tag:blogger.com,1999:blog-13773926702009974062024-02-21T23:55:38.904-08:00Random Financial ThoughtsESMhttp://www.blogger.com/profile/05205329836679086994noreply@blogger.comBlogger47125tag:blogger.com,1999:blog-1377392670200997406.post-83338155475787473292013-03-01T07:28:00.002-08:002013-03-01T11:38:35.224-08:00To Sequester or Not to Sequester, That is SequestionFederal government budget deficits, per se, don't matter. They matter only to the extent that if aggregate demand in the economy is too high (deficits too high), unwanted inflation results, and if aggregate demand in the economy is too low (deficits too low), unwanted excess capacity (e.g. unemployment) results. Thus, demanding spending cuts simply to reduce the deficit is illogical. If there is no inflation, there is no problem.<br />
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That being said, I think the sequester is a good thing. It's really an interesting experiment to see whether government spending can be cut arbitrarily by a small percentage without anybody really noticing except the bureaucrats whose livelihood depends on growing government. It's an exercise, really, and even though many lament the "obvious" idiocy of doing across-the-board cuts, I think it's a useful one. I submit there is not a single federal program that doesn't have at least 10% easy-to-remove waste. There has to be. Bureaucrats have been thoroughly trained to pad their budgets by at least this amount, compounded each and every year, until a mandate from on high comes to implement severe cuts. And that mandate simply has not issued for as long as I can remember, and certainly not in the last 15 years.<br />
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What makes the looming sequester particularly interesting (and delicious) is that the Obama administration has been running around like Chicken Little claiming that the sky will fall because of a 2.3% cut to the budget, which admittedly is a 5-10% cut to discretionary programs because the entitlement programs are immune (on a side note, is this why it's called a sequester - that discretionary programs are isolated from the budget and subject to cuts?). As George Will pointed out, Obama's theory is that the size of federal government is so finely tuned that just a few % points in spending is what's separating us from chaos and economic collapse. And the fact is, this is a time-honored trick of bureaucrats, used at all levels of government. I've seen it referred to as the Washington Monument strategy. The bureaucrats threaten to close the Washington Monument to visitors if their budget requests aren't met. That is, they threaten to make the cuts to spending in those areas which are most painful and most highly visible to the public. In fact, our embarrassing Secretary of Transportation has threatened air travelers with significant flight delays if the sequester cuts are passed through to the FAA.<br />
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Every time I have seen the Washington Monument strategy threatened, it has been a bluff. I saw it here in my own city, where the mayor asked for a $12MM property tax override to increase spending on the schools. The school board (and teachers' union) threatened parents with much larger class sizes if the override was defeated. Opponents of the override claimed that the school board was bluffing - that the money simply was not needed and there was plenty of money in various slush funds. I was actually a proponent of the override, but when it was defeated, and class sizes remained the same, and news articles came out about money being shifted around from various slush funds and new cost savings miraculously being found, I had to admit the override opponents were absolutely right.<br />
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I suspect that Obama will play hardball and will try to make the most painful cuts to the military possible, but there will be room for compromise with House Republicans because Obama will also realize that the cuts to other programs will go unnoticed by the public (a very dangerous development for someone whose main goal is growing government). So my prediction is that they'll compromise on a half a sequester, with a more detailed list of things that will be cut and things that will be spared.<br />
<br />ESMhttp://www.blogger.com/profile/05205329836679086994noreply@blogger.com0tag:blogger.com,1999:blog-1377392670200997406.post-11575165537778597282012-12-17T09:09:00.000-08:002012-12-17T09:09:03.387-08:00The Real Lesson of the Newtown Shooting<br />
<div class="MsoNormal">
The law of large numbers means that horrific, improbable
events will happen from time to time in a country of >310MM people.</div>
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<o:p></o:p></div>
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There are actually two mortality risks Americans face that I
find shockingly low. One is the risk of
dying in a commercial plane crash. It is
absolutely remarkable that a plane carrying thousands of gallons of jet fuel,
with engines the size of automobiles, can travel at 150mph on the ground, rise
tens of thousands of feet into the air at speeds reaching 600mph, travel
thousands of miles, and then land on a narrow strip of asphalt less than two
miles long, all while being controlled by a human being, and still have less
than a 1 in 10MM chance of crashing. <o:p></o:p></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
The other risk I find to be surprisingly low is the risk of
dying in a random mass shooting. There
are over 200MM privately owned firerms in the US, and over 50MM households have
at least one firearm. And yet random mass
shootings occur at the rate of fewer than 5 per year, and those involving
children are much, much less frequent.
If we define an opportunity for a mass shooting as one year of access to
a firearm in the home, then the probability of one such opportunity turning
into a mass shooting is comparable to the probability of a plane crash. That is, if you lived next to a gun owner,
and you somehow managed to convince him that if he were to go on a random murderous
rampage with his gun during the next year, that he should shoot you dead first,
just as a courtesy, then your increased risk of dying over the next year would
be equivalent to the risk of taking a one-way trip on a commercial plane.<o:p></o:p></div>
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<div class="MsoNormal">
I think it almost goes without saying that the risk of dying
in a random mass shooting (or any shooting actually, as long as you’re not a
criminal or suicidal) is so small as to be negligible compared to other risks
in life, and we should waste no more time or resources on the problem unless
evidence arises that the risk is increasing by orders of magnitude. In fact, the statistics show that the risk is
actually decreasing. Despite the
increase in US population, the frequency of mass shootings has stayed
relatively constant, and the rate of shootings at schools has actually declined.<o:p></o:p></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
The real lesson of the Newtown massacre is that we should
not let statistically insignificant events be blown out of proportion by the media
and by our own emotions. The coming push
to enact new laws to restrict our liberties, whether they involve the right to
own and carry a gun, the right to have a weird personality, or the right to
produce and consume media with violent content, should be opposed vigorously. If media focus on exceedingly rare (but
statistically inevitable) tragedies allows the ratchet of liberty-reducing
law-making to progress with each event, then we will become less free over
time. At times like this, it is worth
recalling Benjamin Franklin’s famous maxim, usually paraphrased for dramatic
effect as: “<span style="background-attachment: initial; background-clip: initial; background-color: white; background-image: initial; background-origin: initial; background-position: initial initial; background-repeat: initial initial;">Any society that would give up a little
liberty to gain a little security will deserve neither and lose both.</span>”<o:p></o:p></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
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ESMhttp://www.blogger.com/profile/05205329836679086994noreply@blogger.com6tag:blogger.com,1999:blog-1377392670200997406.post-46565634536387922492011-01-09T11:44:00.000-08:002011-01-09T11:56:18.474-08:00The Politics of the Tucson ShootingsMy immediate reaction to the shooting of Congressman Gabrielle Giffords was "Crap, I hope she wasn't a liberal." There are two reasons for that: if she was, then 1) I wouldn't be able to watch or read the news for several weeks without being inundated by stupid commentary about the "irresponsible vitriol" directed at liberals from the political right; and 2) this random, despicable crime, committed by an obvious lunatic, could significantly impede the new Republican House majority's agenda to curb the growth of government control over the economy. It turns out Giffords was/is not particularly liberal, but because she was a Democrat, it looks like many on the left will try to coopt this tragedy for political gain anyway.<br /><br />It almost goes without saying (at least for the half-dozen people who read this blog from time to time), but I'll say it anyway, that it is idiotic to blame our political discourse for such a tragedy. Besides the fact that political speech is probably more polite and "PC" than at any time in US history, especially when it comes to very emotional and significant political issues, it's unclear that the use of violent imagery and harsh criticism is even positively correlated with political violence, let alone materially so. And any causal relationship is even less clear. Finally, even if colorful political rhetoric could be proven to increase political violence, I think that's just something we have to accept as a society. In a country of 310MM people, the level of political violence is so low that the threat of violence simply doesn't have the intended effect (assuming of course the perpetrator of the threat is not thinking one level deeper and attempting to sabotage the opponents of his target).<br /><br />I'll end this post by pointing out what a jackass Pima County Sheriff Clarence Dupnik is. Without any evidence (the shooter is not talking), he implied strongly that recent political fights in Arizona, which he equates to prejudice and bigotry, would have a motivating effect on unbalanced people like the shooter to commit violence.<br /><br />His implication of course is logically inconsistent with the facts concerning the shooting. If the political environment in Arizona is so toxic that unbalanced people could be incited to commit violence, why was there zero security at a campaign event for a sitting congressman? Literally zero -- there wasn't even a security guard on duty at the shopping mall. If the sheriff really believed that political violence was caused by vitriolic rhetoric, and that Arizona was the "capital" and the "Mecca" of such rhetoric, then he was completely negligent in carrying out his duties.<br /><br />The fact that congressmen generally do not receive security at public events, even liberal congressman who are the targets of Tea Party ire, undermines the credibility of after-the-fact accusations like those of the sheriff's. To be clear, I think it's amazing that important public officials like congressmen do not routinely have security. That's pretty good evidence that the real professionals in the law enforcement establishment do not take political rhetoric seriously.ESMhttp://www.blogger.com/profile/05205329836679086994noreply@blogger.com0tag:blogger.com,1999:blog-1377392670200997406.post-20674589442194445222010-08-15T06:41:00.000-07:002010-08-20T16:04:43.115-07:00Fiat money, part 3(Follow-up to <a href=”http://randomfinancialthoughts.blogspot.com/2010/07/intro-to-fiat-money-part-1.html”>part 1</a> and <a href=”http://randomfinancialthoughts.blogspot.com/2010/07/intro-to-fiat-money-part-2.html”>part 2</a>.)<br /><br />Let’s clear up some potentially confusing points about fiat money on our island:<br /><br />We said that when the government spends, it increases net dollar wealth, and that when it taxes, it decreases net dollar wealth. <br /><br />So you can think of the total government debt as the “national savings account”. But it is important to note that when we say "savings", we are really referring to savings in the form of dollars (or Treasuries, which we’ll get to later). <br /><br />If I chop up some wood and build a bird house for my pet woodpecker, I've created wealth and my net worth (assuming that other people are interested in buying the bird house) has gone up. But my dollar wealth is unchanged. Since the total number of dollars out there is the same but there are more goods it can buy (because that spectacular bird house has been built), overall prices might have to come down. So you could argue that the government has to issue more dollars to keep pace with the amount of “real wealth” that is created.<br /><br /><b>Where does the extra money "come from"? Is the government racking up a bunch of debt?</b><br /><br />You might be confused at this point as to where the money used for deficit spending comes from. There are two possible answers: the government can "print" the money, or it can "borrow" the money.<br /><br />Let’s start with borrowing, since that’s the case most familiar to a lot of us.<br /><br />In order to borrow money, the government has to print up a bunch of IOUs and sell them. We'll call the island IOU's "Treasuries" to match the U.S. terminology. So the government prints some Treasuries and exchanges them for cash with "regular" civilians. For now, those civilians represent island citizens, but later we'll consider what happens if they are foreigners.