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Assorted links

by  Tyler Cowen

1. Measuring the output gap, an excellent post looking at capacity utilitzation and changes in inflation rates to back out an answer to this question.  The bottom line is that the output gap probably isn’t nearly as large as is often claimed.  And Karl Smith comments, I would note the connection between the ppf and trust.

2. Obama’s hardline turn against medical marijuana.

3. Markets between everything and everyone, and Literary Saloon reviews Allan Meltzer.

4. Testing Milton Friedman, new TV show with Caplan, Yglesias, Dalmia, Williams, others.

5. Graphs about Hollywood.

The economics of higher non-profit and for-profit education

by  Tyler Cowen in

Here is a 2009 paper of mine with Sam Papenfuss (pdf), a later version of which was published in this book edited by Joshua Hall.  The paper deliberately sidesteps the recent scandals and focuses on fundamentalist explanations of why higher education might be provided on a non-profit or for-profit basis.

The key stylized facts are this:

Two primary features characterize the observed educational for-profits. First, for-profits tend to specialize in highly practical or vocational forms of training. For-profits are especially prominent in areas where student performance can be measured by a relatively objective, standardized test. Nonprofits, in contrast, have a stronger presence in the liberal arts, although they are by no means restricted to that arena..

This is a general pattern, and not unique to the United States today:

A comparison of for-profit and non-profit institutions in the Philippines [in the 1970s] bears out many of the differences noted above. Filipino for-profits tend to charge lower fees, specialize in education of lower academic reputation, spend less on capital equipment, and serve students who plan on pursuing vocational careers or taking a standardized vocational test upon graduation…Students at for-profits are approximately ten times more likely to take the tests. Adjusting for the lower pass rate from for-profits, the for-profits are putting about five times the number of students through the tests as the non-profits, even though for-profits educated no more than three-fifths of all Filipino students at the time.

Here is one possible (partial) resolution:

Faculty governance implies that for-profits and nonprofits place different relative weight on reputation and profits. The for-profit selects students and faculty on the basis of how easily their reputational benefits can be captured by shareholders, whereas the non-profit places greater weight on the reputational benefits that are kept by faculty. The for-profit pursues “reputation as valued by students in dollar terms” and the nonprofit pursues “reputation with the external world,” or “reputation as a public good.” In the resulting equilibrium, for-profits achieve lower status.

…The hypothesis therefore predicts a segmented market for higher education. Students who seek the highest levels of certification and reputation will attend non-profit institutions, which are run by faculty and use their prestige to raise donations. Students whose quality can be certified by an outside vocational exam do not need the non-profit reputational endorsement. They will pursue the more efficient instruction offered by for-profits.

There is a good recent paper by David Deming, Claudia Goldin, and Lawrence F. Katz on educational for-profits, available here.  Here is a 2010 Dick Vedder piece on for-profits, more positive than most recent accounts.

Sentences to ponder

by  Tyler Cowen in

…when Prime Minister Mario Monti remarked that having a job for life in today’s economy was no longer feasible for young people — indeed, it was “monotonous” — he set off a barrage of protests, laying bare one of the sacrosanct tenets of Italian society that the euro zone crisis has placed at risk.

Reaction was fast, furious, bipartisan and intergenerational. “I think the prime minister has to be careful with the words he uses because people are a little angry,” Claudia Vori, a 31-year-old Rome native who has had 18 different jobs since graduating from high school in 1999…

This point is not irrelevant:

Debate has been especially intense over Article 18 of the 1970 Workers Statute, which forbids companies with more that 15 employees from firing people without just cause. The unions say that line cannot be crossed.

The article is here.  How many years does it take to a) undo this, and b) have it kick in as a positive for growth?  This again also gets back to the question of why Germany does not wish to pay for everything.  By the way, is anyone writing a behavioral economics piece about how “crisis fatigue” increasingly is shaping eurozone policy?

