Thursday, July 28, 2011

How the Gov't. Promoted A Systematic Loosening of Underwriting Standards and Caused the Crisis

Great post by Mark Perry of "Carpe Diem."

In a new article by AEI Resident Fellow Ed Pinto (former executive vice president and chief credit officer for Fannie Mae), he reviews how government policies promoted a systematic loosening of underwriting standards in an effort to promote affordable housing, which then contributed to the housing bubble, mortgage meltdown and financial crisis. Here are six facts about the government's role in the crisis:

1. "In the late-1980s and early-1990s ACORN and other community groups claimed that Fannie and Freddie were standing in the way of their efforts to replace traditional underwriting with flexible underwriting. They lobbied Congress to force the Government Sponsored Enterprises (GSEs) to abandon their traditional underwriting standards. The goal was to force the GSEs to replace their conservative underwriting standards with flexible ones, knowing that this would spur the rest of the market to do the same.

2. These community groups were successful in convincing Congress to impose affordable housing (AH) mandates on Fannie and Freddie. This set in motion 14 years of ever looser loan standards.

3. Fannie embraced AH mandates in order to buy the political protection it would use to defeat any unwelcome changes to its lucrative charter benefits. To this purpose, it vows to “transform” the housing finance system. The strategy worked–Fannie was politically unassailable until 2008.

4. The government implements the National Homeownership Strategy with the goal of replacing traditional underwriting with flexible standards.

5. Dissenting voices (AEI's Peter Wallison among them) predicted that these efforts to transform housing finance would end in disaster.

6. As flexible lending expands, the volume and risk characteristics of so-called prime loans increases markedly, yet these loans were still called prime. For example, loans with no downpayment acquired by Fannie are called prime merely because Fannie is now willing to acquire them. The same logic applies to loans with impaired credit. HUD acknowledges this in a 2000 rule making.

7. The United States, alone among developed countries, turned its prudential regulation of underwriting standards over to a social welfare agency, namely HUD. In 2004, HUD extols its “revolution in affordable lending.”

8. The National Homeownership Strategy resulted in the substantial elimination of downpayments. The proportion of loans with down payments of 3 percent or less steadily increased from 0.5 percent of home purchases in 1990 to 40 percent by 2007 (see graph above). (MP: The bottom graph above shows how the increase in no- and low-downpayment mortgages was associated with an increase in the homeownership rate between 1995-2005.)

Conclusion: The major cause of the financial crisis in the United States was the collapse of housing and mortgage markets resulting from an accumulation of an unprecedented number of weak and risky Non-Traditional Mortgages (NTMs). These NTMs began to default en masse beginning in 2006, triggering the collapse of the worldwide market for mortgage-backed securities and in turn triggering the instability and insolvency of financial institutions that we call the financial crisis. Government policies forced a systematic industry-wide loosening of underwriting standards in an effort to promote affordable housing, compounded by moral hazard spread by Fannie and Freddie."

Government Distortions of Markets Led the Economy to Disaster, Not Unregulated Capitalism

Great post by Mark Perry of "Carpe Diem."

"From a recent column by Mona Charen:

In their new book "Reckless Endangerment," authors Morgenson and Rosner offer considerable censure for reckless bankers, lax rating agencies, captured regulators and unscrupulous businessmen. But the greatest responsibility for the collapse of the housing market and the near "Armageddon" of the American economy belongs to Fannie Mae and Freddie Mac and to the politicians who created and protected them. With a couple of prominent exceptions, the politicians were Democrats claiming to do good for the poor. Along the way, they enriched themselves and their friends, stuffed their campaign coffers, and resisted all attempts to enforce market discipline. When the inevitable collapse arrived, the entire economy suffered, but no one more than the poor.

Fannie Mae lied about its profits, intimidated adversaries, bought off members of Congress with lavish contributions, hired (and thereby co-opted) academics, purchased political ads (through its foundation) and stacked congressional hearings with friendly bankers, community activists and advocacy groups (including ACORN). Fannie Mae also hired the friends and relations of key members of Congress (including Rep. Barney Frank's partner).

"Reckless Endangerment" includes the Clinton administration's contribution to the home-ownership catastrophe. Clinton had claimed that dramatically increasing homeownership would boost the economy, instead "in just a few short years, all of the venerable rules governing the relationship between borrower and lender went out the window, starting with ... the requirement that a borrower put down a substantial amount of cash in a property, verify his income, and demonstrate an ability to service his debts."

"Reckless Endangerment" utterly deflates the perceived history of the 2008 crash. Yes, there was greed -- when is there not? But it was government distortions of markets -- not "unregulated capitalism" -- that led the economy to disaster.""

Warren Buffett is Wrong on Taxes

Great post by Mark Perry of "Carpe Diem."

"Steve Moore in Thursday's WSJ:

"The Oracle of Omaha is at it again. On July 7, Warren Buffett told Bloomberg: "I think the rich have a responsibility to pay higher tax rates." Then he groused that his wealthy friends are "paying lower tax rates than the people who are serving us the food." Mr. Buffett has been voicing this complaint for years, once observing that his personal tax rate of 17.7% is lower than that of his receptionist (30%).

During Monday night's national address, President Obama recited the Buffet line that millionaires and billionaires pay lower tax rates than their secretaries. Democrats in Congress routinely cite Mr. Buffett's tax confessions as irrefutable evidence that tax rates on the very rich are too low and the system is unfair. And the system would be unfair, if Mr. Buffett's tax facts were the whole truth. But they aren't.

I don't know the details of Warren Buffet's personal taxes, and he hasn't made them public. But the IRS does provide reliable data oneffective tax rates—the overall share of their income that various groups pay in federal income taxes (not including state or local taxes) after accounting for all deductions and exemptions. These are different than marginal tax rates, which are paid on the next dollar of income and now peak at 35% for individuals.

IRS data for 2008, for example, show that households in the top 10% of earners (above about $114,000) paid 19% of their income to the feds (see chart above). Those in the top 1% (above $380,000) paid 23.3%. The top 0.1% of earners, with incomes of $2 million or more, end up paying a slightly lower tax of 22.7%, because they get more of their income from investments (more about this below).

So what about the rest of us? According to IRS data, a median-income household ($35,000) in 2008 paid about 4% of its income in federal income tax."

MP: The chart above shows that the U.S. income tax system is progressive (as it's intended to be) and higher income groups pay taxes at a higher rate on average, as a share of their taxable income. For the bottom 50% of taxpayers with incomes of $33,000 or less, the average tax rate is only 2.6%.

As I have mentioned several times before, if Warren Buffett thinks he should pay higher taxes, he doesn't have to wait for the Bush tax cuts to expire, he can pay higher taxes right now by making a gift to the U.S. Treasury, instructions are here."

Tuesday, July 19, 2011

There is no reason to conclude that the net worth of Americans is reduced by any amount when there is foreign investment

See Fletcher’s Zero-Sum Presumptions Shove Him Into Unmistakable Error by Don Boudreaux of "Cafe Hayek."
"In the unreported parts of his e-conversation with the protectionist Ian Fletcher, David Henderson very likely made the following point. But because David didn’t quote that part of his e-debate with Fletcher, I take the opportunity here to highlight another critical way in which Fletcher is just plain wrong. Fletcher writes:
First, you [Henderson] seem to contend that FDI [foreign direct investment] is an exception to the basic rule in economics that, in Milton Friedman’s words, “there is no free lunch.” That is, you ignore the fact that when foreigners make an investment in the U.S., they own the investment. That the investment took place may be a good thing, but this doesn’t change that fact that when foreigners, rather than Americans, own an investment, this increases the net worth of foreigners and reduces the net worth of Americans by the same amount.
Wrong. There is no reason to conclude that the net worth of Americans is reduced by any amount. It is not a “fact” that an increase in FDI in the U.S. increases the net wealth of the foreign investor by some $$ amount and decreases that of some American (or Americans as a group) by the same $$ amount. Any number of examples might suffice to show why Fletcher is utterly off-base to make such an assertion. Here’s a straightforward one:

Suppose my neighbor Smith sells his vacant lot in Virginia for $100,000 to Mr. Lee from China. Mr. Lee then grows corn on that lot and earns profits from doing so. Mr. Lee’s net worth rises. Has my neighbor’s net worth declined? Possibly – if he spends the $100,000 on consumption goods (which, as David ably argues, is not necessarily a bad thing; what, after all, is the ultimate goal of economic activity if not to be able to consume more?).

But “possibly” is not “necessarily,” or even “probably.” If Smith spends the $100,000 to pay his way through medical school or to invest in his sister-in-law’s new business venture that turns out to be quite successful, Smith’s net worth increases. It might increase by more (or by less – it doesn’t really matter) than the increase in the net wealth of Mr. Lee.

