Roland Fryer, School Reformer

Timothy Taylor writes,

These methods involved a lot of change at the schools involved, including changing a number of principals and teachers. But the same student body that had been dramatically underperforming was no longer doing so. Fryer draws the hard lesson explicitly. We know many of the changes that can be made to improve low-performing schools dramatically within a few years. The financial costs of these changes are manageable. But the school systems that need to be changed, and many of the people currently working in those systems, are not ready to make the needed changes.

I remain skeptical. I continue to believe in the ultimate triumph of the null hypothesis. But Fryer is a careful, credible researcher.

Medicare Spending by Age Group

Timothy Taylor writes,

on a per capita basis, Medicare costs are rising faster for those at later ages. In 2000, for example, Medicare typically spent about 2.4 times as much for a 90 year-old as for a 65 year-old. By 2011, it was spending about 2.8 times as much

There is much more at the link. He cites a Kaiser Family Foundation analysis.

Something to bear in mind is that the mix of ages within Medicare can change. If you get an increase in “young old” in a given year, then average spending could decline, even though on a lifetime basis Medicare spending is not falling, and may even be rising.

Rules, Discretion, Principles, and Incentives

Timothy Taylor excerpts from a book on macroprudential regulation.

Paul Tucker: “Legislators have typically favoured rules-based regulation. That is for good reason: it
helps to guard against the exercise of arbitrary power by unelected officials. But a static rulebook is the meat and drink of regulatory arbitrage, which is endemic in finance. Finance is a ‘shape-shifter’.

Rules do not work, because banks figure out a way to manipulate the rules. Tucker gets this. So does Wolf Wagner, also quoted by Taylor.

Also, discretion does not work, in my opinion, because discretion tends to be procyclical, doing exactly the wrong thing at the wrong time. In good times, regulators ease up, and in bad times, they tighten up. Just look at how regulators behaved before and after the housing crash. Or compare Ben Bernanke’s discussion of bank supervision before and after he knew about the crisis.

I think that principles-based regulation might work better. That is, pass a law saying that managers and directors of financial institutions are responsible for prudent management. Require auditors to flag questionable practices.

Also, I think that incentives are important. Casual observation suggests that investment banking was more cautious when investment banks were partnerships rather than limited-liability corporations. We should look for ways to give bank executives more skin in the game in their institutions. Suppose you have a bank that goes bust in 2025. All of its top executives over the preceding 10 years would be held personally liable those losses, in proportion to the compensation that they received over that period.

(For each year, take the five most heavily compensated executives, and put their total compensation into a hypothetical pool. Add these to get a company total for fifteen years. Then divide each executive’s total compensation over the 10 years by the company total to get the fraction of losses for which that executive is liable.)

Actually, I don’t think that the formula needs to be perfectly “just.” The point of any such system is to make executives manage banks as if they were risking their own money, because they would be.

Technological Obsolescence of Labor

Timothy Taylor writes,

when I run into people who are concerned that technology is about to decimate U.S. jobs, I sometimes bring up the 1964 report. The usual response is to dismiss the 1964 experience very quickly, on the grounds that the current combination of information and communications technology, along with advanced in robotics, represent a totally different situation than in 1964. It’s of course true that modern technologies differ from those of a half-century ago, but that isn’t the issue. The issue is how an economy and a workforce makes a transition when new technologies arrive. It is a fact that technological shocks have been happening for decades, and that the U.S. economy has been adapting to them. The adaptations have not involved a steadily rising upward trend of unemployment over the decades, but they have involved the dislocations of industries falling and rising in different locations, and a continual pressure for workers to have higher skill levels.

Suppose we make some simple assumptions:

1. Leisure is a normal good.
2. Skills are heterogeneous and adapt slowly to changes in technology.

The prediction I would make is that we would see a lot more leisure. For those whose skill adaptation is adequate, that leisure will take the form of earlier retirement, later entry into the work force, or shorter hours. For those whose skill adaptation is inadequate, that leisure will show up as unemployment or reluctant withdrawal from the labor force.

I think that if you look only at males in isolation, you will see this in the data. That is, men are working much less than they used to. For some men, this leisure is very welcome, but for others it is not. In that sense, I think that we should look at the fears of the early 1960s not as quaint errors but instead as fairly well borne out.