<br /><br />For instance, if the government collected $500,000 in taxes but wants to spend $520,000, it could issue $20,000 worth of Treasuries and sell them to island residents. In the process, the government has $20,000 worth of cash, and it can proceed to spend or give away the money. If Lenny the Lender purchased $100 worth of government Treasuries, then he's just as wealthy now as he was before. His cash has been reduced by $100 but he now has $100 worth of Treasuries.<br /><br />So now when we refer to "dollar savings" we'll be referring to cash or Treasuries. Both are a form of dollars; the difference is the Treasuries are scheduled to "turn into" regular cash at a future date. Alternatively, you could say that cash is just a "zero maturity" Treasury, i.e. a Treasury that gets paid back by the government right now.<br /><br /><b>So how does “printing” money work?</b><br /><br />Well, on the island, we can literally print it and spend it. It is our imaginary island after all.<br /><br />But does the U.S. actually just print money and spend it?<br /><br />This is a minor point, but the U.S. Treasury works slightly differently. (Thanks to ESM for spelling this out for me.) If the U.S. Treasury wants to "print money", the Treasury issues bonds to the Federal Reserve, and the Fed pays cash to the Treasury. Now the Treasury has cash to spend, and the Fed is holding onto a bunch of bonds. The Fed can either hold the bonds, sell them on the open market, or tear them up. In the last case (which is quite common), we can say that the Treasury effectively printed money, and for some reason, the amount that it printed is not added to the U.S. debt. This is horribly inconsistent, but it’s the way it is. It's as the government periodically get loans and the bank keeps forgetting to collect debt payments.Coupon_Clipperhttp://www.blogger.com/profile/07198213316610844250noreply@blogger.com8tag:blogger.com,1999:blog-1377392670200997406.post-88221229666841741782010-07-18T11:40:00.000-07:002010-07-20T03:44:34.101-07:00Intro to Fiat Money Part 2To review the ideas from <a href="http://randomfinancialthoughts.blogspot.com/2010/07/intro-to-fiat-money-part-1.html">part 1</a>:<br /><br />1. All the island dollars that people have came from government spending at one time or another.<br /><br />2. When the government spends, it increases the net dollar wealth of the world. You can think of government spending as the government printing green pieces of paper and exchanging them for good and services.<br /><br />3. When the government taxes, it decreases net dollar wealth. You might think of taxation as the government collecting money and dumping it into a shredder.<br /><br />4. Fiat money has value because it’s the only form of payment accepted for island taxes.<br /><br />A lot of this probably sounds odd if you're used to thinking about gold backed currency. The goal here isn't to attack or defend fiat currency; rather I just want to explain how it works and how these ideas might affect policy decisions.<br /><br />As Bob and ESM pointed out in the comments to part 1, in year 1 the government has to spend (or give away) at least as much money as it wants to collect in taxes each year; otherwise people won't have money with which to pay their taxes. ESM went further and said that the government has to spend enough for people to pay their taxes <b>and</b> satisfy their demand for dollar savings.<br /><br />If the government spends or gives away $6000 per person per year and collects $5000, then people will be able to save $1000/person on average. Some people might save more or less (and some could end up in debt), but $1000 has to be the average.<br /><br />You should also note that in this example, the government ran a deficit of $1000/person. So each year, the government deficit matches the change in private dollar savings. If the government runs a deficit, then total dollar savings must rise, and if the government runs a surplus, total dollar savings must fall. (This might be the opposite of what you thought previously.)<br /><br />For this reason, some people (though admittedly, not many) refer to the national debt as "the national savings account". People's total accumulated dollar savings must match the government's accumulated dollar debt. It's a closed system after all.<br /><br />A few other interesting points about this system:<br /><br /><ul><li>The purpose of taxation is not to raise revenue, at least not on the federal level. The island government prints and destroys its own currency, so it can spend however much it wants.<br /><br /><li>Of course, printing a lot of money and not destroying very much money can cause the dollar to lose value and trigger inflation. So the real reason for taxation is to reduce the number of dollars floating around to "make room" for the dollars that the government wants to deploy. Another way to say it is that the government taxes in order to reduce aggregate demand and keep prices under control. A second purpose of taxation is to give dollars value in the first place!<br /><br /><li>Not everyone has to pay taxes for this set-up to work. Even if only people whose last names began with "A" had to pay taxes, dollars would still have value to Mr. Aaronson. But Mr. Bozo would still value dollars since he knows that Mr. Aaronson values them. In other words, Mr. Bozo is happy to accept dollars as payment for calculus tutoring, since Bozo can then use those dollars to buy stuff from Aaronson. So they'll both value dollars. To pick a more realistic example, U.S. dollars have value to Canadians even though they (typically) don't have to pay U.S. taxes.<br /></ul><br />Next time: How does government borrowing work? Is printing money the same as borrowing?Coupon_Clipperhttp://www.blogger.com/profile/07198213316610844250noreply@blogger.com2tag:blogger.com,1999:blog-1377392670200997406.post-26353146569514654932010-07-11T10:56:00.000-07:002010-07-11T11:17:04.864-07:00Intro to fiat money part 1The mysterious Bob <a href="http://randomfinancialthoughts.blogspot.com/2010/04/krugman-on-learning-from-greeces-debt.html?showComment=1276022984343#c518983406678081706">requested</a> a short "course" on how fiat money works. Considering that our economy runs on fiat money and probably less than 1% of Americans understand it, it's probably important to come up with a simple way to wrap one's head around it.<br /><br />Imagine we all live on an island, isolated from the rest of the world. (This keeps things simple; we'll talk about international trade later.) People on the island obtain goods and services by trading with each other. Whatever merits this system has, it can be very tedious to enter into a transaction. For example, if you're a calculus tutor and you want some salmon, you have to find someone who has a bunch of salmon and wants calculus tutoring. What are the odds of finding that person in a reasonable amount of time?<br /><br />So the government of the island issues green pieces of paper called "dollars" and lets people trade with dollars. There's just one problem: These pieces of paper have no intrinsic value, so there's no way I'm giving you some of my stuff in exchange for dollars.<br /><br />Now let's add one more kink that will actually make these dollars valuable. At the end of each year, every island resident (government worker or otherwise) has to pay a tax of $5000. These pieces of paper will be collected and tossed into a shredder. [Alternately, the taxpayer can simply submit a YouTube video of himself shredding the money he owed.] If anyone fails to turn in $5000, he'll be put out to sea in a raft with nothing but a DVD player with Britney Spears videos and "What's Happening!!" reruns.<br /><br />Now no matter what you think of the idea of having a "head tax", you have to agree that dollars now have some serious value. They're the only form of payment that the government will accept for tax liabilities.<br /><br />So now dollars have value and people can use dollars for trade. I can buy fish in exchange for dollars because either the fisherman needs the dollars to pay his taxes, or he knows that somebody else needs them for taxes (and thus <i>that</i> guy will trade for them).<br /><br />One last problem we have to address: Where do people get dollars from? They need to accumulate dollars in order to pay taxes each year, after all. Saying that they get dollars from trading with other people is a cop out, because <i>those</i> people need to get dollars from somewhere. Even if somehow people "started out" with a certain number of dollars floating around, they will eventually be destroyed at a rate of $5000/resident/year.<br /><br />The answer is that dollars can only come from one place: the government. The government can create and destroy dollar bills and they're the only ones who can do it.<br /><br />So the island government decides to hire people to do various jobs around the island such as cleaning seaweed off the beach, maintaining the roads, and running a tropical counter-terrorism unit. The employees are paid in dollars. If the government wants to, it could even supplement the supply of dollars by dropping them from a helicopter and letting people find them.<br /><br />So dollars "start" in the hands of people who sell their services (or goods) to the government, the dollars are used for trade, and they eventually end up in the hands of people who need to pay taxes (government workers or private sector workers alike.)<br /><br />Now here's a good question to think about: How much does the government "need" to spend each year? As a follow-up, what happens if they spend more or less than that amount?Coupon_Clipperhttp://www.blogger.com/profile/07198213316610844250noreply@blogger.com3tag:blogger.com,1999:blog-1377392670200997406.post-86035113143585913982010-07-03T07:00:00.000-07:002010-07-03T07:22:50.168-07:00Don't you hate traffic? Part 3Ok, one last note about charging people to use the road. It's easy to draw the wrong conclusion from my posts. When people hear about these ideas, some of the ideas that pop into their heads are:<br /><br />1. "Thank goodness there's a huge tax on parking in some places." Manhattan charges an unbelievable 18.375% tax on parking! (Incidentally, residents can get much of it rebated, but out-of-towners are stuck paying the whole thing. I'm not sure if this has been challenged in court yet). Anyway, taxing parking is totally backwards! What's crazy is that if there's one thing I <i>want</i> people to do with their cars, it's to keep them parked in garages. I don't want those things on the roads during busy times. In other words, road space during rush hour is the scarce resource that needs to be rationed via prices; room in parking garages already is rationed by the owner (since he charges for them).<br /><br />2. "That's why we have a gas tax." A gas tax is <i>not</i> the stupidest thing on earth. As ESM has pointed out to me in the past, the government spends considerable resources keeping the waters safe for oil shipping, and it makes sense to charge the consumers of the oil. There are other externalities associated with gasoline use, so a tax might make sense. But a gas tax doesn't address the traffic problem very well. The guy driving through Nevada at 2 a.m. might be using a lot of gas but he's creating no traffic congestion. But Marginal Matt, who's driving in Manhattan rush hour traffic uses only a litle gas and creates all sorts of delays and aggravation. That's the guy you want to charge.<br /><br />3. "God bless the DMV. They charge registration fees for cars." Again, cars aren't the problem; using road space when it's scarce is the problem. There may be good reasons to charge a small fee for having a car (the police now have to track it down if it's stolen, etc.), but rationing road space isn't one of them.Coupon_Clipperhttp://www.blogger.com/profile/07198213316610844250noreply@blogger.com0tag:blogger.com,1999:blog-1377392670200997406.post-180430101164151802010-06-13T13:34:00.000-07:002010-06-16T18:35:48.816-07:00Don't you hate traffic? Part 2I have a few different loose ends to tie up from the <a href="http://randomfinancialthoughts.blogspot.com/2010/05/dont-you-hate-traffic.html">first installment</a> of <i>Don't you hate traffic? </i>.<br /><br />First, since I've gotten thousands of emails asking about the title of this post, I'll address that first. It's a reference to The Simpsons (clip <a href="http://www.youtube.com/watch?v=0KpmFwVucs4">here</a>) from back when the show was funny. (Yeah, I'm dating myself here.)<br /><br />Second, how do you deal with privacy issues involved with tolls? If we use EZ-Pass, do we really want Big Brother knowing where you've been driving? I think there's a good way to get around this, which some politicians might not like: Sell EZ-Pass tags the same way we sell pre-paid disposable cell phones. If you buy an "anonymous" pre-paid unit with $100 on it and throw it away when you're done, then you haven't really given up much personal information.<br /><br />Now finally, let's throw out this assumption that everyone is the same. Different people dislike traffic to varying degrees. Traffic makes me angry and agitated, but other people are in no rush to get anywhere.<br /><br />So let's say we have a heterogeneous population and roads that aren't sufficient to accommodate everybody. One day I look outside and see 1000 cars on the road, which translates into 2000 units of traffic, using my super-secret traffic grading system.<br /><br />Presumably, there are some people on the road who <i>really</i> value the road and/or don't particularly mind traffic. Perhaps they're willing to deal with up to 5000 units of traffic at this time. Every single one of them is on the road right now, because after all, there are only 2000 units of traffic out there.<br /><br />There are also some people who are willing to deal with 3500 units of traffic, some people who can tolerate 2200 units of traffic, etc. and they're all driving now too.<br /><br />But then there's a guy (call him Marginal Matt) who will only tolerate 2001 units of traffic. He's still driving (since there's only 2000 units) of traffic, but he's getting very little advantage out of having the roads available to him.<br /><br />Here's the problem: If he would get off the road, there would be a little less traffic for the other 999 people. By deciding to drive, Marginal Matt is creating 2 units of traffic that all of those 999 other drivers has to suffer through and he's only getting 1 unit of advantage to himself.