Monthly Archives: June 2013

The FHA Has No Clothes

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So says Joseph Gyourko.

I propose replacing FHA with a new subsidized savings program that provides matches of qualified households’ savings. The goal would be to help those households achieve a 10 percent down payment on the home they wish to purchase.

Of course, the interest groups that benefit from the current FHA will dominate the political discussion and smother this idea. But I still think it is worth articulating good policy proposals, in spite of the interest-group politics. If nothing else, this exposes the importance of public-choice considerations.

Investment and Employment

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Reacting to my post on capital-labor substitution, reader points me to this analysis.

This excess rise in the capital-labor ratio highlights the negative effect of Federal Reserve
policy on wages and unemployment. The persistent, extremely low interest rates are
keeping real wages from climbing and retarding the rate of hiring. The Federal Reserve is
making unemployment worse than it has to be.

Putting on my macro hat, I would say that we are talking about too many endogenous variables here, meaning variables that depend on what is happening to other variables. The capital-labor ratio depends on investment and on hiring decisions. The real interest rate depends on supply and demand factors in the capital market. And so on.

In general, when investment is high, you might expect the demand for labor to be high. This could be because capital and labor are complementary. Even more, from a textbook Keynesian perspective, investment is spending, spending is economic activity, and more economic activity means more employment. The late 1990s exemplify this, with strong investment and a high ratio of employment to population.

Again, from a Keynesian perspective, one expects in a slump that hiring will be low, investment will be low, and real interest rates will be low. All of these are endogenous to whatever caused the slump.

Now, let me put on a PSST hat, meaning that I look at the economy entirely from a structural perspective, not from a Keynesian perspective. I would say that for the past fifteen years, we have seen both capital-labor substitution and factor-price equalization. Both of these require a reallocation of labor. This is not taking place very quickly. What are the reasons? Some possibilities:

1. Weak incentives for the unemployed to take jobs that require a loss of status or an adverse relocation. Older unemployed people can collect disability. Younger unemployed people can live with their parents.

2. Unusually few fast-growing firms. Perhaps entrepreneurs are not finding ideas that pan out. Perhaps when things pan out they are finding ways to grow quickly without adding thousands of workers (think of Internet businesses).

3. Perhaps the labor-leisure choice is being driven by attitudes about health insurance. If you really care a lot about health insurance, you take a job, even if you think that the take-home pay is barely worth it. The same deal gets turned down by someone who does not value health insurance. With the health insurance component of compensation so high these days, this can be important.

Deirdre McCloskey Spoke

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at this event. Here are my reactions to a few things.

1. She suggested that we should replace the term “capitalism” with “market-tested innovation and supply.” I like the term market-tested innovation. I can understand why she wants to add “and supply,” but that phrase may not in fact help so much. But innovation contrasts nicely with stasis or suppression of innovation. And market-tested contrasts nicely with government as an institution.

2. She suggested that starting in about 1848, four bad ideas grew: nationalism, socialism, imperialism, and eugenics. Obviously, this is a neat way to explain the disasters of the first half of the 20th century. But what (if anything) is holding us back today? After all, nationalism, imperialism, and eugenics are all unpopular with elites, and socialism has a lot of baggage with it. Are we beset by new bad ideas? If so, what are they?

3. Her story for the Industrial Revolution is that England became exceptional by bestowing dignity on all men, most notably merchants. She used the example of the word “honest.” In the 16th century, this was a term that might be applied only to someone of an elite class, such as an aristocrat or warrior. It meant someone who lived up to the expectations of that class. By the late 18th century, anyone could be described as “honest.” It meant, as it does today, someone who keeps their commitments and whose word can be trusted.

I have just finished America 3.0, by James Bennett and Michael Lotus. Their view is that Anglo-Saxon exceptionalism goes back 1000 years, and that it consists of the elevation of the nuclear family structure. This might explain why the Industrial Revolution took place where it did. It does not explain the timing.

McCloskey would explain the timing in terms of the English adopting a more small-d democratic outlook. I guess I will have to read more of her work to get the story of how and why this adoption took place.

4. An issue that came up is why it is that so few economists take the view that ideas matter in explaining differences in living standards. Cultures that encourage innovation do well, and other cultures do not. Instead, economists have an easier time focusing on endowments, meaning available resources, which turn out to explain very little. The next fallback for economists is institutions, which McCloskey thinks are over-rated as explanatory variables. She said that trying to pour better institutions into bad economies is as futile as trying to pour in dams and other capital projects.

This is, of course, a very lively debate. The institutionalists will focus on poster-child comparisons, like North Korea vs. South Korea, or Hong Kong and Singapore vs. other Asian countries. Those who belittle institutions will point to the failed attempt to “nation-build” Iraq. Don’t look for this to be settled any time soon.