Mr. Lee is richer. Smith is richer. No American is poorer. No foreigner is poorer. And Lee’s customers are richer (they get more or better or less costly corn as a result of Lee’s efforts), as are Dr. Smith’s patients or the customers of Sister Smith’s booming new business.

Fletcher’s mind seems so stuck in a zero-sum gear that he misses this not-at-all far-fetched possibility.

Or look at the matter from a different perspective by asking what would happen to Americans’ net wealth if foreigners were to completely remove themselves – or be completely removed by Congress – from the pool of potential investors in dollar-denominated assets. Would the value of publicly traded corporate shares currently owned by Americans rise? Would the value of real estate currently owned by Americans rise? Would the value of successful American start-up companies rise?

I gather that Ian Fletcher believes that the answer to these questions is an unambiguous “yes.” Do you?"

Monday, July 18, 2011

Scott Sumner On What Caused The "3 Crises"

See Fannie, Freddie, and the three “crises”.
"I see three separate crises. A “misallocation of resources into housing crisis,” a “federal bailout of banks crisis,” and a high unemployment crisis. Who’s to blame for each?

1. The private banking system and the GSEs both played a major role in causing too much housing to be built in the mid-2000s. The errors of the private banking system were due to both misjudgment (they did lose money after all) and bad incentives (moral hazard due to various government backstops.) Pretty much the same is true of the GSEs, although their role has always been a bit more politicized, and Congress must accept some blame for pushing them to boost the housing market. But this was a modest problem, as the first graph shows. It’s not the “real” issue that the left and right is debating so vigorously.

2. The GSEs are far more to blame than the banks for the bailout problem. And the banks most to blame are often smaller banks that made loans to developers, not the more famous subprime mortgages. Last time I looked the estimated losses to the Treasury from the GSEs was a couple hundred billion, from the smaller banks (i.e. FDIC–which is financed by taxes, BTW) was over a hundred billion, and the big banks was near zero (depending on how much they lose on Bear Stearns.) That’s all you need to know about where to apportion blame for the bailout crisis.

3. As far as the high unemployment crisis, the proximate cause is low NGDP, which means the Fed is to blame. Then we can apportion some blame to Obama for not putting more of his people on the Fed, and not doing it sooner. But ultimately we macroeconomists are to blame, as both the Fed and Obama take their lead from us. We were mostly silent on the need for vigorous monetary stimulus in the last half of 2008, and many have remained silent ever since.

The hero is the EMH, as markets warned the Fed that money was way too tight in September 2008."

A fetish with carbon is driving up the price of electricity and destroying jobs in Britain

See Britain's economic suicide by Matt Ridley.

"British Gas is putting up the cost of heating and lighting the average home by up to 18 per cent, or about £200 a year. Indignation at its profiteering is understandable. But that can only be a part of the story: the combined profits of the big six energy supply companies amount to less than 1.5 per cent of your energy bill, according to the regulator, Ofgem.

Gas prices have gone up this year mainly because of demand from post-Fukushima Japan and booming China. With energy now a big part of household bills, genuine fuel poverty threatens many Britons next winter.

So what does the Government plan to do? This week it publishes a white paper on electricity market reform that will be predicated upon, indeed proud of, pushing up prices even faster. To meet its self-imposed green targets, the Government’s policy is to tax carbon, fix high prices for renewable electricity and load extra costs on to people’s electricity bills — but without showing them as separate items.

This policy is beyond foolish. While you might just get away with driving up energy bills in a boom, to add green stealth taxes on top of supply-driven price increases at a time of economic misery is asking for political trouble.

Cheap energy is the elixir of economic growth. It was Newcastle’s cheap coal that gave the industrial revolution its second wind — substituting energy for labour drove up productivity, creating jobs and enriching both producers and consumers. Conversely, a dear-energy policy destroys jobs. Not only does it drive energy-intensive business overseas; according to Charles Hendry, the Energy Minister, the average British medium-sized business will face an annual energy bill £247,000 higher by 2020 thanks to the carbon policy. That’s equivalent to almost ten jobs it must lose, or cannot create.

So the pain of this policy is huge. Yet even if it works, the gain is tiny. The target is to get 15 per cent of total energy from renewables by 2020 — the current figure is just 1.8 per cent, not counting biomass and landfill gas. Most of that is old hydro; wind contributed less than half a per cent.

And that was the cheap bit. The next generation of wind farms are going to be offshore and their electricity will cost three times as much. Even if we cover half the North Sea with wind farms, at gargantuan expense to the wretched consumer, and they manage to stay upright, we would still have to build gas turbines for when the wind fails to blow — as usually happens in exceptionally cold weather.

And, surprise, the energy companies are demanding subsidies for building gas-fired power stations that are to be unprofitably switched off when the wind blows.

Raising the costs of electricity to subsidise irrelevant wind farms will fail to make the slightest dent in British carbon emissions, let alone global ones. In any case, natural gas is going to do far more than renewables ever could to accelerate the decarbonisation of the world economy, as it replaces high- carbon coal and oil in coming decades.

So the hijacking of energy policy by carbon targets is mad. Far more urgent questions face us than that. How do we replace the one-third of coal-fired stations that will close by 2015? Not by renewables, that’s for sure. How do we replace the capacity of our nuclear power stations, all but one of which will close by 2023? How do we compete with China, where it takes five years, not 15, to build a nuclear power station? How do we compete with America, where companies are now swimming in cheap domestic natural gas, half the price it is over here, thanks to shale gas exploration?

Gas already dominates the British energy market, providing about half of all joules. That dominance will only grow as abundant shale gas joins Russian and Iranian supplies. Given that renewables are an irrelevance in terms of supply, and that coal is being slowly phased out, the key question the Government needs to answer this week is where it wants to fix the price of nuclear electricity to ensure the long-term certainty nuclear investment requires.

Twenty years ago Britain liberalised its nationalised energy markets, introduced competition and the result was one of the cheapest and fairest regimes in the world. Gradually, the bureaucratic yearning to interfere and pursue ideology gained the upper hand again, especially with Tony Blair’s ludicrous “renewable obligation certificates” (ROCs) whose perverse consequences include the shipping of Californian native forest timber to Drax power station in Yorkshire at consumers’ expense.

This week’s White Paper is likely to suggest the replacement of these ROCs with a guaranteed price for renewable and nuclear power, partly reversible in the event that market prices exceed the guarantee. Unless very well designed, this too will have perverse consequences. In May alone National Grid paid wind farm users £2.6 million to switch their wind farms off.

Yet government has done very little to unleash energy entrepreneurs. We could have started the shale gas revolution here, as we started the fossil fuel revolution itself. We could still start the underground-coal gasification revolution here: according to a Newcastle firm called Five Quarter, huge amounts energy could be extracted from coal seams under the North Sea by partial combustion of the coal to make gas underground. We could push thorium reactors. But starting a business in Britain’s regulated economy and planning system is like swimming in treacle.

The future belongs to countries that can get their electricity, heat and fuel supplied as cheaply and reliably as possible. That is the priority, not the carbon fetish."

Why Do Medicare Patients See the Doctor Too Much? They Usually Pay Nothing Out-of-Pocket; So Demand Curves Really Do Slope Downward

Great post by Mark Perry of "Carpe Diem."
"From an editorial earlier this week in the WSJ:

"Almost all discussions about Medicare reform ignore one key factor: Medicare utilization is roughly 50% higher than private health-insurance utilization, even after adjusting for age and medical conditions. In other words, given two patients with similar health-care needs—one a Medicare beneficiary over age 65, the other an individual under 65 who has private health insurance—the senior will use nearly 50% more care.

Several factors help cause this substantial disparity. First and foremost is the lack of effective cost sharing. When people are insulated from the cost of a desirable product or service, they use more. Thus people who have comprehensive health coverage tend to use more care, and more expensive care—with no noticeable improvement in health outcomes—than those who have basic coverage or high deductibles.

In addition, Medicare's convoluted benefit structure encourages the purchase—either individually or through an employer—of various forms of supplemental insurance. Medicare covers roughly three-fourths of total costs, but about 85% of the Medicare population has expanded coverage with small to limited cost sharing. This additional cost insulation pushes seniors' out-of-pocket costs toward zero, thereby increasing overall utilization."

MP: This crystallizes one of our main health care problems: spending other people's money (see chart above, data here). When out-of-pocket costs for medical care approach zero, it shouldn't be any surprise that utilization goes up, that's just the Law of Demand."

Sunday, July 17, 2011

Could Anti-Free Market Policies Be The Root Of The Arab Revolt?

