Merton Finkler

Politicians pontificate profusely about their prodigious plans for procuring Federal budget sanity.  For the most part, their potential policy projectiles miss the mark.  In an essay in today’s Wall Street Journal entitled “Everything You Ever Wanted to Know About the Budget** But Were Afraid to Ask,”  David Wessel highlights six key facts that will constrain the efforts of these pugilistic pundits.

1. “Nearly two-thirds of annual federal spending goes out the door without any vote by Congress.”

2. “The U.S. defense budget is greater than the combined defense budgets of the next 17 largest spenders.”

3. “About $1 of every $4 the federal government spends goes to health care today. That is rising inexorably.”

4. “Firing every federal government employee wouldn’t save enough to cut the deficit in half.”

5. “The share of income most American families pay in federal taxes has been falling for more than 30 years.”

6. “The federal government borrowed 36 cents of every dollar it spent last year, but had no trouble raising the money.”

These “facts” form the basis for Wessel’s new book to be published next week and should inform political debate.  I won’t hold my breath regarding the latter point.  The cartoon reflects an earlier time period, but the political dynamics today, as characterized in the cartoon, still obtain.

In Monday’s Financial Times, economics editor Martin Wolf explains why the “end” will not be soon.  He notes that it has been almost five years since the beginning of our contemporary financial turmoil,  if one marks such by the first major sign of sub-prime mortgage problems in the U.S.  He characterizes the past five years as ones if which policies (both monetary and fiscal) have been very aggressive; yet economies – US, Europe and Japan – have been stagnant.  David Levy describes such a situation as a “contained depression”; that is, these economies feature excessive leverage (debt), especially in household and financial sectors and expansionary macroeconomic policy.  Stated differently, the private sector continues to de-leverage (reduce its debt level) while governments attempt to counter such counter-cyclical demand with public borrowing and money creation.  The two have, in fact, been connected, as central banks purchase much of the newly created governmental debt.  In short – remember the world of IS-LM – there is no crowding out.  The charts below show the depth of the problem.

The lower right hand graph shows that private sector debt in the US has come off its peak (of 296% of GDP in 2008) by roughly 17% (250% of GDP) about where the economy was in 2003.  If Reinhardt and Rogoff are correct, we have at least two more years to go, given that an “average” balance sheet recession last seven years. If the mid-1990s feature a stable debt to GDP ratio, of just under 200% of GDP, we are only half-way “home.”  In terms of economic growth, clearly, the Eurozone has yet to recover; while, the US and Germany have just barely exceeded their previous GDP peak (in 2007) – see upper left graph.

According to Wolf,

We know that big financial crises cast long shadows, particularly in countries whose underlying rate of growth is modest, which makes de-leveraging slow. Policy must both sustain demand and facilitate de-leveraging. This means aggressive monetary and fiscal policies, working in combination, along with interventions aimed at recapitalising banks and accelerating restructuring of private debt.

Policies designed to bring down public debt prior to the end of private de-leveraging will dampen economic growth and extend the period of adjustment.  Though public fiscal consolidation is necessary for long run stability, if it is not crafted to be consistent with an economic growth path that can meet the required debt service, economic stagnation or worse will be the order of the day.

Wolf concludes that

Far too much policy making and advice neither recognises the post-crisis challenges nor crafts effective answers. The heart of the matter is accelerating de-leveraging, while promoting recovery. By that standard, the policies now in place are, alas, very far from good enough.

Given that it’s election season (again), the twin topics of jobs and health care will be upon us ad nauseum.  Employmnet in health care fields has grown rapidly since the passage of Medicare in 1965 (see the chart in the article cited below.)  Is this a good thing?  If the health care industry is terrific at creating jobs, why don’t we just spend continuously more on health care (as we in the U.S. have done steadily for at least the past 60 years)?

