Supply and Demand (in that order)

President and Senator Obama not Straight on Food Stamp Eligibility

2012-01-27T08:10:00.000-08:00

President Obama recently said,

First of all, I don't put people on food stamps. People become eligible for food stamps. Second of all, the initial expansion of food-stamp eligibility happened under my Republican predecessor, not under me. Number three, when you have a disastrous economic crash that results in 8 million people losing their jobs, more people are going to need more support from government.

One major change in food stamp rules -- in the direction of more generosity -- occurred with the 2009 "stimulus" law, which has President Obama's signature, not Bush's.

Another major change in food stamp rules -- in the direction of more generosity -- occurred with the 2008 Farm Bill. We all know that Bush was president in 2008. But what Obama hopes you do not know is that Bush never signed it. Here's wikipedia's narrative:

On May 15, the House and Senate passed the bill, but President Bush issued a veto on May 21. The House voted to overturn the president's veto shortly thereafter, and with the margins by which the bill was passed, a Senate override also occurred; so the Congress overrode the president's veto, passing the bill into law (Public Law 110-234, the Food and Energy Security Act of 2007). However, the veto override was moot, as a 34-page section of the bill was omitted in the version sent to the White House. In effect, the President vetoed a bill Congress never considered. The bill had to be re-passed by Congress.

The House passed the Farm Bill again on May 22, and the Senate shortly thereafter. President Bush again vetoed the measure, but this veto was overridden in both Houses on June 18, so the Farm Bill in its entirety became law.

In summary, Bush vetoed that law twice.

Meanwhile, Obama was a U.S. Senator in 2008. Senator Obama had THREE chances to vote against it, but he never did (he abstained all three times).

Finally, President Obama's Agriculture Department has been remarkably complicit, if not wholeheartedly enthusiastic, with the states', since inauguration day, using the rules from the 2002 and 2008 Farm bills to soak the U.S. taxpayer.

Some, but very little, of the increase in food stamp spending can be attributed to the recession or any other factor pushing people into poverty. It's all about the program's getting more generous.

Whether expanding the food stamp program is "good" or "bad" is a different matter. President Obama deserves some of the credit or blame for those expansions; President Bush deserves none.

[Technical note. One of the provisions of the 2008 Farm Bill, and of the 2009 stimulus law, was to sharply increase what the USDA calls the "maximum benefit." This provision alone expands eligibility and participation, because the maximum benefit determines the amount of income over which food stamp benefits are fully phased out: a larger maximum means that incomes that would be assigned little or no benefit are suddenly assigned a significant benefit. That's part of the reason why the average income of people receiving food stamps actually INCREASED between 2007 and 2010 (see Table A.27 here). The provision also encourages states to do their part to expand eligibility.

Other eligibility related provisions include, but are not limited to, relaxation of the food stamp asset test (2008 Farm bill) and granting states some relief from the requirement that a fraction of their food stamp caseload be employed (2009 stimulus law).]

Who Receives Government Assistance?

2012-01-25T09:29:00.000-08:00

Copyright, The New York Times Company

Thanks to the recession, and changes in program rules, a large fraction of households receive government assistance, especially those headed by people without a four-year college degree.

The three largest government safety net programs serving nonelderly households are Medicaid, unemployment insurance and the Supplemental Nutrition Assistance Program (SNAP). Together they paid out more than $600 billion in benefits during 2010 on behalf of program participants.

A large number of households received these benefits. Using the results of the Census Bureau’s annual demographic survey, I classified nonelderly households by the educational attainment of the household head (I omitted the small number of households headed by people younger than age 25, because their educations might still be in progress), and calculated the fraction of them that received Medicaid, unemployment insurance and/or SNAP sometime during the years 2007 and 2010.

Source: Census Bureau

A few households headed by people with a four-year college degree or more received at least one of these three forms of government assistance, but their recipiency rates were much less than the rates among less educated households. Less than 10 percent of households headed by someone with a doctorate or professional degree (like an M.D. or law degree) received government assistance.

Over a third of households with heads whose formal education was limited to a high school diploma — the most common type of household — received at least one of these types of assistance in 2010. A majority of households with heads who stopped their schooling before graduating from high school received government assistance in 2010.

All of the groups saw the likelihood of government assistance increase between 2007 and 2010. Some of this increase, especially with the Medicaid program, can be attributed to the recession because Medicaid eligibility rules hardly changed during that time. At the same time, a number of people, especially in the less educated categories, saw their incomes fall below the poverty line, which makes Medicaid eligibility much more likely.

But changes in the rules for taking part in unemployment insurance and SNAP changed significantly during this time, and explain a large part of the changes between 2007 and 2010 shown in the chart.

We can hope that an economic expansion will take incomes back to where they were before the recession began, and beyond. But government assistance will not return to prerecession levels until participation rules do, and that return depends on political factors as much as economic ones.

How the States Use a Brochure to Siphon the U.S. Treasury

2012-01-18T06:41:00.000-08:00

My blog entry today explains how the number of SNAP households -- Washingtonspeak for number of families receiving food stamps from the federal government -- has exploded in recent years because states have helped rewrite the eligibility rules.

Specifically, most states have eliminated asset tests. You can own a yacht and now receive food stamps (a yacht is better than stocks or bonds, because the latter will spin off income that could make you ineligible for food stamps).

Aside from low income, even if it is just temporarily low, all you need is one of the states' brochures. For example, if you live in Connecticut, you need the "Helping People in Need" brochure and you are eligible for food stamps. (Actually, you don't need to possess such a brochure, you just need to have been deemed eligible by the state to have received one -- see p. 65 of this document, which means that the state understands your income to be at least temporarily below 150 percent of the poverty line or so). You do not need to be receiving, or eligible for, cash from any other welfare program.

I understand that you find the above difficult to believe. A brochure? That's it? Really?!

Take a look at what the USDA has to say (they fund SNAP, and help the states administer it):

By the end of fiscal year 2010, 39 States had adopted broad-based categorical eligibility (BBCE) policies that confer categorical SNAP eligibility on all households authorized to receive a TANF/MOE-funded noncash benefit. In such States, households meeting the State-determined eligibility criteria for the TANF/MOE-funded noncash benefit are also eligible for SNAP benefits and thus are exempt from the SNAP asset or income tests. The noncash benefit usually takes the form of an informational brochure or handout targeted to virtually all households applying for SNAP benefits. (page 4 of this USDA document)

(TANF is the cash family assistance program. Not too long ago food stamps and TANF were tied together -- if you got cash from TANF you probably would get food stamps too. The TANF language is a legacy of that connection).

Or here:

Many States have very broad programs that provide a simple service––a TANF/MOE-funded brochure on domestic violence, for example––to confer categorical eligibility on a large number of households. These policies are known as broad-based categorical eligibility (BBCE) policies. (pp. 56-7 of this USDA document)

Here is a Colorado state congressman explaining how it really is a free lunch from the states' points of view. The federal government pays for half of the brochure, and some states like Colorado even convince charities to help with the other half!

Testing for Need

2012-01-18T06:35:00.000-08:00

Copyright, The New York Times Company

One myth about the surge in federal government spending over the last four years is that it was an automatic response to the recession. But the “tests” that beneficiaries of various government safety-net programs are required to pass before they can participate have gotten easier since 2007.

The government safety net is intended to help people in need. Because a lot of people don’t need the government’s help, a variety of tests have been designed to distinguish the needy from everybody else. These include employment tests, asset tests, income tests, earnings tests, retirement tests and age tests.

Two of the largest government programs are Social Security and Medicare. They administer essentially one test, for age. Once a person reaches age 65 (sometimes earlier), he or she can receive benefits from these programs regardless of income, assets or employment status.

In the past, and still today in most of Europe, Social Security required beneficiaries not only to be elderly but to be retired – the retirement test.

These days unemployment insurance is another major government expenditure, and its beneficiaries have to pass an employment test. That is, they have to be without a job and actively looking for one in order to receive benefits (a few states have small programs for employed but underemployed workers). Once a person passes the employment test, his or her assets or financial income are irrelevant for determining eligibility or benefits.

Beginning in the 1990s, cash family assistance or “welfare” programs began to have their own employment tests, but with the opposite determination: employment was required for participation. The 2009 American Reinvestment and Recovery Act permitted states to relax some of these requirements.

Family assistance programs traditionally had asset and income tests: a family could qualify only if both its income and assets were low enough. Medicaid – a government-financed health-insurance program for the poor – also has asset and income tests. The Patient Protection and Affordable Care Act of 2010 relaxed some income tests effective 2014, although even then a family with too much income will not qualify for Medicaid.

Traditionally the food stamp program (now called the Supplemental Nutrition Assistance Program, or SNAP, and participants now receive debit cards from the Department of Agriculture, rather than “stamps”) overlapped closely with family assistance programs, with some of the same asset and income tests. The 2002 farm bill provided an opportunity to avoid some of the SNAP tests, and states have recently taken that opportunity.

The bill allowed states to confer automatic SNAP eligibility on all households receiving a specified social service informational brochure, hard as that may be to believe. Households that participate in SNAP under this “broad-based categorical eligibility” rule still have benefits determined by the same formula (of household size and net income) as the other SNAP beneficiaries.

A practical result of broad-based categorical eligibility is that households can receive benefits based solely on their net income – it typically must be less than 130 percent of federal poverty guidelines (about $20,000 a year for a family of four) – and not based on the value of their assets or their employment status.

Even SNAP households not taking part through broad-based categorical eligibility saw the asset test relaxed by the 2008 farm bill, as the values of vehicles, retirement accounts and education savings accounts began to be excluded from the test.

So, simply put, in most states having assets is no longer a barrier to receiving food stamps. That’s the main reason that participation in the program increased 37 percent more than the number of families with income near or below the poverty line.

I agree that safety net programs would have grown from the recession alone, but, for better or for worse, they have grown many times beyond that thanks to numerous changes in program rules.

In Europe, a Longer Perspective on Unemployment Benefits

2012-01-11T19:17:00.000-08:00

Copyright, The New York Times Company
While Americans discuss the duration of unemployment benefits in terms of weeks, Europeans discuss them in terms of months and, sometimes, years. A few countries even pay unemployment benefits indefinitely, in some circumstances.

Unemployment insurance offers funds, for a limited eligibility period (in the United States, now up to 99 weeks) to “covered” people who lost their jobs and have not yet been unable to find and start a new job. In last week’s post, I showed that the United States, for at least 50 years, has never offered unemployment benefits for so long as it does now.

For the 50 years prior to December 2008, the maximum unemployment benefit period was 72 weeks during the 1992 recession. In the severe 1981-82 recession, the benefit period was much less, 55 weeks. This historical perspective may indicate that 99 weeks is long enough, or maybe even too long.

However, international comparisons tell the opposite story. The chart from 2009 Congressional testimony by Gary Burtless below compares the maximum duration of unemployment insurance benefits in 21 nations of the Organization for Economic Cooperation and Development, as of 2005, measured in months. The United States had the shortest duration of the 21 countries, six months. By 2009, when Mr. Burtless testified, the United States had increased its benefit period and would increase it still after that; he did not have 2009 data on the other countries.

Organization for Economic Cooperation and Development, “Benefits and Wages,” 2007.

Even in 2005, before the world financial crisis, many countries had unemployment benefits that lasted 18 months or more. Three countries offered benefits indefinitely, in some situations. By European standards, our 99 weeks appears too short.

Part of the reason that countries can disagree so much on the benefit period is that long periods have both costs and benefits. A longer benefit period makes it more difficult to get people back to work, because they are getting paid for not working. But for the relatively small fraction of people who cannot find a job even after looking for several years, the government benefits help cushion lives that can be very difficult.

Moreover, the aggregate consequences of a long benefit period may not be all that large, because a only small fraction of people are unemployed long enough for it to matter whether the benefit period is 99 weeks or 199 weeks. At the end of 2010, for example, when unemployment in the United States was quite high, only about 2 percent of the unemployed had been unemployed more than 25 months, let alone 50 months.

For the same reason, it makes a lot bigger difference if benefits last 12 months rather than six, because about half of the unemployed have been unemployed more than six months.

We know that long-lasting unemployment benefits have the cost of less employment and the benefit of more safety. But we still don’t know the optimal mix of the two.

With Unemployment Insurance, Is 99 Weeks the Magic Number?

2012-01-05T11:17:00.000-08:00

Copyright, The New York Times Company

A possible compromise between Democrats who want to leave the unemployment compensation system unchanged and Republicans who want to return to pre-recession benefit formulas might be to adopt a benefit formula from some of the previous recessions.

At the end of 2011, Congress allowed unemployment beneficiaries to continue to collect under both the emergency and extended programs, which permit the unemployed to receive benefits for up to 99 weeks of unemployment.

Some economists believe that unemployment insurance stimulates spending because unemployed people are thought to spend most, if not all, of the money they have on hand. Some economists also suggest that unemployment insurance prolongs unemployment because an unemployed person has to give up his benefits as soon as he finds and starts a new job or returns to working at his previous job. Either way, some people cannot find work, and unemployment benefits help cushion their blow.

The ideal amount of time to permit the unemployed to collect benefits is a trade-off between the insurance the program provides and the unintended work disincentives it creates. For now, our government has decided that 99 weeks is the ideal time (92 in many states, and a bit less in others).

The maximum duration of benefits was much less in previous recessions. I examined the 12 episodes since 1960 when Congress increased the amount of time the unemployed could receive benefits, together with the most recent month with unemployment data (November 2011).

U.S. Department of Labor

The vertical axis in the scatter diagram measures the maximum amount of time that the unemployed could receive benefits for each of the 12 law changes. The most recent law change was December 2009, when regular state and federal emergency and extended benefits could last up to 92 weeks (for comparability across recessions, here I ignore the few states that add seven additional weeks of extended benefits, bringing the total to 99).

We reached 92 weeks in a couple of steps. In July 2008, benefits began to last 52 weeks. Later that year, the maximum benefit duration was lengthened to 72 weeks.

In the 50 years before December 2008, the maximum benefit period was 72 weeks during the 1992 recession. Benefits lasted up to 65 weeks in the 2001-2 and 1975 recessions.

The horizontal axis graphs the unemployment rate at the time that unemployment insurance legislation was changed. Since 1960, only in the 1982 recession did the unemployment rate get so high. Nevertheless, unemployment benefits in that recession lasted at most 55 weeks – about three-fifths of the time that unemployment benefits last today.

Since the December 2009 law change, the unemployment rate has fallen, although nowhere near back to normal. With the recession officially ended almost three years ago, today’s unemployment rate is still similar to that in 1975 – one of the more severe recessions of the past. Still, when the unemployment rate was almost 9 percent in spring 1975, Congress decided to limit unemployment benefits to 65 weeks.

These comparisons may suggest that continuing or terminating emergency and extended unemployment benefits are not the only policy choices. The programs could be continued but perhaps with a lesser duration, such as 52 or 65 weeks as in previous severe recessions.

The Biggest Cut in Unemployment Benefits

2011-12-28T17:49:00.000-08:00

Copyright, The New York Times Company

While Congress has been debating whether to cut the duration of unemployment benefits, perhaps the largest unemployment benefit cut occurred when the stimulus law expired.

Unemployment insurance offers funds, for a limited eligibility period, to people who lost their jobs and have not fyet been able to find and start a new job. In 2008, “emergency unemployment” legislation, plus automatic triggers in the unemployment insurance rules, extended the eligibility period to up to 99 weeks from 26 weeks.

Several times since then, and as recently as last week, new legislation has prevented the eligibility period from returning to 26 weeks.

The length of the eligibility period has received much attention; it affects how much the program spends and how much unemployed people receive. For example, if the weekly benefit were $275, and an unemployed person were unemployed for a year, then the average weekly benefit he would receive under the 26-week rule would be about $138 ($275 for half the year, and zero for the other half).

By extending the eligibility period to more than 52 weeks, this person would see his average weekly benefit increase to $275 from $138.

The green line in the chart below shows the average weekly benefit received by unemployed people over time, assuming that:

(a) they were receiving $275 a week until their benefits were exhausted
(b) about half of the aggregate time unemployed occurs in the first 26 weeks
(c) essentially all unemployment spells end in less than 99 weeks

These assumptions are a close approximation to the unemployment spells experienced by people 25 to 64 during 2010. For the reasons explained above, the line jumps to $275 from $138 in mid-2008, and then is constant thereafter.

However, the eligibility period is not the only part of the unemployment insurance rules that have changed since the recession began. The American Reinvestment and Recovery Act (the “stimulus law”) made a number of additional changes.

It increased the weekly benefit by $25 a week (and guaranteed that the $25 increase would not cause anyone to lose Medicaid coverage); federally funded 100 percent of extended benefits; exempted the first $2,400 of unemployment insurance received in 2009 from federal income tax; and paid 65 percent of an unemployed person’s health insurance premiums.

The act also paid states about $7 billion to allow more of the unemployed to qualify for benefits.

The federal financng of extended benefits meant that employers would not be liable for the extended benefits received by their former employees, which makes it less profitable for them to contest unemployment claims made by their former employees.

A $25 weekly benefit bonus was clearly worth $25 a week for as long as it lasted (until mid-2010). At a marginal federal income tax rate of 21 percent, the exemption from federal income tax on the first $2,400 of unemployment insurance received in 2009 is worth about another $10 a week.

Perhaps the most valuable added benefit was the health insurance subsidy. For unemployed people who, through the Cobra program, continued to participate in the health insurance plan they had with their former employer, the federal government would pay 65 percent of the premium. For such people, this subsidy is estimated to be worth about $170 weekly. This benefit ended in mid-2010.

The red line in the chart shows the combined unemployment benefits for an unemployed person participating in the Cobra program, excluding any benefits received from other safety-net programs such as food stamps or Medicaid.

The weekly benefit peaks in 2009 at $455. The increase in early 2009 when the stimulus law passed is even greater than the increase in mid-2008 from the lengthening of the eligibility period.

It is not yet known how many unemployed people received the Cobra health insurance subsidy, but many who did not had their health insurance covered by another federal program, Medicaid.

Moreover, a $455 weekly benefit is not small change; it is much more than someone would earn on a full-time job that paid minimum wage. Among the 106 million working-age heads of households and their spouses lucky enough to be working in 2009, about 25 million of them were earning less than $455 a week.

Even though Congress has not yet let emergency unemployment benefits expire, the largest unemployment benefit cut may have already occurred in 2010 when the stimulus law expired.

Productivity and Real wages since 2007

2011-12-23T06:41:00.001-08:00

A number of bloggers have recently discovered real wages as a labor market indicator. They are at least 3 years late to the party.

Three years ago I blogged about the effect of labor supply on real wages.

I noted how real wages had risen since 2007, and predicted that they would begin to decline in 2010.

I have continued to update this work, eg here, and here.

The fact is that the real wage time series fits my recession narrative very well.

Unemployment Compensation Over Time

2011-12-21T18:40:00.000-08:00

Copyright, The New York Times Company

The propensity of unemployed people to receive unemployment benefits reached historical highs after the 2008-9 recession and may indicate that benefit rules have more impact on the economy than ever before. The changing aggregate impact of unemployment insurance may be worth considering as Congress debates benefit extensions.

Unemployment insurance offers funds, for a limited eligibility period (now up to 99 weeks), to “covered” people who lost their jobs and have yet been unable to find and start a new job.

Some economists suggest that unemployment insurance prolongs unemployment because recipients have to give up their benefits as soon as they find and start a new job, or return to working at a previous job.

Some economists also say they believe that unemployment insurance stimulates spending because unemployed people are thought to spend most, if not all, of the money they have on hand.

But neither of these effects can operate unless people take part in the program.

Historically, many of the jobless have not collected unemployment benefits because of ineligibility, lack of awareness or unwillingness to do so.

The chart below graphs the recipiency rate — the percentage of people unemployed who are collecting unemployment benefits that week — to 1986. It was calculated from weekly data, then averaged over 52 weeks to remove some of the large seasonal patterns.

The percentage is always well under 100, fluctuating from 31 to 68 percent. The peak recipiency rates seem to follow recessions; three national recessions have occurred since 1986, in 1990-91, 2001 and 2008-9. Previous studies covering the period 1960-94 found a similar pattern (although perhaps no recipiency rate peak was found after the 1981-82 recession), with a maximum recipiency rate for all 35 years of about 50 percent.

Some unemployed people cannot collect benefits because they quit their jobs, rather than being laid off. But quits are less common during recessions, one reason the recipiency rate is greatest during recessions.

Another reason that recessions can have high recipiency rates is that, by law, benefit eligibility periods are longer during recessions. Laws often increase the eligibility periods by a greater percentage than the average duration of unemployment increases, with the result that a larger percentage of the unemployed are eligible for benefits.

Among other things, the 2009 American Reinvestment and Reinvestment Act expanded eligibility for unemployment insurance by encouraging states to adopt an “alternative base period” benefit calculation rule that allowed a number of people with weak employment histories to qualify for benefits.

Long-term comparisons of recipiency rates are tricky because the data sources change and because of secular changes in the composition of unemployed, but it appears that recipiency rates were higher during 2009 than they have been in 50 years, and perhaps ever.

With such a large percentage of unemployed people receiving benefits, the potential employment and spending effects of those benefits may be greater than ever.

Hiring, ‘Quits’ and Layoffs

2011-12-14T14:54:00.000-08:00

Copyright, The New York Times Company

The recession and lack of recovery have often been characterized as a lack of hiring, rather than an extraordinary number of employer-employee “separations” (a separation is a layoff or what the Bureau of Labor Statistics calls a “quit”). But the aggregate data on hiring, quits and layoffs can be misleading.

The chart below from the Bureau of Labor Statistics shows total hires, separations and total employment from December 2000 to December 2009. The shaded area to the right indicates the start of the most recent recession. Both separations and hires fell about 20 percent (the hires dropped sooner).

Bureau of Labor Statistics

However, this characterization is quite different for young people than for the rest of the work force. Even during business cycle expansions, young people have high rates of job turnover. The number of young people hired during a typical month is disproportionately high, as is the number of young people quitting or getting laid off (I use the term “layoff” to refer to both layoffs and discharges).

For this reason, young people could dominate the job turnover statistics, even while they do not dominate the employment statistics.

A paper by Michael Elsby, Bart Hobijn and Aysegul Sahin, using a method developed by my University of Chicago colleague Robert Shimer, estimated job separations for different age groups according to the number of people flowing into unemployment. They found a very different pattern for people 16-24 than they did for people 25-54.

Estimated job separations among employees ages 25-54 were 33 percent greater in 2009 than they were in 2007. I tried to update their estimates through 2010 and found that job separations still remained greater than they were in 2007.

In contrast, the low employment rates for young people since 2007 are almost entirely explained by low hiring rates.

The Bureau of Labor Statistics also reports that the composition of job separations has changed a lot since 2007. Before the recession began, quits were by far the most common type of separation; now the number of quits about equals the number of layoffs.

Perhaps the decline in quits is a signal of what’s ailing the economy, although I view it largely as a consequence of the unemployment insurance system. A person who quits his or her job is not eligible for unemployment insurance. As a result, calling a job separation a “quit” rather than a “layoff” results in the loss of unemployment benefits.

I estimate that, before the recession began, a person beginning unemployment would receive about 12 weeks of unemployment benefits, on average, if he or she were eligible for benefits. By 2010, that average was up to about 34 weeks. At $300 a week, that means that the government subsidy for calling a separation a “layoff” rather than a resignation was up to about $10,000 from $3,600.

There is also the employer payroll tax consequence of layoffs to consider, but overall employers and employees now often have a lot to gain by calling their separation a layoff rather than a quit.

These are a couple of reasons the aggregate data on hiring, quits and layoffs can be misleading. Even so, the very different patterns for people 16-24 and 25-54 may suggest that the recession and lack of recovery have more than one cause.

Species Protection and Technology

2011-12-07T05:45:00.000-08:00

Protecting endangered species is a legitimate goal for public policy. But we cannot expect that public policy will prevent all species extinctions, because scientists estimate that hundreds of species, if not thousands, become extinct every year, many without our knowledge.

A rational approach to protecting endangered species would balance costs and benefits. Landowners bear many of the costs, because they can lose title to land that is home to an endangered species or be restricted in how they can use their land. Businesses bear some costs, too, as they are sometimes required to alter their activities to protect an endangered species.

