Thursday, January 31, 2013

An Agenda for Medicare Reforms

What's to be done about Medicare? The Kaiser Family Foundation has usefully pulled together a list of possible "Policy Options to Sustain Medicare for the Future." I especially liked that the report is fairly exhaustive in listing about 130 options (depending on how one counts options, suboptions, and sub-suboptions), and fairly honest in admitting that no realistic cost estimates for many of those options. Here, I'll start with a quick reminder of where Medicare is currently headed, and then list just 12 of the choices--those that in the KFF tally would reduce Medicare costs or raise Medicare taxes by at least $4 billion per year over the next  few years.

Medicare spending is taking off for two reasons: as the baby boomer retire, a rising proportion of Americans will become eligible, and continually rising health care costs will push up costs still further. The first figure shows projections for the rising number of Medicare enrollees and Medicare spending as a share of GDP. The second figure shows Medicare spending projected as a rising share of the overall federal budget.

Discussions of how to fix Medicare often head for happy talk about how, if we all just provide patients and doctors with the right information and incentives, and link them together with the right network of health information technology and thoughtful counselors, we can save billions while improving everyone's health. For a recent example, see this report from the United Health UnitedHealth Center for Health Reform & Modernization, which suggests that steps along these lines could save up to $542 billion in Medicare and Medicaid spending over the next decade. It's a cheerful story, and I'm certainly fine with pursuing these kinds of win-win possibilities. But the U.S. health care system has been facing ever-rising costs and talking about win-win solutions for several decades. While we're waiting for the cost savings from these kinds of more enlightened and efficient practices to arrive, we need to start thinking about some less pleasant options.

 Here's the list of 12 possibilities from the KFF report that would involve Medicare cost savings or revenue increases of at least $4 billion per year. In that report, all the proposals for better information sharing and quality control and improved decision making by patients and providers have the effect on costs and revenues listed as "Not available," which seems fair to me, given historical experience with attempts along these lines as overall health care costs have continues to rise. What's left are choices that sting (with the effect on costs or revenues in parentheses). The KFF Report gives a couple of pages of more detailed explanation for each of these, along with the other 100+ choices.

1) Raise the age of Medicare eligibility from 65 to 67 ($113 billion over 10 years)

2) 10% coinsurance payment on all home health episodes ($40 billion over 10 years)

3) Restrict first-dollar Medigap coverage ($53 billion over 10 years)

4) Increasing premiums for Part B and Part D: for example, raise Part B premiums by 2% per year until they cover 35% of total Part B expenses ($231 billion over 10 years)

5)  Increase Medicare payroll tax by 1 percentage point for all workers ($651 billion over 10 years)

6) Require manufacturers to pay a minimum rebate on drugs covered under Medicare Part D for
beneficiaries receiving low-income subsidies ($137 billion over 10 years).

7) Repeal provisions in the Affordable Care Act that would close the Part D coverage gap by
2020 ($51 billion over 10 years)

8) Reduce and restructure graduate medical education payments to hospitals ($69 billion over 10 years)

9) Rebase SNF and home health payment rates: for example, reducing payment updates for post-acute care by 1.1 percentage points ($45 billion over 10 years)

10) Adopt traditional tort reforms at the Federal level ($40 billion to $57 billion over 10 years)

11) Establish a combined deductible, uniform coinsurance rate, and a limit on out-of-pocket
spending, along with Medigap reforms ($93 billion over 10 years)

12) Set Federal contributions per beneficiary at the average plan bid in a given area, including
traditional Medicare as a plan, weighted by enrollment ($161 billion over 10 years)

A few thoughts:

1) One of the policy changes would dramatically increase costs. Congress has been playing a game for years now in which it lowballs the future costs of Medicare by proposing very large cuts  in payments to health care providiers that will take place a few years in the future. Then Congress perpetually pushes back those cuts. To their credit, the official Medicare actuaries have been quite blunt in pointing out "Why Official Medicare Costs are Understated." But if, for example, the currently legislated future cuts in payments to health care providers were replaced with a 10-year freeze on fees and a "only" a 5.9% cut in fees for non-primary care services each year for the first three years, Medicare costs would be $200 billion higher over 10 years than the current legislative estimates. If fees for health care providers rise at the rate of GDP growth, or a percentage point or two faster, then Medicare costs will be $300 billion or more higher over the next 10 years. Thus, take your first few hundred billion in cost savings or revenue increases above, and assume that it's going to go to sidestepping the huge future cuts to health care providers in current legislation.

2) I did leave out a few proposals on the KFF list for increasing taxes on other items and earmarking the funds for Medicare. For example, one could raise taxes on alcohol, tobacco, soft drinks, or employer-provided health insurance and earmark the funds for Medicare. But one could also raise those taxes and spend the money on deficit reduction or some other program, so at least to me, these are not specifically "Medicare" reforms.

3) Just for the record, you can't just add up the cost estimates several of these proposals with, because they interact in various ways. For example, option #3 on restricting first-dollar Medigap coverage overlaps heavily with option #11  on Medigap reforms. If the Medicare age was raised to 67, it would alter the cost changes from all of the other proposals.

My bottom line is that too many of the arguments over Medicare spending are magically nonspecific. Sometimes they describe innovations in health care delivery that would improve health and save money and leave everyone with a big rosy smile. I'm all for such changes, and I'll believe in their effectiveness as soon as they are actually effective in reducing costs--but not before. Other time, politicians talk tough about how they will just put a cap on Medicare spending, or just not let it rise at faster than some certain rate. Again, I'll believe in the workability of such caps when I've seen them operate for a few years.

In contrast, the list above is not a pleasant one. Some of these proposals reduce coverage for the elderly or require them to pay more. Some reduce payments to health care providers. One raises taxes on current workers. I am fully aware that none of these are popular options! Which options are more palatable is an argument for another day. But these are real choices, and the inexorable arithmetic of Medicare's rising costs is likely to force choices among these sorts of options.

Wednesday, January 30, 2013

Economics of Ideas: Paul Romer and Thomas Jefferson

Here's Paul Romer on the power of ideas, from his article the Fall 2012 Issues in Science and Technology:

"What makes ideas so remarkable is their capacity for shared use. A bottle of valuable medicine can heal one person, but the formula that is used to make the medicine is as valuable as the total number of people on Earth. Economists call this concept “non-rivalry.”... There is a saying that you all know that we use to capture this character of non-rivalry: If you give someone a fish, you feed them for a day, but if you teach someone to fish, you destroy another aquatic ecosystem."

For me, the classic statement about the economic power of ideas and their relation to the patent system comes from Thomas Jefferson, in a letter  he wrote in 1813

"If nature has made any one thing less susceptible than all others of exclusive property, it is the action of the thinking power called an idea, which an individual may exclusively possess as long as he keeps it to himself; but the moment it is divulged, it forces itself into the possession of every one, and the receiver cannot dispossess himself of it. Its peculiar character, too, is that no one possesses the less, because every other possesses the whole of it. He who receives an idea from me, receives instruction himself without lessening mine; as he who lights his taper at mine, receives light without darkening me. That ideas should freely spread from one to another over the globe, for the moral and mutual instruction of man, and improvement of his condition, seems to have been peculiarly and benevolently designed by nature, when she made them, like fire, expansible over all space, without lessening their density in any point, and like the air in which we breathe, move, and have our physical being, incapable of confinement or exclusive appropriation. 

"Inventions then cannot, in nature, be a subject of property. Society may give an exclusive right to the profits arising from them, as an encouragement to men to pursue ideas which may produce utility, but this may or may not be done, according to the will and convenience of the society, without claim or complaint from anybody. Accordingly, it is a fact, as far as I am informed, that England was, until we copied her, the only country on earth which ever, by a general law, gave a legal right to the exclusive use of an idea. In some other countries it is sometimes done, in a great case, and by a special and personal act, but, generally speaking, other nations have thought that these monopolies produce more embarrassment than advantage to society; and it may be observed that the nations which refuse monopolies of invention, are as fruitful as England in new and useful devices."

