What if we stopped reporting GDP?

In January 2009, I posted to say Gross Domestic Product numbers do not provide an accurate picture of our nation's economic health and to call on the Obama Administration to adopt other metrics that would measure progress toward its economic goals. Later I learned that an international commission appointed by French President Sarkozy and headed by Joseph Stiglitz had been working on something like this since the spring of 2008. A primary driver of this effort was the widespread belief that GDP is an inadequate and often misleading measure of economic and social wellbeing and progress, as Stiglitz wrote here just before the report was issued September 14, 2009:

The big question concerns whether GDP provides a good measure of living standards. In many cases, GDP statistics seem to suggest that the economy is doing far better than most citizens' own perceptions. Moreover, the focus on GDP creates conflicts: political leaders are told to maximize it, but citizens also demand that attention be paid to enhancing security, reducing pollution, and so forth - all of which might lower GDP growth. GDP is misleading in many ways.

For example, GDP is no longer a reasonable proxy for middle-class incomes or unemployment rates. Median incomes got decoupled from GDP as long ago as 1973, and in the 21^st Century real median incomes actually went down while GDP was rising. Our labor force participation rate has been declining since 2000, as has non-residential investment, and our current account deficit has been a tribute paid to foreigners of up to 6% since 1983. When recovering from the previous two recessions and this one, the unemployment rate has come down so slowly that they were referred to as "jobless recoveries." The traditional worry in a period of GDP growth has been inflation, but inflation hasn't been a problem in the US since 1984. No doubt the Fed looks at the rate of change in GDP to help it make short-term interest rate decisions, but the Fed looks at many other data sets too. So here's my proposal: Get other more appropriate metrics in place with a decent history (with the past reconstructed if possible), and then de-emphasize and eventually eliminate reports of GDP. One way to de-emphasize would be to change the frequency of reporting from quarterly to annually.

The best reporting I have seen about the work of the "Commission on the Measurement of Economic Performance and Social Progress" is in this NYT Magazine piece. The Commission has recommended that people need a "dashboard" of metrics, just as they do when driving a car. (Only one gauge showing only speed would not be enough, but having dozens of gauges would be too confusing.) A new non-profit, State of the USA, funded inter alia by Hewlett, MacArthur, and Rockefeller foundations, is developing a website intended to serve as a kind of dashboard. As a sample, it has an interactive graphic comparing the US against other nations for healthcare costs versus life expectancy at birth from 1960 to 2007—pretty dramatic, and not in a good way if you're an American.

Update on Sunday, May 16, 2010 at 04:05PM by Skeptic

I first suggested we "Forget about GDP and Start Tracking Family Incomes" in this December 2007 post. 

Update on Wednesday, May 26, 2010 at 07:42PM by Skeptic

I tuned up the argument against relying on GDP in the following comment first posted on this string in Mark Thoma's blog.

The immediate post-WWII period Krugman highlighted [here and here] to show what was possible in America was a time when rising tides lifted all boats--yachts and dinghies equally. Real hourly earnings of production workers increased in lock-step with GDP per production worker, and so did real median family incomes. In those days, if you knew what GDP was doing, you knew a great deal about how ordinary Americans were doing economically. However, that is no longer true and hasn't been for several decades. Consequently, GDP-based arguments about the general welfare and how the real economy will function in the future are no longer valid.

In 1962, real GDP per production worker started increasing faster than real hourly earnings, which stopped growing altogether in 1973 and have been stagnant ever since except for a 5-year surge in the late 1990s. Similarly, real median family income fell away from real per-capita GDP in 1978 and has continued to diverge widely. You can see these and other graphs, links, and a discussion here. http://www.realitybase.org/journal/2009/3/10/the-american-dream-died-in-february-1973.html

The explanation is obvious when you look at productivity and compensation. From 1973 to 2007 labor productivity increased about 85%, but median compensation increased only about 15%. http://www.stateofworkingamerica.org/tabfig/2008/03/SWA08_Chapter3_Wages_r2_Fig-3O.jpg The Treaty of Detroit was abrogated--almost all productivity gains were captured by the owners, managers, and servants of capital.

GDP growth has also gotten decoupled from the unemployment rate and from labor market participation rates, with the result that for the last two decades all three recessions have ended in "jobless recoveries."

As far as I can tell, the only reason to keep reporting GDP is to accommodate all the folks running macroeconomic models that generate GDP outputs and not much else that is useful.

Update on Saturday, May 29, 2010 at 02:09PM by Skeptic

It’s not just that GDP is not correlated with median income and other indicia of welfare, we can’t predict GDP anyway.  Nick Rowe points out here that typical macroeconomic models compute present GDP output from a variety of present inputs such as government spending and employment, but that the models don’t compute future GDP from current inputs.  To get future GDP outputs, the modelers typically guess at the future inputs—which is no more reliable than just guessing at future GDP.  Garbage in, garbage out. 

In contrast, a “weather prediction model” looks though a database to find all the past occasions that had the same combination of parameters (temperature, barometric pressure, etc.) as today and then looks to see what actually happened the next day on each of those prior occasions.  If on 83% of those prior occasions it rained the next day, the forecaster will predict an 83% probability of rain tomorrow.  Apparently, macroeconomists don’t use that approach at all, presumably because the number of important parameters is too large and the database of prior events is too small. 

There are many thoughtful comments on the Rowe post by apparently well-informed people.  I would add that maybe the method Rowe criticizes is not 100% GIGO because if the modeler guesses at all the inputs he can avoid making a GDP prediction that could only happen if one or more of the inputs were implausible. 

Update on Sunday, May 30, 2010 at 04:31PM by Skeptic

Another use for which GDP is of questionable utility is in the sovereign debt to GDP ratio, which has been traditionally used to assess whether a national government has taken on more debt than is safe and must adopt an austerity program.  In that context GDP is used to indicate whether the government has enough practical taxing power to assure markets that the debt is risk free--not only in terms of potential default but the risk that the government may be tempted to inflate away the debt.  However, the tax base has been dramatically changed since Reagan took office in 1981--away from high earners, accumulated wealth, corporate income taxes, and other taxes on wealth and toward earned income and especially on the earned income of those who are not super-rich. Since taxation now bears relatively more heavily on the incomes of those whose incomes are stagnating and less on the dynamic and wealthy parts of the economy, the practical taxing power is a smaller fraction of GDP than it used to be.  Therefore, a 1:1 ratio of debt to GDP (or any other ratio) should give less comfort to bond holders today than it did three decades ago. Unfortunately, there doesn't seem to be another obviously more appropriate metric than GDP to assess practical taxing power--unless it is to compare with tax rates in the past.

Update on Thursday, June 10, 2010 at 09:07AM by Skeptic

Research has shown in the last four years that GDP measurement methods miss some effects of offshoring manufacturing and service jobs and causes overstatement of US GDP.  This probably helps explain the "jobless recoveries" we've had in the last two decades. Louis Uchitelle reported here on a gathering of government and academic economists last November to try to fix the problem. 

WASHINGTON — A widening gap between data and reality is distorting the government’s picture of the country’s economic health, overstating growth and productivity in ways that could affect the political debate on issues like trade, wages and job creation.

The shortcomings of the data-gathering system came through loud and clear here Friday and Saturday at a first-of-its-kind gathering of economists from academia and government determined to come up with a more accurate statistical picture.

The fundamental shortcoming is in the way imports are accounted for. A carburetor bought for $50 in China as a component of an American-made car, for example, more often than not shows up in the statistics as if it were the American-made version valued at, say, $100. The failure to distinguish adequately between what is made in America and what is made abroad falsely inflates the gross domestic product, which sums up all value added within the country.

American workers lose their jobs when carburetors they once made are imported instead. The federal data notices the decline in employment but fails to revalue the carburetors or even pinpoint that they are foreign-made. Because it seems as if $100 carburetors are being produced but fewer workers are needed to do so, productivity falsely rises — in the national statistics.

“We don’t have the data collection structure to capture what is happening in a real time way, or what is being traded and how it is affecting workers,” said Susan Houseman, a senior economist at the W.E. Upjohn Institute for Employment Research in Kalamazoo, Mich., who has done pioneering research in the field. “We have no idea how to measure the occupations being offshored or what is being inshored.”