Our planet benefits from biodiversity, and there can be a large “option value” to helping an endangered species live another generation. We can change our minds at some later date and no longer try to prevent a species’ extinction. But it would seem impossible to change our minds in the other direction — once a species is gone, it would seem too late to decide that we wish we had protected it.

But technology may be changing the option-value calculation, because scientists are learning how to clone extinct animals. The time will come when scientists will produce living versions of previously extinct animals. With enough time, they would probably be able to do so cheaply.

To the extent that cloning will someday be possible, the option value of preserving an endangered species is a lot less. In some cases, it may be cheaper to save some DNA, and let a future, richer and perhaps more enthusiastic generation make its own copy of the species.

One objection to the cloning approach is that cloning is itself too expensive. That’s true with today’s technology, but future genetic technologies will invariably be more efficient (cheaper for what they produce).

Another objection is that a cloned species would not be genetically diverse enough to survive, because it would be cloned from just a few DNA samples. But that objection also springs from today’s technology. Scientists may learn to save a genetically diverse DNA sample or even to produce genetic diversity themselves.

Yet another objection is whether we would have room in the future to house a cloned species. But it would seem to me more space intensive to protect each endangered species’ habitat for hundreds of consecutive years than it would to store some DNA and find space when the time comes for cloning.

The fact is that species go extinct all of the time, while we incur real economic costs protecting others. By bringing cloning into the set of public policy instruments, we can protect more species, reduce economic costs of protection, or both.

Bankers, Too, Cast a Safety Net

2011-11-30T07:33:00.000-08:00

Copyright, The New York Times Company

The combination of housing market events and the profit motive of mortgage lenders turned trillions of dollars of household debt into a huge safety net.

Household debt had been increasing during the 1980s and 1990s, but the rate of increase was extraordinary in the years leading up to the recession. By 2007, household sector debt had reached 114 percent of the nation’s personal income – more than $14 trillion. The change was almost entirely due to accumulation of home mortgage debt.

Normally, home mortgages are fully secured by a residential property, and when a homeowner fails to make the scheduled payments on time, the lender can seize the property and sell it to recover its principal, interest and fees. When the lender has this valuable foreclosure option, borrowers overwhelming either make their home mortgage payments on time or sell their property in an orderly fashion to obtain the money to repay the mortgage lender, even in cases when the homeowner is unemployed.

When residential property values plummeted in 2008 and 2009, a number of residential properties were suddenly “under water” — worth less than the mortgages they secured. In those cases, the lender’s foreclosure option was no longer valuable – selling the property would be likely to yield too little money to cover principal, let alone interest and fees.

Lenders needed a way to estimate which borrowers would still pay in full and a way for other borrowers to work out a mortgage modification that would give them an incentive to pay at least a bit more than their homes were worth.

Naturally, a borrower’s income is a factor considered – borrowers with high income can be expected to repay more than borrowers with low income. Thus, a partial solution to the lenders’ collection problem is to insist that high-income borrowers pay more of the mortgage amount due and allow at least some low-income borrowers to pay less.

From this perspective, the lenders’ desire to maximize debt collections (after the collapse of residential real estate values) causes them to create a kind of safety net program that gives low-income people more help with their housing expenses (much the way the federal food stamp program gives low-income people more help with their food expenses) in the form of modified mortgage payments.

To quantify the size of the loan modification safety net and its changes over time, I estimate the amounts that “home retention actions” (as the federal government calls these mortgage modifications that allows people to stay in their homes) actually changed mortgage payments from the original mortgage contract, which specified only payment in full or foreclosure.

To estimate those amounts for 2008-10, I first measured the number of residential properties in each quarter receiving loan modifications, lender permission for short sale or lender permission for deed-in-lieu of foreclosure.

Next, I multiplied the number of transactions by a $20,319 average value of each loan modification (a typical modification reduced monthly payments by $400 for a minimum of 60 months; at an annual discount rate of 7 percent, that’s a present value of $20,319). I do not have data on the number of home retention actions for the years 2006 and 2007, but I assume the dollar value of discharges those years were, as a proportion to discharges in 2008, the same as total mortgage loan discharges by commercial banks.

Because the home retention actions are necessary primarily when homes are worth less than the mortgages they secure, the amount discharged by home retention actions is much less in 2006 and 2007 when residential property values were still high. During 2010, mortgage lenders discharged more than $70 billion of mortgage debt through home retention actions. Seventy billion dollars for one year is small in comparison to the total amount that homeowners were under water but is more than the spending by the entire food stamp program for that year.

The last row of the table displays discharges on other consumer loans, such as credit card debt. Those discharges are smoother over time because they are not directly tied to the housing cycle but still totaled more than $70 billion in 2010. The combination of discharges of other consumer loans and discharges of home mortgages by home retention actions was almost $150 billion in 2010, which exceeds the peak spending for entire unemployment insurance system.

Bankers deserve a lot of blame for getting us into this mess, have dipped far too deeply into the United States Treasury to help themselves, and have been far too slow to modify mortgages. For these reasons, it’s remarkable that their own selfish pursuits have forced them to create a safety net of sorts that rivals the amounts spent by public sector safety net programs.

Income Security Became More Generous

2011-11-27T11:35:00.000-08:00

Professor Krugman is reiterating his claim that "income security" programs grew solely because of the recession. He is incorrect: only a small fraction of that growth is due to the recession, the rest because of legislation making the programs more generous.

Inflation-adjusted government spending on unemployment insurance (UI) and food stamps (SNAP) has more than doubled on a per capita basis, and most of this growth is due to changes in eligibility rules, and increases in payments per eligible person, rather than increases in the number of people who would have been eligible under pre-recession program rules.

By 2009, the UI program was absorbing a larger fraction of earnings lost due to unemployment than it did in 2007, with the majority of its expenditure made pursuant to federal expansions since 2007. Indeed, among persons aged 25 and over, it was more common to experience unemployment without government help before the recession than it was since 2007.

See also
How Unemployment Benefits Became Twice as Generous
UI Takeup Increases Sharply during the Recession
The Sharp Increase in Food Stamp Spending
Millions Caught by the Social Safety Net

Perhaps legislation changes were the "right thing to do" given the recession. But Professor Krugman is pretending that the legislation changes did not occur.

Millions Caught by the Social Safety Net

2011-11-23T06:19:00.000-08:00

Copyright, The New York Times Company

Despite the severe recession, relatively few people saw their living standards fall into poverty, thanks to the social safety net.

According to the Center for Budget and Policy Priorities, the percentage of the United States population living in poverty increased by 0.6, to 15.5 in 2010 from 14.9 in 2007.

The poverty measure refers to resources available to families, accounting for the taxes they pay and subsidies they receive. Considering all that happened in the economy over those three years, 0.6 percentage points is quite a small change. Measures of the poverty rate typically change more than that over any three-year interval.

The study found that many people were technically above the poverty line in 2010, although their incomes were low, because they received government assistance like unemployment insurance, food stamps and refundable tax credits. The government assistance permitted them to have living standards above poverty, even while their market incomes were below the poverty line.

Were it not for government assistance, the study found, the recession would have pushed 4.2 percent of the population into poverty, rather than 0.6 percent.

One interpretation of these results is that the safety net did a great job: For every seven people who would have fallen into poverty, the social safety net caught six. Perhaps if the 2009 stimulus law had been a little bigger or a little more oriented to safety-net programs, all seven would have been caught.

Another interpretation is that the safety net has taken away incentives and serves as a penalty for earning incomes above the poverty line. For every seven persons who let their market income fall below the poverty line, only one of them will have to bear the consequence of a poverty living standard. The other six will have a living standard above poverty.

The safety net was not as effective before the recession began. As I explained in my last two posts, government assistance programs have not only supported more people but become more generous, thanks to changes in benefit rules since 2007.

Of course, most people work hard despite a generous safety net, and 140 million people are still working today. But in a labor force as big as ours, it takes only a small fraction of people who react to a generous safety net by working less to create millions of unemployed. I suspect that employment cannot return to pre-recession levels until safety-net generosity does, too.

The Sharp Increase in Food Stamp Spending

2011-11-16T05:16:00.000-08:00

Copyright, The New York Times Company

The Department of Agriculture’s food stamp program, now known as the Supplemental Nutrition Assistance Program, or SNAP, provides money to low-income households for the purpose of buying food, often in conjunction with cash assistance programs. Adjusting for inflation, the program spent more than twice as much in 2010 as it did in 2007, before the recession began.

The Department of Agriculture found that the food-stamp spending increase “is likely attributable to the deterioration of the economy, expansions in SNAP eligibility, and continued outreach efforts.” Of particular relevance for the SNAP program is the fact that the poverty rate increased 18 percent, to 153 per thousand in 2010 from 130 per thousand Americans in 2007.

At least two eligibility expansions have occurred since the recession began: work requirements were lifted from April 1, 2009, through Sept. 30, 2010, and monthly income limits were 10 percent higher in the 2010 fiscal year than they were in the 2007 fiscal year, an increase about twice the rate of inflation over that period.

In addition, the American Recovery and Reinvestment Act increased maximum benefits by 13.6 percent, and the minimum benefit increased in October 2008. Increasingly, potential program participants have been given the opportunity to apply for benefits on the Internet.

The declining economy alone, under the previous rules, would have raised the spending on food stamps by 18 percent. But the revised provisions, enacted largely in response to the recession, are responsible for a greater share of the increase. The following table breaks down the program’s spending growth into three components: deterioration of the economy, relaxed eligibility rules and increased maximum benefits.

U.S. Department of Agriculture

The top row of the table is actual program spending for 2007 and 2010, adjusting for inflation and population. The second row of the table estimates the program’s hypothetical spending growth with 2007 eligibility rules, by assuming that real spending per capita increased since 2007 only in proportion to increases in the poverty rate, plus the 13.6 percent benefit increase of the American Recovery and Reinvestment Act. The last row assumes that real spending per capita increased only with the poverty rate. Under either scenario, the hypothetical spending increases are significant but well less than half of the actual spending increases.

Over all, the table suggests that most growth in spending on SNAP is due to changes in eligibility rules and increases in payments per eligible person. The program’s spending would certainly have grown if benefit rules had remained as they were in 2007, but much less than it actually did. And those more generous provisions are now likely to be here to stay, even if the conditions that prompted them abate.

UI Takeup Increases Sharply during the Recession

2011-11-09T05:40:00.000-08:00

Copyright, The New York Times Company

It’s commonly assumed that unemployed people not receiving unemployment benefits have been unlucky enough to go without a job for so long that their benefits have run out. But often more important are limited work histories and a low propensity to take benefits that are available.

Historically, many unemployed people have not collected unemployment payments because of ineligibility, lack of awareness or simple unwillingness to collect benefits. But some of those patterns changed during the recent recession.

The chart below shows the number of unemployment compensation beneficiaries per unemployed person, for people 16 to 24, people 25 and over and all people 16 and over. This ratio can be less than one for all of the reasons mentioned and because some unemployed people may exhaust their benefits sometime during the calendar year.

Not surprisingly, more than three-quarters of young unemployed people do not receive unemployment compensation, in large part because they are much less likely to have the employment history that is required for eligibility. Young people are disproportionately represented among the unemployed, and their limited work histories are the primary reason why a large fraction of the unemployed does not receive benefits.

More striking is the increase to 85 percent from 50 percent among people 25 and over. Before the recession began, about a quarter of unemployed people that age had been unemployed for more than 26 weeks, when unemployment benefits were typically exhausted.

The remaining quarter of the unemployed did not receive benefits for a variety of other reasons: they may not have been interested in or aware of benefits, or they may have been ineligible because they quit their jobs (rather than lost them).

By 2010, unemployment was lasting much longer, but the time for receiving benefits had increased even more. Ninety-two weeks was a typical unemployment benefit period in 2010 (in some states it was 78 weeks, in others 99 weeks), yet only 12 percent of the unemployed 25 and over were unemployed that long.

That means as many as 88 percent of the people that age who were unemployed could have received benefits. That 85 percent received benefits tells us how rare it was for eligible people to forgo benefits during the recession.

The recipiency rate change from 2007 to 2010 is thus a combination of a decreased likelihood of exhausting benefits and an increased propensity to receive benefits early in the unemployment spell. These two factors change so much that even though the average weekly number of unemployed people 25 and over increased by more than six million from 2007 to 2009, the average weekly number of those people not receiving unemployment insurance actually fell by 700,000. (For the purposes of this calculation, I assume that, consistent with the law, nobody received unemployment benefits for a week that she or he was employed.)

This absolute decline in nonparticipating unemployed suggests that people are more willing (equivalently, less unwilling) to collect unemployment benefits than they were before the recession began.

Unemployment insurance is known for its ability to expand eligibility as a recession gets going, whether through the “extended benefits” that take effect at given jobless rates or through legislative action beyond that. But an adjustment almost as important has occurred in the labor force itself: during the recession, people increased their propensity to take advantage of available benefits.

How Unemployment Benefits Became Twice as Generous

2011-11-02T07:12:00.000-07:00

Copyright, The New York Times Company

Government spending on unemployment insurance has soared, and it’s hard to imagine the program ever shrinking back to its prerecession size.

Unemployment insurance is jointly administered and financed by the federal and state governments, offering money to people who have lost their jobs and have as yet been unable to find and start a new job. On average they receive about $300 a week until they start working again, they stop looking for work or their benefits are exhausted.

Between 2006 and 2010, inflation-adjusted spending on unemployment compensation by federal, state and local governments more than tripled.

The program has been around for decades, but the most recent recession and continued economic weakness has created an especially large group of laid-off workers who, despite an extensive search, cannot find another job. More unemployed people equals more spending for the unemployment insurance program, so we expect the program to be spending a lot during a recession.

However, the unemployment program has also become more generous since 2006. Before the recession, an unemployed person in a state without high unemployment would often exhaust benefits after 26 weeks; that is, the program would stop paying after the 26th weekly benefit, even if the beneficiary was still without work.

The federal law in place before the recession included some local labor market “extended benefit” triggers that, based on the statewide unemployment rate, would automatically lengthen the maximum benefit period. These automatic triggers began to extend benefits around the nation in the middle of 2008.

About the same time, new “emergency unemployment compensation” legislation extended maximum benefit periods for the entire nation. The American Recovery and Reinvestment Act of February 2009 further extended these “emergency” periods to up to 99 weeks, and legislation later in 2009 and in 2010 permitted the 99-week maximum to continue. (Among other unemployment insurance expansions, the act also increased monthly benefit amounts and excluded from federal personal income taxation the first $2,400 of benefits received in 2009.)

The chart below shows the size of the “emergency” and extended-benefit expansions, by quarter, measured as a fraction of the entire unemployment insurance program. Essentially, no “emergency” and extended-benefit benefits were paid in 2007 or in the first half of 2008. “Emergency” and extended-benefit benefits immediately became about a quarter of all unemployment insurance benefits and beneficiaries and were a majority of all unemployment insurance benefits by the end of 2009 (the two measures are slightly different because they come from different data sources).

Because “emergency” and extended-benefit benefits are paid to people only when they have exhausted the normal benefits, the fraction shown in the chart is a measure of how much unemployment benefits are paid pursuant to unemployment insurance rule changes, as opposed to payments that occur merely because more people were losing their jobs.

If we assume, merely for simplicity, that the expansions had no effect on the number of people unemployed or on the length of time they were employed, then setting “emergency” and extended-benefit payments to zero as they were in 2007 would have cut total unemployment insurance benefit payments by the fraction shown in the chart. In this case, it appears that the unemployment insurance program is at least twice as generous as it was in 2007, thanks to the federal changes in benefit rules.

The unemployment insurance program is a good example of how federal government spending has grown and how tough it will be to bring it back to pre-recession levels. People are now used to having well more than one year’s unemployment benefits available to them, and politicians will have a lot of trouble asking them to make do with just 26 weeks.

Was Qaddafi Overpaid?

2011-10-26T05:49:00.000-07:00

Copyright, The New York Times Company

By most measures, the former dictator Muammar el-Qaddafi looks to have been overpaid, even as dictators go.

Colonel Qaddafi’s wealth had recently been estimated in the tens of billions. But it now looks as though he could have been worth more than $200 billion.

Obviously, $200 billion, or even $10 billion, is a lot for wealth for one person. But $200 billion is but a fraction of Libya’s national wealth. Its proven oil reserves alone total 46 billion barrels. If those barrels were valued at $100 each, the oil reserves alone would be $4.6 trillion, or 23 times Colonel Qaddafi’s wealth.

In my research on dictators and their public finances, I estimate that, on average, dictators were taking about 3 percent of their nations’ incomes in the form of excessive taxation. Judging from Colonel Qaddafi’s share of Libya’s national wealth, that’s about what he was taking.

Dictators typically spend a lot on the military in order to protect themselves from people who might want to take their lucrative jobs, which itself is a sure sign that a dictator is overpaid. Led by Colonel Qaddafi, Libya’s government spent more of the nation’s income on the military than the average dictatorship does. Libya also spent less of its national income on social security than the typical dictatorship does, although perhaps a bit more than an economically and demographically similar democratic country would.

Colonel Qaddafi’s regime was known to torture and execute its political enemies. So it’s clear that the citizens of Libya were sacrificing too much for their leaders.

What’s less clear is whether the next leaders of Libya will take less or offer better services for the citizens of Libya. Egypt’s experience since Hosni Mubarak shows that the overthrow of a longtime dictator does not by itself bring freedom or democracy. Libya has much more in oil riches than Egypt, and political opponents in Libya are likely to find that wealth worth a violent fight.

Let’s hope that a long, bloody Libyan civil war does not make Colonel Qaddafi’s “fees” for his longtime leadership look cheap.

Three More Aggregate Hours Measures

2011-10-21T06:49:00.000-07:00

On Wednesday I compared the household survey to the time dairy. Below are three more series, from the establishment survey.

The HOABS series is the one used by the BLS to measure productivity. In the 1982 recession, HOABS fell a lot less than AWHI:

Are Employers Requiring People to Work Longer Hours?

2011-10-19T05:37:00.000-07:00

Copyright, The New York Times Company

As employers have sharply cut back employment since 2007, at least one survey asserted that existing employees have to work a lot more in order to maintain what was produced by the formerly larger work force.

The Census Bureau’s monthly household surveys do not suggest that such a pattern is widespread, because they measure that average weekly hours worked per employed person have fallen to 37.8 in 2009 from 39.0 in 2007. Another survey also measures hours worked, with a similar result. So it seems that the number of people employed and the hours they work have fallen, creating a huge drop in the economy’s total work hours.

But sometimes surveys can be misleading about hours worked, because people tend to report round numbers like “40 hours” or “35 hours” even when actual hours worked are not a round number (more than 40 percent of employed people in the monthly household survey reported that they worked 40 hours in the reference week, compared with a mere 0.4 percent who reported 39 hours of work). It is logically possible that a number of employed people were working more hours in recent years, but continued to report the round number of 40.

Since 2003, the Census Bureau has supplemented its population survey with the American Time Use Survey, dedicated to measuring time use. Participants in that survey are asked to account for all their waking hours in a specific day, listing various activities, including eating, watching television, working, traveling, caring for children and so on.

The diary study therefore has no bias toward finding that masses of people work exactly eight hours every day for exactly five days a week. It would be interesting to know if the recent recession looks different when the economy’s work hours are measured from the diaries, rather than from the population surveys as the product of employees and hours per employee.

The chart below displays the results. Eight calendar years are sampled, from 2003 to 2010. The blue line is based on the household survey and is an index (normalized to 100 in the year 2007) of the average number of hours worked by adults. It shows about a 2 percent increase in hours worked from 2003 to 2006. Hours worked were about the same in 2007 as in 2006. For each of the three years after 2007, work hours were significantly below the previous year.

The red line is also an index of hours worked per person — but based on the time diary methodology (here I look at the sum of hours spent at work and in “income-generating activities”). The time diary actually suggests there was a mild recession in 2004, because hours worked per person were lower that year than in the surrounding years. Also unlike the household survey, the time diary suggests that work hours in 2007 were abnormally high by comparison with all previous years.

The time diary closely agrees with the household survey measures for the years 2008-10, confirming that hours worked dropped sharply after 2007. Although a few employers may require their workers to work longer hours, the typical pattern since 2007 is fewer hours per employee, and fewer employees.

Growing Businesses Cut Payrolls, Too

2011-10-12T03:53:00.000-07:00

Copyright, The New York Times Company

In many industries, sharp employment cuts during the recession cannot be attributed to a lack of demand.

The standard narrative of the 2008-9 recession and lack of recovery has been that the financial crisis, housing crash, excessive debt and other factors caused consumers to spend less, and businesses to invest less. With the private sector spending less, employers had a hard time selling their products, so they had to lay workers off, cut back on new hiring, or both.

As Paul Krugman put it, “Businesses aren’t hiring because of poor sales, period, end of story.”

Yes, consumer spending dropped sharply, as did business investment, in 2008 and 2009. But that observation does not tell us whether low employment is a result of low spending or if the reverse is true.

I agree that a few important industries, including manufacturing, home construction and much of the retail sector, did, and still do, suffer from significantly low demand. Those industries vividly illustrate the demand narrative — but they are only a minority of the overall private sector.

The lack-of-demand hypothesis is incorrect for a large fraction of the economy. The chart below illustrates output, revenue and employment from the United States wireless telecommunications industry (that is, cellphones). This industry has clearly not been suffering from a drop in customer demand.

Since 2007, the number of mobile connections has increased almost 20 percent, to 303 million from 255 million. The Bureau of Economic Analysis estimates that consumer spending on mobile communications increased 15 percent (not inflation adjusted) over that time frame.

Bureau of Economic Analysis

Despite continued demand growth, employers in the wireless telecommunications industry sharply cut employment, at an even greater rate than employers in other industries. After growing 6 percent from 2005 to 2007, the industry’s employment had fallen 14 percent by 2010.

There is no way to blame that sharp employment drop on “poor sales.”

This pattern is not limited to the cellphone industry. Other industries sharply cut back their employment even while their revenues were falling little, if at all; the employment loss from such industries numbers in the millions.

To examine this issue more systematically, I used the industry economic accounts published by the Bureau of Economic Analysis. Industries can be examined at varying levels of detail: I divided the private sector into 21 industries and classified them according to the percentage change in their revenue between 2007 and 2009. The table below shows the results.

Bureau of Economic Analysis

In two of the industries, education and health care, revenues grew more than 2 percent (in fact, their increase was about 10 percent), and their employment increased, as is shown in the table’s top row. Five other industries summarized in the next row had a revenue increase but still sharply cut their employment. Four others had minor revenue declines and cut their hiring sharply, too.

The number of full-time equivalent employees declined 2.2 million in those nine industries combined, even though it seems that those industries had enough sales to maintain their employment. Something else motivated them to cut employment and motivated them to forgo an opportunity to hire some of the many workers laid off by declining industries.

As I wrote before much of the employment decline happened, I think “some employees face financial incentives that encourage them not to work, and some employers face financial incentives not to create jobs.”

That’s why even growing business are now getting by with substantially fewer employees.

When Times Get Tough, the Elderly Work

2011-10-05T05:10:00.000-07:00

Copyright, The New York Times Company

The elderly are one group whose work hours now exceed what they were before the recession began. This pattern is most evident in the most depressed regions of the United States.

The recession has varied in different regions of the United States. In some areas – including Arizona, California, Florida, Hawaii, and Nevada – housing prices surged more dramatically in the early part of the 2000s than they did in the rest of America, and their economies fell hard when housing prices collapsed.

One view is that such areas experienced a deeper recession because their banks became overwhelmed with defaults and were unable or unwilling to make new loans to consumers and businesses. Without those new loans, demand collapsed more than it did nationwide, and jobs were especially difficult to find, even while people living in the area were especially eager to work.

Absent demand, just about all workers will have a tough time retaining a job or finding a new one.

Another view is that old loans are the problem, not newer ones. A significant fraction of households and businesses are typically so burdened with the debts they accumulated during the housing surge that they have little incentive to produce and work, because their creditors would get most, if not all, of the fruits of their labor.

In contrast to the no-new-loans-and-no-demand theory, old loans do not affect all workers; some are less burdened by debt. The elderly may fall in this category, because they are more likely to have saved money over their lifetimes and to have paid off their mortgages. Although some elderly working for debt-burdened employers may have lost jobs, on average the elderly in these areas should be working more because they have better incentives to do so.

The chart below compares 2007-10 changes in work hours for two areas –- the regions where housing prices rose and fell the most, on the left side of the chart, and the rest of the United States on the right. For middle-aged and younger people (blue bars), hours worked fell 12 percent in the large cycle regions and about 9 percent in the rest of the United States.