In the current issue of that most famous of medical journals, The New England Journal of Medicine, Katherine Baicker and Amitabh Chandra explain why such a policy is a terrible way to increase the economic welfare of Americans.  The argument is pretty straight forward for any student of economics, though not necessarily for the political cognoscenti.

But this focus on health care jobs is misguided. The goal of improving health and economic well-being does not go hand in hand with rising employment in health care. It is tempting to think that rising health care employment is a boon, but if the same outcomes can be achieved with lower employment and fewer resources, that leaves extra money to devote to other important public and private priorities such as education, infrastructure, food, shelter, and retirement savings.

They provide two graphs to illustrate the strong correlation between employment growth and cost per year of life expectancy gained (not easily transported to this blogpost).  Now, clearly, correlation does not imply causation, and there certainly are health outcomes of interest in addition to life expectancy, but careful studies of such relationships suggest strong diminishing returns to devoting a larger and larger share of our workforce to health care services.

Keynes argued that we could increase employment and spending by hiring one group of people to dig holes in the ground and another to fill the holes back up.  Although this might increase expenditures and employment in the short run, without productivity increases to generate income, such workers would have to be paid out of existing production, and thus, such income generation would not yield sustainable improvements.  Baicker and Chandra make a similar point.

The bottom line is that employment in the health care sector should be neither a policy goal nor a metric of success. The key policy goals should be to achieve better health outcomes and increase overall economic productivity, so that we can all live healthier and wealthier lives. Our ability to ensure access to expensive but beneficial treatment is hampered whenever health care policy is evaluated on the basis of jobs. Treating the health care system like a (wildly inefficient) jobs program conflicts directly with the goal of ensuring that all Americans have access to care at an affordable price.

So what does this have to do with yesterday’s Supreme Court ruling?  Who knows?  It all depends upon how the legislation is implemented and how people respond to incentives provided.

The article described below was published yesterday in Spiegel, a well known German periodical.

Economic historian Niall Ferguson (who typically takes a long term view of economic forces) and economist Nouriel Roubini (who some know as Dr. Doom for his prognostication in 2005 of the housing bust and subsequent financial crisis) have gotten together to argue that the  toxic mix of contemporary economic and political forces could generate both economic and political chaos for Europe.  They suggest a variety of steps that they believe could both resolve the unstable conflicts presently in existence and be palatable to all stakeholders, if they desire to sustain (or expand) the integration of Europe.   In brief there recommendations are as follows:

1.  Banks should be recapitalized by direct (rather than indirect) means  – similar to the TARP program in the U.S.

2.  A deposit insurance program should be constructed – similar to the FDIC program in the US

3.  Funding of 1 and 2 should be through means that minimize moral hazard burdens for tax-payers and avoid the creation of “too-big-to-fail” institutions.

4.  Fiscal austerity should be built into a long run plan but should not be implemented in the current economic context.

5.  Economic growth needs to be the number one priority.

6.  Public policy should employ all available tools – monetary, fiscal, barrier reducing, and infrastructure increasing – to boost income and consumption.

The article begins as below.  For the full piece, follow the link at the bottom of this posting.

The Perils of Ignoring History: This Time, Europe Really Is on the Brink
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The European Union was created to avoid repeating the disasters of the 1930s, but Germany, of all countries, has failed to learn from history.  As the euro crisis escalates, Berlin should remember how the banking crisis of 1931 contributed to the breakdown of democracy across Europe. Action is urgently needed to stop history from repeating itself.

A Commentary by Niall Ferguson and Nouriel Roubini

As many of have heard on numerous occasions, Steven Landsburg has argued that economics can be characterized by just two words: “Incentives Matter.”

Today’s Carpe Diem blog (provided by Mark Perry) provides some rich examples.

Some great examples of unintended consequences from the Wikipedia listing for “Perverse Incentives”:
1. In Hanoi, under French colonial rule, a program paying people a bounty for each rat pelt handed in was intended to exterminate rats. Instead, it led to the farming of rats.