See The Road to Serfdom and the Arab Revolt: The dictators who came to power in the 1950s and '60s were economic levelers who impoverished their countries. Today's unrest is the result. By FOUAD AJAMI. Excerpts:
"It was in the 1950s that the foreign minorities who had figured prominently in the economic life of Egypt after the cotton boom of the 1860s, and who had drawn that country into the web of the world economy, would be sent packing. The Jews and the Greeks and the Italians would take with them their skills and habits. The military class, and the Fabian socialists around them, distrusted free trade and the marketplace and were determined to rule over them or without them.

The Egyptian way would help tilt the balance against the private sector in other Arab lands as well. In Iraq, the Jews of the country, on its soil for well over two millennia, were dispossessed and banished in 1950-51. They had mastered the retail trade and were the most active community in the commerce of Baghdad. Some Shiite merchants stepped into their role, but this was short-lived. Military officers and ideologues of the Baath Party from the "Sunni triangle"—men with little going for them save their lust for wealth and power—came into possession of the country and its oil wealth. They, like their counterparts in Egypt, were believers in central planning and "social equality." By the 1980s, Saddam Hussein, a Sunni thug born from crushing poverty, would come to think of the wealth of the country as his own.

In Libya, a deranged Moammar Gadhafi did Saddam one better. After his 1969 military coup, he demolished the private sector in 1973 and established what he called "Islamic Socialism." Gadhafi's so-called popular democracy basically nationalized the entire economy, rendering the Libyan people superfluous by denying them the skills and the social capital necessary for a viable life.

The Alawites, the religious sect to which the Assad clan belongs, had been poor peasants and sharecroppers, but political and military power raised them to new heights. The merchants of Damascus and Aleppo, and the landholders in Homs and Hama, were forced to submit to the new order. They could make their peace with the economy of extortion, cut Alawite officers into long-established businesses, or be swept aside.

But a decade or so ago this ruling bargain—subsidies and economic redistribution in return for popular quiescence—began to unravel. The populations in Arab lands had swelled and it had become virtually impossible to guarantee jobs for the young and poorly educated. Economic nationalism, and the war on the marketplace, had betrayed the Arabs. They had the highest unemployment levels among developing nations, the highest jobless rate among the young, and the lowest rates of economic participation among women. The Arab political order was living on borrowed time, and on fear of official terror.

Attempts at "reform" were made. But in the arc of the Arab economies, the public sector of one regime became the private sector of the next. Sons, sons-in-law and nephews of the rulers made a seamless transition into the rigged marketplace when "privatization" was forced onto stagnant enterprises. Of course, this bore no resemblance to market-driven economics in a transparent system. This was crony capitalism of the worst kind, and it was recognized as such by Arab populations. Indeed, this economic plunder was what finally severed the bond between Hosni Mubarak and an Egyptian population known for its timeless patience and stoicism.

The sad truth of Arab social and economic development is that the free-market reforms and economic liberalization that remade East Asia and Latin America bypassed the Arab world. This is the great challenge of the Arab Spring and of the forces that brought it about. The marketplace has had few, if any, Arab defenders."
Mr. Ajami, a senior fellow at Stanford University's Hoover Institution, is co-chairman of Hoover's Working Group on Islamism and the International Order.

Africa Benefits From Free Trade

See Africa Is Awakening, Helped by Free Trade: Six of the 10 fastest-growing economies of the last decade were in sub-Saharan Africa By DANIEL W. YOHANNES AND MO IBRAHIM, from the 6-27 WSJ.
"This is where smart development assistance must play a role. Two excellent examples that work hand-in-glove can be found in the United States, with the African Growth and Opportunity Act (AGOA) and the Millennium Challenge Corporation.

Enacted in 2000, AGOA reduces the tariffs that African exporters face in U.S. markets while providing technical assistance to help them take advantage of the legislation. In 2010, the initiative brought in $44 billion in African export earnings, a more than 438% increase since its inception in 2001, according to the U.S. International Trade Commission. Overall, calculates former Assistant U.S. Trade Representative for Africa Rosa Whitaker, the effort has created more than 300,000 African jobs.

To qualify for financing, partner countries must meet international standards for good governance, invest in their citizens, and ensure economic freedom. This means making business-friendly policy reforms, such as fighting corruption and eliminating the red tape that suffocates entrepreneurship. These are many of the same standards that businesses look for when deciding where to invest capital."
Mr. Yohannes is CEO of the Millennium Challenge Corporation. Mr. Ibrahim is chairman of the Mo Ibrahim Foundation and a board member of the global antipoverty advocacy group, ONE.

The Facts About Fracking

Editorial from the 6-25/26 WSJ. Excerpts:
"As recently as 2000, shale gas was 1% of America's gas supplies; today it is 25%."

"Today, proven reserves are the highest since 1971, prices have fallen close to $4 and ports are being retrofitted for LNG exports."
Then they attack the myths:
"Fracking contaminates drinking water. One claim is that fracking creates cracks in rock formations that allow chemicals to leach into sources of fresh water. The problem with this argument is that the average shale formation is thousands of feet underground, while the average drinking well or aquifer is a few hundred feet deep. Separating the two is solid rock. This geological reality explains why EPA administrator Lisa Jackson, a determined enemy of fossil fuels, recently told Congress that there have been no "proven cases where the fracking process itself has affected water.""

"A second charge, based on a Duke University study, claims that fracking has polluted drinking water with methane gas. Methane is naturally occurring and isn't by itself harmful in drinking water, though it can explode at high concentrations. Duke authors Rob Jackson and Avner Vengosh have written that their research shows "the average methane concentration to be 17 times higher in water wells located within a kilometer of active drilling sites.""

"They failed to note that researchers sampled a mere 68 wells across Pennsylvania and New York—where more than 20,000 water wells are drilled annually. They had no baseline data and thus no way of knowing if methane concentrations were high prior to drilling. They also acknowledged that methane was detected in 85% of the wells they tested, regardless of drilling operations, and that they'd found no trace of fracking fluids in any wells."
There is "the possibility of leaky well casings at the top of a drilling site, from which methane might migrate to water supplies." "But the risks are not unique to fracking, which has provided no unusual evidence of contamination.."
"Fracking releases toxic or radioactive chemicals. The reality is that 99.5% of the fluid injected into fracture rock is water and sand. The chemicals range from the benign, such as citric acid (found in soda pop), to benzene.""

"...environmentalists charge that disposal sites also endanger drinking water, or that drillers deliberately discharge radioactive wastewater into streams. " but "Pennsylvania's tests showed radioactivity at or below normal levels."

"Fracking causes cancer. In Dish, Texas, Mayor Calvin Tillman caused a furor this year by announcing that he was quitting to move his sons away from "toxic" gases—such as cancer-causing benzene—from the town's 60 gas wells. State health officials investigated and determined that toxin levels in the majority of Dish residents were "similar to those measured in the general U.S. population." Residents with higher levels of benzene in their blood were smokers. (Cigarette smoke contains benzene.)"

"Shale exploration is unregulated. Environmentalists claim fracking was "exempted" in 2005 from the federal Safe Water Drinking Act, thanks to industry lobbying. In truth, all U.S. companies must abide by federal water laws, and what the greens are really saying is that fracking should be singled out for special and unprecedented EPA oversight.

Most drilling operations—including fracking—have long been regulated by the states.
Operators need permits to drill and are subject to inspections and reporting requirements. Many resource-rich states like Texas have detailed fracking rules, while states newer to drilling are developing these regulations."

Saturday, July 16, 2011

The Size Of The GSEs Role In The Credit Crisis

See GSE Fact of the Day by Greg Mankiw.
"From Peter Wallison (WSJ 7-12-11):
Edward Pinto (a former chief credit officer of Fannie Mae, and now a colleague at the American Enterprise Institute) presented the evidence to the commission showing that by 2008 half of all mortgages in the U.S. (27 million loans) were subprime or otherwise risky, and that 12 million of these loans were on the books of the GSEs."

A 90% Debt Burden Seems To Be A Key To Lower Future Growth And We Are Above That Now

See Reinhart and Rogoff on the Debt Problem by Greg Mankiw.
"They write:
In our study “Growth in a Time of Debt,” we found relatively little association between public liabilities and growth for debt levels of less than 90 percent of GDP. But burdens above 90 percent are associated with 1 percent lower median growth."

Deductions Reduce Tax Revenue About Twice As Much As In 1990

Spending Hidden in the Tax Code by Greg Mankiw.

Click here to see the graph

It shows in 1990 the tax code allowed $500 billion in deductions, like for interest on your mortgage. It looks like about $1 trillion now. Here is what Mankiw says:
"The blue line is total discretionary outlays of the federal government, and the brown line is the sum of tax expenditures. Both are in constant dollars. Note that these two categories of spending are about equal in magnitude. It is just as important to focus on stealth spending implemented through the tax code as on explicit spending."