Hours worked by elderly people increased in both regions.

As I noted a few weeks ago, the average American elderly person worked more in 2010 than did the average elderly person before the recession began, even while work hours were down sharply for middle-aged and young people. The chart above shows that this is true even in the states that generally experienced the largest collapse during this recession.

Demand is not the only factor driving employment patterns.

America's Colonial Safety Net

2011-09-28T06:40:00.000-07:00

Copyright, The New York Times Company

The United States Coast Guard’s search-and-rescue division is considering some of the same trade-offs that are found in better-known safety-net programs related to unemployment and health care.

Among other duties, the Coast Guard rescues people in, on and near United States waters. In addition to having highly trained life-saving personnel, the Coast Guard has ships, helicopters, planes and some of the world’s most modern life-saving equipment.

Taxpayer financed, the Coast Guard every day offers its services free of charge to the people it rescues. In that regard, the search-and-rescue part of the Coast Guard is a kind of safety net –- taxpayers pay so that people can have help on the rare occasions when they need it.

In fact, these search-and-rescue activities predate Medicaid and unemployment insurance; the Coast Guard can be traced back more than 200 years to a private search-and-rescue organization in Massachusetts called the Humane Society.

Safety-net programs have what economists call “moral hazard” as an unfortunate byproduct: recognizing that the government is standing by to help, some people do too little to take care of themselves. For example, a significant fraction of unemployed people delay finding a new job until their benefits run out. This may not be a choice we condone, but because unemployment insurance makes unemployment a little less painful, some people will respond by doing less to exit unemployment.

In their marine rescue efforts, the Coast Guard has noticed that many boaters do not wear life jackets that can prevent or delay drowning, and a number of boats venture miles offshore without a radio beacon that can help rescuers find troubled boaters.

Unfortunately, some boaters’ imprudent actions may actually be the result of the Coast Guard’s life-saving proficiency. Boaters know that they can call the Coast Guard when their boat takes on water, catches fire or otherwise becomes disabled, and many times help will arrive before the boaters have to leave their vessel and jump in the water. The Coast Guard even has ways of locating people who do not have radio beacons.

President Obama signed a health care law that will require Americans to get health insurance. Although less known, President Obama also authorized the Coast Guard to consider mandating radio beacons for boats venturing offshore and mandating that boaters wear life jacket in many situations (the Coast Guard has long required boaters to have life jackets on board, even if they are not worn).

Although it is sometimes asserted that the federal government has limited legal power to mandate citizens’ purchases, there can be a good economic case for mandates. While economists are often not inclined to interfere when a person knowingly risks his life for thrills or any other reason, the fact is that our government is in the safety net business, so individuals may take risks without recognizing the costs they create for rescuers.

A boat owner may save himself a few dollars by forgoing the purchase of a radio beacon, and that can ultimately cost the Coast Guard –- and thereby American taxpayers –- a great deal of money in search-and-rescue resources. Over all, it might be cheaper if the owner were force to make the purchase.

On the other hand, it is possible (although not logically necessary) that mandating marine safety equipment may encourage dangerous activities on the water, because the safety equipment reduces the costs of dangerous activities. Years ago, Prof. Sam Peltzman of the University of Chicago found that mandating the wearing of seat belts in automobiles resulted in more dangerous driving and more accidents, because, thanks to the seat belts, the average accident was less deadly.

As always, helping people has its side effects, and some rescues are necessary because the safety net exists.

Small is not Zero

2011-09-21T09:16:00.000-07:00

Copyright, The New York Times Company

Payroll taxes are by no means the only thing that stops people from working, but one of President Obama’s payroll tax cut proposals could nonetheless create a million or more jobs.

Last week I estimated that the president’s proposal to cut the employer portion of the payroll tax by 3.1 percentage points could raise employment by more than a million, and maybe as much as three million.

You might (as some readers wrote to me) think that a payroll tax cut is not, by itself, a good reason for employers to hire, and on that basis conclude that my estimate is way off.

I agree that jobs are not created by payroll tax cuts alone, and my estimate reflects that fact. About 131 million adults are working now, and 109 million adults are not working. If I’m right that the payroll tax cut would raise employment by one million to three million, that means that 106 million to 108 million adults would still not be working despite the payroll tax cut.

The chart below illustrates the results for the case that the payroll tax cut raises employment by exactly two million.

In other words, my estimate is that at least 97 percent of people not working would still not be working regardless of the payroll tax cut. That’s because, as you might deduce, payroll taxes are only one factor among many that determine how many people are employed. Nevertheless, raising employment by one million to three million would be an accomplishment for the president, and one that would be visible in the national statistics.

By the same logic, if someone were to propose raising the payroll tax by 3.1 percentage points, I would expect employment to be reduced by one million to three million. Again, the payroll tax is only one of many factors affecting hiring decisions, which is why my estimate of a payroll tax increase implies that more than 97 percent of workers would continue to work despite the increase.

Indeed, we all know people who would continue to work even if the payroll tax were raised by 30 percentage points, let alone three. We also know people who would not work even if taxes were eliminated completely.

But the fact that more than 100 million people are not employed, and more than 100 million people are employed, suggests that there could well be a million people (or two million, or three million) who are near the fence. For that small fraction of the population, there are almost as many things pushing toward making them employed as making them unemployed; a payroll tax cut could tip the balance.

For hundreds of millions of others, the balance is tilted too far for a payroll tax cut to make a difference. But while economists can debate the exact numbers, few of us can conclude that a small tax cut has no effect. Rather, a small tax cut should be expected to have a small effect — and at this point one worth seeking.

How Payroll Tax Cuts Can Create Jobs

2011-09-14T04:01:00.000-07:00

Copyright, The New York Times Company

Last week President Obama proposed a collection of policy changes, including payroll tax cuts, unemployment benefit extensions and new infrastructure projects. The latter do not have much job-creation potential, because they reduce private-sector activity in the short run. But they can be desirable for the infrastructure they produce, and because doing some of those projects now would be cheaper than doing them later.

Unemployment compensation may be compassionate, and for that reason alone might be the “right thing to do.” But an unfortunate side effect of unemployment compensation is that it reduces employment by discouraging people from seeking and retaining jobs.

The real job-creating potential in the president’s proposals comes from one of its payroll tax cuts.

The payroll tax is the second most important tax in the United States, normally bringing in almost $900 billion a year through a combination of taxes on employers and employees — about 15 percent of payroll. Although workers may not realize it, most of them pay more payroll tax than they pay in federal income tax.

The president proposes cutting the employer portion of the payroll tax by 3.1 percentage points (bringing the combined total down to about 12 percent) for employers with less than $5 million in payroll. Unfortunately, this last condition is business-distorting. Why encourage a $10 million business to split into two $5 million businesses?

Nevertheless, the 3.1-percentage-point part of the president’s proposal could raise employment by at least a million, albeit the duration of job creation is related to how long the tax cut lasts. I expect that every percentage-point reduction in employers’ costs raises employment by about a percentage point and real gross domestic product by about 0.7 percentage point.

That means employment could be roughly three million greater during the period of the tax cut than it would otherwise.

The tax cut is proposed to last a year, and some of the estimated three million incremental job-years — a job that lasts a year, or 12 jobs that last a month — could be spread over time. So we might see only two million in the first year of the cut, with another one million after the cut expires. But still that’s a lot of jobs.

The other part of Mr. Obama’s payroll tax cut proposal is more complicated — and counterproductive. It would reduce the employer’s proportion of the payroll tax by 6.2 percentage points for increases in its payroll spending. Assuming that this payroll tax change would be in place in 2012, the payroll spending subject to the reduction would be the difference between the 2012 payroll and the 2011 payroll.

Because this part of the cut is based on the payroll difference, it makes expanding the 2012 payroll cheaper — presumably the intention of the law — but it makes it cheaper to contract the 2011 payroll.

That could be part of the reason why employment so far in 2011 has been so low; if you think that tax credits for new hires will catch employers completely by surprise, remember that the Obama administration has been floating ideas like this for three years.

To see this, consider an employer that would have a $1 million payroll in both 2011 and 2012. With the normal rates in place, that employer and its employees would owe a combined $150,000 in payroll taxes in each of the two years (15 percent of payroll; for simplicity I have put to the side payroll tax caps and a employee-side cut that has been in place since Jan. 1), or a total of $300,000.

If this employer decided to increase its 2012 payroll by $100,000, that would add a total of about $15,000 to the tax bills under the normal rates, but only about $9,000 under the proposed cut. In other words, as intended, the proposal makes 2012 payroll expansion about 6 percent cheaper than it would be under the normal rates.

However, if the same employer decided to cut its 2011 payroll by $100,000, that would subtract a total of about $15,000 from the tax bills under the normal rates, but subtract a total of $21,000 from the tax bills under the proposed rates — if the payroll cut was restored in 2012, since that part of the payroll would benefit from the reduced payroll tax rate. Contrary to the policy’s intentions, it makes cheaper certain types of payroll reductions, namely those reductions that occur before the law goes into effect.

While President Obama’s proposals have some real job creation potential, it remains to be seen whether any of them become law and whether the job-creating policies are packaged with too many job-destroying policies.

News is What the Customer Wants

2011-09-07T05:36:00.000-07:00

A few quick google searches (items published Sep 1 - 7 AM) on coverage of the "Jimmy Hoffa speech."

New York Times 0 search results link to story/discussion
Chicago Tribune 1 search result links to story/discussion
New York Post 3 search results link to story/discussion
Fox News dozens of search results link to story/discussion

Who Lost Work During the Great Recession?

2011-09-07T05:21:00.000-07:00

Copyright, The New York Times Company

Young people have seen their work hours drop the most during this recession, while the elderly are actually working more than they did before.

Using data from the Census Bureau’s Household Survey via the National Bureau of Economic Research, I calculated the average hours worked by age for 2007 (people not working during the week of the survey count as zero hours worked) and then again for 2010. The chart below displays each age group’s percentage change from 2007 to 2010. For example, the chart shows that the average 16-year-old in 2010 worked 40 percent fewer hours than the average 16-year-old did in 2007.

Author’s calculation from Census Bureau Household Survey

We all know that hours worked in 2010 were considerably fewer than they were before the recession began, which the chart shows: most of the age groups have a negative percentage change.

But the chart also shows that labor losses lessen with age and are positive for a number of age groups. In percentage terms, work hours fell the most for teenagers, reflecting the high teenage unemployment rate. After the teenagers, work hours fell the most for the age groups 20 to 29. Work-hours losses for groups in their 30s and 40s ranged 5 to 11 percent. Work hours also fell for age groups 50 to 59, but typically less in percentage terms than for the age groups aged less than 50.

As I noted a few weeks ago, average work hours actually increased for the oldest age groups.

Seniority layoff practices would tend to reduce hours worked most for young people because, naturally, they tend to be employers’ more recent hires. You might think it would make sense for employers to retain their most experienced workers, but downsizing employers tend to offer and encourage early retirement to people in their 50s and early 60s, who are paid more than recent hires and are starting to think about leaving the workplace.

Yet the chart does not show especially large declines in hours for those age groups (nor can seniority practices by themselves explain why the elderly end up working more).

Of course, an employer that shuts down does not lay off based on seniority but lays off everyone.

Another possibility is that the labor market distinguishes, at least in a rough way, among workers according to their willingness to work, and that the stock market and housing market crashes have especially stimulated older people to work more. (Young people, on the other hand, had fewer assets before the recession, so a decline in asset prices has little direct impact on them.) This effect tends to increase with age because the propensity to own assets for current needs and future retirement also increases with age.

To the extent that minimum wages reduce employment of people who would otherwise earn a wage less than the minimum, the minimum wage increases of 2007, 2008 and 2009 may be another factor, because propensity to earn near the minimum wage tends to decline with age (although that propensity is not particularly low for the elderly, who do not have work-hours losses on average).

It is also possible that the ability to efficiently find a new job in a tough labor market is a skill, and people tend to accumulate that skill with age.

Economists are still digesting the labor market data from the Great Recession, but for now it appears that getting back to the pre-recession labor market especially requires creating jobs for young people.

Preparing for Disaster

2011-08-31T05:54:00.000-07:00

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Hurricane Irene traveled the East Coast last weekend and was expected to be one of the rare hurricanes to hit New York (by the time it reached there, it had been downgraded to a tropical storm). Although many thousands of people in the region may be without electricity for days to come, New Yorkers are glad that Irene did little damage as hurricanes go.

The storm began to receive media attention the weekend before it arrived, and people in the New York area used the time to prepare themselves. Forecasters have been criticized for overestimating the amount of wind that New York would experience, but the winds and tides were plenty strong. Preparation was an important reason that damage was limited.

For example, the eye of the storm passed right over Kennedy International and LaGuardia Airports, but planes did not crash because the airports were shut during the storm. Few lives and little cargo was lost from ships in the area because the ports were closed, and vessels moved out of the area.

Hundreds of thousands of people were left without power, and many homes were flooded. But, clearly, the damage would have been much worse if Hurricane Irene had hit with no warning.

I have no expertise in climate, weather, physics or aerodynamics, but one of the lessons of economics that environmental changes are less harmful when they can be anticipated. With only a few days of preparation, as with Hurricane Irene, people and mobile capital can be moved out of harm’s way. Protective barriers can be constructed for the immobile capital like homes.

New York was not given a definite warning of Irene a year ahead, let alone a decade ahead. But if it had been warned years ahead, the economy could have adjusted even more by making plans to locate activity in more protected places. Or perhaps even to invent goods and production processes that are more hurricane resistant.

The opportunities for preparation are one reason why economists expect the damage from global warming to be different, and perhaps less, than from natural disasters that hit by surprise.

Global warming is expected to raise temperatures and sea levels over a period of decades – perhaps centuries. Even if scientists are completely unable to retard or reverse the environmental consequences of global warming, thanks to decades of warning the economy can greatly adjust to minimize the economic costs of those environmental consequences.

That’s the thesis of a recent book, “Climatopolis: How Our Cities Will Thrive in the Hotter Future,” by Matthew Kahn of the University of California, Los Angeles (disclosure: Professor Kahn is a friend and was my classmate at the University of Chicago). Given advance warning, people will protect themselves and innovate in order to make sales in future market when the symptoms of global warming are more threatening.

A Fallacy of Composition

2011-08-24T08:02:00.000-07:00

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In 2009 the New York Yankees opened their new stadium on the north side of East 161st Street, replacing the historic stadium on the south side of the street. Not surprisingly, 2009 spending by consumers, news organizations and entertainment businesses, among others, on the north side of East 161st Street was a lot more than it had been in years past. It all started from the Yankees’ spending at the new location.

So a spending advocate might assert that this episode is proof that spending by one organization can stimulate spending by others, because the spending by the others on the north side of the street surged at exactly the same time that the Yankees started having their people work there.

Of course, such an analysis is flawed, because it ignores what happened on the other side of the street. Much of what happened north of East 161st Street was just a displacement of activity from the south side, rather than a creation of new activity. Even the construction workers building the stadium may well have been drawn from other tasks.

This pattern is not special to the Yankees’ move. A number of studies have shown that consumer spending associated with a sports team to a large degree displaces spending in other areas and displaces spending on other leisure activities; a family is unlikely to conclude that because there’s a new team in town or a new stadium, it should sharply increase its spending on entertainment.

Yet ignoring the displacement effects is exactly what Paul Krugman and Dean Baker have done in their praise of recent studies that use “cross-state variation in stimulus spending per capita to estimate the employment effects of the stimulus,” studies comparing states that received more stimulus to states that received less.

Spending from the American Recovery and Reinvestment Act (a.k.a., the “stimulus”) could be very much like the stadium spending — a locality that received more stimulus spending merely enjoyed a displacement of activity into its area from localities that received less spending, and that nationally little or no additional spending occurred as a result of the legislation.

If you want to know about the national effects of the stimulus, at least part of the analysis has to look at the nation as a whole. The same is true of the national effects of changes in labor supply. If one group suddenly becomes more willing to work, it is possible that the group solely takes jobs from the rest of the population, with no new jobs being created for the nation as a whole.

That is why, in addition to looking at the experiences of specific groups and specific regions, I have examined the effects of supply and demand on national employment. (Professor Krugman and Dr. Baker assert in so many words that I ignore national employment, though my papers on the subject look very much at national aggregates. For example, see Figure 3 and Figure 6 of this paper and Table 2, Table 3, Figure 2, Figure 3, Figure 4 or Figure 5 of this paper).

I found, for example, that national employment increases during the summer precisely because young people are more willing to work. Not surprisingly, the summer surge of young job seekers does seem to reduce employment of the rest of the population, but the net national effect is still almost a million more jobs in the summer.

For now, it appears that government spending reduces private spending, even while it may benefit specific regions or groups.

Exceptions to Keynesian Theory

2011-08-17T06:53:00.000-07:00

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While taxpayers have been wondering if all of the extra government spending of the past couple of years has actually served to impede the recovery, Keynesian economists have been asking them to keep faith in the promise that government demand is the secret to economic recovery. Now Paul Krugman, an outspoken Keynesian stimulus advocate, admits that Keynesian theory has many exceptions.

It’s pretty easy to see how various types of government spending might reduce employment, rather than increase it: a number of government programs have been reducing the incentives for people to work, and reducing the incentives for business to hire.

Unemployment insurance is an example (among many) of how the work incentives of so-called stimulus programs operate. Unemployment insurance payments to individuals cease as soon as the individual starts to work again. I agree that such payments are compassionate, and may well be the right thing to do, but economists have long recognized that such compassion is not free: unemployment insurance reduces employment, rather than increasing it, because it penalizes beneficiaries for starting a new job.

Without offering any proof that incentives suddenly ceased mattering, stimulus advocates, and even the Congressional Budget Office, have recently ignored this effect. Many of them aim to prove the potency of unemployment insurance and other components of the stimulus law by insisting that the recession was caused by a lack of demand, and that any public policy that raises aggregate demand must be a big help.

Even if they’re right that the recession was a result of low demand, it does not follow that the way to recovery is to destroy supply, too. Before we turn away from one of the basic lessons of economics, we ought to have some evidence of the fundamental Keynesian proposition that “incentives to seek work are, for now, irrelevant.”

(Another tendency of Keynesians is to “prove” their supply claim by pointing to the existence of unemployment. Of course, unemployment exists in large numbers, but that does not tell us whether, and how much, incentives affect employment rates.)

Part of my research has been to examine episodes, from the current downturn, of changes in the willingness and availability of people to work. If, as Keynesians have been insisting, the incentives to work are in fact irrelevant in a recession, then none of these episodes would be associated with employment changes. (In their view, an increase in the number of people willing to work would just increase, one for one, the number of people who are unemployed.)

I looked at seasonal changes in labor supply. I looked at the increase in supply of workers to the nonresidential construction industry (workers who were leaving home building after the crash). I looked at the increase in the supply of elderly workers. I looked at the increase in supply of workers in Texas. In all of these recession-era episodes, more supply meant more jobs, and less supply meant fewer jobs.

(I also looked at some recession-era demand changes to see if they were at all constrained by supply, and they were — very much as they were before the recession.)

There is still no evidence to confirm the fundamental Keynesian proposition that supply doesn’t matter.

Rather than completely discard that proposition, Professor Krugman has recently formulated a theory of exceptions to the Keynesian theory, which he believes can help explain some of my findings:

Here’s the question: why do patterns of employment over time that are, in fact, normally supply-driven continue to be visible even during a demand-side slump? And here’s the answer: businesses make long-term decisions that influence hiring patterns over time, and those decisions continue to shape their behavior even when there is a surplus of labor.

In other words, Keynesian theory has exceptions that have to do with business’s long-term hiring decisions. For example, businesses have lived through enough seasonal cycles to know that they can normally make more money when their hiring patterns are responsive to the seasonal availability of people to work, so businesses continue to be responsive to the seasonal pattern of labor supply even during a deep recession when there are plenty of workers available throughout the year.

I don’t understand how Professor Krugman explains that the nonresidential construction industry took advantage of the plentiful supply of home builders after housing crashed (he also has no explanation for my minimum wage findings, Christmas seasonal findings or elderly employment findings). He also fails to explains why some business hiring patterns survive the recession intact, while other practices are completely different (e.g., businesses used to think they needed 138 million payroll employees, but by 2009 they got by with fewer than 130 million).

But even if Professor Krugman were correct that the ghost of labor supplies past haunts the recession through business’s long-term decisions, how can he be so sure that the labor-supply effects of government spending programs would not also have the same effects they did in the past?

For example, employers found that people were more difficult to hire and retain when a generous safety net was available. In this way, unemployment insurance would continue to reduce employment even after the recession began because employers have learned that the more generous the safety net, the more they must get by with fewer workers.

Would Keynesian stimulus spending work only when it came as a surprise? Or only when the spending was outside the range of prior business experience? Keynesian economists have not even begun to answer these questions. For now, Keynesian theory has so many exceptions that we might as well discard it.

Supply of Admissions

2011-08-16T15:08:00.000-07:00

Professor Krugman is slowly converging to my view that supply matters even during recessions. I'll explain more tomorrow in a more lengthy blog post, but the basic idea has been in my seasonal supply paper (see the final para).

The Debt Downgrade and Stock Prices

2011-08-10T09:45:00.000-07:00

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The big financial story in the last few days has been the declaration by Standard & Poor’s that United States government bonds were no longer worthy of its AAA rating. The agency, in a nutshell, thinks there is some chance that the government will default or be delinquent on its debt payments.

The announcement was followed by a wild ride in the stock market in the last two days — a plunge of almost 7 percent in the Standard & Poor’s 500-stock index on Monday, followed by a surge of almost 5 percent on Tuesday.

But with the index down almost 18 percent from its April peak, it is clear that investors’ concerns long predated the downgrade.

The real news is how poorly the economy is doing, and how poor its prospects seem. The chart below shows the changes in several indicators of economic activity over the last nine months. The blue series is an inflation-adjusted stock price index, which (even with Tuesday’s big gain) is lower than it was nine months ago. Through May 2011, real housing prices (black series) were down 7 percent. Real consumer spending (red series) has failed to increase, and inflation-adjusted spending on consumer durables has fallen four months in a row.

All of these indicators are forward-looking in the sense that they depend on what people expect to happen to incomes and profits in the future. These indicators had been looking better during much of 2010 but now it seems that consumers and investors are not optimistic about what is ahead (are they worried about riots like in London? higher taxes? government program cuts?).

In my view, a rating agency does not move the market but rather reacts to some of the same prospects that are reflected in the decisions of consumers and investors. For example, to the degree that incomes continue to remain low, tax collections will also remain low, making it that much more difficult for governments to pay their obligations.

Recovery for the stock market, and the wider economy, needs a lot more than an agency to change its mind about government bond ratings.

Previous Trends Continue: More Evidence that Supply Matters

2011-08-03T10:17:00.000-07:00

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The supply of various types of workers has increased during the recession, continuing an earlier trend. That such trends continue to be associated with trends for employment contradicts the Keynesian claim that supply suddenly stops mattering during recessions and “liquidity traps.”

A number of bloggers have pointed out that employment in Texas has been rising and has almost reached prerecession levels. Paul Krugman’s explanation is that the supply of people available and willing to work has been increasing in Texas, continuing a previous trend.

One example of that supply is the inflow of immigrants from nearby Mexico; another is the migration of Americans seeking cheaper housing. I might quibble about the details, but I agree that supply trends are crucial for understanding what has happened in Texas.

In previous posts I have pointed out that national employment per capita actually increased among the elderly during the recession. I, and other researchers, concluded that elderly employment deviated so much from the general population because of changes in elderly labor supply.

In reaction to my post, Dean Baker attributed the elderly increase during the recession to a previous trend. Because the previous trend was itself the result of supply, Dr. Baker’s explanation of the recession is essentially a supply increase, too.

So we all agree that in at least two cases labor supply increased during the recession, and in each case the result was more jobs for the affected groups, or at least fewer job losses than in the general population.

Recession-era supply episodes like these are important to identify, because they can prove or reject Keynesians’ fundamental assertion (so far unproven) that supply does not matter during a recession or a “liquidity trap” such as we’ve experienced since the recession began.

Consider, hypothetically, an immigration trend that continued even after the recession. In my view, the market would create jobs for many, but not all, of the immigrants and would continue to do so after the recession.

