Monthly Archives: January 2013

The Fiscal Outlook

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From a Treasury publication called the Financial Report of the U.S. Government.

The projections in this Report indicate that current policy is not sustainable. The debt-to-GDP ratio is projected to reach 395 percent in 2087 and to rise continuously thereafter. Preventing the debt-to-GDP ratio from rising over the next 75 years is estimated to require some combination of spending reductions and revenue increases that amount to 2.7 percent of GDP over the period. While this estimate of the “75-year fiscal gap” is highly uncertain, current fiscal policies cannot be sustained indefinitely.

It is important to address the Government’s fiscal imbalances soon. Delaying action increases the magnitude of spending reductions and/or revenue increases necessary to stabilize the debt-to-GDP ratio. Relative to a reform that begins immediately, for example, it is estimated that the magnitude of reforms necessary to close the 75-year fiscal gap is nearly 20 percent larger if reforms are delayed by just ten years, and more than 50 percent larger if reform is delayed 20 years.

Thanks to James Pethokoukis for the pointer.

The Treasury report says that its projections show that the primary deficit (excluding interest payments) is

projected to fall rapidly between 2013 and 2018 as the economy recovers and spending reductions called for in the Budget Control Act of 2011 (BCA) take effect, reaching primary balance in 2018 and remaining relatively flat and near zero through 2021. Between 2022 and 2039, however, increased spending for Social Security and health programs due to continued aging of the population and anticipated rising health costs is expected to cause the primary balance to steadily deteriorate and reach 2.3 percent of GDP in 2039. After 2039, the primary deficit-to-GDP ratio slowly declines to 1.7 percent as the impact of the baby boom generation retiring dissipates.

A couple of questions.

1. In order in order to avoid the “fiscal cliff”, did Congress effectively override the BCA? (This is not a rhetorical question. I genuinely wonder whether the BCA should still be considered operative.)

2. Although economic growth helps the primary deficit, will it help the overall deficit? The conventional macro view would suggest that as the economy recovers, real interest rates will rise. Because debt is now high, a rise in real interest rates really makes a difference to the interest burden.

College Sports

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Jordan Weissmann writes,

there are hundreds of colleges in this country where, in the face of ever shrinking state funding, administrators are choosing to spend millions on sports programs with only the faintest hope that they’ll one day see a return on their investment other than the dubious intangible benefits of having a few second-rate sports squads around to keep up school spirit. Moreover, they’re spending more on those programs every year. Even if athletics only make up a relatively small fraction of their overall budgets, this seems like a place where more of higher ed needs to think about cutting.

Why do alumni support donate money for sports teams?

I understand that sports loyalty can be an accidental phenomenon. The fact that I grew up in the St. Louis area made me a fan of the Cardinals baseball team. There are millions of Cardinal fans out there. I bet that you cannot find one who has donated money to the team.

There are many features of popular entertainment in America leave me personally unmoved. But probably the strangest one of all is college sports, particularly Division I football and basketball. Why they are so much more salient to people than minor league baseball is something that is very hard for me to understand.

Mortgage Narrative vs. Reality

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Two papers from the research department at the Boston Fed.

1. Christopher L. Foote, Kristopher S. Gerardi, and Paul S. Willen write,

Borrowers
Borrowers did get adjustable-rate mortgages but the resets of those mortgages did not cause the wave of defaults that started the crisis in 2007. Indeed, to a first approximation, “exploding” mortgages played no role in the crisis at all. Arguments that deceit by investment bankers sparked the crisis are also hard to support. Compared to most investments, mortgage-backed securities were highly transparent and their issuers willingly provided a great deal of information to potential purchasers. These purchasers could and did use this information to measure the amount of risk in mortgage investments and their analysis was accurate, even ex post. Mortgage intermediaries retained lots of skin in the game. In fact, it was the losses of these intermediaries—not mortgage outsiders—that nearly brought down the financial system in late 2008. The biggest winners of the crisis, including hedge fund managers John Paulson and Michael Burry, had little or no previous experience with mortgage investments until some strikingly good bets on the future of the U.S. housing market earned them billions of dollars.

Why then did borrowers and investors make so many bad decisions? We argue that any story consistent with the 12 facts must have overly optimistic beliefs about house prices at its center.

2. Kristopher Gerardi, Lauren Lambie‐Hanson, and Paul S. Willen write,

many borrowers
languish in persistent delinquency, in which they neither cure their defaults nor lose their homes to foreclosure. In short, judicial intervention succeeds in temporarily reducing foreclosure by increasing the incidence of persistent delinquency. We show that persistently delinquent borrowers are unlikely to cure and that most eventually experience foreclosure. Over time, the foreclosure gap between judicial and power-of-sale states shrinks whereas the cure gap, or lack thereof, stays exactly the same. In other words, in the long run, a given number of defaults is expected to yield the same number of foreclosures regardless of the laws. These borrower-protection laws do not prevent foreclosure, they merely delay it.

My take on this is that attempts to prevent foreclosure merely set borrowers up to fail again. This raises the cost to lenders.