How much did Fannie and Freddie cause the financial crisis?

Great post by Tyler Cowen of Marginal Revolution.
"1. It is not denied that the mortgage agencies were guaranteeing about half of all U.S. mortgages right before the crisis (Yet somehow they had not so much to do with the crisis?) And the crisis was not just about subprime. The mortgage market remains screwed up to this day, with no clear end in sight.

2. There is also the more ambitious claim — not necessarily true but not obviously dismissable either — that leverage would have been much, much lower in American real estate markets without the mortgage agencies. It is hard to judge such counterfactuals, but arguably lenders would have demanded more money down and offered fewer 30-year fixed rate mortgages.

3. Arnold Kling has a good response to the delinquency chart which is circulating.

4. Following the crisis, banks recovered and paid back virtually all of their bridge/bailout. The mortgage agencies remain hundreds of billions in the red. And yet the agencies had not much to do with the crisis?

5. It is wrong to suggest that the agencies caused the crisis in the sense that I will cause myself to eat breakfast cereal this morning. One can debate which weaker notion of cause might be appropriate, but I will just say that the mortgage agencies made the crisis much, much worse.

I don’t yet see that the counters to Wallison and Co. should budge me from this position. I would prefer that they start by acknowledging (or challenging) #1 and #4 and then trying to talk their way back to what they see as the truth. As it stands, I see a lot of “devalue and dismiss” being applied to the messengers, rather than focusing on what the agencies did or did not do in the broader scheme of things. From my quiet sofa seat in Fairfax, VA, it ain’t a pretty picture."

Friday, July 15, 2011

When it makes sense to talk of restoring “aggregate demand.”

See It’s the PSST, Stupid! by Don Boudreaux of "Cafe Hayek."
"Ultimately it’s an empircal question – or, rather, a series of empirical questions. The most germane of these questions is this two-part one:

Is the decline in demand for the outputs of many industries throughout the economy (1) chiefly the consequence of an increased demand for money, an increased demand (2) caused not by any structural mal-adjustments in the economy or by actual or anticipated destructive government policies but, instead, simply caused by an intensification of people’s desires to hold larger money balances?

If the answer to this question is “yes,” then the economy will indeed suffer a problem that can fairly be described as “inadequate aggregate demand.” A better term, though, is “excessive demand for money.”

As my great teacher, Leland Yeager, explained – for he is an able advocate of this “monetary disequilibrium” theory – because money “has no market of its own,” attempts by people to satisfy their demands to hold larger money balances have economy-wide repercussions in ways that people’s attempts to satisfy their demands to hold, say, larger inventories of apples do not.

Overlooking the important question of to what extent should consumption patterns, and patterns and techniques of production, in the “real” economy change as a result of people’s increased demand for money, we can nevertheless reasonably conclude that, ceteris paribus, a simple taste-driven increase in the demand for money does not imply that patterns of resource allocation, production plans, and consumption plans are seriously out of whack.

The microeconomic conditions in this scenario are, by assumption, healthy. All that must be done to avoid the negative external effects of each of us attempting to increase the real value of our money balances is for the nominal money supply to grow in order to accommodate this increased demand. (In a fairytale world, prices of all goods and services and inputs would all adjust in unison downward to achieve the same goal. But coordination problems make such price declines too unlikely to rely upon.)

In principle, increasing the supply of money will avoid the problem of inadequate aggregate demand. I say “in principle” because the practical problem of how to get the increased supply of money into the market is real, although typically overlooked.

If the central bank simply injects this new money, (1) how do the central bankers know how much to inject? and (2) how do they avoid what Hayek called “injection effects”? [The new money must enter somewhere, at least potentially distorting relative prices and then causing genuine resource misallocations and malinvestments.] Indeed, how do central bankers know (with reasonable-enough certainty) that the observed declines in demands-for-output economy-wide are in fact the result of a taste-driven increase in the demand to hold larger money balances rather than a reflection of serious microeconomic misallocations and malinvestments, or of greater concerns that government’s economic policies have taken a turn for the worse?

So back to my starting claim that it’s an empirical question. Only if the above conditions – along with some other, smaller and not-worth-mentioning conditions – hold true does it make sense to talk of restoring “aggregate demand.”

But if the decline in GDP growth and in the rate of employment are caused, not by a taste-driven increase in the demand for money but, instead, by a large enough disruption in what Arnold Kling calls “patterns of sustainable specialization and trade,” then kicking up aggregate demand won’t solve the problem. Neither kicking it up, or trying to, through monetary policy or through fiscal policy will work. The problem is not originally one of widespread inadequate demand. In this case, inadequate aggregate demand is a symptom; treating the symptom will not cure the disease and, indeed, will only worsen it.

Without venturing here an opinion on the underlying source of each and every recession throughout American history, I will express an opinion about the current recession: it is clearly the result of distorting government policies, regulatory and monetary, leading up to 2008 as well as of the symptom-treating policies since then that only worsen matters. (And not to mention yet other actual and threatened policies – e.g., Obamacare - that distort microeconomic patterns of sustainable specialization and trade.)

Curing the current recession simply with more money or more stimulus spending is as likely to restore the U.S. economy to health as would dumping more money on Chadians, and raising government spending in Chad, to start that nation on the path to genuine economic growth."

Did We Have Austerity or Prosperity In WWII And Was Rationing A Factor?

See Austerity or prosperity? by Russ Roberts at "Cafe Hayek."
"When you ask Keynesians for empirical evidence of how government spending creates prosperity, their best and most frequently cited answer is how World War II ended the Depression–a massive, increase in deficit-financed government spending. But as Robert Higgs has pointed out, the sharp decrease in unemployment that resulted was not due to the magic of some Keynesian multiplier but rather from conscription—forcing Americans into the Army. Higgs also argues that the increase in GDP is distorted by the challenge of measuring the value of government output–does the price of a tank commissioned under government contract represent value the way the price of a car does?—and price controls–some things were cheap but they were not freely available.

I use a more anecdotal but perhaps more persuasive argument. There was no wartime prosperity in the US or the UK or Germany. No one who lived through those times remembers them as a time of booming economic activity. It was a time of hardship and privation unless you were in the business of making tanks or bombs or bullets. There was no Keynesian multiplier. A dollar of spending on a tank didn’t “stimulate” the private economy. A dollar of government spending didn’t create $1.52 worth of economic output. More tanks meant fewer cars because steel became more expensive and workers did too. And there were fewer resources available for private use.

When I mentioned this to my collaborator John Papola, he pointed me to this post by Paul Krugman that dismissed my argument. Krugman was reacting to this post by Bob Hall and Susan Woodward that made a similar observation to mine arguing that spending in WWII increased GDP by roughly the amount of the spending. There was no stimulative effect. Hall and Woodford don’t argue for a negative effect–here the Higgs argument about measurement is relevant. But they do argue there was no positive effect on the rest of the economy.

But Krugman wants to argue that the Keynesian multiplier was alive and well. He has a two word response to Hall and Woodward (and presumably to my argument as well):
Um, rationing?

He then quotes from a U.S history web site:
With the onset of World War II, numerous challenges confronted the American people. The government found it necessary to ration food, gas, and even clothing during that time. Americans were asked to conserve on everything. With not a single person unaffected by the war, rationing meant sacrifices for all
Help me out here folks. I and others argue that government spending in WWII—a giant spike in government spending financed by debt—did not create prosperity and economic recovery. It created hardship because you can’t eat bombs, you can’t wear tanks, and you can’t sweeten your coffee with bullets. And Krugman, who is a trained economist with a Nobel Prize argues that we’re wrong. It wasn’t crowding out or a failure of the Keynesian multiplier. The reason we’re wrong is that the US government forced people to get by with less because of a government program called rationing. He appears to be arguing that if it weren’t for rationing, then we would have seen the Keynesian multiplier in all its glory. What the heck is he talking about? Does he think the rationing is what produced scarcity rather then being a response to scarcity?

One of the most mindless aspects of the multiplier is to treat is as a constant, such as 1.52. It can’t be a constant, not in any meaningful way. If the government conscripted half of the US population to dig holes all day and conscripted the other half to fill them back in, and paid each of us a billion dollars a day for the task, and valued holes that were dug and holes that were filled in at a trillion dollars a hole, then GDP would be very very large, unemployment would be zero and there would be no stimulating effect and we would soon be dead from starvation. (I ignore the staffing challenge of forcing people to do their tasks.)

