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Oil Prices Are Determined in the World Market: It's Not Just Something That President Obama Says Print
Friday, 02 March 2012 06:42

The Washington Post had an article celebrating the fact that the public is confused about the causes of higher oil prices. This is sort of like a fourth grade teacher being delighted that his students don't know arithmetic. 

Undoubtedly much of the public is confused about the cause of higher oil prices because of articles like this one. It treats the issue as a he said/she said dispute, at one point quoting President Obama:

"the amount of oil we drill at home doesn’t set the price of gas on its own. That’s because oil is bought and sold in a world market. And just like last year, the biggest thing that’s causing the price of oil to rise right now is instability in the Middle East — this time in Iran."

This is not just something that President Obama says, this is true. The price of oil is determined in the world market. If the price of oil plummeted in the U.S. because we drilled everywhere, all the time, then we would lose supply from the rest of the world, because no one will sell us oil at below the world market price.

There is no remotely plausible story where the U.S. could become energy independent (even if we drilled everywhere), but even if we no longer needed imports oil prices would still be determined on the world market. Oil companies would export their oil if they could a higher price in Europe or Asia then they were getting in the United States.

When the media report the truth as a debatable point, it is not surprising that the public is confused about the cause of the rise in the price of oil.

If the Post felt a need to be bipartisan it could have told readers that President Obama's plan to end subsidies to the oil industry would have almost no impact on the industry. The $4 billion in subsidies that President Obama claims is at stake comes to about 4 cents per gallon of gas. It might make sense to end these subsidies, but it will have relatively little consequence for either consumers or the oil industry. 

Secret Commerce Department Report Shows the Economy May be Faltering Print
Thursday, 01 March 2012 07:44

Actually, it wasn't secret, it's right here on the Census Bureau's website, but for some reason no one in the media thought it was worth reporting a drop in durable goods orders of 4.0 percent in January. I am always the first to say that we should not make too much of any single report. Monthly data are often erratic and if one report seems out of line with most other data, odds are that the report was driven by some flukish factor or just sampling error.

Nonetheless, this is a big drop that can't be explained by the usual suspects. New orders excluding transportation (airplane orders are especially erratic) fell by 3.2 percent. Excluding military goods, new orders fell by 4.5 percent, so this is not a result of the peace dividend. The weather goes the wrong here since January was unusually warm this year meaning that businesses were not shut by snow storms. New orders for non-defense capital goods (i.e. investment) fell by 6.3 percent, or 4.5 percent if we exclude aircraft.

In short, this is an unambiguously bad report. My view is that it is probably an anomaly. We will perhaps see upward revisions in the second report for January or a big bounceback in the February numbers. But, this report definitely deserved some attention. It might seem rude to spoil the celebrations over our 3.0 percent growth rate last quarter, but that is what reporters are supposed to do.

China's Premature Aging Process: Another Arithmetic Failure at the Washington Post Print
Thursday, 01 March 2012 05:19

The Washington Post is absolutely obsessed with the costs of an aging population and it refuses to let arithmetic stand in the way. Today it ran an editorial complaining about China's "premature social aging process, saddling China with a large dependent elderly population before it’s truly rich enough to support it."

As the piece correctly notes, China has had very slow population growth over the last three decades by deliberate design, primarily its one child policy. While some results of this policy have been horrible (e.g. infanticide of girls by parents who wanted a boy), the slower population growth has been a huge plus helping China to sustain rapid economic growth with less damage to the environment than would otherwise have been the case.

China's economic growth has been so rapid that it can easily support an aging population. Those familiar with arithmetic can see this by comparing the experience of China with Mexico, our NAFTA partner whose economic policies have frequently been touted by the Post.

If we look at the IMF's data, we see that per capita GDP has risen by 740 percent over the last 25 years while Mexico's per capita GDP has risen by just over 26 percent [warning: more arithmetic ahead]. Now let's assume that China's per capita income doesn't rise at all over the next decade (absolutely no one expects this), while Mexico's continues to grow at the same pace as it has over the last quarter century. This means that in 2020, per capita GDP in China will still be 740 percent higher than it was in 1985, while in Mexico per capita GDP will be 38.6 percent higher.

