Tuesday, December 27, 2011

The End of the University of ... [insert your state]

The Washington Post reported [here, Dec 14th] on the budgetary crunch at Berkeley, amidst a claimed more general trend towards less state support for higher education. As an economist, I wonder why this trimming of support took so long – not because it's laudable, but rather because it is what basic economics permits. After all, why should my state spend money to educate someone who with high likelihood will work in someone else's state? If we close down all of our state schools, businesses may have a harder time recruiting managers, but given current unemployment levels…we here in Virginia can be free riders. But the logic is the same for each and every other state: all will cut. And if the Post is on target with its story, they are doing so.[1]
Can we find other evidence of this sort of behavior? Yes.
The generally abysmal quality of education in the old cotton-and-tobacco South reflects this logic. Plantation crops in the old days relied on brute labor, not brains; why pay for fieldhands to learn to read? That would increase their mobility, threatening the ability to get the crop harvested rather than making the local economy more productive. Equally important, a body is able to work by high school, if not by age 12 or 13. You want to spend money to keep them out of the fields?? That was true for coal mining and textile towns, too. Even in the north, my grandfather had to leave the farm to board in the city so that he could attend high school. Why, today, should residents of Florida retirement communities tax themselves to pay for the education of someone else's grandchildren? My sense is that, increasingly, they don't.
At the global level, society benefits from the constant stream of innovation that has lifted incomes for the past two centuries in industry after industry. Furthermore, by the late 1800s "basic" research underlay invention. But basic science in itself is unproductive. Few research projects pan out; those that do may have no obvious application. Even if they do, there's a (large) gap between laboratory bench and commercial product.[2] So why bother with basic science? The answer is that most of the world doesn't. Would Mongolia benefit from spending 2% of GDP on R&D? Instead, just buy the finished products, or use hints and the poaching of the odd employee. Of course basic research provides a great training ground for high potential grad students. But such workers are internationally mobile. Why should we pay?
To use jargon, education creates a positive externality: the benefits to society increase by more than the output of the (marginal) individual. We're much more productive when we can assume that employees, suppliers and customers are literate and numerate and (nowadays) know how to use computers.
The incremental benefits to education diminish with more years of schooling. Part of the reason is that job skills aren't generic, and so it's not realistic to think that college will provide them: you can add more knowledge, and an improved ability to learn and to communicate. Valuable, but only incrementally so. Now occasionally community colleges will pair with local employers for discrete programs, particularly when there are several companies with similar needs. That helps offset one of the defects of on-the-job training, that employees will take their skills to firms that pay a bit more, enabled because they train a bit less. In general, though, college cannot, and does not try to give, "day one" job capabilities.
That doesn't mean a college education does nothing. It also socializes students (generally for the better, unlike high school) and generates a pedigree that reflects some combination of acumen, ambition, persistence and willingness to do grunt work. Employers generally value all four. So even if a diploma provides little insight into the mix, employers are nevertheless willing to pay something for a diploma. However, now that everyone who is anyone has a diploma, that alone doesn't distinguish a graduate: you need higher higher education, a masters...
So why should we fund universities when their graduates have a hard time finding jobs, when many of the courses are esoteric and unworldly – as though the Greek and Latin education of the 19th century elite wasn't! Maybe we are educating too many for too long. But cutting back on funding won't somehow lead to more "practical" training – the sheer diversity of needs in today's economy precludes that – or to would-be employers not asking to see that diploma. Instead turning our public schools private will squeeze out those youth whose parents don't have the wherewithal to pay tuition,[3] or the sophistication to push them while young to win the scholarship marathon.
Mike Smitka
[1] California is remote from the East Coast, at least as reflected in the job hunting practices of my seniors. Now Washington and Lee is far from average, so I don't want to read too much into that – indeed, my suspicion is that Hollywood and Silicon Valley pull workers from throughout the US, if not from throughout the world. But to the extent it's true for the state as a whole, then Californians should be less willing to see the UCal and CalState systems pared than the rest of the country.
[2] Complete Digression: Xerox
The photoelectric electric effect relied upon lab results, and the lunchtime jottings of an employee of the Swiss patent office in 1905. The cost: a pencil and some paper. While it led to a Nobel prize for Einstein in 1921, there were no practical applications. Turning it into an invention relied up the efforts of Chester Carlson, working in the family kitchen in Queens during 1936-39, to succeed in developing a "proof of concept" using light to turn words into static charges on a selenium plate in 1939, to which sulfur dust could be made to adhere. Now this work involved a bigger budget than did Einstein's, but it was within the realm of his modest Depression-ear salary. Further development at the Battelle Institute ate through rather more, at least $200,000, a tidy sum in those days. In the process they developed a better plate, an effective toner and other core pieces of a working machine. However, the first commercial product didn't arrive until the Haloid Corporation took over development work, and invested much more money. The first shipment of the Xerox Model A Copier came in 1949; the first really successful version took until 1959, after significant additional investment. Now some of this required individuals with a knowledge of physics, and chemistry, and mechanical engineering, drawing in fact from many fields. But it drew upon the stock of knowledge, and lots of good engineering. For this I draw upon Hillkirk, John and Jacobson, Gary (1986). Xerox: American Samurai. New York: MacMillan. But I double-checked this` out of curiosity against Wikipedia.
[3] Some might object that the market will handle everything: academically able students can borrow and succeed even without financially able parents. But in today's environment of dim job prospects, don't the risks to both the bank and the would-be student mean that the only sensible strategy is "to neither a lender nor a borrower be?"

Thursday, December 1, 2011

First Greece, then California?

We know that Greece is in trouble. But what of California? It too is a sovereign entity within a monetary union. Chapter 9 bankruptcy, the provision that covers local governmental entities, is not available for state governments; under the US Constitution they fall outside the jurisdiction of such Federal legislation. And it's large -- 12% of the US economy, much larger than Greece is within the EU. So it may be Too Big To Fail -- perhaps we need to create the term "SIPEs" for "Systemically Important Political Entities" (cf. SIFI).

We would first need basic data. I've outlined what I know and what I think we need to know below. This is a work in progress, so will read choppily until such time as I rewrite in one sitting from beginning to end. Oh, and conclusions are at the very bottom.

