Sunday, February 24, 2013

Government Efficiency: A Natural Experiment

...sequestrian offers a "natural" experiment to test views of government...
Microeconomists will thank Congress for providing a natural experiment to test competing views of government. One is that government is unnecessary, or at least inefficient in an allocative sense -- lots of money on things that aren't very useful (and perhaps not enough money on things that are). If so, then sequestration won't matter. Economists also employ a second concept of efficiency, which in layman's terms could be phrased as "doing the job in a lean manner." If the government is inefficient in this sense, then sequestration will not matter: fire 10% of our civil servants and the remainder should be able to easily pick up the slack.
Then come alternative views of the impact of fiscal policy on the macroeconomy, "the" multiplier. Now I highlight "the" because Principles textbooks and macroeconomists who live in other than a blackboard world have maintained since the 1920s that the impact of fiscal policy in a great recession is large, while that in the midst of an expansion is small or nil. There is no "the" there. We again have a natural experiment: if the multiplier is really zero or negative, as claimed by those who opposed ARRA (the 2009 stimulus package), then sequestration will do no harm to overall growth.
I hope the sequestration experiment will not undertaken long enough to actually provide the evidence we economists need. That's because my priors are that (i) the bulk of the non-defense spending of the government is productive, that (ii) our bureaucracy is surprisingly efficient, and that given our lingering Great Recession (iii) the multiplier is 1.5 or greater [that is, we get more than a dollar boost in GDP for a dollar of properly accounted stimulus]. So we will (ii) see disruptions that (i) will matter and (iii) that if they go on for long, will aggregate through lower expenditures to have a measurable impact on GDP.
So what of the natural experiment jargon? Well, identifying the direction of causation in economics is really hard. Fiscal measures are affected by a recession. Since taxe receipts are dependent on income, budget deficits explode. While expenditure changers also occur, some of those are a function of our growing economy and population, hence "endogenous". Furthermore, new policies are implemented only slowly; measuring "real" stimulus turns out to be hard. Statistical tests therefore seldom convince open-minded skeptics.
In contrast, sequestration will offer a sharp "exogenous" change with discrete timiing and clear numbers. Of course there are lots of other things affecting the economy, and so a one-time event won't be an unambiguous cause. If sequestration extends for months, however, we'll have another data point generated when it ends.
To reiterate: my priors are that sequestration is a big deal. So I hope that Congress (or more specifically, the House) sits down with the Administration in short order, and leaves us economists bereft of data.
...Mike Smitka...

Steve Rattner on fiscal issues

Steve Rattner worked very hard on behalf of our economy with the Auto Task Force. The US was already in the throes of the Great Recession. Had the bankruptcy process not been handled in a timely manner, our economy would have been thrust into a second depression. (See the related Autos and Economics blog.
I had had a bankruptcy lawyer into my classroom before the recession began; he described the nightmare that large corporations face, years of uncertainty and hundreds of millions in lawyers fees under Chapter 11. The Task Force was absolutely brilliant in avoiding that scenario.)
However, while Rattner has been able to step back and rethink standard ways of doing things in the realm of corporate restructuring, he has not similarly been able to distance himself from received thinking on fiscal issues. Above all, he continues to view retirement security (Social Security and Medicare) as boats that ought to run on their own bottoms. Since money is fungible, there is nothing inherent in this, except as it changes the politics. However, over the last four decades Congress has not treated the operating budget as something separate from these programs. The "on-budget" and "off-budget" distinction is irrelevant.
Now Rattner is not an economist, and so also misses details here and there. On the surface these are not matters of substance. However, they do affect the tone of the debate, because they exaggerate the magnitude of issues in some places, and understate or obscure them in others.
As a lay person Rattner does a good job. But we really need everyone who approaches these issues with good intentions to do a better one.
...mike smitka...

