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What's Holding the Economy Back: Revised Version Print
Monday, 04 August 2014 20:26

In the NYT Upshot section Neil Irwin had an interesting piece assessing which sectors are most responsible for the weakness of the economy. His culprits (in order) were residential invesment (housing), state and local government, durable goods consumption, business equipment investment, and federal spending. Irwin's methodology was to take the Congressional Budget Office's estimate of potential GDP (roughly 5 percent higher than the current level) and then assume that each component has the same share of this potential as its average of GDP over the two decades from 1993 to 2013. The difference between this hypothetical level of demand from a component and the actual level of demand from that component in the second quarter of 2014 is the basis for determining the shortfall.

I decided to do a similar exercise with a couple of minor differences. The table below shows the difference between each component's average share of GDP in the period from 1990-2013 (this was an accident -- misread Irwin's start point) and the average for the first two quarters of 2014. The two quarters are taken together because for many components a strong second quarter offset a weak first quarter. I have also lumped components together (e.g. the categories of consumption are all together). The categories in bold are the major components that together add to GDP.

  Percentage Point Change
  Average 1990-2013
  Minus 2014
Consumption expenditures -2.3
Durable goods 0.7
Nondurable goods -0.1
Services -2.9
Nonresidential investment 0.0
Structures 0.0
Equipment 0.4
Intellectual property products -0.4
Residential 1.1
Change in inventories -0.1
Net exports 0.3
Exports -2.7
Imports -3.0
Government 1.1
Federal 0.5
State and local 0.5

 Source: Bureau of Economic Analysis, National Income and Product Accounts, Table 1.1.5.

 

There are a few points that can be made from this table. First, the items that have fallen substantially as a share of GDP are government spending, which had roughly equal dropoffs at the federal and state and local levels, and residential construction. Net exports are also down as the import share had grown more than the export share. Non-residential investment is at its average level for the 1990-2013 period. The big gainer in shares is consumption, which had a 2.3 percentage points larger share of GDP in 2014 than its average in the prior period.

Read more...

 

 
Pension Returns Depend on the Start Point Print
Monday, 04 August 2014 04:57

A New York Times article on New York City's pension funds implied that its assumed rate of return going forward is too high based on past returns over a highly selective period:

"But excessive optimism can lead to financial disaster, because regular shortfalls could ultimately leave the city unable to fulfill its required payouts. For years, the investment return expectation was set at 8 percent. In reality, the system’s returns have often fallen well short of that, earning just 2 percent on average from 1999 to 2009, for instance."

It should not have been surprising that returns would be well below 8 percent in a period that started in 1999 when the price to trend earnings ratio in the stock market was close to 30. The funds should have adjusted their return projections downward in line with the unprecedented run-up in the stock market.

On the other hand, the fact that it is possible to find a year where the market has slumped badly and thereby provided very low returns is completely irrelevant to the a pension fund that in principle can exist forever. It had no need to cash out large amounts of its holdings in 2009, nor is there a plausible scenario in which it would. Of course returns have been far above the 8 percent average in the years since 2009, as the piece notes.

Given this reality, it is entirely reasonable for pensions to use the expected rate of return on their pension assets as the discount rate for future liabilities. This would lead to the smoothest flow of funding. The alternative risk-free rate which is advocated by this article (it uses it in the main chart) would effectively have pensions pre-fund their obligations so that future payments would be much lower relative to revenue. This would be equivalent to building up a large account so that the police or fire department could be paid out of the interest. No policy experts would advocate such an approach.

The piece also misleadingly blames pensions for cutbacks in city programs;

"Already, the growing sums consumed by the pension funds have forced officials to scrimp on certain programs or abandon them, said Marc La Vorgna, a press secretary during Mr. Bloomberg’s administration. One casualty was the Advantage program, which helped homeless people move out of shelters and into apartments. It was eliminated in the Bloomberg administration."

It is equally accurate to say that these programs were only possible (assuming no other revenue or spending cuts) because the city wasn't meeting its obligations to the pension funds. In other words, rather than paying for possibly worthwhile programs, the city was taking the money from its workers' pay in the form of their pensions. It seems more than a bit misguided to blame the pensions for putting an end to this practice.

The points the article makes on the needless cost of investment advisers and questionable returns from private equity investments are well-taken.

