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Beat the press por Dean Baker

Beat the Press is Dean Baker's commentary on economic reporting. He is a Senior Economist at the Center for Economic and Policy Research (CEPR). To never miss a post, subscribe to a weekly email roundup of Beat the Press. Please also consider supporting the blog on Patreon.

Roger Lowenstein had a piece in the NYT’s DealBook section defending share buybacks. I actually agree with much of what he wrote (I can’t see the virtues of paying out money as dividends rather than buybacks), but Lowenstein does miss an important point that can be used to justify the tax proposed by Democrats. There […]
Roger Lowenstein had a piece in the NYT’s DealBook section defending share buybacks. I actually agree with much of what he wrote (I can’t see the virtues of paying out money as dividends rather than buybacks), but Lowenstein does miss an important point that can be used to justify the tax proposed by Democrats. There […]
But socialism is really not the villain. . .it’s actually regulations that restrict supply and raise costs.
But socialism is really not the villain. . .it’s actually regulations that restrict supply and raise costs.
The European welfare states all mandate far more paid time off than the United States.
The European welfare states all mandate far more paid time off than the United States.

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According to a draft document being circulated, the Democrats are looking to save $600 billion over a decade by negotiating lower prescription drug prices. The basic story here is that the United States pays more than twice as much, on average, for prescription drugs than Germany, France, Canada, and other wealthy countries. If we paid something closer to what these countries pay for drugs, there would be very large potential savings.

The Democrats are hoping to use these savings to pay for expanding Medicare (possibly also lowering the age of eligibility; 64 would be a good start), free community college, extending the child tax credit, and all sorts of other good things. While there is some skepticism as to whether the government can actually save $600 billion over a decade on prescription drugs, this is actually a very low target. Arguably, the full cost of the $3.5 trillion (1.2 percent of GDP) reconciliation package could be covered by savings on prescription drugs alone.

Projected Spending on Prescription Drugs

There is very little awareness of how much money the country spends on prescription drugs. This is partly due to the fact that most spending is by third parties, either the government or private insurers, rather than directly out of the pockets of patients. There also is little realization of how high drug prices are relative to the cost of manufacturing and distribution.

The figure below shows projected spending on prescription drugs over the next decade. Spending for 2021 is projected to be just over $500 billion, or 2.2 percent of GDP. The growth rates projected by the Centers for Medicare and Medicaid Services (CMS) imply that spending will rise to $894 billion by 2031, or 2.6 percent of GDP.[1] The base for this spending is taken from the National Income and Product Accounts, Table 2.4.5U, Line 121. It is considerably higher than the spending data from CMS because it includes spending on drugs in hospitals, nursing homes, and other institutions. The CMS data only measures spending on drugs by patients directly.

 

Source: CMS, BEA, and author’s calculations.

As a target for potential spending, the figure assumes that without patent and related protections, we would be spending 20 percent as much as is currently projected. This is a plausible, and possibly even conservative target.

According to data from the Association for Accessible Medicines (AAM), the trade group for the generic drug industry, brand drugs accounted for 74 percent of spending even though they were only 11 percent of the prescriptions sold. By contrast, generic drugs accounted for just 26 percent of spending even though they were 89 percent of prescriptions. This implies that the average generic prescription cost just 3.6 percent of the price of the average brand prescription, or $29.70 per prescription. This figure would mean that we could save 96.4 percent of the money spent on brand drugs if we immediately got rid of protections and allowed them to be sold as generics.[2] (As a practical matter, we would not see generic competition push down prices right away, since it would take several years for a substantial number of competitors to enter the market.)

But even this figure understates the true potential savings from eliminating patents and related protections. The AAM’s data is based on averages, but these numbers are skewed by the fact that many generics sell for high prices in the period immediately after they are introduced. This is due to the fact that they have limited competition, in part by design.

The first generic to enter a market is granted six months of exclusivity, a period in which they enjoy an effective duopoly with the brand drug. For example, a recent analysis found that price declines averaged just over 50 percent in the first year after a generic is introduced. This means that the average cost of generic drugs in the AAM analysis is inflated by the generic drugs that are sold at high prices in the first years after they come onto the market. Also, the price of generics is inflated due to the fact that the generic industry must incur legal costs to contest patent battles with the brand industry. In addition, generic drugs may also be paying royalties on secondary patents that are still in force even after the key patent for a drug expired.

In a world with no patents or related protections, it is likely that generics would cost close to half as much as we now spend since the market would be more fully competitive and the industry would face far lower legal expenses. The table assumes an 80 percent reduction in spending, which is likely a conservative figure. If the average price of a generic drug in a patent-free world was 50 percent of the current price and all drugs were sold as generics, the savings would be more than 85 percent of current spending.

The 80 percent reduction in projected spending would imply savings of $5.6 trillion over the next decade. Of course, the government does not pay for all prescription drugs in the country, so only around half of these savings, or $2.8 trillion, would accrue to the government. Although, since most spending on health insurance is tax-deductible, the government should recoup some of the private sector savings in the form of higher tax revenue. Also, from the standpoint of reducing demand in the economy and limiting the risk of inflation (the purpose of taxation at the federal level), the reduction in private sector spending on drugs is likely to have almost as much impact as the savings to the government.

Research and Development Costs

This picture leaves out the research and development costs incurred by the industry. In 2020, the industry spent $105.7 billion on research and development.[3] If we assume that spending on research increases at the same pace as spending on drugs, then the industry would be spending $1.5 trillion on research and development over the course of the decade, on its current path. (This is in addition to the $45 billion a year that it currently spends through NIH and other agencies.)  If the government had to replace this spending, and we assume that a dollar of government spending has the same value as a dollar of private spending, then we would need to subtract $1.5 trillion from our savings on drug prices to cover these research costs. That would still leave $4.1 trillion in savings.

Whether or not a dollar of government spending has the same value as a dollar of private spending under the patent monopoly system is a debatable point. It could be argued that private companies, with their own dollars on the line, will be more efficient, but there are reasons the story could go the other way. (Moderna, which developed its coronavirus vaccine almost entirely on the public dime, is a great example of public funding being very effective.)

First, there are better and worse ways of doing public funding. In my view, the best route would be to pay out money for research to drug companies on long-term contracts, similar to the way the Defense Department contracts out for major weapons systems. (I describe this more fully in chapter 5 of Rigged [it’s free].) The contractors would have a strong incentive to ensure their money was well spent since presumably, they will want their contracts renewed when they expire.

A big advantage this system would have over military contracting is that everything would be fully open. While there are good reasons for secrecy in designing weapons systems, there is no reason to want to keep research findings on a cancer drug or treatment for heart disease secret. In fact, putting all results on the web in a timely manner should be a condition of getting public funding. This rule would apply not only to contractors but also to all subcontractors. (It is likely that any major drug company winning a contract would contract out for much of the research, just as they do now. Innovative startups are likely to be more efficient with research dollars than large well-established companies.)

If all research is quickly made available to the entire scientific community, we are likely to make progress more quickly than in a world where drug companies are looking to lock up their work behind patent monopolies. Researchers can quickly learn from each other’s research, building on successes and avoiding failures.

In addition, research that is primarily rent-seeking in nature would be largely avoided. In many cases, drug companies look to develop drugs that are not expected to produce major medical benefits over existing drugs, but rather will simply give them a portion of the patent rents earned by a major breakthrough drug. The Food and Drug Administration puts more than 90 percent of its drug approvals in the “standard” category, meaning that they are not a qualitative improvement over existing drugs.

