Category: Economics

Why does unemployment remain high?

Here is the take of Brad DeLong:

First, and most important, the unemployment rate is high because the Federal Reserve misjudged how much investment spending would fall in the aftermath of the collapse of the NASDAQ bubble, and because the Federal Reserve then misjudged how fast productivity would grow. If the Federal Reserve had had an accurate forecast of the investment-spending slowdown, it would have taken appropriate action and the labor market would be in good shape. And if labor productivity growth had exhibited its “normal” recession-and-stagnation slowdown rather than zooming ahead, the amount of demand growth we have had in the past two years would have been enough to put the labor market in good shape. However, don’t blame the Federal Reserve too much: it has a very hard task, it’s policies can’t be perfect, and all-in-all its performance over the past two decades has been amazing.

Plus the Bush tax cuts have not had much of a stimulatory effect on employment. Most of all, Brad tells us, we should not blame trade with China. I am less negative toward the Bush economists than is Brad, but I agree with the core of his analysis.

Can suicide attempts be rational?

…after people attempt suicide and fail, their incomes increase by an average of 20.6 percent compared to peers who seriously contemplate suicide but never make an attempt. In fact, the more serious the attempt, the larger the boost–”hard-suicide” attempts, in which luck is the only reason the attempts fail, are associated with a 36.3 percent increase in income. (The presence of nonattempters as a control group suggests the suicide effort is the root cause of the boost.)

Here is a link to the original research.

Now, you may wonder, how can this be?

Why should suicide be an economic boon? Once you attempt suicide you suddenly have access to lots of resources–medical care, psychiatric attention, familial love and concern–that were previously expensive or unavailable. Doubters may ask why the depressed don’t seek out resources earlier. But studies have demonstrated that psychological and familial resources become “cheaper” after a suicide attempt: It is difficult to find free medical care when you are sad, but once you try to kill yourself, it’s forced on you.

So what should we do? The article, the source of this post, suggests “well funded educational campaigns”. A cynical economist might suggest social stigma for suicide, rather than forgiveness. Personally, I suspect that few people attempt suicide for the resulting free medical care, but rather for the attention. We can’t precommit to ignoring them, so perhaps we are simply stuck. I invite Alex to offer some suggestions on how to limit the number of suicides; keep in mind it is a bigger killer in the United States than is homicide.

Addendum: Thanks to Fabio for the pointer. And Eric Crampton suggests the following: “I have a different take on the suicide post – mean reversion. Assume that people are hit with heterogeneous shocks, positive and negative. If people are most likely to commit suicide at the worst point (after the biggest negative shock), then future income increases are just mean reversion. People who just contemplate it have had negative shocks, but not as strongly negative.”

Once burned, twice shy?

Our colleague Vernon Smith argues that new traders are most susceptible to asset market bubbles, largely because of their inexperience. If the market rises again after a bubble bursts, we should take the run up in prices seriously:

Smith points out that market double dips don’t occur in rapid sequence. Indeed, since 1926 the space between down years for the broad market has always been at least two years, and usually much longer, according to Ibbotson Associates data. The closest sequence in the recent past was the two positive years between the 1973-74 bear market and the 7% downturn in 1977.

In other words, Smith argues that the second round of high prices is usually for real. Experience has beaten the traders down into a state of fearfulness, so presumably there is good grounds for their optimism.

I would like to see the more systematic time series evidence, in the meantime here is the article from Forbes.

Here is my favorite part from the article:

To Professor Smith, bubbles perform a great service for capitalism. “Every bubble is driven by great innovations, and they all leave behind a lot of long-term value,” he says.

How generous is the United States?

Immigration and remittances are the most effective welfare programs ever devised. Anyone who claims to speak for the world’s poor should embrace them. Here are some relevant facts:

1. Total remittances around the world are now about $80 billion a year, twice the amount of so-called “foreign aid,” which often goes to corrupt governments, not poor citizens.

2. Remittances are now ten times the amount of net private capital flows, after adjusting for profit repatriation and interest payments.

3. Mexicans working in the United States send back home $20 billion every year. This sum is twice the value of Mexico’s agricultural exports, and over a third more than tourist revenue.

All the figures are from the November/December issue of Foreign Policy, not yet on-line.

My take: There is altogether too much talk about the United States being ungenerous with foreign aid. We show up as 21st in the rankings, in per capita terms, according to one estimate. These figures neglect remittances, where the U.S. is a very clear first with $28.4 billion a year sent to other countries. The bottom line: when it comes to other nations, the United States is the most generous country in the world.