The fact that WWII did not stimulate the private sector does not prove that Keynesianism always fails. Maybe a smaller army and fewer tanks would have done the trick. But it certainly does not prove that it was a success. It was not a success. It did not stimulate the private sector. It did not create an extra 50 cents or two dollars on top of the original expenditure as the recipients of government contracts and their workers had more money to spend. It starved the private sector. It was a failure as an example of Keynesian stimulus."

Keynes vs. Reality-2

Great post by Russ Roberts at Cafe Hayek.
"In this earlier post, I noted this 1943 Paul Samuelson prediction:
When this war comes to an end, more than one out of every two workers will depend directly or indirectly upon military orders. We shall have some 10 million service men to throw on the labor market. We shall have to face a difficult reconversion period during which current goods cannot be produced and layoffs may be great. Nor will the technical necessity for reconversion necessarily generate much investment outlay in the critical period under discussion whatever its later potentialities. The final conclusion to be drawn from our experience at the end of the last war is inescapable–were the war to end suddenly within the next 6 months, were we again planning to wind up our war effort in the greatest haste, to demobilize our armed forces, to liquidate price controls, to shift from astronomical deficits to even the large deficits of the thirties–then there would be ushered in the greatest period of unemployment and industrial dislocation which any economy has ever faced.

From Paul Samuelson, “Full Employment after the War,” in S.E. Harris, ed., Postwar Economic Problems, 1943.
Samuelson was wrong. When the war ended, there was massive demobilization of the armed forces and a large reduction in government spending. Yet the economy thrived, unemployment remained very low and there was a huge expansion of private sector employment.

One defense of Samuelson is that this quote is mainly about the dynamics of the labor market–it doesn’t say much about aggregate demand. It doesn’t focus particularly on the drop in government spending. But if you go back to the original article (which you can find by taking a line or two and using Google books–I hope to post more on this later) you will find other passages that make it clear that he saw this as a problem caused by a sudden drop in aggregate demand.

There were a number of interesting comments on the post. Some noted the drop in GDP after the war but forgot that wartime price controls and large amounts of government output made measuring of GDP during the war quite difficult. There was a mild recession in 1945–during the war. The most dramatic change was the one I highlighted–a large expansion of private sector employment with very little unemployment. It was an incredible transition achieved with surprising speed.

I’d like to highlight one comment by Daniel Kuehn:
Samuelson was wrong in forecasting. Keynes wasn’t wrong in theorizing.

Why did Samuelson end up being wrong? Have you ever thought that through?

Because post-war demand was substantial and he didn’t expect that.

High levels of private sector demand and a full employment economy… where the hell do you get “Keynes vs. Reality” from that? That has Keynes written all over it.

All you’re demonstrating is that Samuelson didn’t have a crystal ball. That isn’t exactly a news flash.
This defense of Keynes unintentionally highlights a flaw in Keynesianism at least as practiced by Daniel but I don’t think he’s alone or I wouldn’t single him out. (And I would add that I usually appreciate Daniel’s comments, particularly their tone in the face of criticism from the rest of you.) One, would an economist presume that a change in government spending would have no effects on other types of spending? If government spending shrinks and there is suddenly more resources available to the private sector, why would you not foresee a change in private sector spending? Secondly, the fact that full employment corresponds to high levels of spending (regardless of their source) is very close to a tautology. The challenge is to understand causal linkages and the direction of causation.

In the last few sentences of the previous paragraphs, I had originally referred to private demand. I changed it to private spending. I don’t know what private aggregate demand means, or the phrase “pent-up” demand. The usual way that Keynesians explain the post-war expansion despite the huge cut in government spending is to say, well of course the economy boomed, there was a lot of pent-up demand. What does that mean? There is always pent-up demand in the sense there is a stuff I wish I could have but can’t. But the standard story is that people couldn’t buy washing machines or cars during the war–they were rationed or simply unavailable or unaffordable. So when the war ended, and rationing and price controls ended, people were eager to buy these things. But the reason these consumer goods were rationed or unavailable is because all the steel went into the tanks and planes during the war. So when the war ended, there was steel available to the private sector. That’s why cutting government activity can stimulate the private sector. Fewer resources are being commandeered by the public sector. As the Hayek character says in the Fight of the Century when answering the Keynesian claim that WWII ended the Great Depression:
Wow. One data point and you’re jumping for joy
the Last time I checked, wars only destroy
There was no multiplier, consumption just shrank
As we used scarce resources for every new tank

Pretty perverse to call that prosperity
Rationed meat, Rationed butter… a life of austerity
When that war spending ended your friends cried disaster
yet the economy thrived and grew faster

This earlier post where I discuss Krugman’s claims about rationing and the austerity of the early 1940′s may also be of interest."

Arnold Kling On The Role Fannie Mae And Freddie Mac Played In The Mortgage Crisis

See Mortgage Loans with Low and High Risk at EconLog.
"David Min criticizes the analysis of Peter Wallison and Ed Pinto of the role played by Freddie Mac and Fannie Mae in the housing bubble. (Pointer from Mark Thoma.)

The centerpiece of Min's critique is a chart that shows the serious delinquency rate for four categories of loans:

Subprime 28.3 %
Freddie 620-650 credit score: 10.04
Freddie over 90% loan-to-value ratio: 8.45%
Conforming: 6.8 %

Min's point is that the middle two categories, which Pinto classifies as high risk, seem to perform about as well as conforming loans. Therefore, it is wrong to classify them as high risk.

I am not sure what to make of this. The 6.8 percent serious delinquency rate on the conforming loans is horrible. The way Min breaks down the loan categories, every category is high risk.

If I were doing this work, I would try to find categories of loans for which the serious delinquency rate is under 1 percent. Now, they might be loans with loan-to-value ratios under 70 and FICO scores over 720, and only loans to purchase an owner-occupied home or refinance it to reduce the interest rate (in other words, no second mortgages, investment properties, or cash-out refis). I have no idea. But when I was with Freddie Mac in the late 1980's and early 1990's, we would not have said we were happy with a portfolio of loans with a serious delinquency rate anywhere near 6.8 percent, under any scenario.

If my view is correct, then Wallison and Pinto probably understate the shift toward high-risk lending that took place at Freddie and Fannie between, say, 1990 and 2007. By the same token, the extent to which this shift can be attributed to trying to meet affordable housing goals is overstated.

I feel pretty confident in arguing that Freddie and Fannie could have stopped the housing bubble by holding onto their credit standards of the early 1990's. However, I would not be comfortable attributing their relaxation of credit standards to the affordable housing goals. I think that the management attitude toward risk changed exogenously. In part, this was due to new CEO's with less experience in dealing with mortgage credit risk. As home prices rose, all sorts of high-risk loans performed well, and senior management misread this to indicate that it was safe to lower credit standards. Certainly, the political environment reinforced that decision. But the numerical affordable housing goals were not the dominant factor."

Evidence Suggesting Right To Work States Get Better Results

See Letter on Right-to-Work Laws by E. Frank Stephenson of the "Division of Labor" blog.
"Here's a recent submission to the WSJ--since it was responding to a letter published in May, I suspect I sent it in too late for it to be published.
In his May 25 letter (“Right to Work Doesn’t Drive Growth”), Gordon Lafer argues that confounding factors such as climate make it difficult to isolate the effect that right-to-work laws have on economic activity.
Fortunately a paper by economist Thomas J. Holmes published in the prestigious Journal of Political Economy examines the effect of right-to-work laws on economic activity by comparing counties lying on the boundary between states with compulsory unionization (e.g., Kentucky) and those with right-to-work laws (e.g., Tennessee). Climate and other geographically determined factors should not cause abrupt changes in economic activity at state borders; thus, observed changes in would point toward right-to-work laws or other policies as the crucial differences in economic activity.

In his paper Prof. Holmes finds large differences in manufacturing employment on opposite sides of state borders. Manufacturing’s share of employment falls by 5.8 percentage points when going from a right-to-work state to a compulsory unionization state. Moreover, manufacturing employment growth over the 1947-1992 period was 27 percentage points higher in right-to-work states than in compulsory unionization states. So, contra Mr. Lafers’s assertion, right-to-work laws are associated with large differences in economic activity."

Ethanol Now Consumes More Corn Than For Animal Feed for First Time, Corn Prices Reach Record High

Great post by Mark Perry of "Carpe Diem."
"Financial Times -- "U.S. ethanol refiners are consuming more domestic corn than livestock and poultry farmers for the first time, underscoring how a government-supported biofuels industry has contributed to surging grain demand.

The U.S. Department of Agriculture estimated that in the year to August 31 ethanol producers will have consumed 5.05 billion bushels of corn, or more than 40% of last year’s harvest. Animal feed and residual demand accounted for 5 billion bushels.""

