Justin Wolfers shows more of a commitment to coming down in the middle than to being true to the data in his pox on both your houses piece on the impact of North Carolina’s cut in unemployment benefits. The basic story is that in July of last year North Carolina both cut the duration of unemployment benefits and vastly ramped up the job search requirements. The result was that the number of people getting benefits fell by 48,500, a decline of 53.4 percent between May of 2013 and May of 2014.
The conservative position on this cut was that ending benefits would give people the incentive they needed to get a job. The idea was that the government was needlessly coddling these people, when what they really needed was a little push to get them going. This story gives a very clear prediction.
The loss of benefits should lead to notably faster job growth in North Carolina than in the rest of the country. After all, the number of people losing benefits was more than 1.0 percent of the state’s labor force. If the necessary kick story is right then we should have seen a notably faster increase in jobs in North Carolina than in neighboring states with similar economies.
By contrast, the liberal position is that the spending from benefits helps to boost the economy. However, this impact is likely to be relatively limited. First of all, we are not talking about that much money relative to the economy as a whole, and second all the spending will not boost employment in North Carolina. This is in part because North Carolians don’t necessarily spend their money in North Carolina (some will spend it in neighboring states) and also because the spending itself will go to producers around the country and around the world.
Most of what someone pays for a car in North Carolina will go to a car company located in another state or country. The workers at the factories that assembled the car and produced the parts will almost all live outside of North Carolina. Similarly, the rent or mortgage payments made by a worker may go to a landlord or mortgage holder anywhere in the country. Therefore only a fraction of the impact of the spending will be seen in North Carolina.
If we back out the predicted impact of North Carolina’s benefit cut on the state’s economy, it is easy to see that it would be relatively modest. If we assume an average benefit level of $15,000 ($300 a week), the reduction in beneficiaries would lower payments by $720 million over the course of the year. Assuming a multiplier of 1.5 this would cut GDP for the country as a whole by roughly $1,080 million. If half of this loss accrues to North Carolina, it would lower demand in its economy by $540 million. This is roughly 0.12 percent of the state’s $470 billion economy.
Okay, now lets get back to Wolfers’ pox on both your houses story. If the people thrown off unemployment insurance are getting the kick they need to get a job then we should see some visible impact on job growth in the state. As Wolfers notes, we don’t. North Carolina’s job growth is no better than in neighboring states.
On the other hand, if we assume the liberal story is true, it would be very hard to detect a decline in growth of 0.12 percentage point, even if it did in fact occur. There are enough random factors and errors in the data that we could never expect to find such a modest impact even if the economy really did suffer from the cut in benefits.
Certainly some liberals did exaggerate the negative impact from the benefit cuts on the economy. But the evidence that Wolfers presents hardly disproves that the cuts did not have the negative impact that any reasonable analysis would have predicted.
Corrected Note: “billion” corrected to “million.” Thanks to Michael Epton and Robert Salzberg.
Justin Wolfers shows more of a commitment to coming down in the middle than to being true to the data in his pox on both your houses piece on the impact of North Carolina’s cut in unemployment benefits. The basic story is that in July of last year North Carolina both cut the duration of unemployment benefits and vastly ramped up the job search requirements. The result was that the number of people getting benefits fell by 48,500, a decline of 53.4 percent between May of 2013 and May of 2014.
The conservative position on this cut was that ending benefits would give people the incentive they needed to get a job. The idea was that the government was needlessly coddling these people, when what they really needed was a little push to get them going. This story gives a very clear prediction.
The loss of benefits should lead to notably faster job growth in North Carolina than in the rest of the country. After all, the number of people losing benefits was more than 1.0 percent of the state’s labor force. If the necessary kick story is right then we should have seen a notably faster increase in jobs in North Carolina than in neighboring states with similar economies.
By contrast, the liberal position is that the spending from benefits helps to boost the economy. However, this impact is likely to be relatively limited. First of all, we are not talking about that much money relative to the economy as a whole, and second all the spending will not boost employment in North Carolina. This is in part because North Carolians don’t necessarily spend their money in North Carolina (some will spend it in neighboring states) and also because the spending itself will go to producers around the country and around the world.
Most of what someone pays for a car in North Carolina will go to a car company located in another state or country. The workers at the factories that assembled the car and produced the parts will almost all live outside of North Carolina. Similarly, the rent or mortgage payments made by a worker may go to a landlord or mortgage holder anywhere in the country. Therefore only a fraction of the impact of the spending will be seen in North Carolina.
If we back out the predicted impact of North Carolina’s benefit cut on the state’s economy, it is easy to see that it would be relatively modest. If we assume an average benefit level of $15,000 ($300 a week), the reduction in beneficiaries would lower payments by $720 million over the course of the year. Assuming a multiplier of 1.5 this would cut GDP for the country as a whole by roughly $1,080 million. If half of this loss accrues to North Carolina, it would lower demand in its economy by $540 million. This is roughly 0.12 percent of the state’s $470 billion economy.
