Tantalized by Panel Data

Much conventional wisdom among econometricians and applied economists extols the virtue of "panel data": data that follows individuals or regions over time. State panel data -- data that follows each of the 50 states over time, is thought to be especially virtuous because there's never a problem with losing track of one of the states (unlike panels of individuals, from which members can nonrandomly drop). Especially lauded is the practice of including so-called "time effects" in the model, which means that changes over time are NOT examined except to the extent they occur differently among the individuals or regions.

One interesting question in industrial organization and public economics is the "incidence" of excise taxes -- that is, whether a tax on the sales of specific items will reduce what manufacturers receive for making the item, or increase what consumers pay for it. Cigarettes are an important instance of this, because the taxes are large, and policy-makers are concerned about the harmful health effects of smoking. Because the effects of taxes are determined by the interaction of supply and demand, knowledge of cigarette tax incidence would tell us about the nature of pricing in the cigarette industry, as well as effects of federal cigarette taxation on health and state revenues.

Cigarette tax incidence has usually been studied with state panel data. After all, states differ widely in terms of their use of their taxes, and the dates at which they change their rates. The state panel studies usually find that each penny of cigarette tax raises retail cigarette prices by almost exactly a penny, with little effect on the price per unit received by manufacturers.

By this logic, the $0.62 per pack federal excise tax hike this April would raise retail cigarette prices by almost exactly $0.62 per pack, reduce cigarette smoking in an amount commensurate with the $0.62, and have little effect on the amount cigarette manufacturers receive per pack shipped to U.S. retailers.

I have long been dubious of state panel data for this purpose, because the supply curve across states is very different than the national supply curve. Wholesalers in one state can pretty easily ship cigarettes to a wholesaler in a state with a different tax situation, and this possibility requires wholesale cigarette prices to be essentially the same in each state at a point in time. National pricing is very different because nothing requires the wholesale price in, say, 2006 to be the same as it is in 2009 (I'm told that cigarettes do not store well over long time periods).

We have enough data now to check whether I'm right. I found a monthly Consumer Price Index for cigarettes at www.bls.gov. The CPI is an index, telling us percentage changes in retail prices from one month to the next, but do not tell us what a pack actually costs. The aforementioned literature often gets annual (measured in November) cigarette prices from the "Tax Burden on Tobacco", so I used that to pin down the level of national average cigarette prices in Nov 2007 ($4.20 per pack; see also this article that puts average prices at $4.10 in early 2009), and then used the monthly CPI to measure retail prices for all other months Jan 2007 - Oct 2009.

The chart below displays the results. Notice that the vertical axis is scaled so that each tick is $0.62/pack -- if the state-panel studies could be used to project federal tax effects, then prices would go up by exactly one tick.



Instead, cigarette prices increased a lot more than 62 cents: more like $1. The state-panel results wildly underestimate the effect of the tax on retail prices, and thereby wildly underestimate the effect of the federal tax on smoking and excise tax revenues received by the states.

[The vast majority of states kept their excise tax rates constant during the first half of 2009. Exceptions are Arkansas, Kentucky, Mississippi, and Rhode Island.]

Are Banks Undermining Loan Modification?

This article claims that they are:

http://www.nytimes.com/2009/11/29/business/economy/29modify.html

If the terrible government loan modification program is in fact broken, let's leave it that way!

Prescott and Mulligan: Same Song, Different Verse

I just found this interesting July 2009 presentation by Professor Edward Prescott. He says that the anticipation of future taxes/bad incentives is depressing the economy. I say that the bad incentives are already here.

Now is not the time to quibble: what we both say is vastly different from the conventional wisdom, and we both recommend that government refrain from making it worse.

One Minimum Wage Increase With a Side of Fries, Please

Copyright, The New York Times Company

Economists have debated the employment effects of the minimum wage. A recent study of obesity now weighs in on this debate.

Many economists expect the minimum wage, if it has any effect, to (among other things) raise employer costs and therefore reduce employment, especially among people who are likely to work in minimum wage jobs like teenagers and restaurant workers.

However, inspired by a study of a 1992 minimum wage increase in New Jersey, some economists have suggested that minimum wages can increase employment, by helping to cure pre-existing problems in the labor market. In their view, a higher minimum wage could increase employment and output at employers of low-wage workers, and a lower minimum wage would reduce them.

The typical example is a fast-food restaurant.

The minimum-wage-cures-labor-markets view says that a higher wage level causes fast-food restaurants (like other employers of low-wage workers) to hire more workers, produce more fast food and sell more fast food.

