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Nope, Robert Samuelson Is Wrong Again, the Housing Bubble Did Cause the Recession Print
Sunday, 04 May 2014 21:58

Robert Samuelson actually has a lot of sensible things to say about bubbles in his column today, until we get near the end:

"it was not simply the bursting of the housing bubble that created the Great Recession. Consider the contrast between the 1990s’ tech-stock bubble and the housing bubble. Both inflicted multitrillion-dollar losses. Yet the first caused only a mild recession while the second plunged the economy into a deep and stubborn slump. Why?

"The difference is this: The housing bubble spawned a broader financial panic; the tech bubble didn’t. No one knew which banks held “toxic” mortgage securities and which didn’t. Large deposits fled banks, which in turn reduced lending (banks’ loans fell nearly $600 billion in 2009). Borrowers cut their expenses. Firms laid off workers; consumers curbed spending. It was the panic that did the most damage."

No, it actually was the collapse of the housing bubble that caused the Great Recession. First Samuelson is badly mistaken about the "mild" recession that followed the collapse of the stock bubble. While the official recession was short and mild, the economy did not begin to create jobs again until the fall of 2003 almost two years after the end of the recession. And, it didn't get back the jobs lost in the downturn until January of 2005, at the time the longest period without job growth since the Great Depression. And even then the growth was only coming on the back of the housing bubble.

But, contrary to Samuelson, the real difference between the two bubbles was simply that the housing bubble was more important in driving the economy than the stock bubble. It led housing to rise to 6.5 percentage points of GDP, more than two percentage points above its long-term average. When the bubble burst, the overbuilding caused housing construction to collapse to 2.0 percent of GDP, creating a gap in demand of 4.5 percentage points (@ $770 billion a year in today's economy).

On top of that, the housing wealth effect is stronger than the stock wealth effect since housing wealth is more evenly distributed. As a result, there was an even bigger consumption boom in 2004-2007 than in 1999-2000. At the peak of the stock bubble the savings rate fell to just over 4.0 percent of disposable income. It fell to less than 3.0 percent of disposable income at the peak of the housing bubble. (The decline in the savings rate was in fact likely even larger than the official data indicate because of a measurement problem. Measured disposable income rose sharply relative to GDP in these bubbles, possibly because capital gain income was wrongly being recorded as normal income.)

The loss of this bubble driven consumption also created a gap in demand. Throw in the loss of demand from the collapse of a bubble in non-residential real estate and we are looking at a shortfall in demand of more than 8 percent of GDP (@ $1.4 trillion in annual demand in today's economy). The financial stuff was a lot of fun, but really beside the point. What did Samuelson think would replace this lost demand, Jeff Bezos newspaper purchases?

There was no mechanism in the economy that would allow it to replace this demand. The collapse of the housing bubble pretty much guaranteed a prolonged and severe downturn barring a vigorous policy response.

 

Note: Typos corrected.

 
A Heaping Dose of Economic Nonsense from Thomas Friedman on China Print
Sunday, 04 May 2014 08:25

No one expects to get serious insights on the economy from reading Thomas Friedman, but he really went off the deep end in today's column. The piece is a diatribe about how our economic weakness is preventing the United States from acting like a real superpower.

At one point Friedman tells readers:

"We need to counterbalance China in the Asia-Pacific region, but that is not easy when we owe Beijing nearly $1.3 trillion, because of our credit-fueled profligacy."

Presumably Friedman is referring to the amount of government debt that China owns, but it is hard to tell since the statement makes no sense at almost any level.

Let's assume that Friedman is referring to government debt. And this poses a threat to the U.S. exactly how? Yes, China could dump the debt. If they tried to sell it all Monday morning, it would probably drive down the price a little bit and raise interest rates some, but there is not exactly a shortage of people willing to buy U.S. debt right now.

Friedman may not have access to the business section of his paper, but the current interest rate on 10-year Treasury bonds is under 2.6 percent. If China dumps its bonds then maybe it would rise to 2.7 percent, 2.8 percent? Maybe it will go back to the 3.0 percent level we saw in December. A lower interest rate is better than a higher interest rate right now, but I don't recall anyone saying that high interest rates were suffocating the economy five months ago. (in more normal times, 10-year Treasury bonds carry a yield of 5-6 percent.)