1. What is the total volume of California bonds "at risk"?
State finances are potentially complex -- there can be taxes that are legally earmarked for the repayment of specific bonds, e.g. highway bonds matched against gasoline taxes all covering highway maintenance separate from the general budget. So the first approximation would be General Obligation Bonds (or their equivalent), that are backed only by the full faith and credit of the state government.
  • A quick google search suggests that about $80 billion are outstanding. (See "Seeking Alpha" from January 2010; the California State Treasurer gives the December 2011 General Obligation Bond total as $72 billion.) If so, then the amounts are really pretty small: with the GDP of California at about $1.8 trillion, it comes to 4% of state GDP, while Greece's (gross) debt is 116% of GDP.
  • In addition the state has contingent liabilities. The big item is likely unfunded pension obligations, rumored at about $500 billion. If we use $600 billion as a total, then debt is 1/3rd of GDP. But it's not clear that the bond market factors that in, since the need to lay out cash is down the road and the amount fluctuates with the stock market.
  • On 30 November 30 year Treasuries had a yield while California bonds of roughly the same maturity traded at 4.5% according to MunicipalBonds.com, or nearly a 2% premium despite their more favorable tax status -- indeed, for someone in the top income tax bracket, that would be the same as 7.6% on a US Treasury bond, a very stiff premium.
2. Who holds these bonds? Are they held by individuals who for various reasons might have a hard time "dumping" them? For example CALPERS, the state pension fund and the world's largest institutional investor, may hold so many bonds that it is unrealistic to think that they would "dump" them and be forced to book a loss. Or bond holders might be widely dispersed and typically hold only a few. In the former case, this would mute any crisis.
  • My hunch is that debt however is in fact widely held, albeit almost entirely within the state of California because state debt is tax exempt and marketed within states, for example there are mutual funds restricted to California bonds. Furthermore, it is likely held by a combination of individuals and pension funds, not banks (licensed or shadow) and so would not have some of the spillover observed with sovereign debt in the EU.
3. What is the maturity of the debt? In general, the government will refinance debt by rolling it over when it comes due. So a crisis could be accentuated if there is a current deficit that would have been debt financed, and maturing debt that would have been rolled over. More generally, a non-crisis gradual increase in borrowing costs to match perceived risk only affects new debt; the longer the average maturity, the longer it takes for an increase in interest rates to increase the average interest rate on state debt and hence the share of tax revenues needed just to pay interest.
  • I have no information though the unfunded pension liabilities are long-term so my hunch is that only $20 billion is short-term -- a drop in the bucket in US financial markets, even in their current stressed state (or should that be "states currently stressed"?). But that's not so small relative to general revenues in California, which I think are on the order of $75 billion.
  • Floating rate debt accentuates the impact any any short-run issues. Ditto bank loans. In January 2010 (Seeking Alpha) there was $5.5 billion in floating rate notes and $6 billion in bank loans. So at that point it was over 10% of all general state debt. 
4. What of other debt? -- there is likely seasonality in tax receipts and (perhaps less so) in expenditures. How is that financed? -- bank loans? The private sector analog is "working capital".
  • See above -- old data. So I don't know.
5. To what extent is California an "open" economy? -- the greater the share of trade, the smaller an impact a decline in expenditures would have.
  • I'm sure California is more "open" than Greece, in that it has never been an independent nation. However it is large and physically remote from the rest of the US economy so the short-run multiplier might be pretty big.
  • Greece is small, with a population of 11 million, while California has 37 million.
6. How large is the government? Again, parts of the government may be funded by taxes that can't be tapped to cover general budget items -- a debt crisis might not affect those areas at all.
CA state-level GDP is about $1.8 trillion, state and local government is about $0.2 trillion or about 11% of the economy. However there is no breakdown for the state government vs local governments. Furthermore it is not clear whether transfer payments are included (normally they would not be) and how these are handled within the state fiscal system.
  • My recollection from a year or so ago is that current expenditures at the state level are about $100 billion, but that the budget was not unified and reporters in Sacramento felt that no one really had a comprehensive grasp, certainly not those in the state legislature. But this means that the state government only accounts for 5% or so of the economy.
  • In contrast, for Greece we are talking about the central government, which has total expenditures of 47% of the economy and an overall budget shortfall of roughly 8% of GDP. That is very different in scale from a state government in the US, even if we lump city and country governments and the many semi-independent school, water, sewage, transit, port and other units in with the state.
7. How interrelated is government? To what extent would a debt crisis at the state level impede the operations of local government, which probably employs far more people? Most state governments transfer significant amounts of funds to local governments, particularly in support of public education. Is that the case for California?
  • My guess is that the state directly employs relatively few people, indirectly many. In normal times local school systems might have the ability to tide over a temporary shortfall in funds. I very much doubt that's true now.
  • However, under the California constitution education has seniority over debt service; it may be therefore that if crunch turns into default, in the first instance bondholders would be left holding the bag, not state employees. In the second instance, I suspect that the axe would fall on a great many, and that education would be affected through indirect channels.
8. Would Federal-level "automatic stabilizers" mute the impact?
  • My hunch is that state employees fall outside the unemployment insurance and pension guarantee systems. Furthermore, unless I'm mistaken unemployment insurance, medicaid and various other social safety nets are actually administered by, and operate in part with funds from, the state level. So they could suffer from spillover effects that would magnify the more narrow state government component.
9. What of contagion?
  • I think it quite realistic to think that local governments would have a hard time issuing bonds, even if they themselves are fiscally sound. After all, potential purchasers can always purchase Treasuries if they want long-term bonds, though for tax reasons they are imperfect substitutes. (Interest income on state obligations is not subject to either state or Federal income taxes, whereas Federal bonds typically are exempt from state taxes but not Federal taxes.)
10. What of contagion?
  • If California runs into trouble, then surely Illinois also would. And local governments therein (Chicago?). Sipes! (Structurally important political entities!)
11. How big an adjustment?
  • At least one mitigating factor is that the numbers I know are smallish. A current budget shortfall of $25 billion is 1.4% of California's GDP. Add in pension shortfalls of $500 billion and (spread over several years) we get a rather bigger number, but one that is still far below the 8% structural deficit in Greece. Of course this is in the context of a continuing recession and a continuing drop in real estate prices and high level of foreclosures that may mean revenues will continue to fall rather than stabilize.
  • Furthermore, the political system is byzantine, not Greek. Because of the referenda system, the legislature has limited powers; it could take a long while to change the state constitution, even if the will is there, because of the mechanics involved.
12. Should we worry?
  • I can't answer that question. But I don't think it can be brushed aside -- though Dani Rodrik concludes that in a November 2011 blog post. Part of the answer would be whether there is any trigger. What is clear is that the underlying structure is not fiscally sustainable. Will it however generate a "crisis"? Or a slow increase in interest rates on state debt and other pressures that will lead to a non-traumatic resolution? I certainly hope the latter, but wonder whether that is politically realistic. After all, the potential for Europe's current problems was fairly clear before the Euro was launched -- Martin Wolf of the Financial Times wrote about it in the early 1990s.
  • Nevertheless, the numbers above seem pretty small, under $100 billion, not factoring in cities, counties, school districts and other bond issuers within the state that may well be tarred and feathered by what goes on in Sacramento. If a crisis developed, but were limited to California -- a big if -- then it would not be big enough to affect the US as a whole.
  • In the late 1970s, before heading off to graduate school, I worked on Wall Street on Eurodollar syndicate loans to Latin America, and served as a representative of Japanese banks to the IMF organized restructuring of Jamaica's debt in 1980. (I didn't stick around to be part of the team for Brazil and other borrowers.) That was horrific in its impact on the average Jamaican, and the economy has never fully recovered. But a default by a US state would be quite different; once Jamaica began running out of US dollars, importing food and oil became problematic, as no foreign party would accept Jamaican currency. That issue would not be relevant for a subnational entity (and is not relevant in the EU -- incomes in Greece may have fallen, but if someone has a job, the euros they earn have held their value). It's important to keep that limit on the downside in mind, for Greece and for California.

Monday, August 22, 2011

Economic Policy: Treating Symptoms, Treating Causes?