<br /><br />In other words, he's creating thousands of units of harm and only getting one unit of benefit. Clearly, we need a pricing scheme that gets him off the road.<br /><br />The optimal toll would balance these two effects. Switching to dollars, if the optimal toll was $10/mile, then there would be much fewer people on the road -- say 600 people instead of 1000. And if the toll is set correctly, then adding that 601st person would create exactly as much economic benefit to him and it would collectively take away from all the existing drivers.<br /><br />One pleasant aspect of this is that only the people who value the roads the most will use it, and they'll be the ones paying for it. The people who walk to work and then pay an insane city income tax to help pay for roads are getting a raw deal under the current system. Their taxes could be reduced and we could have the drivers pay for the road. The result would be would be less traffic, more business activity (thanks to the lower taxes) and the roads would provide much more value to the residents.<br /><br />Now I don't know what the optimal toll is, but I know that people do study this sort of thing and have attempted to put a price on traffic.<br /><br />This system ideally would also end the "need" to subsidize mass transit. It drives me crazy to hear people say that we need to subsidize the subway in NYC since the alternative would be even more nightmarish traffic. When the idea of congestion pricing on roads is suggested as an alternative, people complain that that would increase the price of doing business, which would "get passed on to consumers".<br /><br />While I don't have the time to delve into all the fallacies embedded in this nonsense, suffice it to say that if we priced roads correctly, a lot of people would take mass transit because it would be much, much cheaper than driving, and in the case of buses, it would be pretty fast (since traffic would be less severe).<br /><br />In any case, how is it fair that my friend who walks to work has to subsidize the subway? How 'bout charging me for the subway ride that I take to work and charge Marginal Matt a buttload for the amount of congestion he's causing during rush hour?Coupon_Clipperhttp://www.blogger.com/profile/07198213316610844250noreply@blogger.com4tag:blogger.com,1999:blog-1377392670200997406.post-91513092030619999062010-06-04T16:38:00.000-07:002010-06-04T17:00:52.648-07:00Vitamins pills and oil spills.I recently saw Bjorn Lomborg on television talking about how to get the most bang for your buck when it comes to improving global welfare. (He wrote an <a href="http://online.wsj.com/article/SB121720170185288445.html">article</a> about this in the Wall Street a while back, and it's worth reading.)<br /><br />He pointed to an economics study done that prioritized different projects that could improve the world:<br /><br /><blockquote>Providing micronutrients -- particularly vitamin A and zinc -- to 80% of the 140 million or so undernourished children in the world would require a commitment of just $60 million annually, a small fraction of the billions spent each year battling terrorism or combating climate change.</blockquote><br /><br />(This is from his <a href="http://online.wsj.com/article/SB121720170185288445.html">WSJ article</a> mentioned earlier.)<br /><br />So if you had a bunch of money to spend, you could either provide micronutrients to the world's poor or decrease global temperatures (in 100 years) by a tiny fraction of a degree. <br /><br />Of course, going to micronutrient rallies doesn't help you meet women or make you seem as trendy as getting worked up over various environmental causes.<br /><br />Ok, fine. But what does this have to do with oil spills? Steven Landsburg made the <a href="http://www.thebigquestions.com/2010/06/04/whats-worse-than-an-oil-spill/">point</a> today that people get very worked up over the gulf oil spill, but there are bigger economic disasters that a lot of people aren't even aware of:<br /><br /><blockquote>The BP oil spill threatens to cause something like $10 billion worth of damage. That’s pretty bad. By contrast, an extra trillion dollars worth of federal spending threatens to cause something like $300 billion worth of deadweight loss (that is, underproduction due to tax avoidance and disincentives to work). That’s 30 times worse. How is it that so much angst about the former seems to be coming from people with a history of shrugging their shoulders at the latter?</blockquote><br /><br />I can't argue with that. Every single year, we incinerate hundreds of billions of dollars through economic distortions, thanks to the tax code. Does anyone care? If you go to a dinner party tonight (instead of sitting at home, eating Chinese food, and watching Bjorn Lomborg on tv like I'll be doing), are you more likely to hear people lamenting the oil spill or deadweight losses due to taxation? How many people at the party are likely to have heard of "deadweight losses"?<br /><br />When it comes to world social causes, people are much more likely to get concerned about #30 on the list (global warming) than #1 (micronutrients for the 3rd world). When it comes to economic disasters, people are much more worried about the (admittedly catastrophic) oil spill than a problem that's 30 times as bad.Coupon_Clipperhttp://www.blogger.com/profile/07198213316610844250noreply@blogger.com2tag:blogger.com,1999:blog-1377392670200997406.post-71653762708928358292010-05-24T14:29:00.000-07:002010-05-24T14:35:00.037-07:00Don't you hate traffic?In his book, <a href="http://www.amazon.com/Armchair-Economist-Economics-Everyday-Life/dp/0029177766/ref=sr_1_1?ie=UTF8&s=books&qid=1274736654&sr=8-1">The Armchair Economist</a>, <a href="http://www.thebigquestions.com/blog/">Steven Landsburg</a> introduced the concept of taxes and fees that generate no revenue. The concept is so ubiquitous that I thought it'd be useful to show an underappreciated example of it.<br><br />I work in Midtown Manhattan. If you look out the window on a weekday at 5 pm, you'll see serious traffic congestion. I used to work near Times Square; if you looked out the window there at almost any time, you saw absolutely horrifying traffic. Consider a few facts:<br><br />1. People in Manhattan (at least those that can afford to keep a car there or take a cab) tend to have at least a moderate income; many of them are very wealthy and work long hours. Either way, their time is very valuable.<br><br />2. Getting to where they're going must also be incredibly valuable. After all, they're willing to sit in ghastly traffic delays to get there. (The traffic is generally not a surprise, so they knew in advance the trade they were making. And if you are surprised by traffic in Times Square, you should be shipped back to New Jersey.)<br><br />3. They're charged a very high toll to get where they're going, but the toll is in the form of lost time, frustration, and unpredictability. (Unpredictability translates into lost time if people have to pad their trip time to get to that important meeting.)<br><br />4. The roads and traffic lights are paid for from tax receipts. I doubt the gasoline tax and DMV-related fees cover it, so many other taxes are probably used, e.g. income taxes and sales taxes. These taxes generate large deadweight losses. <br><br />Right away, I can see that this arrangement has suboptimality oozing out of its orifices. We use inefficient taxes to build very popular roads. The roads are so popular that there are huge “tolls” (time wasted), and the worst part of all is that nobody benefits from those “tolls”. It's a tax that collects no revenue.<br><br />Normally, if I pay a $6 tunnel toll, then I lose $6 and the local government gains $6. That can be used to maintain the tunnel, hire more school teachers, get rid of some of the more destructive taxes, or the money can even be refunded equally to all the residents. Even if the government manages to incinerate half the revenue through bureaucrats' pay and mismanagement, we're still $3 better off than we would be if I paid an equivalent toll that consisted of sitting in traffic. (Even if the bureaucracy is wasteful, it would've been wasteful for income tax revenue and toll revenue alike.)<br><br />So let's do a quick thought experiment. Imagine that there are a very large number of people in your city and they're all roughly the same in their behavior and preferences. Yes, that's ridiculous, but we can relax that assumption later. This simplified case can give some serious insight into the problem.<br><br />Now let's also imagine that there are roads, which are incredibly valuable, but there are not enough roads to accommodate all the people. In other words, they are a scarce resource. This applies to Manhattan and most cities during rush hour, and it probably does not apply to the smaller suburbs of Kalamazoo. <br><br />Ok, now under these assumptions, how many people will use the roads at once? We assumed that the use of these roads is very valuable and so at least some people are going to use the roads. Maybe getting to that meeting a mile away is worth $300 and it really only takes $10 of time, fuel, and wear & tear on your car when the roads are empty. <br><br />What if the roads aren't empty, but there are a tiny number of cars on the road? In this case, the roads are slightly less valuable. Sure, now there are a few guys you could have an accident with, and you might have to actually yield to another car once in a while. But being able to use the road is still very valuable. So now if you have a $300 meeting to go to and it costs $12 in time and money to drive, you're going to do it. <br><br />How many cars are going to be on the road in equilibrium? What will constrain the growth of traffic? The answer is that if everyone has a meeting that's worth $300 to get to, the traffic will keep building until it costs everybody (remember, we're all alike) just about $300 in time, frustration, fuel, wear & tear, and accident risk. Let's say that magic number is 5000 drivers.<br><br />So each driver is “paying” $300 to use the roads and nobody else benefits from that $300 “toll”. Each person gets to his $300 meeting and loses $300 in time, frustration, fuel, wear & tear, and accident risk. I have no idea in advance how much fuel costs, how much their time is worth, etc., but I can still say, assuming the roads can't accommodate everybody, that traffic will increase until the total cost of driving is $300 per mile. At that point, nobody else will decide to jump in his car.<br><br />So the road does just about zero good. Each driver spends $300 and gets $300 of benefits. No one on “the other end” of the transaction collects the $300.<br />Actually, it's even worse than that. I only counted costs to the drivers on the road. But there are costs to the people who didn't drive. They (like the drivers) have to deal with air pollution (again, not a big deal in the suburbs of Kalamazoo, but it can be a big problem in city centers) and noise (try sleeping in Manhattan when you can hear a driver who just discovered how his horn works). While we're at it, the pedestrians are now a little less safe.<br><br />Finally, taxes probably had to be raised to build and maintain the road. A few businesses on the margin may have gone under as a result, a few other entrepreneurs decided not to launch their new business in this city, and a few businesses still in operation made one fewer batch of widgets since the price of production went up.<br />What a great deal! We raise taxes, create some economic distortions in the process, build some roads, the drivers get zero benefit from it, and the non-drivers are made slightly worse off!<br><br />Now, I'm not anti-roads or anti-driving. On the contrary, I love both those things. When they're implemented properly they can be extremely welfare-enhancing, they can make you feel like a real man, and they make you think that you really have freedom. I just think that there are much more (economically) efficient implementations.<br><br />Let's take a first crack at this idealized case, suppose we got rid of whatever inefficient tax was used for getting road money and instead put a $100/mile toll on the use of the roads. (I'm not being very precise about how the tolls are collected, but that's a detail we can work out later.) <br><br />I don't know how many people will choose to drive, but I can guarantee that it will be a lot less than before. This time, if there's only one driver on the road, he faces costs of $110 (the toll plus the $10 from before). Getting to your destination is worth $300 so it's a good deal. So more people will join him. But the number of people can't grow to 5000 anymore since then the cost of driving would be a whopping $400 ($100 toll plus $300 of time/fuel/etc.)<br><br />So maybe only 4000 people drive. Each person is getting $300 of benefit, paying a $100 toll, and paying an additional $200 in traffic delays/aggravation/fuel. So the drivers still gain no benefit from the road, but the city raised $400,000 in the process. Now we can ditch those inefficient taxes we implemented to maintain the roads. Imagine that: Rationing a scarce resource using the price system actually improved things!<br><br />Now I have no idea what the correct toll is and it would almost certainly vary by time of day. ($100/mile in Manhattan rush hour is high but not really as crazy as it sounds.) And if you are worried about poor people not being able to afford to drive, don't be. If you want to help poor people, give them money or cut their taxes. (Incidentally, this toll plan allows you to eliminate job-killing taxes.) Don't try to help poor people by subsidizing their car use. Does anyone actually think that it'd be a bad thing to eliminate NYC's insane income or sales taxes and replace it with a drive-during-rush-hour tax? (I should also mention that any plan that reduces traffic makes it much, much more practical to travel by bus. Currently in Midtown, a Cub Scout troup can run a three-legged race faster than a city bus can drive.)