credibility would force you to stop repeating administration talking points. But you're the secretary of the Treasury. Your job is to make economic policy, not to spout propaganda. Oh, wait.

                                                                              Previous (3/20) column: Paul Krugman: Bogus Bush Bashing Next (3/27) column: Paul Krugman: North of the Border

                                                                                Posted by Mark Thoma on Friday, March 24, 2006 at 01:23 AM in Economics, Income Distribution, Politics

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                                                                                Meltdown

                                                                                At current levels of greenhouse gases, a lot of coastal property may be "liquidated" as seas rise by as much as twenty feet:

                                                                                Climate Model Predicts Greater Melting, Submerged Cities, Scientific American: Over the past 30 years, temperatures in the Arctic have been creeping up, rising half a degree Celsius with attendant increases in glacial melting and decreases in sea ice. Experts predict that at current levels of greenhouse gases ... the earth may warm by as much as five degrees Celsius, matching conditions roughly 130,000 years ago. Now a refined climate model is predicting, among other things, sea level rises of as much as 20 feet, according to research results published today in the journal Science...

                                                                                Such a sea level rise would permanently inundate low-lying lands like New Orleans, southern Florida, Bangladesh and the Netherlands. Already sea level rise has increased to an inch per decade... And evidence that the Arctic is exponentially warming continues to accumulate. ... "We need to start serious measures to reduce greenhouse gases within the next decade," ... "If we don't do something soon, we're committed to [13 to 20 feet] of sea level rise in the future."

                                                                                  Posted by Mark Thoma on Friday, March 24, 2006 at 12:33 AM in Economics, Science

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                                                                                  Bernanke Shrugs Off a Potential Decline in the Dollar

                                                                                  Ben Bernanke is relatively unconcerned about the potential economic consequences of a falling dollar:

                                                                                  Bernanke Says Dollar Risk From Less Capital Not 'Worrisome', Bloomberg: Federal Reserve Chairman Ben S. Bernanke said a possible decline in the dollar because of less foreign investment wouldn't have a "worrisome" effect on the U.S. economy. Bernanke said it isn't clear that faster economic growth in emerging markets would cause investors to shift capital to those countries and away from the U.S. Should that happen, "it might be associated with a decline in the value of the dollar and a narrowing of the U.S. trade deficit," Bernanke wrote in a March 21 letter to Representative Harold Ford Jr... Neither of those events, though, "would be likely to threaten U.S. growth or boost inflation and interest rates to a worrisome extent."... Bernanke told another lawmaker this week, Democratic Representative Brad Sherman of California, that the trade deficit needn't cause a "precipitous decline" in the dollar's value, though the "possibility of a future disruptive correction of the U.S. trade deficit cannot be ruled out."

                                                                                  There's more in the letter to Representative Sherman concerning Bernanke's opposition to allowing non-financial companies to perform banking functions, something Wal-Mart has applied to do:

                                                                                  Bernanke: Economy can handle dollar drop, CNN/Money/Reuters: ...In the letter, Bernanke also restated the Fed's position that Congress should review an exemption that allows commercial firms to acquire industrials banks, warning that decisions on the issue could have "important ramifications" for the U.S. economy. ... Wal-Mart Stores ... has applied to open an industrial bank in Utah, an application under review by the Federal Deposit Insurance Corp. ... In a news release, Sherman said the statement "clearly urges Congress to prevent regulators from mixing banking and commerce."

                                                                                    Posted by Mark Thoma on Friday, March 24, 2006 at 12:15 AM in Economics, International Finance, Monetary Policy

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                                                                                    Creative Construction

                                                                                    The stereotype is that American students aren't very well-trained technically and thus do poorly when tested in areas such as math and science, but their intuitive skills are fairly well developed. Foreign students are just the opposite according to this view, excellent technically, but less able to express the intuitive reasoning behind the mathematics or the science and less able to use intuitive skills to combine ideas creatively. The difference is generally attributed to a difference in emphasis in education with foreign students far more devoted to rote learning than their American counterparts. While this gives Americans a disadvantage in engineering, computer programming, and so on, they are much more likely to come up with innovative new ideas. Or so the story goes. Is this is really true? India and China believe it and are wondering how to change their educational systems to encourage more creativity:

                                                                                    Worried About India's and China's Booms? So Are They, by Thomas L. Friedman, Commentary, NY Times: The more I ... travel, the more I find that the most heated debates in many countries are around education. ... every country thinks it's behind. ... America agonizes that its ... public schools badly need improvement in math and science. I was just in Mumbai attending the annual meeting of India's high-tech association, ... where many speakers worried aloud that Indian education wasn't nurturing enough "innovators."

                                                                                    Both India and China, which have mastered rote learning and have everyone else terrified about their growing armies of engineers, are wondering if too much math and science — unleavened by art, literature, music and humanities — aren't making Indira and Zhou dull kids and not good innovators. Very few global products have been spawned by India or China.

                                                                                    "We have ... everyone going into engineering and M.B.A.'s," said Jerry Rao, chief executive of ... one of the top Indian outsourcing companies. "If we don't have enough people with the humanities, we will lose the [next generation of] V. S. Naipauls and Amartya Sens," he added, referring to the Indian author and the Indian economist, both Nobel laureates. ...

                                                                                    Innovation is often a synthesis of art and science, and the best innovators often combine the two. The Apple co-founder Steve Jobs ... recalled how he dropped out of college but stuck around campus and took a calligraphy course, where he learned about the artistry of great typography. "None of this had even a hope of any practical application in my life," he recalled. "But 10 years later, when we were designing the first Macintosh computer, it all came back to me. And we designed it all into the Mac. It was the first computer with beautiful typography." ...

                                                                                    Capital will now flow faster than ever to tap the most productive talent wherever it is located ... Hence the concern I found in India that it must move quickly from business process outsourcing ... into knowledge process outsourcing ... coming up with more original designs and products.

                                                                                    "We need to encourage more incubation of ideas ... to make innovation a national initiative," said Azim Premji, the chairman of ... one of India's premier technology companies. "Are we as Indians creative? Going by our rich cultural heritage, we have no doubt some of the greatest art and literature. We need to bring the same spirit into our economic and business arena."

                                                                                    But to make that leap, Indian entrepreneurs say, will require a big change in the rigid, never-challenge-the-teacher Indian education system. "If we do not allow our students to ask why, but just keep on telling them how, then we are only going to get the transactional type of outsourcing..." said Nirmala Sankaran C.E.O. of ... an Indian-based education company. "We have a creative problem in this country."...

                                                                                      Posted by Mark Thoma on Friday, March 24, 2006 at 12:06 AM in China, Economics, India, Technology

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                                                                                      March 23, 2006

                                                                                      The Post's "Sekrit Plan" is Working!

                                                                                      There's more trouble for the Washington Post's new right-wing blogger. The Washington Post's "sekrit plan" to discredit the right is working!:

                                                                                      Conservative blogger recently hired by Washington Post appears to be serial plagiarist, Raw Story: Various liberal bloggers around the web are exposing what appears to be a pattern of plagiarism by the new conservative blogger hired by the Washington Post, Ben Domenech... The prominent blogger Atrios has compiled a listing of at least four instances of apparent plagiarism. Several examples were also found by DailyKos. In one instance, Domenech appears to have lifted a paragraph from Salon.com. Read the full list of links to the quotes listed below at Atrios.blogspot.com.

                                                                                      Domenech: At its best, "The Bachelor" skews the absurdity of any human relationships ‹ even the successful ones. As terrified as Jimmie is of losing his freedom, Anne is equally worried about becoming like her parents ‹ who, it turns out, are an older couple nauseatingly and demonstratively still in love with each other. Salon: At its best, it skews the absurdity of any human relationships -- even the successful ones. As terrified as Jimmie is of losing his freedom, Anne is equally worried about becoming like her parents -- who, it turns out, are an older couple nauseatingly, demonstratively, still in love with each other.

                                                                                      In a second instance, he appears to have lifted part of an article from reviewer Steve Rhodes.

                                                                                      Domenech: The most important co-stars in the Bond movies are the spy's toys. These films usually have the audience applauding for the stunts and this episode of the superspy saga is no different. There's plenty of action and vehicles to enjoy, like the helicopter with a super-sized chainsaw attached, which cuts through cars and buildings, and a sleek, one-man boat with jet afterburners that looks like something custom-made for Batman. Rhodes: The most important costars in the Bond movies are the spy's toys. These films usually have the audience applauding for the stunts, and this episode of the superspy saga is no different. The best of the bunch in THE WORLD IS NOT ENOUGH is a sleek, one-man, black boat complete with jet afterburners, which looks like something custom-made for Batman. The vehicle even has the ability to dive underwater briefly while the driver holds his breath. It can turn into a car as well, all the better to engage in a typical Bond demolition derby.

                                                                                      In a third instance, he copies Salon.

                                                                                      Domenech: One night, Frank meets Mary Burke (Patricia Arquette), whose father has suffered a heart attack. Mary, a former junkie, hasn't spoken to her father in three years, but she becomes deeply troubled when she realizes he's so close to death. Frank is even more concerned for her than he is for her father. He begins to fall deeply in love with her, checks up on her at her apartment, invites her to have a piece of pizza at the hospital with him. He's as gentle as a lamb with her, but he's an exhausted one, all bruised and battered. Salon: In the line of duty one night, Frank meets Mary Burke (Patricia Arquette), whose father has suffered a heart attack. Mary is a former junkie who seems to have just barely pulled her life together. She hasn't spoken to her father in three years, but she becomes troubled when she realizes he's so close to death. Frank is just as concerned for her as he is for her father. He begins to fall deeply in love with her, checking up on her at her apartment, inviting her to have a piece of pizza at the hospital with him. He's as gentle with her a spring lamb, but he's an exhausted one, all bruised and buffeted. Domenech: Rhames gives the most delightful and energized performance in the movie. His scenes, particularly his sassy flirtation with a honey-voiced dispatcher (Queen Latifah) let some much-needed light leak into the picture. Arquette is charming but neurotic as the dazed, soft-spoken Mary. She seems to walk around in a haze of confusion half the time, but when she smiles, the air around her seems to clear miraculously. Her scenes with Cage (her husband in real life) have an emotional quality that sets them apart from the rest of the film, but they are sometimes overlong. Salon: Rhames gives the single most delightful and energized performance in the movie. His scenes, particularly his sassy flirtation with a honey-voiced dispatcher (no wonder: it's Queen Latifah) let some much-needed light leak into the picture. Arquette, as usual, is charming, here as the dazed, soft-spoken Mary. She seems to walk around in a haze of confusion half the time, but when she smiles, the air around her seems to clear miraculously. Her scenes with Cage (her husband in real life) have a strange, arrhythmic underwater quality to them that's vaguely maddening but fascinating at the same time.

                                                                                      More instances are available at DailyKos.com.

                                                                                        Posted by Mark Thoma on Thursday, March 23, 2006 at 04:20 PM in Politics

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                                                                                        The Foreign Direct Investment Behavior of Multinational Corporations

                                                                                        A colleague, Bruce Blonigen, writing in the NBER Reporter on the determinants of foreign direct investment by multinational corporations:

                                                                                        Foreign Direct Investment Behavior of Multinational Corporations, by Bruce A. Blonigen, NBER Reporter: There is increasing recognition that understanding the forces of economic globalization requires looking first at foreign direct investment (FDI) by multinational corporations (MNCs): that is, when a firm based in one country locates or acquires production facilities in other countries. While real world GDP grew at a 2.5 percent annual rate and real world exports grew by 5.6 percent annually from 1986 through 1999, United Nations data show that real world FDI inflows grew by 17.7 percent over this same period! Additionally, MNCs mediate most world trade flows. For example, Bernard, Jensen, and Schott find that 90 percent of U.S. exports and imports flow through a U.S. MNC, with roughly 50 percent of U.S. trade flows occurring between affiliates of the same MNC, or what is termed intra-firm trade (1)

                                                                                        Despite the obvious importance of FDI and MNCs in the world economy, research on the factors that determine FDI patterns and the impact of MNCs on parent and host countries is in its early stages. The most important general questions are: what factors determine where FDI occurs, and what impacts do those MNC operations have on the parent and host economies? As I discuss in a recent survey of the empirical literature addressing the first question -- the determinants of FDI decisions -- the answers are not straightforward.(2) In particular, the literature has shown that we cannot simply conclude that factors such as exchange rates or tax policies have an unambiguous general impact on FDI patterns. Instead, meaningful insights come from developing hypotheses about, say, when a factor should matter for FDI, or even just a particular form of FDI, and then finding creative ways to test these hypotheses in the data.

                                                                                        Exchange Rates and FDI

                                                                                        One good example of this is the effect of exchange rate movements on FDI. For years, the conventional theory was to compare FDI to bonds, for which exchange rate movements do not affect the investment decision. A depreciation of the currency in the host country reduces the amount of foreign currency needed to purchase the asset, but it also reduces the nominal return one receives in the foreign currency. Thus, the rate of return for the foreign investor does not change. Empirical studies of FDI seemed to confirm this, often finding insignificant effects of exchange rates. In contradiction to this, the popular press often points to host-country exchange rate depreciations as a contributing factor to inward foreign investment booms, and worries about the selling of key national technological assets.

                                                                                        I find a resolution to this puzzle by considering FDI that involves firm-specific assets (such as patents or managerial skills) - the type of assets previous literature established as crucial to formation of MNCs and FDI.(3) Such assets are typically intangible and easily transferred across a firm's operations. Thus, the purchase prices of such assets through FDI are in the host-country's currency, but returns can be generated anywhere the firm operates and are not necessarily tied to the home country's currency. This means that host-country currency depreciations theoretically can lead to increased acquisition of FDI, particularly of firms that have firm-specific assets. This hypothesis is strongly confirmed for a panel of acquisitions of U.S. firms by Japanese and German firms and provides evidence for the notion in the popular press that currency depreciations ease foreign firms' purchases of U.S. host-country technological assets.

                                                                                        Taxes and FDI

                                                                                        Another factor that the literature finds does not affect FDI in a straightforward manner is tax policy. MNCs are potentially subject to taxation in both the host and parent country. However, most parent countries have policies to reduce or eliminate double taxation of their MNCs. James R. Hines, Jr. and co-authors have shown that the way in which parent countries reduce double taxation on their MNCs (for example, allowing credits or deductions) can have quite different implications for FDI activity.(4)

                                                                                        Many countries also have negotiated bilateral investment treaties (BITs) to mutually reduce withholding taxes on MNCs based in the other country. The Organisation for Economic Co-operation and Development (OECD) has been a big advocate of BITs as a way to enhance FDI across member countries. Others contend that BITs are mainly intended to share tax information across countries in order to deter tax evasion and to reduce administrative costs and, thus, should have little, or even negative, effects on FDI flows.(5) Ron B. Davies and I examine whether the empirical evidence suggests that such treaties increase FDI flows across nations, as the OECD and many economists presume.(6) In separate studies, we examine the evidence for the U.S. and for OECD BITs, respectively, in panel data that span a variety of bilateral country pairs over time. Across these various samples and numerous specifications, we find little evidence that these BITs increase FDI activity, a surprising result in light of OECD promotion of these treaties.

                                                                                        Trade Protection and FDI

                                                                                        The notion that trade protection encourages FDI is folk wisdom for economists, so much so that it is rarely examined empirically. But my research into this relationship has also yielded surprises. In a study examining all U.S. antidumping trade protection actions from 1980 through 1995, I find that FDI responses to these trade actions (tariff-jumping FDI) occur only for firms with previous experience as MNCs.(7) Most firms facing such trade policies (many from developing countries) have no such experience and do not respond with FDI. Instead, these firms must face either significant antidumping duties or go through the costly process of raising U.S. prices and requesting recalculations of the duties.(8) For domestic firms, whether foreign firms tariff-jump the antidumping duties matters significantly. Work with Tomlin and Wilson finds that domestic firms experience a 3 percent increase in expected discounted profitability from antidumping duties unless the foreign firms subject to the duties decide to tariff-jump, in which case the domestic firms do not experience any increase.(9),(10)

                                                                                        Information and FDI

                                                                                        An almost unexplored issue in the literature has been the role of information on FDI decisions. FDI requires substantial fixed costs of identifying an efficient location, acquiring knowledge of the local regulatory environment, and coordination of suppliers. Thus, access to better information about some host countries may make FDI to that location more likely. Ellis, Fausten, and I find an interesting avenue for investigating this hypothesis using information on Japanese industrial groups called keiretsu.(11) Horizontal keiretsu are groups of firms across a wide range of industries, typically centered around a main bank that owns significant shares in these firms. A number of studies have focused on the potentially favorable financing received by keiretsu firms from their main bank as one impetus for greater investment by these firms, including FDI -- but the evidence is mixed on this. However, the major firms in a keiretsu also get together on a regular basis in what are termed Presidential Meetings and presumably share information more than other firms would. My work with Ellis and Fausten examines whether this information affects FDI choices, by estimating how much prior-year FDI by members of a firm's keiretsu in a particular host country increases the likelihood that the firm will also choose that country for its FDI. We find that prior-year investment by a firm in the same keiretsu will raise a firm's probability of locating an investment in that same host country by about 20 percent.

                                                                                        A related paper with Wooster examines whether U.S. firms increase overseas investments when a new CEO who is foreign-born takes over.(12) Our examination of CEO turnover among Fortune 500 firms in the 1990s does show evidence of significant increases in FDI when a "foreign" CEO takes over. It is difficult to disentangle whether such an effect is attributable to better information of foreign markets by the foreign CEO or to different personal preferences influenced by a less U.S.-centric perspective. Regardless, the results suggest that there are likely other important factors behind FDI patterns than the standard economic ones so often mentioned in the literature.

                                                                                        Estimating Long-Run General-Equilibrium Determinants of FDI

                                                                                        Much of the literature described to this point motivates analysis with partial equilibrium models of individual firm-level FDI decisions. But we also want to have empirical specifications of FDI that are grounded in theory and that do a good job of explaining FDI patterns across the world. Researchers looking at world FDI patterns have generally used variations of a gravity framework to model FDI, specifying parent- and host-country GDPs along with distance as core determinants of FDI. These models seemingly do well to describe FDI patterns statistically, but while Anderson and van Wincoop have solidified an appropriate gravity specification as theoretically valid for trade patterns, it is not clear this is true for FDI patterns.(13)

                                                                                        Of course, deriving a theoretically based empirical specification of FDI is a fairly complicated problem. General equilibrium theoretical models of MNCs and their FDI activities only first began to be developed in the mid-1980s with Markusen's development of a horizontal model of FDI where an MNC replicates its process across multiple countries to avoid trade frictions, and Helpman's vertical MNC model where firms locate their production process abroad to take advantage of lower factor costs.(14) A recent important step by Carr, Markusen, and Maskus (CMM) was estimation of empirical specifications of FDI based on general equilibrium models of MNCs.(15) Their work shows that other factors missing from gravity-based FDI specifications, particularly factor endowment differences, are important for explaining FDI patterns.

                                                                                        In recent work with co-authors I have explored the central question of how well these specifications actually fit the real-world data we observe. The empirical specification estimated by CMM was a starting point in this research, since its inclusion of endowment differences clearly outperforms a standard gravity equation of FDI. In initial work with the model, Davies, Head, and I found that the CMM model had a specification of endowment differences that was not consistent with the theory. Once corrected, the model no longer provides evidence that vertical FDI motivations are very important in overall FDI flows between countries.(16) Work with Davies and Wang shows that specification error goes beyond this with not only the CMM model, but also with the gravity specification.(17) Data on FDI between countries are highly skewed, with very large activity between developed countries and small or even no activity for very small countries. We show that even after logging variables, adding country fixed-effects, and splitting samples into developed countries versus less-developed countries, one is still not guaranteed of having normally distributed error terms. In other words, finding an appropriate specification that effectively models the substantial heterogeneity in FDI activity across countries is still an open issue. Until this is resolved, using these models as control variables in studies of how new factors of interest affect FDI can be misleading.