Let's suppose that China's ratio of workers to retirees fell from 5 to 1 to just 2 to 1 over this time horizon (a more rapid decline than actually is taking place). Let's assume that in Mexico the ratio remains unchanged at 4 to 1. Then let's assume that retirees consume 80 percent as much as workers. We will ignore children to make the calculation more favorable to the Washington Post's beloved country.

In this story, China's workers will be able to enjoy living standards in 2020 that are almost 7 times as high as they were 35 years earlier, even though they will be supporting a much larger population of retirees. This will be the case even though the implicit tax on their wages will have risen from 13.8 percent to 28.6 percent. China's retirees will also be enjoying a standard of living at age 70 that is more than 5.5 times as it high as it was when they were 35.

By comparison, Mexico's workers will have seen their after-tax pay increase by just 38.6 percent over this period. The income for a 70 year-old retiree will be just 10.9 percent higher than it was when they were a 35-year old worker. 

If there is a problem in this story for China, it is difficult to see what it is. China's extraordinary growth over the last three decades is sufficient to ensure large increases in living standards for its whole population, if it is evenly distributed. If the Post meant that China can't support its retirees at U.S. living standards, it's absolutely right. However, it's not clear why on earth they would be thinking about this comparison.

Local Governments Argue That Financial Markets are Highly Monopolistic Print
Wednesday, 29 February 2012 05:43

The Washington Post told readers that local government officials complained about the monopolistic nature of U.S. financial markets in an article on the Volcker Rule. The article reported that a number of local government officials complained that the Volcker Rule would force them to pay higher interest rates on their bond issues.

While the article never discussed the issue of monopolistic markets, this is what the complaints by these officials imply. If the markets were highly competitive, then it would make very little difference whether or not banks opted to buy the debt they issued. Even a small increase in interest rates would cause other investors to swoop in and grab up their debt.

Also, if the financial system were reasonably competitive, we would expect that independent investment banks -- which are not subject to the Volcker Rule -- would be created to take advantage of these high yielding bonds, bringing up their price and pulling interest rates down.

The article should have asked the question of why, if these local government officials are correct in what they claim, financial markets are not working as they are supposed to. 

The World Bank's Advice to China on Growth Print
Tuesday, 28 February 2012 05:51

It is striking that the reporters can write about recommendations from the World Bank or International Monetary Fund to China about sustaining its growth, without any comment on the irony. These institutions have been making policy recommendations for six decades that have often not resulted in much growth at all. In some cases, most notably the situation of Argentina following its default in 2001, they have been astoundingly wrong. Therefore it is impressive that Washington Post can report on a set of recommendations from the World Bank to China, whose growth has averaged more than 8 percent annually over the last three decades, without ever noting this irony.

It is also worth noting that the graphs accompanying this article show that China's productivity growth is projected to average close to 6 percent annually over the next two decades. Many news outlets (including the Post) have argued that China will face a problem supporting a larger population of retirees as its work force ages. If this productivity growth projection proves accurate, both China's workers and retirees will be able to see their standard of living double on the next two decades, even as the ratio of workers to retirees falls sharply.

Joe Nocera Claims Fracking Raises U.S. Greenhouse Gas Emissions by Almost 20 Percent Print
Tuesday, 28 February 2012 05:15

In his column today, which argues for responsible fracking, telling readers that there can be enormous gains from using cleaner techniques in fracking. In discussing the importance of reducing fracking related methane emissions Nocera comments:

"How big a difference will it make to the environment if industry can minimize methane leaks? A lot. ... Suppose, for instance, the current leak rate turns out to be 4 percent. Suppose we then reduce it in half. That would mean an immediate reduction in overall U.S. greenhouse gases by — are you sitting down for this? — 9 percent. If the leaks are reduced to 1 percent, the decrease in greenhouse gases jumps to 14 percent."

