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The Fed, Inequality and Accounting Identities Print
Monday, 03 June 2013 09:21

Annie Lowrey at the NYT continues a mini-debate about whether the Fed is promoting inequality with its quantitative easing program. The argument is that by pushing down interest rates it is contributing to the run-up in stock prices and housing prices. Since stock is hugely disproportionately held by the wealthy and homeowners are better off than the population as a whole, this policy is increasing inequality.

This is undoubtedly true, although the extent of the impact can be debated. (High corporate profits are also a big factor behind the rise in stock prices. Also, they began their run-up at unusually depressed levels.)

However, a little income accounting here would go along way in helping this discussion. The country has an output gap of around 6 percent of GDP. This is due to the plunge in residential construction following the collapse of the housing bubble and also the lost consumption that resulted from the loss of $8 trillion in housing equity. Standard measures of the housing wealth effect imply that a reduction of $400 billion to $560 billion in annual consumption.

There are a limited number of channels to fill this lost demand and thereby make up the 9 million jobs deficit we now face. One route is large government deficits, either from increased spending or tax cuts. That is probably the quickest and surest way to make up the demand gap, but the Serious People insist that we can't run large deficits.

Another obvious route, and probably the best long-term solution, is to get the dollar down. This will improve the international competitiveness of U.S. goods and bring the trade deficit closer to balance. Unfortunately this has not been a high priority for the Obama administration. There are powerful interests like Walmart, many large manufacturers, and the financial sector which benefit from an over-valued dollar. As a result, getting the dollar back to a more sustainable level has not been a priority for the administration.



Larry Summers Still Hasn't Heard About the Stock Bubble Print
Monday, 03 June 2013 07:02

It looks like more trouble with Harvard economists (e.g. Reinhart-Rogoff). It seems Larry Summers, who was Treasury Secretary in the last two years of the Clinton administration, is still unaware of the stock bubble that propelled growth in those years.

In a Post column today he tells readers:

"As a consequence of policy steps in 1990, 1993 and 1997 [deficit reduction measures], it was possible by 2000 for the Treasury to retire federal debt. Deficit reduction and the associated reduction in capital costs and increase in investment were important contributors to the nation’s strong economic performance during the 1990s, when productivity growth soared and unemployment fell below 4 percent. We enjoyed a virtuous circle in which reduced deficits led to lower capital costs and increased confidence, which led to more rapid growth, which further reduced deficits."

Of course the reason that the country was repaying debt was that a $10 trillion stock bubble led to an investment boom (much of it in junk dot.com investment) and a much larger consumption boom through the stock wealth effect. This bubble fueled the strong growth at the end of the 1990s.

While the growth and resulting low unemployment rate were great news, bubbles are inherently unsustainable. This bubble burst beginning in 2000 and led to the recession of 2001. It is difficult to recover from a recession caused by a bursting bubble. The economy did not begin to create jobs following the 2001 recession until September of 2003. It did not make up the jobs lost in the downturn until January of 2005. Until the current downturn this was the longest period without job growth since the Great Depression.

The demand from the stock bubble was necessary to support the economy as a result of large trade deficit the country was running at the time. Robert Rubin, Larry Summers' predecessor as Treasury Secretary, pushed a strong dollar policy. He put force behind this policy with his control of the IMF's bailout from the East Asian financial crisis. The sharp run-up in the value of the dollar over these years made U.S. goods uncompetitive in the world economy leading to a sharp rise in the trade deficit. The deficit eventually peaked at 6.0 percent of GDP in 2005. The demand from the stock bubble and later the housing bubble were needed to offset the demand lost due to the trade deficit.

It is remarkable that Summers does not seem to be aware of this history, but I guess economics at Harvard is different from economics elsewhere in the world.

Robert Samuelson Says that Apple Has More Lines of Business Than It Can Reasonably Manage Print
Monday, 03 June 2013 04:32

Actually he made the claim about the government, telling readers:

"Since World War II, American government has assumed more responsibilities than can reasonably be met. Some are unattainable; others are in conflict. Government is, among other things, supposed to: control the business cycle, combat poverty, cleanse the environment, provide health care, protect the elderly, subsidize college students, aid states and localities. There are more. Most are essentially postwar commitments. As I’ve written before, government becomes almost “suicidal” by pervasively generating unrealistic expectations. The more people depend on it, the more they may be disappointed by it."

 It's not clear which items on this list are unattainable -- cleanse the environment, protect the elderly, aid state and local governments -- we've done all of these things with a fair amount of success over the last five decades. Other countries provide health care and have done a much better job of combating poverty and supporting colleges students. Samuelson doesn't present any evidence that people in the United States are less competent than people in Germany, Netherlands, or the Nordic countries. Why should we think we can't follow their examples?