Rattner slides:

1. Slide 2: Why care?

a. Beholden to China, yes, but they are more beholden to us – they are only one of many bondholders, but almost all their bonds are dollar-denominated.

b. Intergenerational transfers can occur via voluntary saving, involuntary taxing (FICA) and debt issued outside our economy. Don't focus on one to the exclusion of the others. Futhermore, ALL retirement at the societal level has to be financed on a pay-as-you-go basis, since what we consume are services, and they can't be saved.

2. Slide 9: Revenues vs Spending

a. Spending and revenue are distorted in the graph due to the sharp decline in GDP, from which we have yet to recover. So you need to incorporate changes in the numerator and not just the denominator. One way to do that is to use potential GDP. (This same issue applies elsewhere.)

b. On the revenue side, reliance on income taxes accentuates the impact of busts and booms. Graphing against the gap between current and potential GDP would highlight that.

3. Slide 13: Tax Expenditures

a. A focus on tax rates obscures other tax rules (carried interest) that affect actual payments, particularly for those in jobs amenable to relabeling compensation to be other than wages.

b. Perhaps in the discussion of the slide, but it's worth noting that some of the tax expenditures are only relevant if you have enough income to itemize deductions.

4. Slide 16: Healthcare costs

a. Projections of social security expenditures are fairly robust, because you can use replacement rate x GDP x claimants / GDP, and demographic projections are robust while the replacement rate is fixed by law.

b. Projections of healthcare are very dependent on projections of healthcare costs. While we have not been successful in the past in controlling costs, the rate of increase has slowed in recent years. If that continues – and since there's little consensus on why the increase has slowed, we simply don't know – then this graph overstates future levels, potentially by a large percentage of GDP

5. Slide 17: R&D and infrastructure

a. We ought to be spending less on infrastructure today, depreciation versus new construction of roads and the like. That it's fallen by half doesn't tell us what we need to know.

b. Accounting for R&D is hard. For example, nuclear weapons programs don't yield private benefits and should be excluded. That was more important in the 1950s, muddying what we might learn from comparisons.

6. Slide 18: Unfunded obligations

a. These are subject to the discount rate and number of years over which projections are made. Social security goes out 75 years – sensible?

b. Furthermore, no one contemplates repaying all government debt. What matters are changes sufficient to stabilize debt.

c. To communicate with lay people, what is the equivalent steady-state change in taxes as a percentage of GDP required to accomplish this?

7. Slides 21-22: Simpson-Bowles? Let's hope not – I've never figured out why people talk about it. Furthermore, when matters, not just how much. Should we be striving to raise taxes and lower expenditures while unemployment remains far, far above historic levels?

8. Slide 25: Wish list.

a. Skimpy on details.

b. The devil rules therein.

9. Slide 26: Social security.

a. All of this presumes that somehow social security ought to be a boat that rides on its own bottom. As an economist, there's no reason for that.

b. In addition, are benefits so generous that they ought to be cut? The lower CPI adjustment does that, and since retirees aren't average – they consume more healthcare – the overall inflation rate already understates the inflation they face.

c. Raising the cap on social security payments only affects higher income individuals; depending on the level, means testing potentially also affect higher income individuals.

d. Raising the retirement age certainly enhances revenue while lowering outlays, but is offset by higher rates of disability at older ages. Since those who are poor are more likely to be disabled, a blanket increase could result in those most vulnerable falling through the cracks.

e. Social security is intended to provide security, as it insures against inflation and swings in returns on stocks and bonds. Private accounts do not provide those functions. Nor would private accounts add to national savings. They also face phase-in issues.

10. Slide 27: Healthcare reforms

a. Several of these proposals parallel those for Social Security and suffer from the same defects.

b. Cost control ultimately requires saying "no" – but current legislation provides very little ability to limit treatments that are not proven more effective than less costly alternatives. In addition, there are no mechanisms to encourage the terminally ill to seek hospice care rather than hospitalization. These are challenging technically, as well as in politics and ethics. Nevertheless, we fool ourselves to think that co-pays and tougher reimbursement guidelines will be adequate, except as they mean that less well-off individuals do without.

11. Slide 29: Sequestration
a. I have yet to see any proposal for a grand bargain that reflects sensible economic analysis.