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January 8, 2008

Economist's View - 7 new articles

Voter ID Requirements and Political Participation

The Supreme Court considered a case on voter ID rules today, so this study is timely:

"It is incredibly clear how voter I.D. requirements disproportionately affect and suppress minorities," said Logan, professor of sociology. "This data shows that if voter I.D. policies had not been in place in 2004, voter turnout would have increased by more than 1.6 million..." [complete report]

Creative Entry

Are business cycles and the creative destruction they bring about healthy for the economy? Do we need business cycles to clear out the inefficient firms to make room for more creative and more efficient firms to take their place?

The research described below finds that "recessions do not appear to be times of massive cleansing of less-efficient incumbents." The creative destruction of existing firms is about the same in both booms and recessions, there is nothing special about the firms that are driven from the marketplace when things are bad, so bad times are no more effective at cleaning out the inefficient than good times. It is on the entry side where there are differences over the business cycle, and making it easier for firms to enter in recessions rather than accelerating their departure may be a means of encouraging innovation and "an effective method for stabilizing the economy":

Are there cleansing effects of recessions? Entry and exit of manufacturing plants over the business cycle, by Yoonsoo Lee and Toshihiko Mukoyama, Vox EU: Creative destruction is a major driving force of modern market economies.[1] Firms enter and exit the marketplace, plants are built and destroyed, and workers change jobs and occupations. In recent decades, economists have started to learn that the amount of reallocation that occurs in market economies is massive.[2] It is the rule rather than the exception, and it is essential in a well-functioning market economy. The microeconomic ups and downs of reallocation allow new products to be introduced, new technologies to be put to use, and resources to be moved to productive places.

Modern market economies also experience ups and downs at the aggregate level. Booms and recessions—sometimes mild, sometimes severe—occur all the time, and stabilizing the business cycle is one of the major policy goals of many governments. But before conducting a stabilization policy, a natural question to ask is: how are macroeconomic fluctuations (business cycles) and microeconomic fluctuations (creative destruction) related? If macroeconomic fluctuations reflect the resource reallocations of a well-functioning market economy, the business cycle may not be such a problem after all.

One popular view among economists is that business cycles do in fact represent waves of creative destruction. Booms are times of heavy creation, and recessions are times of heavy destruction. If so, attempts to stabilize the business cycle could actually hamper the healthy process of resource reallocation. Recessions would not be a bad thing either, especially from a long-run perspective, because they would serve to cleanse the economy of inefficient production units.[3] Not all economists agree. Some hold the opposite view and see recessions as times of slow reallocation,[4] where creation and destruction decelerate. In their view, a recession is indeed a bad thing.

For policymakers then, it is important to know what actually happens to the reallocation process during the business cycle. We examine this issue for the US manufacturing sector in a recent paper (Lee and Mukoyama, 2007), using plant-level data from the US Census Bureau.[5] In particular, we look closely at the entry (birth) and the exit (death) of plants over the business cycle. Overall we find that entry rates (the percentage of plants opening in a given year) are much higher in booms than in recessions. However, exit rates (the percentage of plants closing in a given year) are comparable in booms and in recessions. What is interesting is that plants entering during recessions are very different in terms of employment and productivity from those that enter during booms, whereas exiting plants are rather similar in both phases of the business cycle. On average, plants that enter during recessions are larger (they hire more workers) and are more productive than plants that enter during booms. Such differences are relatively small for plants exiting in booms or recessions.

These results cause us to rethink the relationship between business cycles and micro-level reallocations. In the literature that argues for a cleansing effect of recessions, a lot of emphasis is placed on the belief that cleansing occurs at the destruction (or exit) margin. That belief rests on earlier research, which found that job destructions at continuing plants are strongly countercyclical. In contrast, our research finds nothing special going on at the exit margin. Because closing plants are similar in booms and recessions, it suggests that recessions do not necessarily cause productive plants—those that could have survived in good times—to shut down in large numbers. During recessions, when it is hard for businesses to survive, businesses tend to reduce their workforces by firing existing workers. But recessions do not appear to be times of massive cleansing of less-efficient incumbents. Less productive plants are indeed driven out of the market, but not only in recessions. Rather, cleansing at the exit margin occurs all the time, in a similar manner, regardless of business cycle phase.