More fast food sold also probably means more obesity. Thus, if the minimum-wage-cures-labor-markets view was correct, a higher minimum wage would, all things being equal, probably result in higher obesity rates.

More conservative economists would argue, though, that high minimum wages restrict employment by fast-food restaurants, which means less fast food produced, which means less obesity.

In other words, the traditional economics view implies a lower minimum wage would, all things being equal, result in more obesity.

As you may know, Americans have indeed been getting more obese over the last couple of decades, with increased consumption of fast foods contributing to that enlargement. During most of that period, the inflation-adjusted federal minimum wage had been falling.

A recent study by the researchers David Meltzer from the University of Chicago and Zhuo Chen from the Centers for Disease Control and Prevention now finds that low inflation-adjusted minimum wages are partly to blame for increased obesity.

If their study is correct, it suggests that a higher minimum wage indeed reduces employment and output at fast-food restaurants, and makes it a bit easier for Americans to adopt healthier eating habits.

As with any new study, time is needed to digest the methodology and results, and integrate them with the previous literature. But expect the fight against obesity to weigh in on the debate about low-wage labor markets.

What Does It Cost to Buy a Recession?

By Oct 2009, U.S. labor usage was more than 10 percent below trend. Even if it returned to trend by the end of 2010, that would put labor usage about 20 year x percentage points below trend (i.e., an average 6-7 percentage points below trend for each of three years). A year's labor income is about $10 trillion, so that's $2 trillion that labor income has been reduced over the three years.

How to Purchase a Recession
Suppose for the moment you had a lot of $ to bribe people not to work, or employers not to hire. What method of allocating the bribes would reduce employment the most? How much would it cost you to purchase a recession like this one?

If you simply paid people not to work, shrinking the labor usage by that much might cost about $3 trillion.

It can be a $3 trillion task because people who would not work anyway may take you up on your offer not to work. If you could target your bribes, you would want to target them to the weakest employment relationships -- those for which supply is closest to demand. With very well chosen targets, you could make a recession like this for a mere $100 billion.

But do not expect that you could target so well in practice, because it's difficult to know which employment relationships are the weakest, and once you started paying people for what appeared to you to be weak employment relationships, others might put on the appearance. But at least you could try to target the types of people who are generally expected to be working soon, such as persons searching for jobs (interestingly, that's what unemployment insurance does).

All together, you would be hard pressed to make a recession like this for less than $1 trillion.

UI is an Illustration, but not the Major Force
Unemployment insurance (UI) reduces the employment rate, by increasing the pay someone can earn while not being employment, and reducing the after-tax pay earned while employed. But I raised the question above to demonstrate that UI cannot be the only, or even a major, reason why employment is so low.

Recall that UI benefits are voluntary: nobody forces you to take them. Thus, even if UI had the purpose of reducing employment (which it is not), it could not be much more effective per dollar of expenditure than the hypothetical "recession purchase" discussed above.

UI will spend something like $300 billion for 2008-10, and obviously that $300 billion is not for the PURPOSE of minimizing employment. To make this recession by itself, UI would probably have had to spend more than $1 trillion. (this is the same argument I made in "Public Policies as Specification Errors" for why UI was not a major factor in the Great Depression, either).

Mortgage modification is almost a big enough operation by itself to make this kind of dent in the labor market (whether it actually does is another question). For example, if the Obama Administration achieved its goal of modifying 9,000,000 mortgages and each mortgage were written down an average of $75,000, that would be a total of $675 billion.

If you took the combination of mortgage modification, UI, big parts of the "stimulus" law, and other anti-employment policies, we probably are looking at over $1 trillion worth of spending that encourages people to have lower labor incomes.

Bottom Line
Although it's easy, and at least partly appropriate, to say that government spending of various sorts has reduced employment over the past couple of years, note that buying a recession is no cheap enterprise, and buying a recession of this size may be beyond even what governments can afford.

Investment and Housing Prices Among Various Data Released Today

A couple of housing price indices, plus national accounts revisions were released today. Much of the new data is not newsworthy, but I did notice that real nonresidential investment was even lower in Q3 than it was in Q2 -- another indicator that employment is not coming back soon.

I also noticed that the BEA price index for residential structures investment was (marginally) lower for the seventh quarter in a row. Here is a comparison of quarterly Case-Shiller, OFHEO, and BEA (all expressed relative to the PPI for housing construction).

