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The West Is Indebted Because China Is Not Print
Friday, 25 July 2014 04:30

The NYT ran a confused column by Kwasi Kwarteng, a Conservative member of the U.K.'s parliament, calling for China to adopt the gold standard. The piece has many bizarre claims, most importantly attributing the U.K.'s prosperity in the 19th century and the U.S.'s prosperity in the post-World War II period to the gold standard, as opposed to the strength of their manufacturing sectors and overall economy.

However the most misleading item is the contrast of China, which does not have much government debt, with the rich countries, that mostly do. These are not unrelated situations. As the piece notes, China has pursued a mercantilist policy of deliberately keeping down the value of its currency in order to make its goods cheaper to people in other countries. This allowed it to increase its exports to the West. (It's important to note that U.S. corporations have also been major beneficiaries of this policy, taking advantage of low-cost labor to gain a competitive edge and increase profits.)

The flip side of this policy is that the rich countries, most importantly the United States, ran large trade deficits. This created a huge hole in demand. There is no easy mechanism for a market economy to make up this sort of gap in demand, which now passes under the name "secular stagnation." In the late 1990s the gap was made up with a stock bubble, in the last decade it was made up with a housing bubble. The bursting of these bubbles left nothing other than government budget deficits to fill the demand gap. 

As a practical matter, when rich countries have large trade deficits, their choices are bubbles, large budget deficits, or high unemployment. They also could look to redivide work with shorter workweeks and longer vacations. (The standard economic story is that rich countries should have trade surpluses. Capital is supposed to flow from rich countries that have lots of it to poor countries where it is scarce. But economists never have much problem ignoring their theory when its implications prove inconvenient.) In any case, the issue of China's trade surpluses and rich country government debt are directly related, not independent events.


Charles Lane Is Badly Confused About Obamacare Print
Thursday, 24 July 2014 09:14

Washington Post columnist Charles Lane must have been off the planet or at least out of the country in 2009. In a column on the recent appellate court ruling banning subsidies in the federal exchanges, he tells readers that the Republican obstruction was to be expected given the extreme Democratic positions on the stimulus, cap and trade legislation and the Affordable Care Act:

"Everything might have been different if Democrats and Republicans had operated in a spirit of compromise, the Framers’ hoped-for political solvent."

If he had been following the debates at the time he would know that Obama asked for an $800 billion stimulus even though his top economic aides told him that he would need at least $1.2 trillion to get the economy back on its feet. He then allowed the Republicans to bargain this down so that the actual stimulus was just over $700 billion (sorry folks, the Alternative Minimum Tax fix doesn't count as stimulus), with much of that sum going to tax cuts that had less impact than spending increases.

The cap and trade system is a market-based proposal for dealing with greenhouse gas emissions that was supported by many conservatives in academia. It was an alternative to a carbon tax that likely would have a higher cost to corporate emitters. This is also a conservative measure in the sense that it is charging polluters for the damage they cause to others. Our Framers would never have imagined a country in which some people got to freely dump their garbage and sewage on their neighbors' lawns.

Finally, Obamacare was based on a proposal that came out of the Heritage Foundation. In its fundamental structure it is identical to the proposal signed into law by the Republican governor of Massachusetts and 2012 Republican presidential nominee. Furthermore, Obama worked very hard to pull Republicans on board, agreeing to dozens of amendments put forward by Republican members of Congress and allowing the bill to be tied up for months in the Senate Finance Committee as its chair Max Baucus sought a compromise that would win support from at least some of the Republican members.

In short, on all three of these issues Obama took the path of compromise urged by Lane. With virtual unanimity, the Republicans rejected every effort. As Republican minority leader Mitch McConnell said shortly after President Obama's election in 2008, his job was to make sure that Obama was a one-term president. For some reason Lane is apparently ignorant of this history. 

The Problem Is Not Debt: Consumption Is High Not Low Print
Thursday, 24 July 2014 04:27

Economists and economic reporters continually try to make the problem of the weak economy and prolonged downturn appear more complicated than it is. After all, if it is very simple then these people would look foolish for not having seen it coming and figuring out a way around this catastrophe. Fortunately for us, if unfortunate for them, it is simple.