To be clear, duplicative drugs are not of zero value. People may react poorly to a certain drug, whereas they may be fine with another drug in the same class. Also, some drugs do not mix well with other drugs. However, as a general rule, we would probably like to see research dollars spent finding drugs for conditions where effective drugs do not currently exist, rather than developing the seventh, eighth, or ninth drug for a condition.

There also will be some amount of research spending that will be needed to ensure that production standards are safe and efficient. This spending would be necessary even if everything was sold as a generic, since it will be needed for any manufacturer. The government would not need to replace this spending, which is likely in the neighborhood of 10 percent of the total.

The Opioid Scandal and Patent Monopoly Financings

There is one other very important reason for believing that publicly-funded research could be more effective on a per-dollar basis than patent monopoly financing. Patent monopolies give drug companies an incentive to lie about the safety and effectiveness of their drugs.

While it is common for drug companies to be less than completely honest about the safety and effectiveness of their drugs, we saw a very dramatic example of this dishonesty with the opioid crisis. Purdue Pharma and other major opioid manufacturers paid out tens of billions of dollars in settlements in response to lawsuits alleging that they deliberately concealed evidence of the addictiveness of their drugs in their efforts to promote them to doctors.

To be clear, the allegation was not that these companies made a mistake. The claim was that they knew their drugs were highly addictive, but claimed the opposite when they tried to convince doctors to prescribe them to patients.

There will always be mistakes in research, some with very large consequences. But the issue here was deliberate deception. Had it not been for the opportunity to sell their opioids at patent monopoly prices, the drug companies would have had far less incentive to misrepresent their addictiveness.

If we eliminated patent monopolies for prescription drugs, we also eliminate this perverse incentive. This is likely to lead to considerably better care for patients, since doctors will have honest research guiding their decisions in prescribing drugs.  

Drug Savings and Covering the Cost of the Reconciliation Package

If we think clearly about how much we are spending on drugs, compared to the cost of manufacturing and distributing them, it should be clear that the $600 billion savings figure being tossed around by Democrats is very doable. It is plausible to envision savings many times larger, if we are prepared to jettison the patent monopoly system of financing drug research and replace it with something more modern.

Of course, we should be looking to other routes for offsetting the spending in the reconciliation package, most obviously by increasing taxes on the rich and corporations. My favorite in the latter category involves switching the basis for the corporate income tax from profits to returns to shareholders. The latter are simply dividends and capital gains. This can be done on a simple spreadsheet. (That would be a single spreadsheet for all publicly traded companies.) We could put the tax shelter industry out of business since there is no way to hide what is being doled out as dividends or the rise in share price. (To be clear, this is a corporate income tax, not an individual tax – the corporations will be taxed based on the money they made for shareholders.)    

The Democrats in Congress are in a position to make changes that will have a huge impact on the lives of tens of millions of people. Covering the cost should not be a problem. We can get much or all of the way there from savings on prescription drugs alone, but we have many other good options to add to the mix.

[1] The projections in the chart use calendar year 2019 spending on prescription drugs as a base, since the 2020 numbers were distorted by the pandemic. This is taken from the National Income and Product Accounts, Table 2.4.5U, Line 121. The numbers for later years use the projected growth rates from the Center for Medicare and Medicaid Services, National Health Expenditure Projections, 2019-2028, Table 2. The spending growth rate for 2027 to 2028 (6.0 percent), is assumed to continue for the next three years.

[2] In the case of some very high-priced drugs, high-quality generic versions are available in other countries for less than 1.0 percent of the price charged in the United States.

[3] National Income and Product Accounts, Table 5.6.5, Line 9.

According to a draft document being circulated, the Democrats are looking to save $600 billion over a decade by negotiating lower prescription drug prices. The basic story here is that the United States pays more than twice as much, on average, for prescription drugs than Germany, France, Canada, and other wealthy countries. If we paid something closer to what these countries pay for drugs, there would be very large potential savings.

The Democrats are hoping to use these savings to pay for expanding Medicare (possibly also lowering the age of eligibility; 64 would be a good start), free community college, extending the child tax credit, and all sorts of other good things. While there is some skepticism as to whether the government can actually save $600 billion over a decade on prescription drugs, this is actually a very low target. Arguably, the full cost of the $3.5 trillion (1.2 percent of GDP) reconciliation package could be covered by savings on prescription drugs alone.

Projected Spending on Prescription Drugs

There is very little awareness of how much money the country spends on prescription drugs. This is partly due to the fact that most spending is by third parties, either the government or private insurers, rather than directly out of the pockets of patients. There also is little realization of how high drug prices are relative to the cost of manufacturing and distribution.

The figure below shows projected spending on prescription drugs over the next decade. Spending for 2021 is projected to be just over $500 billion, or 2.2 percent of GDP. The growth rates projected by the Centers for Medicare and Medicaid Services (CMS) imply that spending will rise to $894 billion by 2031, or 2.6 percent of GDP.[1] The base for this spending is taken from the National Income and Product Accounts, Table 2.4.5U, Line 121. It is considerably higher than the spending data from CMS because it includes spending on drugs in hospitals, nursing homes, and other institutions. The CMS data only measures spending on drugs by patients directly.

 

Source: CMS, BEA, and author’s calculations.

As a target for potential spending, the figure assumes that without patent and related protections, we would be spending 20 percent as much as is currently projected. This is a plausible, and possibly even conservative target.

According to data from the Association for Accessible Medicines (AAM), the trade group for the generic drug industry, brand drugs accounted for 74 percent of spending even though they were only 11 percent of the prescriptions sold. By contrast, generic drugs accounted for just 26 percent of spending even though they were 89 percent of prescriptions. This implies that the average generic prescription cost just 3.6 percent of the price of the average brand prescription, or $29.70 per prescription. This figure would mean that we could save 96.4 percent of the money spent on brand drugs if we immediately got rid of protections and allowed them to be sold as generics.[2] (As a practical matter, we would not see generic competition push down prices right away, since it would take several years for a substantial number of competitors to enter the market.)

But even this figure understates the true potential savings from eliminating patents and related protections. The AAM’s data is based on averages, but these numbers are skewed by the fact that many generics sell for high prices in the period immediately after they are introduced. This is due to the fact that they have limited competition, in part by design.

The first generic to enter a market is granted six months of exclusivity, a period in which they enjoy an effective duopoly with the brand drug. For example, a recent analysis found that price declines averaged just over 50 percent in the first year after a generic is introduced. This means that the average cost of generic drugs in the AAM analysis is inflated by the generic drugs that are sold at high prices in the first years after they come onto the market. Also, the price of generics is inflated due to the fact that the generic industry must incur legal costs to contest patent battles with the brand industry. In addition, generic drugs may also be paying royalties on secondary patents that are still in force even after the key patent for a drug expired.

In a world with no patents or related protections, it is likely that generics would cost close to half as much as we now spend since the market would be more fully competitive and the industry would face far lower legal expenses. The table assumes an 80 percent reduction in spending, which is likely a conservative figure. If the average price of a generic drug in a patent-free world was 50 percent of the current price and all drugs were sold as generics, the savings would be more than 85 percent of current spending.