                                                                                        An additional concern is that MNC models typically use a two-country framework and empirical FDI specifications use bilateral FDI data. This assumes that FDI decisions to different markets are independent. There are a number of reasons to think this may not be true. For example, U.S. firms may prefer to locate FDI in one country and then export to neighboring countries (export-platform FDI). In this case, more FDI in a particular host country would mean less in neighboring ones. Alternatively, U.S. firms may have vertical production relationships between affiliates such that more FDI in a country will naturally be associated with more in neighboring ones because of production externalities. Davies, Naughton, Waddell, and I explore this by explicitly modeling spatial interdependence in empirical estimation of U.S. FDI patterns.(18) We find that spatial interdependence shows up significantly in the data, although the nature of these spatial relationships is strongly affected by the particular geographic features of the sample of countries one chooses to examine. However, our finding that the coefficients on the standard control variables in FDI studies are hardly affected by including these spatial considerations is relatively good news for previous work using these empirical specifications.

                                                                                        Conclusion

                                                                                        The study of FDI and MNCs is both fascinating and important for understanding economic globalization. There has been substantial progress in the literature in the past couple of decades, but it is complicated enough that, in many ways, we are still in the process of uncovering what we don't know. I am excited to work on filling more gaps in our understanding in my future research efforts.


                                                                                        1. A.B. Bernard, J.B. Jensen, and P.K. Schott, "Importers, Exporters and Multinationals: A Portrait of the Firms in the U.S. that Trade Goods," NBER Working Paper No. 11404, June 2005.

                                                                                        2. B.A. Blonigen, "A Review of the Empirical Literature on FDI Determinants," NBER Working Paper No. 11299, May 2005, and forthcoming, Atlantic Economic Journal.

                                                                                        3. B.A. Blonigen, "Firm-Specific Assets and the Link Between Exchange Rates and Foreign Direct Investment," American Economic Review, 87(3), June 1997, pp. 447-65.

                                                                                        4. For example, see J.R. Hines, "Altered States: Taxes and the Location of Foreign Direct Investment in America," NBER Working Paper No. 4397, May 1997, and American Economic Review, 86(5), December 1996, pp. 1076-94, and M.A. Desai, C.F. Foley, and J.R. Hines, "Foreign Direct Investment in a World of Multiple Taxes," NBER Working Paper No. 8440, August 2001, and Journal of Public Economics, 88(12), December 2004, pp. 2727-44.

                                                                                        5. For example, see T. Dagan, "The Tax Treaties Myth," New York University Journal of International Law and Politics, Summer 2000, pp.939-96.

                                                                                        6. B.A. Blonigen and R.B. Davies, "The Effects of Bilateral Tax Treaties on U.S. FDI Activity," International Tax and Public Finance, 11(5), September 2004, pp. 601-22, and B.A. Blonigen and R.B. Davies, "Do Bilateral Tax Treaties Promote Foreign Direct Investment?" NBER Working Paper No. 8834, March 2002, and Handbook of International Trade, Volume II: Economic and Legal Analysis of Laws and Institutions, J. Hartigan, ed., Blackwell Publishers, 2005.

                                                                                        7. B.A. Blonigen, "Tariff-jumping Antidumping Duties," NBER Working Paper No. 7776, July 2000, and Journal of International Economics, 57(1), June 2002, pp. 31-50.

                                                                                        8. B.A. Blonigen, "Evolving Discretionary Practices of U.S. Antidumping Activity," NBER Working Paper No. 9625, April 2003, and, forthcoming, Canadian Journal of Economics, documents the rapidly rising trend in U.S. antidumping duties and the sources of this trend. B.A. Blonigen and S.E. Haynes, "Antidumping Investigations and the Pass-Through of Exchange Rates and Antidumping Duties," NBER Working Paper No. 7873, October 1999, and American Economic Review, 92(4), September 2002, pp. 1044-61, and B.A. Blonigen and J.-H. Park, " Dynamic Pricing in the Presence of Antidumping Policy: Theory and Evidence," NBER Working Paper No. 8477, September 2001, and American Economic Review, 94(1), March 2004, pp. 134-54, address the economics of firms' strategic pricing decisions in the face of antidumping duties.

                                                                                        9. B.A. Blonigen, K. Tomlin, and W.W. Wilson, "Tariff-jumping FDI and Domestic Firms' Profits," NBER Working Paper No. 9027, June 2002, and Canadian Journal of Economics, 37(3), August 2004, pp. 656-77.

                                                                                        10. A related issue is how FDI may affect trade protection policies (that is, reverse causality), which I address with co-authors in B.A. Blonigen and R.C. Feenstra, "Protectionist Threats and Foreign Direct Investment," NBER Working Paper No. 5475, March 1996, and in Effects of U.S. Trade Protection and Promotion Policies, R.C. Feenstra, ed.,Chicago: University of ChicagoPress, 1997, pp. 55-80, and B.A. Blonigen and D.N. Figlio, "Voting for Protection: Does Direct Foreign Investment Influence Legislator Behavior?" American Economic Review, 88(4), September 1998, pp. 1002-14.

                                                                                        11. B.A. Blonigen, C.J. Ellis, and D. Fausten, "Industrial Groupings and Foreign Direct Investment," Journal of International Economics, Vol. 65(1), January 2005, pp. 75-91 (An earlier version was circulated as "Industrial Groupings and Strategic FDI: Theory and Evidence" NBER Working Paper No. 8046, December 2000).

                                                                                        12. B.A. Blonigen and R.B. Wooster, "CEO Turnover and Foreign Market Participation," NBER Working Paper No. 9527, March 2003.

                                                                                        13. J.E. Anderson and E. van Wincoop, "Gravity with Gravitas: A Solution to the Border Puzzle," NBER Working Paper No. 8079, January 2001, and American Economic Review, 93(1), March 2003, pp. 170-92.

                                                                                        14. J.R. Markusen, "Multinationals, Multi-Plant Economies, and the Gains from Trade," Journal of International Economics, 16(3-4): pp. 205-26, and E. Helpman, A Simple Theory of International Trade with Multinational Corporations," Journal of Political Economy, 92(3), pp. 451-71.

                                                                                        15. D.L. Carr, J.R. Markusen, and K.E. Maskus, "Estimating the Knowledge-Capital Model of the Multinational Enterprise," NBER Working Paper No. 6773, October 1998, and American Economic Review, 91(3), June 2001, pp. 693-708, and J.R. Markusen, and K.E. Maskus, "Discriminating Among Alternative Theories of the Multinational Enterprise," NBER Working Paper No. 7164, June 1999, and Review of International Economics, 10(4), November 2002, pp. 694-707.

                                                                                        16. B.A. Blonigen, R.B. Davies, and K. Head, "Estimating the Knowledge-Capital Model of the Multinational Enterprise: Comment," NBER Working Paper No. 6773, October 1998, and American Economic Review, 93(3), June 2003, pp. 980-94.

                                                                                        17. B.A. Blonigen and R.B. Davies, "The Effects of Bilateral Tax Treaties on U.S. FDI Activity," International Tax and Public Finance, 11(5), September 2004, pp. 601-22, and B.A. Blonigen and M. Wang, "Inappropriate Pooling of Wealthy and Poor Countries in Empirical FDI Studies," NBER Working Paper No. 10378, March 2004, and Does Foreign Direct Investment Promote Development? T.H. Moran, E.M. Graham, and M. Blomstrom, eds., Institute for International Economics, April 2005, pp. 221-44.

                                                                                        18. B.A. Blonigen, R.B. Davies, G.R. Waddell, and H.T. Naughton. "FDI in Space: Spatial Autoregressive Relationships in Foreign Direct Investment," NBER Working Paper No. 10939, December 2004, and "Spacey Parents: Spatial Autoregressive Patterns in Inbound FDI," NBER Working Paper No. 11466, July 2005.

                                                                                        Posted by Mark Thoma on Thursday, March 23, 2006 at 11:24 AM in Academic Papers, Economics, International Trade

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                                                                                        Was There a Conspiracy to Alter the CPI and Reduce Entitlement Spending?

                                                                                        Did the government change the calculation of the CPI from an arithmetic mean to a geometric mean for valid economic and statistical reasons, or was it a conspiracy designed to save money on entitlement spending?:

                                                                                        macroblog: Is The CPI A Government Conspiracy?: It seems that a lot of people think so, and several readers have pointed me in the direction of Mr. John Williams, whose website appears to be devoted to the proposition that there liars, damned liars, statistics, and the lying damned liars who construct them. Williams' section on the conspiracy that is the consumer price index has several of the usual complaints -- the use of quality adjustments, the invoking of "core" inflation, and so on -- but what he seems most exercised about is the shift in methodology from "arithmetic mean" to "geometric mean" calculations that the Bureau of Labor Statistics implemented in 1999:

                                                                                        In the early 1990s, press reports began surfacing as to how the CPI really was significantly overstating inflation. If only the CPI inflation rate could be reduced, it was argued, then entitlements, such as social security, would not increase as much each year, and that would help to bring the budget deficit under control. Behind this movement were financial luminaries Michael Boskin, then chief economist to the first Bush administration, and Alan Greenspan, Chairman of the Board of Governors of the Federal Reserve System...

                                                                                        Shortly after Clinton took control of the White House ... attitudes changed. ... Over a period of several years, straight arithmetic weighting of the CPI components was shifted to a geometric weighting. ... Once the system had been shifted fully to geometric weighting, the net effect was to reduce reported CPI on an annual, or year-over-year basis, by 2.7% from what it would have been based on the traditional weighting methodology. The results have been dramatic. The compounding effect since the early-1990s has reduced annual cost of living adjustments in social security by a total of 30%.

                                                                                        The material on Williams' website is a bit dated (appearing first in 2004), but his take on the price statistics appears to have a lot of fans, being cited as recently as yesterday in readers' comments to an article by David Wessel. So what is this arithmetic-mean/geometric-mean thing all about? The Bureau of Labor Statistics explains;

                                                                                        In contrast to the fixed quantity weights of the current CPI formula, the geometric mean estimator ... implies that consumers can alter the quantities of goods and services they buy, albeit within the narrow range of a CPI category, when the relative prices of those goods and services change. It is, in part, this property of the geometric mean estimator that led to the Boskin Commission recommendation of its use in the CPI.

                                                                                        In other words, the crime of a geometric weighting scheme is to assume that people change their behavior when prices change. If you are looking for a cover-up, you won't find it at the BLS... What this means is that the methodology employed by the BLS conspires to do nothing more than implement the common sense proposition that consumers substitute high-priced goods for similar lower-priced goods:

                                                                                        Substitution can take several forms corresponding to the types of item- and outlet-specific prices used to construct the basic indexes:

                                                                                        • Substitution among brands of products, for example, between brands of ice cream;
                                                                                        • Substitution among product sizes, for example, between pint and quart packages of ice cream;
                                                                                        • Substitution among outlets, for example, between a brand of ice cream sold at two different stores;
                                                                                        • Substitution across time, for example, between purchasing ice cream during the first or second week of the month;
                                                                                        • Substitution among types of items within the category, for example, between ice cream and frozen yogurt;
                                                                                        • Substitution among specific items in different index categories, for example, between ice cream and cupcakes.

                                                                                        Notably:

                                                                                        ...overall substitution across categories, such as between ice cream products in general and apples in general, is not addressed by the geometric mean formula. ...

                                                                                        Product categories without close substitutes are, in fact, treated in the old-fashioned way that Williams and his fans seem to prefer.

                                                                                        The new formula, the geometric mean estimator, will be used in index categories that comprise approximately 61 percent of total consumer spending represented by the CPI-U. The remaining index categories ... will continue to be calculated as they are currently.

                                                                                        No doubt about it, measurement is hard, and there are a lot of judgment calls that have to be made. But when it comes to assessing the motivation for those calls, I'm with David Wessel...:

                                                                                        I know that is a popular view. I've personally found the technicians at agencies like the Bureau of Labor Statistics to be straight shooters who do their best to cope with the complex methodological issues inherent in measuring our large and dynamic economy.

                                                                                        And, for my money, they do it well.

                                                                                        Mine too.

                                                                                          Posted by Mark Thoma on Thursday, March 23, 2006 at 03:33 AM in Economics, Methodology, Social Security

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                                                                                          The Relationship Between Input and Output Price Inflation

                                                                                          David Altig's post at macroblog on the relationship between shocks to the producer price index (PPI) and changes in the (CPI) piqued my interest:

                                                                                          macroblog: The February PPI -- Hot Or Not?: ...A few years back, Jonathon Weinhagen took a look at what we think we know about the relationship between producer prices and broader measures of consumer prices. If terms like "VAR", "variance decompositions", and "impulse responses" mean something to you, you may want to take a look at his article, which appeared in the November 2002 edition of the Monthly Labor Review. If that doesn't sound too interesting to you, here is what Jonathon concluded:

                                                                                          Several authors have investigated the causal relationship between commodity prices and consumer inflation... The common finding in the majority of these studies was that the power of commodity prices to predict CPI inflation has diminished since the 1980s...

                                                                                          To take a quick look at this issue, I downloaded data on real GDP, the federal funds rate, the CPI for all items, the core CPI (less food and energy), the all item PPI, the crude goods PPI, the intermediate goods PPI, and the finished goods PPI from the St. Louis Fed web site (FRED). All data except the federal funds are logged, and the PPI and CPI indices are differenced to obtain inflation rates. Real GDP enters in levels, but using differences does not change the results meaningfully.

                                                                                          These data are used to estimate a VAR model. For those who are unfamiliar with these models, they are general reduced form models of the form:

                                                                                          where L is the number of lags; 2 lags are used here. These models are able, with some assumptions about the underlying structure that aren't apparent from these equations (on that issue, this uses a Choleski decomposition and the ordering is as shown), to show how each variable in the system responds to a shock to other variables. Various definitions of the CPI (all items and core) and the PPI (all items, crude, intermediate, and finished goods) are used. Here are the results showing how the CPI variously defined responds to shocks to each of the definitions of the PPI. The horizontal axis shows the number of quarters after the shock. The graphs are called impulse response functions:

                                                                                          The main result, at least in this particular specification of the empirical model, is that both core and overall inflation (as measured by changes in the CPI or core CPI) are least responsive to shocks to inflation in crude materials prices. In addition, the response of core inflation to shocks to input price inflation is more persistent than the response of overall inflation. The paper David cites notes differences in the results by sample period, and the results shown here are for the entire available sample, 1957:Q1 to 2005:Q4 with allowances for lags, so sub-sample results may show differences. This does, however, agree with the basic result from the paper that shocks to input prices at earlier stages in processing, in this case crude materials, have a smaller impact on output prices than shocks to prices at later stages of production. [Update: Here are the graphs with the growth rate of output used in the model rather than the levels: graph1, graph 2. The results are very similar.]

                                                                                            Posted by Mark Thoma on Thursday, March 23, 2006 at 02:16 AM in Economics, Inflation

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                                                                                            Transportation Costs and Globalization

                                                                                            Changes in transportation technology have reduced transportation costs substantially helping to fuel the globalization process. Since digital technology is also a means of reducing transportation costs - email is cheaper and faster than air mail - globalization has been facilitated by the ability to move goods and services across borders at a reduced cost. Virginia Postrel discusses the sharp decline in international shipping costs in her last Economic Scene for the New York Times:

                                                                                            The Container That Changed the World By Virginia Postrel, Economic Scene, NY Times: The political showdown over a Dubai company's plan to operate terminals at six American ports briefly focused public attention on one of the most significant, yet least noticed, economic developments of the last few decades: the transformation of international shipping. Just as the computer revolutionized the flow of information, the shipping container revolutionized the flow of goods. ... By sharply cutting costs and enhancing reliability, container-based shipping enormously increased the volume of international trade and made complex supply chains possible.

                                                                                            "Low transport costs help make it economically sensible for a factory in China to produce Barbie dolls with Japanese hair, Taiwanese plastics and American colorants, and ship them off to eager girls all over the world," writes Marc Levinson in ... "The Box: How the Shipping Container Made the World Smaller and the World Economy Bigger"...

                                                                                            50 years ago, businesses and regulators treated distribution not as a single process but as a series of distinct modes: ships, trucks and trains. Every time the transportation mode changed, somebody had to transfer physically every box or barrel. "By far the biggest expense ... was shifting the cargo from land transport to ship at the port of departure and moving it back to truck or train at the other end of the ocean voyage," writes Mr. Levinson... This "breaking bulk" could easily consume half of the total cost of shipping.

                                                                                            Goods often had to wait in warehouses for the next stage. Those transfers and delays made shipping slow and schedules uncertain. They also created opportunities for damage, mistakes and more than a little theft. ... Today, by contrast, "you can call one of the big international ship lines, tell them to pick up your container in Bangkok, which is not a port, and tell them to deliver it in Dallas, which is not a port, and they will make the arrangements to get it ... where it needs to be," Mr. Levinson said. ...

                                                                                            The idea of containerization was simple: to move trailer-size loads of goods seamlessly among trucks, trains and ships, without breaking bulk. But turning that idea into real-life business practice required many additional innovations. New equipment, from dockside cranes to the containers themselves, had to be developed. Carriers and shippers had to settle on standard container sizes. Ports had to strengthen their wharves, create connections to rail lines and highways, build places to store containers and strike new deals with their unions. ...

                                                                                            In the container age, any city with good port facilities, including feeder rail and truck lines, can compete with any place in the same large region. Seattle can take business from Oakland ... That heightens competition among ports. At the same time, container lines keep building larger and larger ships to drive down their cost per unit...

                                                                                            This is Virginia Postrel's last Economic Scene column. She has written columns under that heading for the past six years...

                                                                                            Moving a load of goods as a single trailer-size unit to cut costs seems to be a relatively obvious innovation, so why wasn't this implemented sooner? Dynamist.com, Virginia Postrel's web site, adds more that helps to explain this:

                                                                                            My column barely mentions one important part of the story--the regulatory environment. At first, containerization grew through cracks in the rigid regulatory structure of the 1960s. But today's fully integrated systems became possible only after trucking and rail were deregulated in the 1970s and maritime rates were deregulated (to very little fanfare) in 1984...

                                                                                            As Levinson said in our interview, "Nobody even remembers what the Interstate Commerce Commission used to do. ... This was a key federal agency. And it spent its time hearing arguments about whether this truck line ought to be able to carry cigarettes in the same trucks as it carried textiles or whether the rates that were being charged to carry pretzels were adequate. People have trouble remembering that today." ...

                                                                                            I'm delighted that Tyler Cowen of Marginal Revolution fame will take over my Times slot, beginning in four weeks.

                                                                                            Sorry to see Virginia end her Economic Scene column, but looking forward to seeing what Tyler Cowen will offer in its place.

                                                                                              Posted by Mark Thoma on Thursday, March 23, 2006 at 01:34 AM in Economics, International Trade, Technology

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                                                                                              Rising Costs Undercut China's Competitiveness

                                                                                              According to this report, China's competitive edge is eroding due to rising input costs:

                                                                                              China’s competitiveness ‘on the decline’, by Tom Mitchell, Financial Times: The competitiveness of China’s manufacturing industries has suffered serious erosion over the past year, according to one of the world’s largest trade sourcing companies. Hong Kong-based Li & Fung group, which manages a $7.1bn a year trading business, said price rises crept back into the Sino-US and EU supply chains last year, after at least six years of often “severe deflation”.

                                                                                              William Fung, Li & Fung managing director, reported an average 2-3 per cent increase in the once unbeatable China price its US and European clients were willing to pay. He pointed to a “double-digit” rise in Chinese labour costs, the revaluation of the renminbi and higher oil and energy costs for the shift. “China’s costs are all going up,” Mr Fung said. “It is no longer the most cost-effective country in the region...”

                                                                                              Beneficiaries of China’s rising prices have included textile and garment manufacturers in India, Bangladesh and Cambodia, ... “In Bangladesh factories are so overbooked – it’s like China used to be,” added Bruce Rockowitz ... who oversees sourcing operations on four continents. The inflationary pressure extends to all product categories ... ranging from fashion accessories and furnishings to sporting and travel goods. Li & Fung, which used to buy 90 per cent of its non-apparel products from China, has seen 25 per cent of this “hardgoods” business migrate to cheaper locations in south and southeast Asia. It sells about 70 per cent of its sourced goods in the US, and another 20 per cent in Europe...