Okay, now lets get back to Wolfers’ pox on both your houses story. If the people thrown off unemployment insurance are getting the kick they need to get a job then we should see some visible impact on job growth in the state. As Wolfers notes, we don’t. North Carolina’s job growth is no better than in neighboring states.
On the other hand, if we assume the liberal story is true, it would be very hard to detect a decline in growth of 0.12 percentage point, even if it did in fact occur. There are enough random factors and errors in the data that we could never expect to find such a modest impact even if the economy really did suffer from the cut in benefits.
Certainly some liberals did exaggerate the negative impact from the benefit cuts on the economy. But the evidence that Wolfers presents hardly disproves that the cuts did not have the negative impact that any reasonable analysis would have predicted.
Corrected Note: “billion” corrected to “million.” Thanks to Michael Epton and Robert Salzberg.
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The NYT ran a confused column by Kwasi Kwarteng, a Conservative member of the U.K.’s parliament, calling for China to adopt the gold standard. The piece has many bizarre claims, most importantly attributing the U.K.’s prosperity in the 19th century and the U.S.’s prosperity in the post-World War II period to the gold standard, as opposed to the strength of their manufacturing sectors and overall economy.
However the most misleading item is the contrast of China, which does not have much government debt, with the rich countries, that mostly do. These are not unrelated situations. As the piece notes, China has pursued a mercantilist policy of deliberately keeping down the value of its currency in order to make its goods cheaper to people in other countries. This allowed it to increase its exports to the West. (It’s important to note that U.S. corporations have also been major beneficiaries of this policy, taking advantage of low-cost labor to gain a competitive edge and increase profits.)
The flip side of this policy is that the rich countries, most importantly the United States, ran large trade deficits. This created a huge hole in demand. There is no easy mechanism for a market economy to make up this sort of gap in demand, which now passes under the name “secular stagnation.” In the late 1990s the gap was made up with a stock bubble, in the last decade it was made up with a housing bubble. The bursting of these bubbles left nothing other than government budget deficits to fill the demand gap.
As a practical matter, when rich countries have large trade deficits, their choices are bubbles, large budget deficits, or high unemployment. They also could look to redivide work with shorter workweeks and longer vacations. (The standard economic story is that rich countries should have trade surpluses. Capital is supposed to flow from rich countries that have lots of it to poor countries where it is scarce. But economists never have much problem ignoring their theory when its implications prove inconvenient.) In any case, the issue of China’s trade surpluses and rich country government debt are directly related, not independent events.
The NYT ran a confused column by Kwasi Kwarteng, a Conservative member of the U.K.’s parliament, calling for China to adopt the gold standard. The piece has many bizarre claims, most importantly attributing the U.K.’s prosperity in the 19th century and the U.S.’s prosperity in the post-World War II period to the gold standard, as opposed to the strength of their manufacturing sectors and overall economy.
However the most misleading item is the contrast of China, which does not have much government debt, with the rich countries, that mostly do. These are not unrelated situations. As the piece notes, China has pursued a mercantilist policy of deliberately keeping down the value of its currency in order to make its goods cheaper to people in other countries. This allowed it to increase its exports to the West. (It’s important to note that U.S. corporations have also been major beneficiaries of this policy, taking advantage of low-cost labor to gain a competitive edge and increase profits.)
The flip side of this policy is that the rich countries, most importantly the United States, ran large trade deficits. This created a huge hole in demand. There is no easy mechanism for a market economy to make up this sort of gap in demand, which now passes under the name “secular stagnation.” In the late 1990s the gap was made up with a stock bubble, in the last decade it was made up with a housing bubble. The bursting of these bubbles left nothing other than government budget deficits to fill the demand gap.
As a practical matter, when rich countries have large trade deficits, their choices are bubbles, large budget deficits, or high unemployment. They also could look to redivide work with shorter workweeks and longer vacations. (The standard economic story is that rich countries should have trade surpluses. Capital is supposed to flow from rich countries that have lots of it to poor countries where it is scarce. But economists never have much problem ignoring their theory when its implications prove inconvenient.) In any case, the issue of China’s trade surpluses and rich country government debt are directly related, not independent events.
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Earlier in the week the NYT had an editorial decrying the shortage of doctors and proposing routes to address it. (Strangely, bringing in more foreign doctors was not on the list.) Today the paper ran a number of letters responding to the editorial including one from president of the American Medical Association (A.M.A.) discussing its heroic efforts to alleviate the doctor shortage. This is opposite to the reality.
The A.M.A has long supported measures to restrict the number of doctors in order to ensure that the overwhelming majority earn salaries that put them in the top 1-2 percent of workers. This fact can be discovered simply by reading through past New York Times articles. For example, a 1997 article carried the headline “Doctors Assert There are Too Many of Them.” This article reported on the complaints of doctors’ organizations:
“‘The United States is on the verge of a serious oversupply of physicians,’ the A.M.A. and five other medical groups said in a joint statement. ‘The current rate of physician supply — the number of physicians entering the work force each year — is clearly excessive.’