Of course, this does not mean that the business cycle and reallocation process are not related at all. Quite the contrary—entry behavior is very cyclical. The fact that entrants are very different in booms and recessions suggests that there is some very important selection going on at the entry margin over the business cycle. In booms, a small and relatively unproductive plant can enter—because times are good, an unproductive plant can still be profitable. But in recessions, only productive (and large) plants can profitably enter. Recessions might have a positive effect on average productivity by selecting only more productive plants. However, such selection does not necessarily mean that the cleansing of inefficient, existing plants is taking place. Selecting only highly productive entrants can be more important. In short, when we study the effects of business cycles, we should shift our focus from exit behavior to entry behavior: "Creation" is a more important margin than "destruction."

We believe our findings matter for policy makers in the following respects. First, the fact that the plants that enter in booms are different from those that enter in recessions indicates that there is a much larger barrier to entry during recessions. Such a barrier may hurt the long-run growth of the economy. New plants often embody innovations, and researchers find that entry is an important source of aggregate productivity growth. For this reason, an important question is what makes entry more difficult during recessions. Perhaps the costs of the initial investment for startup are higher or financing is more difficult to obtain.

Second, our research indicates that the outcome of various stabilization policies will depend on their effect on entry and exit rates. In our paper, we build a model that is able to quantitatively replicate the features of the data, and we run several experiments with it. Imposing firing taxes could have a stabilizing effect if the policy did not affect entry and exit behavior, because the tax would induce plants to reduce the frequency of their firing and hiring.[6] But we find that entry rates fluctuate more with the firing tax, which could translate into more volatile aggregate output. Entry rates fluctuate more because the firing tax discourages entry more during recessions than during booms. Because the firing tax is more likely to affect larger plants that tend to reduce their workforces in the near future, entering plants during recessions are more likely to be affected.

Our finding points to the importance of policies that are targeted to the incentive to enter. For example, an effective method for stabilizing the economy is to encourage entry during recessions. In particular, if a market inefficiency (such as financial constraints) is creating barriers to entry, then encouraging entry during recessions is indeed a good thing.

Finally, we would like to emphasize that our empirical results are based on US manufacturing data. An intriguing question for future research is to see how these results can be compared across sectors and across countries.

References

Barlevy, G. (2002). "The Sullying Effect of Recessions," Review of Economic Studies 69, 41-64. Caballero, R. J. and M. L. Hammour (1994). "The Cleansing Effect of Recessions," American Economic Review 84, 1350-1368. Caballero, R. J. and M. L. Hammour (2005). "The Cost of Recessions Revisited: A Reverse-Liquidationist View," Review of Economic Studies 72, 313-341. Davis, S. J., J. C. Haltiwanger, and S. Schuh (1996). Job Creation and Destruction, Cambridge, MIT Press. Dunne, T., M. J. Roberts, and L. Samuelson (1988). "Patterns of Firm Entry and Exit in US Manufacturing Industries," RAND Journal of Economics 19, 495-515. Lee, Y. and T. Mukoyama (2007). "Entry, Exit, and Plant-level Dynamics over the Business Cycle," Federal Reserve Bank of Cleveland Working Paper 07-18. Samaniego, R. M. (2006). "Entry, Exit and Business Cycles in a General Equilibrium Model," mimeo. George Washington University. Veracierto, M. L. (2004). "Firing Costs and Business Cycle Fluctuations," mimeo. Federal Reserve Bank of Chicago.

Footnotes

1 The research in this article was conducted while the authors were Special Sworn Status researchers of the U.S. Census Bureau at the Michigan Census Research Data Center. Research results in this article have been screened to insure that no confidential data are revealed. The views expressed in this article are those of the authors and do not necessarily reflect the position of the Census Bureau, the Federal Reserve Bank of Cleveland or the Federal Reserve System. 2 See the pioneering work by Dunne, Roberts, and Samuelson (1989) and Davis, Haltiwanger, and Schuh (1996). 3 See, for example, Caballero and Hammour (1994) for a theoretical examination of this view. 4 See, for example, Barlevy (2002) and Caballero and Hammour (2005). 5 We use the Annual Survey of Manufactures from 1972 to 1997. 6 See Veracierto (2004) and Samaniego (2006). In Samaniego's (2006) model, entry is endogenous but it fluctuates very little over the business cycle.

Brad DeLong on Huckabee's FairTax Proposal

Can Mike Huckabee use hatred of the IRS to convince the majority of voters to vote against their own economic self-interest and shift the tax burden from those making over $200,000 to those making less than that amount? Brad DeLong says that with the help of a press that refuses to say much about the substance of policy leaving many voters uniformed about the consequences of the proposal, perhaps so:

Mike Huckabee wants to abolish the IRS, by By Brad DeLong, Salon: ...Republican presidential front-runner Mike Huckabee is [proposing]... the "FairTax": a plan to replace the income tax and the Internal Revenue Service with a nationwide federal sales tax. ...