Tuesday, January 29, 2013

Head Start is Failing Its Test

I'll just admit up front that the vast inequities that exist even before children start school bother me, and that I am predisposed to favor programs that would help disadvantaged children early in life. Thus, I was delighted when Head Start announced some years back that it was going to carry out a randomized control trial--that is, to assign some preschool children randomly to Head Start and others not--so that it would be possible to do a statistically meaningful test of how well Head Start worked.  I presumed that the test would provide ammunition for my pre-existing views.

But as the evidence has built up, Head Start is failing its test. The latest evidence appears in the "Third Grade Follow-up to the Head Start Impact Study: Final Report," which was released in December. The report was carried out by a company called Westat and published by the Office of Planning, Research and Evaluation, Administration for Children and Families, U.S. Department of Health and Human Services. Basically, the report shows that Head Start provides short-term gains to preschool children, but those gains have faded to essentially nothing by third grade.

To appreciate how depressing this conclusion is, you need to appreciate the high quality of the study. It's based on a nationally representative sample of more than 5,000 3 and 4 year-olds from low-income families who were eligible for Head Start. These children were randomly either assigned to Head Start, or not. Data collection started in 2002, and so by 2008, data was available on how the children were performing in third grade. The study didn't just look at test scores: it considered a range of data on how Head Start might affect aspects of cognitive development, social-emotional development, health status and services, and even parenting practices.

The findings are summarized in this way:  "In summary, there were initial positive impacts from having access to Head Start, but by the end of 3rd grade there were very few impacts found for either cohort in any of the four domains of cognitive, social-emotional, health and parenting practices. The few impacts that were found did not show a clear pattern of favorable or unfavorable impacts for children."

Of course, because I am predisposed to favor these kinds of programs, I look for silver linings. Perhaps for certain specific subgroups such preschool programs can be useful? Perhaps certain kinds of curriculum are more likely to make a lasting difference?  Perhaps helping children from low-income families catch up before they start school is insufficient, but a sustained set of interventions continuing through elementary school would show lasting results? Sometimes studies of early preschool interventions have found little gain in measured outcomes a few years into school, but later gains like greater rates of high school completion or reductions in certain risky behaviors in adolescence. Maybe as the Head Start study continues, these sorts of longer-term gains will emerge?

I don't have an answer  here. Some years ago, I edited a paper in a special issue of the  Future of Children about the enormous gaps in school readiness for preschool children. Equal opportunity is an important goal of public policy, and as a society, we are clearly not providing equal opportunity to many children--who are already well behind before their first day of school. If the Head Start study had positive results about the long-run efficacy of preschool programs, I'd trumpet it to the hills. But the unfolding evidence isn't backing up the conclusion I would prefer. 

Monday, January 28, 2013

A Dose of Reality for Energy Policy

Bruce Everett  of the Fletcher School at Tufts University offers a healthy double-helping of reality in his essay entitled "Back to Basics on Energy Policy: For the past 40 years, political leaders have promised that government can plan and engineer a fundamental transformation of our energy industry They were wrong." It appears in the Fall 2012 edition of Issues in Science and Technology. He begins:
"In June 1973, President Richard Nixon addressed the emerging energy crisis, saying that “the answer to our long-term needs lies in developing new forms of energy.” He asked Congress for a five-year, $10 billion budget to “ensure the development of technologies vital to meeting our future energy needs.” With this speech, the federal government set out to engineer a fundamental transformation of our energy supply. All seven subsequent presidents have endorsed Nixon’s goal, and during the past 40 years, the federal government has spent about $150 billion (in 2012 dollars) on energy R&D, offered $35 billion in loan guarantees, and imposed numerous expensive energy mandates in an effort to develop new energy sources. During this time, many talented and dedicated people have worked hard, done some excellent science, and learned a great deal. Yet federal energy technology policy has failed to reshape the U.S. energy market in any meaningful way."
For example, about 30% of that energy R&D spending went to nuclear power, with President Nixon forecasting 40 years ago that nuclear would provide half of the nation's electricity supply by 2000. But nuclear power plateaued at 20% of the electricity supply in 1991, and given the lack of new plants and the gradual retirement of older ones, it seems certain to be a declining contributor in the next few decades. 

Over the last 40 years, the U.S. government has backed a number of renewable energy technologies: hydro-power, solar, wind, solar, geothermal, synthetic fuels including ethanol, burning municipal  waste, and others. Over that time, the share of all these renewables in energy consumption went from 6% in 1973 to 8% at present. Hydropower and corn ethanol comprise more than half that total. Current projections from the Energy Information Administration hold that solar power will quadruple by 2035--at which point it will still be less than 0.5% of U.S. energy consumption.

The fundamental problem, Everett argues, is that showing something is possible at high cost is one thing, but commercializing it at low costs is quite another. He writes: "The mantra of the energy R&D program has always been, “If we can put a man on the Moon, we can do anything,” but this comparison is wrong. Apollo was a conceptual and technical triumph with no commercial aspirations. Between 1969 and 1972, the United States landed 12 astronauts on the Moon at a cost of $12.5 billion (in 2012 dollars) per astronaut. The purpose of the program was to accomplish a technically difficult feat a few times despite the enormous cost. Civilian technology requires the exact opposite: the ability to do something on a large scale at a low cost."

 As a matter of public policy, Everett argues, the government has shown a pattern of trying to force-feed commercialization before it is actually ready to happen, through subsidies to nuclear power, or synthetic fuels, or wind, or battery-powered cars. It's always politically enticing to promise that a few temporary subsidies will jump-start large industries with many new jobs, but the record in energy is that the subsidies are often long-lasting and large, while the subsidized companies are short-lived. Managers get their bonuses, but sustainable jobs aren't created. (And for those who argue that fossil fuels are subsidized as well, Everett points out that the taxes collected on oil use are vastly higher than any public support received by the oil industry.)

Everett doesn't emphasize the point, but the newfound ability of U.S. energy producers to access vast reserves of natural gas will reshape energy markets in manifold ways. I've posted in the past about "Unconventional Natural Gas and Environmental Issues" and also about my own preference for "The Drill-Baby Carbon Tax," which would be a policy of moving ahead with all deliberate speed in developing U.S. fossil fuel resources while also imposing a carbon tax and addressing the costs of other environment issues as well.

But after 40 years of watching the U.S. government try to force energy markets on to a different path, it's time for an alternative approach. The U.S. government should stop subsidizing commercial energy firms, and instead put that money into a dramatic increase in energy research and development.

Friday, January 25, 2013

Over 65 and Working

The proportion of U.S. adults who are "in the labor force"--that is, who either have jobs or are unemployed and looking for a job--has been falling for a decade, as I explored in an April 26, 2012, post on "Falling Labor Force Participation." But for one demographic group, the elderly, labor force participation is rising substantially.

Braedyn Kromer and David Howard of the U.S. Census Bureau offer some snapshots of the data in their just-released survey brief, "Labor Force Participation and Work Status of People 65 Years and Older." For example, here are some comparisons for the labor force participation of men and women, for those over 65 and for some age subgroups. While labor force participation is down a bit for the 75+ age group, it is noticeably higher since 1990 for the 65-69 and 70-74 age group. 

From a slightly longer-run perspective, 1990 was roughly the time period when labor force participation rates among the elderly were at their lowest. Here are a couple of figures from "The Increasing Labor Force Participation of Older Workers and its Effect on the Income of the Aged," by Michael V. Leonesio, Benjamin Bridges, Robert Gesumaria, and Linda Del Bene, which appeared in the Social Security Bulletin earlier in 2012. The figures show that for men over age 62, rates of labor force participation were falling through the 1980s, bottomed out around 1990, and have been rising since then. For women, the pattern is a little different, because a much greater proportion of women entered the paid workforce in the 1970s and 1980s, and so compared with earlier generations, a larger share of women continued working into their 60s and 70s, too.