                                                                                                Posted by Mark Thoma on Thursday, March 23, 2006 at 12:06 AM in China, Economics

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                                                                                                March 22, 2006

                                                                                                Rogoff: Artificial Intelligence and Globalization

                                                                                                Ken Rogoff wonders if replacing people with intelligent machines, e.g. pocket economics professors complete with holographic images instead of university professors, will be a bigger factor than globalization and outsourcing in explaining changes in global job and wage patterns in coming decades:

                                                                                                Artificial Intelligence and Globalization, by Kenneth Rogoff, Project Syndicate: Today’s conventional wisdom is that the rise of India and China will be the single biggest factor driving global jobs and wages over the twenty-first century. High-wage workers in rich countries can expect to see their competitive advantage steadily eroded by competition from ... Asia, Latin America, and maybe even some day Africa. ... But I wonder whether ... another factor will influence our work lives even more: the exponential rise of applications of artificial intelligence.

                                                                                                My portal to the world of artificial intelligence is a narrow one: the ... game of chess. You may not care a whit about chess... But the stunning developments coming out of the chess world ... should still command your attention. Chess has long been the centerpiece of research in artificial intelligence. While in principle, chess is solvable, the game’s computational complexity is almost incomprehensible. It is only a slight exaggeration to say there are more possible moves in a chess game than atoms in a universe.

                                                                                                For most of the twentieth century, programmers were patently unsuccessful in designing chess computers that could compete with the best humans. ... The computers gradually improved, but they still seemed far inferior... Or so we thought. Then, in 1997, ... IBM’s “Deep Blue” computer stunned the world by defeating the world champion Garry Kasparov. Proud Kasparov, who was perhaps more stunned than anyone, was sure that the IBM team must have cheated... But the IBM team had not cheated. ... Since 1997, the computers have only gotten better, to the point where computer programmers no longer find beating humans a great challenge.

                                                                                                Only a game, you say? Perhaps, but let me tell you this: when I played professional chess 30 years ago ..., I felt I could tell a lot about someone’s personality by seeing a sampling of their games... Until a short while ago, I could certainly distinguish a computer from a human opponent. Now everything changed like lightning. The machines can now even be set to imitate famous human players – including their flaws – so well that only an expert eye (and sometimes only another computer!) can tell the difference.

                                                                                                More than half a century ago, the godfather of artificial intelligence, Alan Turing, argued that the brain’s function could all be reduced to mathematics and that, someday, a computer would rival human intelligence. He claimed that the ultimate proof of artificial intelligence would be met if a human interrogator were unable to figure out that he was conversing with a computer. The “Turing test” is the holy grail of artificial intelligence research. Well, for me, a chess game is a conversation of sorts. From my perspective, today’s off-the-shelf computer programs come awfully close to meeting Turing’s test. Over the course of a small number of games on the Internet, I could not easily tell the difference. ...

                                                                                                What’s next? I certainly don’t feel safe as an economics professor! I have no doubt that sometime later this century, one will be able to buy pocket professors – perhaps with holographic images – as easily as one can buy a pocket Kasparov chess computer today.

                                                                                                So let’s go back to India and China. Globalization proceeded at a rapid pace through much of the last century, and at a particularly accelerated rate during its last two decades. Yet the vast body of evidence suggests that technological changes were a much bigger driver in global wage patterns than trade. That is, technology, not trade, was the big story of the twentieth-century economy (of course, the two interact...) Are we so sure that it will be different in this century? Or will artificial intelligence replace the mantra of outsourcing and manufacturing migration? Chess players already know the answer.

                                                                                                  Posted by Mark Thoma on Wednesday, March 22, 2006 at 02:48 PM in Economics, International Trade, Technology

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                                                                                                  What Jobs are Safe from Offshoring?

                                                                                                  A commentary by Harold Meyerson in the Washington Post Online asks Will Your Job Survive? and discusses the article Offshoring: The Next Industrial Revolution? by Alan Blinder in the March/April issue of Foreign Affairs. The paper looks at the types of jobs that are vulnerable to offshoring and forecasts how offshoring will affect the U.S. labor market in the future. A free draft version on the paper notes:

                                                                                                  So let us take a fresh look at some rough numbers and try to peer into the future, albeit through the usual befogged glasses, starting with the easy cases.

                                                                                                  • At the end of 2004, there were 14.3 million manufacturing jobs in the United States. The vast majority of these workers produce items that can be put in a box, and so virtually all of their jobs are potentially movable offshore. (...this is not to say that all of them will be offshored.)... • About 7.6 million Americans worked in the other goods-producing sectors: construction and mining. Even though these people produce goods, not services, their jobs are not in danger of moving offshore. You can’t hammer a nail over the Internet, at least not yet. • At year end 2004, there were 22.0 million local, state, and federal government jobs—hardly any of which are candidates for offshoring even though many of them provide just the sort of impersonal services that need not be delivered face to face. (When is the last time you saw an employee of the IRS?) In this case, I believe, politics will prevent the offshoring... • Retail trade employed 15.6 million Americans at the end of 2004. At present, the vast majority of these service jobs are largely or partly delivered in person, or at least require physical presence (e.g., stocking the shelves). That said, Internet retailing is steadily increasing... Hence, more retail jobs will be at risk of offshoring in the future.

                                                                                                  Those are the easy cases. But the classification so far leaves out the majority of private service jobs—some 73.6 million at the end of 2004, including my job (college teaching) and probably yours. Here’s how this extremely heterogeneous group breaks down:

                                                                                                  Educational and health services 17.3 million Professional and business services 16.7 million Leisure and hospitality services 12.3 million Financial services 8.1 million Wholesale trade 5.7 million Transportation 4.3 million Information services 3.2 million Utilities 0.6 million Other services 5.4 million

                                                                                                  It is hard to map such broad job categories into personal versus impersonal services, even under today’s (known) technology. And it is nearly impossible to know what possibilities for long distance electronic delivery the future will bring. But here is my rough stab, reading from top to bottom.

                                                                                                  • The health sector is presently about five times as large as the educational sector, and the vast majority of those jobs seem destined to be delivered in person for a very long time (if not forever). But there are exceptions. I have already mentioned ... radiologists. More generally, laboratory tests of all kinds are already outsourced by most physicians. Why not out of the country rather than just out of town? And with a little imagination, we can envision other medical procedures being performed by doctors who are thousands of miles away... • Educational services are also best delivered face to face; but they are becoming increasingly expensive. My guess is that electronic delivery will never replace personal contact in K-12 education, which is where the vast majority of the educational jobs are. ... But college teaching is more vulnerable. As college tuition grows ever more expensive, cheap electronic delivery will start looking more and more sensible... • Professional and business services comprise an incredibly heterogeneous lot ... ranging from CEOs and architects to typists and janitors. That said, when you scan the list of detailed sub-categories, it is hard to resist the conclusion that lots of these jobs are at least potentially offshorable... • The leisure and hospitality industries seem much safer. If you vacation in Florida, you do not want the beach boy or the maid to be in China. On the other hand, reservation clerks can be (and are) located anywhere. On balance, only a few of these jobs can be moved offshore. • Financial services, a sector that includes many highly-paid jobs, is another area where the future may look very different... To me, it is one big question mark. Today, the United States probably “onshores” more financial jobs (by selling financial services to foreigners) than it offshores. Probably, that will remain true for years. But improvements in telecommunications and rising educational levels in countries like China and, especially, India ... may change the status quo dramatically. • Wholesale trade seems much like retail trade, albeit with a bit less personal contact, and thus with somewhat greater potential for offshoring. The same holds true for utilities. • Information services ... comprise the quintessential types of jobs that can be delivered electronically... The majority of these jobs are at risk. • The phrase “other services” is not very informative. But when you look down the detailed list (e.g., repair and maintenance, laundry, etc.), most of this hodge-podge of services seem to require personal delivery.

                                                                                                  The overall picture defies generalization; draw your own conclusions. My own very rough guess, based on the preceding numbers, is that the number of current U.S. service sector jobs that will be susceptible to offshoring in the electronic future is two to three times the total number of manufacturing jobs. That said, large swaths of American employment look to be immune. However, none of us knows what the future will bring. Technology is constantly surprising us... Leaving aside the details and the nuances, the basic argument of this essay is easy to summarize:

                                                                                                  • Thanks to electronic communications and globalization, the future is likely to see much more offshoring of jobs in ... impersonal services, that is, services that can be delivered electronically over long distance with little or no degradation of quality. • Despite all the political sound and fury, little of this service-sector offshoring has happened to date. But it may eventually amount to a Third Industrial Revolution. And industrial revolutions have a way of transforming societies. • Rich countries will need to shift their work forces away from impersonal services and manufacturing and toward personal services. Unfortunately, Baumol’s disease ... implies that the relative prices of personal services are destined to rise inexorably, so that the relative size of this sector may shrink over time. • That said, the “threat” from offshoring should not be exaggerated. Just as the First Industrial Revolution did not banish agriculture from the rich countries, and the Second Industrial Revolution has not banished manufacturing, the Third Industrial Revolution will not drive all impersonal services off shore. Nor will it lead to mass unemployment. But the necessary adjustments will be large, complex, multifaceted, and difficult. • The societies of the rich countries seem to be completely unprepared for the coming industrial transformation. Our national data systems, our trade policies, our educational systems, our social welfare programs, our politics, and much more, all must adapt to the fundamental movement from impersonal to personal service jobs. None of this is happening now. • Protectionism is not the answer. It will at best slow, not stem, the tide. And it will cause much collateral damage in the process. • Perhaps the most acute need, given the long lead times, is to figure out how to educate our children now for the jobs that will actually be available to them ten and twenty years from now. Unfortunately, the distinction between personal service jobs (which are more likely to remain in the rich countries) and impersonal service jobs (which are more likely to go) does not correspond to traditional distinctions between high-skilled and low-skilled work. So simply providing more education is not the answer. • The more flexible and fluid United States will probably cope with these problems better than Europe and Japan will.

                                                                                                    Posted by Mark Thoma on Wednesday, March 22, 2006 at 01:29 AM in Economics, International Trade, Unemployment

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                                                                                                    Patent Trolls are Not the Problem

                                                                                                    This commentary from the Wall Street Journal continues the discussion in What's Wrong with Our Patent System? While there are differences in the two editorial's diagnosis of the problems with the patent system, e.g. on the importance of patent trolls in contributing to the problem, an area of agreement is that too many patents are granted and many of them are of questionable validity. A suggested solution in both cases is to increase the number of experts in the patent office, and to allow competitors the opportunity to weigh in earlier in the patent review process. In both cases the goal is the same, to reduce problems by reducing the number of bad patents that are granted:

                                                                                                    War on 'Patent Trolls' May Be Wrong Battle, by Alan Murray, Commentary, WSJ: In the business world, the new villains are "patent trolls." The term was coined five years ago by Peter Detkin, then head of litigation for Intel Corp., to vilify companies "that try to make a lot of money off a patent that they are not practicing and have no intention of practicing and in most cases never practiced." The trolls earned their place in the public imagination thanks to NTP Inc., whose patent lawsuit threatened ... to interrupt service to about three million BlackBerry users until it was settled this month...

                                                                                                    Next week, the titans of technology take their antitroll crusade to Washington. On March 29, the Supreme Court will hear arguments in a case involving ... eBay Inc. ...[and] a company called MercExchange LLC, which claims to own the patent on eBay's popular "Buy It Now" process. Touted as the most important patent case to hit the U.S. high court in a decade, this one revolves around whether companies like MercExchange and NTP should be granted injunctions to shut down patent infringers. The following week, Congress ... plans hearings ... to look at, among other things, the BlackBerry fiasco and the role of trolls.

                                                                                                    But patent trolls are getting a bad rap. For one thing, most U.S. research universities fit Mr. Detkin's definition cited above. Does anyone think Stanford University deserves less patent protection than, say, Microsoft, because it doesn't make or sell products? ... [F]ormer Microsoft chief technologist Nathan Myhrvold, ... an outcast among his tech colleagues on this topic, argues there is no reason a company should be given less protection ... simply because it chooses not to commercialize its patents. After all, Thomas Edison, who nabbed more than 1,000 patents, didn't manufacture his inventions. ... At a time when the U.S. advantage in global trade is its intellectual property, weakening patent protection ... would be a big mistake.

                                                                                                    There is a problem in the patent world, but it isn't companies that don't commercialize their own patents. Rather, it is bad patents. These days, too many are granted, too often for "inventions" that seem to the initiated to be as obvious as air... In part, that happens because the Patent and Trademark Office is understaffed and overwhelmed. A good first step would be to beef up the patent agency. .... Second, change the patent laws to allow opponents of new patents to weigh in earlier. Right now, examiners often work in a vacuum. If patent applications were published prior to final approval and allowed to be contested ... fewer bad patents might be issued... [Update: A NY Times editorial echoes the theme.]

                                                                                                      Posted by Mark Thoma on Wednesday, March 22, 2006 at 12:51 AM in Economics, Policy, Regulation, Technology

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                                                                                                      Spinning Unpopular Wars

                                                                                                      This is a news conference president Johnson held in November of 1967. As noted here, this was at a time when "the percentage of Americans who thought Vietnam was a mistake was closing in on 50 percent in the Gallup poll," and four months before Johnson announced he would not seek reelection:

                                                                                                      In the midst of all the horrors of war, in guerrilla fighting in South Vietnam, we have had five elections in a period of a little over 14 months," Johnson said. ''. . . To think that here in the midst of war when the grenades are popping like firecrackers all around you, that two-thirds or three-fourths of the people would register and vote and have five elections in 13 months -- and through the democratic process select people at the local level, a constituent assembly, a house of representatives, a senate, a president, and a vice president -- that is encouraging. The fact that the population under free control has constantly risen, and that under Communist control has constantly gone down, is a very encouraging sign.

                                                                                                      Here's president Bush in a weekly radio address from January, 2005, a time when support for Bush's handling of the war had fallen below 50%:

                                                                                                      In the face of assassination, brutal violence and calculated intimidation, Iraqis continue to prepare for the elections and to campaign for their candidates. They know what democracy will mean for their country: a future of peace, stability, prosperity and justice for themselves and for their children. ... Tomorrow's vote will be the latest step in Iraq's journey to permanent democracy and freedom. Those elected to the transitional National Assembly will help appoint a new government that will fully and fairly represent the diversity of the Iraqi people. ... Tomorrow's election will add to the momentum of democracy. ... as they move further into the light of liberty.

                                                                                                        Posted by Mark Thoma on Wednesday, March 22, 2006 at 12:33 AM in Iraq, Politics

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                                                                                                        March 21, 2006

                                                                                                        China Says U.S. Should Blame Itself

                                                                                                        China criticizes U.S. economic policy and says the U.S. should stop blaming China for the structural problems the policy has caused:

                                                                                                        China warns US not to make it a scapegoat, by Richard McGregor and Geoff Dyer, Financial Times: China will take measures to meet US complaints about their bilateral trade imbalance..., but has warned the US also to take responsibility for its economic problems. Wen Jiabao, China’s premier ... promised new initiatives on issues such as abuse of intellectual property rights,.... “But it is unfair for the US to scapegoat China for the US’s own structural economic problems,” Mr Wen added...

                                                                                                        Brad Setser responds:

                                                                                                        Brad Setser: If China doesn’t like US economic policies … Maybe it should stop financing them. ... At least in my view, Chinese premier Wen's criticism of US economic policy - and US economic scape-goating -- would have a lot more credibility if China wasn't spending around $250b a year (10% of its GDP) resisting market pressure for China's exchange rate to appreciate. Because of that policy, China ends up financing a rather significant fraction of the US fiscal deficit ... and the US current account deficit... In the process, it also masks the impact of bad US economic policies. ...

                                                                                                        No doubt, there is plenty of blame to go around. The US isn't serious about doing anything to reduce its fiscal deficit. Just try to read the President's latest remarks. To the extent that they make any sense (see DeLong)... And President Bush has done absolutely nothing to try to assure that all parts of America benefit from globalization. Cutting taxes on dividends, estates and capital gains -- and proposing to dismantle ... social security ... is hardly a creative policy response to intensified competition from labor rich economies around the globe. Yet China's commitment to exchange rate flexibility seems every bit as thin as the Bush Administration's commitment to fiscal sanity and sharing the benefits of growth widely. ... I'll have much more on the fact that no one really wants to do anything other than talk about global imbalances later. ...

                                                                                                        I agree with Brad, the administration should accept its share of the blame for the fiscal deficit and other misguided policies, but China's currency manipulation is part of the story too.

                                                                                                          Posted by Mark Thoma on Tuesday, March 21, 2006 at 07:11 PM in Budget Deficit, China, Economics, International Finance, International Trade, Politics

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                                                                                                          Don't Spare the Flapdoodle

                                                                                                          Michael Hiltzik of Golden State Blog watches Medicare Administrator Mark McClellan try to sell "malarkey":

                                                                                                          Medicare Clutches at Straws, by Michael Hiltzik, Golden State Blog: It's heartbreaking to watch a government bureaucrat try to defend the indefensible, but I went up to the Whittier Community Center this morning to watch Medicare Administrator Mark McClellan speak up for the Medicare drug program, just the same. As I expected, the experience evoked those sensations of pity and terror of which Aristotle speaks so highly in his Poetics.

                                                                                                          As expected, McClellan didn't spare the flapdoodle. Despite mounting evidence that the drug program has been a disaster from the start--and will elicit even more voter anger when enrollees start hitting the dreaded "doughnut hole," about the time when the Congressional election campaigns kick into high gear at Labor Day--he kept claiming that surveys show that enrollees are "overwhelmingly" satisfied with the program. He told an audience of about 60 seniors that under the rules governing the policies of the private health plans administering the program, "all the plans have to cover the medicines you need." This is manifestly untrue, since within broad limits the private health plans running the program for Medicare can compile their own formularies. The "medicines you need" might be on their list, or might not. Or they might be on the lists now, and gone next month.

                                                                                                          There was more malarkey of this type, but what about those surveys showing "overwhelming" satisfaction. When I queried McClellan, I learned this is a reference to a couple of studies done by AHIP. Who dat? It's "America's Health Insurance Plans," the Washington trade group for the private insurers who are reaping huge revenues from Medicare Part D.

                                                                                                          Very trustworthy.

                                                                                                          But what do the surveys actually say? Let's check. A summary is available here on the AHIP website. It indicates that as many as 40% of enrollees aren't saving money under Part D, or aren't sure. As many as 20% may be taking drugs that aren't covered. (So much for the plans covering "the medicines you need.") Up to a third aren't sure the signing up was worth the effort. Only 16% of enrollees were able to sign up online by themselves, making a mockery of Medicare's insistence that its online portal is a great boon to seniors.

                                                                                                          My favorite part of the survey is this question:

                                                                                                          When you hear politicians criticize the new Medicare prescription drug benefit plan, do you think they are sincerely trying to fix the plan, or just trying to score political points in an election year?

                                                                                                          Interestingly, 40% of respondents refused to answer this question, by far the largest ratio of any question in the survey. Which proves that America's seniors recognize horse manure when they're fed it. Of course, the survey didn't ask what the respondents think of criticism of the plan by doctors, pharmacists, health care advocates, nursing home administrators, or any of the other professionals who have condemned it as a fraud and a disgrace. Are they just trying to score political points, too?

                                                                                                            Posted by Mark Thoma on Tuesday, March 21, 2006 at 02:28 PM in Economics, Health Care, Politics

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                                                                                                            Flexicurity

                                                                                                            When asked how to help workers affected by globalization, economists often recite the stock phrase "education and retraining." But the evidence on the effectiveness of job retraining programs is mixed and it's hard to push strongly for costly job retraining programs without demonstrable benefits. One place to look for evidence of benefits from job retraining programs is Denmark. In the Danish system, workers are protected, but jobs are not. Danish workers are among the most easily laid off workers anywhere, but only one in ten workers expresses concern over job security:

                                                                                                            For the Danish, A Job Loss Can Be Learning Experience, by Marcus Walker, WSJ: After graduating from high school, Susanne Olsen spent 10 years at the local slaughterhouse... It was arduous, unskilled work that left her ill-equipped for most other jobs. Then the slaughterhouse closed down last year, leaving 500 people without jobs... But unlike ... laid-off workers in similar circumstances elsewhere in Europe, Ms. Olsen was sure she was going to find a new job. Now she's an apprentice golf landscaper, with her salary subsidized by the state while she takes four years of training paid for by the government and her new employer...