 
Trade, Wages, and Jobs Print
Sunday, 03 August 2014 11:02

I see that Gary Hufbauer and Cathleen Cimino have responded to my earlier post criticizing their colleague Adam Posen's Financial Times column touting the wonders of trade. They cover a lot of ground in their response, but I will just address two main points:

1) The pattern of trade that we have put in place over the last three decades has been a major factor reducing the wages of most of the work force (the 70 percent that lack college degrees).

2) The large trade deficit that we have at present is costing the country millions of jobs. If we eliminated the deficit, the direct and indirect effect would lead to roughly 6 million additional jobs, enough to bring the economy back to full employment.


On the first point, Hufbauer and Cimino (HC) focus largely on the impact of NAFTA. Certainly the impact of NAFTA would be considerably less than trade more generally since Mexico only accounts for about 8 percent of our imports and only about 60 percent as much as we import from China. In my column I was referring to the impact of trade more generally on wages, following Posen's piece which was a diatribe about progressives and trade.

While HC are dismissive of the idea that trade can have much negative impact on wages, it is not necessary to look far to find evidence of this effect. Lindsey Oldenski's, whose work is cited by both Posen and by HC, recently wrote a paper which has the following in the abstract:

"I fi nd that o ffshoring by U.S. firms has contributed to relative gains for the
most highly skilled works and relative losses for middle skilled workers. An increase
in off shoring in an industry is associated with an increase in the wage gap between
workers at the 75th percentile and workers with median earnings in that industry,
and with a decrease in the gap between workers earning the median wages and those
at the 25th percentile. This pattern can be explained by the tasks performed by
workers. Off shoring is associated with a decrease in wages for occupations that rely
heavily on routine tasks and an increase in wages if the occupation is nonroutine and
communication task intensive."

I referred to work by David Autor, which also finds a substantial negative impact of trade on the wages of less educated workers as well as a recent analysis by Paul Krugman that suggested the expansion of imports from China likely has a large negative impact on the wages of less-educated workers. At this point, the fact that trade has had a negative impact on the wages of a large segment of the U.S. workforce really should not be controversial. The question is the size.

Read more...

 

 
New Drugs Competing With Sovaldi Is Evidence of the Inefficiency of the Patent System Print
Sunday, 03 August 2014 08:35

The NYT tells us the good news on the cost of giving people Sovaldi for treating Hepatitis C. First, the annual costs are likely to fall in the years ahead as the backlog of people with the disease are cured and the numbers needing treatment declines sharply. Second, new effective drugs will come on the market and compete with Sovaldi, driving the price down.

In a context where the government gives Savaldi a patent monopoly it is good to have multiple drugs that can provide competition. However from the standpoint of the efficiency of the drug development process this implies an enormous amount of waste.

Once an effective treatment for Hepatitis C has been developed, there is little medical benefit in having a second or third effective treatment. The resources to develop these alternatives to Sovaldi could have been much better utilized researching treatments for diseases which do not presently have a cure. However the incentives provided by the massive patent rents being earned by Gilead Sciences (the patent holder for Sovaldi) give a huge incentive to other companies to carry through duplicative research. If anyone cared about efficiency in the health care system this point would be widely publicized.

 
Japan Does Not Have a Demographic Time Bomb Print
Sunday, 03 August 2014 08:28

The "hard to get good help" crowd continue to dominate reporting at the Washington Post. An article on Japan's efforts to facilitate women returning to jobs after childbirth told readers:

"Japan is sitting on a demographic time bomb: With its low birth rate, the population is on track to shrink 30 percent by 2060, at the same time 40 percent of its citizens will hit old age."

There is no time bomb. Japan, like most countries, has seen an increasing ratio of retirees to workers. This has been going on for a century. This increase has been associated with rising living standards because of increases in productivity. By all projections, productivity in Japan will be vastly higher in 2060 than it is today, which means that both workers and retirees will be able to enjoy higher living standards even though there will be a lower ratio of workers to retirees.

As labor markets tighten in Japan, workers will go from less productive to more productive jobs. This will mean that people who want workers for menial jobs such as cleaning their house or tending their garden will have to pay more money. This is bad news for them, but it does not amount to a time bomb for the country.

 
Inequality: Don't Blame the Market Print
Sunday, 03 August 2014 07:58

Zachary Goldfarb has an interesting analysis of trends in before and after-tax income inequality in the Obama years. However he is mistaken in attributing the rise in before-tax inequality to the market rather than deliberate policy choices.

