Production and the Black Box

In economics (and other fields) we use the metaphor “black box” to describe a process where we see the inputs and the outputs, but we don’t really understand (or maybe really need to know) what goes on inside.

In the coconut plantation story (or lemonade stand, or apple orchard) we tell to motivate students to think about how production works, we invoke that black box metaphor: labor and capital go in, and output (or real GDP) comes out. When we add a production function, what we’re trying to do is put mathematics on what goes on inside the black box that’s both tractable and economically sensible.

With any luck, this cartoon will make the black box idea stickier for you:

I do want to emphasize that the block box doesn’t necessarily mean better inputs produce better outputs (although most of us believe that to be true most of the time in the real world). In this case, we kept one input the same (labor), changed the other input, and with (what looks like the the exact same) black box produced the same amounts of different outputs. But it could just have easily been different combinations of the same inputs. What’s important is that we don’t need to know more about this to get the point.

Why Is Macro So Hard? The Bridge's Weight Limit Problem

We've all seen signs like this:

There's an old joke about how engineers figure out these limits: they build a bridge, drive successively larger vehicles over it until it collapses, and then they rebuild the bridge and put up the sign.

Of course, in reality, do engineers try to do better than that? Well, of course they do. I'm not implying that they don't, just that we should expect some failures.

Unfortunately, most policy applied at the macroeconomic level is non-experimental. You can't run a controlled experiment to see if it will work or not. Instead, you just do it, and reflect later on whether it worked the way you thought it would. If we're lucky, the decision-makers may even update their thinking. So most of macroeconomic policy is analogous to the bridge's weight limit problem.

This came up when New Orleans was hit by Hurricane Katrina: the levees held ... until they didn't hold any more. Then we cleaned up and pointed fingers. (For readers who have never seen the levees, this was one of the biggest federal infrastructure projects in history).

And yet, Charles Marohn writing at Strong Towns notes that almost the exact same excuse was used by former Federal Reserve Chair Ben Bernanke in describing the policy response to the Great Recession:

My favorite part of that interview was Bernanke reacting to himself from a 2005 MSNB interview where he said housing problems were localized and would not impact the national economy. Here's what he said:

I absolutely – first things you said, by the way, when saying in 2005 and 2006 the economy was going to continue to do well, it did do well.  2007 was not a bad year until the end.  So, the economy was doing OK in a broad sense.  What we missed, what we didn’t anticipate, was that the decline in house prices and the problems in mortgages would generate this huge panic. So that — you know, I can’t, I can’t deny that.  I think that I wouldn’t give us a particularly good grade before the fall of 2007.  After that, when we began to see what was going on, there, we were much more aggressive in responding.

In other words, when he said things were doing well, they were doing well, until everything fell apart, and then they reacted.

Now, let's change direction a bit. Returning to the bridge joke, what do you think get's budgeted for? Building one bridge, or building two? The Katrina case should make it clear to everyone that ultimately we pay twice (or more). But that's not the way we start out. Instead, we budget one version, and then we add to that later on.

So, here's another quote from former San Francisco mayor Willie Brown:

Referring to huge cost overruns during the construction of San Francisco’s four-and-a-half-billion-dollar Transbay Transit Center, Brown wrote, “We always knew the initial estimate was way under the real cost…. If people knew the real cost from the start, nothing would ever be approved. The idea is to get going. Start digging a hole and make it so big, there’s no alternative to coming up with the money to fill it in.” [italics are from the source article]

In terms of macroeconomics, this means that you don't let on how big your policy is going to ultimately be. Instead, you start small, and add to it. Then if there's a failure, you use that to double-down and expand the program.

Oxford business professor Bent Flyvbjerg† dubs this "survival of the un-fittest":

... the least deserving projects get built precisely because their cost-benefit estimates are so misleadingly optimistic. [italics are original]

So now we've got three related issues:

• We don't really know whether some things will work until they fail.
• We don't like to pay enough for something that won't fail, so we start with something cheap and add on to it.
• We fib to ourselves about the cost of doing things right, so we end up choosing what seems cheapest (because we didn't include the opportunity costs of doing it right or doing it twice).

Is there an example of how this works in macroeconomics? Well, how about Social Security, or even better the program that was added to it in 1965: Medicare.

Of course, on the first point, Social Security and/or Medicare haven't failed. But, there have been ominous rumblings for a few decades now.

On the second point, we started with social security in 1935. This offered a government check to former workers, aged 65 and older. Life expectancy for a 65 year old at the time was 2 years. Many things have been added to our government's social security offerings: coverage for spouses and dependent children in 1939, coverage for disabled workers in 1954, early retirement in 1961 (even though people were living longer), coverage for the disabled who weren't workers (SSI) in 1972, and automatic cost-of-living adjustments in 1977. But by far the biggest one is Medicare. Initially, in 1965, this was just two parts (A and B, for hospital stays, and more general insurance). But we got Part C in 1997 (with more broader and more flexible coverage), and Part D in 2006 (with prescription coverage). Now, here's a little secret. "Obamacare" was pitched to the public as being about patient protection and affordable care. But everyone who follows policy knows that a huge part of Obamacare was new fixes to Medicare to rein in costs.

That covers the start small and make additions part of the argument. What about the idea that costs are understated because no one would agree to them?

Well, Medicare is a liability of the federal government (a liability being something that generates cash outflows rather than inflows). The money for those checks needs to come from somewhere. If not, it's called an unfunded liability. Current estimates are that the unfunded liabilities of the Medicare system are about $36T (that's the number that Obamacare reduced, by perhaps $10T). That's twice the size of the "official" national debt. That unfunded liability is not included in the national debt because it hasn't been borrowed ... yet. This sort of like carrying a $1,000 balance on a credit card, and knowing that you're going to have to put a $2,000 car repair on the card, yet still thinking that your debt is only $1,000. Well, technically it is, but this is clearly magical thinking.

Then there's the third point: did we choose to structure the laws this way because we were in denial about some of the costs? I don't know of any direct evidence to support this, but the indirect evidence is how we treat increasing life expectancy. It's no secret that life expectancy has been increasing in the United States for, well, not really decades but in fact a couple of centuries now. And yet 80 years into our era with Social Security, we still do not have any concrete plan for matching up when people can start to collect benefits with how long they can be expected generate costs to the system.

Maybe macro isn't that hard. Maybe what's hard is admitting to this pattern of behavior.

† I swear I did not make that name up.

BTW: Thanks to Cold Spring Shops to pointing me to this source article, from which I'm getting the previous entry in this series too.

Why Is Macro So Hard? Orderly but Dumb or Chaotic but Smart? Choose one.

Here's a quote from Charles Marohn, writing at Strong Towns:

Projects coming from the top down tend to be orderly but dumb while projects coming from the bottom up tend to be chaotic but smart. We all prefer smart to dumb, but we Americans have a really strong preference – and have established systems that enable bureaucrats and elected officials to ensure – that we get orderly over chaotic, even when it means accepting dumb as a result. [emphasis is original]

This goes some way towards explaining things like the "Obama stimulus packages" of 2009. A new government responded in a timely fashion for a representative democracy (over a period of several months), with a large series of nice sounding programs (that roughly match up with the textbook Keynesian prescription for a bad recession), wrapped up in a few large multi-purpose bills.

That's the orderly part.

But mixed in there were some clunkers like ... well ... the "cash for clunkers" program. You know, let's destroy some productive capital because it has relatively larger negative externalities that are still minute when compared to the stream of beneficial services delivered by the capital.

BTW: Thanks to Cold Spring Shops to pointing me to this source article, from which I'm getting the next entry in this series too.

Food for Thought: Did the Great Recession Kill the Great Moderation?

For college students, here’s a bit of ancient history.

As recently as early 2008, macroeconomists spent a lot of time talking about the Great Moderation. Then the Great Recession of 2007-9 hit.

What was the Great Moderation?

Well, first let’s review what macroeconomists think about the Great Recession. That’s a cute name, but it wasn’t coined by macroeconomists. But no one really knows when that name was coined: here’s where it gets ridiculous — for a while people have been calling every recession the great recession until it turns out that it didn’t hurt that much. Well, whatever … I think the name has finally stuck to the 2007-9 recession. Second, as emphasized in class, once you treat the data like you actually care about realistically accounting for average growth … the Great Recession of 2007-9 looks comparable to the bad ones we had in 1981-2 and 1973-5.

So, the Great Moderation is the name given to the period from 1982 through 2007 where we had 3 long expansions (2 of them pretty strong ones too), that sandwiched 2 weak and mild recessions. That’s an entire generation where the U.S. macroeconomy was remarkably benevolent to us.