Assorted links

by  Tyler Cowen

1. Valentine homage to Romer, and a continuous time approach (is it?), and PubMed research papers related to Valentine’s Day.   Here are data on spending.  Here is a Chris Coyne video on the economics of Valentine’s Day; it is a non-Hansonian, non-Keynesian, Treasury view of the day, he is not impressed by a one-time increase in monetary velocity.

3. What science looks like.

4. Peter Conti-Brown on elective shareholder liability.

5. Flying-Bridge Motorhome.

5. Richard Thaler defends fun.

Bubbles and economic potential and potential gdp

by  Tyler Cowen in

Here is a Krugman post on the question, here are earlier posts from Sumner and Yglesias.  I will put my remarks under the fold…This topic is easiest to understand if you sub out the United States and sub in Greece.  There is no AD boost that can (anytime soon, without a lot of extra growth kicking in), restore Greece to its previous output peak and its previously expected performance-to-come.  Circa 2006, Greece was in an unsustainable position, if for no other reason the market didn’t understand the correct risk premium for Greece.  Once the correct risk premium is applied, Greek output falls and furthermore numerous (related) bad events kick in and also a whole set of previous plans are shown to be unsustainable (and no this doesn’t have to be an Austrian argument!).  The gap between Greece’s current path, and the path previously envisioned for Greece is thus:

a. part AD gap which can be fixed by AD policy

b. part a difference in risk premia, and for Greece the old risk premium, when the country borrowed at very low rates, was wrong and is gone more or less forever.  The concomitant financial and fiscal stability is gone too.

c. part a difference in enthusiasm in supply, based on the differences between earlier expectations that “get rich quick” really does apply to Greece, and the current more pessimistic expectation that “get rich quick” is now unlikely, and thus “smaller-scale, scrabble-around projects just to make ends meet” are the order of the day.  DeLong gets at some of this here.

Greece does have to rebuild a) — don’t get sucked into aggregate demand denialism! — but it also has to rebuild b) and c) and perhaps other factors too.  This follows rather directly from — dare I breathe the words? — the synthetic real business cycle/neo Keynesian models which form the backbone of contemporary macroeconomics and which Krugman apparently still doesn’t wish to recognize.  (To various commentators and other bloggers: when I write macro on this blog I usually take knowledge of these models for granted; if you don’t know those models that is fine, call me arcane, but it doesn’t mean I am the one who is wrong.)   Krugman runs through a bunch of weak arguments and responses, and counters them well enough, but he doesn’t see or consider the baseline response that would follow from standard contemporary macro, with the possible exception of his brief parenthetical phrase about credit conditions.

Turning for a moment to broader points, the astute reader will note that in this framework the current sluggishness of recovery need not be evidence for Old Keynesianism.  An ineffective response to fiscal policy does not per se have to mean we just didn’t do enough fiscal policy.  And so on.  Maybe yes, maybe no, but all of a sudden there is a lot more room for agnosticism about macroeconomics and more broadly there is more room for epistemic modesty.

Contra Tim Duy, you can hold this mixed view without wanting to see the Fed raise interest rates.  Just avoid the AD denialism.

Krugman defines “potential GDP is a measure of how much the economy can produce” but keep in mind that this quite possibly won’t be a unique number.  With what risk premium?  With what enthusiasm of supply?  See my Risk and Business Cycles for an extended discussion and also numerous citations.

It’s also worth noting that while gdp is a useful “we can all agree upon what to measure” kind of concept, its real meaning is conceptually fairly slippery and “potential gdp” is not likely to be better pinned down at its foundations.  Let’s not reify that concept above and beyond what it is worth.

In any case, we can be agnostic about the size of the potential gdp gap with regard to the United States today and indeed my original post very carefully used a question mark in its title.  But there is no incoherence to assert that part of the apparent gap is due to the real side.  The new learning about America is not about the correct risk premium for our debt (not yet at least), but about our financial fragility, how well our politics responds to crises, some worrying long-term trends in the labor market, possible misreadings of the productivity numbers, and a few other real factors.  It really is possible that previous investment plans were based on expectations of the real economy that were wrong and unsustainable and now have been (partially?) corrected, with negative growth penalties looking forward.