The rising labor force participation of the elderly in the last two decades represents a remarkable social change. Here's a figure created with the ever-useful FRED website at the Federal Reserve Bank of St. Louis, showing the labor force participation rate of those over age 55, going back to the late 1940s.Through the 1950s, 1960s, and 1970s, the notion that more and more people would retire earlier and earlier seemed like an inexorable social trend. But the patterns have changed--and they changed long before the Great Recession.

When I was starting off as a young adult in the paid workforce in the 1980s, I remember looking at this kind of data and thinking about how I might be retire--like many other people!--in my mid-50s. But that's clearly not going to happen for me; instead, my current expectation is to be working well into my late 60s or 70s. A steadily rising average age of retirement has become the new normal. But then, a pattern of "keep living more years while working fewer years" was never a viable long-term option.

Thursday, January 24, 2013

Plaudits for "The Instant Economist"

Early in 2012, my book The Instant Economist: Everything You Need to Know About How the Economy Works, was published by Penguin Plume. Here's the Amazon link; here's the Barnes & Noble link. At the tail end of the year, the book was named an "Outstanding Academic Title" by Choice magazine, which is published by the American Library Association. It was also listed as one of the Best Books for 2012 in the "Business" category by Library Journal, another prominent trade publication for librarians. 

Here's the review from the August 2012 issue of Choice:
"Currently The Instant Economist is the most readable and up-to-date summary of a typical US college principles of economics course. Following the traditional table of contents--from microeconomics through macroeconomics and international topics--and using original, helpful metaphors (and only two graphs), Taylor (managing editor, Journal of Economic Perspectives) takes the reader through the terminology, key concepts, and controversies dominant in today's economics profession. Noteworthy additions to the standard textbook canon are a chapter on personal investing and detailed accounts of the minimum wage, corporate merger, and inequality debates, introducing readers to the data issues that lie behind these controversies. The 36 short chapters reflect the book's origin in the author's Teaching Company recording, Economics; however, the book is a valuable stand-alone option. For supplementary coverage of the history of
economic thought and more complete institutional context, see Robert Heilbroner and Lester Thurow's Economics Explained (4th ed., 1998; 1st ed., CH, Oct'82). Summing Up: Highly recommended. All levels of undergraduate students as well as general readers wanting a readable introduction to economics. -- M. H. Maier, Glendale Community College

And here's the review from the Library Journal:

"Taylor’s (managing editor, Journal of Economic Perspectives) volume can help conversationalists looking to raise the bar for their watercooler chats and casual readers who want to understand better the current economic condition of the United States. Taylor uses simple language with field-specific vocabulary to explain economic concepts, and each concept is successfully reinforced with a real-life—and usually entertaining—example. He hits all the subjects that might interest a layperson, such as division of labor, supply and demand, wages, competition and monopoly, inflation, banking, and trade, for a total of 36 petite chapters—just enough information to give the reader a basic but well-rounded understanding of the subject. VERDICT This highly readable, nonpoliticized look at some of the economic principles that shape our society, presented in an engaging, anecdotal fashion, is highly recommended for armchair economists and anyone with a general interest in the state of our economy. —Poppy Johnson-Renvall, Central New Mexico Community Coll. Lib., Albuquerque

As these reviews emphasize, the book is written for the general non-economist reader who would like to gain some insight into the terminology and structure of economic thinking. Those who are interested in knowing a bit more about the genesis of the book might check here.
As one of the reviews notes, this book was rooted in a course I several years ago for the Teaching Company, which is available here. Or if you are teaching or taking an introductory college-level course in economics, I of course recommend my Principles of Economics textbook, available here.

Wednesday, January 23, 2013

Does Income Bring Happiness?

Back in 1974, Richard Easterlin published a paper called "Does Economic Growth Improve the Human Lot? Some Empirical Evidence" (available here and here, for example). Easterlin raised the possibility that what really matters to most people is not their absolute level of income, but their income level relative to others in society. If relative income is what matters, then an overall rise in incomes doesn't make me any better off relative to others, and so my happiness does not increase. Income becomes a sort of arms race: even as we all race to get more, it doesn't actually make us any happier.

Since then, the question of whether income brings happiness has been much-debated by economist and other social scientists. In "The New Stylized Facts about Income and Subjective Well-Being," Daniel W. Sacks, Betsey Stevenson, and Justin Wolfers offer a compact and readable summary of the evidence (much of which they generated in earlier research) that income is not just relative--and so more income does increase happiness. The paper is available as IZA Discussion Paper No. 7105, released in December.

At a basic level, this research looks at economic data on levels of income and compares it with survey data on on life satisfaction. For example, the Gallup World Poll provides data from 122 countries on the question: “Please imagine a ladder with steps numbered from zero at the bottom to ten at the
top. Suppose we say that the top of the ladder represents the best possible life for you, and the
bottom of the ladder represents the worst possible life for you. On which step of the ladder would
you say you personally feel you stand at this time?”

As a starting point, let's compare countries across the world in terms of real per capita GPD, along with their answers to this question on a scale from 0-10. The horizontal axis of the graph is a logarithmic scale: that is, rather than rising by a fixed amount between each tic mark, it rises by a fixed proportion (in this case, doubling) between each tic mark.

The general pattern is clear those in higher-income countries tend to report more life satisfaction. The best-fit straight line is drawn through the data. The much lighter dotted line is a "non-parametric" line which is a best-fit line that isn't required to be straight,and thus flattens out near the bottom and curves more steeply at the top than a straight line. Broadly speaking, it seems as if each doubling of income does lead to a distinct rise in the happiness scale, both for low-income and for high-income countries.

Of course, this result by itself doesn't prove the case either way. It could be that people in high-income countries are happier because they perceive that they are not in low-income countries, and so the happiness from their income is relative, rather than absolute. Thus, a second test is to look within individual countries at the happiness level of those with different income levels. If happiness from income is a relative concept, one might expect that, say, the rise in income from being a low-income person in the U.S to being a high-income person in the U.S. would bring more happiness, but the rise in happiness should be much less within a country than it would be across countries. However, the rise in happiness as a result of higher incomes within a country ends up looking very much like the relationship between countries.

Yet another test is to look at comparisons over time: that is, as economic growth gradually raises income levels, do people on average within a given country report a higher level of  happiness. The data here is harder to interpret, because long-run data on happiness measures isn't available for many countries, and the wording of the survey questions about life satisfaction often changes over time. While acknowledging that the existing evidence is messy and difficult to interpret firmly, the authors argue that it is at least consistent with the same finding: that is, higher income levels over time are correlated with higher reported life satisfaction.

But not for the United States! Sacks, Stevenson, and Wolfers write: "The US, however, remains a paradoxical counter-example: GDP has approximately doubled since 1972 and well-being, as measured by the General Social Survey, has decreased slightly." The authors point out that any individual country may have specific social changes that alter the reported "life satisfaction." In particular, they point out that inequality of income started rising in the U.S. economy in the 1970s, which may explain why the typical or median person in the economy isn't feeling much better off. They write: "We suggest that the US is more of an interesting outlier than a key example."

Those who want to sort through why Sacks, Stevenson, and Wolfers reach different conclusion from Easterlin can dig into the paper itself: a lot of the difference, they argue, is just that more and better data is available now.

For my own part, I confess that I find happiness surveys both intriguing and dubious. It seems to me that higher levels of income are typically correlated with more health, education, travel, consumption, and a higher quality of recreation, so it's not a surprise to me it seems to me that happiness rises iwth income. On the other side, it does seem to me that survey questions about life satisfaction are answered in the context of a particular place and time. If a person says that their life satisfaction was a 7 in 1960 on a scale of 0-10, and another person says that their life satisfaction is a 7 in 2013, are those two people really equally satisfied? To put it another way, if the person from 2013 was transported by a time machine back to live in 1960, with all their memories and knowledge of the technologies, medicines, foods, education, and travel available in 2013, would that time traveller really be equally happy in either time period? I suspect that when most people are asked to rank happiness on a scale of 0-10, they don't say to themselves: "Well, people living 100 years from now might have extraordinarily high levels of income and technology, so compared with them, I'm really no more than a 2." At best, survey questions on a scale of 0-10 seem like an extremely rough-and-ready way of measuring life satisfaction across very different countries or across substantial periods of time.