Are you interested in the rest of the top ten, for remittances? Saudi Arabia, with $15.1 billion a year, is a clear number two. Then you have Germany, Belgium, Switzerland, France, Luxembourg, Israel, Italy, and Japan. The Scandinavian nations receive so much kudos for their high foreign aid per capita, but when it comes to remittances, even tiny Luxembourg, population 437,389, beats them out.

Reforming the corporate income tax

Not as sexy a topic as cads and dads, see immediately below. But here is the best short article I have seen on why we should reform the corporate income tax.

Levi Strauss was able to put about $100,000 into a sham Brazilian venture that netted it $180 million in tax deductions. And it was all perfectly legal.

The answer?:

Loopholes need to be closed, rules simplified and the 35 percent rate reduced. And serious thought has to be given to augmenting the corporate tax with an export-friendly value-added tax like the ones used by nearly every other industrial country.

I agree with the first sentence of that paragraph, but not the second. I worry about the transition costs to a VAT, I expect we would end up with both a VAT and an income tax and on that one I vote no.

Why don’t the French work more?

If France were to reduce its effective tax rate on labor income from 60 percent to the U.S. 40 percent rate, the welfare of the French people would increase by 19 percent in terms of lifetime consumption equivalents. This is a large number for a welfare gain. This estimate of the welfare gain takes into consideration the reduction in leisure associated with the change in the tax system and the cost of accumulating capital associated with the higher balanced growth path. The reduction in leisure is from 81.2 hours a week to 75.8 hours, which is a 6.6 percent decline in leisure. I was surprised to find that this large tax rate decrease did not lower tax revenues.

That’s the take of Ed Prescott, one of America’s smartest economists, here is the original research paper.

Consider just how radical the flip has been:

Americans now work 50 percent more than do the Germans, French, and Italians. This was not the case in the early 1970s when the Western Europeans worked more than Americans.

According to Prescott, changes in marginal tax rates are the main reason for this shift. The Prescott cite is from, a never-ending source of interesting material.

My take: Prescott’s critics like to squawk about his oversimplified models and his use of the representative agent construct. Having a background in Austrian economics, I have some sympathy for these criticisms. But on this matter, it is hard to deny that Prescott has nailed it.

The Effect of Police on Crime

Estimating the effect of police on crime is more difficult than it sounds because places with a lot of crime tend to have a lot of police and vice-versa. As a result, naive analyses tend to find that police cause crime! Jon Klick and I, following the amazing Steve Levitt, have what we think is a pretty clever solution. We look at what happens to crime in Washington DC when the terror alert level rises from elevated to high. During a high-alert period the police put on extra shifts, monitor closed circuit cameras on the National Mall and in general step-up policing. We find that crime falls a lot during these high-alert periods. Our new paper is, Using Terror Alert Levels To Estimate the Effect of Police on Crime. Comments welcome.

Here is the abstract:

We argue that changes in the terror alert level set by the Department of Homeland Security provide a shock to police presence in the Mall area of Washington, D.C. Using daily crime data during the period the terror alert system has been in place, we show that crime drops significantly, both statistically and economically, in the Mall area relative to the other areas of Washington DC. This provides strong evidence of the causal effect of police on crime and suggests a research strategy that can be used in other cities.

What we buy from China

Our top categories of imports, by billions of dollars:

$8.6 Shoes
$6.1 Toys
$5.6 Input-output units
$5.1 Data processing machine parts
$3.2 VCRs
$2.6 Wood furniture
$2.0 Transmission equipment
$1.7 Data storage units

Get past the first two categories, and this is not just low-tech junk at your local Wal-Mart.

Now, consider our top imports from China, as a percentage of the overall imports in the stated category:

88% Radios
87% Christmas and festive items
83% Toys
70% Leather goods
67% Shoes
67% Handbags
65% Lamps and lights

From The Fruits of Free Trade, a publication by the Federal Reserve Bank of Dallas, the piece offers many nice illustrations of the benefits of trade.

In the average can of mixed nuts, you might find almonds from Italy, walnuts from china, Brazil nuts from Bolivia [sic], cashews from India, pistachios from Turkey, hazelnuts from Canada – a true international assortment.

Being a nut lover, that was my favorite bit from the brochure.