I think if we went outside of macroeconomics, people would say that of course the Great Recession killed the Great Moderation. But for macroeconomists that’s an open question that someone needs to examine.

New research by Gadea, Gomez-Loscos, and Pérez-Quirós checks the U.S. real GDP data for structural breaks — that is, changes in the underlying structural process that’s generating the data. What they look for is 0, 1, or 2 structural breaks: if there’s 0 there never was a Great Moderation, and if there’s 2 there was a Great Moderation but it ended. But what they find is that the data shows just one structural break, in the early 1980’s corresponding to the onset of the Great Moderation.

One hallmark of the Great Moderation was that the last 2 of the 3 expansions started out weak, and stayed weak for quite a long time (2-4 years) before picking up steam.

I’m sure there’s more research to come, but this first shot at the problem suggests that the Great Moderation is ongoing, and as a corollary, that the Obama expansion — which is getting on the long side but which has never been strong — is a continuation of the pattern.

Why Is Macro So Hard: Social Desirability Bias (Or Caplan Channels Landsburg)?

In a piece on social desirability bias (our tendency to be in favor of things that sound good, while not actually doing them), Bryan Caplan asserts that Steven Landsburg would say something like this:

X being good is a reason to do a lot of X - not a reason to do more X.

I’m reminded of the reductio ad absurdum in Monty Python’s series of Dennis Moore sketches. Dennis is a highwayman who steal from the rich to give to the poor … until the rich are no longer rich, and the poor are no longer poor.

We see this a lot in things like policy proposals to help senior citizens financially. Except that seniors are the richest age group. But no one wants to make the distinction that helping Grandma a lot is not the same thing as helping Grandma more than we already do. Perhaps we ought to help Grandma a lot, but less than we actually do. It’s kind of ridiculous if you think about it: we’re so biased we can’t actually even ask if Grandma’s doing OK as it is.

Why Is Macro So Hard? The Things We Won’t Talk About

Here’s a quote:

You can say anything you like about sex nowadays, but the moment the topic turns to fiscal policy, there are endless things that everyone knows, that are even written up in textbooks and scholarly articles, but no one is supposed to talk about in public.

So I make no claims to thinking in tune with the author generally, or approving of the source article.

I would say that the problem is broader than fiscal policy though.

So what are some random things with fiscal policy that we’re not allowed to talk about? How about:

• Government deficits move with the business cycle: lots of politicians claim responsibility for movements toward budget surplus that are nothing more than side effects of business cycle expansions.
• Governments run deficits in some months and surpluses in others. You’d think this would lead to volatile economic outcomes if deficits were actually important. It doesn’t because they’re not.
• If you thought it was good that Clinton ran surpluses, don’t forget that Bush II did too.
• If you though those surpluses were good, don’t forget that they were the aftereffect of large national tax increases in 1990 and 1993.
• Obama is known for his stimulus package. Bush II should be too.
• Republicans: you can be in favor of reducing taxes without tossing out the trope that the Laffer curve operates everywhere all the time. It doesn’t. It’s not even close.
• Reagan didn’t cut government spending. In some areas he cut the growth rate of government spending.

Technorati Tags: why,macroeconomics,so,hard,what,we,don't,talk,about

Obamacare as Redistribution

I don’t think anyone thinks Obamacare was not about a whole bunch of issues simultaneously.

And I don’t think anyone has any doubts that it was about helping the poorest, who have the most trouble affording healthcare, at the expense of the rich.

OK. So Obamacare is partly about income redistribution. Fair enough.

The thing I don’t think many people realize is that many assume that they are in the income category that benefits. For most people, this just isn’t true.

Check out this chart:

That’s not exactly redistributing from the 1% to the 99%.

In terms of deciles, the middle class is typically defined as the 3rd through the 8th. For perspective, most business school professors are in the 9th decile, and I don’t think casual observers would regard us as “rich”. But, the 9th and 10th deciles are what we more-or-less officially classify as rich.

There are a number of sources to figure out where you sit in those deciles, but a particularly fun and easy tool to assess your income percentile is available at Political Calculations. It shows that in 2014 the cutoff between the 2nd and 3rd deciles was at about $22K in annual income for a household (I chose household rather than individual because most health insurance is sold to cover households).

In sum, the redistributive component of Obamacare is from the rich and the middle class to the poor.

The source for this is a paper from Aaron and Burtless at The Brookings Institute. Here’s an executive summary. Neither of those guys, or Brookings, is regarded as supporting Republicans, conservatives, or libertarians. So this is very much Democratically-sympathetic economists telling us that it’s not about helping the middle class.

Inequality Seems to be Mostly About Where You Work

Income inequality is a big deal in contemporary political discussions. Lots of people believe the appropriate response to that is to redistribute from richer individuals/families to poorer individuals/families.

But what if what's making the rich is rich is ... who they work for?

New research indicates that inequality between firms (do people get paid the same at different employers) is a bigger deal than inequality within firms (do people get paid more or less in the same place).

Common thinking is that it must be the latter: the executives are getting paid too much.

But the data doesn't show that. Instead it shows that there are companies that are doing very well where everyone is getting paid more.*

For example, the employee at the 90th percentile earned 1.69 times as much as his firm’s average wage in 1980, and 1.73 times as much in 2013. An employee at the 99th percentile earned 3.57 times his firm’s average in 1980, and 3.48 times in 2013.

They also checked whether it was only the tippy-top executives that were driving inequality:

... They did find the top 0.2% of earners at firms with more than 10,000 employees did see their income grow much faster than other workers at their own firms.

That's not many people: 20 out of 10,000 whose pay is growing faster than everyone else's. We could make an argument about inequality and "those rich", but it isn't a very large group, and would be unlikely to yield enough money to support any sort of redistribution program.

Currently, there are three explanations being explored for inequality between firms:

• Sorting: the more promising firms are getting better at isolating and hiring the more promising job candidates.
• Core Competencies: the firms that are doing so well are outsourcing a lot of their work to contractors (who don't pay as much) reserving a bigger pie for those left behind, or
• Barrier to entry: the successful firms are better at preventing free entry, that might reduce revenue, and ultimately what compensation could be afforded.

My money is on the last one.

Read the whole thing entitled "What’s Driving Inequality: CEO Pay or Company Success?" on The Wall Street Journal's website, or retitled "Inequality — A Company Thing" in the November 5 print issue.

* I can contribute a personal anecdote here. I have a friend who moved to the bay area in 1978. He had zero future (not too bright, not ambitious, undereducated, slacker personality). Anyway, he got a job as a janitor at chip maker in Silicon Valley and retired before he hit 50, mostly on the basis of stock options and the high risk strategy of reinvesting his retirement contributions in company stock.

Why Isn't Pay Increasing?

A common grouse about the economy is that income is not going up for most workers.

This is only partly true. Compensation is going up normally. That's what the firms pay out. But workers are choosing (or complicit with) compensation increases going to things other than income.

And then we complain because our income hasn't gone up. That's kind of immature.

Average hourly wages have grown slowly since the end of the recession in mid-2009, advancing at a pace of about 2% annually or about 12% since the expansion began, despite steady job creation. In the 20 years before the most recent recession, hourly earnings grew, on average, better than 3% annually. Weak wage growth has been blamed for a wide range of soft spots in the economy, including uneven consumer spending, historically low inflation and many renters’ inability to purchase homes.

Benefits, meanwhile, have increased at a slightly faster clip, 15% since the expansion began. That’s actually a continuation of a much longer trend. Since 2001, benefits increased nearly 60%, while wages advanced 40%.

So, all those stories you hear about the great perks of working at, say, Google, contribute to the data showing that wages and salaries aren't going up as fast as we would like. That's been mostly a talking point for the Democrats over the last few years. And yet both parties are showing a modest increase in mandating something like paid family leave.

Read the whole thing, entitled "Paying with Perks May Carry Cost" in the November 2 print issue of The Wall Street Journal or online in the retitled piece "Shift to Benefits From Pay Helps Explain Sluggish Wage Growth".

Young Macroeconomists: Spread the Word

Usually, conservatives writing in conservative publications are trashing Obama and the Democrats. Not this time.

Do note that this is from an opinion piece, so your mileage may vary.

Anyway, macroeconomists don’t push the idea hard enough about how good life on planet Earth actually is, thanks to economic growth. Here’s Kevin D. Williamson writing in Reason:

… Polio has been eradicated everywhere on Earth except for two places where those who would eradicate it are forbidden to operate: Afghanistan and Pakistan. That’s the Taliban’s gift to the Islamic world: paralytic polio.