The statistical distortions can be significant. At worst, the gross domestic product would have risen at only a 3.3 percent annual rate in the third quarter instead of the 3.5 percent actually reported, according to some experts at the conference. The same gap applies to productivity. And the spread is growing as imports do.

That may help to explain why the recovery from the 2001 recession was a jobless one for many months and why the recovery from this recession is likely to generate few jobs for many months.

. . . .

The federal agencies that compile the nation’s statistics increasingly acknowledge that they lack the detailed data needed to calculate the impact of imported goods and services as imports rise from an insignificant 5 percent of all economic activity 35 years ago to more than 12 percent today, not counting petroleum. As a result, many imports are valued as if they were made in the United States and therefore higher in price than their imported counterparts.

The problem is particularly acute in manufacturing. Imported components constitute an ever greater share of the computers, autos, appliances and other finished merchandise that roll off assembly lines in the United States — and an ever greater share of all of the nation’s imports.

. . . .

The same holds for services. An accounting firm in New York with 50 employees outsources some of its functions to less expensive accountants in India: the paperwork on an income tax return, for example. That work comes back to New York by computer transmission and is billed at New York rates, as if it were value added in this country.

Grappling with these blind spots, nearly all of the 80 experts at the conference, which was sponsored by the Upjohn Institute and the National Academy of Public Administration, agreed that the statistics now published tend to overstate the strength of the economy. That view was shared by those who attended from the Bureau of Economic Analysis, the Bureau of Labor Statistics and the Federal Reserve, all big players in measuring economic performance.

BusinessWeek had a longer story here in 2007 as the Houseman work was just becoming public. Some excerpts suggesting the effect may be quite large:

By BusinessWeek's admittedly rough estimate, offshoring may have created about $66 billion in phantom GDP gains since 2003 (page 31). That would lower real GDP today by about half of 1%, which is substantial but not huge. But put another way, $66 billion would wipe out as much as 40% of the gains in manufacturing output over the same period.

It's important to emphasize the tenuousness of this calculation. In particular, it required BusinessWeek to make assumptions about the size of the cost savings from offshoring, information the government doesn't even collect.

. . . .

Pat Byrne, the global managing partner of Accenture Ltd.'s (ACN ) supply-chain management practice, goes even further, suggesting that "at least half of U.S. productivity [growth] has been because of globalization." But quantifying this is tough, he notes, because most companies don't look at how much of their productivity growth is onshore and how much is offshore. "I don't know of any companies or industries that have tried to measure this. Maybe they don't even want to know."

Phantom GDP helps explain why U.S. workers aren't benefiting more as their companies grow ever more efficient. The cost savings that companies are reaping "don't represent increased productivity of American workers producing goods and services in the U.S.," says Houseman. In contrast, compensation of senior executives is typically tied to profits, which have soared alongside offshoring.

ADDED 6/24/2011: Houseman and a colleague summarize their research in an accessible fashion in this McKinsey Global Institute report.

Update on Tuesday, August 30, 2011 at 05:05PM by Skeptic

Matt Iglesias reports thatSveriges Riksbank deputy governor Lars E.O. Svensson has argued for focusing directly on unemployment as the best measure of the output gap.

Why Bad Beliefs Don’t Die

An article with this title by psychologist Gregory W. Lester appeared in the November/December 2000 issue of Skeptical Inquirer and does a beautiful and persuasive job of explaining why a person's beliefs, bad or good or even trivial beliefs, are so hard to change. I speculated here on why beliefs are so difficult to change, focusing on ways that persistent beliefs are socially useful. Lester goes well beyond that and argues that the human brain has a system for developing beliefs and that this system has survival value because it is independent of the sensory system.

Functionally, our brains treat beliefs as internal "maps" of those parts of the world with which we do not have immediate sensory contact. As I sit in my living room I cannot see my car. Although I parked it in my driveway some time ago, using only immediate sensory data I do not know if it is still there. As a result, at this moment sensory data is of very little use to me regarding my car. In order to find my car with any degree of efficiency my brain must ignore the current sensory data (which, if relied on in a strictly literal sense, not only fails to help me in locating my car but actually indicates that it no longer exists) and turn instead to its internal map of the location of my car. This is my belief that my car is still in my driveway where I left it. By referring to my belief rather than to sensory data, my brain can "know" something about the world with which I have no immediate sensory contact. This "extends" my brain's knowledge of and contact with the world.

The ability of belief to extend contact with the world beyond the range of our immediate senses substantially improves our ability to survive. A caveman has a much greater ability to stay alive if he is able to maintain a belief that dangers exist in the jungle even when his sensory data indicate no immediate threat.

Not only do beliefs make up for gaps in sensory perceptions but they give meaning and coherence to our environment by providing explanations for causes and effects and giving us bases upon which to make predictions. Lester goes on to talk about the power and independence of beliefs:

Because senses and beliefs are both tools for survival and have evolved to augment one another, our brain considers them to be separate but equally important purveyors of survival information. The loss of either one endangers us. Without our senses we could not know about the world within our perceptual realm. Without our beliefs we could not know about the world outside our senses or about meanings, reasons, or causes.

This means that beliefs are designed to operate independent of sensory data. In fact, the whole survival value of beliefs is based on their ability to persist in the face of contradictory evidence. Beliefs are not supposed to change easily or simply in response to disconfirming evidence. If they did, they would be virtually useless as tools for survival. . . .

As far as our brain is concerned, there is absolutely no need for data and belief to agree. They have each evolved to augment and supplement one another by contacting different sections of the world. They are designed to be able to disagree. This is why scientists can believe in God and people who are generally quite reasonable and rational can believe in things for which there is no credible data such as flying saucers, telepathy, and psychokinesis.

When data and belief come into conflict, the brain does not automatically give preference to data. This is why beliefs-even bad beliefs, irrational beliefs, silly beliefs, or crazy beliefs-often don't die in the face of contradictory evidence. The brain doesn't care whether or not the belief matches the data. It cares whether the belief is helpful for survival. Period. So while the scientific, rational part of our brains may think that data should supercede contradictory beliefs, on a more fundamental level of importance our brain has no such bias. . . .

Lester says attacks on even trivial beliefs may be perceived by the brain as threats when such beliefs are part of an integrated worldview. Then he suggests how skeptics should, and should not, engage other people's beliefs with facts--don't get angry, frustrated, or demeaning, don't think it's easy for the other fellow, and don't expect too much. He concludes:

Finally, it should be comforting to all skeptics to remember that the truly amazing part of all of this is not that so few beliefs change or that people can be so irrational, but that anyone’s beliefs ever change at all. Skeptics’ ability to alter their own beliefs in response to data is a true gift; a unique, powerful, and precious ability. It is genuinely a “higher brain function” in that it goes against some of the most natural and fundamental biological urges. Skeptics must appreciate the power and, truly, the dangerousness that this ability bestows upon them. They have in their possession a skill that can be frightening, life-changing, and capable of inducing pain. In turning this ability on others it should be used carefully and wisely. Challenging beliefs must always be done with care and compassion.

Should I believe this?

Update on Sunday, June 27, 2010 at 01:43PM by Skeptic

If there is an evolutionary and neurological basis for beliefs persisting despite a person's perception of overwhelming contradictory evidence, perhaps it has to do with the left-brain-right-brain dichotomy.  In Part 4 of Errol Morris' 5-part series The Anosognosic’s Dilemma: Something’s Wrong but You’ll Never Know What It Is (anosognosia is unawareness, self-deception, or denial regarding one's own disability such as paralysis or ignorance), reports on his interview of Dr. V. S. Ramachandran, an expert in agnosognosia and author of Phantoms in the Brain: Probing the Mysteries of the Human Mind:

Ramachandran has used the notion of layered belief — the idea that some part of the brain can believe something and some other part of the brain can believe the opposite (or deny that belief) — to help explain anosognosia. In a 1996 paper [54], he speculated that the left and right hemispheres react differently when they are confronted with unexpected information. The left brain seeks to maintain continuity of belief, using denial, rationalization, confabulation and other tricks to keep one’s mental model of the world intact; the right brain, the “anomaly detector” or “devil’s advocate,” picks up on inconsistencies and challenges the left brain’s model in turn. When the right brain’s ability to detect anomalies and challenge the left is somehow damaged or lost (e.g., from a stroke), anosognosia results.

