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Faulty Labor Economics at the NYT Print
Saturday, 28 June 2014 07:45

Kevin Carey has an interesting piece in the NYT's Upshot section which notes evidence that U.S. college grads seem to perform markedly worse on standardized exams than their counterparts in other countries. While this discussion is interesting his conclusion is completely wrong.

He concludes by telling readers:

"This reality should worry anyone who believes — as many economists do — that America’s long-term prosperity rests in substantial part on its store of human capital. The relatively high pay of American workers will start to erode as more jobs are exposed to harsh competition in global labor markets. It will be increasingly dangerous to believe that only our K-12 schools have serious problems."

Actually economists would believe the exact opposite of what he asserts. If college graduates in other countries are better educated than our college graduates, and therefore more productive, then this will make us richer as a country. We will be made richer by the fact that we can get the goods and services they produce at a lower cost than would be the case if their college graduates were less educated than ours. This is good news in standard trade models.

Of course the implication is that college grads in other countries will be wealthier than college grads in the United States, but we are made better off, not worse off, by the fact that other countries have well-educated college grads. An editor at the NYT should have caught such a basic mistake.

 

Note: I see from comments that many are convinced that higher productivity elsewhere makes us poorer. This should not in general be true. Whatever we purchase from abroad is almost by definition better or cheaper, or we wouldn't be buying it. That makes us richer. There is the issue of unemployment created by increased imports. In the standard model (which most economists adhere to far more religiously than I do), the rise in imports should lead to downward pressure on the dollar, which will lead us to export more and import less of other goods and services. That will bring us back to full employment.

There is a distributional issue, the people displaced will make less than they had previously while everyone else will in principle earn more. Note that this displacement goes the opposite direction of displacement in prior decades when trade was structured to put our manufacturing workers in direct competition with lower paid workers elsewhere. This tended to put downward pressure on less-educated workers, whereas implicitly we are seeing a story here where our college-educated workers may suffer in international competition.

It is also worth noting that nothing about this story can drive our wages to developing country levels. There are different ways we can tell this story, but perhaps the simplest is to point out that 80 percent of what we consume is produced here. The fact that we can get some items at very low cost due to cheap labor in the developing world is not going to lower productivity for the portion of our economy responsible for this 80 percent of our consumption. Unless you have a story about redistribution from wages to profits that is about 10 times as large as what we have actually seen there is no way that we would see developing country wages.

 
What Sort of Loans Does the NYT Expect Investment Banks to Be Securitizing? Print
Friday, 27 June 2014 05:23

That's the obvious question that readers should be asking after seeing the paragraph at the end of an article on the Treasury Department's plan to help low income people stay and/or become homeowners:

"The Treasury had promised that Mr. Lew would address the expansion of credit to potential home buyers, millions of whom are unable to get a mortgage with today’s tight standards. No new programs were offered, though Mr. Lew said the Treasury was working to jump-start the all-but-vanished market for private mortgage-backed securities, which would help lenders grow more confident and make more loans."

The clear implication is that lenders would be making loans that don't meet the standards of Fannie Mae or Freddie Mac, but would be packaged into mortgage-backed securities by private issuers. Some folks may be old enough to remember the last time we saw something like this.

 
Trillions of Dollars to Help the Poor? Print
Friday, 27 June 2014 05:11

The NYT had an interesting piece on the persistence of poverty in eastern Kentucky and rural areas more generally. However the piece is seriously misleading when it refers to "the trillions of dollars spent to improve the state of the poor in the United States and promote development." This comment would likely lead readers to believe that we are spending large amounts of money on anti-poverty programs. That is a very questionable claim.

Current spending on TANF, the main federal anti-poverty program is $17.4 billion, less than 0.5 percent of the federal budget. The budget for food stamps, which do not go exclusively to the poor, is around $75 billion or a bit less than 2.0 percent of federal spending. Other anti-poverty programs account for a considerably smaller share of federal spending.

In prior decades anti-poverty programs accounted for a larger share of the budget, but it is misleading to imply that they have ever been a major drain on the public's tax dollar. Anti-poverty programs have always been dwarfed by spending on the military and social insurance programs like Social Security (which does have an enormous impact on poverty).

 

 
NYT Says the European Union Tortured Greece Print
Friday, 27 June 2014 04:41

My mistake, it actually began an article on Jean-Claude Juncker, the likely next president of the European Commission, by referring to the "rescue" of Greece. This seems a rather dubious characterization of an economic program that caused a plunge in Greece's GDP of more than 20 percent and pushed its unemployment rate above 25 percent. Greece would almost certainly have fared much better if it had defaulted on its debt, abandoned the euro, and re-established its own currency. In any case, it is no more appropriate to describe the economic plan that the European Commission imposed on Greece as a "rescue" than as "torture." The NYT would never use the latter term in a news story. It shouldn't use the former term either. 