                                                                                                            Most of Western Europe is fighting to hold on to its traditionally strong job protections... Denmark has gone the other way. The government allows liberal hiring and firing as in the U.S. And it has imposed limits on the duration of its high unemployment benefits. But it also invests more than any other country, as a percentage of its gross domestic product, in retraining the jobless -- a combination it calls "flexicurity." Its unusual mix of the free market and big government has helped Denmark cut its unemployment rate in half, from about 10% in the early 1990s to U.S.-style levels of under 5% now. The economy has been relatively robust, growing 3.4% last year. Meanwhile, France and Germany are at or above the Danish jobless rate of a decade ago.

                                                                                                            Even though Danes are among the most easily laid-off workers in Europe, polls show the country's workers are the most secure about their future. ... Danes change jobs more frequently than any workers in the developed world except Americans and Australians... But fewer than 10% say they're concerned about job security, compared with nearly 40% in Germany and more than 60% in Spain. Most Danes believe they can always find work... In the interim, they get security from a dole that replaces up to nine-tenths of their last wage, the highest level in Europe.

                                                                                                            Critics say the experiment might not be easy to replicate. For one thing, Denmark is small, with just 5.4 million people. And close-knit Scandinavian countries historically have had a higher tolerance for taxes. The system isn't cheap: Denmark spends about 4.4% of its GDP every year on supporting and retraining the jobless, the most expensive labor-market policy in the world. ...

                                                                                                            Kirsten Thomsen prepares the "bottleneck analysis" that makes Denmark's peculiar hybrid possible... Every three months, Ms. Thomsen has the ... polling firm Gallup survey employers ... on what jobs they will need in coming years, and uses the feedback to identify the next labor shortages. ... The consultants who deal directly with unemployed people use her reports in picking training courses for individuals. "In our system, we can make supply and demand match," Ms. Thomsen says.

                                                                                                            The true test is how the system deals with low-skilled, manual laborers in declining industries. ... Finding new work for the 500 laid off at Hjørring ... was a double challenge. Most of the workers didn't want to leave their home town. ... In addition, the meatpackers weren't qualified for new employment, says Jim Jensen, ... Despite Hjorring's spate of large-scale factory closures, new vacancies keep appearing in Denmark's flexible labor market. ... Where qualifications are lacking, the state pays for courses at vocational colleges, often sharing the cost with a new employer...

                                                                                                            Ten months after the slaughterhouse closed, some 300 ex-workers have found new professions in addition to the 80 who got other jobs as meatpackers. Others from Hjørring are in full-time education, or chose retirement... Today, only 60 of the 500 laid-off workers from Hjørring are still on unemployment benefits.

                                                                                                              Posted by Mark Thoma on Tuesday, March 21, 2006 at 01:40 AM in Economics, Unemployment

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                                                                                                              Fields of Expertise

                                                                                                              Paul Krugman asks for reciprocal visiting rights into areas covered by other columnists and explains why he deserves to have them:

                                                                                                              Fields of Expertise, by Paul Krugman, Money Talks, NYT: Bruce Bartlett has posted a reply of sorts to my March 10 column, “The Conservative Epiphany.” It’s interesting, because he admits that for a time he was deterred from speaking up about the Bush administration’s flaws because he feared, correctly, that he would be fired from his think-tank job if he did. I won’t pass personal judgment on his behavior; I often tell people that one main reason I was willing to criticize Bush when he was still very popular, and when critics were routinely smeared and accused of being unpatriotic, was that I knew that I could always go back to just being a college professor — in Europe if necessary.

                                                                                                              But I would like to respond to one point, because lots of people who criticize me say the same thing (and I occasionally hear it from people at The Times itself): that I should have stuck to economics, my field of expertise, rather than venturing into other areas. I could point out that as far as I can tell, every other op-ed columnist at the Times writes about economics. Don’t I get reciprocal visiting rights?

                                                                                                              Anyway, what that criticism really means is that I shouldn’t have written about the Iraq war. But the sad fact is that I got things more nearly right on Iraq than the vast majority of opinion writers at major newspapers, including commentators who are supposed to be experts on foreign policy.

                                                                                                              I call it a sad fact because I was a skeptic and a pessimist. At a time when most commentators, even liberals, believed that the Bush administration was making an honest case for war, I suggested that the administration was exaggerating the threat. At a time when quite a few commentators, again including liberals, were enthusiastic about the idea of throwing America’s military weight around, I argued that the occupation of Iraq would be much harder than the invasion; I predicted that the Bush administration would botch the occupation and the reconstruction; and I warned that the war would weaken America’s position in the world. I wish I hadn’t been right on all these points, but I was.

                                                                                                              Why did I get it right, when so few other commentators did? Partly because, as Mr. Bartlett suggests, I wasn’t afraid of losing my job. But mainly, I think, because I was able to apply to foreign policy the lessons about the administration’s character and competence that I had learned from covering economic policy.

                                                                                                                Posted by Mark Thoma on Tuesday, March 21, 2006 at 01:23 AM in Economics, Politics

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                                                                                                                Fed Watch: The Perils of Calling the Top

                                                                                                                Tim Duy with a Fed Watch:

                                                                                                                Policymakers are gearing up for another 25bp rate hike at the end of the month – essentially a given at this point. Market participants are also pricing in another 25bp hike in May, although the odds have backed off a bit. Last week I said the mood on the FOMC appeared to be shifting to favor a pause at 5% on the Fed Funds rate. Soon thereafter, John Berry at Bloomberg argued that 5% was a more likely stopping point than 5.25% or higher. Sounded good to me. But then, while cleaning my office, I stumbled upon this piece that I wrote on May 14, 2001. This part caught my eye:

                                                                                                                We will pay close attention to the Fed’s statement tomorrow. It will probably attempt to lower expectations for further rate cuts while not closing the door entirely. The Fed is definitely feeling around for the end of the easing cycle. Several governors think 4% would be a good pausing point. But April’s employment report served as a warning that the US economy could be set for a fresh downturn. It’s a warning that Fed officials will definitely take to heart..

                                                                                                                Four percent? What in the world was I thinking? Or drinking? The bottom turned out to be 1%. Of course, I wrote this relatively early in that easing cycle, and prior to the September 11 terrorist attacks. Few economists foresaw how low the Fed would push interest rates, and I believe the piece captures the thinking of FOMC members at the time.

                                                                                                                Still, 4% was not just a little bit off. It was way off – and illustrates the perils of looking for a top or a bottom. Accurately calling the stopping point depends on a combination of understanding the underlying policymaking process and correctly anticipating the path of economic activity. Missing either will trip up the Fedwatcher. Another example, brought to us by Bloomberg:

                                                                                                                [Bill] Gross [of PIMCO] as far back as May has been forecasting an end to Fed rate increases. A rate of 3.25 percent to 3.5 percent ``is about all the economy can stand,'' he said at the time. The rate is currently 4.50 percent.

                                                                                                                I do not mean to ridicule Bill Gross; one could have a perfectly reasonable, well thought out position for calling a peak (or trough) in rates, and still miss the call completely.

                                                                                                                So, for the sake of clarity, the case for a pause at 5% hinges on the expectation that growth will slow and inflation remains in the “comfort zone” in back half of this year – essentially, the outlook of most policymakers and forecasts. Considering the substantial amount of tightening that is already making its way through the system, this outlook argues for a pause sometime in the near future to avoid a possible overshoot. At a minimum, Fed Chairman Ben Bernanke’s speech reinforces my view that a move beyond 5% is not in the mindset of the FOMC at this point. At a maximum, it leads me to shave down my expectations for a move to 5%.

                                                                                                                The twists and turns of Fedspeak point in the direction as well. Policymakers are walking a fine line, setting expectations of additional tightening while including a dovish sounding note here and there. For example, in recent speeches, San Francisco Fed President Janet Yellen has indicated the need for further tightening:

                                                                                                                And that brings me to the inflation situation. Specifically, this relatively low unemployment number raises the question of whether the economy has already gone a bit beyond full employment. If it has, then, with real GDP growth expected to exceed its potential rate in the first half of this year, the strain on resources could build further, intensifying inflationary pressures. Additional inflationary pressures at this point would be particularly unwelcome, because inflation is now toward the upper end of my “comfort zone.”

                                                                                                                Later in the speech, however, she is clear that while that higher rates are necessary in the near future, policy beyond that is data dependent:

                                                                                                                Indeed, I view decisions about the stance of policy going forward as quite data-dependent. On the one hand, I will be alert to any incoming data suggesting that economic growth is less likely to slow to a sustainable pace or that inflation is less likely to remain contained; however, I will also be looking for signs of the delayed effects on output and inflation of our past policy actions and will be sensitive to the possibility that policy could overshoot. While the Committee must always have the flexibility to respond to changing circumstances, the need for the flexibility to respond appropriately to incoming data is especially important right now.

                                                                                                                But “data dependent” must be taken in context of expectations:

                                                                                                                …it seems likely that growth will settle back to a trend-like pattern as the year progresses. One likely contributing factor is the winding down of the rebuilding effort later in the year. Another is the lagged effect of monetary policy tightening; in other words, tighter financial conditions will have a dampening impact on interest-sensitive sectors, such as consumer durables, housing, and business investment.

                                                                                                                Putting it altogether suggests that Yellen is comfortable with expectations for two more rate hikes and a pause – assuming of course that the economy looks to slow to trend as expected. In my opinion, her remarks to the press after speeches sound a bit more dovish (see my last piece), but that could be the result of selective quoting by the press. In contrast, Altanta Fed President Jack Guynn sounded a more hawkish note last week:

                                                                                                                Several areas warrant close attention. As I suggested earlier, households and businesses seem to be coping with persistently higher energy prices without a major reallocation of spending. But it’s possible we haven’t yet seen the full adjustment to the new reality of elevated energy costs. Also, we don’t yet know the full effects of the potential transitions in residential real estate markets. Despite the removal of very accommodative Fed monetary policy, credit markets are still accommodative, in my view, and this liquidity could boost the economic expansion and contribute to stronger-than-expected inflationary pressures. The relative lack of broad pricing power that’s been observed in many competitive world markets could begin to change, especially if domestic demand increases beyond present forecasts.

                                                                                                                Boston Fed President Cathy Minehan took a more middle of the road approach today at the New England Realtors Conference:

                                                                                                                From a macro perspective, it makes sense to worry about the potential impact on overall GDP growth of a combination of a reduction in housing construction and a decline in household wealth…. Thus, changes in residential real estate present a source of downside risk to growth. I should also note here that in recent times residential real estate markets have often outperformed expectations, a fact with which this audience is more than familiar….But the risks are not all in the direction of slower growth. Stronger growth and somewhat higher inflation are well within the realm of possibility as well. Consumption could be less affected by waning real estate markets than we expect, particularly if more consumers are working. With unemployment rates at their recent levels, some possibility exists that labor costs will begin to rise faster than productivity, which in turn could put pressure on inflation.

                                                                                                                No one – expect maybe Minneapolis Fed President Gary Stern – sounds like they want to stop hiking rates immediately. The hawks sound too hawkish to pull back just yet. But policymakers won’t keep blindly raising rates until the bottom falls out (critics will argue that they have already missed the boat on that one). The common thread through most Fedspeak is the expectation that a slowing housing market will depress economic activity later this year. That should feed into an easing of inflationary pressures, forming the basis for a pause at 5%.

                                                                                                                But what about the man on top? Arguably, Bernanke’s speech last night was remarkably clear. Except when it came to the policy implications. Then things get a bit tricky. Are we expected to hold at 4.75%? Or is 5.25% more of a possibility?

                                                                                                                My initial impression of the speech is that it is more dovish than I anticipated. True, it is clear that Bernanke does not worry that the yield curve signals a “significant” economic slowdown is in the cards. This could be interpreted as a license to push rates beyond 5%. But I keep getting caught up in the next two paragraphs (so, apparently, did Greg Ip at the Wall Street Journal), in which Bernanke offers the possibility that the natural interest rate has declined. More importantly, he reminded us that this is consistent with his global saving glut hypothesis, concluding with:

                                                                                                                So long as these factors persist, global equilibrium interest rates (and, consequently, the neutral policy rate) will be lower than they otherwise would be.

                                                                                                                I do not see any indication that Bernanke has abandoned this theory, and the fact that he concluded with the suggestion of a lower neutral policy rate is, in my opinion, significant. Recall that the midpoint of the neutral range is often thought to be 4.5%. Unless you believe that there is a need to push rates well above neutral – which is not something I am picking up from the data or any other policymaker – it indicates a willingness to pause on the south side of 5%, lest policy become to restrictive in a world awash in excess saving.

                                                                                                                It is worth noting that if Bernanke is sending a signal, it is not a particularly strong one, and I am not yet confident Bernanke’s colleagues share a dovish view on the neutral rate. On at least one point, the importance of central bank intervention, Bernanke spends two paragraphs rebutting the position of New York Fed President Timothy Geithner, who appears to favor higher rates to counteract the stimulative impact of foreign central banks.

                                                                                                                In short, Bernanke’s speech leads me to shave down my expectations of another hike after next week’s. But I would like to see more Fedspeak swing around toward a pause at 4.75% before I abandon a move to 5% in June. Without stronger data, I remain hesitant to look for anything past 5% as FOMC members will likely want to sit back and assess their handiwork.

                                                                                                                  Posted by Mark Thoma on Tuesday, March 21, 2006 at 12:18 AM in Economics, Fed Speeches, Fed Watch, International Finance, Monetary Policy

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                                                                                                                  What's Wrong with Our Patent System?

                                                                                                                  Adam Jaffe of Brandeis University and Josh Lerner from the Harvard Business School discuss how recent changes in the patent system have caused a breakdown in its ability to protect and encourage innovation, and how to fix the problems:

                                                                                                                  Innovation and Its Discontents, by Adam Jaffe and Josh Lerner, Commentary, WSJ: The problems of the U.S. patent system are under discussion ... with an urgency not seen in decades. ... Congressional subcommittees, with good reason, have recently held hearings asking ... about developments ... in the patent system. The importance of this long-overdue focus on patents cannot be overemphasized. The past decade has seen periodic uproars over particular patents... but the wrong lessons have typically been drawn. Commentators have tended to focus on the incompetence of the USPTO in allowing "bad patents." Others have concluded that the patent system is not working with respect to a particular area of technology. ... [c]oncerns about software awards ... for instance... others have suggested that biotechnology be excluded in various ways from the patent regime.

                                                                                                                  We believe, instead, that the problems with the patent system are ... the result of two congressional changes... At the time they were described as administrative and procedural...; but taken together they have resulted in the most profound changes in U.S. patent policy and practice since 1836. One set of changes has made it easier to enforce patents, easier to get large financial awards ..., and harder for those accused of infringing patents to challenge the patents' validity; another set of changes has made patents much easier to get. The combination has created a ... combination of factors that increasingly makes the patent system a hindrance rather than a spur to innovation.

                                                                                                                  Congress set us on this road in 1982 when it created a centralized appellate court for patent cases... Its decisions ... are largely responsible for the significant strengthening of the legal potency of patents. Then, a decade later, Congress turned the USPTO into a "profit center." The office has been pushed to return "excess" revenue to the U.S. Treasury. This shift led to pressures to grant more patents, difficulties in attracting and retaining skilled examiners, and a torrent of low-quality patent grants. These include such absurdities as patents on wristwatches (paw-watches?) for dogs, a method of swinging on a swing ("invented" by a five-year-old), and peanut butter and jelly sandwiches. But they also include the patents on broad ideas related to mobile email -- virtually devoid of any details of implementation -- that have imposed a $612 million tax on the maker and users of BlackBerries.

                                                                                                                  The combination of making patents easier to get and simultaneously more potent when enforced has led to an explosion in patent litigation. Holders of dubious patents ... established firms or "trolls" whose only business is patent enforcement -- routinely threaten firms that sell valuable products with shutdown based on alleged patent infringement. Even if the target firm believes that it does not infringe..., the cost and risk of proving this in court may be too high. Innovators may choose simply to drop the allegedly offending product, or to settle and pay ransom rather than fight. This is not a problem confined to any single industry. ...

                                                                                                                  It might be tempting to view patent law as just another area where litigation has spun out of control. But ... its effects are particularly worrisome, because a faulty patent system can have profound impact on the overall process of innovation. ...For all its deficiencies and periodic stumbles, our free-enterprise system has demonstrated a unique ability to generate new technology: ... The basis for this advance is the pursuit of profit, which forces firms to innovate. But the profit-based incentive to innovate depends fundamentally on the institutions governing ownership of the fruits of innovation. ...

                                                                                                                  The legal protection patents provide is supposed to mitigate the risks of these investments, but the flood of dubious patents that nonetheless have amplified legal force is increasing rather than mitigating the risks associated with investments in innovation. ... We believe that the incentives of the existing system induce all participants ... to invest in abusing the system rather than innovating. Reform of the system must change these incentives by (1) changing the USPTO review process...; and (2) leveling the playing field between litigants so frivolous patent holders cannot intimidate true innovators into paying protection money.

                                                                                                                  Our proposed reforms start with the recognition that much of the information needed to decide if a given application should be approved is in the hands of competitors of the applicant, rather than the USPTO. ... Most patents would never receive anything other than the most basic examinations. But for those applications that really mattered, [competing] parties would have an incentive and opportunities to bring information in their possession before the USPTO...

                                                                                                                  If bad patents with important consequences were weeded out by the USPTO, the incentive to file frivolous applications in the first place would be reduced. ... But there are always going to be mistakes, and so it is important that the court system operate efficiently to rectify those mistakes, while protecting holders of valid patents. Today, the legal playing field is significantly tilted in favor of patentees.

                                                                                                                  The reliance on jury trials is a critical problem. The evidence in a patent case can be highly technical, and the average juror has little competence to evaluate it. ... The right to a jury of one's peers is a venerated concept in Anglo-American law. But there is ample scope for judges to use pretrial rulings and reports of special "masters" commissioned by the court to resolve more of the most technical issues that determine the outcome of patent litigation. While litigation will always be uncertain, it has to be structured so that complex technical issues are addressed in a way designed to elucidate rather than obscure. ... As much as the USPTO needs to do a better job, it can only do so if the system is modified so that all parties have incentives to help with the job, and the courts provide a reliable backstop when mistakes are made.

                                                                                                                    Posted by Mark Thoma on Tuesday, March 21, 2006 at 12:07 AM in Economics, Regulation

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                                                                                                                    March 20, 2006

                                                                                                                    Bernanke: The Yield Curve and Monetary Policy

                                                                                                                    Ben Bernanke discusses why long-term interest rates have remained low throughout the Fed's current tightening cycle and the implications of this for monetary policy. He notes two main explanations for low long-term rates, and he discusses why the monetary policy implications differ according to which explanation is adopted. If low long-term rates are due to a decline in the term premium, the effect is stimulative and policy would need to be tightened. But if low long-rates are due to current or anticipated economic conditions, e.g. an anticipated slowdown in growth in the future, the implications for policy are the opposite. Tim Duy will have a Fed Watch later, so for now here's a shortened version of Bernanke's remarks:

                                                                                                                    Reflections on the Yield Curve and Monetary Policy, by Chairman Ben S. Bernanke, March 20, 2006: ...I intend to ... address an intriguing financial phenomenon: the fact that, over the past seven quarters or so, tightening monetary policy has been accompanied by long-term yields that have moved only a little on net. Why have long-term interest rates not risen more...? And what implications does this ... have for monetary policy and the economic outlook? As you will see, in my remarks I will do a better job of raising questions than of answering them. ... I will conclude that the implications for monetary policy ... are not at all clear-cut. ...

                                                                                                                    Why have the far-forward rates implied by the term structure of interest rates declined in recent years? Observers have offered two broad (and not mutually exclusive) classes of explanations. One set of explanations holds that bond yields are reacting to current or prospective macroeconomic conditions. Another set focuses on special factors that may have influenced market demands for long-term securities ... independent of the economic outlook. I will first consider explanations that emphasize possible changes in the net demand for long-term securities...

