General Interest

Category: General Interest

The Health Care Arms Race

Are you a fan of Dr. Seuss?  If so, you must see this new video on health care costs done in the style of the good doctor.  If not, watch it anyway.  It displays what happens when supply drives demand, and demand is fueled by third party funding.  Yes, those of you in Money and Monetary Policy will recognize the OPM principle at work:  people spend Other People’s Money much differently than they do their own.  Another principle is also involved.  The creation of jobs for jobs sake is not sustainable.  “Oh, The Jobs You Create” becomes “Oh, The Debt You Create.”  Enjoy.

Harry Kraemer’s Visit

I hope that all of you are planning to attend Harry Kraemer’s matriculation convocation address on values and leadership, which takes place at 11:10 on Thursday in the chapel.   Prior to his convo address, Kraemer will be coming to my Money and Monetary Policy course to talk about his view of the state of the US economy.  This will take place at 10 AM in Briggs Hall 225 (or possibly 224) .  All are welcome to join.

Some Friendly Advice

Foreign policy guru Walter Russell Mead reprints an essay full of advice for those returning students, including some thoughts on a liberal education.  Here’s the bullet points:

  1. The real world does not work like school.
  2. Most of your elders (including parents and teachers) know very little about the world into which you are headed.
  3. You are going to have to work much, much harder than you probably expect.
  4. Choosing the right courses is more important than choosing the right college.
  5. Get a traditional liberal education; it is the only thing that will do you any good.
  6. Character counts; so do good habits.

I suggest you take a look at what he has to say, and in particular the discussion of the importance of a liberal education.

Following this advice will be hard; a liberal education is no easy thing to get, and not everybody wants you to have one.  However, in times of rapid change, it is paradoxically more useful to immerse yourself in the basics and the classics than to try to keep up with the latest developments and hottest trends.  You can be almost 100% sure that the hot theories making waves in academia today will be forgotten or superseded in twenty years — but fifty years from now people will still be reading and thinking about the classic texts that have shaped our world.  Use your college years to ground yourself in the basic great books and key ideas and values that will last.

For the same reason, don’t worry too much about getting specific skills at this stage.  You are going to keep learning new skills all your life and you are going to find many of your skills obsolete as time goes on (when I was a kid I was very good at operating something called a mimeograph machine).  What you want to do now is to develop your ability to learn.

He then lays out the elements of what it means to be liberally educated, concluding with this:

[U]nless you are following up on an interest that is already a deep and passionate one, try to take courses taught by great teachers.  The main purpose of an undergraduate education isn’t to polish up your knowledge and finish your learning.  It is to launch you on a lifetime quest for wisdom and understanding.  You want professors who can help you fall in love with new subjects, new ideas, new ways of investigating the world.  The courses that end up mattering the most to you will be the ones that start you on a lifetime of reading and reflection.

That should get you through registration.

The Fall of the Econ Department

Here is our fall schedule, complete with links to brief course descriptions.  We will also be sponsoring a group read this term.

For those of you new to the department, we are offering Econ 100 this term and in the winter, and Econ 120 in the spring.  For the complete Winter and Spring schedules, click here.

Fall 2011

ECON 100  INTRODUCTORY MICROECONOMICS 1:50-03:00 MWF BRIG 223 ● Mr. Galambos

ECON 170  FINANCIAL ACCOUNTING 2:30-04:20 TR BRIG 223 ● Mr. Vaughan

ECON 205 TOPICS-INTERNATIONAL ECONOMICS (G) 3:10-04:20 MWF BRIG 224 ● Ms. Karagyozova

ECON 206 FIELD EXPERIENCE-SIERRA LEONE (G) Arranged ● Ms. Skran, Ms. Karagyozova

ECON 209  WATER, POLITICS, ECON DEVLPMNT (G) 12:30-02:20 TR BRIG 223 ● Mr. Finkler, Mr. Brozek

ECON 211  IN PURSUIT OF INNOVATION (S) 11:10-12:20 MWF BRIG 223 ● Mr. Galambos, Mr. Brandenberger