While Nocera does not make this point, but if cutting the methane emissions from fracking in half would reduce greenhouse gas emissions by 9 percent, then the methane emissions must come to close to 18 percent of total greenhouse gas emissions. If methane emissions are actually 6 percent, as indicated by a study Nocera cites, then fracking would account for more than one quarter of all U.S. greenhouse gas emissions.

Nocera may have his numbers completely wrong, but the implication of the evidence presented in his piece is that fracking is an incredibly dirty process from the standpoint of greenhouse gas emissions. If his numbers are right, he makes a compelling case for banning fracking unless it can be done far more cleanly than is currently the case.

There Was No Bowles-Simpson Commission Report Print
Monday, 27 February 2012 05:16

The New York Times badly misled readers by repeatedly referring to a report of the deficit reduction commission led by former Senator Alan Simpson and Morgan Stanley Director Erskine Bowles. There was no report from this commission.

The report discussed in this article was exclusively the report of the co-chairs. It did not receive the necessary support of 14 members of the commission that would have made it an official commission report, a point noted only in passing toward the end of the piece.

This mis-characterization is extremely important in the context of the piece, because the main point of the article is that President Obama ignored the report of a commission he appointed. Since this commission did not approve a report, the premise of the article is wrong.

The piece also misled readers when it asserted that, "benefits for an aging population soon would increase deficits to unsustainable levels." In fact, the main problem is rising private sector health care costs that were projected to make Medicare and Medicaid unaffordable. The increased costs due to aging alone are quite gradual and affordable.

It is also worth noting that much of the projected long-term deficit would disappear if the Affordable Care Act is as successful in containing costs as projected by the Medicare Trustees.

Wages and the Lottery Print
Sunday, 26 February 2012 10:21

Adam Davidson has an interesting piece about how many low-paying jobs have a sort of lottery component where people are willing to accept low wages for a period of time in the hope that they will end up having a very high-paying job in the future. The best example of this sort of lottery system is probably the motion picture industry in Hollywood, where many people will spend years working in low-paying jobs in the hope that at some point they will make it big as an actor or director.

The piece then points out that many other occupations have a similar, if less extreme, lottery component. For example, lawyers are expected to work very hard as associates, but then can expect much higher pay if they get promoted to partner. Similarly, non-tenured faculty can face serious pressures to produce large amounts of research, before getting to enjoy the good life as a tenured faculty member.

Taking this view more broadly, most jobs have some sort of lottery component in the sense that there is a benefit to staying with a firm for a long period of time that workers lose if they leave, either by their choice or their employers. In more mundane jobs, the benefit might just be a pension, job security, and perhaps above-market pay for workers as they near retirement. The logic is that workers might get below-market pay when they are young and energetic, but if they stay with a firm long enough the situation is reversed as they slow down and their wage rises with seniority.

This point is interesting because it implies an obvious way that firms can increase their profit, at least in the short-term: take away the lottery prize. The savings on the prize is a pure short-term gain. In the case where a firm is keeping older, less productive, workers on the payroll and paying them a premium for seniority, ending the lottery prize (i.e. firing the workers) is a pure short-term gain. (This is of course a caricature -- older workers are not necessarily less productive.) In the longer term it may not be a profit maximizing strategy, since younger workers will not make a commitment to mastering firm specific skills if they do not expect to be able to stay at the firm.

An article by Larry Summers and Andre Shliefer argued that breaking commitments of this sort was at the heart of the better-than-normal profits that private equity companies were able to earn. They argued that by breaking implicit contracts with workers and other stakeholders, private equity companies could increase profit at least in the short-run. If their intention is to sell out their stake at a profit, then a short-run gain would suit their purposes, even if the strategy might be harmful to the company and the economy in the long-run.