The 80 percent reduction in projected spending would imply savings of $5.6 trillion over the next decade. Of course, the government does not pay for all prescription drugs in the country, so only around half of these savings, or $2.8 trillion, would accrue to the government. Although, since most spending on health insurance is tax-deductible, the government should recoup some of the private sector savings in the form of higher tax revenue. Also, from the standpoint of reducing demand in the economy and limiting the risk of inflation (the purpose of taxation at the federal level), the reduction in private sector spending on drugs is likely to have almost as much impact as the savings to the government.

Research and Development Costs

This picture leaves out the research and development costs incurred by the industry. In 2020, the industry spent $105.7 billion on research and development.[3] If we assume that spending on research increases at the same pace as spending on drugs, then the industry would be spending $1.5 trillion on research and development over the course of the decade, on its current path. (This is in addition to the $45 billion a year that it currently spends through NIH and other agencies.)  If the government had to replace this spending, and we assume that a dollar of government spending has the same value as a dollar of private spending, then we would need to subtract $1.5 trillion from our savings on drug prices to cover these research costs. That would still leave $4.1 trillion in savings.

Whether or not a dollar of government spending has the same value as a dollar of private spending under the patent monopoly system is a debatable point. It could be argued that private companies, with their own dollars on the line, will be more efficient, but there are reasons the story could go the other way. (Moderna, which developed its coronavirus vaccine almost entirely on the public dime, is a great example of public funding being very effective.)

First, there are better and worse ways of doing public funding. In my view, the best route would be to pay out money for research to drug companies on long-term contracts, similar to the way the Defense Department contracts out for major weapons systems. (I describe this more fully in chapter 5 of Rigged [it’s free].) The contractors would have a strong incentive to ensure their money was well spent since presumably, they will want their contracts renewed when they expire.

A big advantage this system would have over military contracting is that everything would be fully open. While there are good reasons for secrecy in designing weapons systems, there is no reason to want to keep research findings on a cancer drug or treatment for heart disease secret. In fact, putting all results on the web in a timely manner should be a condition of getting public funding. This rule would apply not only to contractors but also to all subcontractors. (It is likely that any major drug company winning a contract would contract out for much of the research, just as they do now. Innovative startups are likely to be more efficient with research dollars than large well-established companies.)

If all research is quickly made available to the entire scientific community, we are likely to make progress more quickly than in a world where drug companies are looking to lock up their work behind patent monopolies. Researchers can quickly learn from each other’s research, building on successes and avoiding failures.

In addition, research that is primarily rent-seeking in nature would be largely avoided. In many cases, drug companies look to develop drugs that are not expected to produce major medical benefits over existing drugs, but rather will simply give them a portion of the patent rents earned by a major breakthrough drug. The Food and Drug Administration puts more than 90 percent of its drug approvals in the “standard” category, meaning that they are not a qualitative improvement over existing drugs.

To be clear, duplicative drugs are not of zero value. People may react poorly to a certain drug, whereas they may be fine with another drug in the same class. Also, some drugs do not mix well with other drugs. However, as a general rule, we would probably like to see research dollars spent finding drugs for conditions where effective drugs do not currently exist, rather than developing the seventh, eighth, or ninth drug for a condition.

There also will be some amount of research spending that will be needed to ensure that production standards are safe and efficient. This spending would be necessary even if everything was sold as a generic, since it will be needed for any manufacturer. The government would not need to replace this spending, which is likely in the neighborhood of 10 percent of the total.

The Opioid Scandal and Patent Monopoly Financings

There is one other very important reason for believing that publicly-funded research could be more effective on a per-dollar basis than patent monopoly financing. Patent monopolies give drug companies an incentive to lie about the safety and effectiveness of their drugs.

While it is common for drug companies to be less than completely honest about the safety and effectiveness of their drugs, we saw a very dramatic example of this dishonesty with the opioid crisis. Purdue Pharma and other major opioid manufacturers paid out tens of billions of dollars in settlements in response to lawsuits alleging that they deliberately concealed evidence of the addictiveness of their drugs in their efforts to promote them to doctors.

To be clear, the allegation was not that these companies made a mistake. The claim was that they knew their drugs were highly addictive, but claimed the opposite when they tried to convince doctors to prescribe them to patients.

There will always be mistakes in research, some with very large consequences. But the issue here was deliberate deception. Had it not been for the opportunity to sell their opioids at patent monopoly prices, the drug companies would have had far less incentive to misrepresent their addictiveness.

If we eliminated patent monopolies for prescription drugs, we also eliminate this perverse incentive. This is likely to lead to considerably better care for patients, since doctors will have honest research guiding their decisions in prescribing drugs.  

Drug Savings and Covering the Cost of the Reconciliation Package

If we think clearly about how much we are spending on drugs, compared to the cost of manufacturing and distributing them, it should be clear that the $600 billion savings figure being tossed around by Democrats is very doable. It is plausible to envision savings many times larger, if we are prepared to jettison the patent monopoly system of financing drug research and replace it with something more modern.

Of course, we should be looking to other routes for offsetting the spending in the reconciliation package, most obviously by increasing taxes on the rich and corporations. My favorite in the latter category involves switching the basis for the corporate income tax from profits to returns to shareholders. The latter are simply dividends and capital gains. This can be done on a simple spreadsheet. (That would be a single spreadsheet for all publicly traded companies.) We could put the tax shelter industry out of business since there is no way to hide what is being doled out as dividends or the rise in share price. (To be clear, this is a corporate income tax, not an individual tax – the corporations will be taxed based on the money they made for shareholders.)    

The Democrats in Congress are in a position to make changes that will have a huge impact on the lives of tens of millions of people. Covering the cost should not be a problem. We can get much or all of the way there from savings on prescription drugs alone, but we have many other good options to add to the mix.

[1] The projections in the chart use calendar year 2019 spending on prescription drugs as a base, since the 2020 numbers were distorted by the pandemic. This is taken from the National Income and Product Accounts, Table 2.4.5U, Line 121. The numbers for later years use the projected growth rates from the Center for Medicare and Medicaid Services, National Health Expenditure Projections, 2019-2028, Table 2. The spending growth rate for 2027 to 2028 (6.0 percent), is assumed to continue for the next three years.

[2] In the case of some very high-priced drugs, high-quality generic versions are available in other countries for less than 1.0 percent of the price charged in the United States.

[3] National Income and Product Accounts, Table 5.6.5, Line 9.

It seems a strange concern, but I suppose it’s what we would expect from a political party that is determined to block every effort to contain the pandemic. According to a NYT article on opposition to President Biden’s plan to increase spending on various social program by $3.5 billion (1.3 percent of GDP) over the next decade:

“To critics, the legislation represents a fundamental upending of American-style governance and a shift toward social democracy. With it, they worry, would come European-style endemic unemployment and depressed economic dynamism.”

Many European social democracies have consistently had lower unemployment rates than the United States. According to the most recent data from the OECD, the unemployment rate in Denmark is now 4.3, in Germany 3.6 percent, and in the Netherlands 3.1 percent. It’s now clear what measure of “economic dynamism” these critics use, but using productivity growth, the measure most often used by economists, the dynamism of European economies is comparable to the U.S. economy.

It seems a strange concern, but I suppose it’s what we would expect from a political party that is determined to block every effort to contain the pandemic. According to a NYT article on opposition to President Biden’s plan to increase spending on various social program by $3.5 billion (1.3 percent of GDP) over the next decade:

“To critics, the legislation represents a fundamental upending of American-style governance and a shift toward social democracy. With it, they worry, would come European-style endemic unemployment and depressed economic dynamism.”