ECON 300 MICROECONOMIC THEORY 9:50-11:00 MWRF BRIG 223 09:50-11:00 R BRIG 223 ● Mr. Gerard

ECON 420 MONEY AND MONETARY POLICY 9:00-10:50 TR BRIG 217 ● Mr. Finkler

ECON 460 INTERNATIONAL ECONOMICS (G,Q) 9:50-11:00 MWF BRIG 217 ● Ms. Karagyozova

Hurricane Coverage, Better Late than Never

John Whitehead from the Environmental Economics blog lives in North Carolina and has been keeping us up to speed on all sorts of hurricane-related curiosities, from the opportunity costs of evacuation preparation to a supply & demand example to potential stimulative effects (umm) to predictions of hurricane damages (short version: the predictions are wrong).

As a bonus, here’s Professor Michael Munger — also a Carolina denizen —  griping about subsidizing building in hurricane zones.

(And justifiably so, I might add).

Review of The Big Short in the JEL

Yale economist Gary Gorton reviews Michael Lewis’s The Big Short and Gregory Zuckerman’s The Greatest Trade Ever: The Behind-the-Scenes Story of How John Paulson Defied Wall Street and Made Financial History in the latest Journal of Economic Literature.

Here’s how Gorton describes the books:

Their take is that a small band of wacky outsider characters were able to see the coming crash and profit from it, while greedy, corrupt, Wall Street types were not (p. 450).

Indeed, that sounds about right.  Gorton gives the authors credit for telling lively stories and for laying out the mechanics of financial markets that enabled the disaster.  Yet, a major puzzle remains:

[The widespread view is] that subprime vintages prior to 2006 were much safer; it was supported by the data… But, when the crisis came, there was no distinction between pre- and post-2006 vintages. Everything went down in value, including bonds linked to the earlier subprime vintages! Moreover, bonds completely unrelated to subprime risk, like triple-A bonds linked to credit card receivables, auto loans—everything went down in value! (p. 453).

In other words, we still don’t really understand what caused the crisis.

You should get to know the Journal of Economic Literature (JEL).  As the name suggests, the JEL provides literature reviews and book reviews that characterize and evaluate major strands of the economics literature (in addition to classifying pretty much everything in the profession.  Hence the  JEL classification codes).

My brief review of The Big Short is here, and our posts are Michael Lewis’s work are here

The Pope’s Children Revisited

“Economists festivals tend to be so po-faced, so bitchy"

In the wake of Michael Lewis’s recent piece, Professor Galambos reminds me of the excellent “In Search of the Pope’s Children” from 2006.   If you have read the piece on Germany, you might take a look at the first 15 minutes of part 3, which is amazingly prescient given this was done five years ago (like Lewis, McWilliams also invokes a prostitution metaphor to dissect the situation).   The piece also melds well with Lewis’s piece on Ireland.

Of more recent vintage, McWilliams is the author of The Generation Game and Follow the Money, and also launched a comedy tour dedicated to mocking Irish bankers.

Here’s more on the cheeky McWilliams.

Dividing the Pie — Made in China, Sold in the U.S.

This just across the Marginal Revolution wire, via the Federal Reserve Bank of San Francisco, is an estimate of who gets what piece of products made in China:

Goods and services from China accounted for only 2.7% of U.S. personal consumption expenditures in 2010, of which less than half reflected the actual costs of Chinese imports. The rest went to U.S. businesses and workers transporting, selling, and marketing goods carrying the “Made in China” label.

So who gets what?

Table 1 shows that, of the 11.5% of U.S. consumer spending that goes for goods and services produced abroad, 7.3% reflects the cost of imports. The remaining 4.2% goes for U.S. transportation, wholesale, and retail activities. Thus, 36% of the price U.S. consumers pay for imported goods actually goes to U.S. companies and workers.

That’s a potentially interesting figure that suggests something we probably all know intuitively — that the firm that makes something isn’t necessarily the same firm that captures the value from its sale.