 
The Drop In Health Care Spending in First Quarter Followed Surge in Fourth Quarter of 2013 Print
Thursday, 26 June 2014 04:49

The NYT noted that a sharp drop in health care spending reduced the first quarter growth rate by 0.16 percentage points. It is important to recognize that this drop followed a surge in health care spending reported for the fourth quarter of 2013 that added 0.62 percentage points to growth in quarter. That compares to an average of 0.28 percentage points for the prior four quarters. It is likely that the data overstated the actual increase in spending in the fourth quarter and therefore also overstated the drop in the first quarter. The average impact of health care spending on growth for the two quarters taken together is almost the same as over the prior four quarters.

 
Tax Cuts Didn't Starve Discretionary Spending, Votes to Cut Discretionary Spending Starved Discretionary Spending Print
Thursday, 26 June 2014 04:08

A NYT editorial on Senator Thad Cochrane's narrow victory in a Republican primary criticized his record:

"He has consistently voted for the kinds of tax cuts that have starved discretionary spending and held down the economic recovery."

This is incorrect. There is no direct relationship between the tax cuts Mr. Cochrane has supported and the cuts in discretionary spending that Congress and President Obama agreed to. The cuts came about because of a commitment to hit arbitrary deficit targets. Given the vast amount of unemployment and underemployment in the economy, there is no reason to be reducing the deficit. There is no reason that we could not have both maintained higher levels of discretionary spending and left the tax cuts in place.

It is important to be clear on this issue since the public needs to know that the main factor slowing growth and keeping millions of people out of work is simply a perverse cult of low deficits, not the need to raise taxes on anyone.

 
Barro on Pension Fund Investments Print
Wednesday, 25 June 2014 09:28

Josh Barro has a thoughtful piece on public pensions and risk in the NYT's Upshot section. He makes many points with which I agree, most notably raising cautions about pension fund investments in "alternative investments." These are mostly private equity funds, but can also include venture capital and hedge funds. The problem with these alternative investments is that they come with unknown return distributions (essentially the pension funds have a promise that a smart investor will beat market indexes) and they come with high expenses. The public has good reason to be concerned when their pensions start to go more heavily into these alternatives to make up for funding shortfalls.

The issue where I differ is on how pensions need view the risk in the stock market. Josh notes my comment that pension funds don't need to be concerned about the short-term fluctuations in the market, only long-period averages. His counter is that many funds became underfunded when the stock market plummeted and therefore had to boost funding in the recession. He also notes that many pensions cut back funding and even raised benefits when the stock bubble in the 1990s led to considerable overfunding.

This points are correct, but they stem largely from bad projections about future returns, and I don't mean year to year, I mean long period averages. When price to earnings ratios in the market go above long-term averages, it is not possible to get historic rates of return. This means that the return projections used by pension funds in the 1990s should have been adjusted downward since there was no way on earth they would get the 7.0 percent real (10.0 percent nominal) returns that most funds were assuming.

The same story applied at the peak in the pre-recession period. They should have adjusted downward their assumption on long-term returns to a 5.0-5.5 percent real rate (8.0 percent to 8.5 percent nominal). After the market plunged they should have adjusted their return projections upward, which certainly would have been consistent with the sharp bounceback we have actually seen over the last five years. With these adjustments, pension funds would not have suddenly found themselves hugely underfunded even with the plunge in the market that we saw at the start of the recession.

None of this is 20-20 hindsight. I have been arguing this story about long period stock returns for almost twenty years, first in the context of Social Security and more recently in the context of pension funds.

Barro seems troubled by the idea that governments can benefit by investing in the stock market. It is not clear why this should be troubling, after all individuals benefit by investing in the stock market all the time. And the notion of risk arbitrage comes up in all sorts of different contexts.

For example, the claim that we made money on the TARP bailout is entirely a story of arbitrage. In a time where there was an enormous risk premium associated with lending, we made below market loans to favored banks, where the interest rate charged by the government was still above the risk free rate paid by the government. (The claim we make money on the Export-Import Bank is also a story of risk arbitrage.)

In short, we see instances of the government arbitraging risk all the time. It is not clear what policy we would be advancing if we prohibited it from doing so. We do know that such a prohibition would raise the cost of hiring public employees since they obviously value the guaranteed retirement income from a defined benefit pension.

 

 

Typos corrected -- thanks to Robert Salzberg.

 
Can We Talk About Drug Patents? Print
Wednesday, 25 June 2014 04:55

The NYT had a short editorial discussing the issues raised by the refusal of insurance companies to pay for many expensive drugs of questionable usefulness. It would have been useful to point out the reason that drug prices are high and that drug companies mislead the public about the degree of their effectiveness. 

If the government did not grant patent monopolies, most of these drugs would sell for less than 10 percent of their patent protected prices and possibly less than one percent. This would make their affordability a non-issue in almost all cases. It would also take away the incentive for drug companies to mislead the public about the effectiveness and safety of their drugs. 