Mike Smitka
...Inaction is the Best Medicine?...
The question: can we use an analogy from medicine, that we should treat the disease rather than the symptoms?
  1. Of course treating the common cold or a mild case of the flu may not be worth the effort (tamiflu?!) -- take 2 aspirin, drink lots of fluids and go to bed.
  2. Where there is no direct treatment, or the symptoms themselves are dangerous (and the diagnosis pending) then treating symptoms may be the best policy. That's the standard plot on House, someone's dying, treat the symptoms while the detective work progresses. Of course, to fill up the hour the first choice backfires (or works but then new problems crop up).
  3. Sometimes though the effects of the disease don't, or won't ever, reverse themselves. The stroke is over, blood is flowing but...or the rheumatic fever has subsided, but the heart valve is shot and won't heal itself. Treat the aftereffects, not the cause.
  4. The patient may not cooperate. In the (really) old days of cable bindings skiers broke bones with alacrity. You could set the bone and mostly get it to heal. But keep on skiing ... well, you haven't treated the disease and next time it may be a joint that can't be fixed. I suppose a better example is obesity: few doctors will tell someone "get lost until you lose weight." Now it's good for business, and many patients may be too addicted to snacking and watching TV to shift their net caloric intake (fighting alcoholism may be easier, after all our bodies can survive without drinking, but you can't stop eating). In economic terms, political economic calculations may mean you know what you ought to do, but don't.
So in fact when I think more deeply about the medicine analogy, it suggests there is no quick answer for what an economist ought to propose.
I still hold that best practice remains diagnostic-based treatment. But let me return to the list above.
  1. Being reticent to act is not a bad thing. There are always "shocks" to an economy, good and bad, but in developed countries our economies are both very big and resilient. The effect of most shocks is transient, even when the impact can with hindsight be discerned in the data. Policy has side effects, it can be hard to change and hard to reverse if it creates "winners" (an example is the capital gains tax exemption in the US, originally put in as a response to the distortions caused by the late 1970s inflation). In the macroeconomic context, textbook models suggest that adroit fiscal and monetary policy can eliminate the business cycle, but getting the timing right is hard because the "normal" cycle is short (reverses itself) and we tend to use the wrong policy tools (monetary policy to slow an economy, fiscal policy to boost -- the opposite is ideal). So we have both side effects (higher real interest rates coming and going) and may be giving the wrong medicine (no need to push down body temperature once the fever's gone).
    The losses from Japan's earthquake were horrific and even if we can rebuild, we reverse death or undo privation. But from the perspective of the economy as a whole it was still a fairly small event, and even if Toyota and Honda lost a lot of production, rivals were less affected. So the underlying competitiveness and complexity of a modern economy means there are lots of substitutes. So while there was a short-term impact there's no reason that macroeconomic policy need change. (But every reason to devote resources to recovery...at the local "microeconomic" level.)
    Back to the practical problems of real-time policymaking. This was Milton Friedman's bete noire -- after all he used the same Keynesian analytic framework, so it was not theory that drove him but pessimism about policy makers and the policymaking environment. He wanted a world of rules. Unfortunately the world proved too complex for simple rules, which he himself recognized in his latter years. As long as we permitted innovation in financial services, rules would need to evolve. Ideological correctness is insufficient: with irony, it was Greenspan the conservative/libertarian who poured fuel on the flames of a financial system fixated on short-term returns while trading long-term instruments. Financial innovation provided insurance policies, yes, but not as fast as financial innovation multiplied risk.
  2. Does the economy always quickly recover? Clearly, no. We should be chary of panicking at every sign of recession or the cry of inflation that comes every commodity spike (we are wont to confuse shifts in relative prices from aggregate inflation when it comes to the prices of gasoline and veggies.) That's point #1.
    But neither should we bury our heads in the sand and say things will pass when all evidence speaks to the contrary, when unemployment or inflation is suddenly a multiple of desirable and presumably feasible levels.
    So when the patient may be dying, provide stimulus. If that doesn't work, provide more. It's not hard to back off of emergency measures -- the Civilian Conservation Corps was folded pretty quickly. [President Eisenhower found it harder to trim the War Department, by then artfully renamed the Department of Defense, but its growth was never premised upon macroeconomic necessity, even though commentators from at least the 19th century had pointed out that wars on other people's land weren't so bad, particularly when in the post-draft era they are from a policymaker's perspective fought by other people's children.]
    Keynes in fact was a good example. On matters economic he was a conservative, but he had warned about the large macroeconomic flows built into Treaty of Versailles reparations as something that would be beyond the bounds of normal macroeconomic adjustment. Then, in the 1930s, he found himself staring at 20% unemployment in Great Britain, well, it was clearly not a run-of-the-mill downturn. Worse, he was looking into the abyss of socialism -- in Germany, the National Socialist Party of Adolf Hitler, and there was populism and radicalism at home.  Something was sorely amiss, and sitting on his hands wasn't an option, even if as the creator of modern macroeconomics he was at times groping and unsure of his way (or more precisely, incoherent.) Keynes didn't view his task as that of a plumber fixing the odd leak along a dike; he saw a dike about to collapse with raging floodwaters set to inundate hist beloved England.
  3. Macroeconomic damage is fundamentally irreversable. If you've lost your job and can't find one for 9 months, it becomes increasingly difficult in many industries to get hired back to a similar position. You can never make up for lost consumption -- the pain of telling kids "no" can't be undone. When it lasts long enough, small businesses fail and teachers get fired and roads don't get maintained and communities lose coherence. If you've lost your house, it can take a while to rebuild your credit rating, not to mention build up the downpayment on another house. And if in the interim you've been unable to afford healthcare and haven't been able to pay college tuition, there's long-term damage. These affect society as a whole, too, and not just those hit directly by economic trauma. So while we may not be sure what's causing unemployment, we certainly can engage in direct job creation or pay extended unemployment benefits and offer subsidies to state and local school systems and hospitals to mitigate the side effects of recession.
  4. A financial system that collects fees up front for selling assets that are long-lived has a built-in conflict of interest. Straight bank loans to small businesses are less problematic, because they tend to have a shorter maturity (lessening the mismatch between the time horizon of a bank's assets and liabilities) and because banks can't sell such loans to others as readily and so are more careful in their decision-making. (Asides: the 90-day line-of-credit is illusory, since most businesses structure themselves as ongoing entities; maturity mismatch remains. Likewise the bankers who originally made the loans may well have moved on, and not suffer the consequences of bad decisions.)
    But straight banking is now a small fraction of our financial system. The securities industry, which is what banks have morphed into, is huge, and with a regulatory system that emphasizes the letter of the (common) law, we seem unable to restrain the growth of "shadow banks". When money is "tight" shadow banks and securities firms have a harder time raising funds, and the yield curve can work against them. But it's like a case of AIDS, with a combination of basic regulation and normal monetary policy we can restrain its ability to cause illness but to date we can't eliminate HIV entirely. Lapses in medication lead to bad outcomes.
So perhaps medical analogies have their use. There is however no (simple?) diagnose-and-treat lesson to be had. Rather, it is that the economy, like the human body, is very complicated, and textbooks will only get you so far. Medicine remains rooted in apprenticeship. Economics must as well