Of course the story doesn't end with interest rates. The Obama administration has been publicly committed to a policy of forcing China to raise the value of its currency against the dollar. Many accuse China of "manipulating" the value of its currency, deliberately keeping it low against the dollar to make its products cheaper in U.S. markets.

The way China keeps the value of its currency down is through purchasing hundreds of billions of dollars of assets in the United States, primarily government bonds. If China were to dump its bonds, then it would send down the value of the dollar against the Chinese yuan. This is ostensibly exactly what the Obama administration has been asking China to do.

The result is that we will be able to export more goods and services to China and other countries and domestically produced items will replace imports. This will lower our trade deficit and potentially create millions of new jobs, many of which will be relatively high-paying jobs in manufacturing. Are you scared yet?

But wait, there's more. Friedman is badly confused about the relationship of "our credit-fueled profligacy" and the debt to China. Suppose that we had been running balanced budgets for the last decade, but China had the same policy of trying to prop up the dollar to boost its exports. It could have bought the exact same amount of government debt that was already outstanding. Alternatively, it could have bought up debt of private corporations or bought equity in them. In these cases, the United States would be just as much indebted to China as it is today, even though the government will not have been profligate by Friedman's standard.

In other words, our indebtedness to China is due to the conscious decision of the Chinese government to lend money to the United States, not any need by the U.S. government to borrow. It is probably also worth mentioning that the government has not been in any way particularly profligate in any normal meaning of the word. The deficits were just over 1.0 percent of GDP and the debt-to-GDP ratio was falling before the collapse of the housing bubble threw the economy into a recession.

If we had run smaller deficits over the last six years the main effect would have been to raise the unemployment rate. Friedman may be willing to throw millions of people out of work and weaken the bargaining power of tens of millions of others in the interest of his confused great power ambitions for the United States, but much of the public likely does not share his priorities.

 

Note: Corrections made.

 

 
Washington Post Can't Even Talk About Alternatives to Patent Support for Prescription Drug Research Print
Sunday, 04 May 2014 07:29

Just as the media in the Soviet Union were not allowed to talk about alternatives to one-party rule, the Washington Post apparently can't raise the issue of alternatives to patent supported drug research in the United States. This should be apparent to readers of an article on Sovaldi, a new drug to treat Hepatitis C.

The drug is currently subject to a government granted patent monopoly which allows its manufacturer, Gilead Science, to sell a year's dosage for $100,000. By contrast, a generic version sells in India for about 1 percent of this price. As the piece tells readers:

"If all 3 million people estimated to be infected with the virus in the United States were treated with the drugs, at an average cost of $100,000 per person, the amount spent for all prescription drugs in the country would double, from about $300 billion in a year to more than $600 billion."

To put this number in context, the additional cost of Sovaldi due to the government granted patent protection would in this case be equal to more than 1.7 percent of GDP, or a bit less than 25 percent of after-tax corporate profits. In short, it is real money.

One might think that an article that raises ethical questions, as this one does, about how much we should be willing to pay for saving a person's life, might also ask the question about why this drug is so expensive in the first place. Not in the Washington Post.

The granting of patent monopolies is a government policy to provide incentive for innovation. There are other ways to provide incentives, like paying people directly. (Has anyone heard of the National Institutes of Health? They get $30 billion a year to do basic biomedical research.) The government also finances a large amount of research directly through the Defense Department, with military contractors paid to develop new weapons systems. So there is a great deal of precedent for the government paying directly for research.

Some economists, like Joe Stiglitz, a winner of a Nobel prize, have suggested a prize fund where the government would buy up patents and then place them in the public domain. Under either system, all new drugs could be sold as generics at generic prices.

This would meet the condition that the price would then equal the marginal cost, which is usually a high priority for economists. Economists and people who have been through intro econ classes usually get upset when government policies like tariffs raise the price of a product by 15-20 percent above marginal cost. In this case, the patent monopoly is raising the price by close to 10,000 percent above marginal cost.

All the economic distortions and incentives for corruption that we would see from a 15-20 percent tariff also appear when a patent monopoly raises the price by 10,000 percent, except they are several orders of magnitude greater. The company has enormous incentive to mislead patients and doctors about the effectiveness and safety of their drug and also to market for uses for which it may be inappropriate. Drug companies also have incentives to pay off politicians to get their drugs covered by public programs. And drug companies act all the time in exactly the way predicted by economic theory. (Think of Vioxx.)