Tuesday, January 22, 2013

Wealth-Income Ratios in the Long Run

Thomas Piketty and Gabriel Zucman have been building up an intriguing set of estimates of wealth/income ratios, both over time and across countries. The U.S. wealth/income measures look quite mainstream by European standards, both in the last few decades and when looking back to 1870. The graphs that follow are from an October 2012 presentation called  "Capital is Back:Wealth-Income Ratios in Rich Countries 1870-2010." 

 Just to be clear, "income" to economists is a "flow" concept over a period of time--for example, it might be what you receive in compensation for your labor and in return on your savings in a certain year. Wealth, on the other hand, is a "stock" concept of the accumulation of assets over time--for a person, it would include the value of equity in your home, as well as the value of what's in your savings account or other financial investments. High income and wealth do tend to go together. But it's possible to have high income, spend it all, and have little wealth; alternatively, it's possible to have low income but steady saving, or perhaps the good luck to invest in the early days of IBM or Apple or Google, and end up with high wealth.

For starters, here's the wealth/income ratio for nine countries from 1970-2010. To help make sense of the graph, let's pick out a few of the countries. The line that peaks far above other countries in the middle of the figure, at around 700% in 1990, is Japan at the height of its stock market and property bubble. The country with the highest wealth/income level in 2010 was Spain, presumably driven by a property-market price bubble in that country. The line of black squares, marching higher in recent years, is Italy. In short, a high wealth/income ratio can be a danger signal of possible bubbles in asset markets. Meanwhile, fundamentally healthy economies like Germany (dark triangles) and Canada (light triangles) have seen a rise in wealth/income ratios, but are at the bottom of the range of this group of countries. The U.S. (hollow triangles) is in the middle of the pack. If you look closely, you can see a rise in the U.S. wealth/income ratio in the late 1990s for the dot-com bubble, and again in the mid-2000s for the housing price bubble, but the 2010 value for the U.S. is near the bottom of the range.

Now here's a longer-term perspective, from 1870 to 2010, comparing several major economies of Europe and the United States. In this long-run perspective, both Europe and the U.S. have had a U-shaped pattern of wealth/income ratios over time, but the European U rises higher and dips deeper than the American U.

Just what the wealth/income ratio telling us? Here are some thoughts:

1) When wealth/income spikes up, it's a potential danger sign of financial instability in the economy.

2) Wealth is typically much more concentrated than income, and so when the wealth/income ratio is high, the political power of those holding lots of assets is probably stronger. The power of mega-rich billionaires, not just in the U.S. and Europe, but also in China and across fast-growing economies of the world, is large and growing. 

3) The long-run data suggests that the wealth/income ratios observed from, say, 1940 up to about 1980, were historically on the low side. Thus, it may be that the rise in wealth/income ratios in the last few decades is a return to historical norms. (Piketty and Zucman make this case in more detail.)

4) As Picketty and Zucman write: "There’s nothing bad about the return of capital: k is useful; but it raises new issues about k regulation & taxation." In general, as wealth becomes relatively more important, it deserves a larger share of our social discussion and public policy attention.

For those who are interested, here's a post from June 13, 2012, on "Wealth by Distribution, Region, and Age" in the United States. 

Monday, January 21, 2013

U.S. as a Capital Importer

For a few years now, one of my mental images of the world economy is that the U.S. economy is by far the major importer of capital, while the major exporters of capital are China, Germany, and Japan. While that mental image remains true, the situation isn't as extreme as a few years back.

Here's are the pie graph for 2005, from the Global Financial Stability Report of the IMF. That year, the U.S. economy absorbed nearly two-thirds of all global capital imports. Japan was the major exporter of capital that hear, followed by China and Germany, with Saudi Arabia and Russia also playing large roles.

Now here's the comparable graph for 2011. The U.S. economy is now absorbing only about one-third of all global capital imports. Germany has become the world's largest capital exporter, edging out  China, and then followed by Saudi Arabia and Japan.

On the U.S. side, a large part  of what is driving this change is the reduction in the U.S. trade deficits. Here's a figure showing U.S. current account balances as a share of GDP, created with the ever-useful FRED website run by the St. Louis Fed. After the trade deficit had truly plummeted around 2006, at the worst of housing bubble, it is now back to the depths plumbed during the mid-1980s.

And here's a figure showing quarterly inflows of foreign capital to the U.S. economy. Notice how the U.S. economy became dramatically more dependent on inflows of foreign capital as the housing price bubble inflated during the mid-2000s. In addition, one the reasons behind the financial crisis and lack of available capital during the darkest times of late 2008 and early 2009 was that inflows of international dropped so dramatically--actually turning into outflows for a brief time. The inflow of international capital then rebounded before plummeting again, and turning into outflows during the second quarter of 2012.

Thus, it's fair to note that the U.S. economy is not absorbing the same share of global capital imports as it was a few years back--but it still absorbs an outsized share of global capital imports. In addition, the sharp drops in the quantities of foreign capital coming into the U.S. economy, both during the Great Recession and then from mid-2010 into early 2012, show how the U.S. has come to depend on these inflows of capital imports--and how the U.S. economy can be vulnerable to these inflows being disrupted.

Friday, January 18, 2013

Biofuels and Hunger in Low-Income Countries

TBack in late 2011, I amused myself for a time tracking the reports in which various well-known agencies pointed out the flaws in subsidizing biofuels. a June 2011 post, "Everyone Hates Biofuels," I pointed out a report in which 10 international agencies made an unambiguous proposal that high-income countries drop their subsidies for biofuels. I followed up with "The Committee on World Food Security Hates Biofuels" in August 2011 and  "More on Hating Biofuels: The National Research Council" in October 2011.

But of all the problems with subsidizing the production of ethanol from corn--the cost, the distortions in price of farmland, the lack of any reductions in carbon dioxide emissions, and others--clearly the most serious problem is that that it is causing people in low-income countries to go hungry. Timothy A. Wise lays out "The Cost to Developing Countries of U.S. Corn Ethanol Expansion" in a working paper published in October 2012 by the Global Development and Environment Institute at Tufts University.

The article offers a lot more detail, but the basic outline is simple enough. Primarily because of government subsidies, the share of the U.S. corn crop going to produce ethanol has risen dramatically in the last few years, up to about 40%.

There are  number of reasons why global prices for corn have gone sky-high in the last few years, like the drought in summer 2012 that cut the U.S. corn harvest, but one of the major factors is clearly that government subsidies are diverting large share of corn production into ethanol. Here's a graph of global corn ("maize") prices.

This rise in corn prices has hit many low-income countries especially hard. Wise explains: "Over the last fifty years, and particularly since the 1980s, the world’s least developed countries have gone from being small net exporters of agricultural goods to huge net importers. ... The shift came when structural reforms in the 1980s, usually mandated by the International Monetary Fund and the
World Bank, forced indebted developing country governments to open their economies to
agricultural imports while reducing their own domestic support for farmers. The result: a flood of cheap and often-subsidized imports from rich countries forcing local farmers out of business and off the land." Here's a figure showing how the agricultural trade balance for low-income countries has evolved.

Wise estimates: "Using conservative estimates from a study on ethanol and corn prices, we find that from 2006-2011 U.S. ethanol expansion cost net corn importing countries worldwide $11.6 billion in higher corn prices with more than half of that cost, $6.6 billion, borne by developing countries." Of course, the  high prices for corn hit the pocketbooks of low-income people in low-income countries the hardest.

It's been clear for awhile now that subsidizing the production of corn-based ethanol was primarily a subsidy that flowed to large agri-business concerns that grow and process most of the corn in the United States. These subsidies aren't just a costly and ineffective way of pursuing lower energy imports and reduced carbon emissions--they are also causing higher food prices and hunger for some of the poorest people in the world. They should be stopped.