“The groups, representing a large segment of the medical establishment, proposed limits on the number of doctors who enter training programs as residents each year.
“The number of medical residents, now 25,000, should be much lower, the groups said. While they did not endorse a specific number, they suggested that 18,700 might be appropriate.”
Another article, headlined “U.S. to Pay New York Hospitals not to Train Doctors, Easing Glut,” told readers of a plan:
“that health experts greeted as brilliant and bizarre, Federal regulators announced yesterday that for the next six years they would pay New York State hospitals not to train physicians.
“Just as the Federal Government for many years paid corn farmers to let fields lie fallow, 41 of New York’s teaching hospitals will be paid $400 million to not cultivate so many new doctors, their main cash crop.
“The plan’s primary purpose is to stem a growing surplus of doctors in parts of the nation, as well as to save Government money.”
Any discussion of an alleged shortage of doctors in the United States should include an account of the doctors’ efforts to create this shortage to keep their salaries high. It is also striking that, unlike the case of STEM workers, nurses, or farm workers, no one discusses bringing in more foreign doctors to alleviate this shortage. There would be hundreds of thousands, perhaps millions, of foreign physicians who would be happy to train to U.S. standards and work for even half of the pay that doctors get in the United States. This would reduce the cost of health care in the United States, freeing up tens of billions of dollars to be spent in other areas creating hundreds of thousands of jobs.
And, we do know how to ensure that importing more foreign doctors does not hurt health care in the developing world. If the income taxes paid by foreign trained doctors were transferred to their home country, they could easily train 2-3 doctors for every doctor that came to the United States. This would ensure that developing countries gained from this arrangement as well.
It is striking that the same people who eagerly promote removing barriers to imported goods, putting downward pressure on the wages of manufacturing workers, and support bringing in foreign workers to put downward pressure on the wages of nurses and STEM workers seem unable to even conceptualize the possibility of bringing in foreign doctors to alleviate an alleged shortage.
Earlier in the week the NYT had an editorial decrying the shortage of doctors and proposing routes to address it. (Strangely, bringing in more foreign doctors was not on the list.) Today the paper ran a number of letters responding to the editorial including one from president of the American Medical Association (A.M.A.) discussing its heroic efforts to alleviate the doctor shortage. This is opposite to the reality.
The A.M.A has long supported measures to restrict the number of doctors in order to ensure that the overwhelming majority earn salaries that put them in the top 1-2 percent of workers. This fact can be discovered simply by reading through past New York Times articles. For example, a 1997 article carried the headline “Doctors Assert There are Too Many of Them.” This article reported on the complaints of doctors’ organizations:
“‘The United States is on the verge of a serious oversupply of physicians,’ the A.M.A. and five other medical groups said in a joint statement. ‘The current rate of physician supply — the number of physicians entering the work force each year — is clearly excessive.’
“The groups, representing a large segment of the medical establishment, proposed limits on the number of doctors who enter training programs as residents each year.
“The number of medical residents, now 25,000, should be much lower, the groups said. While they did not endorse a specific number, they suggested that 18,700 might be appropriate.”
Another article, headlined “U.S. to Pay New York Hospitals not to Train Doctors, Easing Glut,” told readers of a plan:
“that health experts greeted as brilliant and bizarre, Federal regulators announced yesterday that for the next six years they would pay New York State hospitals not to train physicians.
“Just as the Federal Government for many years paid corn farmers to let fields lie fallow, 41 of New York’s teaching hospitals will be paid $400 million to not cultivate so many new doctors, their main cash crop.
“The plan’s primary purpose is to stem a growing surplus of doctors in parts of the nation, as well as to save Government money.”
Any discussion of an alleged shortage of doctors in the United States should include an account of the doctors’ efforts to create this shortage to keep their salaries high. It is also striking that, unlike the case of STEM workers, nurses, or farm workers, no one discusses bringing in more foreign doctors to alleviate this shortage. There would be hundreds of thousands, perhaps millions, of foreign physicians who would be happy to train to U.S. standards and work for even half of the pay that doctors get in the United States. This would reduce the cost of health care in the United States, freeing up tens of billions of dollars to be spent in other areas creating hundreds of thousands of jobs.
And, we do know how to ensure that importing more foreign doctors does not hurt health care in the developing world. If the income taxes paid by foreign trained doctors were transferred to their home country, they could easily train 2-3 doctors for every doctor that came to the United States. This would ensure that developing countries gained from this arrangement as well.
It is striking that the same people who eagerly promote removing barriers to imported goods, putting downward pressure on the wages of manufacturing workers, and support bringing in foreign workers to put downward pressure on the wages of nurses and STEM workers seem unable to even conceptualize the possibility of bringing in foreign doctors to alleviate an alleged shortage.