As far as controlling the business cycle, some of us have been (following Keynes) calling the shots pretty well in terms of the severity of the downturn from the collapse of the bubble, the difficulty of the recovery, and the impact of cuts in government spending. If Samuelson't point is that Keynesians have been kept from controlling policy, he's right, but that's just saying that people who share his view of the economy may not be able to control the business cycle, but they have enough control of the political situation to keep Keynesians from setting policy.

In short, there is not much here. Samuelson has zero evidence that the government can't carry through the responsibilities people have come to expect from it. Other governments do quite successfully. In fact, Samuelson's whole framing of the issue is deceptive since we don't have much choice about government involvement in many areas. What would health insurance look like without the government regulation? Would insurers pick up six figure annual bills for cancer victims if they need not fear the heavy hand of the state?

Just as Apple has been able to expand from being a computer manufacturer to being a cell phone company, and a provider of on-line music and books, there is no obvious reason that the government can't take on additional responsibilities through time. The serious question is how best to set the role of government in various sectors, not to repeat a line, like something your parents told you, that "government is too big."

One other point, Samuelson again expresses his admiration for Volcker's use of a recession to attack inflation. He tells readers:

"The subduing of double-digit inflation triggered a 25-year economic boom. As important, it demonstrated that government could govern. Seemingly intractable problems (in 1980 runaway inflation was the country’s No. 1 problem) could be mastered. Optimism revived."

There are two data points that make Volcker's accomplishment look less impressive. Inflation fell everywhere in the world in the early 1980s, including in countries that did not have as severe a downturn as the United States. A major factor was the collapse of world oil prices, which presumably would have happened with or without Volcker's recession, although the reduction in demand certainly hastened the fall.

The other data point is that the "25-year economic boom" was not quite as impressive as Samuelson might have us believe. Economies generally grow, the issue is the rate of growth. In the years from 1981 to 2007 growth averaged 3.1 percent a year. In the prior 25 years it averaged 3.5 percent. (I took 1981, the prior business cycle peak because it doesn't make sense to measure growth from a trough which measures the severity of the downturn. That approach would make Volcker's boom look better if he had engineered a more severe downturn.)

Look Mom, No Patents: Cheap Test for Cervical Cancer Developed With Public Funding Print
Sunday, 02 June 2013 20:09

Great story in the Washington Post (in the sense of very good news) about the successful trial in India of a cheap vinegar test for cervical cancer. According to the article this cheap and easy to administer test can substantially increase the early detection of this cancer. This test can save the lives of tens of thousands of women in India and elsewhere in the developing world who do not have access to more expensive tests.

An interesting and important sidebar is that it seems that this test was developed with support from the National Institutes of Health and an Indian non-profit. This perhaps should not be surprising, but many advocates of patent supported research insist that people become stupid when they get public funding. The success of this test, which holds the promise of enormous gains in public health, shows again that it is possible to have innovations that do not depend on patent support.

Health Care Costs: Don't Blame the Free Market Print
Sunday, 02 June 2013 07:36

The NYT has a very interesting piece documenting how much more people in the United States pay for a wide variety of medical procedures and drugs. While the article provides much useful information, it badly errs in telling readers (in a quote from David Blumenthal, the President of the Commonwealth Fund) that the cost problems stem from a free market.

In fact, one of the main reasons that the United States pays so much for health care, including the items listed in this article, is precisely because it does not have a free market in large sectors of the health care industry. Of course it severely restricts the admission of immigrant doctors into the country, driving up the pay of physicians to two or three times what they would receive in other wealthy countries.

Perhaps more importantly, it grants patent monopolies to drugs and medical devices. These monopolies allow pharmaceutical companies and manufacturers of medical devices to charge prices that are many thousand percent above their free market price. Not only does this raise the cost for these items it also perversely is likely to lead to unnecessary procedures, like the proliferation of colonoscopies that are a main theme of the piece.

Because the equipment used in colonoscopies is subject to patent protection, hospitals and other medical facilities are able to charge exorbitant prices. Since colonoscopies provide large profits (which would not be the case in a free market), there is a strong incentive to push their use on patients in circumstances where they may not be needed.

This is a more general problem in U.S. medicine. Because drug companies can sell drugs for hundreds or even thousands of dollars per prescription, when they can be profitably sold for $5-$10, they have an enormous incentive to mislead the public about the safety and effectiveness of their drugs.

This is why we regularly see stories about drug companies concealing evidence that their drugs are ineffective or even harmful. That is a direct result of the enormous mark-ups that are provided by patent monopolies. If drugs were sold in a free market these incentives would not exist.