Many European social democracies have consistently had lower unemployment rates than the United States. According to the most recent data from the OECD, the unemployment rate in Denmark is now 4.3, in Germany 3.6 percent, and in the Netherlands 3.1 percent. It’s now clear what measure of “economic dynamism” these critics use, but using productivity growth, the measure most often used by economists, the dynamism of European economies is comparable to the U.S. economy.

Last week’s jobs report filled news accounts with stories of gloom and doom. The 235,000 new jobs created in August was well below most projections. The theme was that something had gone seriously wrong with the economy and we should be very worried about the prospects for the labor market and the economy through the rest of this year into next.

While the jobs number was weaker than expected (my number had been 500,000), much of the pessimism in the reporting was a bit over the top. First, we know there is always some random movement in the monthly numbers. This is partly because of the errors in the survey and partly because of erratic patterns in employment. If a company hires a large number of workers in July, it will probably not turn around and hire a large number again in August.

It is likely that we were seeing this story to some extent with the August jobs report. We saw an extraordinarily rapid rate of job growth in June and July, with the economy reportedly adding 2,015,000 jobs, a number that was revised up by 135,000 with the August report. This translates into monthly job growth of 1,008,000 jobs.

It’s hard to know exactly how fast we should expect the economy to be creating jobs at this point, but let’s say 750,000 a month. That would translate into an annual rate of 9 million a year. That would get back the jobs lost in the pandemic in less than 8 months. It’s hard to argue that we should expect growth too much more rapid than this.

If we use 750,000 as a trend, then we were 515,000 above trend for the last two months. That means to stay on trend for the three-month period, we needed 235,000 jobs in August, exactly what we saw.

There clearly were surprises in this report. State and local governments lost 11,000 jobs in August after adding 246,000 in July. This left them down 815,000 jobs from the pre-pandemic level. This is most likely a matter of timing. Most of the decline in employment is due to fewer jobs in education. With nearly all schools returning to in-class instruction, presumably they will need roughly the same number of teachers and support staff as they had prior to the pandemic.

The restaurant sector was the other big surprise, shedding 41,500 jobs in August after adding 290,000 in July. Many commentators were quick to attribute this drop to the Delta Variant, with the idea that the fear of Covid kept people away from restaurants. This is far from clear. The Open Table data on reservations shows no clear trend, and its figure for the Sunday before Labor Day was 30.0 percent above the level from two years ago. There was also a gain of 35,500 jobs in the category of Arts, Entertainment, and Recreation. It is a bit hard to believe that people are comfortable going to concerts and seeing movies, but not eating at restaurants.

Clearly Covid had some effect, but it is at least as plausible that weak employment growth in restaurants is a supply-side story. The argument would be that many of the people who had formerly worked in restaurants are no longer willing to do so, or at least not at the same wages and working conditions. This would mean that these workers had the resources to be more selective on where they choose to work. This could be the case if they were able to save some of the $3,400 in pandemic checks that were paid out to single adults over the course of 2020 and 2021.

Remember, the average weekly earnings for production and non-supervisory workers in restaurants in 2019 was less than $340, so these pandemic payments were equal to ten weeks of normal pay. Also, with the $300 weekly supplements, unemployed restaurant workers likely had been getting more money than when they had been working. So, it shouldn’t seem far-fetched that many of these workers have more of a financial cushion now than they did before the pandemic.[1]

Consistent with this being more a supply-side story than a demand-side story is the fact that we are still seeing very rapid wage growth in the leisure and hospitality sector, which is overwhelmingly restaurant workers. The average hourly wage for production and non-supervisory employers rose at an annual rate of 23.7 percent in the last three months (June, July, August) compared with the prior three months (March, April, May). Over the last year, the hourly wage is up 12.8 percent.

Another item that fits this supply-side story is the fact that both the home health care sector and nursing homes lost jobs in August, 11,600 and 7,100 jobs, respectively. Both these sectors generally have low pay and poor working conditions, making them undesirable jobs.

In the same vein, the number of unincorporated self-employed is running more than 700,000 (7.1 percent) above the average for 2019. This suggests that many workers are considering alternatives to the types of jobs they held before the pandemic.

The Unemployment-Employment Picture

While the weaker than expected jobs numbers got most of the attention on Friday, the unemployment rate did fall another 0.2 percentage points to 5.2 percent. While no one should be satisfied with a 5.2 percent unemployment rate, it is important to recognize that, until recently, most economists would have viewed this as a very low unemployment rate. The unemployment rate did not fall to 5.2 percent following the Great Recession until July of 2015, at which point the Fed was preparing to raise interest rates to slow the economy, so that unemployment would not fall much further.

Last summer, before the passage of the American Recovery Act, the Congressional Budget Office projected that the unemployment rate would still be 8.0 percent in the third quarter of 2021, so we are doing considerably better than expected.

If we look at the employment side, as shown above, the prime age (ages 25 to 54) employment to population ratio (EPOP) rose 0.2 percentage points to 78.0 percent. This is a level not seen following the Great Recession until July of 2016, although 2.5 percentage points below the peak hit in January 2020, just before the pandemic.

By more narrow age groups, the largest falloff is among the 25 to 34 age group, with a decline in EPOP of 2.8 pp. The drop is slightly more for women than for men, 3.0 pp compared to 2.9 pp.  For the 35 to 44 age group, the decline in EPOP was 2.7 pp. The falloff for men and women was almost identical, 2.7 pp and 2.6 pp. The drop in EPOPs for the 45 to 54 group was noticeably smaller at 1.9 pp. The decline for men in this age group was 1.8 pp compared with 1.9 pp for women.

 

The Economy Going Forward: Increased Worker Flexibility, Especially if the Biden Bill Passes

We still need to see more demand in the economy to create more jobs. It’s great if more workers have the bargaining power so that they can demand good jobs, and not be forced to accept work that offers low pay and bad conditions. If we continue to see the unemployment rate fall, then they may have the bargaining power to secure better pay and conditions, especially at the bottom.

Workers’ prospects will be further enhanced if Biden’s bill passes since it will hugely increase the amount of security they have.  Workers will be able to count on support for child care and pre-K for their young children. They will also get subsidies that will ensure them affordable insurance through the exchanges created by Obamacare. And, they can count on a more generous Medicare program so that they will need less money to pay for their health care in retirement.

This will not be sufficient to reverse forty years of upward redistribution, but it’s a good start.

[1] There may have been a modest disincentive effect associated with the $300 weekly supplements, but most research indicated that this was relatively small. The effect of the Pandemic Unemployment Assistance program, which made payments to people who would not qualify for traditional unemployment, may have been somewhat larger, however almost half the states have already eliminated these special pandemic benefits, and the federal program ends this month, so any disincentive effect will be dwindling rapidly.

Last week’s jobs report filled news accounts with stories of gloom and doom. The 235,000 new jobs created in August was well below most projections. The theme was that something had gone seriously wrong with the economy and we should be very worried about the prospects for the labor market and the economy through the rest of this year into next.

While the jobs number was weaker than expected (my number had been 500,000), much of the pessimism in the reporting was a bit over the top. First, we know there is always some random movement in the monthly numbers. This is partly because of the errors in the survey and partly because of erratic patterns in employment. If a company hires a large number of workers in July, it will probably not turn around and hire a large number again in August.