In Ramachandran’s account, then, we are treated to the spectacle of different parts of the brain — perhaps even different selves — arguing with one another.

We are overshadowed by a nimbus of ideas. There is our physical reality and then there is our conception of ourselves, our conception of self — one that is as powerful as, perhaps even more powerful than, the physical reality we inhabit. A version of self that can survive even the greatest bodily tragedies. We are creatures of our beliefs. This is at the heart of Ramachandran’s ideas about anosognosia — that the preservation of our fantasy selves demands that we often must deny our physical reality. Self-deception is not enough. Something stronger is needed. Confabulation triumphs over organic disease. The hemiplegiac’s anosognosia is a stark example, but we all engage in the same basic process. But what are we to make of this? Is the glass half-full or half-empty? For Dunning, anosognosia masks our incompetence; for Ramachandran, it makes existence palatable, perhaps even possible.

I don't see how Ramachandran's left-brain-right-brain conjecture fits within the conventional assignment of characteristics to each, but that doesn't invalidate the idea that different parts of our brains tend to generate different perceptions in different ways, and somehow we pick one and reject the others. It seems plausible that different people would tend to give different weightings to these conflicting signals.

This seems like a good place to quote the line attributed to Josh Billings (and others), which was the subtitle to this blog for its first two plus years: "The trouble with people is not that they don't know but that they know so much that ain't so."

The mother of all jobless recoveries

My purpose here is twofold, to say why recent improvements in labor productivity are probably not a sign of economic recovery and also to applaud Judge Richard Posner for changing his beliefs when the facts change.  

In Richard Posner’s new book, A Failure of Capitalism: The Crisis of ‘08 and the Descent into Depression, reviewed here by Robert Solow, Posner says there was a colossal market failure and calls for government action to rein in an out-of-control financial system. Posner has a big and well deserved reputation for promoting free markets, but he seems to have found a situation where the facts don’t agree with the theory and he has elected to go with the facts.  What caught my eye today is this blog post in which Posner acknowledges that reported increases in labor productivity can result from offshoring jobs and that this type of productivity increase does not lead to resumption of growth and declining unemployment. 

Producers responded to the economic crisis that crested with the collapse of Lehman Brothers in mid-September 2008 by slashing prices and costs. Slashing prices tends to keep output up while slashing costs increases labor productivity (output per unit of labor) because it involves layoffs and (what has the same effect) outsourcing to foreign countries. If all the recent productivity gains had taken the form of outsourcing production, there would be no reason to expect that lower prices would have reduced unemployment even though they would have tended to maintain output and therefore consumption. If higher productivity were achieved by technological advances rather than by layoffs or outsourcing, we would expect it to herald rapid economic growth. If it’s just the result of layoffs and outsourcing, however, it will fall when, faced with increased demand, producers do more hiring.

In allowing that productivity increases can stem from layoffs and outsourcing as well as from technological improvements, Posner has departed from the standard supply side, Say’s Law ideology, endorsed, e.g., by Martin Feldstein in There’s No Such Thing as a “Jobless” Recovery in October 2003, which was after the "official" end of the 2001 recession. Despite Feldstein's assurances, it took 39 months to get back to the number of jobs we had before that recession started.  Worse than that, because population continued to grow, the percentage of adults employed never did recover to the pre-recession level before we entered the 2007 Great Recession. 

 

From BLS Current Population Survey labor force participation ages 20 plus.

As if that wasn't bad enough, median inflation-adjusted annual family income, which was $61,000 in 2000, had declined to $60,500 before the start of the 2007 Great Recession. David Leonhardt has that story here.

Since I see plenty of outsourcing and very few technological advances being deployed in America--and wages still declining--I expect the mother of all jobless recoveries this time.  

Update on Monday, December 6, 2010 at 10:55AM by Skeptic

Oops.  That graph is properly labeled as laborforce participation rate, but that isn't what I said in text.  A better indicator of what's been happening--since March of 2000--is a steep downward trend in the ratio of adults working to the total population.

A bad thing the banksters are NOT doing--withholding credit from the real economy

The frequent assertion that the evil banksters are hindering economic recovery by not extending credit to firms in the real economy, especially to small businesses, is apparently a myth. Forbes asked around and found it is much more accurate to say that loan demand is down. There are many community and regional banks that did not participate in the risky practices that led to the Global Financial Crisis and are sound, well capitalized, and ready to lend. These banks say there is low demand for loans because their usual customers are cautious about expanding because they don't have demand.  In addition, as in every recession, businesses get into trouble and become poor credit risks. The low-demand assessment is supported by this report from the Atlanta Fed:

A recent small business survey performed by the Atlanta Fed suggested that business loan demand was down primarily because of weak sales and modest revenue prospects. The credit availability picture was mixed. No surprise, construction-related firms and manufacturers had the most trouble obtaining credit during the last six months. But others did well in having their credit needs met. Of more than 200 respondents, nearly half did not look for credit at all, mostly citing weak sales or sufficient cash reserves.

Dean Baker suggests the reason the myth persists is because there is no political will to address the real economic problem--stagnant demand--because that implies the need for more government deficit spending to stimulate demand. If one is not willing to solve a problem, it is politically useful to deny it exists.

Mark Thoma reposts the Dean Baker piece and discusses it at length here and also ponders other ways to stimulate the economy. 

Update on Saturday, October 2, 2010 at 11:01PM by Skeptic

The Atlanta Fed report also stated that 55% of respondents gave poor sales/revenues as a reason for their not borrowing.

Too many hedgehogs and not enough foxes among economists

The Global Financial Crisis and the Great Recession have created an intellectual crisis among economists. Essentially their question among themselves is, "What's wrong with the way we do our work that made us fail to predict this?" It helps to keep their attention focused that the Queen of England asked the same question while visiting the London School of Economics in November 2008 and that many others inside and outside the economics priesthood won't let them forget this colossal failure of mainstream economics.

Mark Thoma says part of the problem is that courses in the history of economic thought and economic history have largely disappeared from undergraduate and graduate education in economics. He reports in this review of Simon Johnson and James Kwak's new book, 13 Bankers: 

I was at a conference a few weeks ago at King's College in Cambridge, England hosted by the Institute for New Economic Thinking. Simon Johnson was there as well. The topic of the conference was "The Economic Crisis and the Crisis in Economics." During one of the sessions, a speaker asked the audience -- most of whom were economists from the top schools in the world -- if their departments included the history of economic thought as core part of their graduate curriculum. Nobody raised their hand.

The number of economics programs offering history of thought as a field, or as part of the core program, has diminished over time. Some programs still teach the history of thought (though not always at the graduate level), so it's not gone altogether, but it has become rare.

The situation is even more dire for American economic history which has all but dropped off the map in many programs. That is unfortunate. If economists had studied U.S. financial history in depth, they might have been able to recognize that past patterns were repeating themselves. They might have foreseen that we were headed for trouble. Instead, we missed some fairly obvious similarities between events prior to the crisis and events of the past that should have alerted us to the potential danger ahead. To a large degree, we have lost our historical perspective.

Why have these classes been dropped from graduate programs? I tried to answer that question here by arguing that the technical demands of modern economics crowded these courses out of graduate programs, but it was more than that. There was also a sense that we had solved the macroeconomic problem using a highly mathematical, scientific approach, or at least made enough progress to bring about a "Great Moderation." There was little to learn from macroeconomists of the past, or so it seemed, and that overconfidence turned out to be costly when the crisis hit. Many of the hard learned lessons of the past had to be relearned once again.

Thus, one answer to the problem of regulating the financial sector is to make sure that economists know the history of their field, including US economic history and all of the financial turmoil of the 1800s and early 1900s. That is where 13 Bankers is so valuable. The book begins with an overview of U.S. financial history, and it includes a readable explanation of the economics and politics behind the financial events of the past. This is essential reading for any economist who wants to understand what triggered financial panics in the past, what policies worked or failed and why, and how it relates to today.

Paul Krugman says the "freshwater" economists deliberately purged all knowledge of what went before and what isn't in their paradigm.

For when freshwater macro took over a good part of the field, its leaders gleefully dismissed all the work Keynesian economists had done over the previous few decades, often with sneers and sniggers.