Stephen Williamson offers very detailed comment, noting also that the recession started well over four years ago, which gives plenty of time for nominal resets, and we’ve seen no downward cascading spiral, so maybe there is a non-AD problem with getting back on track at the preferred rate.  He also eschews AD denialism.  Today Krugman has a brief note along the lines that the views of his opponents on these questions are “even worse than your first impression” but that is best thought of as a) his occasional churlishness, and that b) his writings on this topic do not, at least not to date, reflect a very thorough knowledge of the relevant literature(s).

Dividends and taxation

by  Tyler Cowen in

President Obama wants to tax dividends at ordinary income rates.  These results, from Marcus and Martin Jacob, should not come as a huge surprise:

We compile a comprehensive international dividend and capital gains tax data set to study tax explanations of corporate payouts for a panel of 6,416 firms from 25 countries for 1990-2008. We find robust evidence that the tax penalty on dividends versus capital gains is statistically significant and negatively related to firms’ propensity to pay dividends, initiate such payments, and the amount of dividends paid. Our analysis further reveals that an increase in the dividend tax penalty raises firms’ likelihood to repurchase shares, initiate such repurchases, and the amount of shares repurchased. This is strong confirming evidence that when listed industrial firms globally design their payout policies, they take into careful consideration the relative tax implications of their payout choices.

Here are some Finnish results:

Using register-based panel data covering all Finnish firms in 1999-2004, we examine how corporations anticipated the 2005 dividend tax increase via changes in their dividend and investment policies. The Finnish capital and corporate income tax reform of 2005 creates a useful opportunity to measure this behaviour, since it involves exogenous variation in the tax treatment of different types of firms. The estimation results reveal that those firms that anticipated a dividend tax hike increased their dividend payouts by 10-50 per cent. This increase was not accompanied by a reduction in investment activities, but rather was associated with increased indebtedness in non-listed firms. The results also suggest that the timing of dividend distributions probably offsets much of the potential for increased dividend tax revenue following the reform.

Here are more results from Finland.  In the UK dividend tax increase of 1997 it seems pension funds were the marginal investor and they bore much of the burden from that particular reform.

Wealth externalities and limited liability in banking

by  Tyler Cowen in

Arnold Kling writes:

Suppose that you sell your shares in Shakee Bank to me today, and tomorrow Shakee has to be taken over by the FDIC. Am I liable for losses, which probably were caused by decisions made before I bought my shares? Suppose that Shakee has accumulated $8 billion in losses, and all its shareholders of record obtained their shares for a collective $0.10. What happens then?

I don’t envision the FDIC being eliminated, but say the government is in a position to be picking up some potential bondholder losses.  Under one version of the reform, bank shareholders already have posted extra collateral, by requirement of the law.  That is somewhat like higher bank capital requirements, with the twist that there is now a new legal class of bank capital.

That is an improvement over the status quo, but it’s not the most innovative form of the proposal.  One alternative version is for the government to outsource the enforcement to the bank itself.  For instance the regulator can say: “as insolvency approaches, the bank is liable for 1.5 to 1, it can come up with the money any way it wants. If it can’t come up with the money, we will take the major shareholders of record, say a year before the event (or consider a more complicated weighted average of this variable) and send them an income tax assessment for 2-1.”

The bank might preemptively organize like a partnership, or it might apply its own collateral and capital requirements to the shareholders, or it might find some other way of meeting the obligation.  Banks would compete to find the better solutions.

In response, many people fear banks trying to set up with only hobo shareholders.  That would avoid the 2-1 or 1.5 to 1 or whatever, because hobos don’t have extra assets to attach.  I just don’t think those banks will become major money center institutions because the quality of shareholders really does matter at some level.  For instance such banks could not have wealthy, highly motivated, equity-holding CEOs.  Most likely hobo banks would stay small and thus skirt the too big to fail problem or maybe they would not exist in the first place.