It is likely that we were seeing this story to some extent with the August jobs report. We saw an extraordinarily rapid rate of job growth in June and July, with the economy reportedly adding 2,015,000 jobs, a number that was revised up by 135,000 with the August report. This translates into monthly job growth of 1,008,000 jobs.

It’s hard to know exactly how fast we should expect the economy to be creating jobs at this point, but let’s say 750,000 a month. That would translate into an annual rate of 9 million a year. That would get back the jobs lost in the pandemic in less than 8 months. It’s hard to argue that we should expect growth too much more rapid than this.

If we use 750,000 as a trend, then we were 515,000 above trend for the last two months. That means to stay on trend for the three-month period, we needed 235,000 jobs in August, exactly what we saw.

There clearly were surprises in this report. State and local governments lost 11,000 jobs in August after adding 246,000 in July. This left them down 815,000 jobs from the pre-pandemic level. This is most likely a matter of timing. Most of the decline in employment is due to fewer jobs in education. With nearly all schools returning to in-class instruction, presumably they will need roughly the same number of teachers and support staff as they had prior to the pandemic.

The restaurant sector was the other big surprise, shedding 41,500 jobs in August after adding 290,000 in July. Many commentators were quick to attribute this drop to the Delta Variant, with the idea that the fear of Covid kept people away from restaurants. This is far from clear. The Open Table data on reservations shows no clear trend, and its figure for the Sunday before Labor Day was 30.0 percent above the level from two years ago. There was also a gain of 35,500 jobs in the category of Arts, Entertainment, and Recreation. It is a bit hard to believe that people are comfortable going to concerts and seeing movies, but not eating at restaurants.

Clearly Covid had some effect, but it is at least as plausible that weak employment growth in restaurants is a supply-side story. The argument would be that many of the people who had formerly worked in restaurants are no longer willing to do so, or at least not at the same wages and working conditions. This would mean that these workers had the resources to be more selective on where they choose to work. This could be the case if they were able to save some of the $3,400 in pandemic checks that were paid out to single adults over the course of 2020 and 2021.

Remember, the average weekly earnings for production and non-supervisory workers in restaurants in 2019 was less than $340, so these pandemic payments were equal to ten weeks of normal pay. Also, with the $300 weekly supplements, unemployed restaurant workers likely had been getting more money than when they had been working. So, it shouldn’t seem far-fetched that many of these workers have more of a financial cushion now than they did before the pandemic.[1]

Consistent with this being more a supply-side story than a demand-side story is the fact that we are still seeing very rapid wage growth in the leisure and hospitality sector, which is overwhelmingly restaurant workers. The average hourly wage for production and non-supervisory employers rose at an annual rate of 23.7 percent in the last three months (June, July, August) compared with the prior three months (March, April, May). Over the last year, the hourly wage is up 12.8 percent.

Another item that fits this supply-side story is the fact that both the home health care sector and nursing homes lost jobs in August, 11,600 and 7,100 jobs, respectively. Both these sectors generally have low pay and poor working conditions, making them undesirable jobs.

In the same vein, the number of unincorporated self-employed is running more than 700,000 (7.1 percent) above the average for 2019. This suggests that many workers are considering alternatives to the types of jobs they held before the pandemic.

The Unemployment-Employment Picture

While the weaker than expected jobs numbers got most of the attention on Friday, the unemployment rate did fall another 0.2 percentage points to 5.2 percent. While no one should be satisfied with a 5.2 percent unemployment rate, it is important to recognize that, until recently, most economists would have viewed this as a very low unemployment rate. The unemployment rate did not fall to 5.2 percent following the Great Recession until July of 2015, at which point the Fed was preparing to raise interest rates to slow the economy, so that unemployment would not fall much further.

Last summer, before the passage of the American Recovery Act, the Congressional Budget Office projected that the unemployment rate would still be 8.0 percent in the third quarter of 2021, so we are doing considerably better than expected.

If we look at the employment side, as shown above, the prime age (ages 25 to 54) employment to population ratio (EPOP) rose 0.2 percentage points to 78.0 percent. This is a level not seen following the Great Recession until July of 2016, although 2.5 percentage points below the peak hit in January 2020, just before the pandemic.

By more narrow age groups, the largest falloff is among the 25 to 34 age group, with a decline in EPOP of 2.8 pp. The drop is slightly more for women than for men, 3.0 pp compared to 2.9 pp.  For the 35 to 44 age group, the decline in EPOP was 2.7 pp. The falloff for men and women was almost identical, 2.7 pp and 2.6 pp. The drop in EPOPs for the 45 to 54 group was noticeably smaller at 1.9 pp. The decline for men in this age group was 1.8 pp compared with 1.9 pp for women.

 

The Economy Going Forward: Increased Worker Flexibility, Especially if the Biden Bill Passes

We still need to see more demand in the economy to create more jobs. It’s great if more workers have the bargaining power so that they can demand good jobs, and not be forced to accept work that offers low pay and bad conditions. If we continue to see the unemployment rate fall, then they may have the bargaining power to secure better pay and conditions, especially at the bottom.

Workers’ prospects will be further enhanced if Biden’s bill passes since it will hugely increase the amount of security they have.  Workers will be able to count on support for child care and pre-K for their young children. They will also get subsidies that will ensure them affordable insurance through the exchanges created by Obamacare. And, they can count on a more generous Medicare program so that they will need less money to pay for their health care in retirement.

This will not be sufficient to reverse forty years of upward redistribution, but it’s a good start.

[1] There may have been a modest disincentive effect associated with the $300 weekly supplements, but most research indicated that this was relatively small. The effect of the Pandemic Unemployment Assistance program, which made payments to people who would not qualify for traditional unemployment, may have been somewhat larger, however almost half the states have already eliminated these special pandemic benefits, and the federal program ends this month, so any disincentive effect will be dwindling rapidly.

The August jobs report was somewhat disappointing. The economy added only 235,000 jobs for the month, just 48,000 more than the 187,000 pre-pandemic monthly average under Trump. Seriously, most of us did expect more jobs (my number had been 500,000), but after two months where job growth averaged more than 1 million, some falloff should have been expected, even without the impact of the Delta variant.

Anyhow, it’s time to see how the economy’s job performance under Biden stacks up against its performance under Trump. As I always say, this is silly since there are so many things that are beyond the president’s control, so the comparison really is not telling us much. But, you know if the situation were reversed, Donald Trump would be touting this graph to the sky. He probably would even have a huge neon version on top of Trump Tower.

So, here’s where we stand now. Including the August number, and the 135,000 upward revision to growth for the prior two months, Biden has now created 4.5 million jobs in the first seven months of his presidency.  Trump lost 2.9 million jobs over his four years in office.

 

Source: Bureau of Labor Statistics and Author’s calculations.

The August jobs report was somewhat disappointing. The economy added only 235,000 jobs for the month, just 48,000 more than the 187,000 pre-pandemic monthly average under Trump. Seriously, most of us did expect more jobs (my number had been 500,000), but after two months where job growth averaged more than 1 million, some falloff should have been expected, even without the impact of the Delta variant.

Anyhow, it’s time to see how the economy’s job performance under Biden stacks up against its performance under Trump. As I always say, this is silly since there are so many things that are beyond the president’s control, so the comparison really is not telling us much. But, you know if the situation were reversed, Donald Trump would be touting this graph to the sky. He probably would even have a huge neon version on top of Trump Tower.