For example, the big banks still exist today because the government had a policy of saving them from the market. They would have managed to put themselves into bankruptcy in 2008 without huge amounts of below market loans and implicit and explicit guarantees from the government. In the wake of this history, the income and wealth of most of the financial sector can hardly be viewed as a market outcome. (The financial sector also profits by being exempted from taxes that apply to other industries.)

Globalization has increased inequality because of the way the government structured trade. It has designed trade agreements to put downward pressure on the wages of manufacturing workers by putting them in direct competition with their much lower paid counterparts in the developing world. It could have designed trade agreements to make it as easy as possible for people in the developing world to train to our standards as doctors, lawyers, and other professionals and then to compete freely in the U.S. market with native-born professionals. This pattern of trade would have yielded enormous benefits to the economy by reducing the cost of health care and other services, while reducing inequality. The fact that we did not go this way was a policy decision, not a market outcome.

In the same vein, the fact that many products, most notably prescription drugs, sell for high prices is due to government granted patent monopolies. The Hepatitis C drug, Sovaldi, which is being sold by Gilead Sciences for $84,000 for a 3-month treatment, would sell for less than $1,000 in the absence of a patent monopoly. The difference is overwhelmingly a transfer from everyone else to the wealthy. Patent monopolies transfer hundreds of billions of dollars a year to patent holders, who are overwhelming high-income households.

Finally, by running a high unemployment policy the government is transferring money from low and moderate income people to the higher income people. We could bring the unemployment rate down to 5.0 percent or possibly 4.0 percent with larger government deficits or a lower valued dollar, which would reduce the size of the trade deficit. The lower rate of unemployment would not only give millions more people jobs, it would also give workers in the bottom half of the wage distribution the bargaining power necessary to raise their wages. These workers would then have more money, while high income households would have to pay more for help.

In short, there are a whole list of easily identifiable policies that have fostered the large upward redistribution we have seen in the last three decades. It is not just the market.

 
Is There Any Way That Weak Employment Numbers In Europe Might Bolster Concerns That Most Economists Are Right About Government Stimulus Print
Friday, 01 August 2014 05:28

A New York Times article on new economic data from the euro zone noted a 0.1 percentage point rise in the unemployment rate in France. It told readers that this rise (which is almost certainly not statistically significant):

"is likely to bolster concerns that France is stuck in an economic rut and politically incapable of making changes to labor rules or putting in place other overhauls needed to improve economic performance."

There is no one quoted making this claim, it is simply an assertion of the article. In this context, it is worth noting a piece in the NYT Upshot section by Justin Wolfers, which was also highlighted in Paul Krugman's column today. Wolfers noted the nearly unanimous view among the economists surveyed by the University of Chicago's Initiative in Global Markets that President Obama's stimulus created jobs and that it was more than worth its cost.

In the economics profession there is not much dispute that additional government spending in a depressed economy will lead to more jobs and growth. However, this view appears to have no place in the NYT's reporting on Europe's economy, instead we get unattributed assertions about bolstering concerns.

 
More Fun With Budget Numbers: Frat Boy Reporting at the New York Times Print
Friday, 01 August 2014 04:58

The NYT gave us a prime example of frat boy budget reporting today, presenting readers with really big numbers which mean almost nothing to any of them. The article referred to the Senate passage of bills providing funding for veterans health care and transportation. It told readers:

"Prompted by the long waiting lists at veterans’ health centers and the bureaucratic efforts to hide them, the $17 billion bill aims to clean up the scandal-scarred Department of Veterans Affairs by granting the agency’s secretary broad new authority to fire and demote senior executives.

"It would also authorize the leasing or construction of 27 new health facilities; and set aside $5 billion to hire doctors, nurses and other health care providers, and $10 billion to pay for veterans’ care at private and public facilities not run by the department."

Anyone know how large a share of the budget $17 billion is? Will it bankrupt our kids? Are the $5 billion for hiring doctors and $10 billion for care at private facilities in addition to or part of the $17 billion? Is this for one year or multiple years?

(The cost is approximately 0.45 percent of annual spending. The spending on doctors and private care is part of the $17 billion. It seems to cover multiple years [reducing its share of spending], but a quick look at the summary doesn't make the time period clear.)

The article also told readers:

"The Senate bowed to the House, which had approved an $11 billion measure financed largely by a sleight of budgetary hand that avoids any tax increases. Under the maneuver, known as “pension smoothing,” corporations will be allowed to set aside less money for pensions, which will increase profits and raise business tax receipts."