One of the efforts to make it more complex than necessary is to assign an outsized role to the debt associated with the collapse of house prices. This is the argument that we heard on Morning Edition this morning. The argument is that when house prices plunged after the housing bubble burst in 2007, homeowners were left with large amounts of debt, pushing many of them underwater. This debt supposed discouraged them from spending, leading to a sharp falloff in consumption.

There is a big problem with this story. Consumption is not low, it is actually still quite high. The graph below shows consumption as a share of GDP. It is actually higher than during the bubble years and essentially at an all-time peak. That makes it a bit hard to explain the downturn by weak consumption. (Some folks may recall hand wringing about inadequate savings for retirement, as in this NYT column by Gene Sperling yesterday. Too little savings and too little consumption are 180 degree opposite problems, sort of like being too heavy and too thin.)


There would be a modest decline in consumption from the peak bubble years if it was shown as a share of disposable income (tax collections are lower today than in 2004-2007), but it would stiill be unusually high by this measure. The basic story is straightforward. The run-up in house prices created by the bubble created $8 trillion in housing bubble wealth. Standard estimates of the housing wealth effect suggest that this would increase annual consumption by 5-7 percent of this amount, or $400 billion to $560 billion a year. This would have been equal to 3-4 percent of GDP.

When the bubble burst this wealth effect went into reverse, with people cutting back consumption in line with their loss of wealth. The consumption share of GDP did not fall both because GDP fell and also there was a sharp drop in tax collection due to both tax cuts and simply the drop in income. The fact that people had debt may have made some difference, but it was really secondary to the loss of wealth. If a homeowner owed $100,000 on a home whose price dropped from $300,000 to $200,000 (leaving them with $100,000 in equity), we would expect them to cut back annual consumption on average by between $5,000 and $7,000.

If the homeowner owed $250,000 on this house, so the drop in price left them $50,000 underwater, then their decline in annual consumption may be somewhat greater, but this difference would have a relatively modest impact on the economy as a whole. To see why this almost certainly has to be the case, consider that the median income for homeowners is around $70,000. How much do we think their consumption could have fallen from bubble peaks? If we say they fell by an additional $3,500 because of being indebted (beyond the housing wealth effect) and multiply by 10 million underwater homeowners, that gets us $35 billion a year. If we plug in a multiplier of 1.5 that gets us to $52.5 billion a year or a bit over 0.3 percentage points of GDP. That won't explain much of the downturn.

Again, the story of the downturn is simple, too bad the economists missed it.


Note: Typos corrected.



I have a few quick points after reading the comments. First, the wealth effect is based on equity net of mortgage debt. This is people's wealth. If the argument is that people's debt rose relative to their equity when the bubble burst, then this is simply a wealth effect story. For there to be a point to the argument, there has to be some importance to the fact that people actually had negative equity. And to see the significance of the numbers I used, suppose the underwater homeowners' consumption had been on average $3,500 higher each year since 2008. We are now in the 7th year, so in this case, that would have translated into a cumulative increase in spending of close to $24,000. If we assume that these people have been spending close to all of their income, this means a cumulative increase in debt of close to $24,000. Even if these people were marginally above water, as opposed to underwater, in their mortgages, who would have lent them an additional $24k? I just don't see this one as making any sense.

There were some questions raised about whether we "need" more consumption. We need more demand to get to full employment (unless we redivide work), which could come in part or entirely through consumption. But the question is not whether more consumption, or as I wrote the other day more investment, would be good for the economy. The question is whether to believe that the economy would generate more consumption or investment. The answer in this case and the previous case with investment is no.

The basic point is that we have an enormous demand gap created by the trade deficit. The current deficit amounts to $500 billion in annual demand (3 percent of GDP) that is going elsewhere rather than creating growth and jobs in the United States. There is no magical process through which the economy will replace this demand. We can do it with large amounts of government spending, but this is blocked politically. That leaves getting the trade deficit down, most obviously by lowering the value of the dollar, as the only route back to full employment or something like it.




