Month: December 2013

Sentences to ponder…

Notably, easy-to-reach women are happier than easy-to-reach men, but hard-to-reach men are happier than hard-to-reach women, and conclusions of a survey could reverse with more attempted calls.

That is Ori Heffetz and Matthew Rabin, in the new AER.  An ungated version is here.  Understandably, the authors are worried about potential subject selection biases in studies of self-reported happiness.

Assorted Thoughts on the Market for New Econ PhDs

Here’s the good news. There were 1,243 new econ PhDs in 2012 and the AEA has 2,790 job listings. Compared to other fields where quantity supplied far outstrips quantity demanded, econ is doing very well.

Why are there fewer PhDs than jobs? One factor may be that women are underrepresented in economics. Women earn 34% of the PhDs in economics which is below the 46% of doctoral degrees earned by women overall. (On the other hand, economics is more gender-balanced than psychology where 72 percent of all degrees are earned by women). If women earned more degrees in economics would total degrees increase? Perhaps, although that hasn’t happened in medicine where the cartel has limited total physician supply.

What about the bad news? The number of new jobs for econ PhDs fell by 4.3%. The fall was especially pronounced in academia where the number of new jobs fell by 6.6%. New jobs tumbled in 2008 and since that time there has been some recovery but no catch-up. Are we seeing the transition to a new equilibrium?

On the university side, Clay Christensen’s prediction that half of all universities may go bankrupt in the next 15 years is not yet showing up in the data. Should I file that under good news or bad news?

Time and tariffs

We estimate that each day in transit is equivalent to an ad-valorem tariff of 0.6 to 2.1 percent.

That is from David L. Hummels and Georg Schaur, the AER version of their paper is here, various ungated versions are here.  If you are wondering, parts and components are the most time-sensitive goods in international trade, according to the authors.  Note also that airplanes are increasingly important for international trade:

From 1965–2004, worldwide use of air cargo grew 2.6 times faster than use of ocean cargo.

The nature of the Medicaid cost problem

Harold Pollack writes:

The bottom 72 percent of Illinois Medicaid recipients account for 10 percent of total program spending. Average annual expenditures in this group were about $564, virtually invisible on the chart. We can’t save much money through any incentive system aimed at the typical Medicaid recipient. We spend too little on the bottom 80 percent to get much back from that. We probably spend too little on most of these people, anyway. For the bulk of Medicaid beneficiaries, cost control is less important than improved prevention, health maintenance and access to basic medical and dental services.

The real financial action unfolds on the right side of the graph, where expenditures are concentrated within a small and incredibly complicated patient group. The top 3.2 percent of recipients account for half of total Medicaid spending, with average expenditures exceeding $30,000 annually.

Many of these men and women face life-ending or life-threatening illnesses, as well as cognitive or psychiatric limitations. These patients cannot cover co-payments or assume financial risk. In theory, one might impose patient cost-sharing with some complicated risk-adjustment system. In practice, that is far beyond current technologies and administrative capabilities. Even if such a system were available, we couldn’t push the burden of medical case management onto these patients or their families.

Very much worth a ponder, and there is more in the post.

From the comments, on Dodd-Frank

This is on the Volcker Rule:

My own view (and I’m a banking lawyer) is that the ban on proprietary trading will have an immaterial effect on the asset size of banking organizations. It might reduce their complexity.

An overlooked issue is that Volcker applies throughout the banking organization. That is, the ban on proprietary trading is not limited to the federally insured depository institution and restricts the activities of all of the affiliates of the depository institution. That’s a dramatic expansion in scope, with questionable policy justifications.

Another overlooked issue is that Volcker also bans investments in certain types of investment funds. Some think this is simply a ban on investments in private equity and hedge funds that is intended to avoid regulatory arbitrage around the proprietary trading restrictions. The statutory definition of covered funds was sloppy, and so the covered fund restrictions are actually much broader – and without any apparent policy purpose. This is particularly a problem for foreign banking organizations, as it looks that Volcker will have a broad extraterritorial scope.