Patent monopolies are one mechanism to provide an incentive for innovation, however they are a tremendously inefficient mechanism. There are other possible routes for financing innovation (the government already spends $30 billion a year on biomedical research through the National Institutes of Health).

Of course the industry will fiercely contest any changes that threaten their profits, but no alternatives can even be considered until the public understands the nature of the problem. This piece missed a great opportunity to inform readers.

In Spite of Washington Post's Warnings, Military Cuts Don't Appear to be Devastating DC Area Economy Print
Sunday, 02 June 2013 07:30

Last year the Washington Post was anxious to highlight claims from the military industry that the military side of the sequester would have severe economic consequences especially in the DC area (e.g. here and here). Thus far it doesn't seem to have worked out that way. Industry groups tend to exaggerate the general impact of policies that will hurt them directly. Unfortunately the Post apparently is not aware of this fact, at least when it comes to defense related industries.



The Post did run its own piece making this point last week.

Post Gives Us the Bad News on Medicare, Good News May Reduce Pressure for Change Print
Saturday, 01 June 2013 07:51

The Washington Post long ago eliminated any distinction between news and opinion in its reporting on Social Security and Medicare. Keeping with this pattern, it ran a front page editorial that gave us the bad news from the Medicare and Social Security trustees reports released yesterday.

"And on Friday, analysts worried that the sunnier projections, together with an improving economy and a rapidly shrinking federal budget deficit, could serve to further dampen enthusiasm in Washington for tackling the nation’s toughest fiscal problems."

Of course not all "analysts" were worried about the modest improvement shown in the Medicare trustees report and the modest improvement in the economy delaying action on "the nation's toughest fiscal problems." That was only the view of analysts whose views the Post chose to present to readers. Other analysts would have pointed out that Medicare costs are more a problem of the broken U.S. health care system (we pay more than twice as much per person for our health care than people in other wealthy countries) than a fiscal problem.

Other analysts would have also pointed out that the impact of the tax increases potentially needed to fund these programs on the living standards of most workers are swamped by the impact of the upward redistribution of income that we have been seeing over the last three decades. To obscure this fact the Post included a comment from the two public trustees, Robert Reischauer and Charles Blahous that could only have the effect of misleading the overwhelming majority of readers:

"'Even if a Social Security solution were enacted today and effective immediately, it would require financial corrections that are substantially more severe than those enacted' in the last major reforms to Social Security in 1983, they wrote in a message included in the report."

It is highly unlikely that even one percent of the Post's readers know the extent of the reforms implemented in 1983. It is possible that they do remember the tax increases and benefits cuts that were put in place in the 1980s. Most of these had already been in law, although they were moved forward by the 1983 reforms. The payroll tax for Social Security was increased by 2.24 percentage points over the course of the decade. In addition, the self-employed were required to pay the employer side of the tax as well. Since roughly 9 percent of the workforce is self-employed, this amounts to the equivalent of a 2.8 percentage point increase in the tax.

In addition, the Medicare tax was also increased by 1.9 percentage points over the course of the decade. This brings the total tax increase to 4.7 percentage points. Also, the age for collecting full benefits for Social Security was increased from 65 to 67. This increase is being phased in for people reaching age 62 in the years 2002 to 2022.

If Congress were to implement changes to the programs comparable to the ones that were actually put in place in the decade of the 1980s, it would be more than sufficient to keep them fully funded for the rest of the century according to the most recent trustees reports. If the Post had written a news story intended to inform readers it would have pointed this fact out as a clarification of the comments by Reischauer and Blahous, if it included their comments at all.

However, since this piece was written to promote the Post's agenda of pushing cuts in these programs, it opted not to put the Reischauer-Blahous statement in a context that would have made it understandable to most readers.


Capital Gains Are Causing Income to Exceed Output and Economists Are Surprised Print
Friday, 31 May 2013 16:41

Ok folks, this one is a little nerdy, but there are some important issues here. In the last year or so the Bureau of Economic Analysis' measure of national income growth has exceeded its measure of GDP growth. This has led some analysts to jump on the income numbers and say that the economy is actually growing somewhat more rapidly than the GDP measures that were routinely follow, which are measured on the output side.

Just to backtrack for a moment, in principle we should be able to measure GDP on either the income side or the output side and come up with the same number. The income side means that we add up all the incomes generated in production: wages, interest, profits, rents, etc. On the output side we would be measuring the value of all the goods and services produced over the course of a quarter or year. If we had perfect measurements of the economy then the two should end up being the same.