Milton Friedman tribute

I am pleased to report from a Milton Friedman tribute conference, held by the Federal Reserve Bank of Dallas. Milton, now 91 years old, remains incredibly sharp and quick on his feet. Gary Becker, in his talk this evening, challenged Milton as to why he does not believe in competitive supply of currency. Milton replied by saying he does not have a good answer to that question, but that he does not see how to get government out of the money business, given that dollars are already in place. He did suggest freezing the supply of high-powered money, and otherwise letting markets work and supply whatever forms of outside money might be demanded. Richard Ebeling discusses how Friedman’s thoughts on this issue have evolved.

My take: For a long time I favored Friedman’s position. In the meantime I have been more influenced by behavioral economics. I fear that some downward adjustments of prices and wages might be required, which people often find painful or resist, so I wonder if a very slight rate of price inflation might be superior. Of course a frozen supply of high-powered money does not necessitate deflation, but sometimes it will bring it. I also wonder how much short-run interest volatility would result. The supposed advantage of freezing high-powered money is to limit the potential for a repeat of the bad monetary policy of the 1970s, but has the Fed or government really engaged in effective precommitment? I doubt it. So right now I count myself as a monetary agnostic.

Addendum: Virginia Postrel, who is attending the conference, tells us about a forthcoming television biography of Friedman.

Second addendum: Here is a detailed conference report, written by a very smart and articulate attendee, his blog will be giving you updates as well.

We should spend More on Health Care

Tyler appears to be growing more skeptical of the value of health care spending (see his posts here and here). A simple model explains most of what is going on and why he and another of my very smart colleagues Robin Hanson, are wrong. In the graph below spending on health care is on the X axis, health outcomes are on the Y axis. Spending shows diminishing returns. We are currently at point Q on the graph labeled T1 – note that at this point marginal increases in spending have little effect on output (Tyler asks, What margin has low value? Answer: The marginal dollar). Even fairly large increases or decreases in spending will not change outcomes very much given that we are currently at point Q.

Why are we spending so much as to push us into the flat portion of the production function? One reason is that out-of-pocket expenses for medical care are much lower than true costs – we typically are spending someone else’s money. A second reason is that the marginal utility of wealth is low if you are dead so spending on health care near the end of life has unusually low opportunity cost. A third reason may be that various psychological factors make the desire to avoid regret particulary strong for health care, as Tyler speculated earlier.

Although the marginal dollar has low return the value of improvements in medical technology is enormous. These gains are illustrated by the shift from T1 to T2. It has been estimated, for example, that increases in life expectancy from reductions in mortality due to cardiovascular disease over 1970-1990 has been worth over $30 trillion dollars – yes, 30 trillion dollars (for this research see: book, papers, summary). A conservative estimate is that 1/3rd of these improvements in life expectancy were due to better medical technology. One third of the annual benefits is $500 billion – this is much more than total government spending on medical research (the budget of the entire NIH is around 25 billion).

The low value of medical spending at a particular point in time and the high value of medical research over time suggest that we would be much better off if we cut back on medical care spending and devoted the funds to medical research. We should spend less on Medicaid, Medicare, Prescription drug plans etc. and use the savings to better fund the NIH (or other methods of increasing medical research such as prizes etc.)


Notes on Genetic Insurance

My idea of genetic insurance created some controversy with Randall Parker at FuturePundit, Brock Sides at Signifying Nothing, and MR’s guest blogger Lloyd Cohen raising some objections. One of the objections that all three had in common (dealt with in my papers but not in the post) is that adverse selection is still a problem if people lie about having taken a test. This minor problem is easily handled, however. Insurance companies could have a clause in the contract forbidding previous tests. We don’t worry so much about people having a theft and then buying home insurance and the issue here is quite similar. (See my papers for a little more on this issue).

Randall at FuturePundit, however, raises a more serious problem. As the price of genetic tests falls it will soon be economic to sequence a person’s entire genome at birth or even before (see Randall’s posts for some links on costs). In this case, genetic insurance works only if the parents buy the insurance. This is not so implausible (especially not for those who have their child’s DNA sequenced!) but it is a real issue. (We should also remember that genetic insurance will be quite cheap because most people do not have serious genetic defects.) If we have genetic insurance today, however, we can perhaps avoid the adverse selection problem for a couple of decades and that may be good enough for one of two things to happen 1) genetic engineering will reduce the need for insurance (sequencing is much more valuable if there is genetic engineering to correct defects) or 2) genetic insurance could evolve into a more Rawlsian scheme (perhaps involving government at some level) in which payments are made at birth to compensate for Nature’s genetic lottery.

The case for health care spending

In a previous post I wondered whether additional spending on health care in fact brought greater health. Whether we do controlled experiments, or look at cross-national data, a convincing effect is often hard to find.