Thomas Friedman Goes Euphoric on Energy Production Print
Sunday, 26 February 2012 08:38

Correcting Thomas Friedman can keep anyone busy. Today he is excited about the prospect of the United States joining the Organization of Petroleum Exporting Countries. That sounds like a great idea for a country that imports close to 9 million barrels of oil a day.

The basis for his excitement is that the United States is becoming somewhat less dependent on foreign energy imports. The main reason for this is the increased production of natural gas from shale deposits. However it is not clear how long these shale gas deposits will last since it seems that earlier estimates of reserves were seriously overstated. Furthermore, there is almost no plausible story in which increased natural gas supplies and domestic oil production, plus aggressive conservation measures, will cause our demand for imported oil to drop from 9 million barrels a day to zero any time in the foreseeable future.

Of course even if the U.S. miraculously became energy independent it would not free us of concern about events in the Middle East, as Friedman contends, since we are still in a global economy. This means that if war or revolution in the Middle East led to a sharp drop in world oil production it would still have an enormous impact on the U.S. economy.

To see this, imagine that there were severe droughts in Africa and Asia that caused the world price of wheat to quadruple. Guess what would happen to the price of wheat in the United States? That's right, it would also quadruple. The reason is that wheat producers would export their wheat to take advantage of the higher prices available elsewhere in the world, so we would have to match the world price in what we paid for the wheat consumed in the United States.

Since the United States is a net exporter of wheat, the country as a whole would come out ahead in this story. However, since most people do not own wheat farms, they would end up as big losers, paying much more for their bread and other wheat products.

It would be the same story with oil if democratic revolutions temporarily stopped production in Saudi Arabia and the other Persian Gulf monarchies. We would see the price of gas double or triple. Exxon-Mobil and the other oil companies would see corresponding gains in profits, but those of us who don't own lots of stock in these companies would still end up as big losers. In principle the government could tax the windfalls and redistribute them --- okay, we don't have to talk about such silliness. 

Anyhow, it's still fun to see Thomas Friedman get excited. I remember an earlier energy episode back in 2006 when he had Nancy Pelosi send a letter to President Hu in China, just after she won control of the House in the November elections. The letter Friedman drafted for her was about how the U.S. would produce clean technology products and export them to China. 

There is No Shortage of Rental Housing and Rents Are Not Rising Rapidly Print
Saturday, 25 February 2012 15:33

The NYT told readers that a shortage of rental housing is driving up rents. This is wrong and wrong.

The NYT story is that the flood of foreclosures has forced people out of their homes and led them to look for rental housing. While this is true to some extent (homeownership rates have fallen), former homeowners would have discovered that there was a glut of rental housing.

Furthermore, ownership units can become rentals and vice-versa. This is true even for multi-family units, but 30 percent of rental properties nationwide are single family homes. These obviously can be converted very quickly to ownership units or more have been ownership units in the recent past.

So, if we look at the data on rental vacancy rates, we find that in the fourth quarter of 2011 the vacancy rate was 9.4 percent. This is down from the peak of 11.1 percent in the third quarter of 2009, but it is higher than any rate recorded in the 50s, 60s, 70s, 80s, or 90s.

Turning to rents, the best measure to use is the Bureau Labor Statistics (BLS) measure for owner occupied housing. This measure will have some inertia, since it included all units, not just units that have been on the market. (There is more variation in price on units that are placed on the market.) However, it is more desirable than other measures because the BLS controls for quality changes and also because it only includes the rental value of the unit itself. It pulls out utilities which can have a large effect on rents, if they are included in a lease.

Year over Year Change in Owner Equivalent Rent

rentSource: Bureau of Labor Statistics.

As can be seen, rents are increasing somewhat more rapidly than they were at the trough of the downturn, but they are still just rising pretty much in step with the rate of inflation. In fact the current rate of increase is lower than the rate of increase at any point in the decade prior to the beginning of the recession. While there may be some cities where rents are rising especially rapidly, or some narrow markets within cities, clearly this is not generally the case.

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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.