Tuesday, August 16, 2011

Perry and Treason

Mike Smitka
...(your) Unemployment is Good! (for me)...
Treason is a serious charge; I would hope that a presidential candidate would not bandy it about lightly.
But first, I find it unsettling that Rick Perry seems to have flunked Economics 101 in his diatribe yesterday against the Fed, that it should not "print money." He fails to understand that in our (and every other) modern economy banks create money, not the government. That was true when the US was on the Gold Standard, too. The Federal government does print paper bills – but it is Treasury that oversees the Comptroller of the Currency; the Fed has nothing to do with it. Is it too much to ask that someone wanting to be chief executive know a little bit about the tools of governance, or at least listen to people who do?
Second, Perry exhibits a lack of intellectual principles. He charges the Fed with treasonous behavior. He seems to be unaware of Milton Friedman's 1963 magnus opus with Anna Schwartz, A Monetary History of the United States, 1867-1960. Whatever flag of conservatism Perry might be claiming to wrap himself in, it's not Friedman's. Friedman and Schwartz do deride the Fed, justly, for turning the 1929 market crash into a depression – but for not printing enough money, not for printing too much![Note 1] So Perry wants not only to repeat the budgetary idiocy of Herbert Hoover, he wants to repeat the monetary idiocy of Roy Young and Eugene Meyer, the successive Chairmen of the Board of Governors of the Federal Reserve System during 1927-1933. So Perry makes it clear that he has no conservative principles, only campaign ones.[Note 2]
This campaign focus extends to moral principles; Perry displays an ethic that is, well, so self-centered that I find it hard to fathom: he wants the Fed not to print money because it might create jobs and lessen his election prospects. Yes, for his own vanity he wants to keep millions of Americans unemployed.
I'm resigned to the occasional bad student; academic firepower isn't all that matters. Diligence does; even my bad students do their homework, and learn to stick to a consistent line of argumentation. But to lack principles -- well, at Washington and Lee Honor Code violations get you expelled, though guilty verdicts in practice are hard to come by.
I hope primary participants quickly expel Perry from the race. As President he would take an oath to uphold the Constitution, the opening sentence of which states that one purpose of the Federal government is "...to promote the general Welfare...." He must believe that once someone is unemployed they are no longer worthy of being considered a citizen. But that's not what the Constitution says: even slaves counted (though not for much).
Perry is apparently quite willing to destroy livelihoods for his own political benefit. But I don't bandy around the charge of treason lightly; however reprehensible I find that stance, I don't think it merits accusing him of seeking to destroy the country.
Note 1: Ben Bernanke lauds their work; I do as well, though I am uncomfortable with the monocausal view of the causation of A Monetary History. The link to Wikipedia provides a start for those who want to know more of the details.
Note 2: Obama is little better in practice: his stated goals are not pernicious, he on occasion talks a good talk on policy. But refuses to walk the walk, neither leading nor following through. Perhaps he too cares only about his standing in the polls.

Monday, August 8, 2011

Bugger Gold

Mike Smitka
...Gold is for Fools...
The case for commodity metals as an investment must rest either on a supply/demand story or on expectations. Now platinum is valuable as a chemical catalyst. However, dear to an economist's heart, when prices rose for legitimate scarcity reasons, then lo and behold! -- there are other catalysts out there. Gold has some industrial uses, due to its chemical inertness and electrical conductivity. But not many, at current prices. Then there is jewelry. OK, the world's middle class population is growing, though "bling" tends to fads. However, inventories are huge relative to that demand. So gold's value rests fundamentally upon speculation.
Worse, that speculation is driven by one story: inflation. As a Japan specialist, I'm more familiar with the opposite: Japan has seen consumer price deflation, admittedly at low levels, for a baker's dozen of years, while the domestic corporate goods index has fallen on an episodic basis for 25 years. Yet this is despite an increase in base money that in the old days economists of all stripes would have presumed a harbinger of hyperinflation.
Well, the US and EU are set to follow Japan's path. Underlying a rise in prices must be an increase in the largest single cost in a modern economy, labor. I don't see that happening anytime soon. Institutional rigidities make downward wage adjustment slow -- compensation systems in large employers in Japan are highly bureaucratic. But such employment didn't expand; contingent employment did. Japan is now a nation of part-time and short-term contract workers, at least among the young and women and older workers. Worse (better? -- consider the alternative!), productivity also rose. Paired, they meant falling costs.
Institutions in the US and the EU differ; our bias is towards unemployment rather than falling wages. But all in all I'm betting on mild deflation -- and hence I'm not buying gold.[note] There's a flood coming, and the foundation of today's prices is muddy, not even sand. Gold prices should be falling since 2008, not rising.
In Edgar Allen Poe's whimsical short story "The Gold Bug" there is method in madness. In today's markets there is only madness.
Note: To be honest, I'm the unintended owner of two houses, so I've no leeway to buy anything!

Friday, August 5, 2011

Who Feeds Leviathan? -- Children!

Mike Smitka
...Leviathan is the creation of 10-year-olds...
What of Leviathan? Let's rely upon data, here the Bureau of Labor Statistics Employment Situation Table B-1. [note]
First, where are all those bureaucrats I hear about in the local coffee shop? Their level peaked in 1991, a consequence of the policies of the Reagan era. Yet in the following decade our population, our national income and the complexity of our economy increased. We're trying to provide basic government services on the cheap. Now Social Security checks no longer require an army of paper pushers to get them out each month. But checking for food stamp, tax and medicare fraud -- that requires more, and more skilled workers, not fewer. Don't moan to me about welfare cheats in the same breath you complain about the size of government!
So who created Leviathan? – children did! The only significant source of government employment is education. As our population rose, so did the number of teachers.  Despite continued population, increases, however, their numbers were down by 250,000 going into the summer; given budget pressures, it's anyone's guess how many additional cuts will become visible as school starts. But those I hear railing against Big Government in the local coffee shop are retired or approaching retirement; they have no stake in what happens 10 years from now, when today's kids hit the job market. In contrast, tax cuts are immediate...
Note: BLS data don't include those on active military duty, an artifact of the days when military service was involuntary.

Wednesday, August 3, 2011

Tea Party and Tea Tax

The Tea Party makes liberal reference to the "founding fathers" as the bedrock, the principals upon which their principles rest. So what of taxes on tea?
For the answer I checked that old stalwart, Davis Dewey, Financial History of the United States, New York: Longmans, Green, 1902. 1791-1901, which apparently was "the" text for public finance in the early part of the last century, as there was a new edition every few years through at least 1920. See pp. 80-82 for details.
Given the exigencies of the time, a tax bill was submitted to Congress even before George Washington was inaugurated; the bill passed on July 4, 1789. So what did they tax? -- tea! And not modestly, but at a rate of 6¢ to 20¢ per pound. Furthermore, if the tea was carried on a foreign vessel, then that rate was doubled. By the 1870s -- that particular tariff was abolished in 1872 -- it was raising roughly $10 million per year, a tidy sum for that day and age.
For the Founding Fathers, tea was an important symbol (and practical target) for the need for revenue to support the functions of government that underlay the shift from the Articles of Confederation to our current constitution. The fight hadn't been against taxes, the challenge wasn't limiting government, it was finding sources of revenue to support the expansion of government to provide the services that the British would not. Patriots gave their lives for a government that would serve the people, for the right to levy taxes, if need be (and the need was there) for higher taxes.
Mike Smitka, August 3, 2011