The ... FairTax ... promises to be a game changer. It would abolish the IRS and all current federal taxes, including Medicare, Social Security, and personal and corporate income taxes, and replace them with a national, across-the-board, 23 percent point-of-purchase retail sales tax. It would also give each household a multi-thousand-dollar "prebate" every year on their expected annual taxes and exempt people living below the poverty line from taxes altogether.

The FairTax asks: Don't we all hate the IRS? Don't we wish it would just die? And once Huckabee has made the don't-we-all-hate-the-IRS move, his establishment competitors are suddenly thrown on the defensive. ... Cynical on the part of Huckabee? Surely. Dishonest? Somewhat. But remember that this move of Huckabee's is less cynical and dishonest than the standard Republican line on how tax cuts raise revenue, which the other front-running GOP candidates are still mouthing.

From another perspective, however, you have to scorn Huckabee. He is adding yet more layers of confusion to America's conversation about taxes. Huckabee says that the FairTax would mean a 23 percent sales tax rate on all items. First of all, the real tax rate proposed is 30 percent. ... Second, and more important, both conservative and liberal economists believe the real rate would end up even higher. ... Congress' Joint Committee on Taxation, which draws members from both parties and both houses, says the real rate would be 57 percent. (And this leaves aside the enormous federal outlay required by the "prebates"...)

Also, Huckabee calls his proposal a "fair" tax. But it's a mammoth tax cut for the crowd making more than $200,000 a year and a substantial tax increase for those making between $30,000 and $200,000 a year. Does this make economic sense? It is hard to see how...

Does the FairTax make political sense? It is hard to see how -- at least not if people know what he is really proposing. After all, a lot more people make between $30,000 and $200,000 a year than make more than $200,000. ...

So why is Huckabee doing this? I believe ... he is counting on people not knowing what he is really promising. I believe he is counting on the nigh total fecklessness of America's press corps -- a fecklessness that I at least now see as deployed with a sharp partisan edge. ...

Huckabee is a Republican. And it is different if you are a Republican. The New York Times in its big Huckabee profile by Zev Chafets said:

Huckabee's answer to his opponents on the fiscal right has been his Fair Tax proposal ... Governor Huckabee promises that this plan would be "like waving a magic wand, releasing us from pain and unfairness." Some reputable economists think the scheme is practicable. Many others regard it as fanciful ... In any case, the Fair Tax proposal is based on extremely complex projections.

And that's all the crack journalism of the New York Times has to say. If you are seeking information in a daily newspaper, look elsewhere...

Since America's mainstream press believes that it cannot talk about the substance of policy, about who actually would gain and who would lose from a shift to a national sales tax -- that, you see, depends on "extremely complex projections" -- the only point to grab onto when talking about the national sales tax is that it eliminates the IRS. And that sounds very good. And sounding very good is what Huckabee is counting on.

But what replaces the IRS? What agency administers a national sales tax? ... [T]his FairTax selling point is bogus too. The FairTax doesn't eliminate the IRS. It replaces the IRS with another agency -- the United States Fair Tax Federal Revenue Administration and State Tax Authority Reconciliation Service, or the USFTFRASTARS. It is true that the USFTFRASTARS doesn't audit individuals -- it audits businesses and state governments instead. This is a good thing for the $200,000-plus crowd: They are the ones who get audited, and so they get both a big tax cut and greatly increased peace of mind. But this is not a good thing for everybody else. The administrative and enforcement burden does not go away but, rather, becomes even more complicated.

Is Huckabee's FairTax smoke and mirrors? Yes. Is it voodoo economics? Yes. But remember one more thing: It is more reality based than the proposals of the establishment Republican candidates.

Given all the deceptions in Huckabee's FairTax proposal (more here, here, and here), and the actual substance of the plan, I'm not so sure Huckabee deserves to be elevated above the rest of the Republican candidates.

Paul Krugman: From Hype to Fear

The administration's policies rarely change, be it Iraq, or taxes, or whatever, but the justifications for the policies shift with the wind:

From Hype to Fear, by Paul Krugman, Commentary, NY Times: The unemployment report on Friday was brutally bad. Unemployment rose in December, while job creation was minimal... It's no longer possible to hope that the effects of the housing slump will remain "contained,"... the repercussions ... are spreading across the economy as a whole. ...

The November election will take place against that background of economic distress, which ought to be good news for candidates running on a platform of change.

But the opponents of change, those who want to keep the Bush legacy intact, are not without resources. In fact, they've already made their standard pivot when things turn bad — the pivot from hype to fear. And in case you haven't noticed, they're very, very good at the fear thing.