Brendan Kennelly of Lehigh referred me to this OECD paper, which examines cross-national data to find a positive health effect from health care spending. The result is much stronger for women than for men.

I asked Robin Hanson what he thought of the piece, here is his response:

When a coefficient is truly zero, about 5% of the studies estimating that
coefficient should show a significant difference at the 5% level. And if
people search for specifications that will give this result because they
believe the coefficient is not zero, you might expect 10-20% (or more) of
the reported results will show a significant non-zero coefficient. So
given the current state of econometric practice, the most you could
reasonably hope for when a coefficient is really zero is for about 90% of
the studies to fail to find a significant effect of the desired sign. This
is the current state of the evidence on the aggregate effects of medicine
on health.

My take: The whole debate still makes may head spin. I wonder how much of health care expenditure is geared toward alleviating anxiety (“we did all we could…”) rather than improving health per se. We may be mismeasuring the relevant output. If we could measure the total costs of illness, what percentage of the total would come in the form of anxiety? Furthermore, health care is not a single thing. The marginal return from some forms of health care (bypass operations?) is certainly high, in other cases the return much lower or perhaps negative. So perhaps the debate should shift away from aggregates, and toward trying to identify which health care expenditures we can do without, or do not need to subsidize at current margins.

The wonders of money

…lifting children out of poverty can diminish some psychiatric symptoms…A study published in last week’s issue of The Journal of the American Medical Association looked at children before and after their families rose above the poverty level. Rates of deviant and aggressive behaviors, the study noted, declined as incomes rose.

“This comes closer to pointing to a causal relationship than we can usually get,” said Dr. E. Jane Costello, a psychiatric epidemiologist at Duke who was the lead author.

The study tracked 1420 children, many of whom lived on an Indian reservation. A local casino opening lifted many out of poverty, and also improved their mental health:

…the rate of psychiatric symptoms among the children who had risen from poverty was dropping. As time went on, the children were less inclined to stubbornness, temper tantrums, stealing, bullying and vandalism – all symptoms of conduct and oppositional defiant disorders.

After four years, the rate of such behaviors had dropped to the same levels found among children whose families had never been poor. Children whose families broke the poverty threshold had a 40 percent decrease in behavioral symptoms. But the payments had no effect on children whose families had been unable to rise from poverty or on the children whose families had not been poor to begin with.

Even I, author of a book called In Praise of Commercial Culture (see to the right), am surprised by this result. Supposedly the wealthier parents were now able to spend more time with their children, thus improving their mental health. I wonder whether the key factor instead might have been improved behavior on the part of the parents.

Here is the abstract, plus you can buy a copy of the original research for $12.

Addendum: David Levy, citing Adam Smith, wonders if it isn’t the growth rate of income that makes people better off, rather than the level.

Disagreement With Alex Over A Market in Bad Gene Insurance

The Human Genome Project and its offspring, testing for genetic anomalies, have the prospect in the short-term at least of reducing human welfare. Alex is right that we are largely behind a veil of ignorance with respect to our genetic predispositions to diseases that have not yet presented themselves. Genetic testing removes that veil. No insurance market against genetic disease could survive the asymmetry of information between the insured and the insurer. I have written about this in The Human Genome Project and the Economics of Insurance: How Increased Knowledge May Decrease Human Welfare, and What Not To Do About It, 7 Annual Review of Law and Ethics 219 (1999).

It is not just prescription drugs

You may have spent $100 for your textbook, or made your class cough up this money. That same text might have been sold overseas for half of the price or less. Today’s New York Times offers the full account.

And yes, arbitrage has begun:

At one prestigious university, a sophomore imported 30 biology books from England this fall and sold them outside his classroom for less than the campus-bookstore price, netting a $1,200 profit. Next semester, if all goes well, he plans to expand the operation.

How about this:

The differences are often significant: “Lehninger Principles of Biochemistry, Third Edition,” for example, lists for $146.15 on the American Amazon site, but can be had for $63.48, plus $8.05 shipping, from the British one. And “Linear System Theory and Design, Third Edition” is $110 in the United States, but $41.76, or $49.81 with shipping, in Britain.

Many college bookstores, meanwhile, have taken matters into their own hands, arranging their own overseas purchases.

And it is now a business. will get you the text from overseas at the lower price, of course you pay them a commission.

The legal status of these reimportations remains an open question. Some publishers are placing stickers on their books, forbidding reimportation, but the Times article suggests that such reimportation is not obviously against the law.