<br><br />But this gets to the heart of why people reflexively distrust politicians who propose ideas such as congestion taxes. (Mayor Bloomberg got to find this out first hand.) Few of us are naïve enough to think that a new tax will replace an old tax. If a politician proposes replacing tax A with tax B, it's a good bet he's pushing to create tax B, leave tax A in place, and then spend a whole lot more money. And that's why this plan will reliably be shot down over and over again.<br><br />So I really don’t blame voters for opposing congestion pricing on these grounds. But I do hope that the next time you see a traffic jam, you become enraged at the economic waste before your eyes.<br><br /><br /><u>Future post:</u> I’ll toss out that assumption that everyone is the same. And how do you deal with privacy issues?Coupon_Clipperhttp://www.blogger.com/profile/07198213316610844250noreply@blogger.com2tag:blogger.com,1999:blog-1377392670200997406.post-9119985083279599172010-05-02T10:19:00.000-07:002010-05-02T17:20:21.134-07:00Price-Gouging as a Remedy for ShortagesYesterday, the Boston area suffered a catastrophic failure of its water supply system. A 10-foot diameter pipe carrying water from the Carroll Water Treatment Plant to Boston and neighboring communities ruptured and is not currently usable. Although fresh water is widely available from local reservoirs, treated water is not. It will be a few days in the most optimistic scenario before potable water is available at taps for over 2.5MM people. Reading between the lines of press reports, it was (and maybe still is) a distinct possibility that potable water could be unavailable for weeks, as the pipe is custom-designed, and replacement parts would have to be machined from scratch.<br /><br />Of course, all of the supermarkets were stripped bare of bottled water and other beverages within hours of the news. There were even reports of fights and near riots over a product which costs approximately $0.25 per bottle.<br /><br />Local governments announced plans to distribute bottled water (such as they have in storage) free of charge to needy residents.<br /><br />This situation is instructive from the perspective of economics, and a simple analysis leads us to a solution which is both optimal and politically impossible at the same time.<br /><br />If owners of bottled water (e.g. supermarkets, convenience stores, normal citizens, and free lancers) were able to sell at any price without fear of being accused of price-gouging, then there would be two beneficial effects:<br /><br />1) water would be allocated in a more rational way, rather than by luck or by who gets to the supermarket first; and<br /><br />2) supplies would increase as enterprising people truck bottled water in from other areas.<br /><br />To offset the problem that poor people will be priced out of the market, the state government could hand out checks to every affected household -- perhaps $10 per person per day (a $30MM per day hit to the annual state budget of almost $30B). It is up to each person to decide how much of that distribution should be spent on bottled water.<br /><br />It's important to remember that there are other options to drinking bottled water or using it to wash your hands or brush your teeth. It's possible to create your own potable water by boiling tap water for at least 1 minute and then cooling it back down. A pain in the neck to be sure, but boiled water is a cheap substitute.<br /><br />This is pure speculation, but if implicit price controls were removed, I suspect that the price of bottled water would triple or quadruple initially. And then you would see a mad rush of supply as people from as far away as New York rent trucks to ship bottled water to Boston. The opportunity for a quick profit is very attractive. You could probably fit 2,000 half-liter bottles in the bed of a one-ton pickup truck alone. Attach a trailer, and you could probably pull another 5,000 bottles easily. If there was a gross profit of $0.50 per bottle to be had driving 7,000 bottles up from NY in a pickup truck, I think a lot of New Yorkers would jump at the opportunity. And that's for a random guy with a pickup truck.<br /><br />The bottom line is that if price-gouging were allowed, the market would clear at an acceptable level, and there would be enough bottled water to satisfy everybody. Those who are willing to make do with a little less, can save the cash distributed by the state. Those who need more water will have to make do with a little less cash.<br /><br />We see these local shortages from time to time (e.g. gasoline shortages in Florida after hurricanes), and always there is a crackdown on price-gouging. Too bad more people don't recognize that the solution to local shortages is to allow price-gouging. Indeed we should encourage it.ESMhttp://www.blogger.com/profile/05205329836679086994noreply@blogger.com1tag:blogger.com,1999:blog-1377392670200997406.post-59024084999194514782010-04-13T06:05:00.000-07:002010-04-14T09:56:30.067-07:00Krugman on Learning from Greece's Debt CrisisA friend sent me Krugman's <a href="http://www.nytimes.com/2010/04/09/opinion/09krugman.html">op-ed</a> last week with a note that said "it's annoying when he's right." Instead of writing back, I figured I would post my response here.<br /><br />Krugman is right about some things with respect to Greece, and even with respect to policy prescriptions for fighting unemployment in the US today, but he goes off the rails in a couple of places. The central point of the article -- that putting in place austerity measures (i.e. cutting the government budget and raising taxes) is counterproductive -- is certainly correct. And his point that Greece is in a completely different position vis a vis the US because it does not own the printing press for the currency in which its debt is denominated is also correct.<br /><br />But Krugman still uses the terminology of a gold standard or a fixed exchange rate system, which has no application to the US system of a fiat currency with a fully floating exchange rate.<br /><br />Despite the fact that Krugman's penultimate sentence is a tautology, he fails to understand that the US debt is always manageable from a credit risk perspective because the public debt is nothing more than an interest-bearing form of money. The deficit is self-financing because, at the close of business each trading day, every dollar of deficit spending (as well as every other dollar that was created previously) either finds a home in an interest-bearing government security or earns 0% under somebody's mattress.<br /><br />The only problem with having too much debt/money is too much aggregate demand, which causes inflation and the mal-investment and perverse behavior associated with it. But the acid test as to whether we have too much debt/money is whether we have full capacity utilization and inflation, which we clearly do not.<br /><br /><a href="http://www.moslereconomics.com/">Warren Mosler</a> uses full employment (net of the structural rate of unemployment) as his metric for whether the private sector has enough money, although I am not entirely convinced that's useful because the government is quickly raising the rate of structural unemployment through stupid policies (e.g expanding entitlement programs and raising the minimum wage).<br /><br />Krugman is also not correct when he says that there are no good solutions to the Greek crisis. Mosler's solution of having the European Central Bank (ECB) distribute 1T Euros annually, on a per capita basis to each member country in the European Monetary Union (EMU) is a <strong>good</strong> one. Aggregate demand would be restrained by the fact that the member countries would still be restricted from spending the money by the terms of the Maastricht Treaty. The penalty for any country breaking the spending restrictions would be for the ECB to withhold the annual payment to that country the next year (a much easier penalty to enforce than actually fining a country 1/2% of GDP -- talk about getting blood from a stone!).<br /><br />I would add to this solution the idea that the EMU should put in place policies which promote the holding of Greek debt by Greeks and not by European banks. That way, in ten years' time, when Greece gets into trouble again, the Greeks will be left holding the bag themselves, and they can be kicked out of the EMU without too much disruption.<br /><br />So Krugman almost gets it with respect to the US, but not quite. And he completely fails to realize that the solution to Europe's problems is for the ECB to give each EMU country a kitty of pre-printed money to call on for debt repayment as needed. The EMU countries will not own a Euro printing press individually, but they will have the next best thing.ESMhttp://www.blogger.com/profile/05205329836679086994noreply@blogger.com3tag:blogger.com,1999:blog-1377392670200997406.post-87200601618089845092010-03-20T18:12:00.001-07:002010-03-20T19:21:20.454-07:00Implicit Marginal Tax Rates Under Obamacare<div align="left">One of the negative consequences of giving subidies to people based on income is that you drive up the implicit marginal tax rate on income for those targeted for the subsidy. High marginal tax rates discourage people from working harder and making more money, which is bad for them and bad for the economy in general.<br /><br />American society has become accustomed to a progressive income tax in which high income people face higher tax rates than low income people. Because of deductions, tax credits, and subsidies which phase out with income, however, there are many points along the marginal tax rate versus income curve in which low income people face implicit marginal tax rates well in excess of the rate for the highest income tax bracket (currently 35%, going up to 39.6% in 2011).<br /><br />For example, the <a href="http://en.wikipedia.org/wiki/Earned_Income_Tax_Credit">earned income tax credit </a>appears to have a phase out which creates an excess marginal tax rate of 21.06%. Combined with a regular income tax rate of 10%, a social security tax rate on wages of 6.20%, and a medicare tax rate on wages of 1.45% (I've even neglected the employer portion of FICA taxes that most economists would claim is paid implicitly by the worker), the total marginal tax rate for a very poor worker with two or more children exceeds the current rate for the highest bracket. I haven't looked into this carefully yet, but rumor has it that there are pretty common situations where a taxpayer faces marginal tax rates approaching 100%.<br /><br />The new health care reform bill will provide health care insurance subsidies for those making less than 400% of the federal poverty line (which in 2009 was $22,050 per year for a family of four). The subsidies phase out mostly linearly, but with jumps at certain thresholds. I decided to calculate the implicit marginal tax rate of the health care insurance subsidy for a family of four, based on the 2009 federal poverty line. The graph is below:<br /><br /><div align="left"></div><div align="center"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgiEGfI1xG11Cr4yWjepXUYef_CBPWlTrnfyjSfu76l4kKhdo_1LM-cZrsuEHSXvdJjhPTn5kLKaC5NkT1BhPQH8ql80K95RTQKpNwk3sxc7HZcuG1F6TIElSeZoO4AtvDBtWdveF59Gvc/s1600-h/Marginal+Tax+Rate+Graph.jpg"><img id="BLOGGER_PHOTO_ID_5450900168586254450" style="WIDTH: 400px; CURSOR: hand; HEIGHT: 303px" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgiEGfI1xG11Cr4yWjepXUYef_CBPWlTrnfyjSfu76l4kKhdo_1LM-cZrsuEHSXvdJjhPTn5kLKaC5NkT1BhPQH8ql80K95RTQKpNwk3sxc7HZcuG1F6TIElSeZoO4AtvDBtWdveF59Gvc/s400/Marginal+Tax+Rate+Graph.jpg" border="0" /></a><br /></div><div align="left"><br /><br />What isn't shown in the graph is that the marginal tax rate for a family with income at 400% of the federal poverty line ($88,200 in 2009) is infinity. The subsidy completely goes away, and the difference between the cost of the benchmark health insurance plan and $8,379 (i.e. 9.5% of that family's income) is lost to that family if it makes even $1 extra. For my example and my graph, I have assumed of course that the benchmark health insurance plan for a family of four is in excess of $8,379, but I think I'm pretty safe there. Even today such an insurance plan probably costs more than $12K per year, and once Obamacare kicks in, that plan will probably cost 25% higher.<br /><br />Anyway, these implicit marginal tax rates (fluctuating between 10.90% and 21.65% before exploding to infinity) are due solely to the health care insurance subsidies embedded in Obamacare. Families at the relevant income levels will be facing these marginal tax rates in addition to the ones that they're already familiar with. </div></div>ESMhttp://www.blogger.com/profile/05205329836679086994noreply@blogger.com8tag:blogger.com,1999:blog-1377392670200997406.post-64307164915473263582010-03-18T13:08:00.000-07:002010-03-18T19:23:32.340-07:00New Taxes for ObamacareThe proposed reconciliation bill has a new 3.8% tax on investment income for taxpayers making more than $200K per year ($250K for married, joint filers). I don't know if the bill will make it through the Senate under reconciliation, but it's certainly got a decent chance. Note that investment income includes capital gains and dividends, so we're talking about the marginal tax rate on dividends going from 15% in 2010 to 39.6% in 2011 and up to 43.4% in 2013. The marginal tax rate on long-term capital gains will go from 15% in 2010 to 20% in 2011 and up to 23.8% in 2013.<br /><br />That's a remarkable increase and surely will be priced into the stock market at some point.<br /><br />When one considers that US corporations already pay a 35% income tax, then a corporation which distributes its profits to shareholders via dividends will essentially be returning only (1-35%)*(1-43.4%) = 36.8% of its before-tax profits to the owners of the company after they've paid their income tax.<br /><br />For corporations which return cash via stock buybacks, (1-35%)*(1-23.8%) = 49.5% of before-tax profits are returned to the owners.