The problem with both of these papers is that they contradict the oppressed-oppressor narrative. The first paper says that borrowers and investors did not have bad mortgages foisted upon them by evil banks. Instead, everyone involved made assumptions about home prices that proved to be erroneous. The second paper says that treating delinquent borrowers as oppressed and trying to relieve the oppression with leniency is counterproductive.

Seeing Broadband Like a State

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A commenter on my post on Why Large corporations? asks

Any thoughts on subscription tv and/or broadband service? There are obviously economies of scale for the providers. But, how does that impact consumers?

I think it is relatively easy to tell a story in which the state prefers less competition. For one thing, they can tax the heck of out of broadband service. For another, the process of awarding cable franchises fattened many a local politician’s wallet, because the rent-seeking behavior was so heavy.

Technically, I believe it is possible to imagine a world in which spectrum is not allocated to specific uses. Instead, devices are designed to share spectrum, automatically roaming to find the best available band on which to communicate. This approach would take the FCC totally out of the picture. It might allow wireless broadband Internet access without people having to sign up for service from a big telecom company. Not surprisingly, the FCC is not pushing this. From a political perspective, the status quo is much preferable.

Look, maybe I am paranoid. I picked up on the Open Spectrum idea years ago from lefty-techies, and as far as I know they have not backed away from their view that this approach to spectrum usage is feasible. If they are correct, then broadband Internet might very well be a poster child for an industry where large corporations emerge because of government policy rather than any inherent efficiency.

The Non-WPA

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Richard Vedder writes,

Why are Americans working less? While there are a number of factors, the phenomenon is due mainly to a variety of public policies that have reduced the incentives to be employed.

He goes on to cite increased use of food stamps, disability, Pell Grants, and extended unemployment benefits.

I might dub this the non-WPA. Paul Krugman and others talk about reviving the Works Progress Administration, which built public works projects in the 1930s. But would anybody even take those jobs today? With all the other options to get by without working, how many people would be willing to travel to the site of a government construction job and pick up a shovel?

The Recession and World Trade

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From the DHL Global Connectedness Index 2012.

The Netherlands retains the top rank on this year’s DHL Global Connectedness Index, and 9 of the 10 most connected countries are in Europe.

Pointer from Timothy Taylor. (How does he find these things?) Taylor writes,

Globalization is near an all-time high by this measure [world exports of goods and services divided by world GDP], but notice that it after the drop associated with the Great Recession, this measure of globalization is about the same in 2011 as it was in 2007.

It is not clear why a statistic with GDP in the denominator should experience a drop during a recession. However, my guess is that the answer has to do with the location of the recession. If some emerging economies continued growing while Europe slumped, one would observe world GDP holding up better than world trade.

From a PSST perspective, all GDP is trade. Some of it is intra-border and some of it is cross-border. Trade patterns that were based on unsustainable conditions, primarily inefficient firms remaining in business, were broken by the conditions that emerged in 2008. Firms go out of business all the time. All the time, new businesses are starting and some are growing. I take the view that since 2008 an unusually large number of troubled firms failed and unusually small number of high-growth businesses emerged. To me, calling this a decline in aggregate demand is begging the question–it is simply putting another label on the phenomenon, not explaining it. It could be that stress at banks is a cause of it, but I think instead that it is a symptom. But that leaves me struggling to tell a story that accounts for the sudden, sharp drop in GDP that took place in 2008-2009.

Seeing Like a Central Bank

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Tyler Cowen writes,

Eurogeddon is here, as a variety of countries have situations worse, in relative terms, than the Great Depression of the 1930s. It seems the bailout funds, especially the ESM, have given up on the notion of detaching sovereign and bank liabilities from each other. The so-called banking union is at best a common supervisor rather than real risk-sharing for deposit liabilities. The fact that we don’t have daily bond market crises, filling up my Twitter feed, is certainly welcome but constitutes a remarkable lowering of the bar for what success means.

What Tyler calls a “low bar” is in fact that same bar that central banks have always used. If the banks are not in crisis and the bond market is orderly, then everything is fine.

Recently, there were news stories in which AIG was considering joining a lawsuit against the government over loss of its value from the actions of the government during the financial crisis. Lawmakers talked AIG out of joining, but AIG may have had a case. The “AIG bailout” was arguably mis-named. In retrospect, it looks much more like a bailout of Goldman Sachs (and many other large banks, domestic and foreign), financed by the sale of some profitable AIG subsidiaries. From the vantage point of the central bank, that was good policy.

I would encourage economists to consider revising their model of central banks. The model in which the central bank is concerned primarily with inflation and/or unemployment is not necessarily the most predictive. What a central bank sees are banks and financial markets. When there are in turmoil, the central bank sees a need to act. When they are not in turmoil, the central bank is going to be in the mode of “It ain’t broke, don’t fix it.”