In the Keynesian view, immigration might create jobs before the recession, but could not create them once the recession began because “what’s limiting employment now is lack of demand for the things workers produce,” Professor Krugman wrote. “Their incentives to seek work are, for now, irrelevant.”

In the Keynesian view, all that extra supply does during the recession is add to unemployment rather than adding to employment. In other words, supply trends normally affect employment, but Keynesians assert that they cease to affect employment during a recession or liquidity trap.

The chart below shows monthly employment (left scale) and unemployment (right scale) in Texas since 2007. Despite the fact that our nation is in a liquidity trap (near-zero interest rates on Treasury bills, the results of the extra supply in Texas since 2009 have been to increase employment much more than increase unemployment.

Data From The Federal Reserve Bank of St. Louis

Or consider that more recent cohorts have found themselves in careers that involve less manual labor, producing a increasing number of people reaching age 65 and still willing and able to continue their work. In my view, elderly employment would rise and might even be rising enough to more than offset a demand reduction during a recession.

In the Keynesian view, all that extra supply does during the recession is add to unemployment rather than adding to employment.

When it comes to analyzing specific events during the recession, fiscal stimulus advocates often take the common sense approach that labor supply affects employment. But when it comes to making promises about the anticipated results of a large fiscal stimulus, they insist, without proof, that supply doesn’t matter.

Elderly Employment during the Recession: Supply or Demand?

2011-07-27T05:07:00.000-07:00

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The supply of elderly workers increased during the recession, and employment rates of the elderly increased along with it. This result is difficult to reconcile with Keynesian characterizations of the labor market.

Last week I showed how employment per capita had increased slightly among elderly people since 2007, while employment per capita in the general population plummeted. I, and other economists previously, have concluded that employment of the elderly deviated so much from the general population because of changes in elderly labor supply.

Recession-era supply episodes like these are important to identify, because they can prove or undercut Keynesians’ fundamental argument (so far unproved) that supply does not matter during a recession or during a “liquidity trap” such as we’ve experienced since the recession began.

(One Keynesian rhetorical trick is to “prove” the supply claim by pointing to the existence of unemployment. Of course, unemployment exists in large numbers, but that does not tell us whether, and how much, labor supply affects employment rates. Only the latter indicates the value, if any, of Keynesian policy prescriptions.)

In reaction to my post last week, Dean Baker, co-director of the Center for Economic and Policy Research, offered some analysis of weekly earnings and concluded that the demand for elderly workers increased during the recession even while it plummeted for everybody else. Supply played little or no role, he said.

Generally, I agree that wage rates are an important variable for gauging the relative importance of supply and demand (see, for example, my analysis of labor supply during the summer season, which featured hourly wage rates as one of three key indicators). But in this case, Dr. Baker’s weekly earnings results ran into a few contradictions.

First, what was the demand shift experienced by elderly workers that was so large as to completely offset the demand shift purportedly experienced by the rest of the population? Perhaps elderly workers picked up some of the hundreds of thousands of jobs that teenagers and other unskilled workers lost thanks to the minimum wage increases? Dr. Baker did not say.

Second, a huge increase in demand for the elderly might be expected to reduce their unemployment rates, yet the chart below shows how unemployment rates for the elderly followed very much the same time pattern as unemployment rates for the general population. (According to the Census Bureau, every person is either employed, unemployed or not looking for work, which is why unemployment and employment can move in the same direction). Dr. Baker’s purported demand shift is not visible in the unemployment data.

Third, Dr. Baker’s own data suggested that something other than demand was driving most, if not all, of the earnings changes he measured. Elderly employment per capita increased only 4.5 percent. Demand increases by themselves usually increase wage rates about the same amount that they increase employment, which in this case would be well less than 10 percent (for example, during Christmas season, when demand increases employment rates more than it increases wages, not less).

But Dr. Baker measured a weekly earnings increase of at least 17 percent, which tells me that weekly earnings were increasing for reasons other than demand. (This may have been because elderly people were working more hours per week, took on jobs with greater responsibility or because the composition of the elderly work force changed in the direction of greater skill. See this paper for a technical analysis of these forces.)

Labor supply, rather than labor demand, readily explains why elderly unemployment rates tracked the general population’s during the recession, while elderly employment did not: the willingness (or necessity, if you want) of working had changed more for the elderly than for the rest of the population. The fact that labor supply really does matter during recessions means that Keynesian policy prescriptions will not deliver what they promise.

Why Hasn't Employment of the Elderly Fallen?

2011-07-20T06:35:00.000-07:00

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While employment rates have fallen sharply among the general population, they have not done so among the elderly. This result is difficult to reconcile with Keynesian characterizations of the labor market.

The red line in the chart below displays an index of the per capita employment for the general population. For example, a value of 93 for 2010 means that the fraction of people employed in 2010 was 7 percent less than it was in 2007, before the recession began. The red line shows what we all know by now: many fewer people have jobs now than did a few years ago.

The other two series in the chart are for specific age groups: ages 65-69 and ages 70-74. Both groups have a somewhat greater fraction working now than in 2007 (the increase is even more for ages 75+, but that group is small, so it is omitted from the chart).

Recent studies have looked at the labor-market experiences of the elderly during the first half of the recession. The authors emphasize that, while the recession by itself might reduce elderly employment, the elderly have become increasingly willing to work. I agree.

Many elderly people, for example, saw the market values of their homes and retirement assets plummet in 2008 and feel they can no longer afford to be retired. Naturally, many of them react by looking for work.

The blue and green lines in the chart show that the elderly have been much more successful than the general population at obtaining and retaining jobs.

These findings contradict the Keynesian narrative of the labor market, in which the marketplace fails to recognize the degree to which people would like to have a job. (The Keynesian narrative helps rationalize, among other things, the assertion that unemployment insurance did not reduce employment during the recession, because “what’s limiting employment now is lack of demand for the things workers produce. Their incentives to seek work are, for now, irrelevant.”)

Employment, even during a recession, is not solely the result of lucky few finding available positions. All else being the same, the market tends to create and allocate jobs for those people who are most interested in working.

That’s why, if government is to avoid making employment any less than it has to be, it’s so important to pay attention to the incentives created by taxes, subsidies and government regulations.

Where a Minimum-Wage Increase Would Bite

2011-07-13T07:02:00.000-07:00

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Last week I explained how I estimated that the July 2009 federal minimum-wage increase reduced national employment by about 800,000. That 800,000 is the sum of employment impacts for each of several demographic groups and can therefore be used to estimate which groups were most affected by the wage increase.

For each group distinguished by age and part-time status, I calculated “impact”: the percentage gaps between actual per capita employment after July 2009 and the employment I estimated to occur absent the minimum-wage increase.

For example, I found the part-time employment impact among teenagers to be negative 14 percent: that is, 14 percent fewer teenagers were working part time since July 2009 as a result of the federal minimum-wage increase.

The basic economics of the minimum wage suggests that employment impacts will be greatest among groups with the lowest hourly wages. Teenagers employed part time have particularly low hourly wages, and the hourly wages for teenagers employed full time are not much greater. The percentage impact on people 20 and over working full time should be essentially zero, because 98 or 99 percent of them would make more than the minimum wage anyway (see Table 1 of this paper).

The chart below compares, by group, the minimum-wage increase’s employment impact (vertical axis) to a measure of the hourly wages of the workers in the lowest-paid quarter, shown on the horizontal axis). The diagram shows that impacts are negative, or essentially zero, and that the size of the impact is progressively smaller for groups with higher wages – exactly as economic theory predicts.

Compare, for example, the minus 13 percent impact for teenagers in part-time jobs (25 percent of whom were earning less than $5.17 an hour in 2008 — note that a -0.13 log change is essentially a 13 percent reduction) with the zero percent impact for full-time workers 20 to 54 (75 percent of whom were earning more than $11.76 an hour).

Teenage employment rates have fallen to 25 percent from 35 percent over the last four years. Much of that drop cannot be attributed to the federal minimum wage, but my estimates show that the federal minimum wage was a significant factor.

Profs. William E. Even and David A. Macpherson also studied the recent minimum-wage increases for the Employment Policies Institute, using a different methodology. They focused on teenagers (not distinguishing part time and full time), and their state-level model included three federal minimum-wage increases (2007, 2008 and 2009).

They found that those three increases cost 114,000 teenage jobs (I found 800,000 for all age groups combined, only some of which were teenage employment effects; Prof. David Neumark had estimated that teenage and young-adult employment would be reduced 300,000 as a result of the July 2009 minimum-wage increase).

A minority of states were not affected by federal minimum-wage increases because their own state-legislated minimum wage would exceed even the new higher federal minimum (the federal minimum prevails over the state minimum whenever the former is greater).

Thus, whatever jobs were lost because of the federal increase would be lost in the states — 31, after the 2009 increase — and the District of Columbia (which sets its minimum to be $1 above the federal minimum, so when the federal minimum jumps, do does the district’s). Professors Even and Macpherson’s state-level estimates confirmed that this was, in fact, the case.

For the same reason that my model separately considered teenagers and part-time workers, Professors Even and Macpherson followed their teenagers study with a study of 16-to-24-year-old men with less than a high school diploma. They found that each 10 percent increase in a federal or state minimum wage decreased white employment by 2.5 percent, Hispanic employment by 1.2 percent and black employment by 6.5 percent.

For the time being, at least, it seems that increasing the federal minimum wage again would give a few workers a small raise — but at the cost of eliminating entire paychecks for the young, less educated and least skilled.

Kudlow Clip

2011-07-12T19:24:00.000-07:00

Teen Employment Increases Almost One Million

2011-07-08T05:57:00.000-07:00

Based on my view that labor supply always matters, last month I predicted that teen employment would increase the summer, much like summers past, largely because summer is when teens become available to work. When more people are available to work, jobs are created.

This morning the Labor Department reported that teen employment had increased about 900,000 from April to June. I expect that July will show still higher teen employment.

How to Create Jobs and Cut the Deficit

2011-07-06T07:45:00.000-07:00

Copyright, The New York Times Company

Another federal minimum-wage increase would not, as some proponents promise, create jobs, but would reduce employment.

A few months ago, The New York Times editorialized that America’s minimum-wage workers “need a raise.” The Center for American Progress said a higher federal minimum wage “encourages spending, investment and economic growth.”

Many economists expect the minimum wage, if it has any effect, to raise employer costs and thereby reduce employment, especially among people who are likely to work in minimum-wage jobs, like part-time workers.

Federal and state minimum wages have changed a number of times over the years, and each of those instances provides an opportunity to test the employment-reducing hypothesis. For the episodes before 2007 (which I’ll refer to as the historical minimum-wage increases), many statistical studies of minimum-wage effects are summarized in books by David Neumark and William L. Wascher and David Card and Alan B. Krueger.

Not everyone interprets the historical evidence the same way. The New York Times and the Center for American Progress cited some of that evidence to alleviate concerns that a minimum-wage increase would reduce employment.

Even those who believe that historical minimum-wage increases did little, if anything, to reduce employment are still likely to appreciate that a minimum wage that was high enough — a hypothetical $100 an hour, for example — would significantly depress employment. The real disagreement is whether historical minimum wages were high enough, and the economic situations right, for those increases to destroy a large number of jobs.

The most recent federal minimum-wage increase, on July 24, 2009, had the potential to have different effects than its predecessors. Adjusted for inflation (and deflation), by 2009 the real federal minimum wage had been raised to a level 32 percent higher than it had been in 2006 — nowhere near our hypothetical height, which we all agree would be destructive — but perhaps high enough to have some of those effects.

In addition, during a recession hiring decisions may be especially sensitive to employment costs, though some economists say recessions make employment less sensitive to wages.

It’s also easy to exaggerate the effects, good or bad, of the federal minimum wage, because seasonal workers, employees who rely on tips and others are exempt from it, and a few states have minimum wages above the federal minimum.

For these reasons, I have been studying the 2009 federal minimum-wage increase by itself and trying to separate the effects of the recession from the effects of the wage increase (see this recent publication for more details; my next posts will point to some other findings from the 2009 increase).

Part-time and teenage employees are especially likely to have hourly wages near the federal minimum. The red line in the chart below displays seasonally adjusted national part-time employment by month, from the Census Bureau’s monthly household survey. Before July 2009, part-time employment increased by about three million during the recession and that month reached the peak level of part-time employment.

To investigate the possibility that the July 2009 wage increase stopped further increases in part-time employment and perhaps affected other employment categories, I estimated a monthly model of national part-time and full-time employment per capita for each of 12 demographic groups distinguished by race, gender and age (white and nonwhite, male and female, and 16 to 19 compared with 20 to 54 and 55 and over), using data from before the increase.

I used the model to forecast part-time and full-time employment for each demographic group for August 2009 through December 2010. The aggregate deviation of the part-time predictions from the actual was added to the red line to arrive at the aggregate part-time prediction shown as the chart’s blue line.

After falling 9.3 million during the recession through July 2009, aggregate full-time employment fell another 1.8 million by the end of the year and remained below July 2009 levels at the end of 2010. Some people dismissed from their full-time jobs probably had trouble finding another suitable one, and some of them worked part time while they searched.

Consistent with this story, my estimates predicted that part-time employment would have continued to increase during the second half of 2009 because, before the increase, part-time employment tended to increase with full-time job losses.

The actual and predicted data depart dramatically beginning in September 2009, with actual part-time employment 1.2 million below predicted part-time employment by December and averaging 975,000 part-time positions below what was predicted over the months August 2009 to December 2010.

A small number of these job losses were offset by possible increases in full-time employment (relative to what it would have been – more on this next week). I find the total job loss from the July 2009 minimum-wage increase to be about 800,000.

If raising the minimum wage reduced employment by 800,000, cutting it back to its early 2009 level is likely to increase employment by 800,000. That would add a bit to government revenue as some of those people moved from unemployment benefits to tax-paying workers.

Back from Vacation

2011-06-29T19:08:00.000-07:00

I figured that I should spend my Euros while they still mean something. Not in Greece, though.

Summertime Blues for Teenagers

2011-06-29T19:05:00.000-07:00

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Many teenagers cannot find work this summer, victims of a weak economy and a situation made worse by minimum-wage laws. Budget cuts for government youth-employment programs are a much less important factor.

Employment rates among teenagers are much lower now than they were before the recession began. While some people blame cuts to summer youth-hiring programs by state, local and federal governments, even in the best of times these provide only a small fraction of summer jobs for teenagers.

I used the Census Bureau’s monthly household surveys from January 2000 to December 2009 to calculate the amount that each industry’s employment of teenagers (measured as the sum of hours worked by all persons 16 to 19) during June, July, and August exceeded its average value in the months of April, May, September and October. For the economy as a whole, the average teenager worked 11 hours a week during the summer, compared with an average of eight hours a week during the academic year.

Not surprisingly, the arts, entertainment and recreation industries provided more of those extra work hours – about 16 percent of them — than any other industry group. Accommodation and food services — that is, hotels and restaurants — provided 15 percent.

Retail trade and construction were next among the job providers, with 11 and 9 percent, respectively. Local government was fifth, providing less than 9 percent of the extra summer work for teenagers. Even the combination of local, state and federal government hiring explained less than one-eighth of the extra summer work for teenagers (for the contributions of more industries, see Table 4 of this paper).

The vast majority of summer youth hiring is done by the private sector, and even if government eliminated its summer youth hiring, that would hardly dent the total.

(Employment rates for adults are also much lower than they were before the recession, although in lesser percentages than for youth. As with youth, private-sector employment reductions were much larger than the public sector reductions.)

Employment during recessions tends to drop disproportionately among low-skilled people like teenagers, so the latest recession has to be the biggest factor in explaining why teenage employment rates are so low today.

But minimum-wage laws also disproportionately affect teenagers — reducing their employment rates — and the federal minimum wage was increased three times in and around this recession. (Next week I will present more evidence on the number of jobs lost because of the most recent federal minimum wage hike.)

If the government wants to help raise teenage employment rates significantly, a good way to start would be by reducing labor market regulation rather than spending tax dollars on youth employment programs.

The Misunderstood Mortgage Interest Deduction

2011-06-15T18:50:00.000-07:00

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The home-mortgage interest deduction does not by itself significantly distort housing markets. Too much owner-occupied housing has been built because housing is excluded from sales and other taxes owed by businesses.

The housing boom and bust of the last decade, and government revenue shortfalls, have brought back the topic of whether the government excessively encourages home building. Those discussions invariably mention the elimination of the home-mortgage interest deduction.

This deduction allows taxpayers who own a home, have a mortgage and itemize deductions to reduce their personal income tax by including home-mortgage interest payments in their tax deductions. Homeowners rightly consider this when considering whether and how much to invest in a home and how much they should borrow.

A homeowner who pays, say, one-third of his taxable income in federal and state personal income taxes will recognize that a $3,000 monthly mortgage-interest payment really only costs $2,000, because the mortgage interest reduces his taxable income by $3,000 and thus the personal income tax owed by $1,000 a month. It’s as if he paid $2,000 and the federal and state government treasuries paid the other $1,000.

At first glance, the home-mortgage interest deduction would seem to cause homeowners to borrow excessively for home ownership, and thereby deplete government treasuries. But that ignores the fact that one person’s mortgage interest payment produces interest income for another person or a business. The lender may well owe taxes on the interest income.

More home-mortgage borrowing means more home-mortgage lending, and the latter means more interest income that can be taxed. In theory, home-mortgage borrowing could even add revenue to the Treasury if the lender is in a higher tax bracket than the borrower (or if the borrower is not itemizing her tax deductions).

Interest deductions are present in the business sector, too, and have the same essential properties as the home-mortgage interest deduction. A corporation that borrows to finance an investment project can deduct its interest payments from its taxable income, and that borrowing will generate interest income for whoever made the loan.

Landlords can also take out mortgages on their properties and deduct the interest payments from their taxable income (that benefit may, in turn, affect the rent they set). In that sense, the possibility of deducting mortgage-interest payments from income taxes does not by itself discourage renting rather owning.

In contrast, consumer durable goods do not enjoy the interest deductions that housing and business capital do. Someone who takes out a car loan to purchase an personal automobile cannot deduct the interest payments from her taxable income, even while the Internal Revenue Service may be collecting taxes on the interest income of the lender. In this regard, tax policy discourages investment in consumer durable goods relative to investment in housing and businesses.

This is not to say that housing investment has been efficient. Earlier this year I explained how housing is much less profitable than business capital before taxes, largely because of the host of taxes — like sales taxes and income taxes on profits — that are owed by owners of businesses but not
by owners of homes.

Labor Supply Always Matters

2011-06-08T08:11:00.000-07:00

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As it has for the last three summers, the economy’s regular seasonal cycle will accumulate yet more evidence against Keynesian models of recession labor markets.

Two important seasons in the labor market are Christmas and summer. The Christmas season is an obvious time of high demand — people want to spend more in November and December. Basic economics says that Christmastime demand, while it lasts, raises wages, employment and hours, while it reduces unemployment.

Employment and work hours are also high during the summer, and as you are reading this, employment is likely to be surging well above what it was a month ago (the Census Bureau employment data for June is not due out until July 8, and the July data not until a month after that).

In the past, a few readers of this blog have given demand the credit for the summer job surge. In my view, demand contributes a little to the summer job surge (after all, agriculture, construction and other industries are expected to be more active when the weather is warmer), but supply is the primary reason that jobs are created during the summer.

One basis for my opinion is that people in vast numbers become available for work when school lets out for the summer, and about the same number are no longer available when school resumes. For example, about 20 million people 16 and older are attending school during the academic year, and very few of them are working full time. Nobody knows the students’ intentions for sure, but certainly millions of them would like to work during the summer.

I don’t know of any change in demand occurring over the summer that would number in the millions (even doubling the size of our military overnight would not create much more than a million jobs).

It’s easy to tell the summer supply stories and demand stories apart. The demand story is a lot like Christmas — customers demand, employers want to satisfy customers, so they hire more workers. If the demand story applied to summer, then we should see summer employment and work hours surge, and wages increase, too, while unemployment should dip.

If I’m right that the summer job surge comes from supply — the increased availability of workers — then summer wages and unemployment should follow patterns opposite to Christmas: wages should fall and unemployment surge.

The charts below display three labor market indicators — weekly hours worked, hourly pay for full-time jobs and unemployment — for the two seasons. (I use data from the Current Population Survey Merged Outgoing Rotation Group from January 2000 through December 2009).

The charts show seasonal spikes: the level of the indicator during the Christmas season (November and December) or the summer (June through August), relative to the indicator during the four months near the season. Wages and unemployment are represented as a proportional change from their off-season values, and spikes in hours are expressed as a proportion of a group’s average hours for the entire season and adjacent months.

(A person not at work counts as zero. To create this particular chart — other charts and tables are also available — I focus on people less than 35 years old, because their job turnover rates are greater and thus more visibly display the effects of short-term fluctuations like Christmas or summer. Please note that I have truncated the green hours bar and indicated its actual value with text, because the teenage summer hours spike is 0.295, which far exceeds the scale needed to display the other figures.)

Each group’s hours spike is positive on Christmas. During the summer, the hours spikes are positive only for the two younger age groups, which we expect because those are the groups attending school during the academic year and becoming suddenly available to work in June. All three Christmas wage spikes (middle panel) are positive, while all three summer wage spikes are negative.

It’s hard to believe that summer involves the kind of demand surge we see over Christmas; summer wages and unemployment go in exactly the opposite direction that they do during Christmas.

Thus, the summer job surge is nothing like Christmas. The economy creates jobs in the summer — even during the last several years, when our economy supposedly suffered from a lack of demand — because millions of people become willing and available to work. This is not to say that everything is working well in the labor market — employment is much lower than it should be — it’s just that greater labor supply remains one route to higher employment.

As noted by Greg Mankiw, the Harvard economist, and Gauti Eggertsson of the New York Fed, the fact that, even now, jobs are created when people are willing to work is a big challenge to the Keynesian economic model that assumes that labor supply is irrelevant during recessions, liquidity traps and other labor-market crises.

As Paul Krugman put it: “What’s limiting employment now is lack of demand for the things workers produce. Their incentives to seek work are, for now, irrelevant.”

That’s why Keynesians contend that expanding unemployment insurance can increase employment, even while they know that it erodes work incentives. Yes, unemployment is too high and employment is too low, and I applaud Keynesian economists for trying to understand that.

But they have gone too far and have ultimately given the wrong advice, in assuming without proof that labor supply is irrelevant. The labor market’s seasonal cycle shows pretty clearly that they’re wrong.

Listing Gun Owners Might Help Criminals

2011-06-01T06:28:00.000-07:00

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Gov. Pat Quinn of Illinois is considering signing a bill that would prohibit state officials from publicizing lists of registered gun owners. The economics of crime suggests that such a list would put potential victims at a disadvantage and help criminals.

Earlier this year, the state attorney general, Lisa Madigan, asked the Illinois State Police to make public its list of registered gun owners. Proponents of Ms. Madigan’s request say the Freedom of Information Act requires the state to release such information when requested.

The police are concerned that a public list would discourage some gun owners from legally registering their weapon, and, as a result, the owner database would be less accurate precisely because it was public. A more accurate list, the police say, helps them protect officers and facilitates law enforcement.

(Disclosure: I am a resident of Illinois and, for the reasons discussed in this post, I do not disclose whether I own a gun.)

Economists know that information affects criminal activity – that crime is reduced when criminals see a greater likelihood that they will be caught or that they would face a stiffer penalty when convicted. As in other areas of activity, studies show that criminal behavior is, on average, sensitive to the costs and benefits of committing a crime.

Potential victims recognize this sensitivity and take steps to protect themselves. Sometimes they install locks and alarms, knowing that criminals may get through them but would rather spend their effort on another victim who is less well protected.

Just as most criminals would rather avoid locks and alarms, many of them would rather commit their crime without being shot by a victim brandishing a firearm. Without access to a gun-owner database, criminals in Illinois may expect that any victim might use a firearm for defense.

Making the list public would also permit criminals to select victims who do not appear on the gun-owner list, to lower the odds that their victim has a firearm for self-defense.

Some criminals intend to steal guns. A public gun-owner list would help them, too. Either way, the public gun-owner list gives criminals choices — to target a gun owner or a nonowner, whichever better serves their purpose.

This is not to say that all criminals are sensitive to costs and benefits. Certainly some would not consult the gun-owner list. But as long as some do, a public gun-owner list would put those who do not own guns at risk. (To the best of my knowledge, no empirical study of the gun-owner list question has been conducted.)