Last year I poked around for information like this when we were looking at what went into the price of shoes and found Rodrige, Comtois, & Slack’s breakdown in The Geography of Transport Systems.They split up the “cost of a $100 shoe made in China” (click to expand) to the various factors of production, and provide an  explanation here.

The analysis suggests that a $100 shoe has about $12 worth of labor and materials in it, almost none of that paid to labor ($0.40). I assume “profit” goes to the corporation (e.g., Nike, Earth Soles) and the “retailer” percentage includes both retailer costs and retailer profits.

Here’s an important point — the difference between Walmart and Footlocker for a given pair of shoes would probably come out of that 50% retailer percentage. Lower rent, lower personnel costs, lower profit per unit. So where does the difference in shoe quality come from? It seems to me it comes out of that $12 in labor and materials.

Do you see what I mean? If a typical $100 pair of shoes has $12 of parts and labor, then how much does a typical $37.50 pair of shoes have in terms of parts and labor? Somewhere between $0 and $12, I suspect. For the sake of argument, let’s say you could cut those by 25% to $9. That suggests Walmart could offer the same quality shoe (that is, a $12 shoe) by bumping the price up by $3 to $40.50…

Why can China produce at such low “costs”? The chart at the right shows the figures for manufacturing generally — 40% of the cost advantage stems from lower labor costs. My intuition was that labor costs were a major portion of the product costs, but that was incorrect. It is, however, a substantial source of the lower costs. So, to illustrate this point, suppose Indonesia could assemble these shoes for $12.50 — $0.50 more. Of the $0.50 Chinese cost advantage, 40% ($0.20) would be due to lower labor costs.

I would guess that the cost advantage is nowhere in the neighborhood of $0.50. If China produces 8 billion pairs of shoes annually (16 billion total shoes), then a penny per unit in labor savings is $80 million into someone’s pocket. An $0.08 labor cost advantage translates into well over a half billion dollars.

And here’s the iPod for comparison.

Of course, the lesson from the Fed and from Rodrige et al. is that the total amount paid for imported goods is not the same as the amount actually being paid to the country of origin.

English Major Downgrades U.S. Credit Rating

Sam Tanenhaus is the editor of the New York Times Book Review, and he, unsurprisingly, majored in English literature.  His old buddy, John Chambers, is the chairman of S&P’s sovereign rating committee, and Chambers, (perhaps) surprisingly, also majored in English literature. The two were friends at Grinnell College back in the day, and Tanenhaus takes time out to tell us about it at Slate.com.

For those of you completely uninterested in world affairs, Chambers has been making news because the S&P recently lowered America’s credit rating from AAA to AA+, causing something of a stir in world financial markets.

The article only hints at how Chambers got from Grinnell to Wall Street.  Instead, Tanenhaus gives us a taste of spending time in the cornfields of Iowa, the midwestern psyche, and the joys of hashing out the intricacies of Proust.  He then concludes with a more general meditation on the liberal arts:

John has told me the most important thing Grinnell taught him was how to write a well-argued paper. He learned his lesson well. The S&P report, whatever one thinks of its conclusions, is a model of clarity. Even an English major like me has no trouble making sense of the following: “The effectiveness, stability, and predictability of American policy-making and political institutions have weakened at a time of ongoing fiscal and economic challenges.” Or: “The fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics.”

So keep that in mind next time you worry about whether you have the “right” major (or majors).  Clothes don’t make the man.

Add Germany to the List

Michael Lewis continues his Vanity Fair series with a rather disturbing article — disturbing on many levels — about Germany and the world financial crisis: “It’s the Economy, Dummkopf!”

Tyler Cowen at Marginal Revolution calls the piece ” funny, one-sided, slightly offensive, somewhat true.”

I agree with everything except the “slightly” part.  Not for the faint of heart.

ADDENDUM: Walter Russell Mead weighs in.  Paul Krugman expresses some optimism.  Follow his blog for much, much more on the nuts-and-bolts of what’s going on.