This model of central banking is what leads me to expect that, when push comes to shove, the Fed will tolerate much more inflation than most people think. Consider a scenario in which investors start to lose confidence in the ability of the U.S. government to get deficits under control. (This is the opposite of the crisis du jour, which is an artificial concern that Washington might stop living so far beyond its means.) Under such a scenario, bond interest rates soar. The Fed’s first priority will be to maintain an “orderly” bond market. They will do this by printing money to buy bonds. At that point, it will not matter whether inflation and nominal GDP are running above or below target. Inflation could already be high and rising, but if the bond market is in turmoil, seeing like a central bank will lead you to print more money.

Have a Nice Day

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This year’s Edge Question is what people should worry about. John Tooby answers,

The average G-type star shows a variability in energy output of around 4%. Our sun is a typical G-type star, yet its observed variability in our brief historical sample is only 1/40th of this. When or if the Sun returns to more typical variation in energy output, this will dwarf any other climate concerns.

Tooby has these observations:

The mind is designed to balance these two functions: coordinating with reality, and coordinating with others. The larger the payoffs to social coordination, and the less commonly beliefs are tested against reality, then the more social demands will determine belief—that is, network fixation of belief will predominate…

Because intellectuals are densely networked in self-selecting groups whose members’ prestige is linked (for example, in disciplines, departments, theoretical schools, universities, foundations, media, political/moral movements, and other guilds), we incubate endless, self-serving elite superstitions, with baleful effects: Biofuel initiatives starve millions of the planet’s poorest. Economies around the world still apply epically costly Keynesian remedies despite the decisive falsification of Keynesian theory by the post-war boom (government spending was cut by 2/3, 10 million veterans dumped into the labor force, while Samuelson predicted “the greatest period of unemployment and industrial dislocation which any economy has ever faced”). I personally have been astonished over the last four decades by the fierce resistance of the social sciences to abandoning the blank slate model in the face of overwhelming evidence that it is false. As Feynman pithily put it, “Science is the belief in the ignorance of experts.”

Geoffrey Miller is worried about our potential reaction to what he sees as a successful eugenics program in China. Robert Kurzban worries that a main side-effect of this policy, an excess of males in China, will result in increased violence. (Separately, a study looks at possible adverse psychological consequences of widespread absence of sibling.s) Douglas T. Kenrick worries that meanwhile, back at home, we are on the way toward Idiocracy. [UPDATE: Jason Collins comments.]

Thomas Metzinger worries about a sudden expansion of synthetic illegal drugs. I was struck by this response, because it was both unexpected and well supported by evidence.

Dylan Evans worries that democracy may be too stable.

there may be better forms of political organization that we can aspire to. But the spread of democracy may actually make it harder to discover these alternatives. The mechanism of voting tends to anchor society in the political middle ground. The resulting social stability has obvious advantages, in that it helps guard against political extremism. But it has less understood disadvantages too. In particular, it hinders the development of better political systems.

He sounds like he is making a plug for Thousand Nations.

Overall, I thought that the ratio of cute, trying-to-sound clever answers, as opposed to interesting answers, was much higher than in previous years.

A Defensive Question

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The IGM expert panel is asked whether they agree with

Because all federal spending and taxes must be approved by both houses of Congress and the executive branch, a separate debt ceiling that has to be increased periodically creates unneeded uncertainty and can potentially lead to worse fiscal outcomes.

Almost nobody disagrees, so I will not argue. Instead, let me propose a defensive question. Ask the experts to agree or disagree with the following:

Because the ratio of debt to GDP cannot keep growing indefinitely, the failure of the executive branch and the Senate to offer a sustainable long-term Budget creates unneeded uncertainty and can potentially lead to worse fiscal outcomes.

I would venture to suggest that this is a more serious source of uncertainty and political friction than the debt ceiling.

I also would venture to offer this guide to budget politics: those who maximize the symbolic significance of short-term budget controversies do so in order to avoid acting on the long-term problem.

Why Large Corporations?

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In a comment on an earlier post, Ajay asks,

what is the point of a large corporation in the first place?

Some possibilities:

1. Governments want them. Surely, from a “seeing like a state” perspective it is better to have large corporations that are dependent on favors than small firms that are not.

2. There are genuine economies of scale and scope, including network effects.

3. Workers believe that they are more secure working for large corporations, and they are willing to take less compensation as a result. Note that this sort of belief could be self-fulfilling. Note also that it is not terribly consistent with the data: compensation appears to be higher at large firms, although that comparison assumes that the investigator’s idea of objective value of workers is more meaningful than their actual choices.

Think about Google. It needs to retrieve, store, and process huge amounts of data. There are scale economies. Once you have that data, you can benefit from other data, so you want to expand into email, location services, social networking, phones, and anything else that generates data. So there are economies of scope as well.

Maybe that is an exceptional case.

My tendency is to think that economies of scale are fairly common, but economies of scope are relatively rare. I understand big companies that specialize in a relatively narrow capability–something like Fedex, for example. I am less convinced about organizations that branch into many functions, like universities or large financial firms.

When I re-read what I wrote on this topic fifteen years ago, I see that my views have not moved very much.