Thursday, January 17, 2013

Too Much Concern about International Reserves?

A few weeks back on December 19, I posted on "Can $12.1 Trillion be Boring? Thoughts on International Reserves." In that post, Edwin Truman explained the reasons why the enormous size of international reserves should be a legitimate policy concern. As a contrasting point of view, the Independent Evaluation Office of the International Monetary Fund has published a report on "International Reserves: IMF Concerns and Country Perspectives," which makes the case that the IMF and others have overemphasized the potential problems of large international reserves and understated their benefits. 

(For the record, the IMF deserves credit for the existence of the Independent Evaluation Office, which was set up in 2001 with a staff of 11, mostly recruited from outside the IMF, to provide an alternative evaluation of IMF policies.)

Everyone agrees that international reserves have taken off in recent years, largely driven by changes in China, along with other emerging and developing nations.

Worrying about large and growign international reserves may be part of the intellectual DNA of the IMF; after all, the organization was formed in large part to provide a way of dealing with balance of payments problems imbalances across countries. But as the Independent Evaluation Office report points out, countries holding these reserves feel that the IMF should be turning its attention to other targets. Here are some of the arguments (footnotes omitted). 

International reserves are modest relative to overall global capital markets--and the private-sector portion of those markets in particular should be the real cause of instability and concern.

"International reserves remain small relative to the global stock of financial assets under private management ... There is considerable historical precedent and economic analysis to suggest that concerns about global financial stability should focus more closely on trends in private asset accumulation and capital flows. Country officials and private sector representatives also noted that the IMF should be more attentive to the accumulation of the private foreign assets that are the consequence of persistent current account surpluses, and which from a historical perspective have arguably been more destabilizing than official reserve accumulation." For illustration, here's a figure showing those international reserves in comparison with other global financial assets. 

Countries that hold large international reserves see them as providing a number of benefits. 

"There was a common view among country authorities that the IMF tended to
underestimate the benefits of reserves. Thinking about the tradeoff between costs and
benefits of reserves, country officials often mentioned a range of benefits that they
considered important but were not easily incorporated into either single indicators or formal
models. In addition to precautionary self-insurance (also emphasized by the Fund), they
mentioned other important advantages: reserves provide a country with reliability of access
and the policy autonomy to act quickly, flexibly, and counter cyclically, and, as was evident
during the global crisis, they inspire confidence. Reserves have also allowed authorities to
avoid the stigma associated with approaching the Fund for resources—an issue that is very
much alive in a number of countries."

Large international reserves are a symptom of the concerns that countries have about instability of capital flows in the global economy, and rather than worrying about this symptom, policy-makers should focus on underlying causes. 

"Most country officials interviewed for this evaluation also felt that in a discussion of
the stability of the international monetary system, there were more pressing issues to be
considered. These included the fluctuating leverage in global financial institutions and its
impact on global liquidity conditions and hence capital flows and exchange rate volatility;
the role and effectiveness of prudential regulations and supervision in mitigating risks
associated with cross-border finance; and the difficulty in managing capital flows in recipient

A final point made in the IEO report, which seems to me to have a ring of truth, is that a lot of the concern over outsized international financial reserves is really about the reserves held by China. The enormous reserves held by Japan, for example, don't seem to stimulate the same amount of angst. It's probably not wise to try to set a wide-ranging international reserve policy for countries across the world based heavily on the experience of China, which is an extraordinary case in so many ways. 

Wednesday, January 16, 2013

Less Globalization Than You Think: The DHL Global Connectedness Index

Pankaj Ghemawat of the IESE Business School at the Univesity of Navarra in Spain, together with Steven A. Altman, is the author of the DHL Global Connectedness Index 2012. The report has a lot of interesting angles for looking at the extent of globalization in recent years, but I was especially interested in an argument I've made a few times--that while globalization has definitely increased by historical standards, the movement toward globalization is nowhere close to complete, and has in fact stalled in the last few years. The report looks at many dimensions of global connnectedness: here, I'll focus on international flows of goods and services, flows of capital, and international flows of communication and information.

For international flows of goods and capital, this figure shows total exports of goods and services as as share of world GDP. Of course, the estimates from the 19th century and first half of the 20th century are based on less data, but the overall patterns are clear: a first wave of 19th century globalization that lasted up until about the start of World War I, the stagnation or even decline of globalization until after World War II, and then the second wave of globalization since then. Globalization is near an all-time high by this measure, but notice that it after the drop associated with the Great Recession, this measure of globalization is about the same in 2011 as it was in 2007.

A couple of other thoughts to help put this figure in perspective. While the levels of exports/world GDP is high by historical standards, there's still a lot of room for it to expand further. As the report says: "Furthermore, while 20% (or even 30%) of goods and services being traded across borders is far more than the same ratio mere decades ago, it is still far short of the 90% or more that one would expect if borders and distance did not matter at all. If the world truly became “flat,” countries’ exports-to-GDP ratios would tend toward an average of 1 minus their shares of world GDP since buyers would be no more likely to purchase goods and services from their home countries than from abroad. Borders and distance still matter a great deal, implying that even the most connected countries have substantial headroom available to participate more in international trade."

In addition, although the volume of trade has risen, the distance that trade travels on average, between the sending and the receiving country, has not risen. In that sense, geographical distance still very much affects trade."The global connectedness patterns traced in this report also highlight how distance, far from being dead, continues to depress connectedness of all types. While the distance
between a randomly selected pair of countries is roughly 8,500 km, the average distance traversed by merchandise trade, foreign direct investment flows, telephone calls, and human migration all cluster in the range from 3900 km to 4750 km. This accords with the finding that most international
flows take place within rather than between continental regions. ...

[F]ocusing on trade in goods only rather than goods and services combined, as of 2011, 47% of trade took place between countries in different regions rather than within the same region, a proportion that has typically been between 40% and 50% since 1965. The average distance traveled by a dollar worth of traded merchandise in 2011 was roughly 4,750 kilometers, also in line with historical norms over the past four decades ... Thus, while the depth of merchandise trade (the volume of goods traded in comparison to total economic output) has scaled new heights in recent decades, that trend has not been matched by an extension of the distances traveled by traded goods on average. Rather, much of the action in terms of trade integration has been the weaving together of national economies within the same region."

When it comes to flows of foreign direct investment, a similar pattern holds: it's at an historically high level, but it's still recovering from the Great Recession. Here's the figure.

More detailed analysis shows that the "breadth" of  foreign direct investment, as measured by gthe range of different countries receiving such investment, has declined since 2007.The report expalins this way: "This pattern of declining breadth scores was not matched by declines in the average distance “traveled” by FDI or the proportion that occurs between rather than within regions.
Rather, the average distance “traveled” by FDI flows rose from 2007 to 2010 from roughly 4000 to 4900 kilometers and the proportion taking place within regions declined from 58% to 52%. These patterns suggest that while investors are indeed keeping more money at home (declining
depth), they are not generally shifting their foreign investments from distant countries to neighbors. Rather, they are selectively choosing a narrower set of investment destinations, some of which may be distant safe havens, selected in part to diversify risks in investors’ home regions."

We all know that the internet and related technologies have opened up extraordinary possibilities for information and communication to flow across national borders. But by and large, people are still using those technologies to connect with others closer to home. Here are some comments from the report:

"While new technologies indeed have made it far easier and cheaper to share information with people on the other side of the world, we actually tend to use these technologies much more intensively to connect to people close to home. Consider, first of all, postal communications. As a result of efforts spearheaded by the Universal Postal Union, organized in 1874 and one of the world’s first global institutions, it has long been fairly simple to send mail anywhere in the world. And yet, only about 1 percent of all letter mail sent around the world is international.

"What about telephone calls? Only 2 percent of voice calling minutes are international despite rapidly falling costs and improving call quality. These figures do exclude calls placed over the internet via services such as Skype, but including calls over such services would not push this ratio up past 5%. ...