Some Non-Random Investment Advice

So, the Dow is down 635 Monday, then up 430 Tuesday, then down 520 again Wednesday?  What’s a member of the investor class to do?  Should I go bargain hunting and drop my kids’ college funds into Sears stock?  Is it time to buy gold? Or should I get out of the market all together and just park my cash in a bank somewhere?  (Are banks really charging to hold money now?)

Burton Malkiel, author of the extraordinarily influential A Random Walk Down Wall Street, advises you to take a deep breath and let it ride. Here he is in the Wall Street Journal:

My advice for investors is to stay the course. No one has ever become rich by being a long-term bear on the fortunes of the United States, and I doubt that anyone will do so in the future. This is still the most flexible and innovative economy in the world. Indeed, it is in times like this that investors should consider rebalancing their portfolios.  If increases in bond prices and declines in equities have produced an asset allocation that is heavier in fixed income than is appropriate, given your time horizon and tolerance for risk, then sell some bonds and buy stocks. Years from now you will be glad you did.

This is hardly a surprising message coming from Malkiel, who tirelessly points out that index funds routinely outperform professionally managed portfolios.  Indeed, I would say that the median economist believes this to be true. If you haven’t read him yet, you should think about picking up a copy of his book and getting to know it a little bit.

For more on the epic market volatility, check out the always-awesome Political Calculations blog.

Perhaps it is different this time

On my daily rounds of the econosphere, including Professor Finkler’s post here, I note that Ken Rogoff’s Project Syndicate post is getting a lot of traction.

A perusal of the NYT website shows Rogoff here on the USA credit downgrade:

Europe’s plan was to have growth fix the problem. America’s plan was to have growth fix the problem. And that’s not going to work… I think it’s really starting to sink in that we’re not anywhere near an endgame.

And NYT columnist Thomas Friedman cites Rogoff here:

Why is everyone still referring to the recent financial crisis as the ‘Great Recession?’ … The phrase ‘Great Recession’ creates the impression that the economy is following the contours of a typical recession, only more severe — something like a really bad cold. … But the real problem is that the global economy is badly overleveraged, and there is no quick escape without a scheme to transfer wealth from creditors to debtors, either through defaults, financial repression, or inflation. … In a conventional recession the resumption of growth implies a reasonably brisk return to normalcy. The economy not only regains its lost ground, but, within a year, it typically catches up to its rising long-run trend. The aftermath of a typical deep financial crisis is something completely different. … It typically takes an economy more than four years just to reach the same per capita income level that it had attained at its pre-crisis peak. … Many commentators have argued that fiscal stimulus has largely failed not because it was misguided, but because it was not large enough to fight a ‘Great Recession.’ But, in a ‘Great Contraction,’ problem No. 1 is too much debt.

As for economists, Tyler Cowen thinks Rogoff’s contributions have legs:

I don’t expect anyone to change their mind at this point, but the “we should have had a much bigger stimulus” argument is unlikely to go down in intellectual history as the correct view.  Instead, Ken Rogoff and Scott Sumner are likely to go down as the prophets of our times.  We needed a big dose of inflation, promptly, right after the downturn.  Repeat and rinse as necessary.  But voters hate inflation and, collectively, we proved to be cowards.  Too bad.

And Peter Klein also cites Rogoff favorably, though Klein conditions his response with respect to what he believes should be the central implication:

The main point is that a recession like the present one is structural, and has nothing do with shibboleths like “insufficient aggregate demand.” I wish Rogoff (here or in his important book with Carmen Reinhart) talked about credit expansion as the source of structural, sectoral imbalances that generate macroeconomic crises.

It’s almost enough to make you want to pick up the vaunted Reinhart and Rogoff book.

UPDATE: Rogoff in the Financial Times

The Triumph of Ed Glaeser

You know you’ve hit the big time as an economist when the Appleton Public Library starts featuring your stuff.   Those of you who follow the LU blog have probably heard of Ed Glaeser and his recent book, The Triumph of the City. And now, readers of the Appleton Post Crescent have as well, with Bill Coan featuring Glaeser in his discussion of the impact of local libraries.