It is incredible that alternatives to patent supported research were never mentioned in an article that poses ostensibly difficult ethical questions about how much a life is worth.Without the government granted patent monopoly such questions would not arise, unless the Post puts the value of human life at less than $1,000.

It is also amazing that, at a time where much of the intellectual class has been obsessed with Thomas Piketty's book, Capital for the 21st Century, which warns of a growing concentration of wealth and income, a policy that both creates enormous economic distortions and leads to upward redistribution of income, is not even a topic for debate.

It is probably worth mentioning that the Post gets substantial advertising revenue from the drug industry.

 

 
Deficit Dogma Runs Deep Even at the New York Times Print
Friday, 02 May 2014 16:45

This is one of those strange but true stories. Here's the description of Paul Krugrman's column from NYT opinion page for Friday:

PAUL KRUGMAN

Why Economics Failed

Though it’s true that few economists saw the fiscal crisis coming, policy makers and politicians ignored both the textbooks and lessons of history. comment icon Comment

 

You have 30 seconds to see the problem in this story.


That's right, Krugman doesn't believe there was a fiscal crisis, in fact he has vigorously argued the opposite. We clearly had a financial crisis, but as Krugman argues, it had nothing to do with excessive budget deficits.

So how does this find its way into the NYT? Clearly some folks were asleep at the wheel, but this is pretty incredible. It attributes a view that is at 180 degrees at odds with the frequently and strongly expressed view of the paper's most prominent columnist.

 
The Story of How Trucking Jobs Became Low-Paying Jobs Print
Friday, 02 May 2014 15:16

Very good piece in the Washington Post on how the trucking industry contracted out to push down wages in trucking. Now many independent truckers don't earn much more than workers in fast-food restaurants.

 
Bill Clinton and the Trade Deficit: Is There Some Reason We Can't Talk About It? Print
Friday, 02 May 2014 05:26

Following the NYT, the Washington Post had an article on Bill Clinton's economic legacy today. And like the NYT piece yesterday, the Post did not mention the soaring trade deficit. (See my complaint about the NYT piece here.)

This is not a small matter. The trade deficit was less 1.0 percent of GDP when Clinton took office, it was almost 4.0 percent when he left, and headed upward.This increase would be equivalent to more than $500 billion in today's economy.

And this increase was largely a result of Clinton's policy. His team pushed a high dollar policy and put muscle behind it with the bailout they designed for the East Asian financial crisis. A high dollar leads to a trade deficit in the same way that high meat prices lead to fewer hamburgers being sold. A high dollar makes our goods and services relatively more expensive in the world economy, therefore we sell less of them.

The resulting trade deficit creates a huge hole in demand. For arithmetic fans, demand is equal to consumption, investment, government spending, and net exports:

Y = C+I+G+(X-M)

If we have a big trade deficit then we have to make it up with one of the other components of demand, otherwise we have a shortfall in demand and unemployment. This is not whacko lefty thought, this is the simple economics that is taught in every intro class.

In the 1990s we made up for the trade deficit with the demand generated by the stock bubble. Consumption soared based on the stock wealth effect (people increase their consumption as they see the value of their stockholding increase) and there was also an uptick in investment as the dot.com crew could raise billions for nonsense plans by issuing stock.

Read more...

 

 
Thomas Piketty and the Ghost of Joan Robinson Print
Thursday, 01 May 2014 20:16

Okay, I really did not want to spend more time arguing about methodology but there seems to be some simple points getting lost in cyberspace. Paul Krugman picks up on the debate between Simon Wren-Lewis and Tom Palley, coming down clearly on the side of the former.

I won't go through the blow by blow, but I do want to deal with the point Paul raises at the end of his post.

"And what’s going on here, I think, is a fairly desperate attempt to claim that the Great Recession and its aftermath somehow prove that Joan Robinson and Nicholas Kaldor were right in the Cambridge controversies of the 1960s. It’s a huge non sequitur, even if you think they were indeed right (which you shouldn’t.)"

Hmm, I don't quite see it that way. To me there is a very specific issue that Piketty raised that relates directly to the Cambridge controversies. He argued that the elasticity of substitution between capital and labor was greater than one. Therefore even as the amount of capital increased relative to labor, there was no reason that the rate of profit had to fall proportionately. This raises the prospect of an increasing capital share as economies get richer.