So, here’s where we stand now. Including the August number, and the 135,000 upward revision to growth for the prior two months, Biden has now created 4.5 million jobs in the first seven months of his presidency.  Trump lost 2.9 million jobs over his four years in office.

 

Source: Bureau of Labor Statistics and Author’s calculations.

Politicians in Washington tend to be a pretty arrogant group. They think they can just define their own terms and expect everyone else just to accept these terms at face value.

Senator Manchin gives us a great example of this pattern in his Wall Street Journal column complaining about President Biden’s plan for a $3.5 trillion reconciliation bill, which would increase federal spending by an amount equal to roughly to 1.3 percent of GDP over the next decade. Manchin complained that he was worried that this spending would add too much to the debt and could spur higher inflation.

While the proposal would address many issues, such as extending Medicare to include dental and hearing coverage, to expanded support for child care, most of the items in the bill fit clearly under the definition of investment. Much of the spending goes to combat global warming, either by promoting electric cars, conservation, and clean energy or increasing the resiliency of our infrastructure to deal with extreme weather events, like Hurricane Ida.

As a practical matter, spewing greenhouse gases into the atmosphere, without regard for its impact on the climate, is creating a type of debt. In future years, we will have more forest fires, droughts, and hurricanes due to a hotter planet. This will impose enormous costs as governments at all levels have to evacuate people, care for the injured, and constantly repair and replace damaged homes, businesses, and infrastructure.

Senator Manchin wants to pretend that this climate debt does not exist. He only wants to look at the debt that comes from the government directly borrowing money. He wants to ignore that the costs that we are imposing on future generations by not taking steps to counter global warming now. That may somehow work for his conscience, but it is absurd in the real world.

Also, if he is concerned about inflation, he may want to ask what happens to the price of beef when much of the land in the West where cattle now graze becomes too dry to support the herd. Or, to take the case of agriculture more generally, large parts of California, that now provide the bulk of our fruit and vegetable production, may no longer be suited for agriculture if they can’t get water due to persistent droughts. And, we will see more housing shortages and higher house prices, if rising temperatures and sea levels make much of our current housing stock inhabitable.

Inflation can come from too much demand, although that hardly seems the problem today. It can also come from reduced supply, which will be a problem if we insist on not taking global warming seriously.

I will also just briefly make the obvious  point that the government creates debt not only through its direct spending, but also by granting patent and copyright monopolies to things like coronavirus vaccines. Again, choosing to ignore this form of debt (which is enormous) doesn’t make it go away.

Politicians in Washington tend to be a pretty arrogant group. They think they can just define their own terms and expect everyone else just to accept these terms at face value.

Senator Manchin gives us a great example of this pattern in his Wall Street Journal column complaining about President Biden’s plan for a $3.5 trillion reconciliation bill, which would increase federal spending by an amount equal to roughly to 1.3 percent of GDP over the next decade. Manchin complained that he was worried that this spending would add too much to the debt and could spur higher inflation.

While the proposal would address many issues, such as extending Medicare to include dental and hearing coverage, to expanded support for child care, most of the items in the bill fit clearly under the definition of investment. Much of the spending goes to combat global warming, either by promoting electric cars, conservation, and clean energy or increasing the resiliency of our infrastructure to deal with extreme weather events, like Hurricane Ida.

As a practical matter, spewing greenhouse gases into the atmosphere, without regard for its impact on the climate, is creating a type of debt. In future years, we will have more forest fires, droughts, and hurricanes due to a hotter planet. This will impose enormous costs as governments at all levels have to evacuate people, care for the injured, and constantly repair and replace damaged homes, businesses, and infrastructure.

Senator Manchin wants to pretend that this climate debt does not exist. He only wants to look at the debt that comes from the government directly borrowing money. He wants to ignore that the costs that we are imposing on future generations by not taking steps to counter global warming now. That may somehow work for his conscience, but it is absurd in the real world.

Also, if he is concerned about inflation, he may want to ask what happens to the price of beef when much of the land in the West where cattle now graze becomes too dry to support the herd. Or, to take the case of agriculture more generally, large parts of California, that now provide the bulk of our fruit and vegetable production, may no longer be suited for agriculture if they can’t get water due to persistent droughts. And, we will see more housing shortages and higher house prices, if rising temperatures and sea levels make much of our current housing stock inhabitable.

Inflation can come from too much demand, although that hardly seems the problem today. It can also come from reduced supply, which will be a problem if we insist on not taking global warming seriously.

I will also just briefly make the obvious  point that the government creates debt not only through its direct spending, but also by granting patent and copyright monopolies to things like coronavirus vaccines. Again, choosing to ignore this form of debt (which is enormous) doesn’t make it go away.

The release of the new Social Security Trustees Report, coupled with a New York Times article on what strikes me as a rather silly debate on inequality, led me to think again about the lack of self-reflection in economics. We have seen a 180 degree turn in the understanding of one of the most basic economic problems, yet there is almost no one anywhere saying something to the effect of “yeah, we got that wrong, and here’s why.”

I’ll get to the contradiction in a moment, but first I want to explain why I think the debate which was the focus of the Times article is rather silly. The essence of the debate in the Neil Irwin piece (the Times reporter who wrote the article) is over whether inequality is leading to lower interest rates, which generates greater wealth inequality, or whether the big problem is the low interest rates themselves causing wealth inequality.

To my mind, this is a silly debate, starting with the idea that we should be concerned about inequalities in wealth resulting from low interest rates. That one is a bit hard for me to see.

Just to be clear, there is no doubt about the relationship between interest rates and wealth, as traditionally defined. Low interest rates increase the value of assets like houses, stocks, and bonds. In the last case, the relationship is literally definitional. If a very long-term bond pays a $10 a year coupon, it will be worth roughly $250 when the long-term interest rate is 4.0 percent, but $500 when the rate is 2.0 percent. The question is whether we should be bothered when all the rich people see their stocks, bonds, and to a lesser extent homes, double in price when interest rates plunge.

I know this provides a lot of grist for academic papers, and for foundations who are ostensibly concerned about inequality, but I just have a hard time seeing the problem here. Part of the story is that I sort of doubt that any of these people will be celebrating the reduction in inequality if things went the other way – we saw a sudden surge in interest rates and the stock market fell 50 percent (the celebrants weren’t very visible in the 2008-09 crash).

But the bigger problem is that I just see their accounting as giving a very incomplete picture of wealth. For the vast majority of middle-income people, wealth reflects the ability to meet needs they face in their lifetime. They accumulate wealth in order to cover the cost of their retirement, their health care expenses, especially in old age, and their kids’ education. Middle class people rarely accumulate any substantial sums beyond these needs.

If it’s not already evident, these needs are also often met by government-provided social insurance, like Social Security, Medicare, and, in countries other than the United States, publicly supported colleges and universities. In effect, for middle class people, social insurance provides a direct substitute for wealth.

In many cases, this substitution is quite explicit. In a country with a high wage replacement rate for its Social Security program, workers don’t need to accumulate large amounts of wealth in 401(k)s to support themselves in retirement.  The same is true if public health care programs can be counted on to pay their health care expenses. And, they don’t need to save for their kids’ college if it’s free or cheap.