For those of you who missed it, here’s Glaeser talking about his book at one of our more trusted news outlets.

Is Time on Professor Finkler’s Side?

As you may have noticed, Professor Finkler and I are both keeping one eye on the doings in Washington, with the likes of Summers and Roberts weighing in on the deal.  To add to that lineup, Time Magazine has another five economists weigh in on the debt deal, including LU Econ Blog faves Alex Tabarrok and Simon Johnson.

It’s too bad we don’t have a macro course going on right now.

The Second Great Contraction

Professor Gerard’s posting on the debate about the role of fiscal policy starts with the Larry Summer’s point that the debt deal “solves the wrong problem.”  As pointed out previously (see here), I agree with that conclusion.  So, what is the “right problem?”  Kenneth Rogoff’s answer requires  that we understand that this recession is not a typically recession.

The phrase “Great Recession” creates the impression that the economy is following the contours of a typical recession, only more severe – something like a really bad cold. That is why, throughout this downturn, forecasters and analysts who have tried to make analogies to past post-war US recessions have gotten it so wrong. Moreover, too many policymakers have relied on the belief that, at the end of the day, this is just a deep recession that can be subdued by a generous helping of conventional policy tools, whether fiscal policy or massive bailouts.

But the real problem is that the global economy is badly overleveraged, and there is no quick escape without a scheme to transfer wealth from creditors to debtors, either through defaults, financial repression, or inflation.

Rogoff and Carmen Reinhart (R & R), along with others such as economic historian Harold James, emphasize that economic growth built upon too rapid a credit build-up cannot be sustained with expansionary monetary and fiscal policy. It requires de-leveraging (perhaps, you prefer credit build down), a process that cannot be accomplished quickly and offers little positive in the short run that can be gained to soften the blows. The only solutions require that the real level of debt must be reduced to a sustainable level.  As noted in the Rogoff quotation above, somehow creditors must bear some of the burden (a “haircut” in Wall Street parlance.)  The dynamics of this process lead R & R to deem our most recent period as “The Second Great Contraction.”

Rogoff’s suggests that inflation might be the least costly way to address problem – one might argue it is THE “time honored” policy of choice when governmental commitments exceed its ability to meet them.  Of course, this suggestion is not met with great enthusiasm (see “Kids Prefer Cheese” which argues that Rogoff proposes “theft, pure and simple.”)  Is it the least bad approach?  The answer depends upon one’s view of the functionally of our governance structure.  Let’s just say that “dysfunctional” would not egregiously mis-characterize U.S. governance at present.

Recognition of the right problem and a useful framework for policy discussion must come first.  As Rogoff puts it in the article linked above,

The big rush to jump on the “Great Recession” bandwagon happened because most analysts and policymakers simply had the wrong framework in mind. Unfortunately, by now it is far too clear how wrong they were.

Acknowledging that we have been using the wrong framework is the first step toward finding a solution. History suggests that recessions are often renamed when the smoke clears. Perhaps today the smoke will clear a bit faster if we dump the “Great Recession” label immediately and replace it with something more apt, like “Great Contraction.” It is too late to undo the bad forecasts and mistaken policies that have marked the aftermath of the financial crisis, but it is not too late to do better.

Economists Weigh in on Debt Deal

Former White House economist, Larry Summers, gives his take on the debt deal, concluding that it “solves the wrong problem.”  These seem to be the takeaway points:

Despite claims of spending reductions in the $1 trillion range, the actual agreements reached so far likely will have little impact on actual spending over the next decade.   The deal confirms the very low levels of spending already negotiated for 2011 and 2012, and caps 2013 spending about where most would have expected this Congress to end up.  Beyond that outcomes are anyone’s guess—the reality is that Congress votes discretionary spending  annually and the current Congress cannot effectively constrain future actions…

Remarkably for a matter so consequential the agreement that the Supercommittee will seek to reduce the deficit by $1.5 trillion comes without any agreement on what the baseline is from which the $1.5 trillion is to be subtracted.  Is the $1.5 trillion from a baseline that includes or excludes the Bush tax cuts? Includes or excludes tax extenders and the annual AMT fix?