This relates to the Cambridge controversies since the Cambridge U.K. people argued that the idea of an aggregate production function did not make sense. They pointed out that there was no way to aggregate different types of capital independent of the rate of return. The equilibirum price of any capital good depended on the rate of return. Therefore we can't tell a simple story about how the rate of return will change as we get more capital, since we can't even say what is more capital independent of the rate of return.

The takeaway from this, or at least my takeaway, is that we don't have a theoretical construct that we can hope more or less approximates how the economy actually works. The theoretical construct doesn't make sense. This means if we want to determine the rate of return to capital we should not be looking to elasticities of substitution, but rather the institutional and political factors that determine the rate of profit. 

The debate touched off by Piketty's claim about the elasticity of substitution will inevitably be a fruitless one. We are not going to find a technical relationship in past data that will tell us how profit shares will change as the ratio of capital to labor increases.

Does any of this mean that the Great Recession proved Joan Robinson and Nicholas Kaldor right? Not as far as I can see. Although it is pretty damning of the state of the economic profession that almost no one recognized the growth of housing bubbles in the United States and much of the rest of world, and that their collapse would create a hole in demand that would be extremely hard to fill.

I will say that I am a bit at loss to understand the meaning of Simon Wren-Lewis's comment that:

"As I said in my original post, I would like to make students aware of heterodox critiques, but I want to point out where in my mainstream account that critique would enter. (I think what I teach is pretty close to how many central bankers think, if not the rest of 'my tribe'!)"

It certainly is worthwhile to know what central bankers think, but is this supposed to be a source of legitimation? After all, even by the I.M.F.'s measures the wealthy countries are losing well over $2 trillion a year due to economies operating below potential GDP. The cumulative losses to the rich countries from the Great Recession are virtually certain to exceed $20 trillion and could well top $30 trillion. Is it supposed to be some sort of validation that the folks who got us here share your view of the world?

 
Bill Clinton Gave Us a Hugely Over-Valued Dollar and an Exploding Trade Deficit Print
Thursday, 01 May 2014 07:48

Incredibly, the NYT article on Bill Clinton's economic legacy left out the most important facts. The value of the dollar began to rise after Robert Rubin became Treasury Secretary and openly espoused a high dollar policy. He put muscle behind this policy with his handling of the bailout from the East Asian financial crisis which caused the dollar to soar against the currencies of our trading partners. (Lloyd Bentsen, Clinton's first Treasury Secretary, allowed the dollar to fall. This was supposed to allow an increase in net exports to fill the gap in demand created by Clinton's deficit reduction package.)

The high dollar led to a fall in exports, as our goods became more expensive to people in other countries. It also led to a surge in imports, which became very cheap. As a result, the trade deficit rose to almost 4 percent of GDP ($680 billion a year in today's economy) and eventually peaked at almost 6 percent of GDP ($1,020 billion in today's economy) in 2005. Currently the deficit is around $500 billion or 3.0 percent of GDP.

This trade deficit corresponds to income that is generated in the United States but is creating demand elsewhere rather than in the United States. It is very difficult to find ways to replace this demand, especially in a political environment where people like Bill Clinton tout the virtues of deficit reduction.

The trade deficit is by far the main cause of the "secular stagnation" that many economists, most notably former Clinton Treasury Secretary Larry Summers, have been worrying about in recent years. It certainly should have been discussed in any article on the Clinton legacy.

 
Robert Samuelson Warns of Another Housing Bust Print
Thursday, 01 May 2014 07:02

That sounds pretty scary since the last time we had one it cost us almost 9 million jobs, wiped out the wealth of a large portion of the middle class, and led to a recession from which we still have not recovered almost seven years later. Thankfully Samuelson doesn't have much of a case. 

First off, the last bust was so severe because we had a serious housing bubble that was driving the economy. House prices were more than 70 percent above their trend level creating more than $8 trillion in bubble generated housing equity. The record high prices led to a construction boom, with residential construction reaching a record high share of GDP. In addition, the wealth effect from the bubble equity led to a record high share of consumption in GDP as the saving rate fell to near zero.