That’s really good news, right? How come you probably didn’t know about it? That’s weird, right? I suppose it’s bad that you didn’t know about it, but really, it isn’t your area. It’s the sort of thing that someone who cares about making life better should have told you about. What’s weird is that you have to hear it from a macroeconomist, in a class targeted at upper-level majors.

… Economist Angus Deaton, recently awarded the Nobel prize, has spent much of his career working on how we measure consumption, poverty, real standards of living, etc. It is thanks in part to his work that we can say that the global rate of “extreme poverty,” currently defined as subsistence on less than the equivalent of $1.90 a day, is now the condition of less than 10 percent of the human race. In the 1980s, that number was 50 percent — half the species — and as late as the dawn of the 21st century, one-third of the human race lived in extreme poverty. The progress made against poverty in the past 30 years is arguably the most dramatic economic event since the Industrial Revolution. It did not happen by accident. [emphasis added]

The one thing we can be sure of is that it didn’t happen because of government programs. I’m not being anti-government here at all, and neither is Williamson. But let’s be clear: the biggest reason for that is because China moved away from government control of stuff.

Williamson uses a metaphor that I often use in class.

What I sometimes refer to as the black-hats/white-hats school of political analysis.

Too many people start out by deciding who gets to wear the white hats and who has to wear the black hats, and then designing their worldview, or worse their policy prescriptions, around that choice. Some clarity may help you understand why that’s a big problem.

… We have achieved a remarkable thing in that unless we mess things up really badly, in 50 years we’ll be having to explain to our grandchildren what a famine was, how it came to be that millions of people died every year for want of clean water — and they will look at us incredulously, wondering what it must have been like to live in the caveman times of the early 21st century.

Read the whole thing, entitled “From Polio to Poverty, We Are Winning”.

Milanovic On Inequality Sources

Concern about the negative effects of inequality has led to many policy proposals. Most of our proposed policies do something like redistribute outcomes; so it’s very much looking at the end result and shifting things around to what we think is a better distribution.

On the other hand, we probably ought to be more concerned about inequality in inputs. The reason is that it’s probably less serious if two people get the same inputs and produce unequal outputs, than if we give them unequal inputs to start with.

So, what’s the source of inequality. In contemporary circles, we hear a lot of discussion about race, gender, and class as sources of inequality.

Milanovic* looks at the most important inequality: the global kind. It’s kind of morally repugnant to not focus on this aspect. Consider this: how do we justify looking at, say, some Americans, not having as much stuff as some other Americans do … when there are people in other countries who may not have enough food.

But what Milanovic shows is that most inequality globally is not determined by race and gender and class, but rather by location of your birth and who your parents are.

Specifically, about 60% of global poverty is simply bad luck: you were born into a poor region. The best short-term solution to alleviate this is to encourage people to move to richer areas. That will work, but is politically unpopular just about everywhere. But the effectiveness of this method is mind-boggling: Milanovic estimates that the typical resident of the Democratic Republic of Congo (the poorest country in his sample) can more than quadruple their income simply by moving to the U.S.

(Of course, the story all summer and fall has been refugees fleeing the Middle East and Africa into western Europe. Now you know why. Further, a dirty-little-secret of that mass migration is the extent to which it is otherwise middle class people from the Middle East — they have the money to flee, and the time is ripe.)

The longer term solution to that is economic growth. We do know that regions do converge relatively rapidly if the only differences are resources and high tech. But it is the low tech institutions that don’t transmit well across borders, so the long term solution is really go do into poor places and change their institutions. This is called nation-building, and it’s what got Bush II into trouble in Iraq (and on a lesser scale, Clinton into trouble in Somalia … you know … the backstory to the film Black Hawk Down). It’s not clear that this is a politically viable solution either.

The next fraction of inequality, about 20%, is explained by who your parents are. Roughly, if your parents are slackers, you’ll likely end up on the bad end of inequality. The best short-term solution to alleviate this is to take kids away from their parents. You can imagine how that goes over in most places.

The more heinous long-term solution is to encourage the problem parents to have fewer kids. In short, this is the policy of the Nazis, or else the softer forms of eugenics (usually involving forced sterilization) that were popular 75-100 years ago. This is not a politically viable or desirable solution either. Of course, education about family planning, and access to birth control methods is an alternative that works … but that runs into religious strictures in some locations. We can also try to “scare people straight” with more information about the scope and magnitude of the personal costs to being a parent; but it’s hard to get people to think clearly about those issues.

Here’s an interview with Milanovic. I find it interesting that the interviewer glosses over the above points, and pretty much goes straight to what can we do about race and gender. Those are hot topics, and I don’t want to dismiss people’s interest in them. But we need to be clear-eyed that they are tertiary: no matter what we do about the no-more-than-20% that is due to race and gender, it’s still going to be swamped by the 80%-that-isn’t-race-and-gender that we can’t do much about. By analogy, this is like coaching basketball by noting that there is inequality between the best and worst teams, then ignoring the dribbling, passing, and shooting, and trying to make your team better by increasing just rebounding and steals. That certainly won’t hurt, but it probably won’t win many games for you.

I love this chart drawn from Milanovic’s recent paper in the Review of Economics and Statistics.

The way to read this is to note that poorer people within a country are on the left, and the poorer people on the globe are at the bottom. So if we take the poorest people in the USA, we then go towards the right and find that they would be middle-class in China, and in the lower part of the upper class in India. But if we take those poorest people in America, we find by going downwards that they really don’t rate as poor at all on the global scale of things.

That raises a big moral question. Why is it OK to be concerned about the poor within the borders of the United States, when there are people outside our borders who are poorer? This doesn’t have good answers, But for another analogy, it’s like professors being concerned that their kids choose to eat ramen for lunch, and then go to school to teach college students who sometimes have to eat ramen for dinner. Is the professor’s concern for their own children reasonable? I’m not sure any of us know. But if we don’t know the answer to that question, why are we so sure that we need to help the not-that-poor people inside America’s borders more than the definitely poorer people on the other side?

* Milanovic, B. “Global Inequality of Opportunity: How Much of Our Income Is Determined by Where We Live?”, Review of Economics and Statistics, 2015, 97, 452-460.

Productivity In the Obama Expansion

Being more productive collectively is how well-being is improved at the individual level.

The thing is, productivity is hard to measure. What we usually do is measure it as a residual (what’s left over). We start with output growth, subtract out how much of that was due to input growth, and what’s left must be productivity growth … at least approximately.

Productivity flagged a little bit this past winter. But compared to the last 4 expansions (the ones associated with Obama, Bush, Clinton, and Reagan), productivity in this expansion looks pretty normal.

Increased productivity is also why workers get raises. The flip side of that is that owners and managers want unit labor costs to increase. This is the amount of money they get from their outputs for each dollar of inputs (labor, capital or technology).

Again, the Obama expansion looks normal. What’s abnormal is the Reagan expansion. How did unit labor costs go up so quickly when productivity didn’t go up that fast? No doubt this has a lot to do with improved efficiency during that period (why, I don’t know).

Read all about it in the article entitled “U.S. Productivity Falls 1.9% in First Quarter” in the May 6 issue of The Wall Street Journal.

Angus Deaton Wins the 2015 Nobel Prize

The 2015 Nobel Prize in Economic Science was awarded to Angus Deaton this morning.

As always, the best source about this amongst economists is Tyler Cowen and Alex Tabarrok who write Marginal Revolution. Here is Alex:

... When you read that world poverty has fallen below 10% for the first time ever and you want to know how we know— the answer is Deaton’s work on household surveys, data collection and welfare measurement. I see Deaton’s major contribution as understanding and measuring world poverty.

Measuring welfare sounds simple but doing it right isn’t easy. How do you compare the standard of living in two different countries? Suppose you simply convert incomes using exchange rates. Sorry, that doesn’t work. Not all goods are traded so exchange rates tend to reflect the prices of tradable goods but a large share of consumption is on hard-to-trade services. ... A second problem is the cheese problem. Americans consume a lot of cheese, the Chinese don’t. Is this because the Chinese are too poor to consume cheese or because tastes differ? ... A third problem is the warring supermarkets problem. Two supermarkets each claim that they have the lowest prices and they are both right! How is this possible? Consumers at supermarket A buy more of what is cheap at A and less of what is expensive at A and vice-versa for B. Thus, it would cost more to buy the A basket at store B and it would also cost more to buy the B basket at store A! So which supermarket is better? ...