The $11 billion comes to 0.3 percent of annual spending. This spending also covers multiple years, although the time period is certainly not clear from this article.

Anyhow, this should be really good one for the fraternity of budget reporting. It provides virtually no information to readers but apparently meets the quality standards of the NYT. 

 
Larry Kotlikoff Tells Us Why We Should Not Use Infinite Horizon Budget Accounting Print
Thursday, 31 July 2014 21:23

In a New York Times column, Boston University economist Larry Kotlikoff told readers why we should not use infinite horizon budget accounting. Kotlikoff showed how this accounting could be used to scare people to promote a political agenda, while providing no information whatsoever.

For example, after telling us how much money his 94-year-old mother is drawing from Social Security and a widow's benefit from his father's job he ominously reports:

"you’ll find that the program’s unfunded obligation is $24.9 trillion 'through the infinite horizon' (or a mere $10.6 trillion, as calculated through 2088). That’s nearly twice the $12.6 trillion in public debt held by the United States government."

Are you scared? Hey $24.9 trillion a really big number. That's more than even Bill Gates will see in his lifetime. Does it mean our kids will be living in poverty?

Not exactly. Kotlikoff could have pulled a number from the same table in the Social Security trustees report to tell readers that the unfunded liability is equal to 1.4 percent of future income. If we just restrict our focus to the 75-year planning horizon (sorry folks, we don't get to make policy for people living 100 years from now), the shortfall is 1.0 percent of GDP.

That's not trivial, but it is considerably less than the combined cost of Iraq and Afghanistan wars at their peak. Furthermore, if we go out 40 years and assume that our children get their share of the economy's growth (as opposed to a situation in which it all goes to Bill Gates' kids), their before tax income will be more than 80 percent higher than it is today.

This means that even if they pay 2-3 percentage points more in Social Security taxes to cover the cost of their longer retirements (they will live longer than us), they will still have incomes that are more than 70 percent higher than we do today. Are you scared yet?

Read more...

 

 
How Do You Spell "Inflation Hawks on the Warpath?" ECI Print
Thursday, 31 July 2014 08:36

The release of new data from the Employment Cost Index (ECI) has the inflation hawks really excited. It showed that compensation rose by 0.7 percent in the months from March to June. This is a sharp uptick from the 0.3 percent rate in the months from December to March. This could be just what is needed to force the Fed to raise interest rates to slow the economy and keep people from getting jobs. That's pretty exciting stuff.

Before we start designating people to give up their jobs in the war against inflation, it's worth looking at the data a bit more closely. The 0.3 percent ECI growth reported for the winter months was actually unusually low. It had been rising at a 0.5 percent quarterly rate (2.0 percent annual rate) for the last four years. Fans of arithmetic can average together the 0.3 percent measure from the first quarter with the 0.7 percent measure from the second quarter and get (drum roll, please) ....... 0.5 percent. 

In other words, the 0.7 percent rise in the ECI kept exactly on the growth track we have been for the last four years. It is not evidence of an uptick in the rate of wage growth (which would be good news).

Employment Cost Index

ECI-2014-2

                                                  Source: Bureau of Labor Statistics.

 

Addendum:

Since there are people who see the rise in the second quarter ECI as a serious inflation threat, a few more data points may be helpful. The rise in the ECI for state and local employees was unchanged at 0.5 percent in both the first and second quarters. On the private side, the wage index went from a rise of 0.2 percent in the first quarter to 0.8 percent in the second quarter. The benefits index rose 0.3 percent in the first quarter, compared with 1.1 percent in the second quarter.

This leaves us with two possible explanations. The first is that the rate of increase in wages and benefits in the private sector slowed sharply in the first quarter and then accelerated even more sharply in the second quarter. Alternatively, the ECI under-reported wage and benefit growth in the first quarter. This means that if the trend growth was unchanged, we would find the sharp uptick in wage and benefit growth reported in the second quarter data.

When we look at a finer cut of the data it certainly seems consistent with the second story. For example, the increase in compensation for management, business, and financial occupations was 0.0 percent in the first quarter. It was 1.2 percent in the 2nd quarter. The increase in compensation for health care and social assistance industries was -0.3 percent in the first quarter. It was 0.6 percent in the second quarter. Does anyone believe that the world really looks like this?

 

 
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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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