You see, for 30 years American politics has been dominated by a political movement practicing Robin-Hood-in-reverse, giving unto those that hath while taking from those who don't. And one secret of that long domination has been a remarkable flexibility in economic debate. The policies never change — but the arguments for these policies turn on a dime.

When the economy is doing reasonably well, the debate is dominated by hype — by the claim that America's prosperity is truly wondrous, and that conservative economic policies deserve all the credit.

But when things turn down, there is a seamless transition from "It's morning in America! Hurray for tax cuts!" to "The economy is slumping! Raising taxes would be a disaster!"

Thus, until just the other day Bush administration officials were ... still insisting that the economy was strong, and touting the "Bush boom" ... as proof of the efficacy of tax cuts.

But now, without ever acknowledging that maybe things weren't that great after all, President Bush is warning that..., "the worst thing the Congress could do is raise taxes..."

And even more dire warnings are coming from some of the Republican presidential candidates. For example, John McCain's campaign Web site cautions darkly that "Entrepreneurs should not be taxed into submission. John McCain will make the Bush ... tax cuts permanent,... fighting the Democrats' plans for a crippling tax increase in 2011."

What "crippling" tax increase, which would tax entrepreneurs into submission, is Mr. McCain talking about? The answer is, proposals by Democrats to let the Bush tax cuts for people making more than $250,000 a year expire, returning ... to the levels that prevailed in the Clinton years.

And we all remember how little entrepreneurship there was, how weakly the economy performed, during the Clinton years, right? Oh, wait. (I've put some charts comparing job performance during the Clinton and Bush years on my Times blog... It's pretty startling how comparatively weak the Bush era looks.)

Never mind. The whole point of scare tactics is that they can work even in the face of inconvenient facts.

And what I'm not sure about is whether the Democrats are ready for the fight they're about to face.

Not to put too fine a point on it, Barack Obama won his impressive victory in Iowa with a sunny, upbeat message of change.

But there's a powerful political faction in this country that understands very well that any real change will create losers as well as winners. In particular, any serious progressive reform of health care, let alone a broader attempt to reduce middle-class insecurity and inequality, will have to mean higher taxes on the affluent. And members of that faction will do whatever it takes to scare people into believing that change means disaster for the economy.

I don't think they'll succeed. But it would be a big mistake to assume that they won't.

Dean Baker: Year of the Fat Cats

How well have stocks performed over the last ten years? As measured by the S&P 500, the real return has been roughly equivalent to the return on government bonds even though stocks carry more risk. Dean Baker wonders why, in light of such low returns, CEO pay is so high:

Year of the fat cats, by Dean Baker: ...If we go back 10 years, we find that the ... average real return on [the S&P 500] ... has been 3.2%, a bit lower than the yield that was available on inflation-indexed government bonds 10 years ago.

This is rather striking. It is unlikely that many people invested in stock for the sort of return that is typically associated with government bonds, which are much less risky. At least for the last decade, stockholders have not been rewarded for taking this risk.

This brings us to the topic of CEO pay. We saw an explosion in CEO pay that began in the 1980s and has continued into the current decade. ...

This explosion of pay at the top was justified by many economists based on the returns that they produced for shareholders. The argument was that even these incredibly high salaries still were just a small fraction of the value that the CEOs generated, so their pay was money well spent. These exorbitant salaries gave the CEOs the necessary incentive to produce extraordinary returns.

While this argument may never have been terribly compelling..., it clearly is not true today. The typical CEO is not producing great returns for shareholders..., [but] the CEOs still seem to get extraordinary pay packages. ...

Trade and Wages

Dani Rodrik sets the record straight on the existence of empirical evidence showing that international trade contributes to inequality:

Trade and wages, by Dani Rodrik: I have often read or heard the assertion that there is no respectable work by economists that attributes an important part of rising inequality in the U.S. to international trade, with the implication being that it's all (or mostly) due to skill-biased technological change. Greg Mankiw has made this argument in the past, and Alan Blinder implies as much in his recent NYT article.

I have never understood why the work of Rob Feenstra and Gordon Hanson is overlooked in this context. These two are among the very best empirical trade economists today... In a series of papers [e.g.], they have argued that outsourcing and global production sharing act just like skill-biased technological change, and they have played an important role in shaping wage inequality. Their empirical work is careful and driven by a compelling theoretical model of within-industry specialization. ... Importantly, their framework helps explain how globalization contributes to inequality in both developed and developing countries.

links for 2008-01-07

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