And that same adolescent quality was evident in the reactions to the Obama administration’s attempts to deal with the crisis — as Brad DeLong points out, people like Robert Lucas and John Cochrane (not to mention Richard Posner, who isn’t a macroeconomist but gets his take from his colleagues) didn’t say that when serious scholars like Christina Romer based policy recommendations on Keynesian economics, they were wrong; the freshwater crowd declared that anyone with Keynesian views was, by definition, either a fool or intellectually dishonest.

So the freshwater outrage over finding their own point of view criticized is, you might think, a classic case of people who can dish it out but can’t take it.

But it’s actually even worse than that.

When freshwater macro came in, there was an active purge of competing views: students were not exposed, at all, to any alternatives. People like Prescott boasted that Keynes was never mentioned in their graduate programs. And what has become clear in the recent debate — for example, in the assertion that Ricardian equivalence rules out any effect from government spending changes, which is just wrong — is that the freshwater side not only turned Keynes into an unperson, but systematically ignored the work being done in the New Keynesian vein. Nobody who had read, say, Obstfeld and Rogoff would have been as clueless about the logic of temporary fiscal expansion as these guys have been. Freshwater macro became totally insular.

And hence the most surprising thing in the debate over fiscal stimulus: the raw ignorance that has characterized so many of the freshwater comments.

Whether it's from time constraints, intellectual arrogance, and/or something else, it seems clear that too many economists know too little about the context of their narrow knowledge bases. In Isaiah Berlin's metaphor, they are "hedgehogs" who know one big thing, when what we need to guide public policy are "foxes" who know many things.

US government is spending taxpayer money to “onshore” jobs it gave away in trade agreements.

When an American professor and his team at MIT developed technology far superior to lithium ion batteries, the company he formed, A123, not only could not get funding to manufacture in the US, they were told it was a really dumb idea to try. So they outsourced manufacturing to China. Now A123 hopes to start manufacturing in Michigan, but can't go against competitors it created in China without federal and Michigan government subsidies. LAT has the story here.

Despite the promise of Chiang's batteries, many in Wall Street and Silicon Valley were incredulous when he and other leaders at A123 asked for capital to build factories in America – Asia, yes, but Michigan, why would you want to?

Even more daunting, virtually all of the world's battery manufacturing industry is now in Asia, where plants can be built faster and supplies and equipment are much easier to get than in the United States. These days, it's hard to find Americans who even know how to build a battery factory.

. . . .

American manufacturing in the last three decades is replete with similar stories. That came across when David Vieau, A123's chief executive, made the rounds seeking capital in Silicon Valley and on Route 128, Boston's version of California's high-tech hub.

 "A majority of the people liked the idea of letting someone else make things," said Vieau, sitting in his small non-corner office at A123's headquarters in Watertown, a Boston suburb. "

"In the software-oriented, Internet-age investment environment, [they] suggested you do the thinking and let someone else put together the bricks and mortar."

A123 did attract some early private investors, including Qualcomm and Motorola. But with limited funds, the company felt compelled to launch its manufacturing in Asia. It went to South Korea, home to perhaps today's most advanced lithium-ion manufacturing, to China, which is moving up the technology ladder fast, thanks in large part to foreign companies.

. . . .

But in ramping up production in China, A123 paid an immeasurable price, [A123's CTO] Riley says: Loss of its intellectual property – the ideas and engineering that made its products better."

The company did what it could to slow the technology transfer by breaking down the manufacturing process into steps, Riley said, but "we ended up having to teach these guys how to make our state-of-the-art, world-class batteries...And some of them are [now] competing with us directly."

Next month A123 plans to start manufacturing in an abandoned facility it is refitting near Detroit. Incremental employment is projected to be 400 by the end of 2011, going to 2000 eventually. To subsidize this, A123 is getting a $249 million matching grant from DOE's Electric Drive Vehicle Battery and Component Manufacturing Initiative as well as tax incentives from Michigan. So that's a minimum of $124,500 of government money to "buy" each of these jobs for Americans. Even so, manufacturing in Michigan is going to be a struggle.

Labor, though a small part of the overall costs, still figures into the equation. Average wages for production workers at major suppliers to car makers run about $13.50 an hour in Michigan, will go up for companies that unionize, as A123 and others  operating in the state likely will. [Skeptic's note: $13.50 per hour is far below the average US wage for production workers, $18.42.]

By comparison, workers in Changzhou earn about $2.80 an hour, according to the local government figures.    

Chiang is betting that America's superior technological capabilities will not only help close cost gaps but force foreign rivals to keep chasing American innovations.

Apart from government policies, he thinks that may be the only way to ensure his company and green-car manufacturing in the United States flourishes.

"It's going to be a fight," he said. 

Translation: A123 cannot maintain a technological edge if it doesn't do its own manufacturing because much of innovation involves making improvements in manufacturing processes, and those who control the manufacturing—and are co-located with it—have a great competitive advantage. Read more on the innovation process in this post. The visionary management of A123—and DOE and the State of Michigan—see the strategic importance of local manufacturing, but you can bet the bean counters are upset because manufacturing in China would clearly be more profitable. America would be in a much better position today if the US Government had protected strategically important domestic industries and activities like these instead of giving them away in free trade negotiations and getting not much in return. What naifs we were!

Update on Sunday, May 9, 2010 at 08:43AM by Skeptic

LAT has rerun the same story about A123 again 10 days later, this time on the front page with a different headline. I think LAT is overdoing recycling.

Update on Monday, July 5, 2010 at 12:19PM by Skeptic

Perhaps an even bigger issue than making improvements in manufacturing processes is the enormous cost and risk of getting an innovation to commercial scale in the first place.  Andy Grove, retired CEO of Intel, emphasizes the scaling point here.

Update on Saturday, January 15, 2011 at 09:04AM by Skeptic

It gets worse.  Even government subsidies can't keep the jobs at home, according to this NYT report:

BEIJING — Aided by at least $43 million in assistance from the government of Massachusetts and an innovative solar energy technology, Evergreen Solar emerged in the last three years as the third-largest maker of solar panels in the United States.

But now the company is closing its main American factory, laying off the 800 workers by the end of March and shifting production to a joint venture with a Chinese company in central China. Evergreen cited the much higher government support available in China.

Update on Thursday, August 11, 2011 at 04:18PM by Skeptic

There are about 14 million more jobless Americans today than there would be if unemployment were at a normal rate and the economy were humming as it was in 2000. If the US government were going to create 14 million jobs by making grants of the size it did to A123, the total cost would be $1.743 trillion. That's 6% more than the FY2011 federal budget deficit. Of course not all of the 14 million missing jobs were offshored, but wouldn't it be more economical to prevent these jobs from leaving than to buy them back at prices like these?

Update on Tuesday, August 30, 2011 at 03:29PM by Skeptic

According to this more recent NYT Magazine report, our innovation posture is even worse than reported above.  A123 didn't build the Michigan plant just to prevent loss of the technology to China but to acquire technology that had been developed in Korea. To bring it here, A123 built an exact copy of a Korean plant--in just the way the Asia companies used to acquire US technology.

About 30 minutes northwest of Detroit, just off the Interstate, in Livonia, sits the modern, red brick automotive headquarters of A123 Systems, a beneficiary of about $375 million in federal stimulus funds and matching state grants. A123 provides the cells for a new electric car called the Fisker Karma, as well as various electric bus and truck projects around the world. A123 is also the first large-scale lithium-ion manufacturer whose domestic operations are up and running, though its pedigree is international. Its battery technology was developed at M.I.T., and for the last several years, the company had been making its lithium-ion cells in factories in Korea and China. When I asked Jason Forcier, the head of A123’s automotive division, why the company went to Asia to make its products, Forcier said he had no choice. “That’s where the supply base was,” he said. “That’s where the know-how was — it was nonexistent in the U.S.”

Repatriating a high-tech manufacturing plant to the United States is not simply a matter of hiring the local talent. It requires good-old foreign know-how. “We call it ‘copy exact,’ ” Forcier said. “We bought a company in Korea that had the technology around this type of battery and had developed the manufacturing process there. We basically brought that here, copied it exactly and scaled it up.” A123 also brought a team of six Korean engineers to help transfer the technology to the U.S. and sent a team of Americans to Korea to learn.