We could of course count these benefits as “wealth,” but then the story of low interest rates causing inequality would largely disappear. Middle class workers would see the value of their Social Security and retirement health benefits soar when interest rates plummet, in the same way that bond prices soar. The whole problem of interest rates causing inequality then disappears.

Okay, but I don’t really want to destroy the basis for a major academic debate, just noting why I don’t see the problem. (I also have a hard time seeing it as an inequality problem when tens of millions of middle-income homeowners are able to save thousands of dollars a year on their mortgage, car, and credit card payments. But, that’s just me.) Anyhow, let’s get on to the bigger question.

 

Do We Save Too Much or Too Little?

This really should be a joke, but it is now a central question in economics. The reason why this should be a joke is that the answers give images about the economy that are 180 degrees at odds with each other.

The saving too much story is that we don’t have enough demand in the economy. If our main economic problem is that we save too much, then we help the economy, meaning we will have more growth and employment, if we spend more money. If we are in this world, we should worry that budget deficits are too small, not too large. We should be very happy to give low and moderate-income families additional money to support their kids and to ensure they have a decent living standard. (We should be happy in any case, but if our problem is that we save too much, then this money doesn’t have to be a trade off against other spending. We aren’t up against any constraint, so there is no reason not to make these payments.)

President Biden’s investment proposal looks especially good in the saving too much story. If the problem is that we don’t have enough spending in the economy, why wouldn’t we make whatever expenditures are necessary to quickly create the infrastructure for a green economy, as well as providing workers and businesses with subsidies to encourage them to quickly shift to electric cars and trucks, and clean energy sources for their homes and businesses.

And of course, we should want to improve the skills of the workforce by supporting free community college for the short-term and pre-K and child care for the longer term. And, we also should shore up our care-giving economy, with increased support for home health care and other forms of care for seniors and the disabled as well as improving the pay and working conditions for those employed in the sector.

If our economy’s main problem is that we are saving too much, we essentially have a green light to address all sorts of problems that have lingered for decades. The saving too little story is the complete opposite. If this picture is accurate, then we are pushing up against the economy’s limits to produce goods and services. The only way we would be able to spend any substantial sum on the agenda laid out by President Biden is by sharply curtailing spending in other areas of the economy. This typically means raising taxes to reduce the money households or corporations have, and therefore force them to cut back their spending.

While it’s a bit hard to tell the saving too little story today, with the interest rate on long-term bonds hovering near 1.3 percent, it really has been central to economics for many decades. This was the whole rationale for cutting the deficit and balancing budgets in the 1970s, 1980s, 1990s, 2000s, and the last decade. The idea was that our budget deficits were pulling resources away from other sectors of the economy that could better use them than the government.

And, the lack of savings story went far beyond just budget deficits. It was also the motivation for all the supply-side tax cuts, starting with Carter cutting the capital gains tax in 1978, Reagan’s huge tax cuts in the 1980s, George W. Bush’s tax cuts in 2001, and Trump’s tax cut in 2017. All of these tax cuts disproportionately gave more money to the wealthy with the argument that a large share of the cut would then be saved, which would free up resources for investment.

Conservatives also took their savings obsession in the other direction. Martin Feldstein, spent his career trying to show that Social Security reduced private savings. The argument was that typical workers saved less during their working years due to Social Security, which meant that there was less investment than would otherwise be the case, and therefore we were all poorer. His answer was to cut benefits, or better yet, privatize a large chunk of the program.

But, if we were saving too much, then increasing saving with tax cuts (they don’t seem to have had that effect) or cutting Social Security or other benefits, would be taking us in the completely wrong direction. It would mean further reducing demand and employment, and likely also reducing investment, which tends to follow the growth in demand.

We could of course have been saving constrained in prior decades, but not in recent years. This gets to the debate covered by Irwin. One side argued that we have too much savings now because we redistributed income upward, and rich people spend a smaller share of their income.

The other side sees the issue as primarily demographic. We, and other wealthy countries, now have older populations, and older people save a larger share of their income than younger people. In that view, we have a scary road ahead as our population ages further, and even many developing countries, most notably China, are seeing a rapid growth in the share of retirees in their population. So apparently, we are doomed to have too much savings for the indefinite future.

Will Large Numbers of Retirees Break the Bank or Leave the Stores Empty?

This is the point in the story where I have to pause for a little ridicule. The whole deficit debate of the 1980s, 1990s, and 2000s was framed in the context of the looming retirement of the baby boomers. The story as told by Very Serious People, like Peter Peterson and the many organizations he funded, was that the economy would be overwhelmed in meeting the demands of retired baby boomers, at the same time it was providing for needs of its working population and their children.

And, this was not just the perspective of a fringe group. This concern with providing for the needs of retired baby boomers was very much at the center of national politics and the economics profession. This was the whole logic behind Bill Clinton’s balanced budgets and his plan to pay off the debt, touted by leading economists such as Larry Summers. It was also the concern that ostensibly motivated the drive to balance the budget under President Obama and his search for a “Grand Bargain.” And, it was worldwide, as we can see from the World Bank’s volume Averting the Old Age Crisis.

Given this history, we should have a lot of Very Serious People walking around with very serious egg on their face. The view, now widely accepted, that having an older population doesn’t mean too much demand, but rather too little, means that the concerns that had dominated politics here and elsewhere for decades were completely unfounded.

There was no reason to cut back spending on child care, education, clean energy, and thousands of other items in the last two decades with the idea that we somehow would need a larger capital stock to cover the cost of baby boomers retirement. (Okay, that never made much sense in any case.) The Very Serious People not only got the magnitude of the problem created by an aging population wrong, they got the direction wrong.

Policy types can again be thankful that policy work is not like cleaning toilets or washing dishes, where you can get fired for doing bad work. In fact, for the most part getting the story completely wrong will not even be held against you on your career path.  

 

The release of the new Social Security Trustees Report, coupled with a New York Times article on what strikes me as a rather silly debate on inequality, led me to think again about the lack of self-reflection in economics. We have seen a 180 degree turn in the understanding of one of the most basic economic problems, yet there is almost no one anywhere saying something to the effect of “yeah, we got that wrong, and here’s why.”

I’ll get to the contradiction in a moment, but first I want to explain why I think the debate which was the focus of the Times article is rather silly. The essence of the debate in the Neil Irwin piece (the Times reporter who wrote the article) is over whether inequality is leading to lower interest rates, which generates greater wealth inequality, or whether the big problem is the low interest rates themselves causing wealth inequality.

To my mind, this is a silly debate, starting with the idea that we should be concerned about inequalities in wealth resulting from low interest rates. That one is a bit hard for me to see.

Just to be clear, there is no doubt about the relationship between interest rates and wealth, as traditionally defined. Low interest rates increase the value of assets like houses, stocks, and bonds. In the last case, the relationship is literally definitional. If a very long-term bond pays a $10 a year coupon, it will be worth roughly $250 when the long-term interest rate is 4.0 percent, but $500 when the rate is 2.0 percent. The question is whether we should be bothered when all the rich people see their stocks, bonds, and to a lesser extent homes, double in price when interest rates plunge.

I know this provides a lot of grist for academic papers, and for foundations who are ostensibly concerned about inequality, but I just have a hard time seeing the problem here. Part of the story is that I sort of doubt that any of these people will be celebrating the reduction in inequality if things went the other way – we saw a sudden surge in interest rates and the stock market fell 50 percent (the celebrants weren’t very visible in the 2008-09 crash).