<br /><br />This surely must rank as one of the highest marginal tax rates on corporate income in the developed world. In fact, I'm pretty sure of it. Of <a href="http://en.wikipedia.org/wiki/Organisation_for_Economic_Co-operation_and_Development">OECD</a> member countries only Denmark and France had higher effective corporate income taxes in <a href="http://www.oecd.org/dataoecd/26/51/33717596.xls">2009</a> (by 9.2% for Denmark and 6.3% for France), and the new rates in 2011 will put the United States in first place by a wide margin for profits distributed through dividends.ESMhttp://www.blogger.com/profile/05205329836679086994noreply@blogger.com1tag:blogger.com,1999:blog-1377392670200997406.post-88283221877320573562010-03-08T07:57:00.000-08:002010-03-08T08:17:36.734-08:00Obamacare Game TheoryThere is an interesting game theoretic aspect to the current state of health care reform legislation (aka Obamacare). The Democrats need to pass the Senate bill in the House first, and only then can they fix the provisions currently unacceptable to the House with a followup bill that needs to pass both the Senate and the House. The controversy about reconciliation concerns using reconciliation to pass the followup bill in the Senate with 50 votes (our clownish vice-president would cast the tie-breaking vote, so 50 is all the Democrats need).<br /><br />Many consider this use of reconciliation to be illegitimate, since it is facilitating the passage of sweeping legislation that doesn't even come close to meeting the eligibility requirements for circumventing the Senate filibuster. I don't agree on that specific point. Although it's a close call, using reconciliation to fix budget-related aspects of the bill in order to attract more votes in the House strikes me as reasonable. After all, the House still has to pass the Senate bill without any guarantees whatsoever. If Democrats tried to do it the other way around -- pass a reconciliation bill first, then I think that would be an egregious attempt at circumvention of the filibuster.<br /><br />That being said, there is a strong argument that the bill is illegitimate as it stands. There is no doubt that it wouldn't have received 60 votes in the Senate if not for the presence of outrageous provisions used to bribe individual senators. Everybody is rebelling against those provisions now and wants them stripped out of the bill, even some of the senators that negotiated them in the first place, but the bill would not have passed the Senate without them.<br /><br />For the game theory aspect of Obamacare, I'm going to assume that the Republicans actually have a way of severely impeding a reconcilation bill. I believe this is true. One way is to raise points of order repeatedly against reconciliation bill provisions for violating the Byrd rule. A second is to offer hundreds of amendments to the bill after time for debate has elapsed. Each of these amendments takes a minimum of 15 minutes to vote on, and so it is possible to kill an entire legislative day with 50 or 60 relevant amendments. Do this for long enough, and the Senate grinds to a halt.<br /><br />Given that the Republicans might actually have it in their power to obstruct a reconciliation bill, the Republican dilemma is as follows:<br /><br />1) the Senate bill would not pass if House Democrats believed the bill would remain as it is and not be amended immediately; there are just too many House Dems who would vote no on the Senate bill all by itself;<br /><br />2) some of the most important amendments that skeptical House Dems want to see are provisions that Republicans and the general public support (e.g. stronger restrictions on abortion funding, elimination of the Cornhusker Kickback, Louisiana Purchase, and the Florida Flim-Flam and weakening of the mandate to buy insurance);<br /><br />3) if enough House Dems think that the Republicans will be forced to allow those amendments to pass, the Senate bill will pass the House.<br /><br />Essentially the House Dems will play a game of chicken with Senate Republicans. They go first and put the Senate Republicans in a position of having to obstruct popular measures that Republicans themselves support.<br /><br />The Republicans' quandary is similar to that of the United States during the cold war. How did the United States convince the Soviet Union that it would respond to a ground invasion of Western Europe with a nuclear escalation? Once the invasion is underway after all, the logical decision for the US is not to escalate.<br /><br />The solution of course is to implement elaborate protocols to convince the other side of the credibility of the threat of retaliation. The United States developed a whole strategy built around nuclear retaliation in Europe.<br /><br />It kept a few hundred thousand troops on the front lines, which was a force way too small to stop an invasion, but large enough to create a terrible bloodbath for the US if the Soviet Union invaded. The nuclear retaliation strategy was developed in detail at conferences, in military schools, and in the academic literature. And it was widely publicized and discussed by high officials in the US and in Europe, including by US presidents.<br /><br />All of this was effective in preparing the public for the inevitability of nuclear retaliation and for putting the president of the US on autopilot for following the protocol. As a consequence, the threat was credible to the Soviet Union and functioned effectively as deterrence. <br /><br />The Senate Republicans can play this game correctly by laying out their strategy of obstruction in advance and publicizing it widely. They need to publicize the points of order they will raise, as well as the hundreds of amendments they'll have prepared to delay a vote on the reconciliation bill. It strikes me as easy to propose thousands of non-frivolous amendments, by the way. All you have to do is propose reducing spending on items in this year's or next year's budget, one at a time.ESMhttp://www.blogger.com/profile/05205329836679086994noreply@blogger.com2tag:blogger.com,1999:blog-1377392670200997406.post-66290544858785871812010-02-13T05:42:00.000-08:002010-02-13T07:14:28.217-08:00The Treasury Prints Bonds Like the Fed Prints CashIn the wake of Warren Mosler's recent <a href="http://moslereconomics.com/2010/02/11/warren-on-cnbc/">interview</a> on CNBC's Squawk Box, I thought it made sense to clarify a point about government "borrowing." I put the word borrowing in quotes of course because the government is not really borrowing money when it issues Treasury securities. Mosler tried to explain this by running through the way Federal Reserve accounting worked, but I am afraid that most people's eyes glazed over. Certainly Becky Quick at CNBC had no idea what he was talking about.<br /><br />Generally, people understand that the government retains the power (through the Federal Reserve) to print as much as cash as it wants to buy Treasury bonds and therefore to monetize the public debt. What is not widely understood, though, is that the Treasury itself can spend as much money as it wants without forcing the Fed to do anything at all. We can have laws that arbitrarily prevent the Treasury from printing cash (and we do to a certain extent), but that still does not constrain the Treasury from spending an unlimited amount of money.<br /><br />How can that be if the Treasury has to raise the cash first from tax revenues or the issuance of Treasury bonds? What if investors, or the Chinese in particular, decide not to buy new Treasury bonds? Well, let's think about what happens when the Treasury's Federal Reserve account is completely depleted, and it wants to spend an additional dollar:<br /><br />It has an auction for $1 worth of Treasury securities. An investor, usually a bank which has extra cash sitting around in danger of earning 0% interest overnight, bids some positive interest rate in the auction and buys it.<br /><br />The investor has $1 worth of Treasury securities, and the investor's bank account is debited by $1, which means also that his bank's account at the Federal Reserve is debited by $1 (or, if it is a smaller bank which does not have a Reserve account, there is a debit in that bank's account at a bigger bank, etc.). And the Treasury has $1 credited to its Reserve account.<br /><br />The Treasury now spends that $1 by transferring it to the bank account of whoever the recipient is (whether it be a social security beneficiary, a doctor who performed Medicare services, a construction company working on a stimulus project, or a bribe to the head of a union who promises to "get out the vote" for a Democratic candidate).<br /><br />Now, that dollar looks like a credit in the recipient's bank account, but it is also (following the upward chain of accounts) a credit to a big bank's account at the Federal Reserve.<br /><br />So the total amount of bank reserves at the Fed remains the same. All that has happened is that the total amount of Treasury securities has increased by $1.<br /><br />Note that the analysis is unchanged if the recipient of the Treasury's largess decides to spend or invest his windfall. Whoever he buys goods or services or stocks from will now have the credit in his bank account and therefore in his bank's Federal Reserve account.<br /><br />It should be clear by now that the money that the Treasury spent has essentially gone to fund the purchase of the Treasury security which the Treasury originally issued to raise the money to spend in the first place.<br /><br />It is a perpetual motion machine, and by induction we can see that the Treasury can spend any amount of money and the accounting effect of that spending is that the Treasury prints an amount of Treasury securities equal to the amount of its deficit spending.<br /><br />We have <a href="http://randomfinancialthoughts.blogspot.com/2009/04/hennesses-blog-and-netting-of-govt.html">argued</a> in the past that a Treasury security is not fundamentally different from cash. It is a government IOU, same as cash, except that it earns a positive interest rate rather than no interest. It's true that you can't spend a Treasury bond as easily as cash, but the Federal Reserve stands ready to lend to any member bank an unlimited amount of cash against an equivalent market value of Treasury bonds at slightly below the Fed's target interest rates, so the link between Treasuries and spendable cash is very strong.<br /><br />So the Treasury's ability to print bonds is equivalent to the ability to print money. By itself, it can increase private sector net financial wealth.ESMhttp://www.blogger.com/profile/05205329836679086994noreply@blogger.com3tag:blogger.com,1999:blog-1377392670200997406.post-9832194315148115082010-01-12T09:38:00.000-08:002010-01-13T14:31:12.646-08:00Krugman's Claim that Europe Does as Well as the USKrugman argues <a href="http://www.nytimes.com/2010/01/11/opinion/11krugman.html">here</a> that Europe's economy is just as productive and vibrant as the United States' even though Europe is saddled with high taxes, a generous social safety net, and a generally greater role for government in the economy.<br /><br />His evidence is that even though the United States' growth rate in GDP over the last 15 years appears to be higher than Europe's, if one adjusts for the growth in population, the GDP growth rates are almost identical.<br /><br />I give Krugman credit for bringing up the reasonable idea of making an adjustment for population growth. I have argued for many years that Japan's "lost decade" in the 1990s, in which its GDP growth rate was approximately 1.5 pts less than ours, could be explained almost entirely by the difference in our population growth rates.<br /><br />Of course, one could argue that a low population growth rate is a consequence of having poor economic policies. Immigration to your country is less attractive to foreigners than it would otherwise be, and perhaps residents are discouraged from having children.<br /><br />That being said, the whole idea of comparing growth rates to see which economy is more efficient is stupid. One should look at the overall GDP per capita, wealth level, and standard of living to gauge which economy is doing better. The growth rate is not really of much importance if your standard of living is 28% lower. See <a href="http://en.wikipedia.org/wiki/List_of_countries_by_GDP_(PPP)_per_capita">here</a> for a list of countries ranked by GDP per capita adjusted for purchasing power parity (PPP).<br /><br />On top of that, it would seem that growing at the same rate is no great accomplishment for an economy operating at lower productivity. It is much easier to copy what works from a more efficient economy (as the Soviet Union did in the 1930s from the West, as Japan did in the 1950s and 1960s from the United States, and as China is doing now from everybody).<br /><br />Just to make a simple comparison, France's <a href="http://en.wikipedia.org/wiki/List_of_countries_by_GDP_(PPP)_per_capita">GDP per capita</a> (PPP adjusted) is 28% lower than that of the US's. That's what we should be focused on -- not whether France has just barely managed to match our GDP growth rate over the last 15 years. The French are still poorer on average, and the most likely reason is the stifling amount of government control over their economy.<br /><br />Oh, and one final note. The Europeans are getting a free ride off of the United States in many ways, and yet they still have a lower standard of living. The main area is defense, where the US essentially shoulders the entire burden of keeping the world peace.ESMhttp://www.blogger.com/profile/05205329836679086994noreply@blogger.com1tag:blogger.com,1999:blog-1377392670200997406.post-42455256816786233222010-01-10T19:57:00.000-08:002010-01-12T09:38:16.369-08:00Why Didn't the Tech Bubble Cause a Financial Crisis?On Friday, Paul Krugman had <a href="http://www.nytimes.com/2010/01/08/opinion/08krugman.html">this</a> to say about why the collapse of the tech stock bubble in 2000 didn't bring about the same sort of financial crisis we just experienced.