There are alternatives to patent support funding for research, such as the $30 billion in direct funding that the government commits now through the National Institutes of Health. While this funding mostly goes for more basic research, there is nothing except the political power of the pharmaceutical industry that prevents the funding from being used for the development and clinical testing of drugs. If the government were to increase its funding then all drugs developed through this mechanism could be sold as generics and the research findings immediately made public. This way the results would be accessible to doctors, patients, and other researchers.

 
Bankers Could Go To Jail Print
Wednesday, 25 June 2014 04:19

Morning Edition had a strange piece discussing how regulators can punish banks for breaking the law. The piece focused on the various fines and regulatory measures that can be imposed as penalties when banks are found to have broken the law. Remarkably it never considered the underlying logic of the punishment and the likely deterrent effect on criminal activity.

While banks are legal institutions, ultimately it is individuals that break the law. The question that any regulator should be asking is the extent to which the penalties being imposed will discourage future law breaking. As a practical matter, the immediate victims of the measures mentioned in the piece are banks' current shareholders. Since there is often a substantial period of time between when a crime is committed and when regulators discover it and succeed in imposing a penalty, the shareholders facing the sanction will be a different group from the shareholders who benefited from the original crime. This makes little sense either from the standpoint of justice or from the standpoint of deterring criminal activity by bankers.

The imposition of large fines may cause current shareholders to demand the executives who broke the law be fired, but in many cases they will have already moved on to other jobs or retired. In the case of the fraudulent loans that were passed on in mortgage backed securities (MBS) in the housing bubble years, most of the top executives had already left their banks by the time actions were brought by the Justice Department.

In this case, they made enormous amounts of money by breaking the law. The financial crisis may have caused them to retire or leave their banks somewhat sooner than they would have preferred, but almost all of them come out as net gainers from their actions. 

The one sanction that would clearly be effective in deterring bankers from breaking the law would be putting them in jail for breaking the law. It is likely that the prospect of spending several years in prison, along with fines taking away most of their monetary gains, would provide a serious disincentive to bankers who might otherwise break the law. The Justice Department could have pressed cases by showing that top officials in banks had good reason to believe that many of the mortgages they were passing along in MBS were fraudulent.

It is likely that top executives at major investment banks had some knowledge that many of the loans they were securitizing were fraudulent, since there were numerous accounts in the business press about bad loans. There were also widely circulated jokes about the quality of these loans. (It was common to talk about "NINJA" loans, referring to loans where the borrower had no income, no job, and no assets.) It is likely that the top officials at these banks had at least as much knowledge of the loans their banks were securitizing as the people writing about them in the business press. (Deliberately passing along fraudulent loans is fraud.)

 

 
The Inner Protectionist Comes Out for the Export-Import Bank Print
Tuesday, 24 June 2014 04:14

Suppose we proposed giving President Obama the option to put modest tariffs, say 2-3 percent, on imports of various categories of goods and services, if he felt it was important for the economy. Every right-thinking person would denounce this as crude protectionism. The argument for the export-import bank is essentially the same as the argument for selective tariffs.

The big difference is that all sorts of people who would be among the protectionist denouncers are making the case for the Ex-Im Bank. Today's effort comes from Joe Nocera.

His story begins, "In the real world, markets aren’t perfect." He then goes on to tell us that the Ex-Im Bank doesn't just help Boeing sell planes, it also helps thousands of small businesses export their goods.

Let's get out President Obama's selective tariffs. Suppose he imposes a 3 percent tariff on planes and aircraft parts. Defenders of the Obama tariffs will point out that this tariff is not only helping Boeing, but hundreds of small businesses that provides parts and services for these planes. See, in the real world, markets aren’t perfect.

We can point out that the government is actually making money off these tariffs, just like it does with the loans provided through the Ex-Im Bank, what's the problem?

At this point our free traders would jumping up and down yelling that we are paying higher prices for planes because of the tariffs. The government may be making money, but consumers are paying the price.

That's a good argument, but if our free traders have taken intro economics they would know that by diverting capital to the winners picked by the Ex-Im Bank, we are raising the price of capital for other firms. (Increased demand leads to higher prices.) This means that all the small businesses that are not privileged with subsidies from the Ex-Im Bank are now penalized by paying higher interest rates than would otherwise be the case.

In fact, we could actually treat interest rate subsidies and tariffs as interchangeable forms of protection. We can tell the plane and aircraft industry that it will have the option of either a 3 percent tariff on imports or a 3 percentage point reduction (this may not be the exact number) on the interest rate it pays on borrowing by getting loans through our protectionist bank. Is everybody happy now?

(In fairness, in the current economic environment of zero short-term interest rates and considerable unemployment, the impact of subsidized loans on borrowing costs for others would be essentially zero. However it is also easy to show that protectionist measures would increase output and employment in the current economy.)

Anyhow, it is possible to make an argument for the Ex-Im Bank, but it is an argument that people who like to boast about being free-traders should be embarrassed to make. See you at the Neanderthal dance.

 

 
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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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