For women, the story since the 1960s is different. In the economy as a whole, the share of labor devoted to preparing food, washing clothes, and cleaning house has gone down. Also, a higher share of the remaining work in these areas is coming from the market, via restaurants and cleaning services, rather than from unpaid female labor. The upshot is that, from the 1960s to about 2000, we saw a continuation of the trend for women to increase their share of market work and reduce their non-market labor. So, while men were increasing their leisure, women were increasing their market work. Combining men and women, you would not see a decline in market work.

It seems that around 2000, the trend for more market work by women reached its peak, making the trend toward technological unemployment more visible. From now on, what was happening to men before will be what happens to the total labor force. That is, leisure will go up, and some of it will be less than voluntary.

I might suggest also that the distribution of leisure is becoming increasingly distorted by the welfare state. Some people have too much leisure, in part because implicit tax rates for low-skilled workers are high, and in part because we over-subsidize leisure among healthy seniors. Some people have less leisure than they might otherwise enjoy, in part because they are working to support those with too much leisure.

Martin Baily Interviews Robert Solow

Solow says,

The French automobile industry, much to my surprise, turned out to be more capital intensive than the American automobile industry. So it was not that either. The MGI studies instead traced these differences in productivity to organizational differences, to the way tasks were allocated within a firm or a division—essentially, to failures in managerial decisions.

I would note that if this is the case, then it is possible that high executive pay reflects a productivity differential. Of course, if French auto executives are paid as much as American executives, that would spoil my argument.

Solow has a different take:

An interesting conclusion to me was that international trade serves a purpose beyond exploiting comparative advantage. It exposes high-level managers in various countries to a little fright. And fright turns out to be an important motivation.

Pointer from Timothy Taylor. The whole interview is interesting.

Annuities

Timothy Taylor writes,

Annuities may turn out to be one of those products that people don’t like to buy, but after they have taken the plunge, they are glad that they brought. One can imagine an option where some degree of annuitization of wealth could be built into 401(k) and IRA accounts. For example, it might be that the default option is that 30% of what goes into your 401(k) or IRA goes to a regular annuity that kicks in when you retire, another 20% goes to a longevity annuity that kicks in at age 80, and the other 50% is treated like a current retirement account, where you can access the money pretty much as you desire after retirement. If you wanted to alter those defaults, you could do so. But experience teaches that many people would stick with the default options, just out of sheer inertia–and that many of them would be glad to have some additional annuity income after retirement.

The theory of an annuity is that you insure against the risk of outliving your money. Economists tend to be big fans of annuities, and they view the reluctance of people to buy annuities as a behavioral economics puzzle.

I actually think that it is perfectly rational to shun annuities. My reasons:

1. You are charged more than the actuarially fair premium. Part of that is overhead and profit, and maybe part of that is adverse selection–the insurance company has good reason to fear that you are in better health than someone else your age. In any event, the result is that an annuity reduces your consumption possibilities by as much as would be the case if you over-estimated your lifespan by several years and budgeted accordingly.

2. Taylor notes that

people fear that they might need to make a large expense in the future, perhaps for health care or to help a family member, and if they have annuitized a large share of their retirement wealth they would lose that flexibility.

This is a very reasonable fear. An annuity is risk-reducing if the only risk you face is additional longevity. In fact, other risks may be more serious. You could easily find yourself needing to take out a loan if your savings are tied up in an annuity and your spouse requires a home health aide. (Speaking of which, long-term care insurance is something that I think does make sense, but you should buy it to get through age 75 and then self-insure thereafter).

3. It is reasonable to think in terms of declining consumer expenditures as you age. Will I really spend as much at age 90 as I spend at age 60? Medicare will cover many health expenses, and if I need to spend more of my own money on health care it is likely that I will have much less interest in vacation travel or buying a new car.

4. It is possible to substitute inter-generational insurance. If my mother-in-law had outlived her money, we could have supported her. From our family’s perspective, self-insuring in this way was cheaper than buying an annuity.

Canadian Banking and U.S. Banking

Timothy Taylor writes,

Clearly, the U.S. has a larger share of financial activity happening in the “other financial institutions” area, while Canada has a larger share of its financial activity happening explicitly in the banking sector. The Canadian economy is of course closely tied to the U.S economy. But the recession in Canada was milder than in the U.S., perhaps in part because Canada’s financial sector was less exposed to the issues of shadow banking.