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The Washington Post gave us another front page moral hand wringer. A round of treatment of Sovaldi, a new and effective drug for treating Hepatitis C, costs $84,000. With three million people suffering from the disease that comes to $250 billion. Should insurers be required to pay the price? How about government programs like Medicaid?
Yes, that could be a real tough question, but for those not committed to using protectionism to maintain the drug industry’s profits, the answer is simple: trade. Generic versions of Sovaldi are available in India for less than $1,000 a treatment. We can pay to send patients and their families to India and receive the treatment there (in modern facilities) and still save tens of thousands of dollars per patient. The question becomes much simpler if we are talking about something like $10,000 per patient rather than $84,000.
This would of course disrupt the system of supporting research with government-granted patent monopolies, but it is long past time we talked about more efficient ways of financing drug research, even if the drug companies do pay lots of money to advertise in the Washington Post.
The Washington Post gave us another front page moral hand wringer. A round of treatment of Sovaldi, a new and effective drug for treating Hepatitis C, costs $84,000. With three million people suffering from the disease that comes to $250 billion. Should insurers be required to pay the price? How about government programs like Medicaid?
Yes, that could be a real tough question, but for those not committed to using protectionism to maintain the drug industry’s profits, the answer is simple: trade. Generic versions of Sovaldi are available in India for less than $1,000 a treatment. We can pay to send patients and their families to India and receive the treatment there (in modern facilities) and still save tens of thousands of dollars per patient. The question becomes much simpler if we are talking about something like $10,000 per patient rather than $84,000.
This would of course disrupt the system of supporting research with government-granted patent monopolies, but it is long past time we talked about more efficient ways of financing drug research, even if the drug companies do pay lots of money to advertise in the Washington Post.
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The Washington Post told us that homebuilders are having a hard time attracting workers, which is keeping construction of new homes down.
“Labor is scarce. As the housing crisis dragged on, the workers that builders relied on found jobs in other industries, including the energy sector. It’s been tough luring those workers back, Crowe [David Crowe, chief economist for the National Association of Homebuilders] said. Meanwhile, the workers that hung in there are aging, and the industry is having trouble attracting a younger generation.”
When labor is scarce we expect employers to be trying to get workers by raising wages to pull workers away from competitors. This should mean that wages are rising. In fact, real wages in the construction industry have been stagnant for the last three years and are still down by around 3 percent from the peaks hit five years ago.
If no one teaches employers how to raise wages then we are likely to have serious imbalances in the economy for some time into the future.
Note: This was corrected from an earlier version which put the peak as before the recession.
The Washington Post told us that homebuilders are having a hard time attracting workers, which is keeping construction of new homes down.
“Labor is scarce. As the housing crisis dragged on, the workers that builders relied on found jobs in other industries, including the energy sector. It’s been tough luring those workers back, Crowe [David Crowe, chief economist for the National Association of Homebuilders] said. Meanwhile, the workers that hung in there are aging, and the industry is having trouble attracting a younger generation.”
When labor is scarce we expect employers to be trying to get workers by raising wages to pull workers away from competitors. This should mean that wages are rising. In fact, real wages in the construction industry have been stagnant for the last three years and are still down by around 3 percent from the peaks hit five years ago.
If no one teaches employers how to raise wages then we are likely to have serious imbalances in the economy for some time into the future.
Note: This was corrected from an earlier version which put the peak as before the recession.
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Washington Post columnist Charles Lane must have been off the planet or at least out of the country in 2009. In a column on the recent appellate court ruling banning subsidies in the federal exchanges, he tells readers that the Republican obstruction was to be expected given the extreme Democratic positions on the stimulus, cap and trade legislation and the Affordable Care Act:
“Everything might have been different if Democrats and Republicans had operated in a spirit of compromise, the Framers’ hoped-for political solvent.”
If he had been following the debates at the time he would know that Obama asked for an $800 billion stimulus even though his top economic aides told him that he would need at least $1.2 trillion to get the economy back on its feet. He then allowed the Republicans to bargain this down so that the actual stimulus was just over $700 billion (sorry folks, the Alternative Minimum Tax fix doesn’t count as stimulus), with much of that sum going to tax cuts that had less impact than spending increases.
The cap and trade system is a market-based proposal for dealing with greenhouse gas emissions that was supported by many conservatives in academia. It was an alternative to a carbon tax that likely would have a higher cost to corporate emitters. This is also a conservative measure in the sense that it is charging polluters for the damage they cause to others. Our Framers would never have imagined a country in which some people got to freely dump their garbage and sewage on their neighbors’ lawns.
Finally, Obamacare was based on a proposal that came out of the Heritage Foundation. In its fundamental structure it is identical to the proposal signed into law by the Republican governor of Massachusetts and 2012 Republican presidential nominee. Furthermore, Obama worked very hard to pull Republicans on board, agreeing to dozens of amendments put forward by Republican members of Congress and allowing the bill to be tied up for months in the Senate Finance Committee as its chair Max Baucus sought a compromise that would win support from at least some of the Republican members.