                                                                                                                    According to several of the most popular models, a substantial portion of the decline in distant-horizon forward rates over recent quarters can be attributed to a drop in term premiums. ...[W]e can ... divide the term premium into two parts--a premium for bearing real interest rate risk and a premium for bearing inflation risk. Both of these components have trended lower over time..., but the decline ... appears to have been associated mainly with a drop in the compensation for bearing real interest rate risk.

                                                                                                                    At least four possible explanations have been put forth for why the net demand for long-term issues may have increased, lowering the term premium. First, longer-maturity obligations may be more attractive because of more stable inflation, better-anchored inflation expectations, and a reduction in economic volatility more generally. ... if investors have come to expect this past performance to continue, they might believe that less compensation for risk ... is required...

                                                                                                                    A second possible explanation ... is linked to the increased intervention in currency markets by a number of governments, particularly in Asia. ... This interpretation has some support... However, ... Several pieces of indirect evidence suggest that the long-term effect of foreign purchases on yields may be moderate...

                                                                                                                    Changes in the management of ... pension funds are a third possible source of a declining term premium. Reforms ... expected to encourage pension funds to be more fully funded .... Together with the increased need of aging populations in the industrial countries to prepare for retirement ... may have increased the demand for longer-maturity securities. We have seen little direct evidence to date of sizable pension-fund portfolio shifts toward long-duration bonds, at least in the United States. But ... bond investors might be attaching significant odds to scenarios in which pension funds tilt ... their portfolios toward such assets substantially over time.

                                                                                                                    Fourth and finally, as investors' demands for long-duration securities may have increased over the past few years, the supply of such securities seems not to have kept pace. ...

                                                                                                                    What does the historically unusual behavior of long-term yields imply for the conduct of monetary policy? The answer, it turns out, depends critically on the source of that behavior. To the extent that the decline in forward rates can be traced to a decline in the term premium, ... the effect is financially stimulative and argues for greater monetary policy restraint, all else being equal. ...

                                                                                                                    However, if the behavior of long-term yields reflects current or prospective economic conditions, the implications for policy may be ... quite the opposite. The simplest case in point is when low or falling long-term yields reflect investor expectations of future economic weakness. ...

                                                                                                                    What is the relevance of this scenario for today? ... I would not interpret the currently very flat yield curve as indicating a significant economic slowdown to come, for several reasons. First, in previous episodes when an inverted yield curve was followed by recession, the level of interest rates was quite high... Second, ... to the extent that the flattening or inversion of the yield curve is the result of a smaller term premium, the implications for future economic activity are positive rather than negative. Finally, the yield curve is only one of the financial indicators that researchers have found useful in predicting ... economic activity. Other indicators ... would seem to be consistent with continuing solid economic growth. ...

                                                                                                                    An alternative perspective holds that the recent behavior of interest rates does not presage an economic slowdown but suggests instead that the level of real interest rates consistent with full employment in the long run--the natural interest rate, if you will--has declined. For example, ... factors that may create a longer-term drag on the growth in household spending, including high energy costs, the likelihood of slower growth in house prices, and a possible reversal of recent declines in saving rates. If these drags on the growth of spending do materialize, then a lower real interest rate will be needed to sustain aggregate demand.... To be consistent with a lower long-term real rate, the short-term policy rate might have to be lower than it would otherwise be as well.

                                                                                                                    Given the global nature of the decline in yields, an explanation less centered on the United States might be required. About a year ago, I offered the thesis that a "global saving glut"--an excess ... of desired global saving over desired global investment--was contributing to the decline in interest rates. In brief, I argued that this shift reflects the confluence of several forces. On the saving side, the factors include rapid growth in high-saving countries on the Pacific Rim, export-focused economic development strategies that directly or indirectly hold back the growth of domestic demand, and the surge in revenues enjoyed by oil producers. On the investment side, notable factors restraining the global demand for capital include the legacy of the Asian financial crisis of the late 1990s, .., and the slower growth of the workforce in many industrial countries. So long as these factors persist, global equilibrium interest rates (and, consequently, the neutral policy rate) will be lower than they otherwise would be.

                                                                                                                    What conclusion should we draw? Clearly, bond prices, like other asset prices, incorporate a great deal of information... However, the information is not always easy to extract and--as in the current situation--the bottom line for policy appears ambiguous. In particular, to the extent that the recent behavior of long-term rates reflects a declining term premium, the policy rate associated with a given degree of financial stimulus will be higher than usual. But to the extent that long-term rates have been influenced by macroeconomic conditions, including such factors as trends in global saving and investment, the required policy rate will be lower. Given this reality, policymakers are well advised to follow two principles familiar to navigators throughout the ages: First, determine your position frequently. Second, use as many guides or landmarks as are available. ...

                                                                                                                      Posted by Mark Thoma on Monday, March 20, 2006 at 06:02 PM in Economics, Fed Speeches, International Finance, Monetary Policy

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                                                                                                                      Is Bush a Big Spender?

                                                                                                                      In an update to his column today, Paul Krugman adds more on Bush and the perception that spending on domestic programs has grown out of control during his administration:

                                                                                                                      Is Bush A Big Spender?, by Paul Krugman, Money Talks: The idea that George W. Bush has been “spending like a drunken sailor” ... is in danger of becoming one of those factoids that everybody knows to be true, regardless of the evidence. ... But the data just don’t support that claim. Most of what you need to know is in the Congressional Budget Office’s historical budget data. From Table 6 we learn that overall federal spending rose from 18.5 percent of G.D.P. in fiscal 2001 ... to 20.1 percent of G.D.P. in fiscal 2005, a rise of 1.6 percentage points. However, that somewhat understates the true spending increase, because it includes interest payments, which fell because of lower interest rates. Non-interest spending rose from 16.5 to 18.6 percent of G.D.P. — 2.1 percentage points.

                                                                                                                      But where did the money go? Table 8 gives us data on discretionary spending — spending that isn’t mandated by law. Defense and international spending rose from 3.2 to 4.3 percent of G.D.P., 1.1 percentage points. So that’s more than half the spending rise, right there. Domestic discretionary spending rose from 3.2 to 3.5 percent of G.D.P. Conservatives make a big deal about this rise, but as you can see it’s fairly small... And what you ... can infer from other C.B.O. reports, is that a significant part of the rise in domestic discretionary spending ... was really new spending on homeland security.

                                                                                                                      So increases in non-security discretionary spending were a trivial factor in the overall rise in spending as a share of G.D.P., of which well over half – say 1.2 percentage points at least - was security-related. On to health care: Table 10 tells us that combined spending on Medicare and Medicaid rose from 3.7 to 4.2 percent of G.D.P. Health care expenses for current and retired government employees also rose.

                                                                                                                      As you can see, there isn’t much left. The Bush domestic spending binge never happened.

                                                                                                                        Posted by Mark Thoma on Monday, March 20, 2006 at 12:33 PM in Budget Deficit, Economics

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                                                                                                                        Reconsidering the Privatization of Water Systems in Developing Countries

                                                                                                                        In his latest column, Paul Krugman says we are "looking at the failure of a movement." Part of that failure is the ideology that the marketplace is the best solution to all problems, and that many activities now performed by the public sector such as Social Security, Medicare drug benefits, forest management, disaster relief, oil supply to the military, prisons, and so on can be performed more efficiently by the private sector. As this idea is put to the test in the U.S. and around the world and government functions such as water system management are transferred to the private sector, the results are not living up to expectations:

                                                                                                                        At World Forum, Support Erodes for Private Management of Water, by Elisabeth Malkin, NY Times: For more than a decade, the idea that private companies would be able to bring water to the world's poor has been a mantra of development policies... It has not happened. In the past decade, ... private companies have managed to extend water service to just 10 million people, less than 1 percent of those who need it. Some 1.1 billion people still lack access to clean water...

                                                                                                                        The reality behind those numbers is sinking in. At the fourth World Water Forum, ... there is little talk of privatization. Instead, many people here want to return to relying on the local public utilities that still supply 90 percent of the water to those households that have it. There is a "big-time shift" in tone, said David Boys, a water policy expert ... Mr. Boys is a member of an advisory panel appointed by United Nations secretary general, Kofi Annan, that presented its recommendations at the forum, beginning with a call to strengthen local public utilities.

                                                                                                                        "The companies have lost tons of dough and tons of respect," Mr. Boys said. "They are pulling out." Nowhere has that been more evident than in Bolivia, where, in the city of El Alto, residents have been fighting a subsidiary of the French company Suez. The government is now negotiating for Suez to leave ... An uprising in the city of Cochabamba five years ago chased out a subsidiary of the United States company Bechtel after it raised rates but failed to improve service. ...

                                                                                                                        Even officials of the World Water Council, the organization that runs the forum and is heavily weighted toward multinational water companies, appear to be giving up on wholesale privatization. "Let's finance infrastructure for the 50 countries most in need and the twenty poorest megacities through a more intense donation policy," said Loïc Fauchon, president of the council, in his opening speech last week.

                                                                                                                        The debate over privatization is driving the controversy inside and outside the forum... Across town, international and local groups held an alternative forum for activists opposed to privatization, who are unconvinced that governments and organizations like the World Bank have given up on the idea. "The state does not assume its responsibilities properly," said Cuauhtémoc Abarca, a Mexico City activist. "In many cases there is a deliberate intention to show that public utilities work badly" as an excuse to privatize them. ...

                                                                                                                        One in three people in the world, 2.6 billion, does not have access to any kind of toilet or latrine, according to a United Nations report to be presented at the conference on Tuesday. Water-related diseases cause more than three million deaths a year, mostly of children younger than 5. Unicef, the United Nations children's agency, estimates that women and girls in the poorest countries and regions walk nearly four miles a day to carry water. ...

                                                                                                                          Posted by Mark Thoma on Monday, March 20, 2006 at 01:18 AM in Economics, Market Failure

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                                                                                                                          Paul Krugman: Bogus Bush Bashing

                                                                                                                          Paul Krugman discusses how new conservative critics of Bush are not criticizing his policies because they were complicit in bringing those policies about. Instead, they accuse him of violating conservative principles by being a big spender, a criticism that is off base:

                                                                                                                          Bogus Bush Bashing, By Paul Krugman, Bogus W. Attacks Commentary, NY Times: "The single word most frequently associated with George W. Bush today is 'incompetent,' and close behind are two other increasingly mentioned descriptors: 'idiot' and 'liar.' " So says the Pew Research Center for the People and the Press, whose most recent poll found that only only 33 percent of the public approves of the job President Bush is doing.

                                                                                                                          Mr. Bush, of course, bears primary responsibility for the state of his presidency. But ... we're looking at the failure of a movement as well as a man. ... [M]ost of the conservatives now rushing to distance themselves from Mr. Bush still can't bring themselves to criticize his actual policies. Instead, they accuse him of policy sins — in particular, of being a big spender on domestic programs — that he has not, in fact, committed.

                                                                                                                          Before I get to the bogus issue of domestic spending, let's look at the policies the new wave of conservative Bush bashers refuses to criticize. Mr. Bush's new conservative critics don't say much about the issue that most disturbs the public, the quagmire in Iraq. That's not surprising. Commentators who acted as cheerleaders in the run-up to war, and in many cases questioned the patriotism of those of us who were skeptical, can't criticize the ... war without facing up to their own complicity in that decision. Nor, after years of insisting that things were going well in Iraq and denouncing anyone who said otherwise, is it easy for them to criticize Mr. Bush's almost surreal bungling of the war. ...

                                                                                                                          Meanwhile, the continuing allegiance of conservatives to tax cuts ... prevents them from saying anything about the real sources of the federal budget deficit, in particular Mr. Bush's unprecedented decision to cut taxes in the middle of a war. ... They can't even criticize Mr. Bush for the systematic dishonesty of his budgets. For one thing, that dishonesty has been apparent for five years. ... As Berkeley's Brad DeLong puts it ..., conservatives knew that Mr. Bush was lying about the budget, but they thought they were in on the con.

                                                                                                                          So what's left? Well, it's safe for conservatives to criticize Mr. Bush for presiding over runaway growth in domestic spending, because that implies that he betrayed his conservative supporters. There's only one problem ... it's not true. It's true that federal spending as a percentage of G.D.P. rose between 2001 and 2005. But the great bulk of this increase was accounted for by increased spending on defense and homeland security, including the costs of the Iraq war, and by rising health care costs.

                                                                                                                          Conservatives aren't criticizing Mr. Bush for his defense spending. Since the Medicare drug program didn't start until 2006, the Bush administration can't be blamed for the rise in health care costs before then. ... So where does the notion of Bush the big spender come from? ...[L]argely from Brian Riedl of the Heritage Foundation, who issued a report last fall alleging that government spending was out of control. Mr. Riedl is very good at his job ... managing to convey the false impression that soaring spending on domestic social programs is a major cause of the federal budget deficit without literally lying.

                                                                                                                          But the reason conservatives fall for the Heritage spin is that it suits their purposes. They need to repudiate George W. Bush, but they can't admit that when Mr. Bush made his key mistakes — starting an unnecessary war, and using dishonest numbers to justify tax cuts — they were cheering him on.

                                                                                                                          Continuing with the thought on tax cuts, I think the notion that Bush is a big spender also comes from tax cuts bringing about a mismatch between revenues and spending and, unable to blame that mismatch on the tax cuts themselves, conservative critics of high budget deficits resort to criticizing out of control spending.

                                                                                                                          Update: Krugman has more on the perception that Bush is a big spender is his Money Talks column.

                                                                                                                          Previous (3/13) column: Paul Krugman: The Right's Man Next (3/23) column: Paul Krugman: Letter to the Secretary

                                                                                                                            Posted by Mark Thoma on Monday, March 20, 2006 at 12:15 AM in Budget Deficit, Economics, Iraq, Politics, Taxes

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                                                                                                                            March 19, 2006

                                                                                                                            Snow Says High CEO Compensation Justified by High Productivity

                                                                                                                            According to John Snow, CEOs and other "superstars" are paid according to the value they add to the marketplace, i.e. the market is efficiently rewarding them for their high productivity. In addition, he says most Americans are benefiting from the economic expansion:

                                                                                                                            Snow Defends President's Handling of Economy, by Greg Ip, WSJ: Confronting criticism of the Bush administration's economic record, Treasury Secretary John Snow said the widening gap between high-paid and low-paid Americans reflects a labor market efficiently rewarding more-productive people. But he insisted most Americans are benefiting from the economic expansion.

                                                                                                                            "What's been happening in the United States for about 20 years is [a] long-term trend to differentiate compensation," Mr. Snow said... "Look at the Harvard economics faculty, look at doctors over here at George Washington University...look at baseball players, look at football players. We've moved into a star system... Across virtually all professions, there have been growing gaps."

                                                                                                                            Mr. Snow said the same phenomenon explains why compensation for corporate chief executive officers has climbed so sharply. "In an aggregate sense, it reflects the marginal productivity of CEOs. Do I trust the market for CEOs to work efficiently? Yes. Until we can find a better way to compensate CEOs, I'm going to trust the marketplace."

                                                                                                                            Since the 1970s, CEO compensation has gone from 40 times to more than 300 times the average worker's salary... Mr. Snow ... said the administration intends to publicly challenge perceptions that typical workers and families haven't benefited much from the economic expansion. The extent to which the expansion has been broadly shared is "the new sort of battle line in the political arena," he said. ...

                                                                                                                            Mr. Snow distributed a fact sheet that showed after-tax income per person, adjusted for inflation, rose 8.2% from January 2001, when George W. Bush took office as president, through January 2006. The sheet also showed that per-person net worth ... rose 2.4%, unadjusted for inflation, from early 2001 to the end of 2005. "People have more money in their pocket" and in their bank accounts, he said.

                                                                                                                            Mr. Snow's case relies on averages, which can be skewed by big gains among the wealthiest. Other data suggest the typical family has seen little advance in income or net worth since Mr. Bush took office. Census Bureau data show median family income ... fell 3.6% from 2000 through 2004. Incomes for the poorest families fell even further. The only group to gain was the family at the 95th percentile -- that is, richer than 95% of all families. ...

                                                                                                                            As for net worth, a triennial Federal Reserve survey found that the net worth of the median family rose 1.5%, after inflation, from 2001 through 2004. That is far less than the 17% increase from 1995 to 1998 and the 10% increase from 1998 to 2001. ...

                                                                                                                            Robert Gordon, an economist at Northwestern University, says the past few years represent the continuation of a 35-year trend in which a growing share of all labor income goes to a small group of "superstars: professional athletes, CEOs and top corporate officers." On top of this trend, income on capital -- such as interest, dividends, rent and capital gains -- has taken a growing share of national income from labor, and it "goes mainly to a small slice of the population at the very top."

                                                                                                                            Mr. Snow said inequality at "one philosophical level...is troubling. ... We as a society have made two determinations. We're going to let more productive people have higher incomes and we're going to tax them more" through a progressive-tax system. Mr. Snow argued the administration's tax cuts have made the tax code more progressive, because the rich now pay a larger share of total individual taxes. Some scholars counter that the tax cuts still widened the gap between the after-tax incomes of rich and poor Americans. The Tax Policy Center, a joint venture of the Brookings Institution and Urban Institute think tanks, estimates that after-tax incomes of the richest 1% of taxpayers were 4.6% higher in 2005 than they would have been without the tax cuts. Incomes of the middle 20% were 2.6% higher, and incomes of the bottom 20% were 0.3% higher.

                                                                                                                            Greg Ip is a good reporter. As he notes and documents, the statistics do not support the administration's claims.

                                                                                                                              Posted by Mark Thoma on Sunday, March 19, 2006 at 07:12 PM in Economics, Politics

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                                                                                                                              IP and GDP

                                                                                                                              The industrial production (IP) numbers came out on Friday showing industrial production increasing .7%. I hadn't looked at how IP and GDP are related for awhile, and I wondered if there is any noticeable change in the relationship in recent years due to, say, the shift to a more service based economy. Here are the logs of the two series since 1947 (GDP is rescaled and centered through a regression of IP on GDP):

                                                                                                                              From this graph, it's hard to detect any change in the long-run relationship, but I thought I'd post it in case anyone is interested in seeing how the two series are related. Most of the time, the movements in IP are exaggerated versions of the movements in GDP.

                                                                                                                              Update: David Taylor at Dismally.com takes a look at year over year changes for the two series. Here's the graph.

                                                                                                                                Posted by Mark Thoma on Sunday, March 19, 2006 at 06:35 PM in Economics

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                                                                                                                                Social Justice and Global Trade

                                                                                                                                Joseph Stiglitz discusses trade liberalization and asks how to reform the global trading system to "enhance the chances that trade and globalization come closer to living up to their potential for enhancing the welfare of everyone.":

                                                                                                                                Social Justice and Global Trade, FEER, March 2006, By Joseph Stiglitz: The history of recent trade meetings—from Seattle to Doha to Cancun to Hong Kong—shows that something is wrong with the global trading system. Behind the discontent are some facts and theories.

                                                                                                                                The facts: Current economic arrangements disadvantage the poor. Tariff levels by the advanced industrial countries against the developing countries are four times higher than against the developed countries. The last round of trade negotiations, the Uruguay Round, actually left the poorest countries worse off. While the developing countries were forced to open up their markets and eliminate subsidies, the advanced developed countries continued to subsidize agriculture and kept trade barriers against those products which are central to the economies of the developing world.

                                                                                                                                Indeed, the tariff structures are designed to make it more difficult for developing countries to move up the value added chain... As tariffs have come down, America has increasingly resorted to the use of non-tariff barriers as the new forms of protectionism. Trade agreements do not eliminate protectionist sentiments or the willingness of governments to attempt to protect producer and worker interests.

                                                                                                                                The theories: Trade liberalization leads to economic growth, benefiting all. This is the prevalent mantra. Political leaders champion liberalization. Those who oppose it are cast as behind the times, trying to roll back history. Yet the fact that so many seem to have been hurt so much by globalization seems to belie their claims. ...the details of the trade agreements—make a great deal of difference.

                                                                                                                                That Mexico has done so poorly under NAFTA has not helped the case for liberalization. If there ever was a free trade agreement that should have promoted growth, that was it, for it opened up for Mexico the largest market of the world. But growth in the decade since has been slower than in the decades before 1980, and the poorest in the country, the corn farmers, have been particularly hurt by subsidized American corn.