Question About Deflation

Robert asks
"In our industry, the manufacturers claim to be holding prices, but are quietly making all kinds of deals to "help" us be more competitive.

Our competitors are taking those incentives and chasing prospects with what appears to the dealer to be lower prices across the board.

This is new behavior. For the past 8 years, no one really asked what the price was. Currently it's the prime topic.

Then I went online and ordered a pizza from pizzahut Friday. Suddenly every pizza is $10, half the price of the past few years. If that's a short term promotion were ok. If that's the new reality, are we in trouble?"

Let me rephrase Robert's post as three questions:

(1) Is deflation -- that is, a general decline of all prices (both the prices at which we buy, and those at which we sell) -- a problem? Theoretically, it is not a big problem, but just redistributes wealth from those with dollar-denominated liabilities to those with dollar denominated assets. However, this recession arguably got going because of the "underwater mortgages/foreclosure" problem -- a problem that get's better with inflation and worse with deflation. For more on this, see "Inflation, we need you!".

(2) Is there deflation right now, or will there be in the near future? I think we have a bit of inflation right now, and expect more inflation in the next couple of years (see here). It's always a bit difficult to know the inflation/deflation rate precisely, because a lot of price changes can be pretty subtle, as with the promotional discounts indicated in Robert's post. But the Bureau of Economic Analysis and the Dept of Labor have enough serious ways of measuring it that, together with the recent commodity price inflation, I am confident that we do have inflation.

(3) If not general deflation, what is Robert supposed to make of his observations? It's no surprise that various manufacturing prices have been falling a bit over 2009, after falling significantly at the end of 2008. If he's seeing more drops than a "bit" then that's some bad news for his segment of manufacturing.

(4) The pizza bargains may indicate that his region's economy is tougher than the national average, or merely that Robert hasn't purchased a pizza for a year or two (maybe the case -- that's about the time frame he wedded his lovely bride!!).

Bears Fan

Does this picture explain why I blame a large fraction of public policy mistakes (bank bailout, mortgage modification, min wage hike, etc.) on the previous administration?

No News Housing Construction Report

I don't see much news here:

The Minimum Wage and Teenage Jobs

Copyright, The New York Times Company

Teenage employment has fallen sharply since July. The most recent minimum wage hike may be an important factor.

Many economists expect the minimum wage, if it has any effect, to (among other things) raise employer costs and therefore reduce employment, especially among those who are likely to work in minimum-wage jobs, like teenagers and restaurant workers.

In July 2007, the federal minimum hourly wage was increased for the first time in 10 years, from $5.15 to $5.85. It was increased again a year later to $6.55, and increased yet again this July to $7.25.

Because the minimum-wage law still permits employers to pay more than the minimum, economists agree that a low minimum wage has smaller effects than a high minimum wage. The inflation-adjusted federal minimum wage had gotten to its lowest in decades by early 2007, so the July 2007 increase should have had the smallest effects of the three.

The July 2009 increase should have the largest effect, because the combination of the two previous hikes and some deflation ($6.55 bought more in June 2009 than it did the previous summer) had already gotten the inflation-adjusted minimum wage relatively high.

The chart below shows a seasonally adjusted index of the percentage of 16- to 19-year-olds with jobs. That group is especially likely to be affected by minimum-wage legislation. Of course, this is a recession period in which employment has been falling for essentially all groups, so for reference the teenage percentage has been converted to an index by dividing by the percentage for all people, with July 2009 set as the benchmark (i.e., the teenage employment rate that month has been set to 100).

The chart shows teenage employment index values greater than 100 early in the recession, which means that employment rates fell in greater percentages for teenagers even before the July 2009 increase, as it did in prior recessions (even recessions without minimum-wage increases). With the index falling somewhat less than 1 percent a month before July 2009, we would expect the index to be somewhat below 100 after July 2009 even if the minimum wage hike had no effect.



But the teenage employment after July 2009 seems sharply lower. By October 2009, the index had fallen to 92.1 — a drop of about 8 percent in just three months — whereas the prior 8 percent drop had taken more than a year. This suggests that the 2009 minimum-wage increase did significantly reduce teenage employment.

Before this recession, economists hotly debated the employment effects of the minimum wage, with special attention to a 1992 minimum-wage increase in New Jersey (this book got it started, and this book is a good source for the opposing view).

More work is needed to determine whether the 2009 experience is fundamentally different from the earlier episodes that have been studied, but next week I will describe a new study that “weighs in” on those episodes.