In short, on all three of these issues Obama took the path of compromise urged by Lane. With virtual unanimity, the Republicans rejected every effort. As Republican minority leader Mitch McConnell said shortly after President Obama’s election in 2008, his job was to make sure that Obama was a one-term president. For some reason Lane is apparently ignorant of this history.
Washington Post columnist Charles Lane must have been off the planet or at least out of the country in 2009. In a column on the recent appellate court ruling banning subsidies in the federal exchanges, he tells readers that the Republican obstruction was to be expected given the extreme Democratic positions on the stimulus, cap and trade legislation and the Affordable Care Act:
“Everything might have been different if Democrats and Republicans had operated in a spirit of compromise, the Framers’ hoped-for political solvent.”
If he had been following the debates at the time he would know that Obama asked for an $800 billion stimulus even though his top economic aides told him that he would need at least $1.2 trillion to get the economy back on its feet. He then allowed the Republicans to bargain this down so that the actual stimulus was just over $700 billion (sorry folks, the Alternative Minimum Tax fix doesn’t count as stimulus), with much of that sum going to tax cuts that had less impact than spending increases.
The cap and trade system is a market-based proposal for dealing with greenhouse gas emissions that was supported by many conservatives in academia. It was an alternative to a carbon tax that likely would have a higher cost to corporate emitters. This is also a conservative measure in the sense that it is charging polluters for the damage they cause to others. Our Framers would never have imagined a country in which some people got to freely dump their garbage and sewage on their neighbors’ lawns.
Finally, Obamacare was based on a proposal that came out of the Heritage Foundation. In its fundamental structure it is identical to the proposal signed into law by the Republican governor of Massachusetts and 2012 Republican presidential nominee. Furthermore, Obama worked very hard to pull Republicans on board, agreeing to dozens of amendments put forward by Republican members of Congress and allowing the bill to be tied up for months in the Senate Finance Committee as its chair Max Baucus sought a compromise that would win support from at least some of the Republican members.
In short, on all three of these issues Obama took the path of compromise urged by Lane. With virtual unanimity, the Republicans rejected every effort. As Republican minority leader Mitch McConnell said shortly after President Obama’s election in 2008, his job was to make sure that Obama was a one-term president. For some reason Lane is apparently ignorant of this history.
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Economists and economic reporters continually try to make the problem of the weak economy and prolonged downturn appear more complicated than it is. After all, if it is very simple then these people would look foolish for not having seen it coming and figuring out a way around this catastrophe. Fortunately for us, if unfortunate for them, it is simple.
One of the efforts to make it more complex than necessary is to assign an outsized role to the debt associated with the collapse of house prices. This is the argument that we heard on Morning Edition this morning. The argument is that when house prices plunged after the housing bubble burst in 2007, homeowners were left with large amounts of debt, pushing many of them underwater. This debt supposed discouraged them from spending, leading to a sharp falloff in consumption.
There is a big problem with this story. Consumption is not low, it is actually still quite high. The graph below shows consumption as a share of GDP. It is actually higher than during the bubble years and essentially at an all-time peak. That makes it a bit hard to explain the downturn by weak consumption. (Some folks may recall hand wringing about inadequate savings for retirement, as in this NYT column by Gene Sperling yesterday. Too little savings and too little consumption are 180 degree opposite problems, sort of like being too heavy and too thin.)
There would be a modest decline in consumption from the peak bubble years if it was shown as a share of disposable income (tax collections are lower today than in 2004-2007), but it would stiill be unusually high by this measure. The basic story is straightforward. The run-up in house prices created by the bubble created $8 trillion in housing bubble wealth. Standard estimates of the housing wealth effect suggest that this would increase annual consumption by 5-7 percent of this amount, or $400 billion to $560 billion a year. This would have been equal to 3-4 percent of GDP.
When the bubble burst this wealth effect went into reverse, with people cutting back consumption in line with their loss of wealth. The consumption share of GDP did not fall both because GDP fell and also there was a sharp drop in tax collection due to both tax cuts and simply the drop in income. The fact that people had debt may have made some difference, but it was really secondary to the loss of wealth. If a homeowner owed $100,000 on a home whose price dropped from $300,000 to $200,000 (leaving them with $100,000 in equity), we would expect them to cut back annual consumption on average by between $5,000 and $7,000.
If the homeowner owed $250,000 on this house, so the drop in price left them $50,000 underwater, then their decline in annual consumption may be somewhat greater, but this difference would have a relatively modest impact on the economy as a whole. To see why this almost certainly has to be the case, consider that the median income for homeowners is around $70,000. How much do we think their consumption could have fallen from bubble peaks? If we say they fell by an additional $3,500 because of being indebted (beyond the housing wealth effect) and multiply by 10 million underwater homeowners, that gets us $35 billion a year. If we plug in a multiplier of 1.5 that gets us to $52.5 billion a year or a bit over 0.3 percentage points of GDP. That won’t explain much of the downturn.