The article also reports that State grants bumped the total of government subsidies for A123 up to $375 million. It was reported today in an NYT op ed by Susan Hockfield, president of MIT, that A123 has just recently hired its 1,000th employee.  So $375,000 subsidy per new job, or $375 billion for one million new jobs. Another way of looking at the size of these subsidies is that they were large enough to pay 100% of A123's production worker costs and give the company "free" labor for about 12 years. This hardly seems a scalable way to address our unemployment problems.

Both NYT pieces emphasize the tight relationship between manufacturing and innovation and the need to co-locate them.  Hockfield, who is also a director of GE, says:

Manufacturers conduct 70 percent of private-sector research and development and employ 64 percent of the nation’s scientists and engineers. But factories abroad attract design and engineering talent; over time, manufacturing off shore leads to innovation off shore. To make matters worse, as the President’s Council of Advisers on Science and Technology recently reported, other nations are investing heavily in manufacturing, while our investments lag.

Update on Tuesday, October 16, 2012 at 02:55PM by Skeptic

It was announced today that A123 has filed in bankrupcty to facilitate its agreement to sell its major assets to Johnson Controls for $125 million, a very substantial discount off cost.  

WALTHAM, Mass., Oct. 16, 2012 /PRNewswire/ -- A123 Systems, Inc. (Nasdaq: AONE) ("A123" or "the Company"), a developer and manufacturer of advanced Nanophosphate® lithium iron phosphate batteries and systems, today announced that it has entered into an asset purchase agreement with Johnson Controls, Inc. (NYSE: JCI) in a transaction valued at $125 million. Under the terms of the agreement, Johnson Controls plans to acquire A123's automotive business assets, including all of its automotive technology, products and customer contracts; its facilities in Livonia and Romulus, Michigan; its cathode powder manufacturing facilities in China, and A123's equity interest in Shanghai Advanced Traction Battery Systems Co., A123's joint venture with Shanghai Automotive. The asset purchase agreement also includes provisions through which Johnson Controls intends to license back to A123 certain technology for its grid, commercial and government businesses. A123 also continues to engage in active discussions regarding strategic alternatives for its grid, commercial, government and other operations, and has received several indications of interest for these businesses.
PR Newswire (http://s.tt/1qbVN)

NYT has a well-reported story here.  

Update on Tuesday, December 11, 2012 at 09:31AM by Skeptic

Johnson Controls didn't get the A123 assets.  It was outbid by a Chinese company determined to dominate the battery and electric car industries, as reported in NYT December 9. The Chinese company had provided debtor-in-possession financing for A123 and more than doubled the Johnson Controls offer.  

According to the deal, Wanxiang would acquire A123’s automotive, electric-grid and commercial business assets, including all of its technology, products, customers, and factories in Michigan, Massachusetts and Missouri, which will continue to operate.

Wanxiang would also take control of A123’s fledgling operations in China, including its interest in a joint battery venture with Shanghai Automotive, the country’s biggest carmaker.

The Iraq war has exiled, displaced, or made homeless one-fifth of Iraqis.

When we net out the costs and benefits of Mr. Bush's war, we must give great weight to the terrible toll it has taken on Iraqi civilians of all religions, the educated middle class, and the ability of Iraqi society and government to function. The refugees also create great political problems in Syria, Lebanon, and Jordon, and throughout the Middle East. From They Fled from Our War, a NYRB review by Alisa Roth and Hugh Eakin of Deborah Amos' Eclipse of the Sunnis: Power, Exile, and Upheaval in the Middle East:

The flight of Iraqis since the 2003 invasion ranks as the largest human displacement in the Middle East since 1948. Precise numbers are hard to come by: overwhelmingly, the refugees have fled from and to large urban areas. Many are fearful of making themselves known. But according to estimates by the UN and human rights organizations, over one million Iraqis have sought refuge in Syria, and some 500,000 in Jordan, where Amman’s population has swelled by as much as a third as a result. Several hundred thousand more are dispersed elsewhere in the region, including Lebanon, Egypt, Saudi Arabia, and Turkey. Another 100,000 have paid large sums to smuggle themselves into Europe, where they have placed severe stress on asylum courts in countries like Germany and Sweden.

These figures do not include the more than two million Iraqis who have been displaced within Iraq. According to a March 17 report by Refugees International, half a million Iraqis who fled their homes are now squatting in slums around Baghdad and other cities:

These people have no title to the land. Many fear returning to their original homes…. The settlements all lack basic services, including water, sanitation, and electricity, and are built in precarious places—under bridges, alongside railroad tracks, and amongst garbage dumps.

Counting both internal and external refugees, the Office of the United Nations High Commissioner for Refugees (UNHCR) estimates that nearly 5 million of Iraq’s population of 24 million have been uprooted during the conflict—nearly twice the number of Sudanese displaced in Darfur.

This human upheaval has transformed Iraqi society. In her new book, Eclipse of the Sunnis, Deborah Amos, a correspondent for National Public Radio, sees the outflow of Iraqis as part of a long-term shift from Sunni to Shia dominance in Iraq. Since over half of those who have left are believed to be Sunnis, Amos draws a direct connection between the refugees and the common perception that, as she put it in a recent interview with Terry Gross, “the Shiites had won, the Sunnis had lost, and it was the Sunnis who were being driven out.” Adding large numbers of Iraqis to local populations from Damascus to Amman to Beirut, this exodus has caused what Amos calls “a ripple of consequences across all Sunni communities in the Middle East.” Jordan and Syria, she notes, complain that the Shia-led government of Nouri al-Maliki has failed to provide support for the exiles, while Baghdad accuses its neighbors of harboring Iraqi insurgents.

Yet the exile population includes tens of thousands of Shias as well. And proportionally, the conflict has had even greater consequences for other groups: Christians and smaller minorities, families of mixed backgrounds, and especially members of the country’s urban elite—regardless of sectarian identification. “One of the characteristics of Iraq’s civil war,” the International Crisis Group reported in 2008,

has been the extent to which the better educated have been targeted by militia leaders from all confessional groups—including their own…. Ironically—and tragically—large segments of the middle class in which so many hopes were invested at the dawn of the occupation now reside abroad.

. . . .

Meanwhile, Iraq’s neighbors are losing patience. With US government resources stretched by the economic crisis and the war in Afghanistan, the Obama administration has provided only a fraction of the $2 billion in refugee aid promised to host governments in the Middle East. Iraq itself has been far less generous, despite sizable revenues from oil. For their part, humanitarian groups worry that when US troops begin to go home this summer, there will be even less reason to devote political capital to helping refugees. What was once a middle-class society without democracy may, for some time to come, be a democracy without a middle class. For talented Iraqis now scattered around the world, this would amount to a double betrayal: abandoned in their own country by the American and other forces that were supposed to give them a central place in a new Iraq, they now risk being abandoned again outside it.

California has the highest paid K-12 teachers in the nation and the largest classes.

Looking for something else, I came across the following chart that shows California ranks nearly last among States in staff per pupil devoted to K-12 education.

See the second highlighted column "California's Rank." In the 12 categories ranked, California ranks better than 48th place in only three. It is last in the "Total School Staff" ratio. Belying the common complaint that California district offices are bloated with administrative staff, California ranks fatter than only seven other States in the category of "district officials/administrators" per pupil. 

The same web page reports that California ranks #1 in average teacher pay and that California devotes a near-average percent of state-wide personal income, 4.5% versus the national average of 4.6%, to K-12 education. In 2006-07, California spent $9,124 per pupil per year, which was 95% of the national average of $9,565. So California seems to be betting that fewer, but higher paid teachers is the best way to educate our kids, which begs the question, "How's that working out?" Of course, it's entirely likely that California has not made a deliberate decision to get better teachers at higher cost and have them teach larger classes. We could also have gotten here by first ramping up teacher pay and then increasing class size to keep the total staff budget capped.

Update on Tuesday, June 1, 2010 at 09:24AM by Skeptic

This LAT editorial says that when adjustments are made for variations among States in cost of living, California is only 46th in spending per pupil.

Paul Krugman didn’t always have the “Conscience of a Liberal.”