                                                                                                                                The fact of the matter is that the economics of trade liberalization are far more complicated than political leaders have portrayed them. There are some circumstances in which trade liberalization brings enormous benefits—when there are good risk markets, when there is full employment, when an economy is mature. But none of these conditions are satisfied in developing countries. With full employment, a worker who loses his job to new imports quickly finds another; and the movement from low-productivity protected sectors to high-productivity export sectors leads to growth and increased wages. But if there is high unemployment, a worker who loses his job may remain unemployed. A move from a low-productivity, protected sector to the unemployment pool does not increase growth, but it does increase poverty. Liberalization can expose countries to enormous risks...

                                                                                                                                Perhaps most importantly, successful development means going stagnant traditional sectors with low productivity to more modern sectors with faster increases in productivity. But without protection, developing countries cannot compete in the modern sector. They are condemned to remain in the low growth part of the global economy. South Korea understood this. Thirty-five years ago, those who advocated free trade essentially told South Korea to stick with rice farming. But South Korea knew that even if it were successful in improving productivity in rice farming, it would be a poor country. It had to industrialize.

                                                                                                                                What are we to make of the oft-quoted studies that show that countries that have liberalized more have grown faster? Put aside the numerous statistical problems that plague almost all such “cross country” studies. Most of the studies that claim that liberalization leads to growth do no such thing. ... Studies that focus directly on liberalization—that is, what happens when countries take away trade barriers—present a less convincing picture that liberalization is good for growth.

                                                                                                                                But we know which countries around the world have grown the fastest: they are the countries of East Asia, and their growth was based on export-driven trade. They did not pursue policies of unfettered liberalization. Indeed, they actively intervened in markets to encourage exports, and only took away trade barriers as their exports grew...

                                                                                                                                The point is that no country approaches liberalization as an abstract concept... Every country wants to know: For a country with its unemployment rate, with its characteristics, with its financial markets, will liberalization lead to faster growth?

                                                                                                                                If the economics are nuanced, the politics are simple. Trade negotiations provide a field day for special interests. ... Exporters want others’ markets opened up; those threatened by competition do not. Trade negotiators pay little attention to principles... They pay attention to campaign contributions and votes.

                                                                                                                                In the most recent trade talks, for example, enormous attention has been focused on developed countries’ protection of their agricultural sectors—protections that exist because of the power of vested agricultural interests there. Such protectionism has become emblematic of the hypocrisy of the West ... Some 25,000 rich American cotton farmers, reliant on government subsidies for cotton, divide among themselves some $3 billion to $4 billion a year, leading to higher production and lower prices. The damage that these subsidies wreak on some 10 million cotton farmers eking out a subsistence living in sub-Saharan Africa is enormous. Yet the U.S. seems willing to put the interests of 25,000 American cotton farmers above that of the global trading system and the well-being of millions in the developing world. If those in the developing world respond with anger, it is understandable.

                                                                                                                                The anger is increased by the United States’s almost cynical attitude in “marketing” its offers. For instance, at the Hong Kong meeting, U.S. trade officials reportedly offered to eliminate import restrictions on cotton but refused to do anything about subsidies. The cotton subsidies actually allow the United States to export cotton. When a country can export a particular commodity, it does little good to allow imports of that commodity. The U.S., to great fanfare, has made an offer worth essentially zero to the developing countries and berated them for not taking it up on its “generous” offer. ...

                                                                                                                                In short, trade liberalization should be “asymmetric”, but it needs to be asymmetric in a precisely opposite way to its present configuration. Today, liberalization discriminates against developing countries. It needs to discriminate in their favor. Europe has shown the way by opening up its economy to the poorest countries of the world in an initiative called Everything But Arms. Partly because of complicated regulations (“rules of origin”), however, the amount of increased trade that this policy has led to has been very disappointing thus far. Because agriculture is still highly subsidized and restricted, some call the policy “Everything But Farms.” There is a need for this initiative to be broadened. ... In fact, the advanced industrial countries as a whole would be better off, and special interests in these countries would suffer.

                                                                                                                                There is, in fact, a broad agenda of trade liberalization (going well beyond agriculture) that would help the developing countries. But trade is too important to be left to trade ministers. If the global trade regime is to reflect common shared values, then negotiations over the terms of that trade regime cannot be left to ministers who, at least in most countries, are more beholden to corporate and special interests than almost any other ministry. In the last round, trade ministers negotiated over the terms of the intellectual property agreement. This is a subject of enormous concern to almost everyone in today’s society. ... It reflected the interests of U.S. drug and entertainment industries, not the most important producers of knowledge, those in academia. And it certainly did not reflect the interests of users, either in the developed or less-developed countries. But the negotiations were conducted in secret, in Geneva. The U.S. Trade Representative (like most other trade ministers) was not an expert in intellectual property; he received his short course from the drug companies, and he quickly learned how to espouse their views. The agreement reflected this one-sided perspective.

                                                                                                                                Several reforms in the structure of trade talks are likely to lead to better outcomes. The first is that the basic way in which trade talks are approached should be changed. Now they are commercial negotiations. Each country seeks to get the best deal for its firms. This stands in marked contrast to how legislation in all other arenas of public policy is approached. Typically, we ask what our objectives are, and how we can best achieve them. ... If we began trade talks from this position of debate and inquiry, we could arrive at a picture of what a true development round look like. ...

                                                                                                                                As more and more countries have demanded a voice in trade negotiations, there is often nostalgia for the old system in which four partners (the U.S., EU, Canada and Japan) could hammer out a deal. There are complaints that the current system with so many members is simply unworkable. We have learned how to deal with this problem in other contexts, however, using the principles of representation. We must form a governing council with representatives of various “groups”—a group of the least developed countries, of the agricultural exporting countries, etc. Each representative makes sure that the concerns of his or her constituency are heard. ...

                                                                                                                                Finally, trade talks need to have more focus. Broadening the agenda also puts developing countries at a particular disadvantage, because they do not have the resources to engage on a broad front of issues.

                                                                                                                                The most important changes are, however, not institutional changes, but changes in mindset. There should be an effort on the part of each of the countries to think about what kind of international rules and regulations would contribute to a global trading system that would be fair and efficient, and that would promote development.

                                                                                                                                Fifteen years ago, there was a great deal of optimism about the benefits which globalization and trade would bring to all countries. It has brought enormous benefits to some countries; but not to all. Some have even been made worse off. Development is hard enough. An unfair trade regime makes it even more difficult. Reforming the WTO would not guarantee that we would get a fair and efficient global trade regime, but it would enhance the chances that trade and globalization come closer to living up to their potential for enhancing the welfare of everyone.

                                                                                                                                  Posted by Mark Thoma on Sunday, March 19, 2006 at 09:31 AM in Economics, International Trade, Policy

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                                                                                                                                  Fair Enough?

                                                                                                                                  When consumers pay extra for Fair Trade certified goods such as coffee, how much of the money goes to the farmers?:

                                                                                                                                  Fair Prices for Farmers: Simple Idea, Complex Reality, by Jennifer Alsever, NY Times: Tim Terman always looks for the black and white certified Fair Trade logo when he buys bags of coffee ... He pays nearly twice as much — up to $10 a pound — as he would for conventional coffee, hoping the extra dollars go to struggling farmers. That's not always the case. ... Critics say too many fair trade dollars wind up in the pockets of retailers and middlemen, including nonprofit organizations.

                                                                                                                                  But organizations involved in fair trade say the benefits do trickle down. Paul Rice, chief executive of TransFair USA, which controls Fair Trade certification in the United States, said the programs sometimes eliminate as many as five middlemen — a local buyer, miller, exporter, shipper and importer — and instead allow farmers to deal directly with an American wholesaler... "When they do that, they can make dramatically higher prices, often two to three times higher." ...

                                                                                                                                  Fair trade programs, which promise a "fair wage" to family farmers, have grown rapidly. Today, 35,000 retailers and restaurants nationwide ... carry products bearing the fair trade label, an increase of 60 percent in three years. Since 1999, more than 100 million pounds of certified Fair Trade coffee, cocoa, tea, rice, sugar, bananas, mangoes, pineapples and grapes have been imported... "There are now 800,000 small-scale farmers benefiting from fair trade," said Rick Peyser, director of social advocacy at Green Mountain Coffee Roasters... Still, it can be difficult for consumers to quantify the benefit they bring to farmers ... Fair Trade labels don't list the amount paid to farmers; that ... requires research...

                                                                                                                                  The coffee farmer who produced the one-pound bag of coffee purchased by Mr. Terman received $1.26, higher than the commodity rate of $1.10. But whether Mr. Terman paid $10 or $6 for that fair trade coffee, the farmer gets the same $1.26. "There is no reason why fair trade should cost astronomically more than traditional products," Nicole Chettero, a spokeswoman for TransFair USA, said. "We truly believe that the market will work itself out... As the demand and volume of Fair Trade certified products increase, retailers will naturally start to drop prices to remain competitive." ...

                                                                                                                                  Each fair trade commodity has its own fair trade price, or the lowest price farmers will receive even if conventional commodity prices fall. That price is meant to allow them to cover their cost of production and improve their lives...

                                                                                                                                  In some cases, the individual farmers may receive less than fair trade rules require because the money goes to cooperatives, which have their own directors who decide how much to pass on to farmers. "We did a breakdown and saw that sometimes, what they're paying farmers is only 70 cents to 80 cents a pound" for coffee instead of the entire fair trade price of $1.26, said Christy Thorns, a buyer at Allegro Coffee... Transfair, she said, doesn't "clearly communicate that to consumers."

                                                                                                                                  Allegro is among a number of coffee and tea companies setting up their own systems to work directly with farmers ... Starbucks, which bought 11.5 million pounds of fair trade coffee last year, has created a buying program called CAFE, for Coffee and Farmer Equity Practices... Starbucks requires suppliers to provide receipts showing how each party in the supply chain was paid, but it has no fixed price for the coffee. Starbucks' Web site tells consumers about the program. ...

                                                                                                                                  Without fair trade, supporters say, some farmers have no access to market information and can often be duped into selling to middlemen at below-market prices or, if prices fall, can be forced to quit farming. Ms. Chettero acknowledges the fair trade system is not perfect but said it is a step toward farmers improving their lives. If not for consumers and the fair trade system, she said, "Who else is going to do it?"

                                                                                                                                    Posted by Mark Thoma on Sunday, March 19, 2006 at 12:38 AM in Economics, International Trade

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                                                                                                                                    The Economic Effects of the Money Immigrants Send Home

                                                                                                                                    How does the money immigrants send home each year affect economic growth and stability in their home countries?

                                                                                                                                    The Check Is in the Mail, Economics, Scientific American: ...One of the most far-reaching aspects of migration often gets ignored altogether: remittances— the money and gifts that migrants send back to families and friends. Studies have chronicled what individual beneficiaries do with the largesse, but the broader effect is only dimly understood... That is finally starting to change. ...

                                                                                                                                    The reason for all the attention is simple. Even though the average migrant sends back just a couple of hundred dollars a month, it adds up to serious money. The World Bank estimates that developing countries received $167 billion last year—twice as much as they got in foreign aid. Mexico’s intake has quintupled in a decade, to $18 billion; labor is now the country’s biggest export after oil. And that is just the amount flowing through official channels. [The caption under a picture notes "Remittances have become a huge factor in the global economy: in the Philippines’s case, they accounted for 13.5 percent of the gross domestic product in 2004 and have been growing at roughly 20 percent a year."]

                                                                                                                                    To be showered with money seems like a happy arrangement for the receiving country. Yet in the 1980s remittances acquired a reputation among social scientists as “easy money” that, like an oil windfall, can rot out an economy. Case studies have found that recipients invest little of the money in farm equipment or business start-ups, preferring instead to go on shopping sprees. People grow dependent on the MoneyGram in the mail, and all that cash sloshing around pushes up inflation. Those not so lucky to have relatives abroad fall behind, worsening social inequality, and exporters’ costs rise, making it harder for them to compete in global markets.

                                                                                                                                    In the 1990s, though, Durand and others argued that case studies do not track the full effect of remittances as they ripple through an economy. Even if families do not invest the money, the businesses they buy from do, so remittances can jump-start growth. In one widely cited model, $1 of remittances boosts GDP by $3. The infusion of money makes a real difference in places where entrepreneurs have no other access to capital. Compared with alternatives to catalyze economic development, such as government programs or foreign aid and investment, remittances are more accurately targeted to families’ needs and more likely to reach the poor.

                                                                                                                                    Today the debate has settled into a “both sides are right” mode. Some towns achieve prosperity aided by remittances; others get trapped in a cycle of dependency. A number of cross-country analyses, such as one last year by economist Nikola Spatafora of the International Monetary Fund and his colleagues, have concluded that nations that rake in more remittances have a lower poverty rate—but only barely. A larger effect is to smooth out the business cycle, because migrants increase their giving during economic downturns in their homelands and scale it back during upswings...

                                                                                                                                      Posted by Mark Thoma on Sunday, March 19, 2006 at 12:32 AM in Economics

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                                                                                                                                      March 18, 2006

                                                                                                                                      Is Employment Increasing Because Hires are Going Up, or Because Separations are Going Down?

                                                                                                                                      This story from the NY Times Economic View notes there are two employment reports, the one you hear about in the press and the Job Openings and Labor Turnover Survey which gets less attention, but tells us quite a bit about why employment numbers are changing:

                                                                                                                                      Another Month of Jobs Growth? Not So Fast, by Louis Uchitelle, NY Times: Once a month, the Bureau of Labor Statistics, along with the news media and a host of economists, enters into a much-trumpeted ritual ... The occasion is the employment report, in which the bureau announces how many thousands of jobs were added to the work force in the previous month — or, in hard times, how many thousands disappeared. Lately, the work force has been growing by nearly 200,000 jobs a month, on average. ... What generates all those jobs? The report doesn't really say. ...

                                                                                                                                      [A] second monthly data report from the Bureau of Labor Statistics ... awkwardly titled the Job Openings and Labor Turnover Survey and referred to by its acronym, Jolts, when it is referred to at all — adds a much-needed dimension to the monthly employment number that gets all the attention.

                                                                                                                                      What Jolts has been telling us lately is that employers have not really stepped up their hiring since last summer. In fact, hiring has moved along at a pretty level pace. The Jolts report shows instead that there has been a decline in what the bureau calls "separations" — meaning that fewer people are leaving their jobs each month. They aren't quitting in larger numbers..., and fewer are being laid off... This information helps to explain the employment report. It shows that employers as a group are hiring roughly the same number of people each month while fewer employees depart. That combination swells the work force...

                                                                                                                                      "The work force is growing not because employers are hiring a lot of new workers to staff expanding operations," Mr. Zandi said. ... That means the news from the employment report isn't quite so positive. The work force is indeed growing... Employers are experiencing rising demand — but not enough to jump with both feet into hiring and expansion. ...

                                                                                                                                      In the vast and churning American labor market, hires are bumping along at 4.7 million to 4.8 million a month. "An enormous number of people are hired, and in that sense hiring is very strong," said John Wohlford, a bureau economist ... "But the reason for the increase in total employment right now is that separations are going slowly down." They have dropped to 4.3 million, from 4.5 million early last year. ...

                                                                                                                                      If you are interested in more on this topic, see Job Loss, Job Finding, and Unemployment in the U.S. Economy Over the Past Fifty Years, by Robert E. Hall. NBER WP 11678, October 2005. The paper Accounting for the Jobless Recoveries, by Paul Gomme, FRB Cleveland also looks at job finding, job loss, and voluntary separations in recessions and recoveries. The paper shows that the flat job finding numbers during the recovery is a recent phenomena, and that the decreased separation rate in a recovery is not unusual. There's a graph in the NY Times story, but these two graphs (graph 1, graph 2) from the Fed report give a better overall perspective on this issue.

                                                                                                                                        Posted by Mark Thoma on Saturday, March 18, 2006 at 02:30 PM in Economics, Unemployment

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                                                                                                                                        Does Lack of Interoperability Threaten Competition in Online Music Sales?

                                                                                                                                        France moves to promote a more competitive environment in online music sales:

                                                                                                                                        French Bill Threatens To Slice Into Apple's Pie, by Laurence Frost, Associated Press: Apple Computer Inc. faces a serious challenge in France, where lawmakers have moved to sever the umbilical cord between its iPod player and iTunes online music store -- threatening its lucrative hold on both markets. ... Thanks to the success of the iPod models -- in the United States, the players accounted for 72 percent of the portable media player market... iTunes has become the global leader in online music sales. The iPod is currently designed not to play music from rival services.

                                                                                                                                        According to the latest amendments, however, copy-protection technologies like Apple's exclusive FairPlay format and Sony's ATRAC3 "must not result in the prevention of the effective application of interoperability." Companies would have to share all "information essential to the interoperability" of their copy-protection formats with any rival that requests it. If they refuse, a judge can order its delivery, on pain of fines.

                                                                                                                                        The draft law could force Apple to let French iPod users buy their music from download sites other than iTunes. Owners of other music players would also be allowed to buy songs from iTunes France. "Without guaranteed interoperability, we run a major risk of captive client bases and an anticompetitive situation, with the consumer held hostage as a result,"...

                                                                                                                                        Critics of the draft law say legislators have no business forcing Apple to share its proprietary format, which most customers are aware of when they choose to buy an iPod. ... "It's only by resisting interoperability that Apple is able to keep this dominant position," Dourgnon said... If the draft law goes through in its current form, experts say, Apple could be forced to withdraw from Europe's third-largest music download market -- or threaten to do so while seeking a change in the law.

                                                                                                                                        "They may have to bluff initially by pulling product off the market and making everybody uncomfortable," said Roger Kay of U.S.-based research firm Endpoint Technologies Associates. But the French move could also be the start of something bigger, he added. "Apple is now becoming an important player in the digital entertainment domain," Kay said. "And it may be there that ultimately they get challenged on antitrust issues by various governments, including the U.S."

                                                                                                                                          Posted by Mark Thoma on Saturday, March 18, 2006 at 09:50 AM in Economics, Market Failure

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                                                                                                                                          "Only in a Humpty-Dumpty World"

                                                                                                                                          Even the judge appointed recently by Bush opposed the administration in this case:

                                                                                                                                          Judges Overturn Bush Bid to Ease Pollution Rules, by Michael Janofsky, NY Times: A federal appeals court ... overturned a clean-air regulation issued by the Bush administration that would have let many power plants, refineries and factories avoid installing costly new pollution controls... [T]he court said the agency went too far in 2003 when it issued a separate new rule that ... would exempt most equipment changes from environmental reviews — even changes that would result in higher emissions.

                                                                                                                                          With a wry footnote to Lewis Carroll's "Through the Looking Glass," the court said that "only in a Humpty-Dumpty world" could the law be read otherwise. "We decline such a world view," said their unanimous decision, written by Judge Judith W. Rogers, an appointee of President Bill Clinton. Judges David Tatel, another Clinton appointee, and Janice Rogers Brown, a recent Bush appointee, joined her... The provision of the law at issue ... governs the permits required at more than 1,300 coal-fueled power plants ... and 17,000 factories, refineries and chemical plants that spew millions of tons of pollution into the air each year... The decision is unlikely to be the last word; several circuit courts or appeals courts have ... decided related cases, and the issue may eventually reach the Supreme Court...[dual post]

                                                                                                                                            Posted by Mark Thoma on Saturday, March 18, 2006 at 01:33 AM in Economics, Environment

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                                                                                                                                            Water Fights

                                                                                                                                            Water use is increasing at twice the rate of population growth:

                                                                                                                                            Save a little water for tomorrow, by Kevin Watkins International Herald Tribune: One hundred years ago, William Mulholland introduced the citizens of California to ... the water grab. Charged with securing water supplies for a small, thirsty town in a desert, the baron of the Los Angeles Department of Water hit on an imaginative response. He quietly bought up water rights in the Owens Valley, 230 miles to the north, built an aquifer across the blistering Mojave Desert, and took the water to downtown Los Angeles. When local ranchers protested by dynamiting his aquifer, Mulholland declared war, responding with a massive show of armed force.