Again, the story of the downturn is simple, too bad the economists missed it.
Note: Typos corrected.
Addendum:
I have a few quick points after reading the comments. First, the wealth effect is based on equity net of mortgage debt. This is people’s wealth. If the argument is that people’s debt rose relative to their equity when the bubble burst, then this is simply a wealth effect story. For there to be a point to the argument, there has to be some importance to the fact that people actually had negative equity. And to see the significance of the numbers I used, suppose the underwater homeowners’ consumption had been on average $3,500 higher each year since 2008. We are now in the 7th year, so in this case, that would have translated into a cumulative increase in spending of close to $24,000. If we assume that these people have been spending close to all of their income, this means a cumulative increase in debt of close to $24,000. Even if these people were marginally above water, as opposed to underwater, in their mortgages, who would have lent them an additional $24k? I just don’t see this one as making any sense.
There were some questions raised about whether we “need” more consumption. We need more demand to get to full employment (unless we redivide work), which could come in part or entirely through consumption. But the question is not whether more consumption, or as I wrote the other day more investment, would be good for the economy. The question is whether to believe that the economy would generate more consumption or investment. The answer in this case and the previous case with investment is no.
The basic point is that we have an enormous demand gap created by the trade deficit. The current deficit amounts to $500 billion in annual demand (3 percent of GDP) that is going elsewhere rather than creating growth and jobs in the United States. There is no magical process through which the economy will replace this demand. We can do it with large amounts of government spending, but this is blocked politically. That leaves getting the trade deficit down, most obviously by lowering the value of the dollar, as the only route back to full employment or something like it.
Economists and economic reporters continually try to make the problem of the weak economy and prolonged downturn appear more complicated than it is. After all, if it is very simple then these people would look foolish for not having seen it coming and figuring out a way around this catastrophe. Fortunately for us, if unfortunate for them, it is simple.
One of the efforts to make it more complex than necessary is to assign an outsized role to the debt associated with the collapse of house prices. This is the argument that we heard on Morning Edition this morning. The argument is that when house prices plunged after the housing bubble burst in 2007, homeowners were left with large amounts of debt, pushing many of them underwater. This debt supposed discouraged them from spending, leading to a sharp falloff in consumption.
There is a big problem with this story. Consumption is not low, it is actually still quite high. The graph below shows consumption as a share of GDP. It is actually higher than during the bubble years and essentially at an all-time peak. That makes it a bit hard to explain the downturn by weak consumption. (Some folks may recall hand wringing about inadequate savings for retirement, as in this NYT column by Gene Sperling yesterday. Too little savings and too little consumption are 180 degree opposite problems, sort of like being too heavy and too thin.)
There would be a modest decline in consumption from the peak bubble years if it was shown as a share of disposable income (tax collections are lower today than in 2004-2007), but it would stiill be unusually high by this measure. The basic story is straightforward. The run-up in house prices created by the bubble created $8 trillion in housing bubble wealth. Standard estimates of the housing wealth effect suggest that this would increase annual consumption by 5-7 percent of this amount, or $400 billion to $560 billion a year. This would have been equal to 3-4 percent of GDP.
When the bubble burst this wealth effect went into reverse, with people cutting back consumption in line with their loss of wealth. The consumption share of GDP did not fall both because GDP fell and also there was a sharp drop in tax collection due to both tax cuts and simply the drop in income. The fact that people had debt may have made some difference, but it was really secondary to the loss of wealth. If a homeowner owed $100,000 on a home whose price dropped from $300,000 to $200,000 (leaving them with $100,000 in equity), we would expect them to cut back annual consumption on average by between $5,000 and $7,000.
If the homeowner owed $250,000 on this house, so the drop in price left them $50,000 underwater, then their decline in annual consumption may be somewhat greater, but this difference would have a relatively modest impact on the economy as a whole. To see why this almost certainly has to be the case, consider that the median income for homeowners is around $70,000. How much do we think their consumption could have fallen from bubble peaks? If we say they fell by an additional $3,500 because of being indebted (beyond the housing wealth effect) and multiply by 10 million underwater homeowners, that gets us $35 billion a year. If we plug in a multiplier of 1.5 that gets us to $52.5 billion a year or a bit over 0.3 percentage points of GDP. That won’t explain much of the downturn.
Again, the story of the downturn is simple, too bad the economists missed it.
Note: Typos corrected.