This New Yorker article contains a fascinating account of the evolution of Paul Krugman's economic and political beliefs. He went from Council of Economic Advisors staffer in the Reagan Administration (1982-83), economic consultant to Enron (1999), and strong supporter of monetarism, deregulated markets, and other views of Milton Friedman in the 1990s to author of The Great Unraveling: Losing Our Way in the New Century (2003), The Conscience of a Liberal (2007) and a liberal column and blog in The New York Times. Along the way he has gone, for example, from belief in the "platonic beauty" of traditional Ricardian (comparative advantage) trade theory to showing that it has been displaced in practice by trade based on economies of scale and "economic geography" (first mover advantages), both of which are subject to manipulation by governments' "industrial policies."

Since I've only been reading Krugman for the last decade, I was unaware that there was an earlier, economically conservative Krugman. The whole article is worth reading for its insights into what motivated Krugman's general transformation into a self-described liberal. (Spoiler alert: The George W. Bush Administration was a big factor.) But since, I have a special interest in globalization, I'll focus on that here. The New Yorker piece summarizes Paul Krugman ver. 1.0 this way:

He was driven mad by Lester Thurow and Robert Reich in particular, both of whom had written books touting a theory that he believed to be nonsense: that America was competing in a global marketplace with other countries in much the same way that corporations competed with one another. In fact, Krugman argued, in a series of contemptuous articles in Foreign Affairs and elsewhere, countries were not at all like corporations. While another country's success might injure our pride, it would not likely injure our wallets. Quite the opposite: it would be more likely to provide us with a bigger market for our products and send our consumers cheaper, better-made goods to buy. A trade surplus might be a sign of weakness, a trade deficit a sign of strength. And, anyway, a nation's standard of living was determined almost entirely by its productivity—trade was just not that important.

. . . . Until the late nineties, when he became absorbed by what was going wrong with Japan, he believed that monetary policy, rather than government spending, was all that was needed to avoid recessions: he agreed with Milton Friedman that if only the Fed had done its job better the Great Depression would never have happened. He thought that people who wanted to boycott Nike and other companies that ran sweatshops abroad were sentimental and stupid. Yes, of course, those foreign workers weren't earning American wages and didn't have American protections, but working in a sweatshop was still much better than their alternatives—that's why they chose to work there. Moreover, sweatshops really weren't the threat to American workers that the left claimed they were. "A back-of-the-envelope calculation . . . suggests that capital flows to the Third World since 1990 . . . have reduced real wages in the advanced world by about 0.15%," he wrote in 1994. That was not nothing, but it certainly wasn't anything to get paranoid about. The world needed more sweatshops, not fewer. Free trade was good for everyone. He felt that there was a market hatred on the left that was as dogmatic and irrational as government hatred on the right.

. . . .

Krugman wrote his thesis on exchange rates, but another class, on international trade, inspired him. "There was this kind of platonic beauty to the whole thing," he says. "I remember going through the two-by-two-by-two model—two goods, two countries, two factors of production. The way all these pieces fitted together into a Swiss-watch-like mechanism was beautiful. I loved it." The traditional theory of international trade, first formulated by the British economist David Ricardo, two hundred years ago, explained trade by comparative advantage: a country exported the goods that it could produce most cheaply, owing to whatever advantages it possessed—cheap labor, climate, technological expertise, and so on. It followed from this theory that countries that were the most dissimilar should do the most trade—countries in the Third World dispatching labor-intensive goods to the First World, the First World selling technology- or capital-intensive goods in return.

Krugman's earliest departure from economic orthodoxy was in trade theory, which led eventually to his Nobel prize in 2008.

In the years following the Second World War, however, economists had noticed that much international trade didn't follow this pattern at all. There was a large amount of trade between countries whose economies were extremely similar, and these countries traded goods that were virtually identical: Germany sold BMWs to Sweden and Sweden sold Volvos to Germany. People had speculated about why this should be so, but nobody had come up with a model that explained it in a rigorous manner.

Krugman realized that trade took place not only because countries were different but also because there were advantages to specialization. If one country was the first to begin manufacturing airplanes, say, it might accumulate an advantage in economies of scale so large that it would be difficult for another country to break into the industry later on, even though there might not be anything about the first country that made it particularly well suited to airplane-making. But why would countries trade goods that were almost the same? Because consumers like to have a choice, and, as Avinash Dixit and Joseph Stiglitz had pointed out a few years earlier, the same logic of increasing returns to scale that Krugman had identified as an essential dynamic in trade could apply to a single brand as well as to a whole industry. . . .

. . . .

Later on, Krugman became interested in economic geography, in the related question of why there were regional specialties—why, in the United States, for instance, were cars produced in Detroit, carpets in Dalton, Georgia, jewelry in Providence, and chips in Silicon Valley? Again, the answer turned out to be history and accident. Once an industry started up in one place, for whatever reason (the carpet industry in Dalton appears to have its origin in a local teen-ager who in 1895 made a tufted bedspread as a wedding present), local workers became trained in its methods, skilled workers from elsewhere moved there, and related businesses sprang up close by. Then, as more skilled labor became available, the industry could grow and benefit from economies of scale. Soon, as long as it didn't cost too much to transport the industry's products, the advantages of the place would be such that it would be impractical for someone to open up a similar business anywhere else. Many economists found the idea that economic geography could be so arbitrary "deeply disturbing and troubling," Krugman wrote, but he found it exciting.

Again, as in his trade theory, it was not so much his idea that was significant as the translation of the idea into mathematical language.

This work provided important theoretical support to left-wing economists in their opposition to trade liberalization in the Ricardian model, but in those days Krugman remained a free trader.

One implication of Krugman's theory was that, contrary to economic orthodoxy, industrial policy might have its benefits. If the location of a new industry was essentially arbitrary, then a government, by subsidizing and protecting its emergence, could enable it to gain such a lasting advantage that other countries would find it difficult to catch up. But Krugman tried to discourage industrial strategists who cited him. For, while in principle industrial policy could be helpful, in practice, he believed, it was so difficult to determine which industry should receive government help, at the expense of all the others—so difficult to predict an industry's future, and so difficult to determine merit when powerful interests would be trying to influence that determination—that in the end industrial policy would be likely to benefit mostly the owners of a few businesses and hurt everybody else.

However, by June 2007 Krugman was waiving red flags about harmful effects of trade on US wage levels based on more current data.

What all this comes down to is that it’s no longer safe to assert, as we could a dozen years ago, that the effects of trade on income distribution in wealthy countries are fairly minor. There’s now a good case that they are quite big, and getting bigger.

This doesn’t mean that I’m endorsing protectionism. It does mean that free-traders need better answers to the anxieties of those who are likely to end up on the losing side from globalisation.

In December 2007, Krugman cautioned the NYT editorial board that its assertion that imports do not hold down US wages might be wrong, and in recent months Krugman has been saying other things about international trade that are anything but orthodox. In his One-Minute Trade Policy Theorist at page 10 he uses an example to show that although there are positive effects from trade, the impact is rather small.  He summarizes with these "two big lessons:"

1.  Major growth effects from trade policy, if they exist, must come from unconventional channels.  Conventional trade theory DOES NOT justify claims of huge positive payoffs from free trade.

2.  In the politics of trade policy, distributional effects can easily swamp concerns about efficiency.

(Emphasis in original.) Further, Krugman calculated in this December 2009 column that China’s defense of non-market currency exchange rates has cost the US about 1.4 million jobs and countered the arguments that the US should not take action to fix this problem: 

[China’s] trade surplus drains much-needed demand away from a depressed world economy. My back-of-the-envelope calculations suggest that for the next couple of years Chinese mercantilism may end up reducing U.S. employment by around 1.4 million jobs. 

. . . .

Second, there’s the claim that protectionism is always a bad thing... If that’s what you believe, however, you learned Econ 101 from the wrong people — because when unemployment is high..., the usual rules don’t apply.

Let me quote from a classic paper by the late Paul Samuelson...: “With employment less than full ... all the debunked mercantilistic arguments” — that is, claims that nations who subsidize their exports effectively steal jobs from other countries — “turn out to be valid.” He then went on to argue that persistently misaligned exchange rates create “genuine problems for free-trade apologetics.” The best answer to these problems is getting exchange rates back to where they ought to be. But that’s exactly what China is refusing to let happen.