Wednesday, July 27, 2011

Earthquakes, Man-made and Natural

Mike Smitka
...the source of the red ink is an economy run amok, not a government run amok..."
Most of my analysis is of the Japanese economy; in the next day I'll post more there. One of the lessons from disasters is that decision-making under crisis is imperfect, as is decision-making in general. So we ought not be surprised if a natural earthquake is followed by a man-made one.
At this point in time, the real estate bubble is best viewed as a natural catastrophe; the origins lie in the early 2000s, with regulatory forbearance and too easy of monetary policy as contributing factors in a world with large global imbalances.
Enough said. The issue is to keep from reacting in a manner that generates a second, man-made quake.
One of the consequences the first earthquake, the popping of the bubble, has been a steep recession that cut severely into government revenue -- income taxes are the biggest item, corporate and personal, and incomes have fallen. Meanwhile the government (at the Federal level) automatically raised outlays for unemployment while more people "retired" and began drawing social security. Then there's our wars. So of course the deficit expands, but it's not expansionary, it at best keeps the economy from falling as far as fast.
What happened (and continues to unfold) at the state and local level is similar in that revenues have taken a hit, and will continue to do so, as real estate prices fall. Expenditures are stagnant (ditto sales tax receipts in states and localities where that's relevant), and the income tax story is the same. But unlike the Federal government, institutional factors and "hard" borrowing constraints mean that expenditures get cut. So we're gutting public education and otherwise firing people in the midst of a severe downturn.
The net effect is that despite large deficits the government as a whole is cutting jobs, not providing stimulus. Now (sensibly) a stimulus package was passed [the American Recovery and Reinvestment Act of 2009]. However, about half of it was smoke-and-mirrors, and the other half was only big enough to offset what was happening at the state and local level. (Such detailed calculations don't mesh well with the blog format, contact me if you want the numbers.)
That package however was deliberately temporary -- under the expectation that we'd now be in the midst of a recovery. Well, we're not. Obama listened to a limited circle of "inside" advisors. Those from Wall Street emphasized they could stabilize the financial system, looking back to Black Monday in 1987, while the handful of economists among them drew on a specific set of models that emphasized an economy's tendency towards "normalcy" as well as the efficacy of monetary policy. All of that reflected President Obama's own apparent conservative bent; he's no centrist. (Indeed, if he is to the "left" of his predecessor on economic policy, it's not by much.) Of course the temporary aspect also reflected political reality.
The bottom line is that the Federal government is pulling back on its expenditures even though state and local governments continue to cut. There's no stimulus now.
But our politicians are lawyers, and are not only unsophisticated in approach to budgets, but often show little ability to do basic arithmetic. They focus on red ink and rhetoric, never mind that the source of the red ink is an economy run amok, not a government run amok.
So now we appear poised to "pass" (or pass on) a large expenditure increase that does nothing to help the economy now, and does much to harm it down the road. Federal debt is roughly $15 trillion. A downgrade to our credit rating will raise borrowing costs 50 bp (basis points, .01 percentage points = 0.5 percentage points). Now in the short run monetary policy can and will continue to hold short-term interest rates at zero. But the funding costs of long-term debt will rise, and as our debt is "rolled over" we will end up spending $750 billion a year in addition interest. The other interest rates most closely tied to long-term government bonds are home mortgages. What we need in our current economy is a boost in mortgage rates to cool our overheated housing market, right? But that's not an earthquake, that's slow bleeding.
If the debt ceiling isn't raised, we won't be cutting just a few Federal jobs, we'll be cutting a lot, overnight. We'll also not be cutting social security and unemployment and healthcare checks. Yet some of those most adamant about not raising the debt ceiling claim preach that "confidence" is the real issue. They can't be bothered by the lack of consistency, how can retirees shop for anything if they aren't confident they'll be getting the retirement pensions towards which they contributed for decades?
Now that will be an economic earthquake, and it will entirely man-made.

Monday, June 20, 2011

The (Low) Number of Happily Employed

Let's look at a variation on employment, which I call the number of "happily employed." It's simply the civilian employment number less the number of those on involuntary short hours.
Not surprisingly (at least with the advantage of hindsight) the number of Americans on involuntary short hours rose sharply after December 2006. They're not counted as unemployed, but they're surely unhappy about their employment status. The change is not small: we seen a drop of 10.6 million in those happily employed, from 141.8 million in December 2006 to 131.2 million in May 2011.
Worse, the trend rate of growth of employment in the US is 1.1% per annum (a bit below the rate of job growth during the bubble), reflecting steady population growth. It turns out that happy employment grows at the same rate. So by now we should be at 150.2 million ... that is, we're 19 million jobs below trend. If job growth picks up to a steady 3.7% from June on -- a number that would be totally unprecedented for our economy -- we won't be back to trend until 2017. We'll be lucky if we only have a lost decade.
OK, we should add those on active military duty to employment -- it's been a long time since that was involuntary -- but I've put in enough time on this for today. Of course lots of others are in jobs well below their aspirations, or even where they were before the recession, but I know of no way to adjust for that. The baby boomers are starting to retire, so it's also possible that 1.1% overstates the growth of the potential labor force. Finally, I've not fiddled with the starting point of the projection; using December 2006 may overstate things a bit. As with any such calculation, what we'd like to measure is not what we can (or at least regularly do) measure. But the number of active duty has to my knowledge not risen a lot the past several years, the baby boomers are only starting to retire while new school graduates are up a bit, and using December 2006 isn't far off the mark. So to the extent there is a bias in this exercise, it is surely to understate the human cost of the recession.

Thursday, April 7, 2011

The devil in the unemployment details

Two charts. One is the number of employed, compared to where employment should be absent the Great Recession. I've not tried to correct this for the pending retirement of the Baby Boomers, but the bottom line (or rather the gap) is unfortunately all too robust.
The second eliminates those who are employed but on involuntary short hours. That's a measure of the human cost -- focused on that narrower group of employed takes cognizance that not only have many lost their jobs in the recession, but many have also been put on short hours.
Now what to make of this? We need to return to the trend line to be back at the status quo. The latest jobs report doesn't provide bad news, it just doesn't provide good enough news. We need to have unusually good job creation -- and recent history has no examples of sustained rapid job growth beyond a couple quarters in a row. When I do back-of-the-envelope calculations I come up with 5 more years. More careful analysis could show that the gap is too large (I've used a trend, not actual demographic data) and that we can have both sustained and rapid job growth. I hope I'm off on both counts, but I still believe "five years" is the right order of magnitude.
Unless, that is, Congress throws us back into recession. Is threatening Medicare and randomly shutting down government services going to encourage people to spend [and businesses to invest] rather than save? Not likely.
Then there are the mass firings of teachers and others at the state and local level. California already has to pay a stiff premium so state-level legal constraints aside, markets aren't going to let them borrow money to stop their local downward spiral. And it's not just California, but state and local governments across our land. US Federal debt is not an issue -- look at the market's judgement revealed in low interest rates. And because it's not an issue, it does offer a way to keep us from digging our hole deeper. For better or for (in this case) worse, Congress is washing its hands of watching after the commonweal in favor of generating sound bites for the campaign trail.
My numbers by themselves are too pessimistic. But not if you correct them for politics

Friday, April 1, 2011

Still Lost

The latest employment data release unfortunately shows little signs of a return to "normalcy" any time in the next few years. The economy needs to create 140,000 jobs a month just to keep up with population growth; right now we're roughly 13 million jobs below trend. The latest data show 216,000 new jobs, so we're chipping away at that jobs deficit by less than 100,000 jobs a month. So let's round up to 100,000 a month: that's 130 months to get back on track, or 10-plus years. It's not quite that grim; job creation can pick up some, and the retirement of the baby boomers will help create additional demand. The economy stopped adding jobs in January 2007; with luck, we'll add enough to be back on track in another 6 years: a full "lost decade."
I'll post updated graphs later; they make it easy to see what's going on. Or rather, what's not: robust recovery has yet to rear its head.