"Global data on information flows over the internet, however, indicate that while internet traffic is more international than phone calls or mail, it remains primarily domestic, with international internet traffic accounting for about 17% of the total. And what about communications on social media? Facebook aims to provide a platform for “frictionless” sharing that theoretically makes it as easy to “friend” someone around the world as one’s next door neighbor. But the reality is that relationships on social media reflect offline human relationships that remain highly distance sensitive. Less than 15 percent of Facebook friends live in different countries. ...

"While the growth of international internet bandwidth implies that we can just as easily read foreign news websites as domestic ones, people still overwhelmingly get their news from domestic sources when they go online: news page views from foreign news sites constitute 1% of the total in Germany, 3% in France, 5% in the United Kingdom and 6% in the United States (and are in single digits everywhere else sampled – as low as 0.1% in China). Furthermore, news coverage by domestic sources itself tends to be very domestic. In the U.S., 21% of U.S. news coverage across all media was international according to a recent study, and of that 11 percent dealt with U.S. foreign affairs (such as U.S. diplomacy and military engagements), leaving only 10% of coverage for topics entirely unrelated to the U.S."
When it comes to focusing on the U.S. economy in particular, our particular experience of globalization differs from most other countries. The U.S. has a huge internal economy, and so our international trade--relative to the size of the huge domestic U.S. economy--is actually much smaller than most other countries. However, U.S. economic ties are very widespread: in the terminology of the report, U.S. global connectedness has a lot of "breadth." In addition, U.S. global connectedness is more related to finance than to goods and services. Here's the report:

"The United States ranks 20th overall [in global connectedness] and has the world´s second highest breadth score, reflecting its significant ties to nearly every other country around the world. It has a more modest rank on depth (89th), which is not unusual for a country with a very large internal market. The U.S. has its strongest position on the capital pillar on which it ranks 6th overall and 1st on breadth. On the other hand, the U.S. has a remarkably low score on the trade pillar, 76th overall and 139th (next to last) on depth. Merchandise and services exports account for only 14% of U.S. GDP and imports add up to only 18%. The U.S. has maintained a stable level of connectedness since 2007."

For those who doubt and oppose the movement to globalization, there is a good news/bad news story here: sure, globalization has risen, but it remains far from dominant. For those who welcome and support the movement to globalization, there's a converse good news/bad news story here: sure, globalization has risen, but there is so very much further to go. The report takes the second view, and offers an interesting argument that the potential gains from additional trade may be substantially larger than many economic models suggest:

"[I]n calculating the benefits of additional trade, these kinds of models focus almost exclusively on growth generated by reductions in production costs as each country’s output becomes more specialized, a limited fraction of the potential gains. To broaden the range of benefits covered, consider a modified version of the ADDING Value Scorecard, a framework originally developed to help businesses evaluate international strategies. ADDING is an acronym for the following sources of value: Adding Volume, Decreasing Costs, Differentiating, Intensifying Competition, Normalizing Risk, and Generating and Diffusing Knowledge. Because traditional models assume full employment (especially problematic in times like these) and leave out scale economies, they capture only part of the gains in the first two categories, Adding Volume and Decreasing Costs. And they entirely leave out the last four categories, whose benefits can be seen clearly, for example, in the U.S. automobile industry. Decades ago, Japanese automakers started offering consumers differentiated (more reliable) products. Increased competition prompted U.S. automakers to improve their own quality. Now, GM sells more cars in China than in the U.S., diversifying its risks and helping it recover from the crisis. And cars are becoming “greener” faster because of international knowledge flows."

Taking these sorts of factors into account, the report estimates that reasonable expansions of globalization could generate gains on the order of 8% of world GDP: in round numbers, call that $5 trillion or so per year in benefits.

A final note: My discussion of the report touches on some of the main points that caught my eye, but completely leaves out other points, like discussions of specific countries, of regional differences, international migration, industry studies of mobile phones, cars, and pharmaceuticals, and more. Thus, those interested in additional detail and insights will find a lot more in this report.

Tuesday, January 15, 2013

Management in U.S. Manufacturing Firms

Everyone knows that good management matters, but in a research study, how do you define "good management"? For example, defining "good management" according to whether a company earns high profits would be circular logic; it would assume ("good management leads to higher profits") what needs to be proven. Instead, "good management" has to be defined in some at least moderately objective way, so it can then be compared to how firms perform.

Nicholas Bloom and John Van Reenen, along with various co-authors, have been leaders in academic work that bravely seeks to define "good management," surveys the management practices of firms,  and then looks at how firms with "good management" are performing. Much of their early work compared management practices across countries: for example, see their  article "Why Do Management Practices Differ across Firms and Countries?" in the Winter 2010 issue of my own Journal of Economic Perspectives.

But now the U.S. Census Bureau has for the first time used this approach as part of a survey of 30,000 U.S. manufacturing firms.  A group of authors include Bloom and van Reenen, together with
Erik Brynjolfsson, Lucia Foster, Ron Jarmin, and Itay Saporta-Eksten provide the first glimpse of these results in "Management in America," a discussion paper written for the Center for Economic Studies, which is based in the U.S. Census Bureau.

Before describing the results, it's useful to say a bit more about how "good management" is measured in this survey. They refer to it as "structured management," a term which is more neutral than  "good." But the basic concept is a list of 16 questions about management at the firm, divided into questions about monitoring, targets and incentives. They offer these examples:

"The monitoring section asked firms about their collection and use of information to monitor and improve the production process. For example, how frequently were performance indicators tracked at the establishment, with options ranging from “never” to “hourly or more frequently”. The targets section asked about the design, integration and realism of production targets. For example, what was the time-frame of production targets, ranging from “no production targets” to “combination of short-term and long-term production targets”. Finally, the incentives asked about non-managerial and managerial bonus, promotion and reassignment/dismissal practices. For example, how were managers promoted at the establishment, with answers ranging from “mainly on factors other than performance and ability, for example tenure or family connections” to “solely on performance and ability”? The full questionnaire is available on" 

For each of the 16 questions, they arbitrarily say that the lowest possible answer is given a score of 0, the highest possible answer is given a score of 1, and in-between answers are given fractional totals. They then just sum up the total points to get a management score for each firm. A number of other questions collect information both about the firm and about the personal characteristics of the middle manager answering the survey. Those who want additional gory details on the survey process can head for the report. Here are some findings.

The obvious starting point is to figure out whether manufacturing firms that get higher scores for "structured management" are performing better in some way. They divide up the firms into tenths, or deciles, from lowest score to highest, and find that firms with higher scores do better on profits, productivity, output growth, research and development spending, and patents. Here are a few sample figures to give you a feeling for what these relationships look like. The relationships continue to hold after adjusting for all the obvious factors, like size of firm, industry type, and the like.

An additional conclusion is that there is a great deal of variation in structured management across firms. As they write: "[T]here is enormous dispersion of management practices across America: 18% of establishments adopt at least 75% of structured management practices for performance monitoring, targets and incentives; while 27% of establishments adopt less than 50% of these practices."

They also find that management scores tend to be growing from 2005 to 2010; that management scores are higher in larger firms; and that firms in the South and Midwest tend to have  higher management scores that firms in the West and Northeast.

This research is, if not quite in its infancy, still in its toddler-hood, and so it would be unwise to draw conclusions too aggressively. But some preliminary conclusions would be: 1) It's possible to come up with a survey tool that captures at least a significant portion of what is meant by "good management;" 2) This measure of management appears to be correlated with positive performance by firms on a number of dimensions; and 3) This measure of management differs quite substantially across firms.

But there are also difficulties at this stage. Good management, of course, isn't just a matter of responding in a certain way on survey questions, or announcing a certain set of policies. In real life, good management is also about implementing those policies, and even of having a culture within the company in which the implementation of those policies is widely practiced and accepted. It may be, for example, that companies which lack structured management have a range of other problems or issues not well-captured by the existing data. It may be that implementing more structured management in a company that isn't used to this approach will prove difficult process in many firms. I expect that future research will delve more deeply into these issues, and others. 