But the bigger problem is that I just see their accounting as giving a very incomplete picture of wealth. For the vast majority of middle-income people, wealth reflects the ability to meet needs they face in their lifetime. They accumulate wealth in order to cover the cost of their retirement, their health care expenses, especially in old age, and their kids’ education. Middle class people rarely accumulate any substantial sums beyond these needs.

If it’s not already evident, these needs are also often met by government-provided social insurance, like Social Security, Medicare, and, in countries other than the United States, publicly supported colleges and universities. In effect, for middle class people, social insurance provides a direct substitute for wealth.

In many cases, this substitution is quite explicit. In a country with a high wage replacement rate for its Social Security program, workers don’t need to accumulate large amounts of wealth in 401(k)s to support themselves in retirement.  The same is true if public health care programs can be counted on to pay their health care expenses. And, they don’t need to save for their kids’ college if it’s free or cheap.

We could of course count these benefits as “wealth,” but then the story of low interest rates causing inequality would largely disappear. Middle class workers would see the value of their Social Security and retirement health benefits soar when interest rates plummet, in the same way that bond prices soar. The whole problem of interest rates causing inequality then disappears.

Okay, but I don’t really want to destroy the basis for a major academic debate, just noting why I don’t see the problem. (I also have a hard time seeing it as an inequality problem when tens of millions of middle-income homeowners are able to save thousands of dollars a year on their mortgage, car, and credit card payments. But, that’s just me.) Anyhow, let’s get on to the bigger question.

 

Do We Save Too Much or Too Little?

This really should be a joke, but it is now a central question in economics. The reason why this should be a joke is that the answers give images about the economy that are 180 degrees at odds with each other.

The saving too much story is that we don’t have enough demand in the economy. If our main economic problem is that we save too much, then we help the economy, meaning we will have more growth and employment, if we spend more money. If we are in this world, we should worry that budget deficits are too small, not too large. We should be very happy to give low and moderate-income families additional money to support their kids and to ensure they have a decent living standard. (We should be happy in any case, but if our problem is that we save too much, then this money doesn’t have to be a trade off against other spending. We aren’t up against any constraint, so there is no reason not to make these payments.)

President Biden’s investment proposal looks especially good in the saving too much story. If the problem is that we don’t have enough spending in the economy, why wouldn’t we make whatever expenditures are necessary to quickly create the infrastructure for a green economy, as well as providing workers and businesses with subsidies to encourage them to quickly shift to electric cars and trucks, and clean energy sources for their homes and businesses.

And of course, we should want to improve the skills of the workforce by supporting free community college for the short-term and pre-K and child care for the longer term. And, we also should shore up our care-giving economy, with increased support for home health care and other forms of care for seniors and the disabled as well as improving the pay and working conditions for those employed in the sector.

If our economy’s main problem is that we are saving too much, we essentially have a green light to address all sorts of problems that have lingered for decades. The saving too little story is the complete opposite. If this picture is accurate, then we are pushing up against the economy’s limits to produce goods and services. The only way we would be able to spend any substantial sum on the agenda laid out by President Biden is by sharply curtailing spending in other areas of the economy. This typically means raising taxes to reduce the money households or corporations have, and therefore force them to cut back their spending.

While it’s a bit hard to tell the saving too little story today, with the interest rate on long-term bonds hovering near 1.3 percent, it really has been central to economics for many decades. This was the whole rationale for cutting the deficit and balancing budgets in the 1970s, 1980s, 1990s, 2000s, and the last decade. The idea was that our budget deficits were pulling resources away from other sectors of the economy that could better use them than the government.

And, the lack of savings story went far beyond just budget deficits. It was also the motivation for all the supply-side tax cuts, starting with Carter cutting the capital gains tax in 1978, Reagan’s huge tax cuts in the 1980s, George W. Bush’s tax cuts in 2001, and Trump’s tax cut in 2017. All of these tax cuts disproportionately gave more money to the wealthy with the argument that a large share of the cut would then be saved, which would free up resources for investment.

Conservatives also took their savings obsession in the other direction. Martin Feldstein, spent his career trying to show that Social Security reduced private savings. The argument was that typical workers saved less during their working years due to Social Security, which meant that there was less investment than would otherwise be the case, and therefore we were all poorer. His answer was to cut benefits, or better yet, privatize a large chunk of the program.

But, if we were saving too much, then increasing saving with tax cuts (they don’t seem to have had that effect) or cutting Social Security or other benefits, would be taking us in the completely wrong direction. It would mean further reducing demand and employment, and likely also reducing investment, which tends to follow the growth in demand.

We could of course have been saving constrained in prior decades, but not in recent years. This gets to the debate covered by Irwin. One side argued that we have too much savings now because we redistributed income upward, and rich people spend a smaller share of their income.

The other side sees the issue as primarily demographic. We, and other wealthy countries, now have older populations, and older people save a larger share of their income than younger people. In that view, we have a scary road ahead as our population ages further, and even many developing countries, most notably China, are seeing a rapid growth in the share of retirees in their population. So apparently, we are doomed to have too much savings for the indefinite future.

Will Large Numbers of Retirees Break the Bank or Leave the Stores Empty?

This is the point in the story where I have to pause for a little ridicule. The whole deficit debate of the 1980s, 1990s, and 2000s was framed in the context of the looming retirement of the baby boomers. The story as told by Very Serious People, like Peter Peterson and the many organizations he funded, was that the economy would be overwhelmed in meeting the demands of retired baby boomers, at the same time it was providing for needs of its working population and their children.

And, this was not just the perspective of a fringe group. This concern with providing for the needs of retired baby boomers was very much at the center of national politics and the economics profession. This was the whole logic behind Bill Clinton’s balanced budgets and his plan to pay off the debt, touted by leading economists such as Larry Summers. It was also the concern that ostensibly motivated the drive to balance the budget under President Obama and his search for a “Grand Bargain.” And, it was worldwide, as we can see from the World Bank’s volume Averting the Old Age Crisis.

Given this history, we should have a lot of Very Serious People walking around with very serious egg on their face. The view, now widely accepted, that having an older population doesn’t mean too much demand, but rather too little, means that the concerns that had dominated politics here and elsewhere for decades were completely unfounded.

There was no reason to cut back spending on child care, education, clean energy, and thousands of other items in the last two decades with the idea that we somehow would need a larger capital stock to cover the cost of baby boomers retirement. (Okay, that never made much sense in any case.) The Very Serious People not only got the magnitude of the problem created by an aging population wrong, they got the direction wrong.

Policy types can again be thankful that policy work is not like cleaning toilets or washing dishes, where you can get fired for doing bad work. In fact, for the most part getting the story completely wrong will not even be held against you on your career path.  

 

That seems to be the case. This article on the $3.5 trillion budget outline didn’t mention once that the spending would be over ten years. (Hey, ten years, one year, what difference does it make?) This spending comes to a bit more than 1.2 percent of projected GDP over this period. For another comparison, we are projected to spend $8.6 trillion on the military over this period.

That seems to be the case. This article on the $3.5 trillion budget outline didn’t mention once that the spending would be over ten years. (Hey, ten years, one year, what difference does it make?) This spending comes to a bit more than 1.2 percent of projected GDP over this period. For another comparison, we are projected to spend $8.6 trillion on the military over this period.

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