To me, one of the more interesting aspects of Volcker is its implications for administrative law. There are many who would prefer that Congress delegate less to the administrative agencies and instead legislate with particularity. The Volcker experience suggests that might not always work well. The statute defines “private equity and hedge fund,” “proprietary trading,” “solely outside the United States,” etc. with particularity, but those definitions are generally not well-connected to the underlying policy concerns. The statutory language really left the regulators with few options to salvage a good and sensible rule. We probably would have been better off had Congress deferred more to the agencies here.

Finally, as a general matter, the difference between “security” (subject to the proprietary trading ban) and “loan” (not subject) probably isn’t a distinction that matters when it comes to the safety and soundness of banking organizations. Stepping back a bit, it’s hard to imagine what, why and how Volcker is up to.

Thinking for the Future

That is the new and very good David Brooks column about Average is Over.  Here is one excerpt:

So our challenge for the day is to think of exactly which mental abilities complement mechanized intelligence. Off the top of my head, I can think of a few mental types that will probably thrive in the years ahead.

Synthesizers. The computerized world presents us with a surplus of information. The synthesizer has the capacity to surf through vast amounts of online data and crystallize a generalized pattern or story.

Humanizers. People evolved to relate to people. Humanizers take the interplay between man and machine and make it feel more natural. Steve Jobs did this by making each Apple product feel like nontechnological artifact. Someday a genius is going to take customer service phone trees and make them more human. Someday a retail genius is going to figure out where customers probably want automated checkout (the drugstore) and where they want the longer human interaction (the grocery store).

Motivators. Millions of people begin online courses, but very few actually finish them. I suspect that’s because most students are not motivated to impress a computer the way they may be motivated to impress a human professor. Managers who can motivate supreme effort in a machine-dominated environment are going to be valuable.

Do read the whole thing.

The “new rich” are about twenty percent of the U.S. population

Hope Yen reports:

It’s not just the wealthiest 1 percent.

Fully 20 percent of U.S. adults become rich for parts of their lives, wielding outsize influence on America’s economy and politics. This little-known group may pose the biggest barrier to reducing the nation’s income inequality.

The growing numbers of the U.S. poor have been well documented, but survey data provided to The Associated Press detail the flip side of the record income gap — the rise of the “new rich.”

Made up largely of older professionals, working married couples and more educated singles, the new rich are those with household income of $250,000 or more at some point during their working lives. That puts them, if sometimes temporarily, in the top 2 percent of earners.

Even outside periods of unusual wealth, members of this group generally hover in the $100,000-plus income range, keeping them in the top 20 percent of earners.

I have been predicting that this group will do increasingly well over time, relative to lower earners.

An “entrance fee” theory of why some real rates of return are persistently low

Some portion of the negative real returns on U.S. government securities can be explained by risk premia, but yet many other indicators of risk are these days not so extreme.  Times appear pretty stable, if not exactly what we had hoped for.  So how else might we fit these negative returns into a theory?  Here is one attempt, by me:

1. Imagine that financial institutions and traders have to hold large quantities of T-Bills (and similar assets) to participate in financial markets.  That may be to satisfy collateral requirements, to meet government regulations, to be credible in private market transactions, and so on.

2. The demand for these assets is now so high and so persistent that the assets have persistently low nominal returns and often negative real returns.

3. The holders of these assets do not however receive negative returns on their portfolio as a whole, when deciding to hold these T-Bills.  Holding the T-Bills is like paying an entry fee into financial markets.  And once they are in financial markets of the right kind, these market players can earn high returns by possessing special trading technologies (the technology may vary across market participants, but think HFT, hedge funds, prop trading, employing quants, and so on).

4. Let’s say you are not a major financial institution.  Then you really will earn negative returns on your safe saving.  You might try holding equities, but a) you are not wealthy and thus you are fairly risk averse, and b) as a small player you do not have access to these special trading technologies and indeed you must trade against those who do.  You thus will often earn negative or low returns on your portfolio no matter what.