Monday, January 14, 2013

Some Thoughts on James Buchanan

When I think of James Buchanan, who died last week, I remember hearing him answer a question at a conference in the late 1980s, not long after he had won the 1986 Nobel prize. A questioner with stars in his eyes asked how Buchanan had been able to write, not a few dozen journal articles, but a series of more than 30 book-length tomes like The Calculus of Consent during his career. (In fact, Buchanan's work was later collected into 20 volumes.) Buchanan paused for a moment, the very image of a courtly, soft-spoken, silver-haired Southern professor, and then gently drawled: "Apply butt to chair." Words to live by!

I had barely heard of Buchanan's work when he won the Nobel prize in 1986: it certainly didn't have much prominence in my undergraduate or graduate studies in economics. But Buchanan contributed an article, "Tax Reform as Political Choice," to the first issue of my own Journal of Economic Perspectives in Summer 1987. (As with all JEP articles from the first issue to the most recent, it is freely available on-line courtesy of the American Economic Association.)

At that time, Buchanan had just presented his Nobel lecture, "The Constitution of Economic Policy,"
which offers an overview of his arguments about how economists should do policy analysis. He quoted the great Swedish economist Knut Wicksell (1851-1926) who wrote things like: "[N]either the executive nor the legislative body, and even less the deciding majority in the latter, are in reality ... what the ruling theory tells us they should be. They are not pure organs of the community with no thought other than to promote the common weal. ... [M]embers of the representative body are, in the overwhelming majority of cases, precisely as interested in the general welfare as are their constituents, neither more nor less."

In a similar spirit, here's Buchanan in his own words: "Economists should cease proffering policy advice as if they were employed by a benevolent despot, and they should look to the structure within which political decisions are made. ... I called upon my fellow economists to postulate some model of the state, of politics, before proceeding to analyse the effects of alternative policy measures. I urged economists to look at the "constitution of economic polity," to examine the rules, the constraints within which political agents act. Like Wicksell, my purpose was ultimately normative rather than antiseptically scientific. I sought to make economic sense out of the relationship between the individual and the state before proceeding to advance policy nostrums."

The first issue of JEP back in 1987 had a symposium on the 1986 Tax Reform Act, and in his JEP paper, Buchanan applied his perspective to how one might think about the passage of a largely revenue-neutral tax reform that sought to reduce special deductions, credits, and deductions, and to use the revenue saved to reduce marginal tax rates.

Buchanan argued that the "political agents" who set tax policy in general prefer higher taxes, because they like to have control over more resources. They also like to offer tax breaks to special constituencies, who reward them with political support. But as the political agents offer tax breaks to special constituencies, they need to ratchet up tax rates on others--and as those rates get higher, it becomes harder to offer still more tax breaks. From the perspective of these kinds of political agents, the 1986 tax reform could thus be interpreted as a chance to wipe the slate clean: that is, start over again with lower tax rates and fewer tax breaks. But this just meant that the political agents could then again start their pattern of offering tax breaks and pushing up rates all over again.

"The 1986 broadening of the tax base by closing several established loopholes and shelters offers potential rents to those agents who can promise to renegotiate the package, piecemeal, in subsequent rounds of the tax game. The special interest lobbyists, whose clients suffered capital value losses in the 1986 exercise, may find their personal opportunities widened after 1986, as legislators seek out personal and private rents by offering to narrow the tax base again. In one fell swoop, the political agents may have created for themselves the potential for substantially increased rents. This rent-seeking hypothesis will clearly be tested by the fiscal politics of the post-1986 years. To the extent that agents do possess discretionary authority, the tax structure established in 1986 will not be left substantially in place for decades or even years."
Over time, Buchanan's prediction has held true: new tax breaks have been created, and marginal tax rates have been pushed back up to pay for them. Thus, one common proposal for dealing with the disturbing prospects of long-run budget deficits is to raise additional revenue by limiting many tax breaks, and then using some of the revenue for lower marginal tax rates and some for deficit reduction. For previous posts of mine about such proposals, see my February 2012 post on  "Tax Expenditures: A Way to End Budget Gridlock?" or my  August 2011 post on "Tax Expenditures: One Way Out of the Budget Morass?"

Of course, Buchanan's work is a continual reminder that even when economists are involved in drawing up some plans for a tax reform that would broaden the tax rates and lower the base, political agents will be the ones who actually draw up the plan, vote on it, and determine how much it changes each year. This insight about the centrality of politics is perhaps obvious to the average person, but many of us who focus on the economy can lose sight of it. Buchanan's work is one reason that in my own Principles of Economics textbook  (available here), I follow up all the chapters on what can go wrong in markets--monopoly, externalities, public goods, inequality, incomplete information, all the rest--with a chapter on political economy. As a teacher, I want to encourage students to be thoughtful skeptics of how markets work, but I also want them to be equally skeptical about the extent to which political agents will implement the sort of economically enlightened policies that will actually address the problems of markets.
Buchanan's obituary in the New York Times is here. It closes with a great line from Buchanan, who once said: “I have faced a sometimes lonely and mostly losing battle of ideas for some 30 years now in efforts to bring academic economists’ opinions into line with those of the man on the street. ... My task has been to ‘uneducate’ the economists.”

Friday, January 11, 2013

The National Taxpayer Advocate Speaks Up

Yes,.there is a National Taxpayer's Advocate, and her name is Nina E. Olson. She has just released the National Taxpayer Advocate 2012 Annual Report to Congress. The report covers a lot of ground, each year looking at issues like taxpayer rights, taxpayer rights, identity theft, and other topics. Here, I'll just focus on one topic:  "The most serious problem facing taxpayers — and the IRS — is the complexity of the Internal Revenue Code." Here are some samples of the comments (footnotes omitted): 

  • "According to a TAS analysis of IRS data, individuals and businesses spend about 6.1 billion hours a year complying with the filing requirements of the Internal Revenue Code. And that figure does not include the millions of additional hours that taxpayers must spend when they are required to respond to IRS notices or audits. If tax compliance were an industry, it would be one of the largest in the United States. To consume 6.1 billion hours, the “tax industry” requires the equivalent of more than three million full-time workers. ... Based on Bureau of Labor Statistics data on the hourly cost of an employee, TAS estimates that the costs of complying with the individual and income tax requirements for 2010 amounted to $168 billion — or a staggering 15 percent of aggregate income tax receipts."
  • "According to a tally compiled by a leading publisher of tax information, there have been approximately 4,680 changes to the tax code since 2001, an average of more than one a day."
  • "The tax code has grown so long that it has become challenging even to figure out how long it is. A search of the Code conducted using the “word count” feature in Microsoft Word turned up nearly four million words."
  • "Individual taxpayers find return preparation so overwhelming that about 59 percent now pay preparers to do it for them. Among unincorporated business taxpayers, the figure rises to about 71 percent. An additional 30 percent of individual taxpayers use tax software to help them prepare their returns, with leading software packages costing $50 or more."
  • "IRS data show that when taxpayers have a choice about reporting their income, tax compliance rates are remarkably low. ... [A]mong workers whose income is not subject to tax withholding, compliance rates plummet. An IRS study found that nonfarm sole proprietors report only 43 percent of their business income and unincorporated farming businesses report only 28 percent. Noncompliance cheats honest taxpayers, who indirectly pay more to make up the difference. According to the IRS’s most recent comprehensive estimate, the net tax gap stood at $385 billion in 2006, when there were 116 million households in the United States. This means that each household was effectively paying a “surtax” of some $3,300 to subsidize noncompliance by others."
  • "From FY 2004 to FY 2012, the number of calls the IRS received from taxpayers on its Accounts Management phone lines increased from 71 million to 108 million, yet the number of calls answered by telephone assistors declined from 36 million to 31 million. The IRS has increased its ability to handle taxpayer calls using automation, but even so, the percentage of calls from taxpayers seeking to speak with a telephone assistor that the IRS answered dropped from 87 percent to 68 percent over the
    period. And among the callers who got through, the average time they spent waiting on hold increased from just over 2½ minutes in FY 2004 to nearly 17 minutes in FY 2012."
  • "The IRS receives more than ten million letters from taxpayers each year responding to IRS adjustment notices. Comparing the final week of FY 2004 with the final week of FY 20102, the backlog of taxpayer correspondence in the tax adjustments inventory increased by 188 percent (from 357,151 to 1,028,539 pieces), and the percentage of taxpayer correspondence classified as “overage” jumped by 316 percent (from 11.5 percent to 47.8 percent)."
  • "In 2012, TAS [the Taxpayer Advocate Service] conducted a statistically representative national survey of over 3,300 taxpayers who operate businesses as sole proprietors. Only 16 percent said they believe the tax laws are fair. Only 12 percent said they believe taxpayers pay their fair share of taxes."
  • "To alleviate taxpayer burden and enhance public confidence in the integrity of the tax system, the National Taxpayer Advocate urges Congress to vastly simplify the tax code. In general, this means paring back the number of income exclusions, exemptions, deductions, and credits (generally known as “tax expenditures”). For fiscal year (FY) 2013, the Joint Committee on Taxation has projected that tax expenditures will come to about $1.09 trillion, while individual income tax revenue is projected to be about $1.36 trillion. This suggests that if Congress were to eliminate all tax expenditures, it could cut individual income tax rates by about 44 percent and still generate about the same amount of revenue."