Deaton’s book, The Great Escape, on growth, health and inequality is accessible and a good read. A controversial aspect of this work is that Deaton falls squarely into the Easterly camp (Deaton’s review of Tyranny of Experts is here) in thinking that foreign aid has probably done more harm than good.

Here is Deaton on foreign aid:

Unfortunately, the world’s rich countries currently are making things worse. Foreign aid – transfers from rich countries to poor countries – has much to its credit, particularly in terms of health care, with many people alive today who would otherwise be dead. But foreign aid also undermines the development of local state capacity.

This is most obvious in countries – mostly in Africa – where the government receives aid directly and aid flows are large relative to fiscal expenditure (often more than half the total). Such governments need no contract with their citizens, no parliament, and no tax-collection system. If they are accountable to anyone, it is to the donors; but even this fails in practice, because the donors, under pressure from their own citizens (who rightly want to help the poor), need to disburse money just as much as poor-country governments need to receive it, if not more so.

What about bypassing governments and giving aid directly to the poor? Certainly, the immediate effects are likely to be better, especially in countries where little government-to-government aid actually reaches the poor. And it would take an astonishingly small sum of money – about 15 US cents a day from each adult in the rich world – to bring everyone up to at least the destitution line of a dollar a day.

Yet this is no solution. Poor people need government to lead better lives; taking government out of the loop might improve things in the short run, but it would leave unsolved the underlying problem. Poor countries cannot forever have their health services run from abroad. Aid undermines what poor people need most: an effective government that works with them for today and tomorrow.

One thing that we can do is to agitate for our own governments to stop doing those things that make it harder for poor countries to stop being poor. Reducing aid is one, but so is limiting the arms trade, improving rich-country trade and subsidy policies, providing technical advice that is not tied to aid, and developing better drugs for diseases that do not affect rich people. We cannot help the poor by making their already-weak governments even weaker. 

Eating In and Eating Out

Weird things resonate with students. Professors are always looking for ideas that are “sticky” (to use the terminology popularized by Malcom Gladwell in The Tipping Point).

In Spring 2015, one of the sticky ideas was that spending on eating out has grown faster than spending on eating in, basically forever, so that now the amount we spend on either category is about the same.

Oops. That result was premature. So let me backtrack.

There is a comparison for which eating in and eating out are equal. Except that “eating in” has a pretty tight definition, and “eating out” has a pretty expansive one.

The figure quoted as “eating in” was for grocery store sales only. It did not include food bought at warehouse clubs, supercenters, or pharmacies. It doesn’t even include standalone retailers like bakers and butchers. Face palm.

The figure for “eating out” is more reasonable. But it’s not just restaurants. It’s caterers too. And bars (presumably it is counting just the food sold at bars, but it isn’t just Applebees). And it also counts contractors … like food service for SUU students (who may not really be able to cook much in their dorm rooms).

Anyway, yes, “eating out” is growing, but it’s more than just restaurants. And “eating in” is growing more slowly, but a lot of that is because we don’t go to Lin’s and Smith’s as much as we used to (or the Albertson’s, or Safeway’s that used to be located in Cedar City).

Read more about this in the article entitled “Don’t Believe the Hype: Eating In Still Tops Eating Out” in the May 15 issue of the The Wall Street Journal.

Disability Trust Fund to Run Out

This issue wears a black hat. Bwoo-ah-hah-hah-hah.

There’s likely to be some panic about this in 2016. Don’t let it bother you.

First off, there’s no trust fund. At least not in the sense that most people think of: a pile of money in an investment somewhere that can be used at any time.

Our federal government isn’t allowed to make investments for the future like you and I do, so there isn’t a sense in which it can have a trust fund for anything.

So why do we say trust fund, and what do we mean?

We say trust fund because Congress tells us that’s the name for it. But it’s a lie, and there’s no law that says they can’t lie about that.

What they mean is that they made projections way back in the past about where the money was going to come from (mostly FICA taxes withdrawn from our paychecks), said that some percentage of that was going to go to disability payments, called what they didn’t allocate a trust fund and then spent it on something else (and not necessarily something bad, they just can’t legally save it), and now they’re going to spend it (by not spending it on something else) except they expect to spend more than they pretended to save.

This isn’t as horrible as it sounds, but it isn’t good. Let me give you an analogy from my life. The family goes on vacation. My daughter brings her own money. But since she was young we haven’t trusted her with a lot of cash. So she asks me to hold it for her. And I put it in my wallet with all my other cash, and keep a mental note of how much is hers. Then I spend the cash wherever we need it. And sometimes when she finds something she wants to buy, I have to say that I have to go the ATM first because I don’t have “her” cash in my wallet any more. (I confess: it’s a tiny little bit immoral, but parents do stuff like this all the time). Oh, and she wants all her cash back right now because she wants to buy something that costs more than all the cash she gave to me in the first place, so she needs a little loan too. In the analogy, the ATM is taxpayers, I’m Congress, my daughter is the Social Security Administration, and the retailer is disability recipients.

Second off, there’s no disability crisis either. I’ve debunked this topic many times on this blog over the last several years. Instead, what we have is this big demographic hump in the labor market called the baby boomers. The economy thrived in the 80’s because they were young and healthy. The economy isn’t thriving in the teens because they’re old … and at the age where they get disabled a lot.

Americans today are about as likely as those in the past to report that they have a work-limiting disability, according to Census Bureau data. For instance, 5.6% of Americans ages 35-44 reported having a work-limiting disability in 1984, while in 2014 that figure was 5.4%. …

Yet the percentage of the working-age population collecting disability insurance benefits has more than doubled to 5.7% in 2014 from 2.7% in 1984. These increases were not anticipated …

Demographic factors have played a major role. Older workers are more likely to become disabled, and as more women entered the labor force in the 1970s and 1980s, they began receiving benefits alongside men.

And third, Congress has made it easier for some people to collect disability. But most of this happened a generation ago. It’s just catching up to us now. And don’t forget that it’s totally natural to be good-hearted and take care of more people, but also natural to blow off figuring out how to pay for that.

Congress loosened eligibility standards in 1984, allowing multiple non-disabling ailments to be combined to qualify for disability benefits. The legislature also ordered the Social Security Administration to favor evidence provided by an applicant’s medical representatives over the judgments of SSA medical professionals.

Anyway, the coming crisis is that we haven’t allocated a big enough fraction of incoming revenue to cover this. So we’ll either have to allocate more to disability (and less to other stuff), or increase taxes.

Read all about it in the article entitled “Averting the Disability-Insurance Meltdown” in the February 23 issue of The Wall Street Journal.

Bernie Sanders

As I write this in late September, the Democratic presidential campaign is in a state of flux. Hillary Clinton is still the favorite, but the train-wreck-in-slow-motion of her ethics problems has created a lot of doubters. Those folks are flocking to Bernie Sanders, the I’m-too-left-to-be-a-Democrat Senator from Vermont. Sanders has historically called himself a Socialist, but he really doesn’t have much choice to run for president other than as a Democrat.

What Sanders has proposed is to make the U.S. more like our urban myth of how western Europe is run: with a much bigger government, providing many more social services, all on the backs of the rich.

First a digression on the urban myth part. There are three aspects to this. First, the central governments of western European countries are a larger share of their economies than ours is … but … our regional governments (states, cities, counties, and especially school districts) are much larger. If you lump them all together, you’d find that government in America is a tad less than the middle of the pack for western Europe. Second, America gets knocked because we pay for much of our healthcare, and some of our higher education, with private funding. Except we also get more for what we pay for: that’s why foreigners come here for medical care and college educations. This spending is often used to beat up America about its priorities, but that’s probably misplaced since American’s don’t seem to think it’s a bad enough deal to go elsewhere for medical treatment or college educations. Third, there aren’t that many rich people to tax to pay for this. The dirty little secret of all these discussions is that total income of “the rich” is already smaller than what the government spends: if we took it all, we’d still end up short. Way short. In order to afford big increases in government spending, we can’t define “the rich” as the top 1%, or even the top 10%, instead it has to be more like top 50%. Some people are OK with that, but many of them are in denial that this includes themselves.

Anyway, let’s take Sanders proposals at face value, since they are gaining in popularity. What does Sanders propose: 1) expanding Medicare into a single payer healthcare system that covers everyone for everything (that’s 75% of it right there), 2) shoring up predicted shortfalls in social security, 3) infrastructure improvements and repairs, 4) making college more affordable, and 5) government funded family leave.

The Sanders program amounts to increasing total federal spending by about one-third—to a projected $68 trillion or so over 10 years.