2. 19th century palaeontologists traveling to China used to pay peasants for each fragment of dinosaur bone (dinosaur fossils) that they produced. They later discovered that the peasants dug up the bones and then smashed them into many pieces,greatly reducing their scientific value, to maximize their payments.

3. Opponents of the Endangered Species Act in the US argue that it may encourage preemptive habitat destruction by landowners who fear losing the use of their land because of the presence of an endangered species, known as “shoot, shovel, and shut up.”

4. In the former Soviet Union, managers and employees of glass plants were at one time rewarded according to the tons of sheet glass produced. Not surprisingly, most plants produced sheet glass so thick that one could hardly see through it. The rules were changed so that the managers were rewarded according to the square meters of glass produced. The results were predictable. Under the new rules, Soviet firms produced glass so thin that it was easily broken.

5. Private companies were paid to transport convicts/prisoners from the U.K. to Australia during the late 1700s and the early 1800s.  The first payment schedule was based on the number of prisoners who boarded ships in the U.K. As you might imagine, there was no incentive to deliver living prisoners to Australia, and many of them died during the trip, due to overcrowding, lack of food and water, unsanitary and unsafe conditions, untreated diseases, etc. The payment schedule later changed, and was subsequently based on the number of living prisoners delivered to Australia. Result?  Fewer prisoners died during transport.

In honor of Brad Bateman’s visit tomorrow, today’s opinion piece in the Financial Times poses an answer to the question above from two other Keynesian scholars, Robert Skidelsky and Marcus Miller.  You may or not be able to access this piece directly from the Financial Times.  First try here and if that doesn’t work, try here.

For those of you who want “to cut to the chase,” the short answer is as follows:

Eurozone countries must be allowed to grow again. For a country in such desperate straits as Greece, however, orderly exit from the euro to regain competitiveness looks to be the best option. But it is in the interest of both Greece and its creditors that the resulting devaluation be controlled. We must not add currency wars to our present pile of problems.

I will have more to say about this in future postings.

Last Thursday at our weekly discussion of specific works in economics, we discussed Backhouse and Bateman’s book, Keynes: Capitalist Revolutionary. At one point in our discussion, Professor Gerard asked which economist today might be viewed as Keynes was in his heyday.  One reasonable answer was Larry Summers who, as noted here, has held numerous positions including the presidency at Harvard University.  Are there other reasonable answers?  I think so.  Paul Krugman might be a good candidate for a “contemporary” Keynes.

Despite interest in who might be today’s Keynes, this posting addresses remarks that Summers made January 14, 2005 at the NBER Conference on Diversifying the Science & Engineering Workforce.  Asked to be provocative, Summers did not disappoint.  What did he say? I strongly encourage you to read the full speech (go here) which contains carefully constructed cautions and references. He posits, in order of strength, three reasons why women are less prominent in scientific fields.

1. Differences between men and women in terms of their willingness to make the incredible time commitments of high powered jobs.

2. Differences between men and women in “availability of aptitude at the high end”

3. Differences between men and women in terms of socialization and patterns of discrimination.

The controversy focuses on the second reason which he states more fully as follows:

It does appear that on many, many different human attributes-height, weight, propensity for criminality, overall IQ, mathematical ability, scientific ability-there is relatively clear evidence that whatever the difference in means-which can be debated-there is a difference in the standard deviation, and variability of a male and a female population.

Stated differently, he presents some evidence for the claim that there are more males than females at both the high and low end of the distribution of mathematical and scientific ability.  This is a statement about variance, not about means. I believe, as does Claudia Goldin, “whose own research has examined the progress of women in academia and professional life” , that Summer’s arguments are constructive food for thought and deserve serious reflection.

My suspicion is that few people have read Summers’ remarks but have settled for the soundbites that have found their way into the popular media.  A liberal arts education should encourage you not to settle for these inflammatory simplifications.