5. The implied prediction is that differential rates of wealth accumulation will be a driver of inequality over time.  This seems to be the case.

6. This equilibrium is self-reinforcing.  The crumminess of T-Bill returns drives some individuals into trading against those with special trading technologies, even though that means they do not get a totally fair deal.  The ability to trade against these “suckers” increases the value of paying the entrance fee into the higher realms of financial markets and thus increases the demand for T-Bills and keeps their rate of return low.

6b. Bailouts and moral hazard issues may reinforce the high returns to the special trading technologies, at social and taxpayer expense.

7. In this equilibrium this is a misallocation of talent into activities which complement the special trading technologies.

8. Imagine a third class of agent, “Napoleon’s small shopkeepers.”  These individuals earn positive rates of return on invested capital, though those returns are not as high as those enjoyed in the financial sector.  You become a shopkeeper by saving some of your earnings and then setting up shop.  Yet now it is harder to save and accumulate wealth for most people (the rate of return on standard savings is negative!), and thus the number of small shopkeepers declines.  This hurts economic growth and it also thins out the middle class (“Average is Over”).  Most generally, the quality of your human capital determines all the more what kind of returns you will earn on your financial portfolio and that is a dangerous brew for the long term.

9. Business cycles may arise periodically if those who control the special trading technologies periodically “empty out” the real economy to too high a degree; you can think of this as a collective action problem.  Then the financial sector must shrink somewhat, but unfortunately the game starts all over again, following a period of recovery and consolidation.

10. The John Taylors and Stephen Williamsons of the world are right to suggest there is something screwy about the persistently low interest rates, and thus they grasp a central point which many of their critics do not.  Yet they don’t diagnose the dilemma properly.  Tighter monetary policy would simply add another problem to the mix without curing the underlying dysfunctionality.

11. In this model, fixing the negative dynamic requires financial sector reform of such a magnitude that real rates of return on safe assets rise significantly.  That is hard to pull off, yet important to achieve.

11b. It would help for the Chinese and some other East Asian economies to diversify their foreign holdings into riskier and higher-earning investments.  They need a new trading technology in a different way, and you can think of their demands for safe assets as a major market distortion.  Edward Conard saw a significant piece of this puzzle early on, by noting that a globalized world will skew real rates of return on safe assets (it is easiest to overcome “home bias” on the safest and most homogenized assets of a foreign country).  Singapore and Norway are to be lionized in this regard for their risk-taking abroad.

12. If you so prefer, monetary and fiscal policies can have the “standard” properties found in AS-AD models.  Yet in absolute terms they will disappoint us, and this will lead to fruitless and repeated calls to “do much more” or “do much less,” and so on.

13. In this model, the activities of the Fed can be thought of in a few different ways.  In one vision, the Fed is the world’s largest hedge fund and has the most special trading technology of them all.  Forward guidance on rates is actively harmful and the Fed should instead commit to a higher rate of price inflation or a higher rate of ngdp growth.

13b. Under another vision of the Fed, they understand this entire logic.  Interest on reserves is a last resort “finger in the dike” attempt to keep rates higher than they otherwise would be.  Of course both visions may be true to some extent.  (And here I am expecting Izabella Kaminska to somehow make a point about REPO.)

14. Unlike in models of demand-side “secular stagnation,” the observed negative real rates of return do not imply negative rates of return to capital as a whole and thus they do not have unusual or absurd implications.  They do require some degree of market segmentation, namely that not everyone has access to the special trading technologies, but those who do have enough wealth to push around the real return on T-Bills, especially if China is “on their side.”

That is what I was thinking about on my flight to Tel Aviv.  It should be thought of as speculative, rather than as a simple description of my opinions.  Still, it fits some of the data we are observing today.  Another way to put it is this: the recent secular stagnation theories need a much closer examination of the financial sector and its role in our current problems.  We should focus on the gap in returns, rather than postulating a general negativity of returns per se.