Saturday, March 12, 2011

The US Lost Decade

There's widespread discussion of an improving US economy, that we've turned the corner. It is true that we're no longer seeing as high a level of job losses, and "headline" unemployment is slightly lower. There's even discussion of renewed job creation, though the data are less than compelling.
The unfortunate reality is that we've not yet begun to catch up with where we ought to be. That's because in the doldrums (and worse) of the past 4-plus years our population has grown: to tread water we need jobs to increase at 1.1% per annum. To move towards the (old?) normal job growth has to be much stronger. For example, to return to trend by the end of 2015 would require job creation averaging 3% per annum over the 5 years. That would be an extraordinary accomplishment.
It's looking more and more likely that recovery will require a full decade. And that's despite monetary policy more aggressive than Japan's. If states, localities and even the Federal government do as much to cut employment as the "right" proposes in their concern over deficits, we'll end up chasing our own tail, producing slower growth and the need for yet more cuts. It's now almost inevitable that we'll manage to underperform Japan. That would also be an extraordinary accomplishment.

Friday, February 25, 2011

Pensions and Unions

Mike Smitka
The brouhaha in Wisconsin is confusing issues. Whatever the merits of unions, changing their status will not alter the budgetary problems of state and local governments.
Of course one cause is the lingering Great Recession. Governments cannot readily trim services -- the number of teachers and firemen and police are a function of population -- but things are tight for the time being. Enhancing revenues is more challenging politically than in normal times. Unlike the Federal government, state and local governments can't borrow, either, so they can't wait until incomes rise and taxes return to normal.
That's a short-term problem. We hope. There is however a serious long-term problem: Americans live long enough to retire. The baby boomers are at that point now, while their immediate predecessors seem to be in no hurry to die. However, state and local governments began promising pensions and healthcare a long time ago; in New York it was written into the state constitution in 1939.
I don't know the origins of that; at the time, however, people didn't live long and healthcare was cheap, so I don't think there was anything nefarious. But over time the deal shifted: improving pensions was used in lieu of higher pay and higher taxes.
In other words, the predecessors to today's politicians tried to do things on the cheap. For example, as the pay for college graduates rose, it became more expensive to recruit teachers. Local governments tried to finesse that: we won't pay you very well, but we'll let you retire with a pension. Perhaps in some cases municipal employee unions struck unusually good deals for themselves. Again, however, that was only possible because politicians thought they could get away with promises that current taxpayers wouldn't have to fund. By and large, voters winked at that game -- let the next generation pay.
We're the next generation.
Will breaking unions make any difference? No.
You can't change a pension agreement retroactively. Indeed, in general even bankruptcy won't help: pensions take priority over bondholders and often current employees. For that matter, there is no legal mechanism by which a state can declare bankruptcy--that's not part of the US Constitution.
I don't have the patience to listen to the rhetoric in Wisconsin. It seems however that either the politicians there can't do arithmetic, or can't take the heat. Workers have to be paid -- retired ones, anyway. And when push comes to shove I am willing to lay a bet that the Tea Party can't actually find much to cut in the budget. Should Wisconsin stop funding snow removal and leave the spring's potholes to grow? [To any southerners out there: when water freezes, it expands: winter potholes are a fact of life there.] End all support for education? Fire police, stop funding fire departments? Some of that will happen. Will it make Wisconsin a better place to live? I wonder. But it won't change the obligation to pay pensions and healthcare to their retirees.