<br /><blockquote><p>The short answer is that while the stock bubble created a lot of risk, that risk was fairly widely diffused across the economy. By contrast, the risks created by the housing bubble were strongly concentrated in the financial sector. As a result, the collapse of the housing bubble threatened to bring down the nation’s banks. And banks play a special role in the economy. If they can’t function, the wheels of commerce as a whole grind to a halt.<br /><br />Why did the bankers take on so much risk? Because it was in their self-interest to do so. By increasing leverage — that is, by making risky investments with borrowed money — banks could increase their short-term profits. And these short-term profits, in turn, were reflected in immense personal bonuses. If the concentration of risk in the banking sector increased the danger of a systemwide financial crisis, well, that wasn’t the bankers’ problem.</p></blockquote>Krugman's op-eds are usually infuriating because he writes a lot of false stuff that he knows to be false. In this case, I'm willing to concede that he genuinely doesn't understand what he's talking about.<br /><br />The true short answer is that the Nasdaq bubble collapse was not an outlier event. It was seen as a reasonably high probability event by everybody throughout the financial system. Options on internet stocks were trading with implied volatility of hundreds of percent per annum, and long-term options on even the boring S&P 500 index were trading at over 20% implied volatility -- extraordinarily high by historical standards. So when the Nasdaq fell over 75% and the S&P fell almost 50% over a period of 18 months, financial professionals were not terribly surprised.<br /><br />Here's another way to put it. No bank or money manager fund was making non-recourse loans on a stock with a 20% downpayment and no ability to demand variation margin. Yet, that's what a traditional, conservative mortgage on a home is essentially. So when stocks fall 50%, it's not a big shock to the financial system. Few people consider stock market wealth to be as real or as stable as AAA-rated bonds for example.<br /><br />Homes, on the other hand, had enjoyed low price volatility and had not fallen in nominal price on a nationwide basis since World War II. So when homes across the country fall 35% in nominal price (and over 50% if you look at where most of the mortgage loans were made), this is obviously going to cause a lot of distress throughout the financial system. AAA-rated bonds went from 100 cents on the dollar to 10 cents in some cases. The entities owning AAA-rated bonds did not think they were taking risk. Losses like that simply did not appear on their radar screens. This was very different from the wealth destruction during the tech bubble collapse.<br /><br />All things considered, I'd have to say that the turmoil caused by the housing fiasco has been pretty mild. The reason is that we have the advantage of a fiat currency system, in which the government can print money at will. The government has made a lot of mistakes which exacerbated the problem, but since the collapse of Lehman in September 2008, the Fed has handled things relatively well (the Treasury less so, but it's done more good than harm).ESMhttp://www.blogger.com/profile/05205329836679086994noreply@blogger.com0tag:blogger.com,1999:blog-1377392670200997406.post-38610080603712159802010-01-01T09:42:00.000-08:002010-01-01T13:27:48.713-08:00Are Cars More Dangerous Than Terrorists?A reader of Andrew Sullivan's <a href="http://andrewsullivan.theatlantic.com/the_daily_dish">daily dish</a> had <a href="http://andrewsullivan.theatlantic.com/the_daily_dish/2009/12/cars-or-terrorists.html">this</a> to say in response to Bill Maher's point that cars are more dangerous than terrorists.<br /><br /><blockquote><p>In 2008 there were 34,017 deaths (and nearly 100,000 major injuries) related to automobile accidents in the United States. Terrorists would have to blow up 113 Boeing 777-200s each year in order to kill that many people! That is, they'd have to blow up all but six of the 777-200's (which hold 301 people in a 3-tier international setup) currently owned by American Airlines, United Airlines and Continental Airlines (together they own 119 777-200s) and would have to do so every single year, which is probably faster than they can be built. And yet there is hardly any talk of defending the American people from their Buick!</p></blockquote>The argument that we shouldn't worry so much about terrorism because cars kill more people than terrorists is seductive to faux intellectuals like Bill Maher. The more general point is that we as a society accept all kinds of risks which are greater than the historical, statistical danger due to terrorism. I'll focus on the comparison to cars because, as far as we know today, the largest risk of violent death in the US comes from car accidents.<br /><br />The first reason that the analogy is simplistic is that the car is a necessity in modern life. The benefit we derive from cars vastly outweighs the cost. In terms of deaths and injuries, cars almost certainly save far more lives than they end prematurely. There is no benefit to us from terrorism that I can think of, but plenty of costs in addition to the direct damage and fatalities. Second, most car-related casualties happen due to negligence or recklessness, and those casualties usually happen to the people who are directly responsible. One can reduce the risk of traveling in a car dramatically by wearing a seatbelt, driving carefully, and maintaining the car in good working order. Third, society has already come to terms with the risk. This is not something that can be easily duplicated in other areas. Traveling by plane is still far safer than driving the equivalent number of miles in a car, but far more people are afraid of dying in a plane crash than in a car crash. This may be irrational, but it is a reality. Terrorists can dramatically raise the fear associated with flying (rational or not), and if they do that they can degrade our standard of living as they already have done to a significant extent since 9/11.<br /><br />Finally, it is not clear how effective terrorists can be if they become encouraged by success. The daily dish reader is correct that it is extremely unlikely terrorists could cause as many deaths per year as cars do simply by blowing up planes. But success at blowing up planes encourages more people to join the terrorist/jihadist cause and emboldens the leaders of that cause. It's possible that such success actually increases the probability of nuclear terrorism. Even Bill Maher would understand that a small nuclear explosion in a US city would dramatically change our society for the worse. <blockquote></blockquote>ESMhttp://www.blogger.com/profile/05205329836679086994noreply@blogger.com13tag:blogger.com,1999:blog-1377392670200997406.post-59331576605305022182009-12-23T05:11:00.000-08:002009-12-23T05:14:06.016-08:00The 85% SolutionIt almost goes without saying that the health care reform (HCR) bill that is about to pass the Senate is extraordinarily bad policy. The perceived problem we have with health care in this country is exploding cost. Health care expenditures continue to rise much faster than the rate of inflation.<br /><br />Now this is not on its face an unacceptable situation. As a country becomes wealthier, it might make sense for a larger and larger fraction of its GDP to be spent on health care. There is an easily approachable limit to how much food, shelter, and I-Phones a person can consume, but given the fact that we all grow old, get sick, and die, the limit to how much health care we can consume over our lifetime is high enough that we won't be bumping against it for quite some time.<br /><br />But I think most people agree (although perhaps for the wrong reasons) that there is something horribly awry with our current system. Costs are rising much faster than they should, and there are probably some simple adjustments that could be made to contain costs and make health care more affordable.<br /><br />Anyway, rising health care costs are perceived to be the problem. So, what does the HCR bill do? It subsidizes consumers and taxes providers and producers. That's right, it artificially stimulates demand for health care, and enacts new taxes and fees which artificially suppresses the supply of health care resources.<br /><br />Brilliant! This ranks right up there with Cash for Clunkers as a textbook case of fallacious reasoning in economics.<br /><br />That said, I wanted to focus on just one small part of the HCR bill which highlights the lack of thought that goes into the crafting of such legislation. The provision to which I refer requires, in the <a href="http://www.dailykos.com/storyonly/2009/12/20/817142/-A-Historic-Step-Forward:-Why-Im-Supporting-The-Senate-Health-Reform-Bill">words</a> of Senator Al Franken, "... health insurance companies to spend 85% of premiums on actual health services -- not administrative costs, TV ads, or gargantuan CEO bonuses..."<br /><br />No doubt Harry Reid and his pals have put a lot of thought into that number 85% (sorry if i dripped sarcasm on the page here), but isn't it amazing that a government bureaucrat could come up with a single number like that which works for the whole country and for all large group insurance plans (of course, the states will be given the freedom to raise the bar even higher, although one hopes that 100% will be understood as a natural limit)?<br /><br />Now, one might expect a somewhat more precise and legalistic definition of the phrase "actual health services" in the "actual" bill, and here it is:<br /><br />(1) on reimbursement for clinical services provided to enrollees under such coverage; [and]<br />(2) for activities that improve health care quality;<br /><br />Well that clears it up. Let's do something novel and try to put ourselves in the shoes of a rational human being for a minute, one that responds to incentives and tries to game the wording of vague regulations.<br /><br />You're the CEO of a health insurance company, and Congress tells you that you have to spend at least 85% of your premium revenue on health care services or activities that improve health care quality. You can do math, so you quickly determine that the amount of money available for other expenses, salaries, and profits is at most (100%-85%)*(total premiums) = (100%-85%)*(total expenditures for health care servides)/85% = 17.65% * (total expenditures for health care services).<br /><br />The amount of money available scales linearly with total health care expenditures, which is interesting. Now if you can just find a way to spend more on health care, without increasing your administrative and marketing expenses, you can pay yourself, your employees, and your stockholders more money. Hmmm.<br /><br />Suppose you cut co-pays and deductibles and encourage your customers to get more health care. You could pay doctors more too, and even fund all kinds of ridiculous perquisites for doctors under the category "activities that improve health care quality."<br /><br />Of course you would have to raise health care premiums for all this to work, and normally you would be constrained by competition from other health care insurance providers. But under the new law, all of the other providers would be thinking the same way. All the incentives are now skewed towards increasing health care benefits and costs, with commensurately higher premiums to pay for it all.<br /><br />The intent of this language, I guess, was to provide an incentive to insurance companies to cut administrative expenses. But that incentive was always there. All this provision will manage to do is remove any incentive to cut costs for "actual" health care services. Perversely, it does the opposite.ESMhttp://www.blogger.com/profile/05205329836679086994noreply@blogger.com0tag:blogger.com,1999:blog-1377392670200997406.post-64171627432080191572009-11-17T06:49:00.000-08:002009-11-17T07:12:11.143-08:00Does Lack of Health Insurance Cause 45K Deaths Per Year in the US?This <a href="http://pnhp.org/excessdeaths/health-insurance-and-mortality-in-US-adults.pdf">paper</a> has been cited by a lot of people recently, including Nicholas Kristof in his November 12th <a href="http://www.nytimes.com/2009/11/12/opinion/12kristof.html">op-ed</a> (I'll have more to say about Kristof later as he has been <a href="http://www.nytimes.com/2009/11/05/opinion/05kristof.html">spreading</a> health care falsehoods under the guise of countering health care myths).<br /><br />The research has been interpreted as demonstrating that approximately 45K people die every year in the US because of lack of health insurance.<br /><br />This is almost certainly <a href="http://www.john-goodman-blog.com/does-lack-of-insurance-cause-premature-death-probably-not/">wrong</a>.<br /><br />I note the following points to keep in mind about the paper:<br /><br />1) the principal author is <a href="http://pnhp.org/">PNHP</a> (Physicians for a National Health Plan) founder Dr. David Himmelstein;<br /><br />2) in the paper itself the authors do not claim to have shown a causal relationship between lack of health insurance and higher mortality; they only claim to have shown that there is a positive correlation.<br /><br />PNHP has an extreme agenda. The group was formed to promote socialized medicine in the US. In addition, PNHP recognizes that its goal of equal access to health care is undermined if a private market for medical services is allowed to develop in parallel with the government run network (such a 2-tier system exists in the UK). Therefore, PNHP wants essentially to ban <a href="http://pnhp.org/resources/key-features-of-single-payer">private</a> medical practice. Himmelstein et al want to make it impossible for someone to pay to see a doctor.<br /><br />The fact that Himmelstein is the principal author of the paper does not necessarily mean that the paper is wrong (although one should probably be more skeptical than usual). Even if the paper is substantially correct, we should keep in mind that Himmelstein's political agenda may interfere in a number of ways. For example, data that undermines his political agenda may have been suppressed or at least not released publicly. Also, he may spin, or allow others to spin, the paper's results in a way which is not justified by the data.