Reuters also provides some space for alternate viewpoints, including those of Cafe Hayek bloggers Russ Roberts and Don Boudreaux.  Roberts doesn’t seem to buy Summers’ claim that spending is “low” this year:

Spending in 2011 is estimated to come in at $3.8 trillion or just over 25 percent of GDP. That’s the highest ratio since 1945 — in 2005, the ratio was under 20%. Calling $3.8 trillion dollars “very low” is very hard to understand, unless you see a crying need for an even larger number…

What does it matter? As regular readers probably know, Roberts is in Hayek’s corner in the Keynes v. Hayek dust up, with Summers in the Keynesian corner. Hence, there is some disagreement as to what’s likely to happen here:

And that brings us to the essence of Summers’ worldview… The key problem, says Summers, isn’t that we spend too much, it’s that we spend too little to reduce the unacceptably high level of unemployment. According to Summers, growth is driven by aggregate demand and aggregate demand is driven by government spending. What is the evidence that increases in government spending lead to growth? Very little, unfortunately…

We’ve plowed this ground before.

Schumpeter a Marxist? “Not so fast,” says Galambos

Nathan Rosenberg explicates Schumpeter’s Marxist proclivities in the most recent issue of Industrial and Corporate Change.

Was Schumpeter a Marxist?

Abstract: This article explores the degree to which Joseph Schumpeter may be regarded as a follower of Karl Marx. It argues that Schumpeter and Marx shared a common vision, including agreement on the growth in the size of the firm and in industrial concentration, the inherent instability of capitalism and the inevitability of “crises”, and the eventual destruction of capitalist institutions and the arrival of a socialist form of economic organization as a result of the working out of the internal logic of capitalist evolution. Schumpeter’s main qualification is his insistence upon the importance of temporal lags, i.e., social forms that persist after they have lost their economic rationale, and he suggests that the essence of capitalism lies in the inevitable tendency of that system to depart from equilibrium. The article emphasizes the continuing importance of economic history for economics.

In one of the two responses to Rosenberg’s piece, Louis Galambos doesn’t think the shoe fits:

Was Schumpeter a Marxist? My own answer is “No.” Why? Because I have a simple standard for judging who is in and who is out when Marx is the subject. To be a Marxist, I think you need to use the labor theory of value; you need to use social classes as a central element in your theory; and you need to believe that the end point of capitalist development is the inevitable economic collapse of a system that cannot sustain itself even with desperate political and military measures.

Since Schumpeter did not use the labor theory of value, did not employ social classes as a central element in his grand theory, and certainly did not see economic collapse as the end point of capitalism, he cannot be a Marxist.

Each of these is available through The Mudd via the campus IP address.  Those of you who slogged through Capitalism, Socialism, and Democracy should find these very illuminating reads, indeed.

The Debt Ceiling Is At Best Superfluous

In today’s New York Times Economix column, former advisor to presidents Ronald Reagan and George H. W. Bush Bruce Bartlett argues persuasively that the debt ceiling and debate about it accomplishes nothing constructive that is not already contained in the Congressional Budget and Impoundment Control Act of 1974.  Former Fed Chair Alan Greenspan made this point emphatically in his 2003 testimony to Congress.

In the Congress’s review of the mechanisms governing the budget process, you may want to reconsider whether the statutory limit on the public debt is a useful device. As a matter of arithmetic, the debt ceiling is either redundant or inconsistent with the paths of revenues and outlays you specify when you legislate a budget.

Current Fed Chair Bernanke put it even more starkly when he noted that the debt ceiling legislation is equivalent to using a credit card to buy things and then refusing to pay the bill when it arrives.