Although some gun owners might refrain from registering their guns to keep their ownership private, other people might consider purchasing and registering their first firearm to avoid being known as someone who could not protect himself with a gun.

In this way, a public owner list could increase the number of households owning guns and thereby increase the number of accidents and other undesirable outcomes associated with gun ownership.

When it comes to Illinois’s gun-owner database, both gun owners and nonowners can benefit from privacy.

Lobby, Lend, Lobby

2011-05-25T05:54:00.000-07:00

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A recent update to a continuing study finds a link between bailouts and the lobbying of the financial industry.

It is sometimes asserted that the housing boom of the first half of the last decade was largely a result of easy credit by the Federal Reserve – that low interest rates made it too easy for too many people to borrow to purchase a new, bigger home.

But interest rates were only a bit lower in the decade than they were in the 1990s, when there was not a housing boom. By the standards of the 1990s, one might expect the somewhat lower interest rates of the last decade to elevate housing prices only a bit (as I have estimated; Edward Glaeser of Harvard and his co-authors have, as well), rather than the much sharper increase that actually occurred.

It’s also true that bank lending standards were relaxed during the housing boom, with risky borrowers allowed to purchase homes, and all kinds of borrowers allowed to purchase homes with little money down. But as Professor Glaeser has frequently noted, for instance in this post, the housing boom is not primary explained by easy credit.

Even if interest rates and lending standards had been the same in the last decade as they were in the 1990s, however, a crisis might still have been brewing, because interest rates should have been higher during the housing boom than they were before.

Housing prices were elevated during the boom (in part for the reasons cited above) and, by comparison with the 1990s, this made it more likely that — if and when housing prices came back down — even high-income borrowers making 20 percent down payments would default. With default more likely, interest rates needed to be higher, even for high-income borrowers putting 20 percent down.

The study, by Deniz Igan, Prachi Mishra, Thierry Tressel, three economists at the International Monetary Fund, suggests that implicit subsidies and a lack of regulation helped make it possible for lenders to offer lower rates on mortgages that were increasingly likely to default. My fellow Economix blogger Simon Johnson has also noted the interplay of political influence on regulation and finance.

The study by the I.M.F. economists found that the heaviest lobbying came from lenders making riskier loans and expanding their mortgage business most rapidly during the housing boom. The loans originated by those lenders were, by 2008, more likely to be delinquent.

Most important, lobbying meant access to tax dollars. The lenders lobbying more heavily were 7 percent more likely to receive bailout funds, received larger amounts of those funds, and enjoyed a 27 percent greater increase in their market capitalization in October 2008, the month the bailout program was announced.

The authors did not disentangle the path by which lobbying brought forth bailout funds, but it is likely to have followed some combination of political access enjoyed at the time and the lobbying lenders’ assertions of need — created by the lax lending that had gone before, itself facilitated by lobbying during the housing boom years.

Nobody knows for sure how much of the blame for the housing boom can be put on the federal government, but we’re starting to see how political influence was associated with mortgage lending and, ultimately, with taxpayer subsidization of delinquent and defaulting mortgages.

What Might Cause a Two-Track Recession?

2011-05-18T06:51:00.000-07:00

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Census Bureau data on employment by pay level cast doubt on credit-crunch and demand-based theories of the recession. One theory is that a credit squeeze left businesses short on funds, and they responded by cutting payroll, their major expense. Indeed, the bank bailouts were rationalized on the grounds that a bailout would help employers maintain their payrolls.

If cutting payroll spending had been the primary motivation of employers, then they should have cut deepest among their most expensive employees. Firing one person making, say, $2,000 a week saves more than firing three people making $600 a week.

It is true that part-time employment, which is typically low-paying, increased significantly during the recession. However, last week I showed Census data suggesting that employment of people making more than $2,000 a week may have been greater in the 12 months after Lehman Brothers failed than it was before, even while employment of people making less than $2,000 a week fell several million.

Hiring more high-paid people is not a way to reduce payroll spending.
Moreover, payroll spending now exceeds what it was when the recession began, yet employment remains millions lower. Apparently, payroll spending is not enough to bring those jobs back.

Another theory of the recession is that it was caused by a lack of demand — fewer employees were needed because employers were selling less to their customers. The low-demand theory is a good description of a couple of industries, like manufacturing and home construction, but if it described the economy as a whole we would have seen all types of employment cut, not just employment of people making less than $2,000 a week.

Another set of theories say that high-paid employees are replacing low- and middle-income employees. This replacement might come from employers’ attempts to cut personnel during the recession, rather than payroll spending. For example, employers might have worried about health insurance and other employment regulation whose costs are proportional to the number of employees they have. In this view, the bank bailout did little to prevent layoffs.

Some of the replacement could come from families, as they react to some new incentives presented during the recession. Unemployment insurance reduces incentives for unemployed people to accept a new job, because, for up to 99 weeks, the insurance pays them for being unemployed.

Unemployment insurance benefits are capped, so the disincentive is much less for people making $2,000 or more a week than for people making less. Some homeowners with underwater mortgages may react by earning more, while others earn less as they recognize that all their extra earning ultimately ends up with their mortgage lender.

The chart below explores the replacement theories further.

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For each of the 50 states and the District of Columbia, the chart compares the percentage change in the fraction of adults in the state who make $300-1,200 a week (the middle two-thirds of employees are paid in that range) to the percentage change in the fraction making $2,000 or more.

For example, the fraction of Arizona adults earning $300-1,200 was 10 percent lower from October 2008 to September 2009 than it was in the previous 12 months, and the fraction of Arizona adults earning more than $2,000 a week was 29 percent higher.

The low-demand and payroll-cutting theories say that the two should be positively correlated, because the states with the largest demand reductions (or the employers most motivated to cut payroll spending) would have cut employment across the board.

But the Census data suggest that they are negatively correlated (the correlation is also negative if the small or “outlier” states shown in the chart are excluded or downweighted according to population).

These patterns of employment by pay level reveal a number of insights that are not visible in the aggregate employment statistics: the credit crunch and lack of demand may have received too much of the blame for the recession’s job losses.

Job Losses Classified by Weekly Earnings

2011-05-11T05:54:00.000-07:00

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Ben Bernanke, the chairman of the Federal Reserve, said recently that people with less-than-average incomes bore the brunt of the recession’s job losses. Census Bureau data confirm Mr. Bernanke’s statement and show employment gains at the high end.

For the 12 months ended September 2008 — the month Lehman Brothers failed — employment in the United States was 146 million. Over the next 12 months, employment fell to 141 million.

The Census Bureau conducts a monthly survey of households and asks some of them what household members have been earning, if anything, on their jobs. I have used that data to investigate the types of jobs that were lost during the Great Recession and have classified the jobs by their weekly pay.

Among people who are working, the median weekly earnings are a bit more than $600 a week. That is, about half of working people earn less than $600, and about half earn more. So if Mr. Bernanke is correct, the bulk of the losses were of jobs paying less than $600 a week.

Chart 1 categorizes people by their weekly earnings –- people earning $1 to $100 a week are in the first group, those earning $101 to $200 a week in the second, and so on. Although the chart’s horizontal axis goes to $2,500, most workers are in the first seven categories.

The vertical axis measures the change, from the 12-month period ended September 2008 to the 12-month period ended September 2009, in the number of people (in millions) in the various categories. Because the zero earning category is excluded, the sum of all of the changes shown in the chart, plus a year’s adult population growth (about two million), is equal to the change in the number of people without paying jobs, a category that grew by six million.

(These totals do not agree exactly with the Census Bureau’s employment totals for technical reasons related to the lack of reliable earnings information from some respondents. For brevity, I make no distinction between “workers” and “jobs,” although some data shown in the chart include people earning money from more than one job during a week.)

The first two categories gained a bit, which probably reflects the surge in part-time employment during this period. But, over all, Mr. Bernanke was correct: an awful lot of jobs were lost in the $201-to-$600-a-week range. Essentially no jobs were lost in the combined $1,101+ categories.

Because less than a quarter of workers are earning $1,100 a week or more, it helps to examine those categories’ job losses in percentage terms, as in Chart 2.

For example, a value of 9 percent in Chart 2 for $2,101 to $2,200 means that 9 percent more people earned $2,101 to $2,200 a week in the 12 months after Lehman failed than earned that amount in the 12 previous months.

The percentage job losses tend to be less for the higher-paying jobs. All the categories above $2,000 a week actually gained jobs (although those types of jobs are relatively rare, the Census Bureau survey is large enough that it includes more than 12,000 people earning that amount over 24 months).

Economists have yet to examine the recession-era pay data thoroughly, but further study of the employment growth at the high end may someday help gauge the importance of unemployment insurance, “skill mismatch” and other factors that are said to have contributed to the employment downturn.

New Keynesian References

2011-05-04T18:07:00.001-07:00

Today I wrote about "New Keynesian" models of the recession:

I clearly defined New Keynesian models as "… built on the assumption that employers charge too much for the products that their employees make and are too slow to cut their prices when demand falls" in which the recession originated with a surge in "the demand for safe assets."

"Debt overhang" was absent from my definition.

I claimed that, according to those models, our labor market problems would be absent if only employers were charging less for the goods their employees make. "Price stickiness" stops them from doing so.

Assuming the New Keynesian models were correct, I offered a calculation of what the CPI would have been if prices had been fully flexible.

I claimed that, with the passage of time, prices and wages in the New Keynesian model would fall, thereby moving in the direction of what a fully flexible CPI would have done.

Professor Krugman would have his readers believe that, among other things, none of the above items are correct. My purpose here is to provide further evidence on items 1-4 so that readers might decide for themselves.

Definition. By "New Keynesian," I had in mind neoclassical growth models with flexible wages but augmented with Calvo-type staggered price setting (I have written separately about sticky wage models).

According to Clarida, Gali, and Gertler's 1999 Journal of Economic Literature article, those setups are workhorses in the "New Keynesian" (their terminology, not mine) literature. More recently, Woodford (2010) used such a model to characterize the government expenditure multiplier and Eggertsson (2010) use such a model to describe the recent recession as a consequence of a time preference shock (and perhaps also in increase in the willingness to work).

In case you are wondering whether Professor Woodford and Dr. Eggertsson have received Professor Krugman's seal of approval, click here and here.

The Clarida, Gali, Gertler survey, the Woodford paper, the Eggertsson paper, and many other papers that call themselves "New Keynesian" feature sluggish price adjustment, and make no mention of "debt overhang."

A number of economists, including myself, have written about debt overhang in FULLY FLEXIBLE price models, and did not describe their analysis as "New Keynesian." I think that debt overhang has a lot to do with this recession, but nothing to do with New Keynesian economics. So I see absolutely no reason to revise the accepted definition of New Keynesian.

If only prices were flexible. In order to see that my claim (2) is correct for the above defined models, take a look at Eggertsson (2010), p. 8. His equations (21) and (25) describe the impact of the time preference shock (embodied in his rs*) on output and labor.
1. In each equation, the size of the impact depends on the speed of price adjustment as parameterized by k. The more flexible are prices, the larger is k. Think of fully flexible prices as k à¥.
2. Equations (23) and (25) show that a time preference shock of a given size has no effect on labor in the fully flexible price limit k à ¥. In other words, the model blames the recession on the combination of sticky prices and the time preference shock: eliminate either of those, and there would have been no recession.

Fully flexible hypothetical. Assuming for the sake of argument that the recession is to be blamed on price stickiness (i.e., labor would have followed its previous trend but for price stickiness), I calculated the flexible price hypothetical by using a money demand function that relates the quantity of money to the price level, output (which is the same as labor in Eggertsson's model), and nominal interest rates. The percentage gap between actual and hypothetical CPI is equal to the percentage gap that labor has fallen short of trend (about 10) times the income elasticity of money demand (about one) times the elasticity of output with respect to labor (about ¾) plus an interest rate term (I assumed that money demand is insensitive to interest rates in the relevant range).

Deflation will continue as long as the recession does. I gave the intuition in my original article, but that's too much "bar talk" for Professor Krugman, so let's look at Eggertsson's equations again. His equations (23) and (25) say that the inflation rate has the same sign as the deviation of labor from its steady state. Since a recession is a negative deviation for labor, inflation must be negative.

For more of my critiques of New Keynesian models of recessions, see here and here.

New Keynesian Economics Misses the Point, for Now

2011-05-04T05:57:00.000-07:00

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Our labor market has long-term problems that are not addressed by Keynesian economic theory. New Keynesian economics is built on the assumption that employers charge too much for the products that their employees make and are too slow to cut their prices when demand falls. With prices too high, customers are discouraged from buying, especially during recessions, and there is not enough demand to maintain employment.

When the financial crisis hit in 2008, the New Keynesian “sticky price” story had some plausibility because economic conditions were, in fact, deflationary (although I have my doubts about other aspects of their theory). That is, the demand for safe assets surged in 2008, which means that those assets had to become expensive or, equivalently, goods had to get cheaper in order to clear the market.

Normally the Federal Reserve could expand the money supply to satisfy the extra demand for safe assets, so consumer prices wouldn’t have to fall to maintain employment. But the financial crisis was severe enough that the Fed’s best efforts would not be enough.

At the time, New Keynesian fears seem to have been realized: consumer prices had to fall to maintain employment, but too few employers were willing or able to make the price cuts quickly enough. The result was going to be a severe recession that could be partly cured, in the short term, by fiscal stimulus or, in the longer term, as more companies had the time needed to cut their prices.

The red line in the chart below shows the consumer price index that, according to New Keynesian theory, was needed to maintain employment. I have rescaled the index to be based in December 2007, when the recession began: a value of 96 means consumer prices were 4 percent below what they were in December 2007.

In theory, the index of consumer prices had to fall eight percent below their peak (of almost 104) in the summer of 2008 to maintain employment. (I measure all consumer prices here, not merely the “core” price index that excludes fuel and many other items, because the excluded items provide jobs, too.)

The blue line shows actual consumer prices. We readily see the “downward pressure” on consumer prices at the end of 2008, because, in fact, prices stopped rising and actually fell a couple of percent.

But New Keynesians say that with the eight percent drop needed to maintain employment, the blue line needed to fall as much as the red, and a drop that large would take more time. In the meantime, employment would be low and employers would enjoy cheap labor for a while, as so many unemployed people were desperate to work.

But the availability of cheap labor would eventually give employers room to cut their prices – in theory the blue and red series would converge and employment would eventually return to previous levels.

Early on, I thought the New Keynesian theory was wrong because I didn’t see that employers perceived labor to be cheap. Federal law had increased minimum wages three times in and around the recession. A number of other public policies made labor more expensive. My fellow blogger Nancy Folbre has written that American labor looks increasingly expensive compared with potential workers abroad.

The price chart above shows little or no tendency for the blue series to converge with the red one, because, contrary to the theory, high unemployment rates have not caused employers to perceive labor as cheap.

The low employment rates we have today are too persistent to be blamed on price adjustment lags (I have similar reservations about another business-cycle theory: “job search” theory says that jobs are there to be found, but that unemployed people have not been lucky enough to look in the right places).

Our labor-market problems may not disappear by themselves and are not addressed by New Keynesian theory.

Who Cares About Inflation?

2011-04-27T06:23:00.000-07:00

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Normally, inflation is one of the most harmful taxes, but these days inflation may do less harm than good.

During most of our lifetimes, the prices of things we buy have generally increased over time. We can name some exceptions, but most items (even houses) have prices that are higher now than they were 10, 20 or 30 years ago. This general increase in consumer prices is called inflation.

The Federal Reserve is charged with limiting the rate of inflation, which it can do over the long run by limiting the supply of money and similar assets in the hands of the public.

Inflation is widely disliked. A number of economists think that inflation’s bad reputation is undeserved, and that, while people complain that inflation makes things more expensive, they fail to recognize that inflation also raises their wages.

The net result of inflation could be to increase wages and prices in the same proportion, without harming consumer’s purchasing power.

A person on a fixed income, such as a pensioner receiving a specific number of dollars a month – a so-called “defined benefit” pension – does have less purchasing power when prices rise. However, Social Security benefits automatically increase with wages in the economy, and thereby automatically increase with inflation in the long run.

And these days defined-benefit pensions are less common than they used to be (and even many defined-benefit pensions were adjusted for inflation on an ad-hoc basis).

We also have to remember that for everyone receiving a payment specified in dollars, there’s someone else making those payments. For example, a worker with a fixed mortgage payment sees that payment decline as a share of his income as inflation pushes up his wages. For this reason, inflation is said to favor debtors and harm creditors.

The government is a major debtor, and some people suggest that sudden inflation would relieve the government’s debt burden and permit the government to spend more (prolonged inflation would just require the government to pay higher interest rates on its debt).

More government spending is bad news for those who want the government to spend less, and good news for those who want the government to spend more. In any case, my research suggests that inflation is not associated with more government spending.

Even if our government had no debt, inflation would increase tax revenue. Ronald Reagan famously complained about “bracket creep”: the personal income tax was not automatically indexed to inflation, so taxpayers moved into higher tax brackets as inflation raised their incomes, even though the extra income was barely enough to keep up with rising prices.

Much of the personal income tax is now indexed to inflation. But interest and capital gains are not indexed (neither are some provisions of the corporate income-tax code), so inflation increases the tax burden on saving and investment.

Consider, for example, a zero-inflation economy in which homes and business normally sell for what the seller paid when he originally purchased the property. According to our tax laws, those sellers would owe no capital gains tax.

In a 10 percent-inflation-rate economy, assets would appreciate in dollar terms at about 10 percent a year, even though their inflation-adjusted values were constant. When the assets were sold, their accumulated value, including that annual 10 percent gain, would be taxed.

With saving being less profitable thanks to inflation’s back-door income tax hike, people will save and invest less. Inflation’s harm to capital accumulation reduces productivity, and ultimately the inflation-adjusted wages workers receive. Martin Feldstein of Harvard has stressed that America’s capital accumulation was the major loser from 1970s inflation.

Without offsetting Congressional action to revise the tax laws, inflation today would increase the tax burden on capital, and that by itself would reduce investment. But what’s different today from the 1970s is how mortgage debtor troubles – foreclosures of underwater mortgages and the harmful economic activity surrounding them – have reduced gross domestic product and living standards.

At this point, an inflation that harmed banks and helped homeowners might be an overall improvement.

Holding Taxpayers Hostage

2011-04-27T06:18:00.000-07:00

The Treasury says that we must not only send it money in the present but, but raising the debt ceiling, promise to continuing send it money in the future (government debt is a taxpayer promise to pay in the future), or else utter disaster.

Who Cares About the Fed?

2011-04-20T05:43:00.000-07:00

Copyright, The New York Times Company

Short-term interest rates have an obvious effect on the housing market, but not the rest of the economy.

Federal Reserve policy affects short-term interest rates, bank regulation and eventually inflation. I will write about inflation next week, and my fellow Economix blogger Simon Johnson has written much about bank regulation, so today I focus on short-term interest rates.

The Federal Reserve, especially its New York branch, is actively engaged in buying and selling Treasury securities, and it lends money to banks on an overnight basis. As a result, it is widely thought that the Federal Reserve is an important determinant of the rate of interest paid on short-term Treasury securities.

By raising the supply of Treasury securities and reducing overnight lending, so-called “tight” monetary policy raises short-term interest rates. High short-term interest rates are said to discourage borrowing, and thereby curtail private sector investment projects. The idea is that private sector projects are undertaken only when their expected return exceeds the cost of borrowing.

In theory, high short-term interest rates result in relatively few capital projects, with high expected returns, and low short-term rates result in more capital projects, including those with lower expected returns.

But the effect of high short-term interest rates on Main Street’s economy has been exaggerated. Although it is commonly assumed that today’s rock-bottom rates should help strengthen a business recovery, it appears that business conditions actually have little to do with short-term money markets.

Many important private sector investment projects are relatively long term — it most likely takes a year or more for a project to be completed and deliver a positive cash flow to investors. As a result, many capital projects are financed through long-term borrowing, with equity financing, or out of corporate retained earnings, rather than borrowing in the short-term market where the Fed’s fingerprints are so obvious.

In theory, long-term interest rates could rise as the Fed tightens the short-term money market, because some savers would be on the margin of saving in either the short- or long-term markets. Equity capital markets and retained earnings could, in theory, also be subject to similar indirect effects.

Thus, the effects of Federal Reserve interest-rate policy on investment are indirect, and it is an empirical question as to whether the expected effects — tight money discourages investment projects — are significantly reflected in preventing capital projects with low expected returns.

Luke Threinen and I have measured national average profitability of capital projects from the national accounts by dividing total interest and profits in the economy during a year by the total capital stock in place at the beginning of the year. In doing so, we have distinguished residential capital (i.e., houses) from business capital.

Capital produces value over a number of years. In the case of housing capital, the value is in the form of shelter and the convenience of a home. For any piece of capital, profitability (capital’s marginal product, as economists call it) can be calculated as the dollar value it creates during a year — after subtracting depreciation, costs of labor, maintenance and intermediate goods — per dollar invested.

Owners of capital prefer their capital to be more profitable, rather than less. It’s the profitability of capital (after taxes and subsidies; more on those below) that makes an owner willing to purchase capital in the first place.

Chart 1 compares the profitability of housing capital to the inflation-adjusted return on one-year Treasury bills (for comparability with T-bills, housing profitability is adjusted for property taxes). Consistent with the view that tight monetary policy both raises Treasury bill rates and reduces housing investment, the two series are positively correlated. The home-mortgage market appears closely linked, so high Treasury bill rates cause banks to charge more for home mortgage loans, which discourages homeowners and landlords from building homes unless the demand for homes is sufficient (i.e., landlords can earn enough rent from their tenants to cover a high mortgage rate).

Among other factors, easy credit from the Federal Reserve in the early and mid-2000s made it easy to buy and build homes, and as the inventory of homes grew the amount of rent that each home could earn (many homes went vacant, for example) fell, which shows up in Chart 1 as especially low values for the red series. In this way, the housing cycle of the 2000s confirms the usual story about how monetary policy can affect housing investment.

The usual story about Federal Reserve policy and business investment says that a similar process works on the business sector: High Treasury bill rates cause banks to charge more for business loans, which discourages business from investing unless demand for their product is sufficient (i.e., businesses can earn enough profit from their operations to cover a high loan rate).

Our findings for the business sector are quite different from the usual story. Chart 2 compares the profitability of business capital to the inflation-adjusted return on Treasury bills, and the correlation is negative.

One way that easy monetary policy could hurt business investment is by encouraging home-construction activity, and home construction takes resources away from business construction.

The evidence in Charts 1 and 2 suggests that the housing market can be stimulated by easy monetary policy, at least in the short run. But the link between monetary policy and the business sector is much weaker, and our data are consistent with the view that, holding constant the rate of inflation and the amount of banking regulation, monetary policy does not have a discernible effect on the cost of business capital.

Who Cheats on Their Taxes?

2011-04-13T03:27:00.000-07:00

Copyright, The New York Times Company

The United States Treasury has taxpayer integrity to thank for many of its tax collections. But some Americans are not honest with the Internal Revenue Service.

Last week I explained how many taxpayers accurately report their income to the I.R.S., despite apparently low penalties for underreporting. Many economists say that people are willing to sacrifice some disposable income in order to be honest taxpayers; others say that fear of penalties is the overwhelming motivation for tax payments.

Three years ago, in his Ph.D. dissertation at the University of Chicago on “Tax Compliance and Social Values,” Oscar Vela suggested both that taxpayers are honest and that they are largely so because honesty keeps them from losing income.

In other words, some people pay taxes not because of fines that the I.R.S. might levy, but because a tax conviction would harm their professional reputation and that, in turn, would lower their income.

Dr. Vela looked at the importance of integrity in job performance in the Occupational Information Network and found that the occupations where integrity was especially valued coincided with the occupations where the I.R.S. found tax compliance rates to be the highest.

The chart below shows some of Dr. Vela’s results, with tax compliance measured as the fraction of business income that was found by the I.R.S.’s special compliance study to be underreported.

Integrity and Tax Compliance by Occupational Groups

Vela Trevino, Oscar Ernesto, “Essays on the Economics of Individual Tax Compliance,” Ph.D. Dissertation, 2008.

Business income reporting has a large scope for potential underreporting, because the I.R.S. cannot as easily match third-party transaction reports to business tax returns the way it can with, say, employee W-2s.

For example, the construction trades do not appear to value integrity as much as other occupations do – Dr. Vela found the occupation to be ranked third from the bottom, based on the Occupational Information Network. Construction is also one of the top occupations in terms of underreporting business income.