Finally, I'm not the biggest fan of infographics,which often seem to me like overcrowded Powerpoint slides on steroids. But for those who like them, here's one from the National Taxpayer Advocate summarizing many of these points: 

Thursday, January 10, 2013

FTC Data on Horizontal Merger Enforcement

The Federal Trade Commission has published Horizontal Merger Investigation Data: Fiscal Years 1996 - 2011. I found it interesting to notice the categories the report used to classify about horizontal merger enforcement: and the categorizes them along five dimensions: the Herfindahl-Hirschman Index before and after the proposed merger, the number of competitors in the market, the presence of "hot documents," the presence of "strong customer complaints," and ease of entry into the market.
 What surprised me was that the the notion of classifying merger policy along these kinds of categories is often de-emphasized in the recent economic research literature on industrial organization. Here, I'll first say a bit about the categories in the FTC report, and then compare it to the emphasis of recent empirical work in industrial organization.

The data for the FTC report comes from a requirement in the Hart Scott Rodino legislation, which I described in a post last June 14, "Next Merger Wave Coming? Hart-Scott-Rodino 2011," which reviewed some of the evidence from the annual HSR report. As I noted there: "The Hart-Scott-Rodino legislation requires that when businesses plan a merger or an acquisition above a certain price--typically $66 million in 2011--it must first be reported to the Federal Trade Commission. The FTC can let the merger proceed, or request more information. Based on that additional information, the FTC can then let the merger proceed, block it, or approve it subject to various conditions (for example, requiring that the merged entity divest itself of certain parts of the business to preserve competition in those areas)." Thus, the  most recent FTC report looks at those 464 horizontal merger cases from 1996-2011 where the FTC requested additional information, and whether those requests led to an enforcement action of some sort (either blocking the merger or placing conditions on it), or alternatively if the request was followed by closing the case without an enforcement action.

The firsts category discussed in the report is the Herfindahl-Hirschman Index (HHI): as the report says, "The HHI is the sum of the squares of the market shares of the competitors in the relevant market." In other words, if an industry has two firms, one with 60% of the market and one with 40% of the market, the HHI would be 60 squared, or 3600, plus 40 squared, or 1600, which would equal 5200. The highest possible HHI would be 10,000--that is, a complete monopoly with 100% of the market. The lowest HHI would be for an industry with many very small firms, each with only a miniscule portion of the market. After squaring these miniscule market shares and summing them up, the result would be a very low number.

Here's a table making HHI comparisons , with the columns showing how much the HHI would increase as a result of the merger and the rows showing the level of the HHI after the merger. This is measured across markets, where a given proposed merger often has implications across several different markets. Notice that none of the 14 cases where the post-merger HHI was less than 1700 and the rise in HHI was less than 99 led to an enforcement action. In the cells in the bottom right corner, if the post-merger HHI is above 3,000 and the gain in the HHI is above about 800, it's highly likely that an enforcement action will be taken. 
The next category in the FTC report is the number of competitors--which of course, in some ways, is based on the same information used to calculation the HHI. In the 20 cases with more than 10 competitors, there were no enforcement actions. But if the number of competitors is being reduced from 2 to 1, or 3 to 2, or 4 to 3, the request for additional information is very likely to lead to an enforcement action.

The FTC report then looks at a few other categories. "Hot documents" refers to a "cases where the staff identified one or more party documents clearly predicting merger-related anticompetitive effects." "Strong customer complaints" refers to cases "where customers expressed a credible concern that a significant anticompetitive effect would result if the transaction were allowed to proceed." And "ease of entry" is determined by an assessment by the FTC staff of the "timeliness, likelihood, and sufficiency" of entry. As one would expect, hot documents and strong customer complaints make enforcement actions more likely; ease of entry makes enforcement less likely.

 For teachers of undergraduate or high school courses in economics, this may all seem pretty straightforward, basically offering some background material for what is already being taught. But what was striking to me is that the direction of research in empirical industrial organization in recent years has tended to steer away from the HHI and such measures. For a nice discussion, I recommend
the discussion by  Liran Einav and Jonathan Levin of "Empirical Industrial Organization:A Progress Report," which appeared in the Spring 2010 issue of my own  Journal of Economic Perspectives. Like all articles in JEP going back to the first issue in 1987, it is freely available on-line courtesy of the American Economic Association.

As Einav and Levin point out, there was an older tradition in industrial organization called "structure-conduct-performance." It typically looked at the structure of an industry, as measured by something like the HHI, and then at how the industry behaved, and then at what profits the industry earned. But by the 1970s, it was clear that this approach had run into all kinds of problems. As one  example, the factors that were causing a certain industry structure might also be causing the high profits--so it would be muddled thinking to infer that the profits came from industry structure if both came from an outside factor. The available data on "profits" is based on accounting numbers, which differ in many ways from the economic concept of profits. More broadly, the whole idea that there should be common patterns across all industries in structure, conduct and performance seemed implausible.  They explain:

"Both the concerns about cross-industry regression models and the development of clearer theoretical foundations for analyzing imperfect competition set the stage for a dramatic shift in the 1980s toward what Bresnahan (1989) coined the “New Empirical Industrial Organization.” Underlying this approach was the idea that individual industries are sufficiently distinct, and industry details sufficiently important, that cross-industry variation was often going to be problematic ... Instead, the new wave of research set out to understand the institutional details of particular industries and to use this knowledge to test specific hypotheses about consumer or firm behavior, or to estimate models that could be used for counterfactual analysis, such as what would happen following a
merger or regulatory change. The current state of the fifi eld reflects this transition. Today, most of the influential research in empirical industrial organization looks extensively to economic theory for guidance, especially in modeling firm behavior. Studies frequently focus on a single industry or market, with careful attention paid to the institutional specifics, measurement of key variables, and econometric identification issues."
Einav and Levin go on to describe how this kind of research is done, and to evaluate its strengths and weaknesses. But my point here is that the summary of HHI, number of competitors and the rest across broad categories provided by the recent FTC report is quite different in spirit than how Einav and Levin are describing the research literature.

It seems to me that there are two possibilities here. The pessimistic view would be that the FTC just put together this report based on old categories and old thinking, and that it has little relevance to how antitrust analysis is actually done. But the more optimistic view, and the one that I prefer, is that the old traditional categories of measuring market structure with methods like the Herfindahl-Hirschman Index or a four-firm concentration ratio, as well as looking at factors like ease of entry, remain a more-than-adequate starting point for thinking about how antitrust enforcement is actually done. The more complex analysis described by Einav and Levin would then be applied to the hard cases, and discussion of the fine details of hard cases can be reserved for higher-level classes.