Why Would Anyone Think Republican Opposition to Obamacare Is Based on Ideology as Opposed to Just Money Print
Wednesday, 23 July 2014 07:19

It's understandable that conservatives would like to say that their arguments are based on deeply held convictions, as opposed to crass self interest, but it's difficult to understand why liberals feel the need to help them make this argument. Jonathan Cohn is the guilty party today. In his Q.E.D. section in the New Republic, a segment discussing the appellate court ruling on Obamacare tells readers:

"But the motives of Republican leaders, like the motives of the individuals who thought up these lawsuits, are no mystery. As I noted yesterday , they simply don’t believe in universal health care. They don’t believe it’s the job of government to make sure every person can pay for medical care without going bankrupt."

Let's try an alternative. Suppose they don't have deep convictions about universal health care insurance, but do have deep convictions about money leaving the pockets of rich people. Of course taxes were raised on the rich to cover part of the cost of subsidies in the exchanges.

Suppose also they like a cheap docile labor force. The type that fears unemployment and also needs a full-time job just to get health care insurance. (This makes it easier to get good help.)

In this respect it is worth noting that the number of people working part-time by choice has increased by 800,000 over the last year. This is consistent with a story where people who don't need to work full-time to get health care insurance will work less. This is great news for workers and bad news for "it's hard to get good help" crowd.

If my suppositions are true then the Republican leaders would hate Obamacare even if they never gave a thought to universal health care and the government's obligations to individuals. It's a question of taking money from rich people, end of story.

Okay, neither Jonathan nor I know the inner motives of Republican leaders which is probably why it's best to avoid making assertions about them, but I see no reason to believe that his explanation is more plausible than mine.

Enough Magical Thinking on Trade Print
Tuesday, 22 July 2014 15:22

In his Financial Times column Adam Posen gets out the old trade magic story, throwing away conventional economics to make bizarre arguments about trade's wondrous impact on the U.S. economy. Among other things, he tells readers:

"Econometric studies have established that when US companies invest abroad, the net result is increased employment, stronger demand and more investment at home. This makes sense, since it should on average be the more competitive businesses that have the resources and opportunities to expand abroad, and investing should increase their productivity. This conclusion applies specifically to US companies that have invested in Mexico. Recent research has found that, on average, for every 100 jobs US manufacturers created in Mexican manufacturing, they added nearly 250 jobs at their larger US home operations, and increased their US research and development spending by 3 per cent."

Hmmm, maybe we should subsidize the export of jobs. If we could export another 4 million jobs to Mexico, we could add 10 million here and close the employment gap. I doubt you will get many people, especially those familiar with economics, to agree that anything like this makes sense.

In fact econometric studies have shown that, consistent with economic theory, trade has been a source of downward pressure on the wages of the 70 percent of the workforce that lacks a college education. The basic story is that we put our manufacturing workers in direct competition with low paid workers in the developing world while protecting our doctors, lawyers, and other highly paid professionals. The predicted and actual result is lower pay for the vast majority of U.S. workers.

In additional to the negative impact of current trade patterns on wages, there is also the simple problem of the massive loss of demand due to the trade deficit. We currently import $500 billion a year more than we export. This is $500 billion that is creating demand in Canada, the European Union, Mexico, and elsewhere, rather than in the United States. Is there some story as to how domestic consumption or investment is somehow larger because of this trade deficit? If so, it would be worth a Nobel Prize if someone could lay it out with a straight face.

The $500 billion trade deficit, coupled with a standard multiplier of 1.5, translates into $750 billion of lost annual output (roughly 4.5 percent of GDP). This in turn would come to about 6 million jobs. That is close to enough to get us back to full employment. That would give workers enough bargaining power to secure real wages. So yes, trade is a big deal.

It is also worth noting that the "trade" deals currently on the table, the Trans-Pacific Partnership and the Trans-Atlantic Trade and Investment Pact, have little to do with trade. Both are primarily about putting in place a pro-corporate regulatory structure that would almost certainly not pass in Congress through the normal process or in any other democratically elected parliament. It will also include increased protectionism in the form of stronger patent and copyright protections. These will have the effect of raising prices, slowing growth, and costing jobs. 