He has a chart which shows that the price of a bushel of corn has risen from about $2 at the start of 2005 to over $6 now.

Markets in Everything and Antidote to Obamacare: 24/7 Access to MD Consultations via Phone/Video

Great post by Mark Perry of "Carpe Diem."
"From the Teladoc website:

1. You wake up one morning with sudden cold-like symptoms: stuffy nose, cough, congestion. You don’t want to miss time at work by sitting in an urgent care or ER waiting room. What to do?

2. Simply log in to your account or call 1-800-Teladoc to request a phone or online video consultation with a Teladoc doctor. You can use Teladoc from home, work, on vacation, or while traveling internationally. The average doctor call back time is 22 minutes.

3. A U.S. board-certified doctor or pediatrician licensed in your state reviews your Electronic Health Record (EHR), then contacts you, listens to your concerns and asks questions. It's just like an in-person consultation. There is no time limit to the consult.

4. The doctor recommends the right treatment for your medical issue. If a prescription is necessary, it's sent to the pharmacy of your choice.

5. Teladoc costs far less than in-person visits: $38 or lower, depending on your plan design. Teladoc charges the credit card you provided when requesting your consultation or your billing information on file. You can request a receipt for deductibles or reimbursement, if needed. The doctor updates your HIPAA-compliant EHR based upon the consultation. Teladoc is a qualified expense for HSA, FSA and HRA accounts.

From the Teladoc website:

1. You wake up one morning with sudden cold-like symptoms: stuffy nose, cough, congestion. You don’t want to miss time at work by sitting in an urgent care or ER waiting room. What to do?

2. Simply log in to your account or call 1-800-Teladoc to request a phone or online video consultation with a Teladoc doctor. You can use Teladoc from home, work, on vacation, or while traveling internationally. The average doctor call back time is 22 minutes.

3. A U.S. board-certified doctor or pediatrician licensed in your state reviews your Electronic Health Record (EHR), then contacts you, listens to your concerns and asks questions. It's just like an in-person consultation. There is no time limit to the consult.

4. The doctor recommends the right treatment for your medical issue. If a prescription is necessary, it's sent to the pharmacy of your choice.

5. Teladoc costs far less than in-person visits: $38 or lower, depending on your plan design. Teladoc charges the credit card you provided when requesting your consultation or your billing information on file. You can request a receipt for deductibles or reimbursement, if needed. The doctor updates your HIPAA-compliant EHR based upon the consultation. Teladoc is a qualified expense for HSA, FSA and HRA accounts.

MP: Another example of market-based, consumer-driven, convenient and affordable health care delivery as an alternative to government-managed Obamacare."

Monday, July 11, 2011

A Market Solution To High Health Care Costs

See Markets in Everything and Antidote to Obamacare: On-Site Modern, Full-Service Medical Clinics by Mark Perry of "Carpe Diem."
"LA Times -- "Major employers across the country, eager to curb fast-rising healthcare costs, are opening their own state-of-the-art health centers where doctors and nurses provide medical care to workers often just steps from their desks.

The cost-cutting strategy has been embraced by dozens of companies — typically large employers that are self-insured and pay their own medical claims, including Walt Disney Co., Qualcomm Inc. and American Express Co.

Many of the health centers are full-service medical offices equipped with exam rooms, X-ray machines and pharmacies. Some provide on-site appointments with dentists, dermatologists, psychiatrists and other specialists who treat life-threatening illnesses.

Executives say providing in-house medical care keeps workers healthy and productive. But the clinics also help the bottom line by reducing absenteeism and slashing employers' medical bills for outside doctors and emergency rooms.""

Saturday, July 9, 2011

Problems With Nudging Or The New Paternalism

See New Paternalist Surprises by David Boaz of Cato.
"The front pages of Thursday’s Wall Street Journal and Washington Post (links below) both featured stories on the unexpected consequences of the sort of “nudging” policies recommended by so-called “libertarian paternalists.” Mario Rizzo, an economist at New York University who often blogs at ThinkMarkets, sent along this commentary to share with C@L readers:
As Glen Whitman and I have repeatedly argued, new paternalism faces a knowledge problem similar to that uncovered by F.A. Hayek in his critique of socialist calculation. In our view, paternalists cannot acquire the knowledge they need to implement policies that are effective according to their own standards.

The new paternalism purports to nudge people toward the better satisfaction of their own preferences than people can achieve themselves. We are too ignorant, too weak-willed, and computationally too incompetent to satisfy our real or underlying preferences. We save too little for our retirement because we are overly impatient and cannot postpone spending. We eat too many calories because we underweight the costs of future illness due to obesity.

The new paternalists thought they had at least a partial solution to the first problem of undersaving. For those people who have employer-sponsored retirement savings programs we can use a common “defect” in decisionmaking to help them out. People are prone to status-quo bias, that is, they tend to leave in place whatever situation they may find themselves in. So when employees are automatically enrolled in retirement savings unless they opt out, more people are enrolled than when the default is non-enrollment unless they opt in. What could be simpler? Make the default automatic enrollment, and voila more retirement savings!

Now comes the annoying data.

According to a recent study commissioned by the Wall Street Journal more people are indeed enrolled in 401k programs as predicted. However, those who would have chosen enrollment under the old opt-in system (around 40% of new workers) tended to remain in a lower salary allocation in the default (frequently 3%) than they would have chosen on their own. So instead of using the status-quo bias to increase savings it turned out that the automatic enrollment decreased savings among this group.

What was the result overall? Savings in these plans have gone down. Vanguard estimates that half the decrease in 401k savings rates in its plans from 7.3% in 2006 to 6.8% in 2010 was due to automatic enrollment. Of course, this was not entirely unexpected, as Whitman and I pointed out in our 2009 law review article.

Moving on to obesity. Mandatory posting of the caloric content of food in chain restaurants has been another new paternalist light-touch intervention in the market. Although restaurants are coerced, consumers are simply given information. With the calorie-postings staring at people at the moment of sale it was thought that many people would cut down on calorie consumption. An article in Thursday’s Washington Post indicates that the local laws mandating calorie-postings have not had the desired effect. Instead of concluding that perhaps people simply value the pleasure of caloric food more than the projected negative consequences, paternalists conclude that a stronger policy may be necessary. Many of them stand ready to impose a heavier touch: an excise tax on “junk food.

Each of these cases illustrates the same problem. Trying to determine what people’s true or underlying preferences are (Do they want more 401k savings? Do they want to reduce calorie consumption? Do they want to incur the opportunity costs of each?) is more difficult than it may seem at first. Trying to engineer the appropriate response from individuals requires a detailed knowledge of the interaction of many conflicting incentives. New paternalists do not take seriously the very biases literature they often cite. For one thing they choose to analyze only one — or perhaps two — biases at a time. The reality is one of many conflicting complex-interacting biases. Biases are also very context-dependent and so they may vary in direction and quantitative magnitude from case to case and from year to year.

The moral of the story: Expect more surprises and unintended consequences from new paternalist policies."

Here is a letter to the editor of the Chronicle of Higher Education I write that got printed.

“I enjoyed Evan R. Goldstein’s “The New Paternalism” (The Chronicle Review, May 9) about Richard H. Thaler and Cass R. Sunstein, authors of Nudge. Who could disagree that “human perception is flawed,” or that we all have “cognitive limitations”? This suggests enacting policies that “nudge” people in the right direction.

But it seems like a straw man is being used when Thaler and Sunstein say that policy makers previously assumed that all people can think like Albert Einstein and can exercise the patience of Mahatma Gandhi. Surely no neoclassical economist would believe that. Even Milton Friedman, in Capitalism and Freedom, said that “there is no avoiding the need for some measure of paternalism.” But he also said that the principle that “some shall decide for others” is very troubling and that “there is no formula that can tell us where to stop.”

Coincidentally, Alan Wolfe summarized John Stuart Mill’s view in the same issue: “The purpose of liberty is not to give us what we want but to help us grow so that we can best understand our wants” (“The Forgotten Philosopher,” The Chronicle Review). Let us hope that the “new paternalism” does not end up stifling such human growth. In understanding our wants, we get to know ourselves. If someone else is always nudging us in the right direction, we will never figure anything out on our own.”

Cigarette Taxes Don't Usually Generate The Expected Revenue

See Minnesota's Misguided Cigarette Tax by Anthony Randazzo & Carson Bruno of Reason. Excerpt:
"Even if the proposed tax were accepted and the budget passed in Minnesota, the state could be right back where it started within just a few months. Additional revenue from Gov. Pawlenty’s 2005 tax increase was estimated to generate $174 million per year, but Minnesota's cigarette tax revenue has only increased by an average of $4 million per year—a paltry 2.72 percent of the estimate.