Another finding is that the much-disparaged legal occupation is near the top in terms of valuing integrity, and that lawyers underreport a relatively small fraction of their business income.

Dr. Vela also examined other times of tax cheating and other demographic factors that were correlated with it, such as education (education and tax compliance were positively correlated).

He concluded that taxpayer integrity cannot be taken for granted, and that it evolves over time according to changes in a nation’s education and occupational structure.

Why Pay Income Tax?

2011-04-06T13:54:00.000-07:00

Copyright, The New York Times Company Millions of taxpayers are filling out their tax returns over the next several days. Economists are still not sure whether taxpayer honesty or fear of the Internal Revenue Service explains why taxpayers’ income reporting is pretty accurate.

But with the Treasury spending more than ever, it’s important to know why people pay their taxes and what will continue to motivate them to pay in the future.

It’s difficult to get exact numbers on income tax cheating, but I.R.S. studies (read about them and other tax-evasion analysis in Prof. Joel Slemrod’s paper) suggest that reporting of wages and salaries is so high that the Treasury receives 99 percent of what it would if all taxpayers were honest about that income (see Page 2 of this I.R.S. report).

You might think that people pay taxes merely to stay out of trouble with the I.R.S. But 99 percent of people are not audited by the I.R.S., and even the remaining 1 percent are penalized only about 10 percent of the amount underpaid. (The I.R.S. is, however, increasing its audits of the wealthy.) From a financial point of view, underpaying taxes looks like a high expected return investment: a 99 percent chance of keeping the, say, $10,000 that you underpaid the Treasury and a 1 percent chance of having to pay the $10,000 plus a $1,000 penalty (on average, you get $9,790 for every $10,000 you hold back from the Treasury).

Some economists have tried to reconcile low penalties with high compliance, arguing that people obey the tax laws for non-economic reasons – people want to be honest and pay their share. Or perhaps individuals don’t understand that any one person’s tax payment is not critical to the functioning of our government, while the aggregate of millions of tax payments are.

To the extent that much of the Treasury’s revenue arrives because taxpayers are honest, public policy might not want to take honesty for granted. For example, the Treasury may receive less revenue over time if taxpayers increasingly distrust government because they perceive their tax dollars are wasted.

There’s some truth to the honesty theory (I’ll write next week about a study of integrity and tax compliance), but tax compliance still responds to incentives. When the probability of audit falls, compliance falls.

It’s difficult for the I.R.S. to verify many types of business income: as a result the amount of proprietor, rent and royalty income that is reported is actually less than the amount unreported.

Nanny taxes -– self-employment taxes paid for household employees -– are another type of tax on which many people cheat, and enforcement on this front is weak. Though on this and other tax issues, high-profile people –- like political appointees –- should beware.

Among those whose failure to pay various taxes were widely publicized were Tom Daschle, President Obama’s nominee as secretary of health and human services; Treasury Secretary Timothy Geithner, and Zoe Baird, President Clinton’s nominee for attorney general.

A Ph.D. dissertation being written by Mark Phillips, a University of Chicago student (and an I.R.S. intern) argues that a reasonable fear of penalty explains much of why taxpayers pay their income tax. He agrees that I.R.S. audits are rare, but that the audits are well targeted, so the agency would quickly detect many ways that taxpayers might consider underreporting.

For example, Mr. Phillips asserts that the I.R.S. would easily notice a taxpayer who reported less wage and salary income on her return than appeared on the W-2 reported by her employer to the I.R.S. Taxpayers understand this, so they are pretty careful that their return matches the W-2, and the result is that deliberate discrepancies are infrequent and frequent audits are unnecessary.

For now, it looks as though both honesty and incentives help bring revenue to the Treasury.

Measuring Unemployment by Family

2011-03-30T03:33:00.000-07:00

Copyright, The New York Times Company

New data from the Census Bureau show that the frequency of families without employment was sharply higher during the recession — but still fairly rare.

Many indicators of economic activity, like the poverty rate and consumer spending, are measured at the family level, but widely cited labor market statistics like the unemployment rate are measured at the level of individuals.

The unemployment rate, for example, is the fraction of people who are actively seeking work (or on layoff) and are not employed. It is the fraction of people working — not the fraction of families working — that is one of the primary indicators used by the National Bureau of Economic Research to declare a recession.

These standard personal labor market indicators are incomplete and potentially misleading, because they do not put labor market activity in a family context. Among other things, a majority of working-age adults live with a spouse and apparently share their income. More than 85 percent of people live in families.

Presumably, it’s less traumatic for a family to have one of its two employed members out of a job than to have all its employed members out of a job.

For these reasons, it would be interesting to know what percentage of families have somebody working, as opposed to the percentage of people who have a job. The two measures could be more or less the same if each family had at most one worker but could be quite different when many families have two or more people who could potentially work.

In a study that Yona Rubinstein of the London School of Economics and I did several yeears ago, we calculated such measures for the years 1965 to 2000. We focused on prime-age families -– that is, families headed by an adult (or adults) 25 to 54 and therefore not expected to be in school or retired (two activities that interfere with working). On average, all but 5 percent of people lived in a family with at least one person working (this includes one-person families). By comparison, almost 20 percent of prime-age adults were not employed.

In other words, it is much more common for a person to be without a job than for a family to be without a job.

As Catherine Rampell wrote in a post on Economix on Monday, the Census Bureau has released family employment statistics through 2010. The Census statistics are a bit different from those I cite above, because they include households headed by retirees and exclude people who live by themselves.

Not surprisingly, Professor Rubinstein and I found that the family nonemployment rate increased during recessions, like those of the early 1980s and of the early 1990s. The nonemployment rate increased by almost a third during those recessions, although even at their peak nonemployment was rare for families.

The latest Census Bureau release includes the most recent recession but needs some adjustment for its inclusion of retirement-age people. As a rough adjustment, I estimated the number of elderly people who live in families of more than one and the number of elderly people who live in families (of more than one) and have jobs.

The results are shown in the chart below (the Census Bureau technical notes and my paper explain why a more precise adjustment requires a lot more work).

The severity of this recession is obvious in the data, with the series reaching new highs in 2010. Still, it is relatively uncommon for a family to have nobody who is either working or retired.

Same Analysis for Iraq

2011-03-23T05:24:00.000-07:00

Today I wrote that Allied efforts in Libya are unlikely to bring democracy.

Iraq's situation is not much different. Tsui and I wrote in 2006:

Regime challengers are twice encouraged in Iraq – once by the expected future value of leadership and a second time by political freedoms. Perhaps attempts to grab power in Iraq would have been less intense if the country’s oil assets had not gained so much value since 2003, or entry into the Iraqi political process were as difficult as in neighboring nondemocratic countries.

Don't Hope for Change in Libya

2011-03-23T04:34:00.000-07:00

Copyright, The New York Times Company

Even as the United States and its allies press their military campaign against forces loyal to the longtime dictator Muammar el-Qaddafi, economic indicators suggest that helping Libyan rebels will neither reduce oppression nor result in democracy for Libya.

Libya’s oil reserves are among the largest and most valuable in the world, and that alone is a big obstacle to democracy. Leaders of oil-rich countries almost always enjoy rich economic rewards, and there’s an endless supply of factions that would, no doubt, like to have those rewards for themselves.

So even if rebel forces succeed under the banner of an essentially democratic revolution in overthrowing Col. Muammar el-Qaddafi, and regardless of whether Libya’s next leader arises from a democracy movement, at some point he is likely to consider political oppression as a survival strategy that helps hold back all his competitors.

For this and other reasons, research in economics and political science has found that democracy’s advances are few in oil-rich countries. Prof. Robert Barro of Harvard found that countries with relatively large net oil exports were less likely to have a democratic national government. Prof. Michael Ross of the University of California, Los Angeles, also found that effect.

Citizens of rich countries like democracy and like to use a lot of energy, so they generally import a lot of oil. The Barro and Ross results are sometimes questioned on the basis that oil exports are a symptom rather than a cause of a country’s political and economic situation.

This is one reason that Prof. Kevin Tsui of Clemson (my former student at the University of Chicago) examined oil reserves rather than net oil exports in a study published in The Economic Journal.

He found that democratization –- the process of moving to fair elections, allowing free speech, free political expression and so on -– was much less likely to occur after a country discovered significant oil reserves, regardless of how much oil the country chose to export.

Libya has other characteristics that make democracy unlikely. It is more Muslim that the average country in the world and more ethnically heterogeneous, and Professor Tsui has found both of these conditions to be associated with less democracy.

If Libya’s rebels are successful, no amount of Allied help will change the country’s location or its basic economics. Nor would it change Libya’s demographics, though perhaps a post-Qaddafi Libya would consist of multiple countries, each more homogeneous than the unified Libya was.

The Allied intervention will not bring Libya peace in the short term, and will not bring democracy in the long term as long as Libya has valuable oil in the ground.

Real Estate Crisis? It Depends on Supply

2011-03-16T06:11:00.000-07:00

Copyright, The New York Times Company

Real estate’s future can often be understood by closely watching the supply of residential and commercial buildings.

In early 2009, employment and gross domestic product were dropping sharply, and real estate values had plummeted from their highs in 2006. The housing market was already in crisis, so it felt right to expect the commercial real estate market to follow.

Nouriel Roubini predicted, “More than 700 banks could fail as a result of their exposure to commercial real estate.” Elizabeth Warren later reported, “There is a commercial real estate crisis on the horizon.”

And journalists frequently referred to a looming commercial real estate crisis.

But none of this commentary noted how the supply situation in commercial real estate was drastically different than it was in housing.

By 2008, it was clear that too many homes were built for the market to bear. But the four-to-five-year boom in housing construction had taken resources away from commercial building, holding down the inventory of structures that would be available for business use.

With commercial structures in relatively short supply, I concluded in early 2009 that there would probably not be a commercial real estate crisis creating waves of bank failures.

My conclusion was greeted with much skepticism (one example was Salon’s article on “The NYT’s Chicago Economist: Wrong Again,” insisting that warning of a commercial real estate meltdown was part of “reliable economy-watching”). Paul Krugman also weighed in.

More than two years have passed, and we no longer hear much about the once-imminent crisis.

Professor Roubini still thinks that a commercial real estate crisis is ahead. Others said the crisis was averted. Either way, it is now recognized that the relatively low supply of commercial real estate made a big difference.

In order to assess the likelihood that the housing sector double dips – that is, has another crisis something like the one in 2008 – it helps to look at the supply.

The black line in the chart below shows an index of housing inventory per person at the end of each year from 1990 to 2011 (with housing inventory measured as square footage, adjusted for quality; 2011 is a forecast). Housing supply almost always increases faster than population, but the housing boom of 2002-6 stood out compared with the other years in terms of the relative rate of housing construction.

By 2007, housing supply was well above the trend of the 1990s (before the housing boom). If you think that a rational market would have more or less followed that 1990s trend, then the excess supply in 2007 meant that housing prices had to come down.

Of course, housing prices did come down a lot in 2007 and 2008, and the housing supply stopped growing. By the end of 2010 – the second-to-last observation shown in the chart – housing supply had fully returned to the trend of the 1990s.

Because the pace of housing construction continues to be slow, it looks as if housing supply will be significantly below trend by the end of this year.

These supply results tell us something about the future of housing prices. Those prices depend on demand, too, but as long as housing demand is near or above the preboom trend, it looks as though housing prices are low enough already.

Part of the inventories of housing and commercial property sit vacant, but those vacancies are largely part of a slow economic recovery and the difficult task of dividing property losses from previous years among homeowners, landlords, banks and commercial tenants.

With the slow pace of new construction, neither the housing nor commercial real estate markets can any longer be characterized as having supply that significantly exceeds the fundamentals of demand.

Why the Big Deal About Consumer Spending?

2011-03-08T08:35:00.000-08:00

Copyright, The New York Times Company

Economic commentary makes a big deal out of consumer spending, but with little explanation. The many facets of consumer spending are confusing, and public policy often ends up treating the symptoms rather than curing the disease.

Both Republican and Democrat politicians tout their economic policies as ways to put money in the hands of consumers. Unemployment insurance, for example, helps people who are unemployed, of course, but it is also purported to benefit employed people because the unemployment benefits received are spent elsewhere in the economy.

Much of the debate about President Bush’s 2008 tax rebate centered on whether taxpayers would spend it, rather than invest or save it.

But a person receiving money from the government has to do something with the it. And policymakers like to tout investment as healthy for the economy, too. So isn’t investment just as good as spending? Don’t we admire the thrifty more than the spendthrifty?In order to answer these questions, we need to know whether consumer spending has a causal influence on the wider economy – as politicians often suggest – or whether it is a barometer of economic efficiency.

Journalists and commentators often note that consumer spending is more than 80 percent of private-sector spending and more than two-thirds of all spending. Thus, at first glance, it would seem that inducing a person to spend would have a larger impact on gross domestic product than inducing that person to invest.

However, the size of the consumption sector is not evidence of its potency, because any one dollar is necessarily a smaller share of consumer spending than it would be as a share of investment. One dollar either has a larger effect on the smaller investment sector or a smaller effect on the larger consumption sector – the effect on the total economy could well be the same by either route.

Regardless of whether consumer spending stimulates the wider economy, economists generally agree that it is an excellent barometer of the economy. Soviet-style economies sometimes achieved high levels of production but could never be considered successful without permitting high levels of consumer spending.

Consumers tend to spend more when they expect their futures to be successful and tend to tighten their belts when bad times are on the horizon. Consumers vary in terms of where they live, their occupations, their expectations and their spending patterns.

Aggregate consumer spending is a kind of referendum among many different people, and we can tell from the changes in the aggregate whether spending increases outweighed spending decreases.

In this view, a consumer spending drop is a symptom of problems ahead, even if it does not contribute further to the disease.

The distribution of wealth and saving is even more unequal than the distribution of consumer spending; more people are consumers than are investors. For politicians seeking voting majorities, this alone may be a reason why they want to see more money in the hands of consumers rather than in the hands of the relatively small group of investors. But this does not mean that consumer spending stimulates the economy, just that it stimulus incumbents’ re-election.

Nevertheless, Keynesian economists continue to insist that consumer spending is more than a barometer of the economy — that consumer spending is a driver of the economy, and that right now it is a problem for our country every time a person shifts spending away from consumer goods and toward saving.

Regardless of whether Keynesians are correct, they often do not explain themselves. In a way, they agree with me that consumer spending is not the root cause of recessions, because they believe that the real problem is deflation – the tendency for wages, the prices of consumer goods and the prices of investment goods to fall rather than rise – and that deflation is the result of consumers’ belt-tightening.

In the Keynesian view, large sectors of the economy accidentally fail to keep pace with deflation, so wages and prices there end up being too high, compared with wages and prices elsewhere in the economy (or compared with wages and prices expected in the future). The sectors with sticky prices have trouble selling their goods (customers view the goods as too expensive) and workers in sectors with sticky wages have trouble finding a job (potential employers view the workers as too expensive).

Wages and prices are measured in units of money – how many dollar bills or debits to one’s checking account it takes to buy something. So deflation is equivalently a rise in the relative value of money, checking accounts and other liquid guaranteed financial assets (hereafter, I refer to the three as money).

Assuming that deflation is the root problem, Keynesians emphasize consumer spending because they assume that a consumer who doesn’t spend is a consumer who tries to add to her or his holdings of money. With more demand for money, money becomes more valuable and nonfinancial goods and services become less valuable – deflation.

Conversely, when a person is willing to part with her or his money to purchase consumer goods, that reduces the value of money and raises the value of the consumer goods – inflation.

That’s why Keynesians like it when (during a recession) the government borrows money from investors to, say, give funds to the unemployed. They assume that the investors would have held on to money if they had not lent it to the government, and they assume that the unemployed will not hold on to the money they receive in the form of unemployment insurance.

Putting aside the fact that redistribution from investors to the unemployed is a rather indirect means of reducing the relative value of money (that is, creating inflation), Keynesians have assumed, rather than proved, that investors finance their lending to the government out of their money holdings rather than by reducing their purchases of investment goods.

If it were even partly the latter, then the borrow-to-finance-unemployment-benefits policy could itself create deflation as it puts downward pressure on the prices of investment goods.

Regardless of whether you agree with the Keynesian assumptions, the facts fail to confirm their emphasis on consumer spending as a driver of the economy. When the latest recession got under way, hiring fell much more than consumer spending.

More recently, we have seen real consumer spending reach all-time highs, while employment remains lower than it was 10 years ago. All of this is consistent with my view that consumer spending reacted to a bad labor market and rejects the assertion that a consumer spending recovery would bring back the labor market.

Public policy needs to help cure the labor market disease, not merely treat the consumer sector symptoms.

Do Government Spending Cuts Reduce Growth?

2011-03-03T04:15:00.000-08:00

We can test this proposition using the stimulus wind-down over the past couple of quarters. The blue squares in the chart below are measures of actual inflation-adjusted government spending growth and real GDP growth. It looks like the economy grew more as government spending was cut after the stimulus peaked.

(For an explanation of the red and green hypotheticals shown in the chart, click here).

You might argue that government spending cut back only when the economy began to recover for other reasons, but I see two problems with that argument:

the wind-down of the ARRA "stimulus" was set two years ago when the law was passed. By what miracle did the stimulus designers get the timing exactly correct, while at the same time were wildly off on how deep the recession would ultimately prove to be?
If you believe that government spending really does increase GDP, what exactly is helped the economy endure the end-of-stimulus spending cuts by actually growing faster that it did a year ago when stimulus spending was peaking?

Where's the Stimulus Hangover?

2011-03-02T06:09:00.000-08:00

Copyright, The New York Times Company

Last week’s final report on gross domestic product for 2010 provides a fresh opportunity to evaluate the stimulus law passed two years ago. The data and economic reasoning suggest that the effect of government spending on G.D.P. was minimal at best.

As planned, almost all of the tax cuts and public spending increases from the American Recovery and Reinvestment Act of 2009 are finished. The Obama administration and its supporters promised that the fiscal stimulus law would create or save more than three million jobs by now. Their stated intention was to provide government spending while the economy was weak, then end the extra spending as the economy recovered.

But instead of adding jobs, employment is now about two million below what it was when the law was passed in February 2009.

Some of us think that the fiscal stimulus made a bad situation worse, and that employment would have grown, or fallen less, if the stimulus law had not been passed. The Obama administration contends that, apart from the stimulus law, the economy was in worse shape than anyone expected, and that the law kept the employment drop to two million, rather than a potential drop of more than five million.

While the increase in the stimulus by design coincided with economic weakness, the stimulus decline did not coincide with economic strength. Unemployment rates remained high, and employment, home prices and the Federal funds rate remained low as stimulus spending was winding down (as this profile of stimulus spending shows; note that we are now in the middle of fiscal year 2011).

If Keynesian stimulus advocates are correct, economic growth should have been sharply reduced when stimulus spending slowed.

I use real G.D.P. results from the Bureau of Economic Analysis to measure actual economic growth through the end of 2010. In order to compare the results with the Keynesian theory, I assume a government spending multiplier of 1.5, as the Obama administration did when it projected the impact of the law.

Such a multiplier means that each additional dollar in government spending adds $1.50 to G.D.P., and each dollar subtracted from government spending subtracts $1.50 from G.D.P.

Because we know that the economy would have been weak in the first few quarters of the stimulus regardless of the law, I do not begin the measurement until the fourth quarter of 2009, when the president’s Council of Economic Advisers declared that the stimulus law had successfully started a slow recovery.

If the advisers were right, economic growth should have increased further when government spending grew still faster in the next couple of quarters, and then economic growth should have been less as government spending grew more slowly later in 2010.

I have illustrated the Keynesian-multiplier-1.5 as a red line in the chart below, and the actual results as blue squares. The blue square at the end of the red line is the data for the fourth quarter of 2009. If the multiplier of 1.5 held up, all of the data for the subsequent quarters should have appeared on the red line. (The quarters represented by the squares are not in chronological order.)

Instead, actual G.D.P. growth ended up below the red line and, more important, the quarters with more government spending growth tend to be those with less G.D.P. growth.

Stimulus advocates lament that the stimulus law was too small and was significantly offset by shrinking state and local government spending. But my chart measures total government spending at all levels.

We can see from the chart that real government spending did in fact grow rapidly at times and grow slowly at other times: the actual growth rates range from less than 1 percent per year to more than 7 percent per year.

The red line shows that the range was wide enough to, according to the 1.5 multiplier, make G.D.P. growth rates of almost 9 percent per year (technical note: as drawn, the red line does not have a slope of 1.5 because, in terms of growth rates, the slope is the product of 1.5 and the ratio of government spending to G.D.P.).

A number of Keynesians outside the Obama administration would distinguish government spending on “transfers to individuals” from government spending on goods and services (among other things, government spending on goods and services is automatically counted in G.D.P.; transfers are not).

My chart’s green line shows an alternate Keynesian hypothetical based on a multiplier of 0.75, which might represent a smaller multiplier for transfers.

(Because the Obama administration’s original projection made no distinction between purchases and transfers to individuals – even though it knew that much federal spending would be the latter and some federal grants to state and local governments would allow those governments to make transfers – the 1.5 hypothetical is the appropriate one for evaluating their promises of stimulus results, even it is not appropriate for evaluating other Keynesian theories).

The blue squares showing actual results for our economy do not fit anywhere in the cone formed by the two Keynesian hypotheticals, suggesting that, contrary to the Keynesian promises, the stimulus law did not noticeably increase G.D.P. and might even decrease it.

After all, the stimulus spending penalized success, since its benefits — for example, extending unemployment insurance — were aimed at people and businesses with low incomes, and not at those who were working and/or achieving a certain income level. So it would be no surprise if the result was to keep incomes below what they would have been — as in other cases, a counterproductive result of a well-intentioned program.

Perhaps you think that government spending does its stimulation with a lag, but the Keynesian theories do not fit the lagged data any better. The chart below is the same as the one above except that government spending growth is measured in the quarter prior to the G.D.P. growth.

Again, the data fail to fall in the cone predicted by the 0.75 to 1.5 range of Keynesian multipliers. (Further variations on these charts provide no better results).

Recent G.D.P. growth results are just one way to attempt to measure the amount of stimulus the stimulus act provided. But the longer we go without any vivid empirical demonstration of the stimulus law’s potency, the more we are driven either to reject Keynesian theory or to accept it solely as a matter of faith.

Stimulus Estimates: Sensitivity Analysis

2011-03-01T07:36:00.001-08:00

Tomorrow I will post an article about government spending and GDP growth during 2010. That article has two charts showing Keynesian projections for economic growth, using 2009 Q4 growth as a benchmark.

The article briefly notes that the benchmark doesn't really matter for the conclusion, because the data show a clear negative correlation between government spending growth and GDP growth. But the charts below help show more vividly that the benchmark does not matter, by using an alternate normalization -- the average government spending and GDP growth during the period shown. All of this will make more sense when the original article is posted Wed March 2.

What's Next for Egypt?

2011-02-23T08:14:00.000-08:00

Tens of thousands of people gathered in Tahrir Square in Cairo last week to call for Egypt’s military rulers to speed changes and crack down on corruption, one week after Hosni Mubarak resigned as president.

Egypt overthrew its longtime leader while the world watched. But its economics and demographics suggest that the next leader will not be particularly democratic.

Almost three weeks of pro-democracy demonstrations in Egypt ended Hosni Mubarak’s reign as president. Widely regarded as undemocratic, he enjoyed decades without a serious challenger for his position, and, among other things, did not hesitate to shut off Egypt’s Internet access when he thought it might help keep him in power.

Now the Egyptian military is in charge and promises to hold elections in six months.

But elections are not the same as democracy unless more than one candidate has a fair opportunity to run. Living in the United States, it is often difficult to imagine anything but a fair election for president and the other major government positions, but our world is full of countries with rigged elections that, for example, require that candidates be approved by the government.

Mr. Mubarak himself won sham elections. With the next elections be any more genuine? Will the winner of those elections be willing to keep the process going?

I used a recent study in The Economic Journal to help me assess the outlook. Prof. Kevin Tsui of Clemson (my former student at the University of Chicago) studied democratization in 132 countries in the latter part of the 20th century – democratization referring to the process of moving from rigged to fair elections, allowing free speech, free political expression and so on.

Based on its past elections, Egypt was considered among the least democratic countries in the world, although a bit more democratic than some of its neighbors, like Saudi Arabia and Libya.