As a practical matter they never are the same. Most often the output side is somewhat higher (@ 0.5 percent) than the income side. The conventional wisdom is that income is more poorly measured because people have a reason to lie about their income (i.e. taxes). So economists have traditionally looked at the output side as the better measure of growth.

While the output side has historically shown a somewhat higher measure of GDP, there have been some exceptions to this, most notably in the late 1990s and the peak of the last business cycle. These were both periods in which there were large amounts of capital gains generated by bubbles in the stock market in the 1990s and housing market in the last decade.

While capital gains are not supposed to count as income for GDP purposes, it is almost certain that some do. (Short-term capital gains are taxed the same way as normal income, so there is no reason for people to distinguish between capital gains and normal income on tax forms.) Anyhow, if we hypothesize that some amount of capital gains end up being counted as normal income then any time we have more capital gains in the economy we would expect that the income side measure of GDP would rise relative to the output side measure.

David Rosnick and I tested this view a couple years back, measuring the extent to which the statistical discrepancy (the gap between the output measurement and income measurement of GDP) fluctuated in response to recent trends in capital gains. And, we got a very solid fit. So we were not surprised when the recent run-up in the stock market, coupled with a recovery in the housing market, caused income growth to again exceed output growth. But hey, there can be lots of good jobs struggling over this one.

Anyhow, this matters both for the answer to the question as to how fast the economy is growing, but also how we view savings. Savings are defined as the difference between income and consumption. If capital gains are showing up as income, then we are overstating income and therefore overstating savings. We think this was very likely the case at the peaks of both the stock and housing bubbles, which means that the consumption driven by these bubbles was even larger than the conventional data show.


Note: Typos corrected -- thanks Joe and Medgeek.




Growth, Debt, and Assets: Why Politicians are Better at Economics Than Economists Print
Friday, 31 May 2013 09:08

The wealthy countries of the world have spent the last three and half years falling off a 90 percent debt-to-GDP growth cliff that we should now all be able to agree does not exist. While I am happy to see that economists have been able to demonstrate conclusively that the world is not flat, I will just quickly explain again why I always knew this fact.

As I have explained numerous times, in addition to debt, governments also have assets. In fact, governments routinely sell assets, not just out of ideological or corruption driven privatization drives, but in the normal course of events they will have occasion to sell off items like land, unneeded office space, portions of the broadcast spectrum, etc.

If there were some serious growth penalty associated with certain debt levels then it would imply that selling off assets would give an above market return. Not only would the government get the market price for whatever asset it was selling, but it would also lead to a growth premium as a result of pushing its debt lower. In the case of the Reinhart-Rogoff cliff story, this premium would be enormous since we could envision raising growth by a full percentage point by selling enough assets to lower our debt-to-GDP ratio from 95 percent to 85 percent (roughly $1.6 trillion in assets).

We don't typically see governments selling assets for this reason. This would suggest that either governments were very dumb for not taking advantage of an easy way to boost growth or that debt does not have the negative impact on growth that was advertised.

While there are plenty of politicians who are to lunch when it comes to economic policy, this struck me as too out to lunch to be believed. For this reason, I could never be a believer in the Reinhart-Rogoff debt cliff even before other economists were able to show that the relationship did not exist. 

The United States Already Has Cuddly Capitalism Print
Friday, 31 May 2013 07:01

Thomas Edsall devoted his blogpost yesterday to a paper by Daron Acemoglu claiming that the United States can't follow a path like Sweden and have "cuddly capitalism." By this Acemoglu is referring to a welfare state that protects most people from the risks in a market economy.

However what Edsall, following Acemoglu, overlooks in his discussion is that the United States already has cuddly capitalism. The difference between the United States and Sweden is who gets cuddled. While Sweden's welfare state is designed to provide protections to ordinary people, in the United States it is those on the top who can count on the state's help.

For example, if you are an incompetent bank executive at Goldman Sachs or Citigroup whose reckless lending threatens to sink your bank, you can count on the Treasury Department and the Federal Reserve Board to provide trillions of dollars in below market loans to support your bank through the rough times. If you are a drug or medical supply company you can count on the government to grant you patent monopolies so that no one can compete with you in the market for long periods of time. Highly paid professionals like doctors and lawyers can count on a trade policy that is designed to depress the wages of most people who provide you services, while protecting you from the effects of foreign competition.

There are a long list of ways in which the U.S. government gets very cuddly with those at the top as noted in my classic The End of Loser Liberalism: Making Markets Progressive. Of course those at the top would prefer that the only government interventions that are put up for debate are the ones that help more ordinary people, they would rather keep the interventions that benefit the wealthy out of the discussion. Unfortunately both Acemoglu and Edsall follow this path.


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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.