In any event, I think it is fair to say that economists are caught up in the project to do social science, meaning looking at material and quantifiable factors as explanatory variables. Also, I am starting to think that there are positive feedback loops between certain professions and politicians. In journalism and economics, the selection pressures may work against those of us whose ideas lead to skepticismm toward political power.

At another event, Art Carden introduced her.

The Stock Market

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Even after yesterday’s 2-1/2 percent drop, the S&P 500 is still higher than when I wrote

if the stock market is up on the basis of little or no positive economic news otherwise, then that sort of says that the reason people are buying stocks is because the market has been going up. That’s not what one would call a sustainable model.

The financial pages say that markets have realized that the Fed cannot keep monetizing large deficits forever. And this is news because…..?

I am one economist who makes a point of not giving an economic interpretation to stock market moves.

The Baby Boom and Entitlements

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Stephen C. Goss testified about the rise in the disability rolls,

Demographic changes, principally the drop in the birth rate after the baby boom, have dramatically changed the age distribution of the population. This change has increased the cost of the DI program as a percent of taxable payroll (and as a percent of GDP) over the past 20 years in much the same way that it will raise OASI and Medicare costs over the next 20 years. Disability insured rates and incidence rates have increased substantially for women, further contributing to higher DI cost. However, all of these trends have stabilized or are expected to do so in the future.

For progressives, this is good news and bad news. The good news is that this analysis suggests that the rise in disability reflects the aging of Baby Boomers, rather than what Casey Mulligan calls the redistribution recession.

The bad news is that the Baby Boom really does have predictable adverse effects on the entitlements budget. As the Boomers hit the prime age for disability, up went the disability rolls. Coming next? The Baby Boomers reaching the age of eligibility for retirement benefits and for Medicare. As Andrew Biggs points out, this is in fact the main driver of increased Medicare spending going forward.

James Hamilton on the Rise in Interest Rates

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He writes,

The yield on 10-year U.S. Treasuries has jumped 50 basis points since the start of May, leading some to speculate that the market is already starting to price in anticipation of an end to the Fed’s bond-buying program. There may be some truth to that, but it’s only part of the story.

…It’s worth emphasizing that the recent rise in interest rates has been a global phenomenon, not just something seen in the United States.

It would be nice if you could attribute the rise in interest rates to a rise in expected growth in nominal GDP. However, my portfolio, which should benefit from an increase in expected inflation, instead was hurt by the rise in rates. I infer that there has been an increase in the expected real rate of interest. It’s not clear where that is coming from, other than the fact that real rates cannot stay absurdly low forever.

Of course, the rise in real rates could indicate that investors have become optimists like Tyler Cowen.

Richard Green Disses Car Dealers

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He writes,

The Wall Street Journal has a good story today about how car dealerships are (successfully) lobbying legislatures to ban Tesla Motors from marketing their cars directly to consumers. GOP legislators, who get the willies about regulation that actually solves real problems, are on board with supporting protectionist policies for auto dealerships.

In economics textbook, government acts to correct market failures. I am tempted to say that, in the real world, government acts to create market failures.

I wish that the car-dealer case were an unusual exception. But basic public choice theory (which ought to be in more economics textbooks) suggests that concentrated interests win and broader interests, including correcting market failures, lose.

I was tempted to title this post, “Richard Green shoots at Republicans, hits mainstream economics,” but that would have been uncharitable.

Supply-Side Housing Policy

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From the Center for an Urban Future.

An Accessory Dwelling Unit is a small, self-contained residential structure sharing a lot with an existing house. In Seattle, Vancouver and Santa Cruz, legislation was enacted to permit ADUs on sufficiently sized lots in one- and two-family zones. Building regulations were also relaxed to allow formerly illegal subdivisions to be safely brought to code without facing severe fines.

They argue that this could be useful in the outer boroughs of New York city. Overall, our country’s policy on housing is to raise demand (think HUD, Freddie Mac, Fannie Mae, etc.) and restrict supply (think urban zoning laws). We also do that in higher education and in health care. The result is what you would predict, given the laws of supply and demand.

The Great K-L Substitution

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Loukas Karabarbounis and Brent Neiman have a paper on the decline in labor’s share of income.

We start by documenting the pervasive decline in labor shares around the world at the country, U.S. state, and industry levels. Next, we document a decline in the relative price of investment goods, which we later show to be the key factor explaining the global trend in the labor share.

Recall that Timothy Taylor blogged on this topic (although not on this paper in particular). The story is that computers and computer-driven machines are getting cheaper, leading businesses to substitute capital for labor, causing labor’s share of income to fall.

To me, this, along with factor price equalization, is the most intuitively plausible account for trends in the distribution of income over the past twenty years.

On K-L substitution, TechReview has a new article on Brynjolffson and McAfee, although scanning it I did not see anything new (I liked their e-book and their debate with Tyler Cowen.)