Milton Friedman’s 1969 commentary on the West Bank

“Much to my surprise, there was almost no sign of a military presence…I had no feeling whatsoever of being in occupied territory…This wise policy [of the Israelis] involved almost literal laissez-faire in the economic sphere…To a casual observer, the area appears to be prospering.”

That is from Friedman’s “Invisible Occupation.” Newsweek column, May 5, 1969, reprinted in There’s No Such Thing as a Free Lunch: Essays on Public Policy. La Salle, Illinois: Open Court Press, 1975, pp.298-99.

That is cited in an old paper of mine on the economics of international conflict, with reference to the Middle East.  See my related earlier post, “Why Don’t People Have More Sex?

Notes on Israeli inequality

Inequality in Israel has been rising rapidly, but it is neither from trade with China nor because of robots.  In part more of the Israeli economy has shifted — for technological reasons — into inequality-inducing sectors, such as information technology.  The greater size and openness of the Israeli economy also mean that preexisting educational disparities, many of them rooted in religious and ethnic differences, now map into greater income differentials.  For instance a growing role for exports in the economy boosts income inequality because not all workers have access to the international customers, whether directly or indirectly.

Many of the ultra-Orthodox here have characteristics of “threshold earners,” as I have discussed that concept in the past.  Their wages have stagnated in real terms or even fallen over the last decade.

Russian-born Israelis have enjoyed strong income gains, whereas the non-Haredi Israeli-born middle class Jews have lost a small amount of ground.

The price of housing remains inefficiently high.

I sometimes say that Israel is where “Average is Over” happens first:

“…the income gap between the 90th percentile and the median worker in Israel is the highest of all the developed countries, as is the income gap between the median (50th percentile) and the 10th percentile. And if that is not enough, the income gap between the 75th percentile and the 25th percentile, in other words the income gap within the middle class − between the upper and lower middle class − is also the highest in the developed world.”  The link is here.

The bottom decile actually has done quite well in terms of rates of change, but the 6th through 8th deciles have done especially poorly (same link).  That source serves up the intriguing hypothesis that the disappearance of middle class-earning middlemen in the Israeli economy is due to the disintermediation of the internet, although without citing any data.  In any case, it is the non-substitutable, non-automatable, manual labor jobs which have seen rising pay at the very bottom.

(As an aside, a number of recent studies of rising income inequality caricature the technology hypothesis in a variety of non-useful ways, and thus (incorrectly) reject it.  I hope to consider those arguments in more detail, in the meantime I will note that the Israel case study is a useful corrective to those views, by showing the broad spectra of ways in which technology influences income distribution.  It’s not just or even mainly about “robots.”)

The Israeli economy has a high degree of economic and financial concentration.  How much that problem would be alleviated if Israel could have normal trade and investment relations with its immediate neighbors?

A higher employment to population ratio would yield a good deal of low-hanging fruit.  It is hard for me to judge across what time horizon that might happen here.

Is the Volcker rule a good idea?

Treasury Secretary Jacob J. Lew has strongly urged federal agencies to finish writing the Volcker Rule by the end of the year — more than a year after they had been expected to do so — and President Obama recently stressed the importance of the deadline.

By the way, five (!) agencies are writing the rule, which is not a good sign.  As for the Volcker rule more generally, here are a few points:

1. If restricting activity X makes large banks smaller, that will ease the resolution process, following a financial crack-up.  That is a definite plus, although we do not know how much easier resolution will be.

2. It is not clear that banning bank proprietary trading will lower the chance of such a financial crack-up.  The overall recent record of real estate lending is not a good one, and as Edward Conard pointed out, restricting banks to the long side of transactions is not obviously a good idea.  I do see the moral hazard issue with allowing banks to engage in the potentially risky activity of proprietary trading.  Still, so far the data are suggesting that the banks which cracked up during the crisis did so because of overconfidence and hubris, not because of moral hazard problems (i.e., they still were holding lots of the assets they otherwise might have been trying to “game”).