Krugman is careful to assert that his views about trade are being driven by the data and that since the explosion of trade with China the data are showing negative effects on the US that theorizing did not anticipate.

Update on Tuesday, July 6, 2010 at 12:19PM by Skeptic

Here's an example of Krugman circa 1998 commenting on William Greider's then-new book, One World Ready or Not: The Manic Logic of Global Capitalism.

Six causes of the global financial crisis

Paul Krugman collects six contending narratives about the causes of the global financial crisis:

- Size: Our largest financial institutions have just gotten too big

- Shadows: The rise of shadow banking, institutions that fulfill banking functions but evade the regulatory regime, has undermined stability

- Opacity: We've come to rely on complex financial instruments that neither regulators nor the private sector [understand]

- Predation: Financial firms deliberately misled consumers and investors

- Government intervention: Public policy pushed lenders into making bad loans, especially to the poor

- Monetary mismanagement: The Fed did it by keeping interest rates too low for too long, and/or policymakers panicked in 2008 and spooked the markets

He goes on to discuss the merits and problems of each before declaring himself most persuaded by Shadows, with some contributions from Opacity and Predation.

My bottom line: even among experts with no obvious axe to grind there is a distinct lack of agreement about what caused the crisis and what measures would be most likely to prevent the next one. Combine this technical hair ball with a powerful financial industry that wants nothing to change and it gets very hard to be optimistic we can fix this. We will of course have legislation that the proponents will claim is effective in order to get these tough issues behind them politically--but fix the problem???

The federal government is a big insurance company with an army.

In the 2010 federal spending budget, 20% is for defense and security, 6% is for interest on the federal debt, and 65% is for retirement, disability, medical, education, and other welfare programs. That leaves only 10% for everything else.  Hat tip to Mark Thoma who posted here the following pie chart from CBO.

Intergenerational tax equity

We hear much about how infeasible and unfair it is for young people to pay Social Security taxes that get transferred directly to retirees. A recent study at UC Berkeley finds that the value of the educations the young receive at the expense of tax-paying older folks is worth more than the intergenerational transfer of Social Security benefits.

On average, Americans pay the taxes that subsidize education 30 years after receiving the benefits, the study noted. By contrast, people start drawing their Social Security and Medicare benefits 30 years or so after paying taxes into these government funds. Thus, each education dollar is worth $10 in retirement benefits, according to the study, which is published in the March issue of the journal Population and Development Review.

So, if it's wrong for 40-year-old John Doe to pay taxes that support 70-year-old retirees, was it also wrong for them to be paying taxes 30 years ago to give 10-year-old John a free education?

Replace the bean counters with visionaries.

Ben Bernanke says federal entitlement programs are unsustainable:

To avoid large and unsustainable budget deficits, the nation will ultimately have to choose among higher taxes, modifications to entitlement programs such as Social Security and Medicare, less spending on everything else from education to defense, or some combination of the above. These choices are difficult, and it always seems easier to put them off–until the day they cannot be put off any more. But unless we as a nation demonstrate a strong commitment to fiscal responsibility, in the longer run we will have neither financial stability nor healthy economic growth.

But a Rand Corporation study sees a way out:

An unprecedented upturn in the number of older Americans who delay retirement is likely to continue and even accelerate over the next two decades, a trend that should help ease the financial challenges facing both Social Security and Medicare, according to a new RAND Corporation study.

Hat tip to Mark Thoma for these. My thoughts:

When actuaries project that raising the retirement age from 65 to 67 (or 71 to 72, as I heard proposed on the radio recently), what do they assume about the number of jobs that will be available? If 65-year-olds keep at it another 5-7 years, will there be that many more domestic jobs for them, or would younger folks be forced into unemployment? I strongly suspect it's the latter. Labor force participation rates for men have been declining since the 1970s and for women since 2000, according to EPI. 

 

If we could put in place policies that cause sustained broad increases in real wages and increasing labor force participation, fiscal problems all over the nation would start to shrink and disappear. On the other hand, if real middle class incomes continue to stagnate and decline, there will be no good solutions to fiscal problems.

Furthermore, Social Security cannot morally be discussed as a mere problem of fiscal management for the national government. There is no realistic prospect that reduced Social Security benefits will be replaced by private savings or any other program because employer benefits and private capacity are shrinking even faster. What's really being discussed is managing the regression to dystopian conditions that our grandparents struggled to put behind us. Our leaders should be thinking the big ideas that will be necessary to prevent that decline, not about how to cope with it.

A fine Republican sentiment

From Theodore Roosevelt’s speech at the dedication of the new House Office Building on April 14, 1906, as quoted by Edmond Morris in Theodore Rex at 442: 

It is important to this people to grapple with the problems connected with the amassing of enormous fortunes, and the use of those fortunes, both corporate and individual, in business. . . .  No amount of charity in spending such fortunes in any way compensates for misconduct in making them.  As a matter of personal conviction, and without pretending to discuss the details or formulate the system, I feel that we should ultimately have to consider the adoption of some such scheme as that of a progressive tax on all fortunes, beyond a certain amount, either given in life or devised or bequeathed upon the death of any individual—a tax so framed as to put it out of the power of the owner of one of these enormous fortunes to hand on more than a certain amount to any one individual.

It's hard to imagine any President since Lyndon Johnson endorsing this idea. Oddly, this part of Roosevelt's speech was hardly noticed at the time because it seemed almost mild in the context of a very strong progressive movement led by William Jennings Bryan, Robert M. LaFollette, et al., the great media attention to the evil doings of corporate America (remember the muckrakers), and the perceived control that the uber-capitalists of the time had over State and federal governments.

Corporatism in America

Tax professor Linda Beale describes her perception of "corporatism" as it has developed in America:

As readers of this blog know, one of the worrisome developments over the last few decades, related to the rise of the distorted view of commercial markets under the pseudo-scientism of freshwater economics, is a version of "corporatism" that concedes enormous political power to large and wealthy corporations and their managers/owners.  The worrisome brand of corporatism is a  politico-social view under which large corporations' activities are presumed to be appropriate because they are businesses, and corporations' interventions in the political marketplace are as welcome as individual citizens' participation.  Corporate wealth translates to political power and that leads to greater corporate wealth.  It requires the government to refrain from actions that might be construed as governmental intervention in corporate decisionmaking--be it compensation of workers, compensation of executives, ability of unions to form freely, concentration and consolidation of industries.  But it also assumes the kinds of government support for business that business demands, such as low taxes, relaxation of anti-trust enforcement, supportive legal structures that empower corporations over individual citizens and that further corporate aggrandizement (e.g., the proverbial "tort reform" calls by the medical-insurance establishment; the expansion and relaxation of rules for tax-free corporate mergers and consolidation during the Bush Administration; Treasury's "nullification" of statutory law by administrative fiat in allowing Wells Fargo to use Wachovia's losses in violation of section 382, etc.), and the socialization of losses/privatization of gains that we saw in the way that the financial crisis "bailout" was handled.  (See prior ataxingmatter postings regarding the kinds of controls that we should have imposed at the moment of coming to the "too big to fail" financial institutions' aid.)

Corporatism is furthered by the Supreme Court's obscene decision in Citizens United that corporations are "persons" fully protected by the First Amendment free speech protections in respect of how they may spend lobbying money to support (or undercut) political actors.  As a result, corporations can now use their huge size, their multinational presence, their enormous coffers to influence elections to ensure that politicians friendly to the corporate agenda will be elected and a corporate-friendly agenda will be enacted and enforced--regardless of the impact on standards of living and life generally for ordinary Americans.  This threatens the very foundations of democratic capitalism.

The general support by various propaganda tanks for the corporatist agenda--in the guise of being for "freedom" and "liberty", which are mistakenly constantly evoked as involved when one talks about competitive businesses or the appropriate balance in politico-social-economic policies--has already helped to foster a prevailing mindset in America that anything that big business does must per se be good and that equity concerns should take a back seat to "economic growth" (as prescribed by the pseudo-science).  This is like the worst nightmare scenario for development out of the efficient market hypothesis--an absurdly limited theory (based on a slew of assumptions that do not hold water in real life) is used to foster the idea that "the market is always right" and "the market can self-regulate".  What we end up with is the financial crisis, where banks gambled on high stakes with socialization of their losses and privatization of their gains. 