Professor Tsui found that oil resources are an important variable – the more valuable a country’s oil resources, the less likely it is to become democratic. Interestingly, Professor Tsui finds that Egypt is about average in terms of oil resources, so that variable by itself does not lead us to expect that Egypt’s future elections will be all that different than they were in the past.

Egypt is more Muslim that the average country in the world, and somewhat poorer in terms of per-capita gross domestic product. Professor Tsui found both of these conditions to be associated with less democracy.

On the other hand, Egypt is more ethnically homogeneous than the average country in the world and more homogeneous than nearby Iraq and Libya. Homogeneity is a factor associated with more democracy.

Over all, Professor Tsui’s study shows that the Egypt of Mr. Mubarak has been about as nondemocratic as countries similar to it in terms of demographics and economic circumstances.

Professor Tsui, who wrote his paper before Egypt’s revolution, did not offer a prediction of what would happen there next. But if the same factors continue to be important determinants of democracy, little may change in Egypt.

One thing that seems different in Egypt’s revolution is that an executive at Google is credited with helping plan the protests with his Facebook page. Perhaps a dictator’s survival is more difficult these days in a world with Twitter, Facebook and other technologies for coordinating revolutionaries.

But nondemocratic leaders will fight back, and I expect the Internet revolution will, in the near term, cause government to monitor, censor and otherwise regulate the communications of its political opponents more, not less.

Moreover, new technologies can also help governments control their citizens, using such tools as pilotless spy drones and urban surveillance cameras.

So I will be somewhat surprised if the aspirations of Egypt’s democracy proponents are realized in the next decade. Egypt’s next leader or group of leaders will have a different name, but are likely to reign with tight political control.

Dumping Violence on the Poor

2011-02-17T05:06:00.000-08:00

Copyright, The New York Times Company

The war on drugs sends middle- and upper-class American problems to the residents of poor areas. Nevertheless, the federal government continues the war in earnest.

Almost 20 years ago, an infamous memo by Lawrence H. Summers, at the time the chief economist of the World Bank, stirred a debate as to whether it was appropriate for the United States and other developed countries to pay poor countries to accept dirty industries, toxic waste or other garbage from the developed world.

Both sides in the debate seemed to agree that it would be inappropriate to force poor countries to accept our garbage, without compensation. But that’s very much what the war on drugs does.

The war is an outright prohibition on the sale and consumption of contraband substances in the United States. That prohibition is enforced domestically by federal and local law enforcement and abroad by the United States military.

Some of the most violent battles are fought in Mexico, Guatemala and other countries poorer than the United States (see especially the comments of Gary Becker of the University of Chicago on this topic). The war also foments violence in our poorer inner cities.

Yes, the war makes it more costly for Americans to obtain the prohibited substances. Yet plenty of people in the United States are willing to pay the higher prices – prices far in excess of what it costs to grow, harvest and manufacture the drugs.

The gap between the prices consumers pay and the production costs creates a profit opportunity for someone willing to break laws, battle law enforcement and deliver drugs to Americans.

Some of these contraband entrepreneurs – drug smugglers and dealers – are from poor countries or poor neighborhoods in the United States, so in this way some American consumer dollars make it to poor areas.

Of course, most people in poor areas are not in the contraband business and have no part of the drug industry’s revenue. Yet they suffer enormous harm from the violence and the drug activity.

The war on drugs thus pushes the “toxic waste” of America’s drug consumption into poor neighborhoods with no compensation.

Middle- and upper-class parents are unlikely to witness personally the war’s violence, and they want to discourage their own children from taking drugs. So many of them appreciate that the war makes it more difficult, or at least more expensive, for their children to obtain drugs.

And their appreciation is an important reason why our federal government has yet to legalize drugs and strongly discourages states from doing so.

Legalizing and taxing the use of what are now illegal substances would remove the profit motive for dealers and smugglers, and the revenue might be used to help the residents of poor neighborhoods, as Professor Becker notes. The great challenge to ending the war on drugs is finding a way to give American parents the protection they want for their children.

The Summer Job Surge: Supply or Demand?

2011-02-09T04:52:00.000-08:00

The summer teen employment surge is largely a consequence of seasonality in supply, not demand. To see this, note that a pure summer demand surge would draw teens into the labor market with low teen summer unemployment, high summer real wages, and low summer unemployment among persons not enrolled in school during the academic year. The hypothetical demand surge would also have to be quite large – about as large as doubling the size of the nation’s military in a mere two months – because the end result is about a million new jobs for teens.

In fact, teen unemployment spikes in June as the labor market absorbs more than one million teens. Unemployment of persons aged 25 and older (not shown in the figures) is high throughout the summer, peaking in July at almost 700,000 persons above trend. Median nominal and real weekly wages for teens are often at their lowest of the year in the third quarter (July – September), and presumably hourly wages are even lower due to longer teen summer work weeks. These patterns reverse when the academic year ends.

Also consistent with the supply interpretation, Mulligan (2010b) shows how age groups with the largest summer log employment and log unemployment spikes are those with the greatest school enrollment rates during the academic year, and the summer log employment spike may even be negative for groups with near zero school enrollment.

Nor do many of the summer jobs for teens appear to be in industries that have a significant spike in labor demand, because 77% of those jobs are in industries that expand their employment of persons aged 25-34 less than two percent, if at all. Based on calculations from the May, July, and September 2005 Current Population survey, the top industry hiring teens in the summer was “arts, entertainment, and recreation” (accounting for 19 percent of the teen summer jobs), which had no change in the number of persons aged 25-34 employed. The second industry (also accounting for 19 percent) is “accommodation and food services,” which actually cut its employment of persons aged 25-34 by 4 percent during the summer.

These are all indicators of supply shifts during the summer that are large, and exceed the demand shifts.

Economics on the Go

2011-02-09T04:36:00.000-08:00

Copyright, The New York Times Company

Although economists haven’t yet discarded their laptop and desktop computers, the mobile-device revolution has changed how they and their students work.

At the University of Chicago, I see more mobile devices from Apple — the iPhones, iPods and iPads — around campus than I do BlackBerrys, or, for that matter, pencils. So I’m focusing primarily here on apps for Apple devices.

I like A2ZEconomy for viewing major economic data, such as gross domestic product, housing prices, inflation and so on. (I long for the day when the Federal Reserve Bank of St. Louis creates an app for accessing its huge library of economic data and graphing utilities.)

I also like Economy for iPad, which has major national economic data and state-specific data on unemployment, per-capita personal income, housing starts, G.D.P. and health insurance coverage. Some data is also available on Canada and Mexico, including exports to and imports from the United States and currency exchange rates.

Beyond these apps I use for reading, I use PocketCAS Pro to automate relatively simple algebraic and calculus formulas.

The Economist magazine has an app for mobile devices that parallels its print edition, in terms of both content and subscription options. Users can subscribe to the digital edition, purchase a single issue or view selected “editors’ highlights.” Users can view The Economist’s compilation of economic and financial indicators, and the app will also play an audio version of feature articles.

Of course, I regularly read this Economix blog, to see what my fellow bloggers and our readers have to say. (Did you know that Economix has a Twitter feed?).

While these various sites and apps offer excellent content, over time I have stopped going to them directly and instead read all that content through RSS (a mode of information distribution on the Web; its initials stand for really simple syndication) and Twitter feeds. I find these more time-effective ways to skim through a range of content.

Many magazines and newspapers have an RSS feed, Twitter feed or both, and often have separate feeds for separate sections, so you could review material from, say, the DealBook and Economix areas of The New York Times, the Markets section of The Wall Street Journal and the latest economic indicators and releases from the National Bureau of Economic Research, all in the same place.

Most reader apps notify you when new content is available and offer a measure of how much content you have yet to review.

The app I use most these days is River of News, for reading blogs and newspapers that are distributed by an RSS feed.

The screen is structured like a river bank and river – with a list of blogs followed to the left and the individual articles flowing past on the right. A user controls the river flow with his finger, stopping to read or letting an article flow by to be marked as read. River of News users can cover many potential reads in a short period of time.

Flipboard (shown below) is a slightly less efficient, but a more beautiful reader for both blogs and Twitter feeds. Flipboard automatically digs into the posts of the various blogs and Twitters that you follow to find an image (rather than just text) and displays the image on the Flipboard front page with the headline.

Most reader apps have a function to mark articles for later reading. Instapaper is a nice one that works with several different readers and browsers – creating a button in each for saving articles to your Instapaper account. The app will automatically download articles from your account, and save them on your mobile device so you can read even when not connected to the Internet.

Economists read unpublished material, too – including student papers and research papers by colleagues – so we commonly read PDF and PowerPoint files (Adobe’s portable document format and Microsoft’s presentation format, respectively) on our mobile devices. Apple’s iBooks app is an easy and functional PDF reader. ReaddleDocs will display PowerPoint files, too.

It helps to take handwritten notes on documents we read – especially those unpublished items that really need changes. I use Note Taker HD (there’s an iPhone version, too) for that purpose. By opening a PDF file with Note Taker HD, a user can use the tip of his finger to write on the PDF much as one would do on paper with a pen or pencil (some people like to use a pencil-shaped stylus to mark a PDF, but it has to conduct electricity so the touchscreen will recognize it; I just use my index finger).

Blank pages can be marked too, which makes Note Taker a notepad for (literally) handwriting quick lists, diagrams, equations etc.

Once you are creating your own notes and documents, you need an app for sharing the results with friends and perhaps other devices. Note Taker HD lets you convert any of your creations into a PDF file for attaching to an email or transferring to another file manager app. Some file managers, like Files² HD, manage your files in a folder system on the iPad itself and can allow other computers on your network to view the files. Others apps, like Dropbox, synchronize your mobile-device files with a storage area on the Internet, which you or friends can access from another device.

I’m eager to learn of more apps, so readers, let us know what you like.

Bloomberg Radio Today 11AM EST

2011-02-08T07:36:00.001-08:00

http://www.bloomberg.com/radio/

In Construction More Spending Can Also Mean Less

2011-02-02T03:12:00.000-08:00

Copyright, The New York Times Company

The Census Bureau released its latest estimates of construction activity for the various sectors of the economy on Tuesday. Those data suggest that more spending in one sector tends to reduce spending in other sectors, contrary to the multiplier hypothesis put forward by Keynesian economists.

Last week I examined measures of the profitability of capital in the housing and business sectors and noted how, during the housing boom, profitability in the two sectors moved in opposite directions: housing profitability fell while business sector profitability rose.

The market appears to have built so many homes during those years because of an expectation that houses would be profitable in the future, and, in part, because home buyers were encouraged by easy credit. As a result, an ever-growing housing inventory was competing for the same demand for shelter, which kept rents low and vacancies high.

At the same time, it was more difficult for business to obtain capital, because so much of it was going into housing.

The battle for resources between the business and housing can easily be seen in the data for each sector’s structures investment (that is, construction activity), at least before 2009. The chart below shows quarterly data back to the beginning of the year 2000. A value of, say, 90 for either series means that structures investment, adjusted for inflation, was 90 percent of what it was in the first quarter of 2000 (for a related series, see this post).

The housing boom and bust are readily visible in the housing sector’s green line, which rose sharply through the end of 2005, and then fell even more sharply through 2009.

Nonresidential building normally increases over time with growth in the population and the economy, but it was low during the housing boom (see the red line in the chart), probably because so much capital was going into home building. Both residential and nonresidential investment turned at almost exactly the same time, in opposite directions. Nonresidential investment increased throughout 2006, 2007 and 2008, while residential investment was collapsing.

When President Obama was proposing his stimulus law in early 2009, he and his advisers contended that government spending would stimulate private spending.

Yet a number of economists warned that sectors compete with each other for resources, so government spending tends to displace – “crowd out,” in economics jargon – private spending. For example, some people employed by stimulus projects are people who quit their private-sector jobs to accept better positions funded by the new law.

Even the Obama administration, in its first Economic Report of the President (click here and scroll to page 124), pointed to the same data and noted how this seemed to be crowding out, at least before the recession. Admittedly, looking at the economy as residential versus nonresidential is not the same as looking at it as public versus private, but the former gives us some information about how economic activity spills from one sector to another.

Crowding out comes from scarcity of supply, and Keynesian economists assert that supply is not at all scarce during recessions. Perhaps they would point to the parallel movement of the residential and nonresidential building series after 2008 as evidence that crowding out stopped once the recession worsened.

However, even if the availability of former home builders was by itself encouraging nonresidential building, nonresidential building could fall during the recession because of declining demand. The large reduction in the workforce that became apparent by 2009, not to mention tight credit, is likely to have reduced the desired number of nonresidential buildings, and this, by itself, would cut nonresidential investment activity. So determining whether crowding out stopped after 2008 requires separating the effect of increased supply of resources for nonresidential investment from reduced demand.

In doing so I looked at the relationship before 2008 between building in the two sectors and the business cycle. Not surprisingly, nonresidential building follows a business cycle, going up and down with national employment.

As you might guess from Chart 1, more residential building is associated with less nonresidential building at a given point in the business cycle: each $3 billion of home building seems to crowd out nonresidential building by at least $1 billion. Now that’s crowding out: something that stimulated home building by $3 billion would raise total building activity, but only by $2 billion.

I used the pre-2008 relationships to predict nonresidential building during this recession and through the third quarter of last year, under two assumptions: that crowding out continued as before, and that crowding out ceased once the recession began.

Chart 2 shows the results, together with the same red actual investment data from Chart 1. The black line shows what would have happened to investment if it continued to move with employment, but crowding out disappeared. The blue line shows what would have happened to nonresidential investment if, in addition to moving with employment, crowding out continued at the same rate it did before the recession.

The predictions based on continued crowding out (the blue line) correctly anticipated this pattern, as well as the actual sharp drop to begin 2009. Nonresidential building did fall after 2008 but, thanks to the movement of resources away from housing, it fell less than it would have in a recession this deep.

The Keynesian model ignores the crowding-out effect, and thereby consistently underpredicts nonresidential building during the recession. Thus, all else the same, it appears that less spending in one sector is partly replaced by more spending in another.

Sometimes there are good reasons for the government to spend more, but Chart 2 shows how one of the costs of government spending is that it displaces spending in other sectors, even during a recession.

Housing-Sector Profitability Returns to Previous Levels

2011-01-26T04:25:00.000-08:00

Copyright, The New York Times Company

The housing boom further increased our economy’s bias against business capital, but by 2010 housing profitability was back to normal.

Last week I examined a measure of the profitability of housing capital: the value added by houses in the form of shelter and convenience for their occupants during a year, expressed as a fraction of the total value of homes. Before the housing boom, housing added much less value per dollar than business capital did, largely because business taxes restrict the supply of business capital.

The less business capital there is, the higher the rate of return that remaining business capital earns, because each unit of capital serves more customers, as I noted last week. A low profit rate for housing is a symptom of its abundance.

The profitability gap between nonresidential and residential capital shows that our economy was overinvested in housing, long before the housing boom of the early 2000s. Business taxes cause an underinvestment in business capital, and business capital has been so profitable to the economy because it is more scarce.

Value added to the economy would have been greater if some housing investment had been invested in business instead; each $10 billion of housing investment redirected to business investment could have added almost a billion dollars to G.D.P.

The chart below displays the same marginal product measure of residential capital profitability (red line, from the first quarter of 2000 to the third quarter of last year (Luke Threinen, a University of Chicago student, helped with these calculations).

The chart also displays the marginal product of business capital (blue line). Because of the extraordinary “depreciation” from Hurricane Katrina, values for 2005 have been interpolated.

The marginal product of residential capital is measured on the right axis, while the marginal product of nonresidential capital is measured on the left axis. By looking at the 2000-1 values – 6.6 percent for residential and 15.2 percent for nonresidential – we see the result, noted last week, that nonresidential capital was twice as profitable before taxes than residential capital.

After the 2001 recession, and during the housing bubble, the marginal product of residential capital fell sharply. (This finding is related to previous findings that rent-to-price ratios were low during the mid-2000s, because housing profitability is essentially the rent-to-price ratio minus the expense-to-price ratio.) During this period, housing construction was booming.

Housing was not particularly profitable during the housing construction boom – the market appears to have built so many new homes during those years because of an expectation that houses would be profitable in the future, and in part because home buyers were encouraged by easy credit.

As a result, an ever-growing housing inventory was competing for much the same demand for shelter, which kept rents low and made vacancies high.

While housing sector profitability became so low, business sector profitability was quite high. At the peak of the housing boom, the marginal product of nonresidential capital was more than triple the marginal product of residential capital.

By widening the profitability discrepancy between the two sectors, the housing boom was more damaging than it would have been if the boom hadn’t begun with an abundance of housing.

When the housing bubble burst in 2006-7, and housing construction nearly came to a halt, the marginal product of housing began to rise toward previous levels as the population grew into the extra housing, and some existing housing deteriorated. By the fourth quarter of 2009, the marginal product of residential capital hit 6.2 percent and has remained about there since then.

The good news is that the 6.2 percent housing sector profitability of the past is actually a bit higher than the historical average from 1950 to 2000, which means that housing is adding value at a rate similar to the pre-bubble years.

The strongest economic pressures preventing further increases in our housing inventory have been gone for a year now, which is one reason I do not expect the housing market to get any worse.

Business capital profitability has also returned to previous levels, but the bad news is that housing capital remains much less profitable than business capital. In this sense, housing is still too abundant, an economic waste that shows no signs of repairing itself.

Supply & Demand Now Burned to Twitter

2011-01-26T03:09:00.000-08:00

http://twitter.com/caseybmulligan

This blog will be "feedburned" to the above twitter feed. (I think that means a copy is sent over there). In addition, twitter will have web links that I am saving for further reading.

The original purpose of this blog was to keep notes on the economy -- help me remember rather than forget. A blog is still a fine way to do that when the notes are authored by me, but for book markers to notes/articles/etc by others it seems that reading and browsing software these days is makes a twitter post easier than a blog post.

Cheesehead

2011-01-22T04:29:00.001-08:00

Housing Profitability -- Video Version

2011-01-21T07:22:00.000-08:00

Willing to Work?

2011-01-20T10:28:00.000-08:00

Some people, described in this article as "eager to work," found 1000s of jobs in construction.

http://www.reuters.com/article/idUSTRE70J37P20110120

I have also done research on the recession-era employment rates of eager workers.

Housing Sector Profitability

2011-01-19T04:48:00.000-08:00

Copyright, The New York Times Company

Long before the housing boom, overbuilding effects of government policy were evident.

A house is a piece of capital, meaning that it produces value over a number of years. In the case of housing capital, the value is in the form of shelter and the convenience of a home.

As with any piece of capital, a home’s profitability (its marginal product, as economists call it) can be calculated as the dollar value it creates during a year – after subtracting depreciation, costs of labor, maintenance, and intermediate goods – per dollar invested.

Owners of capital prefer their capital to be more profitable, rather than less. It’s the profitability of capital (after taxes and subsidies – more on those below) that makes an owner willing to purchase capital in the first place.

For a home that is rented or vacant, the home profitability calculation is straightforward: take the landlord’s rental income for the year, subtract depreciation, costs of maintenance and labor expenses (if any) for the same year and divide by the amount the home is worth.

A home occupied by its owner does not have rental income per se – the homeowner does not pay himself rent – but a hypothetical rental income can be imputed to owner-occupied homes by looking at the rental incomes earned by comparable homes that are on the rental market.

The Bureau of Economic Analysis makes rent imputations part of its preparation of gross domestic product and other items in the national economic accounts and reports a total value created during the year by all homes. It also estimates an aggregate home value (more precisely, it estimates what it would cost to replace each home with one just like it). The table below shows its results for the year 2000.

The first row of the table reports that the homes, condos and mobile homes in the United States in the year 2000 provided $1.01 trillion of housing services — that is, the value of the housing in rent or imputed rent — in the year 2000 (next week I’ll examine the years 2000 to 2010 more closely). A total of $160 billion of intermediate goods and services — mainly closing costs and brokers’ fees — were used, and the normal rate of depreciation of homes amounted to a cost of $162 billion.

The housing sector employed some people, such as apartment managers, with a payroll that amounted to $11 billion. But the Bureau of Economic Analysis does not try to measure the value of time of people who maintain their own homes, and for this reason the housing sector’s labor costs are significantly understated. With this caveat, the operating surplus of the housing sector was $677 billion.

The housing stock in the year 2000 was worth $10.63 trillion, so the housing sector’s operating surplus amounted to 6.4 percent of the value of its housing capital. (This surplus was divided among owners and mortgage lenders, but today I focus on the overall profitability of capital without regard to how it is shared).

Luke Threinen, a University of Chicago student, and I used these ingredients, and some minor adjustments for inflation during the year, to calculate housing profitability rates for 80 years. The chart below displays our results for the years 1950 to 2000.

The profitability of housing fluctuated between 4 and 7 percent, averaging 5.7 percent over the decades shown in the chart. The 5.7 percent may seem large, because few of us earn that much on our savings accounts.

Part of the explanation is that most homes owe property tax, and the chart shows pretax profitability (another part of the explanation is that savings accounts are generally low-return investments).

More notable is the comparison of housing’s 5.7 percent profitability to the profitability of business capital. Mr. Threinen and I made analogous calculations for the nonresidential sector – annual business revenue minus variable (nontax) costs expressed as a percentage of the amount of business capital – and found business capital to have a profit rate of 15.3 percent.

We concluded that the profitability gap between nonresidential and residential capital shows that our economy was overinvested in housing, long before the housing boom of the early 2000s.

Business capital has been so profitable to the economy because it is more scarce. It’s the law of demand: the less business capital there is, the higher the rate of return that remaining business capital earns because each unit of capital serves more customers. A low profit rate for housing is a symptom of its abundance.

With each dollar of business capital adding 15.3 cents of value per year and each dollar of housing capital adding only 5.7 cents, total value added in the economy would have been greater if some of the housing investment had been business investment instead, even before the housing boom. Each $10 billion of housing investment that could have been redirected to business investment have added almost a billion dollars to G.D.P.

Business capital has been more scarce largely because of business taxes and housing subsidies. Houses are not tax-free — I mentioned the property tax — but, in addition to property taxes, investors in businesses also owe sales taxes, corporate income taxes and personal income taxes.

The business-residential profitability gap is almost 10 percent, but our attempts to adjust both profit rates for applicable taxes show that the after-tax profitability gap is zero to five percentage points.

I mentioned last week how, in the short run, capital income taxes result in lower after-tax returns for the owners of the capital being taxed. In the long run, the opposite occurs: investors have choices about where and how to invest, so the after-tax profitability of housing has to be pretty close to the after-tax profitability of business.

Business taxes cause an underinvestment in business capital – scarcity is the only way business capital can earn an after-tax return that compares with the return on lesser-taxed housing – and overinvestment in housing.

Early Doubts About Whether Tax Credits Stimulate Investment

2011-01-12T08:03:00.000-08:00

Copyright, The New York Times Company

By its very name, the 2009 American Recovery and Reinvestment Act was advertised to increase investment. Yet years before this stimulus act was proposed, Austan Goolsbee, now chairman of the President’s Council of Economic Advisers, explained in his doctoral dissertation how investment tax credits might do little to stimulate investment during the life of the credit.

In at least one respect, the results of the act appear to confirm his theory.

An investment tax credit permits someone who purchases one of the capital goods covered by the credit to pay less tax in proportion to the amount he spends on the investment. The 2009 stimulus act included tax credits for various capital items, the most publicized being homes: qualified first-time home buyers, for a limited time, received a 10 percent capped tax credit. The program was later expanded to include repeat home buyers.

With the government helping an investor pay for a capital good, each investor is more willing to pay for such goods than he or she would be without the credit. You might guess that eager investors would stimulate more investing – leading to the production of more capital goods. With more capital goods being produced, the credit would create jobs for people who make those goods.

This guess is correct in the long run when it comes to housing tax credits: a housing credit or subsidy does result in the building of more houses (I’ll explore this subject in more detail next week).

But in the short run, the situation may be very different, as Mr. Goolsbee’s dissertation explained. The production of capital goods may get more expensive. In the extreme case, investors may pay more for their capital goods, and more of those goods will not be available. (In technical terms, we economists say that the supply of capital goods is inelastic.)

With no additional capital goods being produced, the credit would not create any jobs – just create a windfall for people already making those goods.