<br /><br />I think the latter concern is clearly at play right now, and primarily with respect to the rather widespread confusion about <a href="http://xkcd.com/552/">causality vs correlation</a>. That is, when sticking to the science, the paper only makes a claim about there being a positive correlation between lack of insurance and mortality rates (1.4x higher mortality rates for the uninsured vs the insured population when adjusted for a variety of factors). But correlation is not causation. Although the uninsured have a higher mortality rate, it may be due to some factor other than the lack of insurance. This is important because it might be that even if these people were given insurance for free, their mortality rates would remain high. I suspect this to be the case, at least in part.<br /><br />Although not specifically mentioned in the Himmelstein paper (a surprising and telling omission I think), a reasonable hypothesis is that there is self-selection involved among people who are uninsured. People who are responsible about their health, who care about their health, and who therefore will go to the doctor when they are sick and then stick to a prescribed course of treatment, those people are more likely to care enough to go out and make sure they have insurance. It is the lazy, irresponsible people who will be skewed towards being uninsured.<br /><br />I think that this effect is real, even in a system where most people get insurance through their employer. Remember, most honest economists would agree that health insurance is paid for out of employee wages, not out of company profits. All other things being equal, jobs which do not provide health insurance will pay higher wages than jobs that do. People who do not value health insurance will choose those jobs that do not provide health insurance because they will earn commensurately higher wages.<br /><br />The authors of the paper try to normalize for various factors, including income, education, ethnicity, and current health status. But they cannot control for personal responsibility. In fact, their attempt to normalize for health status might exacerbate the effect they have captured (i.e. it makes the correlation between lack of insurance and mortality rates higher) because people who are already sick are probably focusing more on getting health insurance than people who are healthy. In other words, those who have good health status <strong>and</strong> are short-sighted about their health are more likely to be uninsured. So those without insurance are probably in a healthier pool after controlling for income, education, and ethnicity.<br /><br />[To be fair, I should mention that the authors think that the effect of controlling for health status can go the other way because those who have poor health status at the start of the study might have already suffered from lack of health insurance.]<br /><br />In any case, the paper only claims correlation, not causation. The researchers did not have access to cause of death data, and, accordingly, there was no way to know if lack of insurance played any role at all in the excess death rate for the "normalized" pool of uninsured.<br /><br />Perhaps by design, however, the authors of the paper have created a perception in the media that causation has been proved and that 45K deaths per year could be prevented if we extended health insurance coverage to every US resident. I think that if you cornered Himmelstein himself, he would back off of that claim very quickly.<br /><br />This <a href="http://www.hsr.org/hsr/abstract.jsp?aid=4470695438">paper</a> finds that there is actually little correlation between excess mortality for the uninsured when mortality is restricted to "amenable" causes of death. Additionally, it finds that there is no change in the relative mortality rates for the uninsured pool of people once they become eligible for Medicare coverage at age 65. That is, giving the uninsured insurance does not improve their survival rates relative to the insured, at least once they've reached age 65.<br /><br />Of course, as I've expressed before, even if the lack of health insurance causes excess mortality rates, we have to judge that effect relative to other wealth or income based factors that cause excess mortality. Eating cheap, starchy food, living in crime-ridden neighborhoods, driving unsafe cars, and working in dangerous jobs all cause excess deaths among the poor and are clearly direct consequences of being poor. If the money required to give out free health insurance could get better results in these other areas, then we shouldn't waste our limited resources on universal health insurance.ESMhttp://www.blogger.com/profile/05205329836679086994noreply@blogger.com1tag:blogger.com,1999:blog-1377392670200997406.post-90918520792920601182009-10-31T12:27:00.000-07:002009-10-31T12:46:27.468-07:00Minimum Wage Laws and Entry Level JobsIt is interesting to compare Bob Herbert's <a href="http://www.nytimes.com/2009/10/31/opinion/31herbert.html?_r=1&hp=&adxnnl=1&adxnnlx=1256990885-Nx3DtWxlo7w+MCvBYmAg7Q">article</a> in the NY Times yesterday about unemployment among recent college graduates with a Wall Street Journal <a href="http://online.wsj.com/article/SB10001424052970203440104574402820278669840.html">op-ed</a> from earlier this month about the effect of the recent minimum wage hike.<br /><br /><a href="http://www.nytimes.com/2009/10/31/opinion/31herbert.html?_r=1&hp=&adxnnl=1&adxnnlx=1256990885-Nx3DtWxlo7w+MCvBYmAg7Q">Here's</a> Herbert from October 30, 2009:<br /><br /><blockquote>As jobs become increasingly scarce, more and more college graduates are working for free, at internships, which is great for employers but something of a handicap for a young man or woman who has to pay for food or a place to live.<br /><br />"The whole idea of apprenticeships is coming back into vogue, as it was 100 years ago," said John Noble, director of the Office of Career Counseling at Williams College. "Certain industries, such as the media, TV, radio and so on, have always exploited recent graduates, giving them a chance to get into a very competitive field in exchange for making them work for no — or low — pay. But now this is spreading to many other industries."<br /><br />Lonnie Dunlap, who heads the career services program at Northwestern University and has been advising young people on careers since the mid-70s, said today’s graduates are experiencing the worst employment market she’s ever seen.<br /><br />...<br /><br />Like Mr. Noble, <strong>she mentioned the growing use of interns versus paid employees and said she can see the value of such unpaid work for some recent graduates,</strong> "though, of course, not everyone can afford to do that." </blockquote><br />Herbert concludes:<br /><br /><blockquote><strong>If we’re having trouble finding employment for even these kids, then we’re doing something profoundly wrong.</strong> </blockquote><br />Ahh, but what could we be doing wrong?<br /><br />From the WSJ <a href="http://online.wsj.com/article/SB10001424052970203440104574402820278669840.html">article</a> on October 3, 2009, aptly subtitled “The minimum wage hike has driven the wages of teen employees down to $0.00”:<br /><br /><blockquote><p>Yesterday's September labor market report was lousy by any measure, with 263,000 lost jobs and the jobless rate climbing to 9.8%. But <strong>for one group of Americans it was especially awful: the least skilled, especially young workers.</strong> Washington will deny the reality, <strong>and the media won't make the connection, but one reason for these job losses is the rising minimum wage.<br /></strong><br />Earlier this year, economist David Neumark of the University of California, Irvine, wrote on these pages that the 70-cent-an-hour increase in the minimum wage would cost some 300,000 jobs. Sure enough, the mandated increase to $7.25 took effect in July, and right on cue the August and September jobless numbers confirm the rapid disappearance of jobs for teenagers.<br /><br />The September teen unemployment rate hit 25.9%, the highest rate since World War II and up from 23.8% in July. Some 330,000 teen jobs have vanished in two months. Hardest hit of all: black male teens, whose unemployment rate shot up to a catastrophic 50.4%. It was merely a terrible 39.2% in July.<br /><br />...<br /><br /><strong>As the minimum wage has risen, the gap between the overall unemployment rate and the teen rate has widened, as it did again last month.</strong> (See nearby chart.) The current Congress has spent billions of dollars—including $1.5 billion in the stimulus bill—on summer youth employment programs and job training. <strong>Yet the jobless numbers suggest that the minimum wage destroyed far more jobs than the government programs helped to create.</strong><br /></p></blockquote><br />Now, I don’t want to mislead you; Herbert is writing specifically about college graduates, and the numbers from the WSJ article are for teenagers. However, there is obviously a strong correlation. Recent college graduates are usually unskilled and trying to land their first real jobs, just like teenagers. And employers are not currently willing to pay $7.25/hour (plus the 7.65% employer portion of FICA taxes) for an on-the-job trainee of limited productivity.<br /><br />The fact that zero wage internships are widely available means that the need for young, unskilled workers is there (after all, taking on interns is not exactly free – interns do require some supervision from paid employees), but that given the choice between paying zero (which is legal) and minimum wage, employers choose zero because the minimum wage does not make economic sense.<br /><br />It is highly likely that there is some hourly wage between zero and $7.25/hour that could better clear the market for entry level labor and could match hundreds of thousands of additional entry level workers with entry level jobs. But the federal government, in its unbounded wisdom, has made that wage illegal.<br /><br />I recently remarked to an economist friend of mine that economics must be a depressing field in which to be a researcher. In the hard sciences, new research is often translated into practical applications which benefit society. In economics, however, <a href="http://randomfinancialthoughts.blogspot.com/2009_07_01_archive.html">ideas</a> that were worked out and widely accepted by practitioners centuries ago are not only not implemented, but are contradicted and disparaged by those who wield the most power over our society.<br /><br />I suppose that we should feel fortunate that lawmakers don't try to repeal the law of gravity, even as they try again and again to repeal the law of supply and demand.ESMhttp://www.blogger.com/profile/05205329836679086994noreply@blogger.com0tag:blogger.com,1999:blog-1377392670200997406.post-36601228350055399832009-10-09T18:02:00.000-07:002009-12-24T05:42:56.642-08:00The Nobel Peace Prize and the Cause of World PeaceAlthough this post does not pertain to economics directly, I think there are general economic principles at work in every aspect of human life. As such, no topic is off-topic for this blog (isn't that convenient?).<br /><br />Most observers are stunned by the announcement today that President Obama is the winner of the 2009 Nobel Peace Prize. I have to confess (brag really) that it was not so much a surprise to me. Before I was even out of bed this morning my wife turned on her laptop to check the news and immediately gasped and said "Guess who won the Peace Prize." I immediately said "Don't tell me it was Obama."<br /><br />The Peace Prize, as well as the Literature Prize, are quite different from the science Nobel Prizes in that they are essentially political in nature. Although there are sometimes controversies about how important Nobel Prize winning scientific research is or whether the particular people who were awarded the prize actually deserved it more than others, there is rarely controversy about the work itself. The prize winning work is almost always already accepted as correct and already considered a significant contribution to human knowledge (although there was at least one prize given for erroneous <a href="http://www.smithsonianmag.com/science-nature/Prize_Fight.html">research</a>). Not so for the Peace and Literature Prizes.<br /><br />I note in passing only that a Peace Prize, but not a scientific prize, has been awarded for global warming research.<br /><br />The Peace Prize is unique in that the prize committee sees it as a vehicle for promoting world peace, rather than just recognizing important and completed work. And the committee clearly believes that it can promote world peace by enhancing the stature of the recipient and encouraging him to keep doing what he's doing.<br /><br />Choosing Obama is logical in the sense that the committee wishes to encourage his recent overtures to the world, his professed commitment to peaceful diplomacy, and his apparent desire to reduce the military capacity of the United States. I think the timing in particular proved irresistible to the committee because the award could possibly influence Obama's pending decisions on escalating the war in Afghanistan and taking more aggressive measures against Iran.<br /><br />But the choice is overtly political because it is not at all clear that Obama's professed peace-making strategy is correct. There are reasonable people (and I count myself as one of them) who believe that the current strategy is one of appeasement which actually does great harm to the cause of world peace.<br /><br />The simple truth is that there are a lot of evil people in the world, and many of them accumulate vast powers through the apparatus of a state. I've seen references to medical studies which estimate that roughly 1% of humans are literally psychopaths. Probably a reasonable percentage of psychopaths are clever enough that they can play by society's rules in order to survive into adulthood unscathed and unjailed.