This resonates with me because she focuses, as I often do, on macroeconomic pseudoscience as bogus but politically useful support for policies that are good for elites but objectively harmful to the vast majority of Americans. 

"Financial innovation" is the brand name of deliberate financial complexity and obfuscation.

Felix Salmon reviews here a new paper advancing the thesis "that financial innovation is, by its nature, inherently and predictably dangerous." 

Left to its own devices, a market with financial innovations is very likely to end up harming investors, while still making lots of money for the innovators:

In our model, innovation benefits intermediaries who earn large profits selling securities, but hurts investors, who are lured into an inefficient risk allocation and suffer from ex-post price drops… Investors’ losses from risk misallocation may be so large as to eliminate the social value of innovation altogether.

Commenter Sprizouse posted this good insight:

Stop calling it “financial innovation” and start calling it “financial complexity”. Needless complexity was re-branded as innovation back in the 80s and that’s been a major source of our problems.

Complexity is easier to condemn, because we all understand that needless complexity is fabricated game to see who can outsmart who. But when it’s called “financial innovation” it makes it sound like some great public service has been done.

"Financial innovation" has been widely criticized by experts and by me here, but Sprizouse's insight may be one of the most perceptive and useful. 

Whither macroeconomics?

I have posted several times on the intellectual crisis in macroeconomics.  I have been following closely what Mark Thoma has to say about this, and today he posted a really good summary of some of the possible future directions for macro. 

The session I moderated at the INET Conference was called "What Kind of Theory to Guide Reform and Restructuring of the Financial and Non-Financial Sectors?" (the panel was Franklin Allen, Sheila Dow, Axel Leijonhuvfud, and Joe Stiglitz). During the introduction, I made (or meant to make) the following points:

... If you believe, as I do, that macroeconomics needs to change, there are three possible ways to proceed.

First, we could try to reform the DSGE model used widely today. How much would it help to do one or more of the folowing: (i) Within the DSGE model, develop better connections between the real and financial sectors. In particular, the model should allow for the endogenous collapse of financial intermediation. Recent models of financial frictions and endogenous leverage cycles give an indication of how to proceed. (ii) Replace rational expectations (and the efficient markets hypothesis) with a better approximation of how expectations are actually formed. One possibility along these lines is to added learning to the models. Another is behavioral economics. (iii) Replace the representative agent assumption with heterogeneous agents. It's hard to have realistic financial markets with one agent. However, adding heterogeneity is not as simple as it might seem. Generically, having heterogeneous agents in a model makes it difficult to aggregate across individuals – once the representative agent assumption is dropped you cannot, for example, guarantee that uniqueness or stability will appear at the aggregate level even if individual agents are well-behaved neoclassical agents. There are clever ways to allow for heterogeneity without sacrificing the ability to aggregate, but they aren’t fully satisfactory. If we are going to go this route, then more cleverness is needed. (iv) You may be surprised to learn that regulations such as capital requirements have very little theoretical backing -- they are largely ad hoc (see the talk by Franklin Allen). If the problem wasa failure of regulation and not a failure of the model more generally, then perhaps better models of regulation are all that is needed (or, if you believe the crisis was caused by the Fed's pursuit of low interest rates, perhaps all we need is a better model of monetary policy). However, this brings up the question of whether the DSGE structure is an adequate foundation for models of regulation, and I am not convinced that it is. (v) This wasn't part of my remarks, but a physicist spoke at the conference and one of his main points was that financial markets are dictated by power laws, not the Gaussian distributions that are commonly assumed in theoretical work (often for analytical convenience). Is addressing this problem all that is needed?

The second way we might proceed is to adopt new models. Possibilities along these lines are: (i) To develop network (complexity) models and their associated measures of network characteristics such as centrality and degree distribution that can be used to estimate the risk of network failure. (ii) There is George Soros' Reflexivity theory, and (iii) there is the theory developed by Frydman and Goldberg, Imperfect Knowledge Economics. (Both of these had been discussed in earlier sessions.) (iv) We could begin the modeling process at the aggregate level and give up the insistence that the models be microfounded. This would, among other things, avoid the problems associated with aggregating from realistic microfoundations discussed above.

Third, take a whole new approach to theory. (i) The call for pluralism that Sheila Dow will talk about falls into this category (see here for more on this). (ii) Economics could give up trying to model itself after physics as it existed a century or more ago, drop the "natural" language, and embrace the methods of the "softer" sciences. These disciplines have already successfully addressed many of the problems that economists face. ...

Read Thoma’s whole post and comments.

Update on Monday, April 12, 2010 at 09:24AM by Skeptic

Rebecca Wilder, who says much of what she learned to get her recent Ph.D. in economics is now obviously wrong, attended the INET conference at Kings College Cambridge (funded by George Soros), provides some additional details, and links to some conference materials here.

Update on Thursday, April 15, 2010 at 09:16AM by Skeptic

Mark Thoma provides links to Joseph Stiglitz's presentation on video and his paper here. 

Even underpaid teaching assistants can be replaced by virtual TAs in Asia.

Grading papers has traditionally been the work of underpaid teaching assistants, but even that work is being offshored to less expensive advanced degree holders working for Virtual-TA in India, Malaysia, and Singapore, according to this report in The Chronical of Higher Education. Doesn't this mean that colleges and universities with tight budgets must consider virtual TAs as an alternative to hiring more on-site TAs or raising their pay?  If this important part of financial assistance to advanced degree candidates is to shrink, that must have an adverse impact on the affordability of US advanced degree programs.   

Hat tip to Christine.

Theodore Roosevelt on economic class divisions

During his first two years in office, President Theodore Roosevelt had begun to push back against Big Business. He initiated the suit against the Northern Securities railroad trust, intervened to settle the anthracite coal strike, was openly contemplating banking regulation, and had substantially wrested control of the Republican Party from Mark Hanna. On the other hand, he first encouraged and then disappointed labor unions as he sought to avoid seeming a partisan for labor or managment. On September 7, 1903, in the midst of a periodic stock and credit panic on Wall Street, he philosophized about these divisions at the Labor Day parade in Syracuse, New York. From Edmond Morris, Theodore Rex at 267:

Roosevelt was identifying with Euripides—like himself, an upper-class celebrant of middle-class virtues—as he mused at length on the vulnerability of republics that failed to preserve their social equipoise. Whichever class arose to dominated others—whether high, low, or bourgeois—always made disproportionate claims on the government: [quoting Roosevelt]

Again and again in the republics of ancient Greece, in those of medieval Italy, and medieval Flanders, this tendency was shown, and wherever the tendency became a habit it invariably and inevitably proved fatal to the state. . . . . There resulted violent alternations between tyranny and disorder, and a final complete loss of liberty to all citizens—destruction in the end overtaking the class which had for the moment been victorious as well as that which had momentarily been defeated. The death-knell of the republic had rung as soon as the active power became lodged in the hands of those who sought, not to do justice to all citizens, rich and poor alike, but to stand for one special class and for its interests as opposed to the interests of others.

Uniquely, the checks and balances of American democracy worked to prevent any such lodgment. National unity was a moral challenge, rather than an economic one: [Roosevelt again]

The line of cleavage between good and bad citizenship lies, not between the man of wealth who acts squarely by his fellow and the man who seeks each day's wages by that day's work, wronging no one. . . . On the contrary, [it] separates the rich man who does well from the rich man who does ill, the poor man of good conduct from the poor man of bad conduct. This line of cleavage lies at right angles to any arbitrary line of division as that separating one class from another, one locality from another, of a man with a certain degree of property from those of a less degree of property.

A civilized commonwealth, enjoying "the true liberties which can only come through order," depended on square dealing between representatives of capital and labor. Just as the former had accepted a limited degree of public scrutiny, so must the latter face up to their own public duty. In any recession acerbated by strikes and union violence, "the first and severest suffering would come among those of us who are least well of at present."

Who coulda know'd there was a financial crisis brewing?

A lot of people actually, and they said so repeatedly as early as 2000. The Real-World Economics Review is sponsoring the Revere Award for Economics for the three economists who first and most clearly saw the Gobal Financial Collapse coming and whose work is most likely to prevent another GFC in the future. It's fascinating to read chronological quotations from the 12 candidates here, where you can also vote for your three favorites.