One problem with traditional capital requirements is that the government ends up making comovement-inducing ex ante decisions about which assets count toward satisfying the capital requirement.  Remember AAA CDOs in America and AAA government securities in Europe?  Under non-limited liability, only cash is accepted but it only has to be delivered ex post in the case of failure.  The regulations themselves need not create the same kinds of uniformity, misjudgments, and excess systemic risks up front.

One tricky question is how to apply non-limited liability to foreign banks operating in the United States.  This is a problem with all regulatory schemes based on less than perfect international coordination.  The first cut approach is to insist on non-limited liability for U.S. operations, though of course evasion and reclassification of operations may occur.

Mark Thoma adds lengthy comments.  Here is a very relevant paper by Claire Hill and Richard Painter, and a blog post by them.  Here is Suzanne McGee.  Here are some debates on non-limited liability in economic history, including work by Lawrence H. White.

Should we break up the large banks?

by  Tyler Cowen

In my column today, I say no.  Here is part of my argument:

…the logic of cutting down huge institutions could mean splitting the largest ones into several pieces. Yet banks do not always come in easily divisible parts. Such a move could amount to eradicating the largest banks rather than splitting them up — and eradication is both politically unlikely and potentially disastrous for the economy. In short, if the resulting parts of a divided bank cannot turn a profit, the split-up may prompt the very bailout it was trying to avoid.

Another fear is that American money market operations would move to larger foreign banks, which would have a newly found competitive advantage. If a financial problem arose, we would either bail out the foreign banks or rely on a foreign central bank to protect our own interests. Neither option seems appealing.

Even if a breakup went well, the incentives for the new, smaller banks would be unhealthy. Those banks could make mistakes or take on bad risks without being punished very much in terms of capitalization or revenue, because of their legally capped size. Even if they made big mistakes, these banks would probably be pushing on the frontier of maximum allowed growth. Eventually, the competitive process would cease to make these banks tougher or smarter or leaner, and we would just be cultivating another kind of banking system where bad or irresponsible decisions don’t lead to financial failure.

Most important bank failures spring from correlated risks, like the bursting of a real estate bubble, that affect many banks at roughly the same time. Bailing out a large number of smaller failing banks may be easier than bailing out a smaller number of large ones, since it is easier to apply bankruptcy and the procedures of the Federal Deposit Insurance Corporation to the smaller institutions. But that outcome hardly gets rid of bailouts.

There is still another problem. The more a bank is legally limited in terms of easily measurable size, the more it may resort to off-balance-sheet activities to make up the difference. “Breaking up big banks” may really mean making these less-transparent bank activities much more important to a bank’s fate.

The rest of the piece considers non-limited liability as an alternative for banking reform, and I thank Scott Sumner for drawing my attention to a recent piece by Eugene White (pdf) on this topic.   Stephen Williamson comments, see also his references.  I’ll respond to Arnold Kling’s remarks in a separate post, soon enough probably tomorrow.

“Engineering an Orderly Greek Debt Restructuring”

by  Tyler Cowen

That paper is by G. Mitu Gulati and Jeromin Zettelmeyer, the link is here, and the abstract is this:

For some months now, discussions over how Greece will restructure its debt have been constrained by the requirement that the deal be “voluntary” – implying that Greece would continue debt service to any creditors that choose retain their old bonds rather than tender them in an exchange offer. In light of Greece’s deep solvency problems and lack of agreement with its creditors so far, the notion of a voluntary debt exchange is increasingly looking like a mirage. In this essay, we describe and compare three alternative approaches that would achieve an orderly restructuring but avoid an outright default: (1) “retrofitting” and using a collective action clause (CAC) that would allow the vast majority of outstanding Greek government bonds to be restructured with the consent of a supermajority of creditors; (2) combining the use of a CAC with an exit exchange, in which consenting bondholders would receive a new English-law bond with standard creditor protections and lower face value; (3) an exit exchange in which a CAC would only be used if participation falls below a specified threshold. All three exchanges are involuntary in the sense that creditors that dissent or hold out are not repaid in full.

We’ll see soon enough.