Tuesday, January 11, 2011

The Simple [yet counterintuitive] Economics of Social Security

Originally published at Autos and Economics on August 11, 2010
Social Security Projections, 80% Confidence Intervals
Pay-Go and the Trust Fund
Economic Structure
Most consumption in the United States is of services, not goods; of the rest, a significant proportion consists of time-sensitive goods, either because of their physical nature (food), because they reflect style (clothing) or because they are subject to aging and obsolescence (cars, cell phones, computers). As a result, as a first approximation goods and services must be consumed when they are produced; they cannot be stored.[1] That distinction is critical for understanding the economics of retirement (as opposed to the legal institutions and the politics of the Old Age, Survivors, and Disability Insurance or OASDI, to use the official name of "social security").[2]
It is natural to think of social security as operating in a manner analogous to a household, and to think of the Trust Fund in that context. In this instance, that analogy is simply wrong. A household can reduce its consumption today in order to save and build up financial resources that can later be sold to permit greater future consumption. An entire economy cannot. Even in a purely private retirement system, retirees can consume more only if workers consume less. If workers are uninterested in saving, then retirees will find few buyers for their assets and won't be able to consume much, even if they lived frugally while working in order to save more for retirement. Conversely, they might retire at a time when every worker wants to buy stocks and real estate, and find they can live very well; a couple of my colleagues retired just before the 2000 "dot.com" bubble broke, to find that their monthly income exceeded that while they were working. But with the mass of baby boomers retiring en masse, the latter scenario looks less likely, though attempts to quantify that effect don't suggest that it will large in magnitude.[3]
What this means is that for social security to be economically solvent (as opposed to institutionally solvent), the government must tax and/or borrow commensurate with outlays. The amount needed at any given point in time is straightforward to calculate: the tax must equal (i) the "replacement rate" of social security (monthly pensions as a percentage of current workers' taxable incomes), current about 38%, (ii) divided by the ratio of workers to retirees, which given unusually high unemployment in 2010 was about 2.9. So on a per worker basis, covering payments requires a tax rate of 38/2.9 = 13.1%. Since the current rate is 12.4% that leaves the system with a modest deficit, which will be reversed if employment picks up during 2010-11.[4]
As the baby boomers retire, the ratio of workers to retirees will with certainty decline. As a result, the implicit tax that social security represents will increase. The August 2009 Congressional Budget Office estimate is that estimate is that this will result in outflows exceeding revenues in 2017. The gap will increase in their baseline scenario to 1.3% of GDP until 2035, when the baby boomers will begin dying off, and will then shrink to about 0.8% of GDP. However, unless there is an increase in mortality rather than in longevity, the population will remain more aged than in 2010, and after about 2050 the gap will increase again, albeit at a very slow rate.
Now 1% of GDP may sound like a small number, and in an economic sense 1% of GDP is a small number. Of course with an economy of $15 trillion, 1% means $150 billion a year, small stuff compared to the Department of Defense. But those who oppose Social Security for one or another reason can manipulate that number. Social security has a legally mandated 75-year planning horizon; add up $150 billion a year for 75 years and you get a large number, by intent a frightening number; even discounted for compound interest, it is equivalent to a $3.7 trillion increase in national debt.[5] But when viewed on an annual basis, now and into the distant future, a modest shift in taxes -- again, far less than the budget of the Department of Defense -- would be enough to cover projected shortfalls.
Institutional Structure
In the early years -- from 1937, when it was enacted, and throughout the 1940s -- there would clearly be very few Social Security recipients, but it would not would not remain that way. So the decision was made to raise taxes proactively, and to try to "set aside" the excess by segregating it from the regular budget in a "trust fund". The institutional hope was that other taxes would be adjusted to keep the “regular” budget in balance, so that the overall budget could be kept in balance as the number of retirees increased without needing to "enhance revenue" for that purpose. Now Congress in fact did behave on an "every ship on its own bottom" basis until the mid-1960s: the "regular" budget was kept in balance while social security accumulated surpluses. That's no longer the case but is not economically relevant; after all money is fungible -- one tax dollar looks like any other tax dollar. Indeed, recession-linked temporarily shortfalls aside, subsequent adjustments to the social security tax mean that almost 75 years later inflows continue to exceed outflows. That will change around 2017, depending on how many people retire early in the current recession, and on the rate of recovery of incomes of the lower nine-tenths of the US population.
But even in 2017 there will be no crisis, because the US government isn't suddenly going to be broke, and in addition payments are legally tied to the Trust Fund. As long as there are (paper) assets remaining there, Social Security checks will continue to be cut each month without any need for action by Congress. That will change circa 2039, under current projections. At that point things start to change, because under the (by that point) century-old enabling legislation Social Security payments will be limited to the level of FICA (Social Security payroll tax) receipts. Absent change in the interim, total payments would fall in 2039 from roughly 6.0% of GDP based on the number of retirees to 4.9% of GDP based on anticipated same-year FICA receipts. That represents roughly a 20% drop in benefits. At some point the legislation will need to be amended. Given the political importance of social security recipients, it surely will be.
The alternative would be to allow expenditures – the size of social security checks – to fall. Retirees, current and future, paid taxes for decades, and planned on social security to supplement retirement. (Relative to Europe, and relative to pre-retirement incomes in the US, social security isn't particularly generous; it was intended as a supplement. Conceptually, allowing payments to fall 20% would rob retirees of anticipated income and be every bit as much a tax increase as (say) bumping the Federal income tax or (the preference of most economists) levying a national sales tax. I personally would view that as unethical and because the impact would be on a narrow group, unfair.
Over most of its history social security has "paid" less in a financial sense than average private returns; given the insurance implicit in defined benefit pensions, it is much more neutral. Because they ignore the size of the insurance premium, which the social security trustees are not required to calculate, conservatives have argued that the system ought to be privatized as unfair to retirees. If they want to be intellectually consistent -- I know, dream on -- that implies that if the current system isn't done away with, conservatives are effectively arguing that social security payments to retirees ought to be increased. So I am puzzled (well, disturbed) that the same people who are arguing that fairness mandates a privatized system are at the same time arguing that benefits must be cut because we can't afford them.
I fear however that our political system is too fractured and places too much emphasis on short-run campaign strategies for us to address the structure of the social security system today rather than in 2037. Some of the crying wolf over "crisis" is from economists who observe the political dynamics and want to try to create a sense of urgency, not because they fail to understand the nature of retirement systems. I fear however that their strategy is counterproductive because it conveys the impression that we as a society can't afford to maintain the social security system. That is simply not the case; the US remains and in 2037 will remain the richest large country in the developed world, and social security is not a big slice of the economy. Now if lessening the overall Federal deficit is important -- and I believe it is -- it may be politically necessary that everyone is seen as bearing some of the cost of adjustment. The basic ignorance of the fundamental difference between household and societal retirement however seems to fuel demagoguery that may lead to a disproportionate emphasis on this one program.
So . . . . if for argument's sake, we assume that all of the social security shortfall were to be covered by higher social security taxes (FICA), how large of a change would this be? With current receipts of 4.8%-4.9% of GDP, "saving" social security in the long run will require boosting this at peak to 6.1% or by 1.3/4.8 = 27%. With the current rate of 12.40%, this would imply we would need a peak rate of 15.75%. While no one likes higher taxes, this is hardly a shift that is infeasible from an economic perspective. If there are problems with the sustainability of social security, then they are political. Other alternatives include increasing the tax base rather than the tax rate (payroll taxable for FICA purposes is only 38% of GDP) or cutting benefits (including by increasing the retirement age). Given that social security is but one contributor to the fiscal challenges facing the US, it may be politically convenient to consider it as a separate entity, but the fiscal pressures that stem from social security itself could be addressed by shifts in taxes and expenditures elsewhere in the budget. If we could go for a decade without getting involved in another war...sigh.
That returns the discussion to the relevance of the Trust Fund: does it have any economic significance? (It clearly is significant from a legal-institutional perspective and, because of the "drop-dead" nature of changes triggered circa 2039, it has large future political implications.) The answer depends on whether (i) it served to increase national saving (via a smaller budget deficit) and in turn whether (ii) changes in national saving are linked to investment in productive resources.
Until 1965, the Trust Fund was kept separate from the overall budget, and so until that point it may have had an impact on national saving, because it did not serve to reduce the operating deficit with which Congress dealt. Thereafter, however, the "off budget" distinction has not been substantive. The budget record suggests that, to the extent that Congress pays attention to balancing budgets, it has done so by looking at the entire budget, and not the budget net of social security surpluses. So the evidence is that the Trust Fund has not served to increase national saving. Furthermore, as a share of GDP the US has run large balance of payments deficits since roughly 1980, or in other words, we have been able to borrow from the rest of the world. While the situation is not uniform across countries, that means that in the case of the US, there is no longer a strong link between national savings and investment. At some points in the past 3 decades US real interest rates have been higher than in Europe and Japan, so there is evidence of some link, but fundamentally the magnitude of national savings has not been a binding constraint on investment. So the answer to the question(s) of whether the Trust Fund has been economically significant are (i) "no" and (with qualifications) (ii) "no."