And Minnesota isn’t alone: A 2008 Maryland cigarette tax increase only yielded 50 percent of projected additional revenue while cigarette tax revenue in Illinois has decreased by $69 million since 2007. Overall, only 30 percent of cigarette tax increases between 2003 and 2007 have met revenue projections—not a record on which to stake a state’s future. No matter what projected additional revenue Gov. Dayton thinks a $1 per pack cigarette tax increase will yield, it will most likely not come to fruition as regular smokers go elsewhere to purchase their cigarettes and causal users cut back.

When New York raised its cigarette tax in 2010, neighboring counties in Vermont and Pennsylvania saw an increase in cigarette sales of between 17 and 30 percent. This is because while increases such as Gov. Dayton’s proposal—which would raise the total tax per pack to $2.23 in Minnesota—are not enough to impact consumption, they are enough to drive smokers to shop out of state. New Yorkers simply took a little trek across the state border to save a few dollars. Those few dollars add up over time.

Minnesotans might do the same, traveling to the Dakotas or Iowa where tax rates on cigarettes are much lower. And the current rate in Minnesota is already three times North Dakota’s rate.

More damningly, the “Land of 10,000 Lakes” would lose revenue from cross border purchases from Wisconsin, where a $2.52 tax rate on cigarettes drives business away. The lost consumer traffic and subsequent depleted tax revenue would not be good for Minnesotan businesses or the state's budget shortfall.

States with high cigarette taxes tend to be more fiscally irresponsible than others. Of the top 10 highest cigarette taxing states, six received a C+ or worse in the most recent Pew Center Money Performance rating, which examines a state’s fiscal responsibility. The correlation is typically because increasing cigarette taxes is often a last resort when real fiscal responsibility has been eschewed."

Friday, July 8, 2011

Kenneth Rogoff on why rising inequality may be self-correcting

Hat tip to Greg Mankiw. See Technology and Inequality. I don't agree with one of the last things he says about progressive taxation. Excerpt:
"Expert computer systems are also gaining traction in medicine, law, finance, and even entertainment. Given these developments, there is every reason to believe that technological innovation will lead ultimately to commoditization of many skills that now seem very precious and unique.

My Harvard colleague Kenneth Froot and I once studied the relative price movements of a number of goods over a 700-year period. To our surprise, we found that the relative prices of grains, metals, and many other basic goods tended to revert to a central mean tendency over sufficiently long periods. We conjectured that even though random discoveries, weather events, and technologies might dramatically shift relative values for certain periods, the resulting price differentials would create incentives for innovators to concentrate more attention on goods whose prices had risen dramatically.

Of course, people are not goods, but the same principles apply. As skilled labor becomes increasingly expensive relative to unskilled labor, firms and businesses have a greater incentive to find ways to “cheat” by using substitutes for high-price inputs. The shift might take many decades, but it also might come much faster as artificial intelligence fuels the next wave of innovation.

Perhaps skilled workers will try to band together to get governments to pass laws and regulations making it more difficult for firms to make their jobs obsolete. But if the global trading system remains open to competition, skilled workers’ ability to forestall labor-saving technology indefinitely should prove little more successful than such attempts by unskilled workers in the past.

The next generation of technological advances could also promote greater income equality by leveling the playing field in education. Currently, educational resources – particularly tertiary educational resources (university) – in many poorer countries are severely limited relative to wealthy countries, and, so far, the Internet and computers have exacerbated the differences.

But it does not have to be that way. Surely, higher education will eventually be hit by the same kind of sweeping wave of technology that has flattened the automobile and media industries, among others. If the commoditization of education eventually extends to at least lower-level college courses, the impact on income inequality could be profound.

Many commentators seem to believe that the growing gap between rich and poor is an inevitable byproduct of increasing globalization and technology. In their view, governments will need to intervene radically in markets to restore social balance.

I disagree. Yes, we need genuinely progressive tax systems, respect for workers’ rights, and generous aid policies on the part of rich countries. But the past is not necessarily prologue: given the remarkable flexibility of market forces, it would be foolish, if not dangerous, to infer rising inequality in relative incomes in the coming decades by extrapolating from recent trends."

Does Economic Growth Decline As Government Grows?

See Government size and economic growth at Marginal Revolution.
"I thought the new paper by Andreas Bergh and Magnus Henrekson was both useful and wise:
The literature on the relationship between the size of government and economic growth is full of seemingly contradictory findings. This conflict is largely explained by variations in definitions and the countries studied. An alternative approach – of limiting the focus to studies of the relationship in rich countries, measuring government size as total taxes or total expenditure relative to GDP and relying on panel data estimations with variation over time – reveals a more consistent picture. The most recent studies find a significant negative correlation: An increase in government size by 10 percentage points is associated with a 0.5 to 1 percent lower annual growth rate. We discuss efforts to make sense of this correlation, and note several pitfalls involved in giving it a causal interpretation. Against this background, we discuss two explanations of why several countries with high taxes seem able to enjoy above average growth: (i) that countries with higher social trust levels are able to develop larger government sectors without harming the economy, and (ii) that countries with large governments compensate for high taxes and spending by implementing market-friendly policies in other areas. Both explanations are supported by current research."

Why Pensions are Underfunded

Great post by Megan McArdle.
"This table uses after inflation numbers, which makes the returns appear small. In reality, CalPERS, CalSTRS, and most other pension funds, project a long-term rate of inflation of 3.0%. This means that the nearly best case scenarios here, 7.5% before inflation (showing as 4.5% after inflation on the table), are representative of the current official long-term projections used by most pension funds. Based on the official rates of projected returns for pension fund investments, a 30 year veteran, retiring on a "3.0% at 50″ pension, will collect 90% of their salary in retirement, and they will need to contribute 32.5% of their pay into their pension fund every year they work. On that basis, 9% is less than one-third what will be necessary to fund their retirement pension. But what if the pension funds return less than 4.5% (7.5% before inflation) per year?

As can be seen, for every 1.0% the real rate of return drops, the required contribution increases by over 10%. That is, if CalPERS can only deliver a 6.5% return (3.5% after inflation), the contribution goes up from 32.5% of salary to 43.4% of salary. If CalPERS rate of return goes down to a 5.5% return (2.5% after inflation), the contribution goes up from 32.5% of salary to 57.9% of salary."

Thursday, July 7, 2011

Possible Ethical Problems In Health Care Reform And A Capitalist Twist To John Rawls

See John Goodman Hits a Home Run by David Henderson of EconLog.
"On his health policy blog this morning, John Goodman asks whether there's a moral case for the Affordable Care Act. The whole thing is worth reading. Some excerpts:
Search the world's ethical codes and you will have a hard time finding any that are consistent with a health reform that:
Gives people in health insurance exchanges up to 10 times as much federal subsidy as people at the same income level getting insurance at work.
Forces young people to pay two or three times the real cost of their insurance in order to subsidize older people who have more income and more assets.
Takes from low-income seniors in order to provide subsidized health insurance for non-seniors who have higher incomes.
Takes from people who use tanning salons and people who need crutches and wheelchairs and pacemakers and gives to ... well .... who knows?

One's first thought might be to point to the late John Rawls, author of A Theory of Justice, right? Goodman thinks of that. He writes:
Some might point to John Rawls and his theory of justice. Because of a quirky assumption, Rawls concludes that a just society is one organized to maximize the wellbeing of the least well off. As an economist, I can assure you that doesn't mean socialism. In fact, if you consider the least well off indefinitely into the future (and it's impossible to justify excluding them), Rawls' theory implies an extreme form of capitalism -- one that maximizes economic growth. Minus the quirky assumption, Rawls' theory implies garden variety utilitarianism of the type embedded in neoclassical welfare economics."

Vote Buying--It Works!

Great post at Division of Labor.
"From the abstract of a paper in the AEJ: Applied:
This paper estimates the impact of a large anti-poverty cash transfer program, the Uruguayan PANES, on political support for the government that implemented it. Using the discontinuity in program assignment based on a pretreatment eligibility score, we find that beneficiary households are 11 to 13 percentage points more likely to favor the current government relative to the previous government. Political support effects persist after the program ends."

A Possible Example Of The IPCC Distorting Global Warming Research

See A fat tale by Matt Ridley.
"As most people know, I am a lukewarmer -- somebody who accepts carbon dioxide's full greenhouse potential, but does not accept the much more dubious evidence for net positive feedbacks on top, and who therefore thinks that a temperatuire rise of more than 2C in this century is unlikely.