Addendum:
I have a few quick points after reading the comments. First, the wealth effect is based on equity net of mortgage debt. This is people’s wealth. If the argument is that people’s debt rose relative to their equity when the bubble burst, then this is simply a wealth effect story. For there to be a point to the argument, there has to be some importance to the fact that people actually had negative equity. And to see the significance of the numbers I used, suppose the underwater homeowners’ consumption had been on average $3,500 higher each year since 2008. We are now in the 7th year, so in this case, that would have translated into a cumulative increase in spending of close to $24,000. If we assume that these people have been spending close to all of their income, this means a cumulative increase in debt of close to $24,000. Even if these people were marginally above water, as opposed to underwater, in their mortgages, who would have lent them an additional $24k? I just don’t see this one as making any sense.
There were some questions raised about whether we “need” more consumption. We need more demand to get to full employment (unless we redivide work), which could come in part or entirely through consumption. But the question is not whether more consumption, or as I wrote the other day more investment, would be good for the economy. The question is whether to believe that the economy would generate more consumption or investment. The answer in this case and the previous case with investment is no.
The basic point is that we have an enormous demand gap created by the trade deficit. The current deficit amounts to $500 billion in annual demand (3 percent of GDP) that is going elsewhere rather than creating growth and jobs in the United States. There is no magical process through which the economy will replace this demand. We can do it with large amounts of government spending, but this is blocked politically. That leaves getting the trade deficit down, most obviously by lowering the value of the dollar, as the only route back to full employment or something like it.
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It’s understandable that conservatives would like to say that their arguments are based on deeply held convictions, as opposed to crass self interest, but it’s difficult to understand why liberals feel the need to help them make this argument. Jonathan Cohn is the guilty party today. In his Q.E.D. section in the New Republic, a segment discussing the appellate court ruling on Obamacare tells readers:
“But the motives of Republican leaders, like the motives of the individuals who thought up these lawsuits, are no mystery. As I noted yesterday , they simply don’t believe in universal health care. They don’t believe it’s the job of government to make sure every person can pay for medical care without going bankrupt.”
Let’s try an alternative. Suppose they don’t have deep convictions about universal health care insurance, but do have deep convictions about money leaving the pockets of rich people. Of course taxes were raised on the rich to cover part of the cost of subsidies in the exchanges.
Suppose also they like a cheap docile labor force. The type that fears unemployment and also needs a full-time job just to get health care insurance. (This makes it easier to get good help.)
In this respect it is worth noting that the number of people working part-time by choice has increased by 800,000 over the last year. This is consistent with a story where people who don’t need to work full-time to get health care insurance will work less. This is great news for workers and bad news for “it’s hard to get good help” crowd.
If my suppositions are true then the Republican leaders would hate Obamacare even if they never gave a thought to universal health care and the government’s obligations to individuals. It’s a question of taking money from rich people, end of story.
Okay, neither Jonathan nor I know the inner motives of Republican leaders which is probably why it’s best to avoid making assertions about them, but I see no reason to believe that his explanation is more plausible than mine.
It’s understandable that conservatives would like to say that their arguments are based on deeply held convictions, as opposed to crass self interest, but it’s difficult to understand why liberals feel the need to help them make this argument. Jonathan Cohn is the guilty party today. In his Q.E.D. section in the New Republic, a segment discussing the appellate court ruling on Obamacare tells readers:
“But the motives of Republican leaders, like the motives of the individuals who thought up these lawsuits, are no mystery. As I noted yesterday , they simply don’t believe in universal health care. They don’t believe it’s the job of government to make sure every person can pay for medical care without going bankrupt.”
Let’s try an alternative. Suppose they don’t have deep convictions about universal health care insurance, but do have deep convictions about money leaving the pockets of rich people. Of course taxes were raised on the rich to cover part of the cost of subsidies in the exchanges.
Suppose also they like a cheap docile labor force. The type that fears unemployment and also needs a full-time job just to get health care insurance. (This makes it easier to get good help.)
In this respect it is worth noting that the number of people working part-time by choice has increased by 800,000 over the last year. This is consistent with a story where people who don’t need to work full-time to get health care insurance will work less. This is great news for workers and bad news for “it’s hard to get good help” crowd.
If my suppositions are true then the Republican leaders would hate Obamacare even if they never gave a thought to universal health care and the government’s obligations to individuals. It’s a question of taking money from rich people, end of story.
Okay, neither Jonathan nor I know the inner motives of Republican leaders which is probably why it’s best to avoid making assertions about them, but I see no reason to believe that his explanation is more plausible than mine.
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Neil Irwin argues the case that a rise in investment would provide a much needed boost to the economy. The point is well-taken, but there is little reason to expect a marked upturn any time soon.
The basic story is, while there is some room for investment to expand, it is not especially low by historical standards. Non-residential fixed investment was 12.2 percent of GDP in 2013. This compares to an average of 12.8 percent of GDP in the years from 1970 to 2007. Irwin reports a larger gap by just focusing on investment in equipment, citing Justin Lahart pointing to spending equal to 5.2 percent of GDP over the last five years compared to 6.5 percent of GDP over the prior 50 years.