3. There is no strong connection between proprietary trading and our recent financial crises.

3b.  Today the bugaboo is “big banks” but once it was “small banks” and for a while “insufficiently diversified banks.”  Maybe it really is big banks, looking forward, or maybe we just don’t know.  Small banks have their problems too.

4. There is some chance that proprietary trading will be pushed to a more dangerous, harder to regulate corner of our financial institutions.

5. There is some danger that loopholes in the regulation itself — especially as concerns permissible client activities — may undercut the original intent of the regulation. This will depend on exactly how well the regulation is written, but past regulatory history does not make me especially confident here.  And the distinction between “speculation” and “hedging” cannot be clearly defined.  Should we be writing rules whose central distinctions may be arbitrary?  And yet CEOs will have to sign off on compliance (with 950 pp. of regulations) personally.  Is that a good use of CEO attention?  Here is a good FT piece about how hard (and ambiguous) it will be to enforce the rule globally.

6. I do not myself shed too many tears over the “these markets will become less liquid without banks’ participation” critique, but I would note this is a personal judgment and the scientific status of such a claim remains unclear.

7. Many people, even seasoned commentators, approach the Volcker rule with mood affiliation, starting with how much we should resent our banks or our regulators or how we should join virtually any fight against either “big banks” or regulators.  I see many analyses of this issue which spend most of their time on “mood affiliation wind-up,” as I call it, and not so much time on the actual evidence, which is inconclusive to say the least.

8. We still seem unwilling to take actions which would transparently raise the price of credit to homeowners.  We instead prefer actions which appear to raise no one’s price of credit and which are extremely non-transparent in their final effects.  You can think of the Volcker rule as another entry in this sequence of ongoing choices.  That should serve as a warning sign of sorts, and arguably that is a more important truth than the case either for or against the rule.

When I add up all of these factors, I come closer to a “don’t do the Volcker rule” stance in my mind.  The case for the rule puts a good deal of stress on #1, but overall it does not fit the textbook model of good regulation.  I probably have a more negative opinion of “an extreme willingness to experiment with arbitrary regulatory stabs” than do most of the rule’s supporters, and that difference of opinion is perhaps what divides us, rather than any argument about financial regulation per se.

I really do see how the Volcker rule might work out just fine or even to our advantage.  I also see the temptation of arguing “I am against big banks, this is the legislation against big banks which is on the table, so I am going to support it.”  But let us at least present to our public audiences just how weak is the evidence-based case for doing this.

Addendum: You will find a different point of view from Simon Johnson here.  Here is a counter to his claim that prop trading losses were significant in 2008: “Loan losses didn’t just dwarf trading losses in absolute terms. Loan losses as a share of banks’ total loan portfolios also exceeded trading losses as a share of banks’ trading accounts. Yet no one’s arguing banks should stop lending in order to protect depositors (and rightly so). In short, those expecting the Volcker Rule to be a fix-all for Wall Street’s ills have probably misplaced their hope—the rule seems like a solution desperately seeking a problem.”

The sequester really was a good idea

Here is the latest:

House and Senate negotiators were putting the finishing touches Sunday on what would be the first successful budget accord since 2011, when the battle over a soaring national debt first paralyzed Washington.

I have not seen enough detail to judge this emerging deal, but it seems it will reverse some of the initial cuts to discretionary spending from the sequester.  You will recall my original take on the sequester, namely that it brought some much needed spending reductions (relative to baseline, they are mostly not actual spending reductions!), and that undesirable side effects could be handled by a subsequent Coasian bargain between the parties.  (And here is me on the macro consequences of the sequester, and there was also plenty of monetary offset.)  That appears to be exactly what is in progress.  It is unlikely that bargain will approximate an ideal, but the pre-sequester spending decisions were not ideal either.