This view just got a strong boost. Nic Lewis, the indefatigable mathematical sleuth who helped expose the mistakes in a paper about Antarctic temperature trends has been looking at how the IPCC estimates climate sensitivity -- that is, the warming expected for a doubling of CO2. He finds that the one study that estimated sensitivity entirely from experimental data -- Forster and Gregory 2006 -- was distoted by the IPCC when it came to present their results. The distortion was the imposition of a Bayesian "uniform prior" in a way that statisticians say is wholly inappropriate, because it effectively assumes a priori that strong warming is more probable than it is. Yet you don't even have to know that the use is inappropriate to know that it's inappropriate to take a published result and alter the graph from it, adding an obscure footnote to say you have done so. A published result is a published result.

The effect was to fatten the tail of the graph, making a warming of more than 2C look much more probable.

I defy you to look at that graph -- the green one -- and tell me that a temperature rise oif more than 2C is not "unlikely" according to that study. I defy you to look at the graph -- the blue one -- and not conclude that whoever drew it had better have a very good argument for fattening the tail compared with what the authors had originally published.

NIc has found that the IPCC did much the same to most of the other estimates of climate sensitivity, which rely mostly on models. This mistake is central to the IPCC's case, not peripheral. It undermines the credibility of the case for urgent action against climate change and strongly supports the argument that, other things being equal, CO2 doubling will not cause more than a mild and net beneficial warming.

Here's Nic's first paragraph:

The IPCC Fourth Assessment Report of 2007 (AR4) contained various errors, including the well publicised overestimate of the speed at which Himalayan glaciers would melt. However, the IPCC’s defenders point out that such errors were inadvertent and inconsequential: they did not undermine the scientific basis of AR4. Here I demonstrate an error in the core scientific report (WGI) that came about through the IPCC’s alteration of a peer-reviewed result. This error is highly consequential, since it involves the only instrumental evidence that is climate-model independent cited by the IPCC as to the probability distribution of climate sensitivity, and it substantially increases the apparent risk of high warming from increases in CO2 concentration."

Wednesday, July 6, 2011

Economic Freedom Extends Life Expectancy

See Economic Freedom Extends Life Expectancy by Mark Perry of "Carpe Diem."

"Following my recent post on life expectancy and economic growth in Chile, here's a more comprehensive analysis in the chart above of the relationship between: a) economic freedom measured by the Heritage Foundation, on a scale from 1 (repressed) to 100 (free), and b) life expectancy for 176 countries in 2009.

The regression line in the chart above shows a clear and positive relationship between economic freedom and life expectancy, with higher levels of economic freedom being associated with longer life expectancies. Specifically, from the regression equation we can say that every 10 point increase in the economic freedom index is associated with a 4.6 year increase in life expectancy.

Bottom Line: As Larry Kudlow reminds us all the time, "Free market capitalism is the best path to prosperity," and I'll add "the best path to a longer life." There's nothing more precious than human life, and the evidence shows that economic freedom will sustain, nurture, conserve and extend human life, while economic repression does the opposite: it stifles and squashes the human spirit and shortens life expectancy."

From 1979-2007: Rich Got Richer, Poor Got Richer

See Challenging the Middle Class Stagnation Myth: From 1979-2007: Rich Got Richer, Poor Got Richer by Mark Perry of "Carpe Diem."

"It’s a familiar and frequently-told narrative that middle-class incomes have stagnated over the last several generations while the upper-income groups have gotten richer. President Obama has promoted this stagnation narrative by claiming in 2009 that “For many years, middle class Americans have been working harder, yet not enjoying their fair share of the fruits of a growing economy.”

But a new working paper titled “A "Second Opinion" on the Economic Health of the American Middle Class” by NBER and Cornell researchers provides new evidence that the popular narrative is largely mistaken. By taking into account previously unmeasured shifts in household size and the tax units in them, taxes paid, transfer payments received, and the increasing importance of fringe benefits, the researchers find that the growth in after-tax household income has been substantial not only for the middle class, but for all income quintiles over the last thirty years.

From the paper:

“The median pre-tax pre-transfer income of all tax units (filers and non-filers) only increased by 3.2% in real terms over the entire period between 1979 and 2007. These results are consistent with the view that the typical American has not gained much from economic growth over the last 30 years.

But when we broaden the sharing unit to the household, account for economies of scale in household consumption, and recognize that the payment of taxes or the receipt of tax credits as well as government transfer income and in-kind benefits all impact the economic resources available to individuals, we find the story changes. Specifically, when using our broadest measure of available resources—post-tax, post-transfer size-adjusted household income including the ex-ante value of in-kind health insurance benefits—median income growth of individual Americans improves to 36.7% over the period from 1979 and 2007.

The table above illustrates the change in income for each income quintile over the entire 29 year period. Importantly, in contrast to tax unit market income measures of income where the bottom two quintiles get poorer (first column of data) and only the top quintile gets noticeably richer, each of the other series shows income growth throughout the distribution. Once taxes and health insurance are taken into account, each of the quintiles of the distribution are shown to have sizable growth over the 29 year period - with the slowest growth being a 26.4% increase in mean incomes for the bottom quintile of the distribution (last column). Growth in the middle quintile is 36.9%, dramatically greater than their 2.2% growth in private market income when measured at the tax unit level."

Conclusion: "These more inclusive measures of access to economic resources suggest that income inequality increased in the United States not because the rich got richer, the poor got poorer and the middle class stagnated, but because the rich got richer at a faster rate than the middle and poorer quintiles and this mostly occurred in the 1980s. Growth was substantial in all quintiles once the influence of government tax and transfer policy as well as the shift in compensation from wages to health insurance provided by employers and the shift to increased in-kind health insurance by government is more full recognized.""

More On The Problems With The Auto Bailout

See Driving to Delusionville: Obama’s former auto czar is in deep denial about the government’s failed bailout by Shikha Dalmia of Reason. Excerpt:
"For starters, many experts suspect that at least GM could have obtained private bankruptcy financing if it had presented a credible restructuring plan addressing the cause of its malaise: the uncompetitive costs of its unionized work force. If it couldn’t, then the government could have offered guarantees to private lenders for the amounts they loaned, which likely would have been smaller than the bailout.

But the administration took matters in its own hands, using taxpayer dollars to commandeer the bankruptcy process to protect key constituencies, while giving short shrift to others. It gave Chrysler’s secured creditors, who would have had priority in a normal bankruptcy, 29 cents on the dollar. Chrysler’s unions, on the other hand, got more than 40 cents, even though they are equivalent to low-priority lenders. This made a mockery of longstanding bankruptcy law, something that will make credit markets wary of lending to political sacred cows in the future.

The administration favored union workers not only over creditors, but also other workers. All United Auto Workers retirees at Delphi, GM’s auto supplier, got 100 percent of their pension and retirement benefits. But 21,000 nonunion, salaried employees lost up to 70 percent of their pensions, and all of their life and health insurance. The Treasury could have covered 93 percent of the benefits of all employees for the same funds it spent on full union benefits, testified Bruce Gump, a representative of the Delphi Salaried Retirees Association.

Even for GM and Chrysler, the bailout constitutes a missed opportunity, not a second chance. They didn’t get nearly the kind of relief from labor costs that they would have in a normal bankruptcy. Not only are they on the hook for most of their legacy costs, they still pay union workers $58 per hour including benefits. This wouldn’t be so bad if Toyota, whose costs are $56 per hour, were setting the industry’s cost curve. But that’s no longer the case. Hyundai and Kia, with $40-an-hour costs, do that. The bailout prepared GM and Chrysler to compete with the industry leaders of yesterday, not tomorrow.

Absent the bailout, these companies would have survived, but they would have looked very different. They might have merged into one, pooling resources and slashing excess capacity from the industry. Alternatively, entrepreneurs might have purchased their more viable brands and run them as independent companies, breaking up the industry’s big vertically-integrated players into myriad smaller ones. Either way, the labor and capital squeezed out from the industry would have been more productively deployed elsewhere. History offers examples: A bankruptcy-triggered reorganization of the steel industry three decades ago led to an 18 percent increase in employment in the plastic industry, which replaced steel for some uses. The auto bailout has entrenched the status quo, strangling new possibilities.

Worse, it has unleashed a systemic moral hazard. GM had accrued $70 billion in losses in the two years before the bailout and debt 24 times its market capitalization. By contrast, Ford had eliminated money-losing brands and mortgaged all its assets -- including its logo, the Blue Oval—raising funds to weather the economic downturn. By bailing out GM, the administration rewarded its recklessness and penalized Ford’s prudence. Every company that feels it is too big to fail, or is a national icon or major regional employer, will wonder whether it makes more business sense to save for a rainy day or simply hold out for taxpayer assistance. And just as the Wall Street bailout became a justification for the auto bailout, the auto bailout will become a justification for the bailout of future reckless players."