There are a few reasons for questioning the significance of this comparison. First, the figure for 2013 was 5.6 percent of GDP, which is closer to the 50-year average. Second, there has been a huge increase in investment in intellectual property products. This spending was 3.8 percent of GDP in 2013 compared to an average of 2.6 percent from 1970 to 2007. To some extent investment in intellectual property products should be a substitute for investment in equipment.
Finally, much of the investment in equipment is occurring overseas as U.S. corporations continue to shift production to Mexico, China, and other sources of low-cost labor. Equipment investment in the last recovery (2002-2007) averaged just 6.0 percent of GDP.That would likely be a more appropriate comparison than the longer period since it was also a time when U.S. corporations were shifting production abroad on a large scale. This implies relatively little increase in investment spending from current levels.
Trade really is the underlying problem that economists do not want to discuss for some reason. The country has a trade deficit of more than $500 billion annually (3 percent of GDP). This translates into demand that is going overseas rather than the United States. There is no easy mechanism to replace this demand (other than verboten government budget deficits). This means that we will likely see an underemployed economy long into the future. Hopes for a surge in investment will prove to be in vain.
Neil Irwin argues the case that a rise in investment would provide a much needed boost to the economy. The point is well-taken, but there is little reason to expect a marked upturn any time soon.
The basic story is, while there is some room for investment to expand, it is not especially low by historical standards. Non-residential fixed investment was 12.2 percent of GDP in 2013. This compares to an average of 12.8 percent of GDP in the years from 1970 to 2007. Irwin reports a larger gap by just focusing on investment in equipment, citing Justin Lahart pointing to spending equal to 5.2 percent of GDP over the last five years compared to 6.5 percent of GDP over the prior 50 years.
There are a few reasons for questioning the significance of this comparison. First, the figure for 2013 was 5.6 percent of GDP, which is closer to the 50-year average. Second, there has been a huge increase in investment in intellectual property products. This spending was 3.8 percent of GDP in 2013 compared to an average of 2.6 percent from 1970 to 2007. To some extent investment in intellectual property products should be a substitute for investment in equipment.
Finally, much of the investment in equipment is occurring overseas as U.S. corporations continue to shift production to Mexico, China, and other sources of low-cost labor. Equipment investment in the last recovery (2002-2007) averaged just 6.0 percent of GDP.That would likely be a more appropriate comparison than the longer period since it was also a time when U.S. corporations were shifting production abroad on a large scale. This implies relatively little increase in investment spending from current levels.
Trade really is the underlying problem that economists do not want to discuss for some reason. The country has a trade deficit of more than $500 billion annually (3 percent of GDP). This translates into demand that is going overseas rather than the United States. There is no easy mechanism to replace this demand (other than verboten government budget deficits). This means that we will likely see an underemployed economy long into the future. Hopes for a surge in investment will prove to be in vain.
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The Washington Post had an interesting piece reporting on how many young couples are putting off having children for economic reasons. At one point the piece told readers:
“Births have slowed so sharply that researchers note that future economic growth could be stunted by a smaller labor pool. Immigration is often seen as a fix. But the downturn crimped supply lines for both babies and new foreign faces. The change was so dramatic that the Census Bureau in 2012 was forced to revise the 2050 U.S. population projection it made just four years earlier, dropping it by 9 percent, to just under 400 million.”
Contrary to the impression given by this paragraph, the prospect of slower population growth should be good news for most people. It is likely to mean a relatively smaller labor supply, and therefore higher wages for most workers. It will also mean less strain on the infrastructure and on natural resources. In other words, smaller traffic jams and less crowded beaches and parks. It also will be easier to contain greenhouse gas emissions with a smaller population.
The only people who are likely to be hurt by the prospects of a smaller population are the “it’s hard to find good help” crowd, since they will likely have to pay more for people they hire to clean their houses, mow their lawns, and care for the kids. Since more people do such work than pay for such work, most people will end up as winners with slower population growth.
The Washington Post had an interesting piece reporting on how many young couples are putting off having children for economic reasons. At one point the piece told readers:
“Births have slowed so sharply that researchers note that future economic growth could be stunted by a smaller labor pool. Immigration is often seen as a fix. But the downturn crimped supply lines for both babies and new foreign faces. The change was so dramatic that the Census Bureau in 2012 was forced to revise the 2050 U.S. population projection it made just four years earlier, dropping it by 9 percent, to just under 400 million.”
Contrary to the impression given by this paragraph, the prospect of slower population growth should be good news for most people. It is likely to mean a relatively smaller labor supply, and therefore higher wages for most workers. It will also mean less strain on the infrastructure and on natural resources. In other words, smaller traffic jams and less crowded beaches and parks. It also will be easier to contain greenhouse gas emissions with a smaller population.
The only people who are likely to be hurt by the prospects of a smaller population are the “it’s hard to find good help” crowd, since they will likely have to pay more for people they hire to clean their houses, mow their lawns, and care for the kids. Since more people do such work than pay for such work, most people will end up as winners with slower population growth.
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