For many years, government spending has equaled about 20% of gross domestic product annually; his proposals would increase that to about 30% in their first year. As a share of the economy, that would represent a bigger increase in government spending than the New Deal or Great Society and is surpassed in modern history only by the World War II military buildup.

So this is a huge deal. What I wonder is if you asked people, did Roosevelt expand government enough, or did Johnson further expand government enough, I wonder how many would say “yes” to one of those, but would still be in favor of Sanders’ proposal? Those people definitely have a cognitive dissonance issue that they need to resolve, particularly since any rollbacks in those programs by Republicans are mostly reductions in positive growth rates rather than reductions in size and scope. For the true believers who answered “no” to both, then Sanders is probably their guy.

How would he pay for this?

[Sanders] has so far detailed tax increases that could bring in as much as $6.5 trillion over 10 years, according to his staff.

This reality check is problematic.

Having said that, if Sanders does push through conversion of our healthcare system to Medicare, then everything we now spend on healthcare would be up for grabs to be taxed away. That would more than cover the cost, so we shouldn’t really argue that his Medicare proposal creates a funding problem. Of course, it creates a huge political problem because people are not going to want that stuff taxed away, but that’s another story.

What’s interesting to me about this has two parts.

First, he’s proposing the healthcare spending, without the healthcare financing. This is financially dishonest in the small ways that we’re used to from members of Congress. The thing we need to keep our eye on as macroeconomists is that the money will come from somewhere.

Second, if my assertion is correct that there’s enough healthcare spending already out there to cover his proposal, so that we’re just moving money between different accounts … then why does he need the other $6.5 billion in proposed taxes? That’s twice the remaining spending proposals.To the extent that we buy into the Keynesian view (and I’m sure Sanders does) that spending pushes the economy forward, and taxes pull it back … then Sanders proposal to have excess taxes is a plan to hit the brakes on the economy. Who does that make sense to?

You can read about Sanders’ proposals in this piece entitled “Price Tag of Bernie Sanders’ Proposals: $18 Billion” in the September 14 issue of The Wall Street Journal.

“A Career In Economics”, from the AEA

The American Economics Association (AEA) has a new video out entitled “A Career In Economics”. In it, four economics majors talk about how useful their major was for their career as someone who uses economics without being an economist.

A career in Economics...it's much more than you think from American Economic Association on Vimeo.

Technorati Tags: career,economics,doctor,google,american,association

Consumption Inequality

Growth numbers are OK, the U.S. has posted 5 longer than average expansions in the last 2 generations, and everyone seems to have an awful lot of stuff.

But clearly there’s a growing problem with inequality. Part of the reason for this is that the top is doing very well, while the rest are merely doing OK.

Note two things: 1) this is already adjusted for inflation, and 2) it measures households. Households have been getting smaller through time, so the 30% improvement in consumption shown here packs more punch than is shown, and would be higher if we corrected for that. Of course, it would be higher for the top 5% too.

Drawn from the article entitled “How a Two-Tier Economy Is Reshaping the U.S. Marketplace” in the January 28 issue of The Wall Street Journal.

What Should We Call Poorer Countries?

Here’s a social problem that’s broader than economics: what do you call people who aren’t doing as well that isn’t insulting, doesn’t sound patronizing, and doesn’t open up an avenue for those less well-off to rationalize their situation?

Macroeconomists and politicians have this trouble with countries. We need a label. In the handbook for this class, I’ve primarily used “developing”, but I’ve also mentioned “third world”.

Third world is an older term, that’s seen as insulting by some.

Developing has been on the rise for a couple of decades, but it’s seen as patronizing.

Using either phrase (or others) can open up the third can of worms. This has two facets.

First, some will argue that the developed countries are richer because they’ve stolen stuff from developing countries. This is a popular notion, tied up with exploitation, for which there’s actually not much supportive data. The really scary thing is not that the U.S. has taken a lot from, say, Cuba — but rather that if Americans actually cared about Cuba as much as Mexico, Cuba would probably be better off.

Second, there are many people who will say things like “we’re doing this our way because we don’t want to be developed … we don’t want to turn out like you”. This is actually really frightening, because often the people saying this are already the ones with most of the money and power in these countries. In short, they’re big fish in a small pond, and they like it that way.

I’m posting this during Pope Francis’ first visit to the U.S. Personally, I have very strong feelings that Pope Francis may be the biggest exponent of this view at the moment. While personally, he has taken a vow of poverty, he’s been elevated to the top of institution that got rich from just about very means except economic growth, and he’s using that position to criticize societies that got rich from pretty much only economic growth. I find that irony disturbing.*

Some of these ideas, and others, are touched on in the article “The Rise and Fall of the Term ‘Third World’” from the May 1 issue of The Wall Street Journal. For the curious, they date the usage of the phrase third world to French sociologists in the early 1950’s. They came up with that term to put a positive spin on those places, even though now some people think of it as insulting.

FWIW: I’ve lived and worked in Utah for a majority of my adult life, but I am not Mormon. I grew up in a heavily Catholic area, and have a great many close Catholic friends. I do not advocate that you take my viewpoint as anti-Catholic, or even anti-Francis. I am merely very much opposed to the publicly stated economic positions of this Pope.

China’s Real GDP Growth Rate

It’s late July and I’m writing up an article from late April. In the past 3 months, not only are we continuing to worry about how China’s economy is doing, but now their stock market has crashed too: it’s off by 1/3 since mid-June. For perspective, that’s roughly as much as the NYSE lost in 1929.

I am not a huge fan of the stock market as an indicator of macroeconomic performance. And that’s in the U.S. where investors have thick markets to choose from. In China, investors are limited in their choices, and are allowed to buy stock on margin: this is a recipe for a stock market to get unhinged from the underlying economy.

But, back to China’s growth rate, and the article I found interesting.

“Growth Likely Overstated,” said a Citibank report, concluding that actual quarterly growth could be below 6% year to year, depending on the factors weighed. Other research firms put their numbers far lower, with Capital Economics pegging the quarter at 4.9%, the Conference Board’s China Center at 4% and Lombard Street Research at 3.8%.

That’s quite the range of numbers. And that low end of 3.8%. That’s the range a developed economy can hit fairly regularly (although we’ve had trouble with that for 8 years now). But for a developing country like China, that rate is terribly low. As in, never-going-to-develop low.

Here’s the kicker:

… The figures are suspiciously smooth, with none of the sharp gyrations seen in the U.S. or other economies. The methodology often appears inconsistent or contradictory. Also, no one knows how China accounts for inflation when tabulating its gross domestic product.

Note that last sentence, and think about how we work through GDP in class. We start out by counting up nominal GDP. But there’s no way to count up real GDP. Instead, we estimate inflation, remove it from nominal GDP, and what we’re left with is real GDP.

If analysts are saying “no one knows how China accounts for inflation”, what they really mean is no one thinks their growth rates are credible or accurate.

Off the record, the leaders in China seem aware of this problem:

… Roundabout backing of Premier [Li], who in 2007 as Communist Party chief of northeastern Liaoning province criticized China’s GDP numbers as “man-made and therefore unreliable,” according to a memo by the U.S. ambassador at the time, later released by WikiLeaks.

I guess WikiLeaks was good for something.

Read the whole thing, entitled “China’s True Growth Is a Mystery; Economists Weigh the Clues” in the April 26 issue of The Wall Street Journal.

America’s Crude Oil Export Ban

Politics often leads to economic policies that are nothing short of stupid. One of the especially stupid periods for such policies was the 1970’s. It was if the country had hit a string of bad luck so the politicians figured they’d start kicking it while it was down.

I’m done now.  

One of the things that came out of that was a ban on the export of crude oil.

This was at the time of the two OPEC oil crises (1973-5 and 1978-9). But note the bizarreness: because oil we imported was getting more expensive we banned the export of our own oil.

An analogy may help. In the labor market, a teenager exports time/labor from the family when they work outside the home, and when the parents hire, say, a cleaner, they’re importing labor. With those ideas in mind, the oil export ban is like the parents responding to cleaners getting more expensive by telling the teenager they have to quit their job. Yeah … that might make more time available within the home so that they teenager could do more cleaning … but I think it’s fair to say it’s probably not the approach most parents would choose. But that is what the politicians chose back in the 70’s when they instituted the oil export ban.

And don’t fail to note that even if this could be justified as a slightly panicked response to a transitory problem with crude oil supplies … we still have the ban in effect 40 years later.

Yet high prices are an incentive to develop new technologies, and while it took decades, the response of Americans to higher crude oil prices was to develop horizontal drilling and its ugly stepchild fracking. Now we have cheap crude oil. But we’re not allowed to sell it to people who’d pay more for it.