                                                                                                                                            Nowadays southern Californians fight over water in courts of law. Angelenos [are]... piping in water from hundreds of miles away and draining a Colorado River so depleted that it barely reaches the sea. ...it means disputing every drop of the Colorado with Arizona. The Mulholland model represents a brutish form of what has been a global approach to water management. Want to urbanize and industrialize at breakneck speed? Then dam and divert your rivers to meet the demand. Want to expand the agricultural frontier? Then mine your aquifers and groundwaters. ...

                                                                                                                                            Water is being pumped out of the aquifer on which Mexico City stands at twice the rate of replenishment. The result: the city is subsiding at the rate of about half a meter every decade... The mining of groundwaters for irrigation has lowered the water table in parts of India and Pakistan by 30 meters in the past three decades. As water goes down, the cost of pumping goes up, undermining the livelihoods of poor farmers. Meanwhile, a lethal combination of water shortages, soil salination, and waterlogging threatens the breadbaskets of both countries. In India, about one quarter of grain production is based on unsustainable groundwater use. In China, urbanization and rapid growth has ... left a water crisis of epic proportions. The Hai-Huai-Yellow river basin tells its own story. More than 80 percent of river lengths are chronically polluted...

                                                                                                                                            What is driving the global water crisis? Physical availability is part of the problem. ... With water use increasing at twice the rate of population growth, the amount available per person is shrinking - especially in some of the poorest countries. Over the next 25 years, the number of people living in countries with water crises will increase from 700 million to 2.2 billion, with more than half of the populations of South Asia and sub-Saharan Africa affected. Factor in global warming, which could reduce rainfall in parts of sub-Saharan Africa by up to a quarter over the next century, and this is starting to look like a crisis in the making...

                                                                                                                                            Growing scarcity means more competition. And as William Mulholland taught us all those years ago, competition without good governance can turn ugly - especially for those without power. ... The danger is that the poorest farmers with the weakest voice in water management will lose out, with devastating consequences for global poverty reduction efforts. Challenging as physical scarcity may be in some countries, the real problems in water go deeper. The 20th-century model for water management was based on a simple idea: that water is an infinitely available free resource to be exploited, dammed or diverted without reference to scarcity or sustainability.

                                                                                                                                            Forty years ago, the Aral Sea covered an area the size of Belgium. Thanks to Soviet-era planners who diverted the ... rivers into cotton irrigation, it has been reduced to a couple of small, lifeless hypersaline lakes. In the United States, farmers on the High Plains are pumping water from the Ogallala aquifer ... at eight times the recharge rate. ...

                                                                                                                                            Across the world, water-based ecological systems - rivers, lakes and watersheds - have been taken beyond ... ecological sustainability by policy makers who have turned a blind eye to the consequences of over- exploitation. We need a new model of water management for the 21st century. What does that mean? For starters, ... that means using it more efficiently at levels that do not destroy our environment. ... it means is that governments need to manage the private demand of different users and manage this precious resource in the public interest.

                                                                                                                                            There is another, equally profound challenge. In an era of intensifying competition, we have to ensure that the world's poor do not suffer... That means strengthening the rights and the voice of the poor - and it means putting social justice at the center of water management.

                                                                                                                                              Posted by Mark Thoma on Saturday, March 18, 2006 at 12:15 AM in Economics, Environment, Policy

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                                                                                                                                              Looking for the Goalpost

                                                                                                                                              I hadn't read anything from Molly Ivins in awhile, so I thought I'd head over to the Ancient, Hermetic, and Occult Order of the Shrill and see what her latest column has to say:

                                                                                                                                              The fog of victory, by Molly Ivins, CNN: President Bush has once more undertaken to explain to us "Why We Fight," which is also the title of an excellent new documentary on Iraq. According to the president, "Our goal in Iraq is victory." I personally did not find that a helpful clarification.

                                                                                                                                              According to the president, we are doomed to stay in Iraq until we "leave behind a democracy that can govern itself, sustain itself and defend itself." That's not exactly getting closer every day. But, the Prez sez, "A free Iraq in the heart of the Middle East will make the American people more secure for generations to come."

                                                                                                                                              So far, no good. After three years, tens of thousands of lives and $200 billion, we have achieved chaos. As Rep. John Murtha put it, "The only people who want us in Iraq are Iran and al Qaeda." Since the revisionist myth that we went to war to promote democracy keeps seeping into rational discussion, it is worth reminding ourselves that there never were any weapons of mass destruction in Iraq.

                                                                                                                                              We are inarguably facing more terrorists now than there were when we started, so the Pentagon has decided to fight what it is now calling "the Long War." Has anyone asked you about this? Me, neither. Nor has anyone asked Congress. The administration -- mostly Donald Rumsfeld -- just decided we would have a long war and declared it, and is now committing us to fight against a fuzzy ideology no one seems to be able to define.

                                                                                                                                              Our problem now is that we're not fighting the people who attacked us -- they're still running around on the Afghan-Pakistan border while we battle Iraqis who don't like us occupying their country.

                                                                                                                                              As of September 11, 2001, there were a few hundred people identified with al Qaeda's ideology. Even then, it was unclear the American military was the right tool for the job. Now, Rumsfeld is apparently prepared to put the full might of the U.S. military into this fight indefinitely, backed by the full panoply of ever-more expensive weapons and the whole hoorah. I don't think the people who got us into Iraq should be allowed to do this because, based on the evidence of Iraq, I don't think they have the sense God gave a duck.

                                                                                                                                              On top of everything else, Rumsfeld is now circulating a grand strategy for the Long War written by Newt Gingrich. Am I the only person covering politics who ever noticed that Newt Gingrich is actually a nincompoop? When Newt bestrode the political world like a colossus (Time magazine's Man of the Year in 1995), many people took him seriously -- but he was a fool then, too. The Republicans were so thrilled to have someone on their side who had ideas, they never seemed to notice Newt's were drivel.

                                                                                                                                              From orphanages to space colonies, it was all shallow but endearingly enthusiastic futurism. Gingrich was the kind of person who read a book or two on something and would then be quite afire as to how this was going to fit into some shining future. Republicans are so amnesiac, they didn't even snicker when Newt turned up recently posing as a respected party elder to give them advice on ethics. Ethics. Next, family values.

                                                                                                                                              I have no idea whom this administration plans to talk into its Long War, but I'm sure they won't roll out the new campaign in August. In order to sell this, they'll have to scare us, assuming some obliging terrorists don't do it for them.

                                                                                                                                              I came across this quote in a recent obituary for George Gerbner, who headed the Annenberg School for Communication for 25 years: "Fearful people are more dependent, more easily manipulated and controlled, more susceptible to deceptively simple, strong, tough measures and hard-line postures. ... They may accept and even welcome repression if it promises to relieve their insecurities."

                                                                                                                                                Posted by Mark Thoma on Saturday, March 18, 2006 at 12:06 AM in Iraq, Politics

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                                                                                                                                                March 17, 2006

                                                                                                                                                Measuring Corruption

                                                                                                                                                The Economist looks at some of the ways economists measure corruption:

                                                                                                                                                Digging for dirt, Economics Focus, The Economist: Corruption ... is not easy to measure. Vast amounts of money flow through public hands. How much is diverted into private pockets? ... Fortunately, a growing number of economists, not least at the bank, are turning to the tricky task of quantifying corruption. ...

                                                                                                                                                Some of the biggest ... were attracted to Iraq's oil-for-food programme, which ran from 1997 to early 2003. Under the scheme's original terms, Iraq sold its oil to whomever it chose... The proceeds ($64 billion in 2000 dollars) were paid into an escrow account and spent largely on food and medicines, under UN supervision. American intelligence officials estimate that Iraq received $230m-240m in bribes from those eager to buy its oil. Economic intelligence, as applied by Chang-Tai Hsieh and Enrico Moretti, of the University of California, Berkeley, suggests that it got far more. As they point out, Iraqi oil, such as Basra Light, is a close substitute for Arabian Light. Before UN sanctions, there was no systematic price difference between the two. But in 1997-98, Basra Light fetched $2 a barrel less; in 2000-01, the gap was more than $5. Bidders would be happy to offer bribes, kickbacks and political favours to secure oil this cheap. Indeed, they could pay up to $5 billion and still break even. ... Messrs Hsieh and Moretti reckon Iraq collected $700m-2 billion.

                                                                                                                                                Although a lot of money, this is a small proportion (1-3%) of Iraq's oil revenues. Petty corruption often cuts more deeply. During Indonesia's rainy season, the dirt tracks that connect Javanese villages to their fields often become impassable. According to one estimate, every dollar spent surfacing these roads ... brings benefits worth $3.30 over the roads' lifetime. But Indonesia suffers from widespread corruption, collusion and nepotism. Some of the World Bank money allocated to village infrastructure ends up greasing palms not smoothing gravel.

                                                                                                                                                But how much? ...Ben Olken, of Harvard University, dug deep into the sand and stone to find out. He reports the gap between what a village claims it spent on a road, and what he and his engineers reckon the road really cost. They left little to guesswork. ... they surveyed quarries, labourers, truckdrivers and suppliers. ... they dug holes in the roads, taking a sample of the material that had gone into their construction. And then they built their own “test roads”... Mr Olken calculates that on average 28% of reported spending went missing, mostly because roadbuilders skimped on materials...

                                                                                                                                                He reaches an unfashionable conclusion. The bank puts great store by “empowering” the poor to keep their officials honest. In Indonesia, villages must hold public hearings before they get the second and third slices of their money. ... For all its romantic appeal, monitoring by villagers suffers from a free-rider problem. If your neighbour keeps a beady eye on road spending, you can benefit from his vigilance without making an effort yourself. Why, then, should you bother? But by the same logic, why should he?

                                                                                                                                                Mr Olken puts his faith in a less fashionable ally: auditors. A group of villages, chosen at random, were told that they would be audited at the end of the project. This threat reduced missing expenditures by about eight percentage points, to 20% or so. The audits are not cheap ... and auditors have been known to lapse into cosy collusion with those they scrutinise. But done properly, Mr Olken says, bean-counting is a promising way to extend the useful life of roads.

                                                                                                                                                A victory for centralised accountancy over local democracy, then? Not quite. Mr Olken shows that corrupt officials care both about their chances of being caught and about the severity of the punishment... The threat of an audit weighed more heavily on village heads who were politically insecure... Detection cannot be left to the village, but punishment can be. On this point..., Kautilya, writing 2,300 years ago, offers a helpful observation: as punishment for the theft of public property by government servants, he recommended smearing the offenders with cow dung and ashes.

                                                                                                                                                  Posted by Mark Thoma on Friday, March 17, 2006 at 01:09 PM in Economics, Market Failure

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                                                                                                                                                  The Economics of Capital Punishment - Part I

                                                                                                                                                  This discussion of the economics of capital punishment is from the Becker-Posner blog and appears in the latest issue of Economists' Voice. Richard Posner goes first:

                                                                                                                                                  Becker-Posner Blog: The Economics of Capital Punishment--Posner: The recent execution by the State of California of the multiple murderer Stanley "Tookie" Williams has brought renewed controversy to the practice of capital punishment... From an economic standpoint, the principal considerations in evaluating the issue of retaining capital punishment are the incremental deterrent effect of executing murderers, the rate of false positives (that is, execution of the innocent), the cost of capital punishment relative to life imprisonment without parole (the usual alternative nowadays), the utility that retributivists and the friends and family members of the murderer's victim ... derive from execution, and the disutility that fervent opponents of capital punishment, along with relatives and friends of the defendant, experience. The utility comparison seems a standoff, and I will ignore it...

                                                                                                                                                  Early empirical analysis by Isaac Ehrlich found a substantial incremental deterrent effect of capital punishment, a finding that coincides with the common sense of the situation: it is exceedingly rare for a defendant who has a choice to prefer being executed to being imprisoned for life. Ehrlich's work was criticized by some economists, but more recent work by economists Hashem Dezhbakhsh, Paul Rubin, and Joanna Shepherd ... found, in a careful econometric analysis, that one execution deters 18 murders. Although this ratio may seem implausible given that the probability of being executed for committing a murder is less than 1 percent ..., even a 1 percent or one-half of 1 percent probability of death is hardly trivial; most people would pay a substantial amount of money to eliminate such a probability.

                                                                                                                                                  As for the risk of executing an innocent person, this is exceedingly slight, especially when a distinction is made between legal and factual innocence. Some murderers are executed by mistake in the sense that they might have a good legal defense to being sentenced to death, such as having been prevented from offering evidence in mitigation of their crime, such as evidence of having grown up in terrible circumstances... But they are not innocent of murder. The number of people who are executed for a murder they did not commit appears to be vanishingly small. ... Although it may seem heartless to say so, the concern with mistaken execution seems exaggerated...

                                                                                                                                                  [T]here is an economic argument for speeding up the imposition of the death penalty...; the gain in deterrence and reduction in cost are likely to exceed the increase in the very slight probability of executing a factually innocent person. What is more, by allocating more resources to the litigation of capital cases, the error rate could be kept at its present very low level even though delay in execution was reduced. However, even with the existing, excessive, delay, the recent evidence concerning the deterrent effect of capital punishment provides strong support for resisting the abolition movement.

                                                                                                                                                  A final consideration returns me to the case of "Tookie" Williams. The major argument made for clemency was that he had reformed in prison and ... had become an influential critic of the type of gang violence in which he had engaged. Should the argument have prevailed? On the one hand, if murderers know that by "reforming" on death row they will have a good shot at clemency, the deterrent effect of the death penalty will be reduced. On the other hand, the type of advocacy in which Williams engaged probably had some social value, ...clemency is the currency in which such activities are compensated and therefore encouraged. Presumably grants of clemency on such a basis should be rare, since there probably are rapidly diminishing social returns to death-row advocacy, along with diminished deterrence as a result of fewer executions. For the more murderers under sentence of death there are who publicly denounce murder and other criminality, the less credibility the denunciations have.

                                                                                                                                                  Posted by Mark Thoma on Friday, March 17, 2006 at 02:33 AM in Economics

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                                                                                                                                                  The Economics of Capital Punishment - Part II

                                                                                                                                                  Here is Gary Becker's response to Posner's comments on capital punishment, also appearing in the Becker-Posner blog and in the latest issue of Economists' Voice:

                                                                                                                                                  Becker-Posner blog: More on the Economics of Capital Punishment-Becker: Posner has a good discussion of the various issues... I will concentrate my comments on deterrence, which is really the crucial issue... I support the use of capital punishment for persons convicted of murder because, and only because, I believe it deters murders. If I did not believe that, I would be opposed because revenge and the other possible motives that are mentioned and discussed by Posner, should not be a basis for public policy.

                                                                                                                                                  As Posner indicates, serious empirical research on capital punishment began with Isaac Ehrlich's pioneering paper. Subsequent studies have sometimes found much weaker effects than he found, while others, including a recent one cited by Posner, found a much larger effect... The available data are quite limited, however, so one should not base any conclusions solely on the econometric evidence, although I believe that the preponderance of evidence does indicate that capital punishment deters.

                                                                                                                                                  Of course, public policy on punishments cannot wait until the evidence is perfect. Even with the limited quantitative evidence available, there are good reasons to believe that capital punishment deters murders. ... Opponents of capital punishment frequently proclaim that the State has no moral right to take the life of anyone, even a most reprehensible murderer. Yet that is absolutely the wrong conclusion for anyone who believes that capital punishment deters. To show why, suppose that for each murderer executed (instead of say receiving life imprisonment), the number of murders is reduced by three- which is a much lower number than Ehrlich's estimate... This implies that for each murderer not given capital punishment, three generally innocent victims would die. This argument means that the government would indirectly be "taking" many lives if it did not use capital punishment. The lives so taken are usually much more worthwhile than that of the murderers who would be spared execution. For this reason, the State has a "moral" obligation to use capital punishment...

                                                                                                                                                  Saving three other lives for every person executed seems like a very attractive trade-off. Even two lives saved per execution seem like a persuasive benefit-cost ratio for capital punishment. But let us go further and suppose only one life was saved for each murderer executed. Wouldn't the trade-off still be desirable if the life saved is much better than the life taken, which would usually be the case? As the deterrent effect of capital punishment is made smaller, at some point even I would shift to the anti-capital punishment camp. But given the difference between victims and murderers, the deterrent effect would have to be considerable less than one person saved per murderer executed before I would shift positions...

                                                                                                                                                  Of course, one wants to be sure that the number of persons wrongly executed for murder is a very small fraction of the total number executed. Posner argues convincingly that the safeguards built into the American system are considerable... Capital punishment cannot be used if the goal is never to erroneously execute anyone, but then its deterrent effect is lost completely. ...

                                                                                                                                                  To repeat, the capital punishment debate comes down in essentials to a debate over deterrence. I can understand that some people are skeptical about the evidence, although I believe they are wrong both on the evidence and on the common sense of the issue. It is very unpleasant to take someone's life, even a murderer's life, but sometimes highly unpleasant actions are necessary to deter even worse behavior that takes the lives of innocent victims.

                                                                                                                                                  What if, say, executing convicted drunk drivers saved innocent lives through a deterrence effect, what should we do then, especially if society decides drunk drivers are morally reprehensible so that "...the life saved is much better than the life taken..."? Is deterrence and a "difference between victims and murderers" enough?

                                                                                                                                                    Posted by Mark Thoma on Friday, March 17, 2006 at 02:31 AM in Economics

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                                                                                                                                                    Hurricanes and Ocean Temperatures

                                                                                                                                                    Ocean surface temperatures have been rising over time and several studies have linked this increase to more frequent hurricanes, but not in a way that completely eliminates natural processes as an alternative explanation. This study helps to remove some of the doubt about the link between surface temperatures and hurricane frequency:

                                                                                                                                                    Intense Storms Tied to Rising Ocean Temperature, by Valerie Bauerlein, WSJ: A new study published yesterday in the online edition of the journal Science says rising ocean temperatures around the globe are to blame for the surge of intense hurricanes that has slammed the U.S. and other countries in recent years -- a finding likely to further roil the debate over whether human activity is triggering more-devastating storms. The study ... concluded that the sharp increase in the number of very intense hurricanes can't be attributed to a normal weather cycle or other natural explanations. ...

                                                                                                                                                    Scientific American has more on the analysis.

                                                                                                                                                      Posted by Mark Thoma on Friday, March 17, 2006 at 01:11 AM in Science

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                                                                                                                                                      macroblog: Median CPI is Not Cool

                                                                                                                                                      David Altig at macroblog has the inflation news, and he say it's not as rosy as many reports suggest:

                                                                                                                                                      macroblog: CPI -- Cool... CPI ex Food and Energy -- Cool... Median CPI -- Not So Cool: The market apparently liked today's report on consumer inflation in February, but if you feel any affection for the median CPI as a measure of core inflation, things are not as rosy as the reported numbers suggest. From the Cleveland Fed:

                                                                                                                                                      According to the Federal Reserve Bank of Cleveland, the median Consumer Price Index rose 0.3% (3.5% annualized rate) in February. ... Earlier today, the BLS reported that the seasonally adjusted CPI for all urban consumers rose 0.1% (0.6% annualized rate) in January. The CPI less food and energy rose 0.1% (1.8% annualized rate) on a seasonally adjusted basis. Over the last 12 months, the median CPI rose 2.5%, the CPI 3.6%, and the CPI less food and energy 2.1%.

                                                                                                                                                      The summary table:

                                                                                                                                                      Table_1

                                                                                                                                                      A look at the distribution of individual price changes (weighted by expenditure shares) reveals why the median is giving a less benign signal than the average. Here's how things looked in January...

                                                                                                                                                      January_cpi_1

                                                                                                                                                      ... and here is how they looked in February:

                                                                                                                                                      February_cpi

                                                                                                                                                      So, while there has been a noticeable shift away from very high rates of change toward very low rates of change, there has also been a large shift from the moderate 2-3 percent range to the less moderate 3-4 range. Personally, I'm not feeling a lot of love for this picture.

                                                                                                                                                      My own view of the various pieces of incoming data is that it's possible to tell whatever story your priors support. If you believe the economy is strong, that labor markets are recovering, and that inflation is a worry, it's possible to find evidence to support that position. But if you believe the incoming data point to potential weaknesses and, given the lags in the policy process, it's time for the Fed to consider pausing, it's becoming easier to find support for that position as well.