Researchers Who Know Economics Worry About Per Capita GDP Growth, Not Overall Growth Print
Tuesday, 22 July 2014 08:05

The Washington Post had an interesting piece reporting on how many young couples are putting off having children for economic reasons. At one point the piece told readers:

"Births have slowed so sharply that researchers note that future economic growth could be stunted by a smaller labor pool. Immigration is often seen as a fix. But the downturn crimped supply lines for both babies and new foreign faces. The change was so dramatic that the Census Bureau in 2012 was forced to revise the 2050 U.S. population projection it made just four years earlier, dropping it by 9 percent, to just under 400 million."

Contrary to the impression given by this paragraph, the prospect of slower population growth should be good news for most people. It is likely to mean a relatively smaller labor supply, and therefore higher wages for most workers. It will also mean less strain on the infrastructure and on natural resources. In other words, smaller traffic jams and less crowded beaches and parks. It also will be easier to contain greenhouse gas emissions with a smaller population.

The only people who are likely to be hurt by the prospects of a smaller population are the "it's hard to find good help" crowd, since they will likely have to pay more for people they hire to clean their houses, mow their lawns, and care for the kids. Since more people do such work than pay for such work, most people will end up as winners with slower population growth.

That Boom In Investment: Waiting for Godot Print
Tuesday, 22 July 2014 04:44

Neil Irwin argues the case that a rise in investment would provide a much needed boost to the economy. The point is well-taken, but there is little reason to expect a marked upturn any time soon.

The basic story is, while there is some room for investment to expand, it is not especially low by historical standards. Non-residential fixed investment was 12.2 percent of GDP in 2013. This compares to an average of 12.8 percent of GDP in the years from 1970 to 2007. Irwin reports a larger gap by just focusing on investment in equipment, citing Justin Lahart pointing to spending equal to 5.2 percent of GDP over the last five years compared to 6.5 percent of GDP over the prior 50 years.

There are a few reasons for questioning the significance of this comparison. First, the figure for 2013 was 5.6 percent of GDP, which is closer to the 50-year average. Second, there has been a huge increase in investment in intellectual property products. This spending was 3.8 percent of GDP in 2013 compared to an average of 2.6 percent from 1970 to 2007. To some extent investment in intellectual property products should be a substitute for investment in equipment.

Finally, much of the investment in equipment is occurring overseas as U.S. corporations continue to shift production to Mexico, China, and other sources of low-cost labor. Equipment investment in the last recovery (2002-2007) averaged just 6.0 percent of GDP.That would likely be a more appropriate comparison than the longer period since it was also a time when U.S. corporations were shifting production abroad on a large scale. This implies relatively little increase in investment spending from current levels.

Trade really is the underlying problem that economists do not want to discuss for some reason. The country has a trade deficit of more than $500 billion annually (3 percent of GDP). This translates into demand that is going overseas rather than the United States. There is no easy mechanism to replace this demand (other than verboten government budget deficits). This means that we will likely see an underemployed economy long into the future. Hopes for a surge in investment will prove to be in vain.

Government Administered Saving Accounts Go Back Before 2006 Print
Monday, 21 July 2014 05:12

Steven Pearlstein has a good piece on a proposal in Illinois to have the state administer retirement accounts for workers who don't have access to one at their workplace, however he gets one part wrong. Under the proposal, 3.0 percent of a workers paycheck would be automatically deducted for a retirement account, but she would have the option to not have the deduction or to reduce (or increase) the amount. He tells readers:

"This concept goes by the name of “Automatic IRA.” It was first proposed in 2006 by two respected policy wonks, David John, then of the conservative Heritage Foundation (now at AARP), and Mark Iwry, then at the more liberal Brookings Institution (now at the Obama Treasury). It quickly won support from Democrats and Republican sponsors on Capitol Hill. In the 2008 presidential campaign, both John McCain and Barack Obama endorsed it."

Actually the idea goes much further back than this. There were many similar concepts being debated in the 1990s. My friends at the Economic Opportunity Institute in Washington State had been working on this concept in the form of Washington Voluntary Accounts since 1998. So, it's a good piece, but many more folks deserve credit on advancing this proposal.