There’s also a problem with path dependence. Path dependence is the idea that you get where you are by following a certain path, and that path may have had side effects. In the case of the U.S., some of the crude oil that we import comes mostly from Mexico, Venezuela, and other places. And it’s the dirtier, nastier, harder to refine kind of oil. So we have a refinery industry based around turning the nastiest crude oil into lots of nicer products, like gas, jet fuel, plastics, and so on. Except that now, not only are we producing a lot more crude through horizontal drilling with fracking, but it’s also coming out of the ground in a nicer form that we’re not well-equipped to process. Importers in other countries will pay a premium for the good stuff, but we’ve made it illegal to sell it to them.

Mind you, it’s not illegal to export all the good stuff we make out of the lousy crude we import. So, we still need to import a lot of lousy crude to keep the refineries we have doing what they’re designed to do.

You can’t make this stuff up.

Oh, and BTW, it’s been several years since the horizontal drilling boom started to hit, and D.C. still hasn’t fixed this.

Here’s an op-ed from an oil industry executive entitled “The Oil Export Ban: A Relic of the 1970s”. It’s from the April 24 issue of The Wall Street Journal and it touches on some of these issue.

This Summer’s Financial Crisis

Next up on the chopping block for financial collapse is … Moldova.

Never heard of it? Read the article linked below, which includes a map showing where Moldova is.

Moldova has been simmering for a while. When the Soviet Union broke up,* some of its “states” became independent formally, and some because independent informally. Ukraine was in the former group. Moldova was in the latter group. When Ukraine became independent, Moldova didn’t want to leave Russia … but was no longer physically connected to Russia. And it’s landlocked. So basically, the locals and Russian in the government kinda’ sorta’ broke away from the new Russia because it wasn’t corrupt enough for them, and no one was going to fly over to Moldova to straighten things out.

These things matter macroeconomically because rich guys in eastern Europe, especially those who got rich through illegal activities, start moving their money through places like Moldova to launder it before they, say, go buy a house in London … or maybe Park City.

Greece has been in the news because the IMF has had difficulties dealing with them, and the Greeks currently owe them a lot of money. The IMF doesn’t even send negotiating teams into Moldova because there’s no one to negotiate with. It’s that bad.

Here’s an example of the problems. A London based consulting company named Kroll was brought in to file a report about the financial crisis. part of the reason why:

I have read Kroll’s report, and I regard it as deeply flawed. I cannot comment on the accuracy of Kroll’s forensic investigation, but the explanation of the liquidity transfers between the entities concerned – particularly transfers between the three banks and Russian companies – displays a lamentable lack of understanding of how banks actually work.

That’s from Frances Coppola, a journalist who writes for Forbes, who I don’t regard as terribly hard on developing countries. But clearly she thinks Kroll was out to make a paying client happy.

Yet this report with a” lack of understanding of how banks actually work” was denounced by what passes for a government in Moldova because it was too hard on them.

Oh … and BTW … the EU had turned a blind eye to so much of this that they were very close to admitting Moldova to their union last December. Of course, we know from the Greek story that that are people working for the EU who will turn a blind eye to fudged economic data because it’s so important to them that Europe be united no matter what the problems.

So, in a couple of years, I’ll be using my Google Search toolbar above to find this article so that I can tell the ECON 3020 students that we’ve been watching this for a while.

* Before World War II, the Nazis and the Soviets had plans for divvying up eastern Europe. As the Soviets started rolling back the Germans in 1944, in some places they put in place sympathetic puppet governments, and in others they pushed out the locals and had Russians move in. Today we call this ethnic cleansing, although that term didn’t come into vogue until about 20 years ago. Anyway, Moldova used to be mostly filled up with Moldavians, who are one of the two big groups that make up Romanians (if you’ve ever seen Ghostbusters II, Vigo claims to be the scourge of Moldavia). But the Russians liked the Moldovians’ land, so they pushed out enough of them, and brought in enough Russians that it’s now like a Russian enclave that’s not attached to Russia any more. Oh … and … Moldova has a breakaway part, called Transnistria, that’s even more lawless.

Why Is Macro So Hard – Who Could Have Seen That Coming?

Former student TW sent along a piece from Cato@Liberty. That’s a blog from the libertarian Cato Institute, so your mileage may vary. It’s entitled “Who Could Have Seen That Coming?”

It discusses, snarkily, the all too earnest presentation of news items where the consequences of dumb policies are presented as surprised.

To economists, they usually are not surprises at all.

We talk a lot about unintended or unanticipated consequences around here, but in these cases the consequences were anticipated and even predicted by a lot of people.

The examples come from three news items where the economics would probably be straightforward for an undergraduate with a semester or two of economics:

• Minimum wage increases are causing the fast food industry to look for ways to automate (price floors on labor will do that)
• Predicted outcomes from clean energy initiatives aren’t materializing (probably because it was just rent seeking to begin with)
• The list price of college is more expensive because we offer a lot of financing options to students (which shift demand to the right).

The overwhelming problem is not that people don’t see these things coming – the author documents that. Rather, it’s that people choose not to listen to the people who tell them their pet project won’t work out the way they hoped.

With fresh students every year, it’s always a good idea to bring back this old Hillary Clinton quote (I’m not even picking on her, it’s just representative of her ilk):

"I'm not going to put my lot in with economists." --after being asked by George Stephanopoulos about economists' claims that her gas tax holiday proposal would not bring down gas prices.

I don’t think Stephanopolous is that great either, but at least he respects a point from principles about the incidence of a tax on a specific product.

Why Is Macro So Hard? Someone Meant Well

There’s a philosophical argument that’s much larger than mere macroeconomics, about the appropriate relationship between the ends and the means of a decision.

Does the means justify the end?

Or does the end justify the means?

There are no answers that satisfy both questions. Indeed, Thomas Sowell argued that one of the big distinctions in the political arena is whether someone is focused on motivations or consequences. Part of the craft of economics is that you need to think about both. Part of the problem with understanding economics is that politicians and bureaucrats appear increasingly skewed towards a focus on motivations at the expense of consequences.

Kevin Williamson, writing at the conservative/libertarian National Review has an excellent take on the problems with motivation as your basis for judgment.

Politicians tell us what a policy is supposed to do, what it is intended to do, and they ask to be judged by their intentions.

That paragraph continues with an extended dig at Obamacare. I’m OK with this, but isn’t good enough to quote … except for the zinger I highlighted in bold, which doesn’t make much sense without the rest of it:

The so-called Affordable Care Act, we were assured, was intended to make health insurance a better value and to make health-care institutions give their customers better service at better prices. Never mind the unspoken premise that is the law’s foundation — “We can radically increase demand for health-care services while reducing costs and improving quality because politicians are magic!” — and its inescapable contradictions. “We meant well,” they say, and that is supposed to be enough.

It isn’t.

This blog is read by non-majors, but the target audience is economics majors. As a major, here’s what your future holds in store:

It falls largely to persnickety, unpleasant eat-your-spinach types, and to certain happy souls blessedly liberated from the romance of politics by events and experience, to document that what is supposed to happen and what happens are not the same thing.

Again, there’s some hyperbole in the middle of the paragraph before another zinger:

You can raise wages at Walmart in the naïve expectation that there will be no consequences — in much the same way that all manner of bad decisions begin with the exhortation, “Here, hold my beer.” But there will be consequences.

I actually kinda’ like that vision. Without advocating alcohol consumption, can you imagine what the legislative process would look like if it was shown as reality TV, with all the legislators holding beers (and some of them probably partaking), and one of them said something like “Here, hold my beer, I’ve got to go pass some new laws.” What would you call such a show — Jacklegislator? OK. My daydream is over.

Economics has sometimes been characterized as the social science of unintended consequences.

Some unintended consequences are unforeseeable, but many are not. They are at least partly foreseeable, even if unintended, and our good intentions do not entitle us to blind ourselves to reality. …

That we can be reasonably sure that there will be unintended consequences does not mean that we know what they will be; these things are unpredictable by nature. …

So, how do we move forward in this sort of world?

[We need to] ask ourselves: How much economic chaos are we willing to accept in exchange for the small probability that we might get what we want out of economic policy? If your answer is “Not much,” then what you want is stable rules and as little policy uncertainty and regime uncertainty as you can achieve. But that means more or less swallowing something close to the whole of free-market economics like a goldfish and leaving very little room for the politicians to engage in policy entrepreneurship. It is easy to understand why politicians oppose that sort of thing.