  1. Small "open" economies -- Belgium -- have more leeway because imports (services included) are a far greater share of consumption; foreign assets can accumulated now and sold as the population ages. That's not applicable in the US context because we are too large and physically remote to import much, particularly of services. In any case we as a nation are substantial net debtors to the rest of the world: it's too late to use the international margin of adjustment. If anything it could work against us if we are forced to "rebalance" (export more, net) because the rest of the world wants to sell their US assets.
  2. I ignore the survivor and disability insurance components here, because they are small relative to the purely retirement component.
  3. Takats, Elod. "Ageing and Asset Prices." Basel: Bank for International Settlements, August 2010, BIS Working Paper No. 318. This paper finds an effect (unlike previous papers that were relatively optimistic) that the author characterizes as "headwind not meltdown." Note too that this up-and-down nature of private assets values should be a reminder that social security includes an insurance component that is lacking in private alternatives, indeed that is impossible to purchase on a private basis.
  4. One fallacy that is widely repeated is that Social Security is a Ponzi scheme. However, Ponzi schemes blow up because you need ever-increasing numbers of "marks" for the scam to operate, exponentially increasing. They cannot be sustained except in the short term, and there is no way that everyone can get their money out. That is not true of social security. It is fundamentally sustainable. Because the ratio of those paying in and those paying out changes, the ratio of what people pay in versus what they take out will change from generation to generation (or more accurately cohort to cohort). In practice older generations will do better – but on average they also had lower incomes and longer work hours and on and on while young; most of us would not want to trade lives with them even if the pay-out they receive from social security relative to what they put in will be a little more favorable than for me and in turn I may do a little better than my children. There is no way to undo the fertility choices of our grandparents and parents, and the numbers aren't huge in the case of the US. For more on this overall concept of "generational accounting" Laurence Kotlikoff (with various co-authors, particularly Alan Auerbach) has written widely on this topic, both for the US and for a wide range of other countries; the CBO and others have published critiques. I've not put in citations – you don't want to touch this literature if you're not a serious policy wonk or economist who needs to know, and if you are one of those, you know how to find it readily enough.
  5. In the background are much bigger numbers for healthcare, because retirees consume disproportionately more than workers, and there has been no success to date in keeping the rise in costs below the growth rate of the economy.
Mike Smitka Written in Preparation for a talk to the Lexington, VA Coffee Party on 16 August 2010

Republicans and Federalism

Original post March 3, 2009 on "Autos and Economics" blog, moved here as part of reorganization of my blogs.
This has become a hot topic: for a related post see a Paul Krugman NYT op-ed on Texas.
One of the legacies of George Bush will be a n erosion of state's rights. There is much irony in that, because it is in direct contradiction to his self-proclaimed position of opposing the power of the Federal government in favor of those of these several States assembled.
First of course is his own push for an imperial presidency, that sits above both courts and legislature. Here we have had an administration that claimed to seek judges for our highest courts who would adhere to our founding father's faith as expressed in the Constitution. But not in practice. Who is the arbiter of what is legal? The presidency. What is the role of the legislator? To do his bidding, and if not, to be overridden in signing statements.
Second were a series of policies that intruded into historic state powers, over education, over law enforcement and in other areas. This is hardly new, and not necessarily inappropriate: there is no particular reason that the range of contemporary issues will line up neatly with the divisions of locality and state that prevailed in the past, much less the distant past. However, a number of such policies, including in education, have not been accompanied by a commensurate transfer financial resources from the federal government. In other words, while on paper states had been delegated responsibility, from their perspective these were unfunded mandates to follow federal guidelines for tasks that as often as not had long been delegated to them. So the reality has been that in the name of states rights their powers have been abrogated by the federal government in a manner costly to their fisc.
Third and not yet apparent is the long-run impact of multiple bubbles. As long as real estate prices and retail sales boomed, grumbling did not translate opposition to the above changes. With 50 states and over 10,000 localities, priorities vary widely; organizing joint "voice" proves well-nigh impossible. This is the in line with the standard "tragedy of the commons," but the common result is that states and localities throughout the US are facing budgetary pressures unknown in memory – perhaps they were worse in the 1930s, but not in my memory. For all practical purposes they are unprecedented.
Here I am making a prediction, bolstered by years of casual observation as an economist rather than a close reading of developments in local public finance. I believe, however, that states and localities in hardest-hit regions will face bankruptcy before the current recession recedes, not the least of which will be California. In the meantime, the provision of basic services such as education and public safety is being pared to the bone, and beyond, weakening these systems for years to come. The only way to stave off collapse will be through a vast expansion of subventions from the federal government. This will represent a de facto transfer of power to Washington, unlike anything seen before, wrought out of the dregs of 8 years of Republican rule.
As an economist I have mixed feelings about this; I believe that today the US is primarily a national economy rather than a collection of local economies. We can see this in our personal mobility, in the growth of retailers that are national in scope, and in the multi-state (though not yet truly national) structure of our banking system. Having political subdivisions disjoint from the geography of our economy does not (always? every?) make sense. What the Republicans have done is to undermine the status quo from multiple directions. This seems not to have been a conscious process; there certainly was no vision of a new order. But it may already be too late to shore up that old infrastructure.
In any case, the irony remains that politicians mouthing the mantra of states rights have unleashed forces that in hindsight serve instead to increase the power to the central government.

Lessons from Greece

This was originally posted April 30, 2010 on the Japan and Economics blog. I've moved the blogs that focus primarily on the US economy here, to better unify the content.
The following was written with the financial end of the auto industry in mind. But I fear it's rather more general than that.
The US faces its own Olympic hurdles, ones likely far higher than those faced by the government in Athens. But the hurdles are much the same: a political economy where the lines of central versus local government do not mesh well. The European Union has known from the beginning that it would face tensions between local macroeconomic performance and the common monetary policy that comes with a common currency. Hence it placed requirements that potential new members meet debt and inflation restrictions before joining the Euro zone. Those were applied with a wink and a nod, and with hindsight poorer countries inevitably faced inflation as the convergence of salaries in the service sector raised costs for agriculture and manufacturing, which faced trade competition. Furthermore, no mechanism was put in place to handle the sort of crises facing the southern fringe of the EU. With little in the way of a central government and no substantial central taxing ability, such rules probably could not have been put in place. But the EU now faces a high hurdle, and it's not clear that the members of that clumsy, cobbled-together semi-polity can jump very high, or even at the same time.
We have California, and Illinois and other states that face fiscal problems as grave as those of Greece. We had the recent spectacle of Arnold Schwartzenegger begging and pleading for mercy from bondholders, and somehow managing to float billions of short-term debt – at a substantial premium. No one was so foolish as to try to sell long-term bonds. But California is fundamentally broken, with the ability to put propositions on the ballot making any shift on the revenue side unlikely in the extreme, while basic public services collapse. Our most populous state has one of the worst performing set of school systems in the nation, something that should have the rest of us frightened. While further cuts will (must?!) be made in the short term, given the lack of cash, doing so is surely being penny-wise and pound-foolish.
So in due course California's debt will become unmarketable, and the economy will collapse. Unlike Greece, California is large – were it its own country, it would rank in the world's top 10. And if California goes, then surely we would see contagion, as panic would spread to the holders of the debt of other highly leveraged states, counties and cities.
The Federal Reserve holds no sway in those markets. Under our Federal system, it's not clear what could be done by Washington – unlike with the financial system, it would be unconstitutional to ask for a quid-pro-quo (though the courts might finesse the issue by taking a few years to get around to a ruling). And the screams of "bailout" would be loud, perhaps overwhelming. After all, Californians know their fiscal system is broken but have been – let's be frank – too cheap to levy the modest taxes on themselves that would be needed to set things aright. Unfortunately the same can be said of a host of entities across the US – we have something like 17,000 governmental issuers of debt, from the legislature in Sacramento down to local water and school systems.
The banking and shadow banking systems may have returned to a semblance of normalcy. But to think we are out of the woods is hubris, and we're bigger and taller than Greece. Tragedy makes good theater, if you are in the audience. However, we won't be spectators, we won't even be actors. We'll be victims. Is your balance sheet ready?
Mike Smitka