Btw, he describes Illinois public employee pensions as "overgenerous." I'll let this one pass (workers did forgo pay for these pensions), since my mother gets one.

Yes, It's Another Monday and Robert Samuelson Is Yelling About the Deficit Print
Monday, 21 July 2014 03:44

Last week the Congressional Budget Office issued its new long-term budget projections. They were little changed from prior projections, but Robert Samuelson still wants to use them as a warning of impending doom.

"Under favorable assumptions, the CBO projects deficits of $7.6 trillion from 2015 to 2024. Under less favorable (maybe more realistic) assumptions, the added debt would total $9.6 trillion. The big drivers are an aging population and rising health spending. ...

"The CBO pronounces present policies 'unsustainable,' but it does not know — no one does — when and how a breakdown might occur or what the consequences might be. It warns that large deficits will crowd out private investment, reducing future living standards. It speculates that excessive debt might someday so frighten investors that they would retreat from Treasury bonds and cause a financial crisis."

Okay, there is lots to have fun with here. First, we get the really big numbers, $7.6 trillion and $9.6 trillion. Are you scared?

Next to no one reading this column has any clue as to what these numbers mean, Samuelson has opted to present them without any context to make them understandable to readers. This must have been a conscious choice on Samuelson's part because CBO actually presents the numbers in context itself. Table 1-1 tells readers that the ratio of debt to GDP is projected to rise because of these deficits from 74 percent this year to 78 percent in 2024. Are you scared now?

If you are worried about the date when we see that "breakdown" or when frightened investors retreat from Treasury bonds and cause a financial crisis, you probably plan to live a very long life. The projections show the debt to GDP ratio rising to 106 percent in 2039. That's not as high as the debt to GDP ratio that we saw at the end of World War II and still far lower than the 134 percent debt to GDP ratio faced by Italy today and the 244 percent ratio in Japan. Due to the fearful investors, Italy now has to pay 2.81 percent interest on its long-term debt and Japan has to pay 0.55 percent.

The other aspect of Samuelson's piece that provides good Monday morning entertainment is that it is totally wrong about the origins of high debts and deficits. As recently as 2008 the debt to GDP was as low as 35 percent. It didn't rise to its current 74 percent because of the moral failings of our political process as Samuelson claims, or at least not the ones to which he points. (The failings have more to do with an over-sensitivity to the profits of the financial industry.) The debt to GDP ratio soared because we actually did have a financial crisis when the housing bubble collapsed and sank the economy. Samuelson seems to have missed this one even though the economy still has not recovered with millions unnecessarily unemployed or underemployed.

The other item worth noting about Samuelson's scare story and morality play is that he never mentions that the reason we face deficits is that our health care costs are hugely out of line with the rest of the world. If we paid the same amount per capita for our health care as people in other wealthy countries we would be looking at huge budget surpluses, not deficits. The reason that we pay more than everyone else is that we pay twice as much for our doctors, our drugs, our medical supplies and blow a fortune on an incredibly inefficient insurance system.

But Samuelson doesn't like to talk about this. It's more fun to complain about greedy seniors.

Question for Thomas Friedman: Is Airbnb So Cool and Hyperconnected That it Can Put People in Fire Traps? Print
Sunday, 20 July 2014 16:50

It would be nice if someone could force Thomas Friedman to learn a little bit about the topics of his columns. Today he ran another ad for Airbnb, touting its hyperconnectiveness. While Friedman is ecstatic over the company's hyperconnectiveness, he fails to answer the most basic questions.

Can Airbnb guarantee that its rooms are safe? If not, can we sue and imprison its executives if people who use the service die in fires? What about the nuisance of living next to a hotel room when you paid to buy a condo or rent an apartment? Can neighbors of popular guest rooms sue Airbnb for the diminution of the value of their homes?

These questions are probably too complex for someone like Thomas Friedman, but perhaps the NYT could hire someone to seriously deal with the issues that Thomas Friedman raises.


Note: An earlier version raised questions about local and state taxes, which Airbnb reports it tries to collect.

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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.