But why ordinary functioning adults with a passing understanding of how the world works and without brain damage oppose it — and they do — is a mystery.

I’m starting my 27th year as a professor, and it was 9 years before that when I started thinking of being an economist as a career. When I started out I would have thought this viewpoint interesting, but I would have dismissed it as impractical. Two thirds of a lifetime spent watching politicians and bureaucrats get away with a balance shifted too far over towards motivations at the expense of attention to consequences has made me think it may be the only way for a country to consistently succeed.

Read the whole thing entitled “Why Walmart Is Reducing Worker Hours, After Raising the Minimum Wage — and Other Lessons in Reality Read more at: http://www.nationalreview.com/article/423413/economics-good-intentions-don%27t-guarantee-good-results”

Hat tip to Steve Karlson writing at Cold Spring Shops for bringing that article to my attention.

Deficits by Month Instead of by Year

People freak out over government deficits.

Deficits are a flow variable. They are measured over a period of time, and can be roughly proportional to the length of that period of time.

But deficits also have up and downs. There’s a problem that’s been known in time series analysis for a long time, called aliasing. Aliasing is where you average or sum a time series over two or more observations … and the resulting time series doesn’t look like what you started with.

This is a huge problem with deficits. Deficits are supposed to be bad: they wear black hats. Surpluses are supposed to be good: they wear white hat. ;)

The thing is, if you look at deficits month by month, sometimes they’re in deficit and sometimes they’re in surplus. That should mean the economy is being pushing in the wrong and then the right direction.

But no one talks about that.

Instead, what we do is we add up those numbers of one sign (the deficits) and those numbers of the opposite sign (surpluses) until we get a number of the sign we like. Usually that shows a deficit … because deficits are bad … they wear black hats. Boo-wha-ha-ha.

This little bit of statistical sleight-of-hand should make you think twice about taking deficits seriously. I sure hope so.

Anyway, this was all motivated by the biggest monthly surplus in 7 years that occurred in the spring. If surpluses are good, that should have caused the biggest boost to the economy in 7 years. I’m still waiting.

Read about it in the article entitled “U.S. Posts Biggest Monthly Budget Surplus in Seven Years” in the May 12 issue of The Wall Street Journal.

How Worried Should We Be About China?

Outside of macroeconomics classes, the common worry about China is that their economy is big, and growing fast, and will soon be taking over the world … or something like that ;)

Macroeconomists are worried about something different though: how far off from reality are the official numbers announced by China. And, as a corollary, how bad is it?

We also worry about something called the middle income trap. This is the idea that while some countries grow from undeveloped to developed relatively smoothly (think South Korea), others seem to stall once they climb that ladder a ways (think Brazil). Macroeconomists are worried that China’s economy might stall before they become the biggest economy in the world. We really don’t know why economies stall, but a majority of them seem to.

So how does China look to a macroeconomist? The answer is: not great. China has certainly grown extraordinarily over the last 35 years. But the growth is uneven, both regionally and across industries. And there are a lot of warning signs.

As I write this (over several days in July 2015), the Chinese stock market has spent most of the last couple of months crashing. That’s kind of a big deal — more on this towards the end.

I’m not a China expert, but here’s some quotes from someone who is. This is from a post entitled “Considering the Veracity of Chinese GDP” from Balding’s World.

After China released above consensus GDP numbers showing 7% growth, many asked questions about the accuracy of Chinese GDP growth data.  Articles were written by The Economist and Financial Times, by both publications and journalists I respect, essentially arriving at the conclusion that the numbers are good faith estimates, aren’t perfect, can be considered generally accurate, and have the trend right.  I understand this line of thinking but I think this view point fails to grasp the depth of data manipulation that is being thrust upon the world in the world. 

The author then spends several paragraphs getting into the specifics of his own research showing that official Chinese estimates of home price inflation seem to be ridiculously low (I’m not too concerned that you digest all of that). Anyway, 10% inflation in the price of housing, in total, over 15 years, seems ridiculous just about anywhere.

But, recall that real GDP is not measured directly. It’s measured by counting up nominal GDP first, and then removing the effects of inflation. Remove too little inflation, and you’re left with real GDP growth rate estimates that are too high.

… China experienced some of the highest levels of money growth excluding high inflation states; while numerous countries had comparable or higher nominal GDP, China reports inflation levels over the 2000 to 2011 time period less than the United States and among the lowest of even all developed countries.  All of the Chinese real GDP story is dependent on low inflation data.

… To anyone who has spent anytime in China in recent history the question is simple: do you believe the price of renting an apartment has risen in urban areas by less than 10% since 2000?

It cannot be emphasized enough that this is not a rounding error or an accident …

However, it would be a mistake to think this type of behavior has disappeared.  Just this past February a major statistical change was made to GDP numbers that was only uncovered by researchers at McKinsey after numerous people, myself included, expressed surprise at the rapid increase in Q4 2014 consumption.  The NBSC went so far as to note that consumption data in 2014 was not comparable to previous years and this change was found only after inquiries were made by people questioning the data. 

The NBSC is the agency of the Chinese government that compiles macroeconomic data.

Revisions to macroeconomic data are common. The thing is, in other countries, no one does a revision unless it can be compared to previous years.

Throughout the years, China has been a serial GDP reviser with a non-exhaustive list of changes in 2004, 2008, and 2014 though it is quite possible there are others that are either public or non-public with all revisions making significant upward changes.  Furthermore, the NBSC has admitted that it has not standardized the data so almost any year to year comparison over more than a couple years is worthless.  In fact, even when back to back years are non-comparable due to methodological changes, there is no mention of this anywhere on the NBSC website.

This next bit is huge, but you have to put on your statistics hat for a bit:

There is also indirect evidence that Chinese data is less than accurate.  Let me give you two examples.  First, Chinese economic data has virtually no variance …

I start out in principles of macroeconomics by pointing out that routine variation in U.S. real GDP growth rates is much broader than most people recognize, with a standard deviation that’s roughly 2%. That’s not 2% of the growth rate, that’s 2%, so that a plus or minus 2 standard deviation range (approximating a 95% confidence interval) is 8% wide. Normal U.S. real GDP growth runs from –1% to +7%.

Second, China is probably the fastest country in the world to release quarterly and annual GDP. … A mere 15 days after the quarter, China has such efficient statisticians that they have collected a sampling of data and crunched the numbers?  Makes you wonder why companies can’t release quarterly numbers in a few hours.

So what’s the truth?

When studying the Chinese economy, it isn’t enough to say we believe GDP or other data is wrong as we need to have comparable data that allows us to say with confidence what a better figure is.  … common sense should tell us that Chinese GDP growth is much weaker than advertised.

… Producing 7% more as a country and consuming only 1% more electricity would require a monumental shift in production techniques or industrial restructuring for a country of 1.3 billion people in one year.  …

… Look at trade partners where exports to China have absolutely collapsed across a range of products from consumer to industrial inputs and commodities.  Official trade data with imports declining 15.5% …

… absent the stock market boom, Chinese firms saw no profit growth.

…

Finally, I am always puzzled when I hear people talk about the “weak” Chinese economy when they turn around and talk about 7% growth.  The official growth estimate for 2015 has declined from only 7.1% to 7.0% but somehow this 0.1% has sent commodity prices plummeting, close trading partners like Singapore into recession, cause electricity consumption to flatten, and cars sales to evaporate.  …

…

Here’s what’s really scary:

Li Keqiang [the number 2 guy in China’s government] made his now famous remarks about GDP growth in the context that the data he received as a provincial leader was unreliable so he focused on measures that were more difficult to manipulate.  The risk here is that Chinese leaders and other interested parties are receiving manipulated data.  … If Chinese leaders are telling the world how poor the statistical agencies in China are, imagine the reality.

N.B. There’s a little bit of statistical jargon in Chinese economic data. The acronym YOY means “year over year”. It’s basically a growth rate for the last 12 calendar months, not this year’s 12 calendar months.

*************************************************************

Now, what about that stock market boom and then crash? There’s a lot of evidence piling up that that the boom is coming about from lending money to buy stocks (you know … that whole 1929 thingie). Oh, and BTW, this article also notes that Li Kequaing forecast 7% real GDP growth this quarter, and lo and behold, the NBSC says the economy hit it exactly (you know … that whole no variance thingie).

And, the source is wonkie, but the Chinese government tried to rein in that borrowing and lending ( a lot of which is being funded by provincial governments), and failed. The scope of the problem was too large for the solution, so they are now implementing a bigger but more focused second plan that seems to be working better.