When the bubble burst construction fell from record highs to record lows. The boom led to enormous overbuilding and the vacancy rate reached new records. At the same time, consumption fell sharply as the housing wealth that had been driving it disappeared. This was the basis for the recession and seven years later we still do not have any source of demand that can replace the demand generated by the housing bubble.

Now Samuelson warns us of another housing bust. Really?

Samuelson doesn't even argue that housing construction will fall from its level of 2013, which at 920,000 was less than half of the bubble peak. He doesn't say prices will fall at all. (They're currently around 10 percent above trend levels.) Where's the bust?

The story, insofar as there is one, is that housing will not be driving the economy in 2014. It's not clear why anyone would have expected it to be driving the economy. Existing home sales in 2013 were at or somewhat above trend levels. In the mid-1990s, before the bubble started driving the market, existing home sales averaged around 3.5 million a year. If this is adjusted upward by 20 percent for population growth in the last two decades we get 4.2 million, a rate that is substantially below the recent pace.

This simple arithmetic makes far more sense than Samuelson's explanation that prices are too low for sellers but too high for buyers. In other words, we are seeing roughly the amount of home sales that we should expect to see in a normal economy.

Housing construction is still somewhat below normal levels but this is easily explained by the fact that vacancy rates are still extraordinarily high, although down from the recession peaks. Furthermore, the new normal is likely lower than the old normal for simple demographic reasons. With the baby boomers in their 50s and 60s, they are likely to be moving down the ladder in terms of house size rather than up.

The share of health care spending in GDP is about 6 percentage points higher than it was two decades ago. That has to come from somewhere. In other words, housing is likely to be a somewhat smaller share of the economy going forward than it was even before the bubble.

So the only surprise here is that anyone could have expected housing to play a large role in the recovery in 2014. Any serious analysis of the data would not lead to this conclusion.

 

 
Do People Really Get Paid to Own Television Sets These Days? Print
Thursday, 01 May 2014 04:47

That's a cheap shot, but an editor at the NYT was clearly asleep at the wheel when they allowed a graph into the paper showing that the relative price of televisions had fallen by somewhere around 110 percent since 2005. (Actually the base year doesn't look right either, since these look like much longer trends in prices.) The graph appears alongside a mostly good article about how the living standards of the low-income families have not kept pace with the rest of the population.

The article is at least imprecise when it tells readers:

"The same global economic trends that have helped drive down the price of most goods also have limited the well-paying industrial jobs once available to a huge swath of working Americans. And the cost of many services crucial to escaping poverty — including education, health care and child care — has soared."

The factors that have destroyed well-paying industrial jobs were conscious policy, not abstract global trends. The United States has trade policies that were explicitly designed to put our manufacturing workers in direct competition with low-paid workers in places like Mexico, China, and Vietnam. This had the predictable effect of driving down their wages.

We could have put in place a trade policy that made it as easy as possible for smart kids in the developing world to train to U.S. standards and work as doctors, lawyers, dentists and other highly paid professionals in the United States.This would have driven down the pay of these professionals and made items like health care much cheaper in the United States. This was a policy decision, not a global economic trend.

This decision was aggravated by the high dollar policy pursued by the Clinton administration. That led to the soaring trade deficit at the end of the 1990s and into the last decade. This deficit has cost the country millions of relatively high-paying manufacturing jobs.

There is also a policy to run a high unemployment budget. Congress has decided to run budgets that leave millions of people out of work rather than spending enough money to bring the economy close to full employment. As Jared Bernstein and I show in our book, lower rates of unemployment would hugely benefit lower paid workers, not only by increasing their likelihood of finding a job, but also increasing their hours and wages.

In short, the low income of the poor is largely a result of deliberate policy decisions that have made them poorer, not global economic trends.

 

Correction:

I may have missed this the first time, but the chart indicates it is showing percentage point changes relative to a 23 percent overall increase in prices over the period from 2005-2013. This means that an item showing a 10 percentage point drop on this chart would have seen its price increase by 20.7 percent, 2.3 percentage points less than the 23 percent overall price rise. If this is correct, then a 110 percentage point decline in television prices would mean that their prices had fallen by 2.3 percent since 2005.

This may not be the most useful way to convey information. Imagine if the rate of inflation over this period had been near zero, as was the case in Japan. It would have been more standard just to show the percentage change in real prices for each item.

 

 
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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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