Mr. Goolsbee’s statistical analysis found that “much of the benefit of investment tax incentives does not go to investing firms but rather to capital suppliers through higher prices. A 10 percent investment tax credit increases equipment prices 3.5-7.0 percent.”

Mr. Goolsbee’s study looked at equipment and not structures, and we cannot assume that the nature of housing supply is identical to the nature of equipment supply. Economic theory and experience suggest that housing is even less elastically supplied in the short run than is business equipment.

In other words, an increase in housing demand – which the tax credit helped create – would, in the short run, do more to make housing construction expensive, less to create houses and less to create jobs than Mr. Goolsbee found for equipment.

And, indeed, whatever the overall objectives of the stimulus bill, it appears to have made construction more expensive.

I do not know if President Obama’s advisers discussed this issue, or whether they expected job creation to come from other parts of the stimulus act.

White House economists are probably Keynesian, in the sense that they believe that the 2008-9 recession was a special time when supply did not matter, even though it normally matters in most economic circumstances.

Mr. Goolsbee’s dissertation examined a number of tax credits that were put in place during recessions and seems to refute the idea that supply doesn’t matter during recessions.

Yet we have to acknowledge that the home construction industry was unusually depressed in 2008-9 and might have been a rare example where a stimulus could create jobs without increasing prices.

Now that the Home Buyer Tax Credit has come and gone (it began in early 2009 and ended April 30, 2010, although some buyers had until September to finish transactions), we can look at home construction costs and home construction activity during that period.

The chart below displays the monthly producer price index for home building materials (the blue line, measured relative to the producer price index for all finished goods), along with employment in the residential building industry (the red line), for the period January 2008 through December 2010.

The blue line shows a curious spike in the prices of home building materials, peaking at the end of April 2010, almost exactly when the home buyer credit expired.

Perhaps Mr. Goolsbee’s dissertation applies here, and the rush to finish home transactions before the credit expired made home building 3 to 5 percent more expensive during that period than it would have been without the credit. In contrast, the red employment series shows no visible spike in people employed as home builders.

The Home Buyer Tax Credit is just one part of a complicated stimulus law, but it illustrates a general principle of economics.

Even when government spending, subsidy or credit is targeted at a highly depressed industry, with plenty of unemployed workers apparently available for hire, the government’s purchases may, in the short run, raise prices and costs without necessarily causing more of those items to be produced.

Bad News from the Housing Sector?

2011-01-05T06:29:00.000-08:00

Copyright, The New York Times Company

A few economists are contending that our housing market is now in a “double dip,” based in part on last week’s report of housing price indexes for September and October that were lower than they were during the summer. In my opinion, the data on housing prices and construction do not show any significant housing market change during the second half of 2010.

When connecting the housing sector with the wider economy, three different measures of housing prices are helpful: inflation-adjusted housing prices, inflation-unadjusted housing prices and cost-adjusted housing prices.

Inflation-adjusted housing prices tell us how much the prices of homes have changed relative to the prices of other consumer goods. If, for example, we want to know whether demand for housing these days is any different than it was before the housing bubble, it helps to check whether, from the 1990s through 2010, housing prices failed to increase as much as other prices have.

In this case I look at a housing price index that has been normalized by a consumer price index.

Inflation adjustments are not appropriate for the purposes of analyzing foreclosures – a big drag on our economy – because the mortgage principal that pulls homeowners “under water” is not adjusted for inflation either. If unadjusted housing prices increase, even if more slowly than other consumer prices, that helps homeowners swim out of the water.

For this purpose, I look at an index of the dollar value of housing properties, without any adjustment for inflation.

For the purposes of understanding construction activity, it helps to know whether housing prices have increased more than the costs of building materials. The more that housing prices increase beyond the cost of materials, the more value that can be created by home construction activity.

For this purpose, I look at an index of housing prices that has been normalized by an index of building costs.

It turns out that practice is messier than theory, because there are so many different houses in America and many different price trends. In practice, it matters which housing price index is used, regardless of which inflation or cost adjustment is used.

The Case-Shiller repeat sales index is one such index of existing homes. The Federal Housing Finance Agency has another index of existing homes (and there are others, as well). The Census Bureau has a quality-adjusted index of new home prices.

Chart 1 displays the three aforementioned home price indexes, measured quarterly without any inflation adjustment. The Case-Shiller index for the third quarter of 2010 (the first quarter without the government’s home buyer tax credit) was essentially the same as in the previous quarter. The other two indexes show slight decreases over the same time period, although well within the range of ups and downs over the previous six quarters.

By themselves, these data suggest that homeowners did not go significantly deeper under water in the third quarter and that the housing market trends were not dramatically different in the third quarter than in previous quarters.

Chart 2 displays the same three indexes, adjusted by the implicit price deflator for consumer spending. Because inflation has been low recently, it shows a similar pattern to Chart 1. By themselves, these series show no dramatic change in housing demand over the most recent quarter.

Chart 3 displays the same three indexes, adjusted by the producer price index for home building materials. Deflated this way, the Case-Shiller index actually shows a housing price increase from the second to the third quarter. That’s because building costs peaked in May and have been lower since then.

Without home prices falling by this measure, we do not expect construction activity to be lower than it was during 2009 (but, unsurprisingly, lower than it was during the short rush to sell homes before the tax credit expired).

You may notice that various housing price indexes disagree, and our most recent data is still three months old. Yet another approach is to look at home construction activity. Chart 4 displays monthly home construction activity through November 2010, measured as the number of housing permits, housing starts, homes under construction and homes completing construction.

Permits and starts are particularly interesting, because homes take time to build and we presume that many builders are looking ahead to the prices homes will command in the future, when the construction project is complete. Those series were actually higher in November 2010 than they were for several months before.

Predicting the future is difficult, but the price and construction data so far do not seem to suggest that home values will be significantly different this year than they were in 2010.

Spending and Value Added over the Seasonal Cycle

2011-01-03T16:13:00.000-08:00

I've heard some complaints about my seasonals article: that I should have looked at the impact of Christmas value-added rather than Christmas spending. If the complaints prove anything, they prove that Keynesian theory has not yet progressed beyond a statement of faith to a theory that might actually be tested.

First of all, this complaint is a great example of slippery Keynesian rhetoric. We have been told time and time again that the recession and sluggish recovery are to be blamed on too little consumer spending. We can and should help fix it -- create millions of jobs, they claim, with trillions of dollars of government spending. They even claim that unemployment insurance (UI) -- a transfer that is normally expected to reduce employment -- would, these days, increase employment because UI is spending.

In summary, the Keynesians say that spending really matters during a recession, and that employment, value-added, etc., would be the result of that sorely needed spending.

Now we're told that value-added is supposedly what's missing, not spending. So what happens to consumer spending in December is, all of the sudden, no big deal, because most of the December action is purportedly spending rather than value-added.

You might think that I'm being too harsh with the Keynesians because, after all, they are trying to explain economics to politicians and laymen who might be overwhelmed by a term like "value-added", so the Keynesians say "spending" when they really mean value-added.

But UI is an excellent example for sorting this out, because we all agree that UI is spending, but not value-added (UI actually pays people for not adding value!). So Christmas consumer spending should create as least as many jobs per dollar (probably more, for the incentive reasons I mentioned in my earlier post) than a UI program does.

Second of all, in claiming (without evidence) that the retail sales seasonal is very different from the value-added seasonal, econbrowser probably has the facts wrong. Professor Jeffrey Miron has written a book about the seasonal cycle, and reports that value-added falls sharply from the fourth quarter to the subsequent first quarter -- very much in line with the drop in retail sales. The value-added of Christmas is not all that different from the spending.

Third, I do not doubt that December retail sales are associated with some significant production in November, and October, and maybe even with some significant production in the 3rd quarter. But both of my recent posts on this topic repeatedly reference drops FROM DECEMBER TO JANUARY. At lot of the seasonal jobs lost at the end of the year include those that started in October and November, so in making December-January comparisons I do not have to assume that all of the employment and production associated with December spending occurred in December.

Keynesians are understandably nervous that the seasonal cycle appears to contradict the most fundamental tenets of their theory. Many of them really do think that government spending is as good as Christmas.

Does Supply Matter During Recessions? Evidence from the Holiday Seasonal

2010-12-29T05:02:00.001-08:00

Copyright, The New York Times Company

There will be almost three million fewer jobs next month than in December, and this outcome reveals a lot about how the labor market works.

As I noted last week, employment normally falls sharply after Christmas, for the obvious reason that consumer demand is significantly less in January than in the preceding December. Next month should be no exception.

Three million is a lot of jobs – that happens to be the total number of jobs that the Obama administration contended that it had “created or saved” over the entire life of the stimulus law passed in 2009. Yet next month’s multimillion loss of employment will be largely ignored by news organizations, because it will not be much different than it has been any other January.

But it’s big news that the seasonal employment cycle continues to operate as normal. The cycle is, of course, the outcome of seasonal fluctuations in supply and demand, and Keynesian economists insist that supply and demand have not been operating normally since the recession began and that the economy has been caught in a “liquidity trap.”

Keynesian economists assert that labor supply – the willingness of people to work – doesn’t matter right now, which is why they advocate government stimuli that increase “demand” spending even while they erode work incentives. As Paul Krugman put it: “What’s limiting employment now is lack of demand for the things workers produce. Their incentives to seek work are, for now, irrelevant.”

In other words, a recession like the recent one is purported to be one of those rare times when demand is not constrained by supply.

My view is that lack of demand has not been the primary problem with our labor market, which is why the stimulus law has created no visible employment increase. Because of this disagreement among economists about the roles of supply and demand during recessions, it’s important to examine whether demand was operating normally during the latest recession.

If the Keynesians are right, the disappearance of Christmas demand in January would be even more devastating for total employment during a recession than it would be normally, when supply limits the effects of Christmas demand.

If so, the holiday employment seasonal would be about twice as large during recessions – with January job losses in a recession of five million or six million, compared with the normal three million.

The chart below tests the Keynesian claims by comparing the holiday employment cycle across years. Each series measures the deviation of December employment from the October-January trend (Christmas shopping begins after October and is finished by January).

The green and red bars measure employment from the establishment survey and the household survey, respectively, both conducted by the Bureau of Labor Statistics.

The average holiday seasonal data previous to the recent recession is shown at the left, and the rest of the chart isolates the season for 2007, 2008 and 2009, some, if not all, of which years when our economy was purported to be in a supply-doesn’t-matter liquidity trap. (For further description of these and related calculations, see this paper)

Take, for example, the green bars from the establishment survey. On average from 1980 to 2006, December employment exceeded the October-January trend by 1.5 percent. During the years 2007, 2008 and 2009, the December employment seasonal turned out to be similar – about 1.3 percent, rather than the 3 percent or so that we would expect if the economics of supply and demand were really as different during those years as Keynesian economists say they are.

The red bar of the household survey is noticeably lower in 2009 but well within the range observed over the past several decades.

You might think that Christmas became smaller during the recession, and that change offset the purported extra impact of each dollar of Christmas spending. It is true that almost all kinds of spending are lower during a recession, but I adjusted for that by measuring the seasonal data in percentage terms.

The retail sales data show that, in percentage terms, the holiday spending surge was not much different from 2007 to 2009 than it was in previous years.

People can argue about whether demand effects are marginally bigger during a recession. But the seasonal cycle clearly shows a recession does not free demand – whether it be holiday demand or government demand – from the constraints of supply.

2010 Democracy Ebbs and Flows

2010-12-24T02:37:00.000-08:00

http://www.chicagotribune.com/news/columnists/ct-oped-1223-chapman-20101222-column,0,6322548.column

More Evidence of Hamp Failures

2010-12-23T09:56:00.000-08:00

CNBC reports:

"Homeowners applying to the foreclosure-relief program say the program is a bureaucratic mess, with banks losing documents and failing to return phone calls. Banks blame homeowners for failing to submit needed paperwork."

This result is no surprise.

The Holiday Stimulus Package

2010-12-23T06:45:00.000-08:00

Retail sales are typically 15 to 20 percent higher in December than they are in September, October and November, and 30 percent higher than they are in the following January (as averages show for 1939 to 2009).

In dollar terms, that means that retail sales rise and fall by roughly $90 billion in a single month.

A $90 billion change in spending in a single month is larger than even the American Recovery and Reinvestment Act, the fiscal-stimulus legislation that was increasing federal government spending by about $50 billion a quarter (less than $20 billion a month).

Likely a consequence of December retail spending, December employment is high each year. Retail employment in December is typically 3.9 percent higher than in October and 5.2 percent higher than in the following January. Some extra retail employment comes at the expense of non-retail employment, but total employment may be as much as 500,000 greater in December than in other months, because of the retail surge.

Although the holiday spending surge is clearly associated with a high level of employment, it also shows how spending is a rather indirect way of creating jobs. That holiday spending of roughly $90 billion more in December is associated with about 500,000 additional jobs for a month – that amounts to $180,000 per job per month!

Both Christmas and the fiscal-stimulus act increase demand, but the fiscal-stimulus act depresses supply, because many of its major programs – the unemployment-insurance extension, the food-stamp program expansion, the home buyer tax credit and more – are directed at people with low incomes.

In other words, the less you work and earn, the larger your entitlement to various components of the act.

By reducing supply as it increases demand, the fiscal-stimulus act could well reduce total employment, rather than increasing it as Christmas does.

In any case, our experience with Christmas shows how large amounts of spending do not necessarily create large numbers of jobs.

Marginal Tax Rates in the Private Sector

2010-12-21T08:34:00.000-08:00

I have written about the erosion of incentives to earn income, especially during this recession, by a variety of public and private sector programs (foremost among the private sector programs are debt collection programs that forgive debts for people with low incomes, but enforce them for those with high incomes). Here's another example that involves fewer dollars, but illustrates the point:

http://www.google.com/hostednews/ap/article/ALeqM5hTp5DVv4Qisj9CFdbTFX-j1rBE6Q?docId=4d140ccf08a0495f9f55429d89b5afe6

Keynesian Flavors

2010-12-15T05:00:00.000-08:00

Copyright, The New York Times Company

The effects of the payroll tax holiday — part of the new federal tax bill being considered in Washington — depend on the flavor, if any, of Keynesian economics that best describes our economy.

Since 1983, employers and employees have each “contributed” 6.2 percent of payroll to the United States Treasury, earmarked for the Social Security program (those contributions apply only to the first $100,000 or so that each employee earns for the year). President Obama and members of Congress have proposed to reduce the employee contribution rate to 4.2 percent for the duration of 2011 while keeping the employer contribution rate at 6.2 percent.

They argue, and I agree, that the proposed tax cut will increase what employees take home after taxes.

Essentially all economists believe that it usually doesn’t matter whether employers or employees, or some combination, are obligated to pay Social Security tax, because the employer portion of the tax just results in lower wages for employees (and lower wages induce employers to hire more.)

Thus, if the current tax-cut proposal were instead aimed at employers, employees would still see more take home pay because employers could afford to pay higher wages.

From that perspective, it’s fine that politicians are proposing a cut for employees; maybe they score some extra political points for a cut that would be more obvious to employees than an employer cut would be.

However, one version of Keynesian economics stresses that our economic recovery from the recession is hampered by “sticky wages.” That is, employment would rebound more vigorously if only wages would fall, making it more economical for employers to hire. But imperfect competition in our labor market prevents wages from falling as much as would be efficient.

If the sticky-wage flavor of Keynesian economics were correct, then cutting taxes for employees has less impact on employment than cutting taxes for employers would, because the employer tax cut is the only way employers will see lower hiring costs. (It may be true that the employee cut would “put money in the hands” of different people than an employer cut would, and perhaps it is also true that money in the hands of employees would do more to increase national spending. But that effect on employment, if any, is less direct than lowering employer hiring costs).

I admire our labor market more than sticky-wage Keynesian economists do, but parts of the sticky-wage model are relevant for some sectors. In particular, minimum wage laws prevent wages from fully reflecting economic conditions, and those laws are most relevant for the low-skilled workers who are experiencing the highest unemployment rates.

In such cases, it matters whether a payroll tax cut goes to employers or employees (Prof. Stephen Trejo of the University of Texas wrote a dissertation on this at the University of Chicago).

If the sticky-wage Keynesians are right, then the employee payroll tax cut will have hardly any effect on employment among low-wage workers and will actually increase the measured unemployment rate for such groups, as they try harder to seek employment that, in 2011, would pay more after taxes.

Another flavor of Keynesian economics emphasizes sticky prices for consumer goods, rather than sticky wages. In this view, prices need to fall more to stimulate demand, and only that extra demand can create hiring. Unfortunately, they contend, imperfect competition in our consumer goods markets prevents prices from falling as much as would be efficient.

Sticky-price Keynesians agree that an employer tax cut would have the same effect as an employee tax cut. But both cuts have a minimal employment effect, if any, because it’s not employer costs that hold back hiring — it’s the lack of demand for consumer goods that would be there if only prices would fall.

Indeed, some sticky-price Keynesians have argued that payroll tax cuts would actually reduce national employment, because more people would compete for jobs that aren’t there.

In summary, the proposed payroll tax cut does not increase national employment in the sticky-price Keynesian model, regardless of whether the cut is aimed at employers or employees. The sticky-wage Keynesian model says that, because the cut is aimed at employees, it will not increase hiring in those sectors where wages are sticky — such as the market for low-skilled workers.

In my view, all flavors of Keynesian economics ignore the many mechanisms that permit markets to adjust to changes in costs and benefits. Although a minimum wage cut would be an effective and revenue-free way of raising employment, the proposed payroll tax cut increases the benefits and reduces the costs of employment and will result in more employment among people earning less than $100,000 a year — even among those earning the minimum wage.

The Marginal Products of Residential and Nonresidential Capital through 2010 Q2

2010-12-10T10:33:00.001-08:00

We will soon be updating our paper.

The level of the non-residential series changed a bit when we changed our treatment of indirect business taxes. Here's the (slightly) revised introduction:

Economic theory suggests that marginal product of capital series might help predict economic growth forward one or two years, even under abnormal conditions such as wartime or depression. In some situations, the marginal product of capital is an essential ingredient in cost-benefit analyses (Harberger 1968; Byatt, et al., 2006; Mityakov and Ruehl, 2009). Evidence on the marginal product of capital can also help test various explanations for business cycles, help identify causes and consequences of the recent housing “bubble,” and help quantify the economic burdens of business taxes. The purpose of this paper is to produce annual and quarterly estimates of the marginal product of capital (net of depreciation), one each for the residential and nonresidential sectors of the U.S. economy.

By definition, the marginal product of capital net of depreciation is the change in net domestic product (NDP) during the accounting period (e.g., one quarter) that would result from an increase in the beginning-of-period capital stock of $1 worth of capital, holding constant the total supply of all other factors. The additional $1 of capital is assumed to have the same composition as the rest of the capital stock. For example, if the economy’s capital consisted of 400 identical structures and 100 identical vehicles, each of which cost $2 to acquire, then the marginal product of capital would be the extra NDP attained by starting the quarter with 400.4 identical structures and 100.1 identical vehicles (that is, $0.80 worth of structures and $0.20 worth of vehicles).

Suppose that origins of the current recession could be traced back to limits on the supply of aggregate investment due to a “credit crunch.” (Real investment did fall through the first year and a half of this recession.) The credit crunch theory says that the marginal product of capital would rise over this period as a consequence of the increased cost of capital faced by those with new capital projects. Alternatively, a financial crisis or something else could reduce labor usage more directly, and, given the complementarity of labor and non-residential capital in production, a fall in non-residential investment would merely result from low marginal products of capital, thereby putting the non-residential capital stock on a path that is consistent with a lesser amount of labor usage (Mulligan, 2010).

The marginal product of capital is also interesting as an aggregate leading indicator of business conditions, which is the motivation for its use in a number of studies (e.g., Feldstein and Summers (1977), Auerbach (1983)). This relationship alone may make it a predictor of subsequent economic growth.

Additionally, Fisherian consumption-saving theory suggests that the marginal product of capital, or variations of it, should predict consumption growth. In a Robinson Crusoe economy, the consumer would save for the future by reducing current consumption and using the proceeds to build capital assets. She would then use the marginal product and capital gains from those assets to add to consumption in the future. Because the saving decision is made in the present while the principal and interest are spent in an uncertain future, the incentive to save depends on, among other things, the expected marginal product and expected capital gains. The current marginal product itself helps predict the incentive to save only to the extent that it is closely related to the expected sum of future marginal product and capital gains. For this reason, we present measures of the marginal product that might be more indicative of those expected gains, and (consistent with national accounting practices: see Fraumeni, 1997) measures of depreciation that reflect expected depreciation and obsolescence, rather than actual depreciation and obsolescence.

It is helpful to examine the marginal product of residential capital separately from the marginal product of non-residential capital for at least two reasons. For one, the aggregate demand for labor is expected to have a closer relationship with the stock of non-residential capital than the stock of houses, because workers use non-residential capital in doing their jobs. Additionally, some important capital market distortions – such as business taxes and the “housing bubble” – are expected to have opposite effects on the stocks of residential and non-residential capital, and thereby opposite effects on their marginal products.

Section II presents our methods for calculating annual marginal products, and discusses the findings for 1930-2009. The marginal product of capital is very different in the residential and non-residential sectors, both in terms of levels and fluctuations. Section III examines the importance of taxes in explaining the gap between marginal products in the two sectors. The methods and results for quarterly postwar marginal products through 2009-IV are presented in Section IV. In order to isolate some of the possible determinants of measured marginal products, Section V compares them with average products. Section VI concludes, and Appendices record the time series values discussed in the body of the paper.

Who Gets Paid by Big Government?

2010-12-08T06:10:00.000-08:00

Last week I examined tax payments by income distribution decile in France and the United States. France’s bottom decile (the 10 percent of French households with the lowest incomes) paid more than half of its income in various taxes, compared with less than 20 percent paid by America’s bottom decile. France’s top decile is taxed at a rate that looks more like the rate in the United States – less than 40 percent.

Taxes help finance, among other things, government transfer payments and other social-welfare expenditures like medical spending. These payments are more generous in France than in the United States, and some of them are received disproportionately by low-income people.

But there are two reasons we cannot immediately conclude that low-income people get their money’s worth from big government that, as in France, takes more than half of their income in various taxes.

First, much social-welfare expenditure goes to the elderly, in the form of public pension benefits and medical spending. Some of the elderly are poor in every sense of the word. Others receiving medical and public pension benefits are only technically poor (by the definition of the tax incidence studies I cited two weeks ago), because they no longer generate income on a job, but enjoy above-average living standards (which they afford by owning their own homes and receiving pension payments from their former employers).

Indeed, the fact that someone has been able to live until her or his elder years may itself be evidence of some amount of affluence: good health is something enjoyed disproportionately by higher-income people.

Public pension benefits have been so generous in France that the elderly have obtained a disproportionate share of the nation’s labor income through the pension system, while France’s young people did a disproportionate amount of the labor.

The amount of public pensions paid has exceeded one-fifth of the nation’s labor income (and this does not even begin to count any private-sector incomes received by elderly people), even when France’s elderly were less than one-fifth of the population.

As a result, the average elderly person in France has a better living standard than the rest of its population does. Even in the United States, the elderly poverty rate is below the poverty rate for other adults and below the poverty rate for children (see page 16 of this Census Bureau publication).

This is not to say to say that the elderly do not deserve their public pension payments, for which they worked many years. But it is incorrect to characterize many payments they receive as payments to poor people (for this reason, a few economists have attempted the difficult exercise of relating taxes and public spending to people’s lifetime incomes).

Second, taxes and transfers cannot be simply subtracted to determine the net position of the poor and other groups vis-à-vis the public treasury, because the government benefits often come with strings attached — that is, because the government spends poor taxpayer money in different ways than the poor would spend it themselves, government spending is less valuable to them than the equivalent number of dollars they may have paid in taxes.

The phenomenon of “topping off” illustrates how higher-income people derive more value from various types of government spending than low-income people do. High-income people seem to value pensions, which is why they “top off” Social Security: they accumulate pensions above and beyond what the government forces them to accumulate though the Social Security system. You might say that pensions are easy to accumulate when your income is high — and that’s the point.

Low-income people, on the other hand, often accumulate no pension beyond what Social Security forces them to accumulate.

That’s why the taxes being paid are that much more burdensome on the poor — snatching money from people trying to pay their bills. Big government is taking money from people when they need it most; what consolation is the promise that government will help out later in life?

Big government leaves both poor and rich taxpayers with less to spend on themselves, and more to be spent at the discretion of big government.