                                                                                                                                                        Posted by Mark Thoma on Friday, March 17, 2006 at 12:39 AM in Economics, Inflation

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                                                                                                                                                        March 16, 2006

                                                                                                                                                        Carter Has Company

                                                                                                                                                        From the WSJ's Washington Wire:

                                                                                                                                                        Washington Wire: Bush Confronts persistent skepticism about his leadership: The president’s job approval, now 37% in a Wall Street Journal/NBC News poll, has held below 40% since October 2005. That is the longest sustained period below 40% of any president since Carter in WSJ/NBC and Gallup data. Just 11% of independents and 29% of Republicans call the Bush administration “very competent,” ... Majorities in every region call Bush’s predicament “a longer-term setback” that’s unlikely to improve.

                                                                                                                                                          Posted by Mark Thoma on Thursday, March 16, 2006 at 09:18 PM in Politics

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                                                                                                                                                          Primogeniture as a Source of Productivity Differences

                                                                                                                                                          Hal Varian recently discussed productivity differences between the U.S. and the U.K. and noted:

                                                                                                                                                          It appears that United States companies are much farther up the learning curve .... Professors Bloom, Sadun and Van Reenen looked at 7,500 establishments in Britain and found that in terms of value added per worker, American multinational corporations were 23 percent more productive than the average in Britain. ...

                                                                                                                                                          He cites differences in the use of information technology as a major factor in the productivity differences. Perhaps there's another reason as well:

                                                                                                                                                          London School of Economics/McKinsey study says the best way to ruin a UK family business is to give it to an eldest son, by Finfacts Team: Research published today by the Centre for Economics Performance at the London School of Economics and McKinsey the consultancy, suggests that the best way to ruin a UK family business is to give it to an eldest son. The research into the gap between the UK's productivity performance and that in the US, France and Germany found ... that half of the difference between British companies and their overseas competitors ... could be explained by the prevalence in Britain of second or later generation family-run companies. If those were removed from the analysis, British performance did not look nearly so bad.

                                                                                                                                                          Nick Bloom, one of the authors, urges the UK Government to scrap the 100 per cent inheritance tax relief given to large family businesses. Bloom says that if tax relief were to be capped at £1m, it would spur productivity growth, save taxpayers £250m a year and avoid entrenching poor management in Britain's boardrooms. "Can you imagine if the current England football team was picked from the sons of the team in 1966? We wouldn't win anything."...

                                                                                                                                                          Family firms exist across the world so why single out the UK? From our survey of manufacturing, it turns out that the UK has a high number of firms that are both family-owned and family-managed. The ... number of family-owned firms is about 30% in the UK, France and Germany and 10% in the United States. ... the majority are managed by the family in the UK and France, but not in Germany. Moreover, ... about half of all these family firms in the UK reported handing down CEO control by primogeniture – that is, to the eldest son.

                                                                                                                                                            Posted by Mark Thoma on Thursday, March 16, 2006 at 06:14 PM in Economics, Technology

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                                                                                                                                                            Do Workers Oppose Immigration Because They Don't Understand Economics?

                                                                                                                                                            Bryan Caplan at EconLog says workers oppose immigration because they don't understand economics, not because of the effect on wages and income:

                                                                                                                                                            EconLog: More Cool Work By Hainmueller and Hiscox, by Bryan Caplan: In "Educated Preferences: Explaining Attitudes Toward Immigration In Europe," Hainmueller and Hiscox confirm what I've been telling economists for years: Low-skilled workers are more opposed to immigration because they are less economically literate, not because they selfishly calculate that immigration is especially bad for their pocketbooks:

                                                                                                                                                            [P]eople with higher levels of education and occupational skills are more likely to favor immigration regardless of the skill attributes of the immigrants in question. Across Europe, higher education and higher skills mean more support for all types of immigrants. These relationships are almost identical among individuals in the labor force (i.e., those competing for jobs) and those not in the labor force.

                                                                                                                                                            As a professor, I work in one of the few labor markets that is almost totally open to foreign competition. How often do you think I've heard an American professor grumble that foreign Ph.D.s "Are taking our jobs!"? Try never. P.S. For more on Hainmueller and Hiscox's work, see here.

                                                                                                                                                            The idea that workers will be less opposed to globalization and immigration with more education was echoed recently by Mankiw:

                                                                                                                                                            Maybe the answer is [to] put an economics course in every high school and we’ll be OK,” said Summers, taking a jab at Mankiw who earlier suggested that introducing economic principles to Americans in high school would help people better understand globalization.

                                                                                                                                                            What happens when they learn that immigration or geographic expansion of labor markets through digital technology reduces wages?:

                                                                                                                                                            The simplest supply-demand framework implies that “an increase in supply will, other things being equal, tend to depress wage rates” (Samuelson, 1964, p. 552). ... This study ... seems to suggest that the supply-demand textbook model is correct after all: increases in labor supply do move the labor market along the demand curve and lead to lower wages for competing workers.

                                                                                                                                                              Posted by Mark Thoma on Thursday, March 16, 2006 at 11:25 AM in Economics, Income Distribution, International Trade

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                                                                                                                                                              Monetary Policy and Asset Prices

                                                                                                                                                              Donald Kohn gave a speech on asset prices and monetary policy as part of a conference in honor of the ECB's chief economist, Otmar Issing who is retiring soon. The speech discusses a disagreement between Kohn and Issing on the role of central banks in managing asset prices:

                                                                                                                                                              Monetary policy and asset prices, by Donald Kohn, Fed Reserve Governor: I am honored to participate in this tribute to Otmar Issing. ... I can think of no better way to celebrate the signal contributions of this leading force in the world of monetary policymaking than to address an issue of great importance to central banks, ... the proper role of asset prices in the determination of monetary policy. Otmar and I have debated this issue on many occasions...

                                                                                                                                                              Two Strategies for Dealing with Market Bubbles Most fluctuations in stock prices, real estate values, and other asset prices pose no particular challenge to central banks... But many argue that pronounced booms and busts in asset markets are another matter, especially if actual valuations appear to be misaligned with fundamentals. What should a central bank do when it suspects it faces a major speculative event...? To help frame the discussion, I will focus on two different strategies that have been proposed for dealing with market bubbles.

                                                                                                                                                              The first approach--which I will label the conventional strategy--calls for central banks to focus exclusively on the stability of prices and economic activity over the next several years. Under this policy, a central bank responds to ... asset prices only insofar as they have implications for future output and inflation over the medium term. ...

                                                                                                                                                              The second strategy, by comparison, is more activist and attempts to damp speculative activity directly. ... I am labeling this second approach extra action, as it calls for steps that would not be taken in ordinary circumstances. Compared with the first approach, the extra-action strategy responds to a perceived speculative boom with tighter monetary policy--and thus lower output and inflation in the near term--with the expectation of significantly mitigating the potential fallout from a possible future bursting of the bubble. Thus, the strategy seeks to trade off the near-certainty of worse macroeconomic performance today for the chance of disproportionally better performance in the future... But the extra-action proposal is by no means a bold call for central banks to prick market bubbles. ... Rather, the extra-action strategy is intended only to provide some limited insurance against the possibility of highly adverse events occurring down the road.

                                                                                                                                                              Common Ground I will be talking at length about the differences between the two strategies, but I must stress up front how much they have in common. ... I think it fair to say that most central banks, faced with only a limited understanding of asset prices and their interactions with the full economy, engage in a form of risk management when dealing with market booms and busts. In part, they do this because any particular policy ... is never associated with a single forecast for the future paths of output and inflation but, instead, with a large set of possible scenarios with differing odds... While no one uses formal Bayesian methods to solve this difficult problem, I think most policymakers do engage in at least an informal weighing of the various possibilities and their implications when setting policy.

                                                                                                                                                              Three Conditions for Extra Action to Lead to Better Outcomes Now let me turn from areas of agreement to more contentious issues... As I see it, extra action pays only if three tough conditions are met. First, policymakers must be able to identify bubbles in a timely fashion with reasonable confidence. Second, there must be a fairly high probability that a modestly tighter policy will help... And finally, the expected improvement in future economic performance that would result from a less expansive bubble must be sizable. ...

                                                                                                                                                              To wrap up this critique, I summarize as follows: If we can identify bubbles quickly and accurately, are reasonably confident that tighter policy would materially check their expansion, and believe that severe market corrections have significant non-linear adverse effects on the economy, then extra action may well be merited. But if even one of these tough conditions is not met, then extra action would be more likely to lead to worse macroeconomic performance over time than that achievable with conventional policies that deal expeditiously with the effects of the unwinding of the bubbles when they occur. For my part, I am dubious that any central banker knows enough about the economy to overcome these hurdles. However, I would not want to rule out the possibility that in some circumstances, or perhaps at some point in the future when our understanding of asset markets and the economy has increased, such a course of action would be appropriate.

                                                                                                                                                              Asymmetries and Moral Hazard Proponents of extra action have their own bones to pick with the conventional strategy... In particular, the claim is often made that, based on the FOMC's actions over the past twenty years, the Fed actively works to support the economy in an event of a sharp decline in asset markets but does little or nothing to restrain markets when prices are rising, thereby creating moral hazard problems.

                                                                                                                                                              This argument strikes me as a misreading of history. U.S. monetary policy has responded symmetrically to the implications of asset-price movements for actual and projected developments in output and inflation, consistent with its mandate. ... Conventional policy as practiced by the Federal Reserve has not insulated investors from downside risk. Whatever might have once been thought about the existence of a "Greenspan put," stock market investors could not have endured the experience of the last five years in the United States and concluded that they were hedged on the downside... Nor, for that matter, should they have concluded that the Federal Reserve does not act on the upside... one can argue that extra action may pose a more significant risk of moral hazard. ...

                                                                                                                                                              One more thought. If the central bank is perceived to be actively managing asset prices and the economy crashes, its reputation could take a substantial hit. Of course the reverse is true too and it is the source of criticism of the Fed's actions surrounding the dot com crash, i.e. failure to act when a bursting bubble can be avoided is also a policy mistake. But given existing uncertainties, e.g. we don't know for sure if central bank policy could have changed the dot com outcome, it is easier to defend against the failure to prevent a crash than to justify actions that might have caused it.

                                                                                                                                                                Posted by Mark Thoma on Thursday, March 16, 2006 at 10:27 AM in Economics, Fed Speeches, Monetary Policy

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                                                                                                                                                                Who is Harmed by Polygamy?

                                                                                                                                                                Robert Frank looks at the economics of polygamy:

                                                                                                                                                                Polygamy and the Marriage Market: Who Would Have the Upper Hand?, by Robert H. Frank, Economic Scene, NY Times: ...The debut on Sunday night of "Big Love," ... about a polygamous fictional family in Salt Lake City, has touched off renewed debate... Barb, Nicki and Margene ... chose to marry Bill Henrickson, a successful businessman... Mr. Henrickson chose to marry them. Should society outlaw such arrangements because they cause unacceptable harm to others? If so, who is harmed, exactly, and how? Economic theory, it turns out, has interesting things to say about these questions.

                                                                                                                                                                The traditional argument against plural marriage is that it harms women, particularly younger women who may be coerced to enter such marriages. Needless to say, society should prohibit forced participation ... But mature women who freely choose plural marriage reveal a preference for that arrangement. So if plural marriage harms women, the victims must be those who prefer monogamy.

                                                                                                                                                                It is easy to see how some of these women may be harmed. In a monogamous world, ... Barb's first choice might have been to marry Bill, who would also have chosen to marry her. But with plural marriage permissible, Bill might prefer to marry not just Barb, but also Nicki and Margene. Barb would then have to choose between two lesser outcomes: a continued search or a plural marriage not to her liking.

                                                                                                                                                                Of course, ... that allowing plural marriage may eliminate attractive options for some women does not imply that it imposes unacceptable harm on women generally. Suppose ... that if polygamy were legal, 10 percent of adult men would take an average of three wives apiece and that all remaining marriages would be monogamous. ... The law of supply and demand applies no less to social relationships than to ordinary commercial transactions. With an excess supply of men in the informal market for monogamous marriage partners, the terms of exchange would shift in favor of women. Wives would change fewer diapers, and their parents might even escape paying for weddings.

                                                                                                                                                                What about men? Here, too, plural marriage would clearly benefit some. After all, there are surely other men like Bill Henrickson of "Big Love" who would not only prefer multiple wives, but also be able to attract them. But what about those who prefer monogamy? Permitting plural unions would, as noted, create an imbalance of men over women among monogamists. With so many formerly eligible women no longer available, the terms of exchange would turn sharply against men ... Many men would fail to marry at all.

                                                                                                                                                                In short, the logic of supply and demand turns the conventional wisdom about plural marriage on its head. If the arrangement harms others, the most likely victims are men, not women.

                                                                                                                                                                This conclusion is reinforced if we take account of the costly, and mutually offsetting, jockeying for position associated with ... "positional arms races" ... illustrated by examples from nonhuman animal species. The overwhelming majority of such species are polygynous, meaning that some males take more than one mate. Since having multiple mates is extremely advantageous in Darwinian terms, males typically battle one another ferociously for access to females. Size often decides these battles, so males tend to be considerably larger than females in polygynous species.

                                                                                                                                                                Some bull elephant seals, for example, are more than 20 feet long and weigh more than 6,000 pounds ..., whereas females are typically less than 12 feet long and weigh about 1,500 pounds. Natural selection favored larger males because the winners of the long and bloody battles between males often command nearly exclusive sexual access to harems of more than 50 females.

                                                                                                                                                                But although being bigger ... is clearly advantageous..., they are also less mobile and hence more vulnerable to sharks and other predators. Relative size, not absolute size, governs the outcomes of fights, so it would clearly be better if each male were only half as large. All fights would be resolved as before, yet all males would be less vulnerable to predators. Unfortunately, however, seals have no practical way of curtailing the arms race that makes them so big.

                                                                                                                                                                Permitting plural marriage in human societies would unleash competitive forces analogous to those we see in other species. With women in chronically short supply, men would face even more intense pressure than they do now to get ahead economically, to spend even longer hours honing their abs. More men would undergo cosmetic surgery. Expenditures on engagement rings would rise... Yet no matter how valiantly each man strove, the same number would be destined not to marry.

                                                                                                                                                                Unlike other animal species, human societies can employ the power of law to constrain such positional arms races. In addition to whatever other purposes they may serve, laws against plural marriage may function as positional arms control agreements that make life less stressful for men. And this may help explain their appeal to the predominantly male legislatures that enact them.

                                                                                                                                                                  Posted by Mark Thoma on Thursday, March 16, 2006 at 01:44 AM in Economics

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                                                                                                                                                                  Will the ECB Abandon Its Monetarist Tradition?

                                                                                                                                                                  Change at the European Central Bank:

                                                                                                                                                                  How the loss of an ECB pivot will be felt, by Ralph Atkins, Financial Times: ...Otmar Issing, the European Central Bank’s chief economist, who steps down in May. ... has played a pivotal role since the ECB was established in the late 1990s as the central bank of Europe’s monetary union. For the past eight years, he has guided its economic thinking and the successful switch from national currencies to a stable and strong euro. “He made it actually work,” declares Adam Posen, of the Washington-based Institute for International Economics.

                                                                                                                                                                  So does his departure herald a big shake-up for the ECB? Do not expect a revolution – this is a central bank, after all. ... It is a moment of historical as well as economic significance. The departure of the German-born and -educated monetarist ... breaks the link between the ECB’s executive board and the once-revered Bundesbank, on which the pan-European institution is largely modelled. ... Mr Issing bequeathed to the ECB not only that institution’s gravitas and market credibility but also its approach to managing the economy.

                                                                                                                                                                  As at the German institution, Mr Issing has been the guiding spirit behind the monetary “pillar” of the ECB’s strategy, with its focus on monetary aggregates such as M3, the broad money supply measure. The ECB’s adherence to such yardsticks puts it out of step with most other central banks...

                                                                                                                                                                  Jean-Claude Trichet, the ECB’s president ... will be quick to reassure ... that no cracks will appear ... after Mr Issing leaves. He may also stress his own monetarist instincts and those of the ECB’s rate-setting governing council. ... Mr Trichet has little choice but to stress continuity and stability ... Any hint of changes to its “two pillar” strategy – in which the analysis of real economy variables such as gross domestic product growth is “cross-checked” against the monetary “pillar” – would risk the credibility that it has established ...

                                                                                                                                                                  Jürgen Stark, vice-president of the Bundesbank, has already been chosen to succeed him. But the expectation in Frankfurt is that Mr Stark ... may not be handed Mr Issing’s brief in its entirety. At least part of the economics portfolio may be transferred to Lucas Papademos, the former Greek central bank governor who is the ECB’s vice-president... He is arguably more in tune with international mainstream economic thinking, in which monetary aggregates play less of a role. ...

                                                                                                                                                                  Ideas previously considered taboo have started to creep into discussions. An important example is the concept of “output gaps” – the degree of slack in an economy, which indicates whether monetary policy is appropriate. Mr Issing regarded such ideas as too vague and dependent on unreliable data. But Mr Papademos was influential in developing the concept. ...

                                                                                                                                                                  Some in Frankfurt expect a more mainstream economic emphasis in future... Over time, such thinking could shape policy, possibly making it appear less “hawkish” – although hardened German monetarists claim the bank is already too lax...

                                                                                                                                                                    Posted by Mark Thoma on Thursday, March 16, 2006 at 12:48 AM in Economics, Monetary Policy

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                                                                                                                                                                    Greg Ip Says 4.75% Likely with More Possible

                                                                                                                                                                    The Wall Street Journal's Greg Ip reports on the likely outcome of the next two monetary policy meetings after speeches today by Federal Reserve Bank presidents Yellen and Guynn:

                                                                                                                                                                    Bernanke Is Expected To Follow Greenspan's Lead, by Greg Ip, WSJ: The Federal Reserve's first meeting under Ben Bernanke is likely to ...[be] another interest-rate increase with the door left open to more. U.S. and foreign economic growth are better than Fed officials expected a few months ago, and inflation, though steady, is at the high end of many officials' preferred range... Mr. Bernanke ... presides over his first policy meeting on March 27-28. At that meeting, the Fed is likely to boost its short-term-rate target to 4.75% from 4.5%.

                                                                                                                                                                    Markets are counting on an increase at the March meeting and also put high odds on a boost to 5% at the May 10 meeting. Fed officials appear comfortable with those expectations, but don't have strong convictions. ... "During the past 20 months...the [Fed] was able to clearly communicate...the path of policy," Federal Reserve Bank of Atlanta President Jack Guynn said yesterday. "Our policy path over the coming period is somewhat less certain."...

                                                                                                                                                                    Fed officials had expected the economy to grow strongly in the first half... However, growth has been a bit stronger than expected... In a speech yesterday, Federal Reserve Bank of San Francisco President Janet Yellen said unemployment at 4.8% raises the "question of whether the economy has already gone a bit beyond full employment." If so, with growth expected to exceed its long-run trend "in the first half of this year, the strain on resources could build further, intensifying inflationary pressures."

                                                                                                                                                                    She added: "Additional inflationary pressures at this point would be particularly unwelcome, because inflation is now toward the upper end of my 'comfort zone.'" ... Still, Ms. Yellen said there are other indicators that suggest the economy still has slack in it, and she expects inflation "will remain well contained."

                                                                                                                                                                    Mr. Guynn said the risks of weaker growth and higher inflation are "now close to being equal."...

                                                                                                                                                                    Bloomberg has more on the speeches by San Francisco Fed president Janet Yellen (speech) and Atlanta Fed president Jack Guynn (speech). On Yellen:

                                                                                                                                                                    "While we face a great deal of uncertainty, the economy appears to be approaching a highly desirable glide path," ... In comments similar to those she made three days ago, Yellen said she's "sensitive" to signs the Federal Reserve might "overshoot" by raising interest rates too much and is "looking for signs of the delayed effects on output and inflation"... "The most likely outcome over the next year or so is that inflation will remain contained," ... In response to questions after the speech, Yellen said she expects core inflation to move to the "center" of her preferred range and wages to remain steady. "I see growth slowing and the unemployment rate as stabilizing where it is," she said...

                                                                                                                                                                      Posted by Mark Thoma on Thursday, March 16, 2006 at 12:05 AM in Economics, Monetary Policy

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