And China seems to have triple bubbles. Remember 2007-8 in the U.S., where we had one bubble in primary residential real estate? China has one of those, and it measures out at 3 times the relative size. Oh … and they have the stock market bubble (that seems to be deflating), and the credit market bubble (that the government seems to be trying its hardest to prick).

Inequality: What If No One Has Any Idea What They’re Worried About?

Lots of economists are talking about a working paper that has just come out. Often these can be downloaded for free, but sometimes they are behind walls and cost money. SUU has no budget for this, so as I write this (June 5, 2013), I’m going from quotes rather than the whole paper.

The paper is by Gimpelson and Treisman and is called “Misperceiving Inequality”. What they did was go out and assess 1) whether peoples’ subjective perceptions of inequality matched up with objective measurements, and 2) which was more important for the political itch for income redistribution — subjective beliefs or objective measures.

So, what do people know?

Higher inequality is thought to increase demand for government income redistribution in democracies and to discourage democratization and promote class conflict and revolution in dictatorships. Most such arguments crucially assume that ordinary people know how high inequality is, how it has been changing, and where they fit in the income distribution. Using a variety of large, cross-national surveys, we show that, in recent years, ordinary people have had little idea about such things. What they think they know is often wrong. Widespread ignorance and misperceptions of inequality emerge robustly, regardless of the data source, operationalization, and method of measurement.

And, how is that related to policy pressures?

Moreover, we show that the perceived level of inequality—and not the actual level—correlates strongly with demand for redistribution and reported conflict between rich and poor. We suggest that most theories about political effects of inequality need to be either abandoned or reframed as theories about the effects of perceived inequality.

Those are quotes from the publicly available abstract. Bryan Caplan, writing at EconLog, has a university that actually supports professors reading new stuff that isn’t free. He quotes extensively from the article itself.

The actual poverty rate correlates only weakly with the reported degree of tension between rich and poor; but the perceived poverty rate is a strong predictor of such inter-class conflict.

Given 5 choices, could survey respondents identify the level of inequality in their own country?

Respondents turn out to be wrong about their country's income distribution most of the time. … Respondents worldwide were able to pick the "right" diagram only slightly more often than they would have done if choosing randomly.

Basically, perceptions of inequality are a multiple choice test on which respondents know so little they can’t even narrow down the choices to make a better guess.

But, inequality can follow a progression from more even to less even, so maybe respondents showed some inkling of what’s going on:

Were most people at least close? To check this, we examined what proportion of respondents were within one diagram of the correct one (for instance, if the correct diagram was B, we measured how often the respondents picked A, B, or C). With only five options to choose between, getting within one place of the correct option is not a very difficult task. … they were right 69 percent of the time, just one percentage point better than if they picked randomly.

So, perceptions are about as accurate as guessing the other player’s move in a game of rock-paper-scissors-lizard-spock.

It’s actually worse than that: quite a lot of the time peoples’ subjective perceptions of inequality are often negatively correlated with objective inequality. This is really bizarre: it’s like watching a game and thinking your teams’ turnovers are actually helping them win.

But, it’s even worse than that. No one thinks they’re rich themselves.

Owning two houses is usually a sign of wealth. … At most one in four respondents said that his or her family owned a second residence, and in all but three countries the frequency was less than one in six. Yet most such property owners did not consider themselves especially rich. On average, 60 percent of the secondary residence owners placed themselves in the bottom half of the income distribution. … Such anomalies were somewhat rarer in the developed countries. Still, in France, Italy, and Great Britain, 40 percent or more of second residence owners placed themselves in their country's bottom half.

I could actually put myself in that category. When I was a kid, my parents owned a second home at a summer resort. Now, this was mostly an income property that got rented out … but we spent 2 weeks there every summer too, plus innumerable warm weekends in the spring and fall when my parents worked hard on upkeep and repairs (albeit, in a pretty nice environment where they could relax quite a bit too). I never thought of myself as rich; heck, I still think of my upbringing as middle, or maybe even second quintile from the bottom. I must be some kind of idiot: I make far more money than my dad ever did, plus my wife works, and we’re nowhere near affording a second house.

But it gets even still worse. Check out this chart:

Actual objective improvements in inequality are towards the right, while subjective perceived improvements in inequality are going up. They’re not even positively correlated: when things actually get better people think they’re getting worse. This is like a Patriots fan being upset that they’ve just intercepted the Seahawks on the goal line at the end of Super Bowl XLVIII.

WTF?

And we base policy on this!

How’s This Expansion Doing?

I pulled an interesting graphic from an article about the weakness of the current expansion.

There’s a lot here, and not all of it is good (plus, no graphic designer would ever encourage using the vibrant colors). The colors are there to help the viewer keep track of years by going in a ROY G. BIV ordering, except with darker and lighter gray substituted for the R and the O, and with them totally ignoring indigo because … well … everyone else does, or something like that.

Anyway, what I really liked was the panel at the bottom left. This shows the cumulative real GDP growth after each trough since the late 1940’s.

One note of caution: the white area at the right of some of the bars shows all the growth for years past the 6th one. So, there’s only three expansions that went that long, but for each of them there was still significant growth … and under Clinton it was almost half of the growth from the expansion.

What’s the takeaway from that panel? First off, the partial rainbow of colors shows that this expansion is already longer than most of them. Second, the cumulative growth in this expansion is particularly weak: the expansions that weren’t as strong as this one were weak because they were already done by this point. Third, there really isn’t a sense that this expansion is weak because it was weak at one particular point. It’s been weak throughout.

And that’s an important point. I tend to be an apologist for the Obama record. It’s not great, but it’s on the low end of normal, and good enough to stay let’s wait and see. But a graph like this emphasizes my feeling that the longer we go with that story, the harder it becomes to rationalize. The pervasive weakness with each passing year suggests that there’s something holding the economy back over the medium term that just isn’t going away, and wasn’t there before Obama came along.

This is drawn from an article entitled “Economy Picks Up But Stays In It’s Rut” which appeared in the July 31 issue of The Wall Street Journal. The charts came from a companion piece entitled “Six Year Checkup”.

Prosperity

This map of the Legatum Prosperity Index gives a good summary of what macroeconomists mean when they talk about rich and poor countries, or developed and developing countries.

I believe this is for 2013 (or 2012): for later years I couldn’t find the map in a standalone form. You can go to prosperity.com where they have interactive versions if you want greater detail.

This hits the right notes though. The dark countries are rich and/or developed. This is the U.S. and Canada, western Europe, Australia and New Zealand, and Japan and South Korea. South Korea is the newest addition to the list. Singapore is probably on there, but too small to see. Taiwan should be on there, but China bullies them, lowering some scores. Israel would be on there, but gets marked down for safety and security due to terrorist threats and actions. They’ve put a couple of Persian Gulf countries in this group, which is OK, but I wonder if the whole society there feels like they’re living in a developed place. Lastly there’s Uruguay. This country is doing OK, but that shading is driven a lot by huge decreases in the enforcement of drug laws there over the last few years. I’m not against that, but I think it might be overrated. I think Chile is better developed top to bottom. Italy probably should be included in the dark blue group; this may be an effect of the poorer southern parts outweighing the richer northern parts.

The light blue is the countries that are doing pretty well. The orange countries, not so well. The red ones are doing poorly.

And don’t forget about the gray countries. They’re labeled as “No Data”. Typically this means they don’t collect or don’t report the data that underlies this index. Often, this is because of mismanagement: if you’re a kleptocrat, no one can tell what you stole if no one is measuring it. So some of these are places that just don’t cooperate with anyone (like North Korea and Cuba), kleptocracies (like Myanmar/Burma, or Turkmenistan), some are failed states (like Somalia and LIbya), some are too new (like South Sudan or Papua New Guinea), and some are still colonies (like Greenland, or Western Sahara).

N.B. There’s a statistical fact that you can’t rank, say, n items if you have less than n pieces of data. The most familiar example of this is college football rankings; who’s the best if South Florida beats Notre Dame, Notre Dame beats Michigan State, and Michigan State beats South Florida (this is the example that I found with many seconds of searching on the google, but it happens a lot). We also see this in things like U.S. News and World Report’s famous ranking of colleges. And we see it in things like this prosperity index. We work around that by assigning weights to the different components, and then taking a weighted average. The thing is, if a different person makes up the weights, it can yield a different ranking. Just keep in mind that you’re really looking for plausibility, rather than definitiveness. So, when I say Israel should be higher and Uruguay should be lower, that’s a personal opinion … but don’t presume that the numbers say that’s not correct just because we used one websites weights.