Two interesting possibilities:

1. The Canadian shadow banking sector is underdeveloped. Canada is an ok place to get a mortgage or a commercial loan, but for more sophisticated financial transactions you have to go elsewhere.

2. The American shadow banking sector is overdeveloped. Our financial institutions are playing a game of hide-and-seek from the regulators, and shadow banking has emerged to enable banks to produce balance sheets that appear (to regulators) to be safer than they really are.

Of course, both of these could be true to some extent. I am more inclined to believe (2).

As an aside, I have no idea how one could measure the size of the shadow banking sector with any precision. I picture large books of derivatives, and do you look at gross or net exposure, current market value or potential value at risk, etc.?

A Rant on Narrative vs. Reality re the Financial Crisis

1. Narrative: Subprime mortgages were a consumer protection failure. Thus, we need the Consumer Financial Protection Bureau.

Reality: By a strict definition, predatory lending is when the loan is made with the intent of going to foreclosure and allow the lender to take possession of the house. This was not a factor in the subprime boom, which was fueled by the originate-to-distribute model. In the originate-to-distribute value chain, there is no one whose goal is to take the house from the borrower.

I think you could accuse loan originators of Ponzi lending. That is, lending to borrowers who could only avoid defaulting on the loan by taking out a new loan. Taking out a new loan in turn required continual increase in home prices, so that the borrower could use the equity in the house as collateral. But I would say that the biggest pushers of Ponzi lending were the “affordable housing” lobby, and I think that the last thing we will ever see is the CFPB take on the affordable housing lobby.

2. Narrative: The 1980s deregulation in banking was driven by the free-market ideology of Reagan and Greenspan.

Reality: The three main regulations that were dropped were the restrictions against banks paying market rates for deposits, the restrictions on interstate banking, and the restrictions on combining commercial banking with investment banking. I do not recall any pushback by the left on any of these–until 2008, when they made the retroactive claim that getting rid of Glass-Steagall caused the financial crisis.

In fact, these three regulatory boats had started sinking in the 1960s. The legislation that was passed in the 1980s and 1990s was simply the final order to abandon ship.

In the 1970s and 1980s, the big fight in bank regulation was not left vs. right, or deregulation vs. regulation. It was interest groups battling it out. Wall Street, big banks, savings and loans, and small banks had divergent interests, and that caused gridlock in Congress until things unraveled so much that Congress had no choice but to act.

If you want a parallel today, look at the battles between Amazon and the book publishers, or between Verizon and Google. You aren’t seeing legislators line up on ideological lines in those contests.

3. Free-market economists wanted to turn bankers loose to take whatever risks they wanted, and they got their wish.

Reality: Free-market economists were the strongest proponents of higher bank capital regulations and the biggest skeptics of the Basel risk-based capital regulations. We see the same thing today, with free-market economists skeptical of Dodd-Frank, and mainstream, establishment types like Stan Fischer saying things like

The United States is making significant progress in strengthening the financial system and reducing the probability of future financial crises.

In other words, this time will be different. Pointer from Timothy Taylor.

Textbooks, Venture Capital, and Pharmaceuticals

Timothy Taylor writes,

It is by no means obvious that a lower-cost book (yes, like my own) works less well for students than a higher-cost book from a big publisher. Some would put that point more strongly.

Yes, I know that professors do not care much, if at all, about the prices of the textbooks they select for their students, but that is not the only reason that prices are so high.

Another factor is that the industry is similar to venture capital and pharmaceuticals. The organizations that fund projects in these areas incur heavy expenses on failures. A lot of textbook projects fail. The author may not even finish the book. Or it will flop in the market.

For a VC firm to stay in business when most of the companies that it funds wind up failures, it has to earn spectacular returns on its successes. For a pharmaceutical firm to stay in business when a lot of its research fails to yield a marketable compound, it has to charge a lot for those drugs that do make it. And for textbook publishers to stay in business when many of their projects flop, they have to charge a high price for the books that do sell.

Advances in technology have made it easier to produce a textbook at low cost. However, by the same token, it has probably increased the probability that any given textbook will fail to get a toehold in the market. So the overall economics of the business still requires publishers to absorb a lot of failed-project costs.