<br /><br />It is probably also true that a much larger percentage of people are capable of being trained to become psychopaths in practice. That is, they have moral consciences but can be indoctrinated to suppress them in order to achieve a greater good for their people, their cause, their country, or their religion.<br /><br />Many of these psychopaths end up in control of states. In fact, in undemocratic states, there is probably a selection bias in favor of leaders who are violent psychopaths (whereas in democratic states there appears to be a selection bias in favor of narcissists).<br /><br />Whatever the root cause, history is replete with examples of countries that start wars for no good reason except to accumulate power and wealth and to subjugate other people.<br /><br />George Bush was widely derided for his Manichean world view -- which is that there are good people and bad people, and that the good people have to stand up to the bad people. But Winston Churchill had the same view, and he is generally recognized as an inspiring and brilliant leader. The main difference is that Winston Churchill was a lot better at speaking off the cuff (and was much more of a warmonger).<br /><br />I'm beating around the bush (no pun intended), but my central point is one that Winston Churchill believed in and one that Ronald Reagan made into a campaign slogan -- that peace comes through military strength.<br /><br />The US spends more than 4% of its GDP on defense. It is roughly equal to the total military spending of the rest of the world combined. Is this necessary? Is it overkill? I'm not sure of what the right number is, but the size and strength of the US military should be above the level at which other countries don't even think about challenging us.<br /><br />You don't want a potential adversary to get even a glimmer of an idea that it is possible to initimidate the US militarily. Because if an adversary doesn't even think to try, we will have real and stable peace.<br /><br />In financial terms, one might describe this idea thusly: the convenience yield of having a huge military capacity is equal to the potential cost of the devastating wars that such a capacity allows us to avoid. Given the shockingly high cost of war between modern countries in terms of human suffering and economic loss, that convenience yield may well be far in excess of 4% of GDP.<br /><br />Now that might not be so comforting to a left-wing politician in Oslo who thinks that the United States is just as susceptible to being taken over by a psychopath as any other (especially since, in his view, it <strong>was</strong> ruled by a psychopath for the last eight years).<br /><br />But the truth is the system of government we have in the US makes immoral military aggression extremely difficult and unlikely. Bush-haters hyperventiliate a lot about Iraq, but whether you think the Iraq war was smart or dumb, farsighted or rash, justified or not, it is necessary to ignore completely the prior 15 years of Iraq's history to judge the motivations for the Iraq war as immoral. According to any reasonable moral calculus, the 10 years of economic sanctions which preceded the Iraq war were far less moral than the war itself.<br /><br />And given the surprising, suicidal hatred shown by some of our enemies on 9/11, it was not unreasonable to use our power to preempt a latent, albeit uncertain, threat. That this threat was hyped as more short-term than it really was (although perhaps not more than it was genuinely perceived to be) doesn't change the fact that it was a rational decision and not a psychopathic one.<br /><br />Anyway, I think that what has kept the reasonably stable peace during the two decades since the end of the Cold War has been the United States' dominant military power, and the willingness to use it to maintain the peace on land and on the high seas.<br /><br />The Nobel Peace Prize Committee disagrees and wishes to use the selection of Obama to promote its idea that global peace is attained by holding hands and singing kumbaya around campfires. Ten thousand years of human history says that the committee is wrong. Let's hope that Obama will come to see that before real damage is done.ESMhttp://www.blogger.com/profile/05205329836679086994noreply@blogger.com10tag:blogger.com,1999:blog-1377392670200997406.post-54088819577447250452009-09-13T19:54:00.001-07:002009-09-16T07:31:49.721-07:00What is a Waste of Resources?Obama promises to cut $500B of waste, fraud, and abuse out of Medicare and Medicaid over 10 years. To say that this claim has been met with <a href="http://meganmcardle.theatlantic.com/archives/2009/09/waste_fraud_and_abuse.php">skepticism</a> would be an understatement.<br /><br />I am not nearly so skeptical because what Obama and the left wing are really demanding from Congress is more power to ration government provided health care, as well as to pay drug companies, medical equipment companies, doctors, and hospitals less for their products and services (which will of course lead to more rationing).<br /><br />I think the savings in terms of money could easily materialize. The problem I have is that saving the government little green pieces of paper is not a worthy goal in and of itself. After all, the government can create little green pieces of paper almost for free.<br /><br />If the government were to save $50B/yr in Medicare costs by cutting Medicare reimbursement rates and by raising the eligibility age from 65 to 67 years, would anybody think that is real savings? How about if the government mandated that no doctor be allowed to make more than $100K per year? Or that all drugs currently on the market are deemed no longer on patent? All of these changes would dramatically lower the cost of government provided health care, but would they actually prevent the waste of or increase the supply of health care resources?<br /><br />Resources are tangible things -- valuable services, goods, products, information, trained people -- and not little green pieces of paper. Tackling waste means freeing up or increasing the amount, quality, and availability of resources. Paying people less doesn't do that.<br /><br />Consider the following paired examples:<br /><br />1.<br />(A) A drug company wins a patent extension which allows it to keep charging high prices for a successful and effective cancer drug;<br /><br />(B) A drug company realizes that its new cancer drug provides essentially no benefit over existing ones, but decides to spend $1B developing and promoting it anyway because it calculates that it can capture a significant share of the market and generate a net profit;<br /><br />2.<br />(A) a health insurance company CEO is granted a bonus that exceeds the industry average by $10MM even though by most measures he is doing a mediocre job;<br /><br />(B) a health insurance company with an antiquated billing and reimbursement system spends $10MM more than it should this year on administration costs;<br /><br /><br />3.<br />(A) a doctor submits fraudulent claims to Medicare for services he never performed;<br /><br />(B) a doctor orders unnecessary MRI tests for most of his patients because he has an equity interest in the MRI facility;<br /><br />4.<br />(A) a doctor has to pay $150K/yr in malpractice insurance;<br /><br />(B) a doctor orders a wide range of unnecessary tests for a patient, in order to protect himself from a potential malpractice suit in case of an adverse outcome;<br /><br /><br />I believe that to first order the (A) examples are merely (possibly unfair) transfers of money from one entity to another, but not a waste of resources.<br /><br />The (B) examples represent true waste. Real (mostly human) resources are being used which could have been deployed better elsewhere.<br /><br />It is not surprising that the focus of politicans is on the (A) examples. Perceived unfair transfers of money get people riled up, and being natural demogogues, our politicans cater to that anger.<br /><br />Ironically, putting in place policies that curtail the (A) examples will, if anything, decrease the supply of health care resources (which is not necessarily a bad thing - see further down).<br /><br />Reducing the amount of money transferred to the health care industry in the aggegate (even including outrageous examples of overpayment, abuse, and fraud) will not encourage an increase in supply.<br /><br />When Obama and his speechwriters make the mistake of lumping corporate profits in with overhead (as they do repeatedly), it is clear that they don't understand any of this at all.<br /><br />Now I am not claiming that we should tolerate overpayment and fraud. Far from it. A distortion in favor of the health care industry is just as bad as a distortion against it. As only one part of a complex economy, the health care industry should have no stronger claim on aggregate resources than any other area. Too many people becoming doctors, for instance, is as bad as too few. [How we could know how many is the right number is something that the free market is best at determining, by the way.]<br /><br /><br />Finally, here's a trio of hypothetical examples. Which of these represent a waste of resources?<br /><br />5.<br />(A) a drug company spends $100MM on a public and doctor-focused advertising campaign to introduce its new product;<br /><br />(B) a drug company spends $100MM in litigation defending itself against claims that its product causes serious problems in approximately 1% of patients;<br /><br />(C) a drug company spends $2B developing a new cancer drug that gives terminal patients a 25% probability of living an extra 2 months;<br /><br /><br />I am inclined to believe that (A) and (B) are wasteful, but (C) is not.<br /><br />Advertising is a complex subject. Some economists consider marketing expense a dead weight loss to the economy. I have always felt that it has some informational value for consumers, but it also appears to be <a href="http://falkenblog.blogspot.com/2009/08/is-marketing-expense-wasteful.html">necessary</a> for free market <a href="http://bpp.wharton.upenn.edu/waldfogj/987/readings/benham.pdf">competition.</a><br /><br />The competition hypothesis seems less convincing in the case of drug companies, however, since they only compete directly in those rare instances when they have identical drugs on the market.<br /><br />The benefits of litigation are difficult to quantify as well. Obviously, one way that the sanctity of contracts is upheld and consumers are protected is through litigation. But our system has gone awry, and you probably couldn't find one serious economist today who didn't think that the US is an overly litigious society and that the costs of litigation are excessive.<br /><br />As for example 5.(C), the drug company would be wasting resources only if its prospects for making a profit depended upon the market price for the drug being anomalously high. It is in the nature of our 3rd party payer system for medical care to create such inefficiencies. Since consumers don't see the true cost, they make inefficient cost benefit decisions.<br /><br />Still, my sense is that the medical community has generally made sound choices when it comes to approving expensive new drugs. My evidence is that hundreds of miraculous drugs have been invented over the last 30 years, and yet drug companies account for only about 1.5% of world GDP (in the US, it's about 2%). I would be willing to spend that fraction of my income on Claritin. Fortunately, it's much cheaper than that.ESMhttp://www.blogger.com/profile/05205329836679086994noreply@blogger.com1tag:blogger.com,1999:blog-1377392670200997406.post-46583542724089068302009-08-24T05:52:00.000-07:002009-08-24T06:03:39.783-07:00Health Care RationingThere will be rationing under a government health insurance system. That is just simple economics. If you give away a valuable thing for free, then demand will exceed available supply. The government will have to allocate health care resources according to some formula, and I guarantee you, this will be extremely controversial and morally agonizing.<br /><br />Proponents of a government health plan point out that in a free market rationing is also done, but it is done by price rather than by bureaucrats and lawmakers. The price rises until demand and supply are matched, and those unwilling or unable to pay that market clearing price will receive less health care.<br /><br />This is certainly true, but rationing by price is more efficient and morally sound. Those that value health care a lot will be more likely to obtain it than those who don't value it very much. It is important to remember that health is not something everybody values equally. And pretty much everybody makes tradeoffs between health and money. That is why some people are willing to be coal miners or firefighters or football players, or are willing to work overtime with little vacation or even rest. It is also why some people don't eat healthy foods or exercise or stop smoking.<br /><br />Some people care a lot about having (painful) surgery so they can continue to play tennis. Others not so much.<br /><br />When you have rigid rules divvying up resources, you inevitably wind up giving something the government bureaucrats say is worth X to somebody who values it at X/10. Meanwhile, a person who values that thing at 10X must go without.<br /><br />Perhaps most important of all, rationing by price will lead to more production of the health care services that are the highest price and therefore in the most demand versus available resources. In the long term, a market-based system will produce vastly more health care resources for everybody.<br /><br />It's amazing that some people (read Barack Obama, Nancy Pelosi, Harry Reid, and other Democratic leaders) so easily forget the lessons of the Soviet Union and Communist China. Government control of the market stifles economic growth. It has been shown empirically that government bureaucrats simply can't do as good a job as the free market at pricing goods and services, providing incentives, and stimulating increases in productivity.<br /><br />Some people want to believe health care is or should be exempt from market forces, but it isn’t, and it shouldn’t be.ESMhttp://www.blogger.com/profile/05205329836679086994noreply@blogger.com3