How to Create Jobs

Nobelist Paul Krugman vs Nobelist Gary Becker.

Harvard's Finances

The Boston Globe takes a look at what went wrong.

P < AVC

Economics textbooks, including Chapter 14 of my favorite one, explain how firms shut down production when the price of output falls below average variable cost. Here is an example:

NY apple growers leaving more fruit on trees

New York's apple orchards are being carpeted with red as unpicked apples drop to the ground.

With the best of the crop off to market, growers say this year it's cheaper to leave leftovers on the trees than to pick and sell them for juice....

One reason is an abundant crop, not only in New York but in neighboring Pennsylvania and nearby Michigan, which has produced more second-tier fruit than juice and applesauce makers need and driven down market prices.

When labor and transportation costs are factored in, selling anything but the cream of the crop for the supermarket can become a losing proposition.

"In some cases it's not worth the bother of picking them off the tree," said Peter Gregg, spokesman for the New York Apple Association.

The difference in prices is the biggest one-year swing some have ever seen. Last year, growers hurt by severe hailstorms were getting an above-average 12-18 cents per pound for processing apples, those sold for sauce and slices. The price is about 5-8 cents this year.

Thanks to econ prof Linda Ghent for sending this along.

My Crib

The Harvard Crimson visits the Mankiw family abode.

A Reading for the Pigou Club

A profile of the club's namesake.

Is a Tobin Tax feasible?

The Tobin tax--a tax on financial transactions--is very much in the news. Before one gets to the issue of the desirability of such a tax, one has to address the question of whether the policy is even feasible. I am skeptical. Financial transactions are easy to move: If two parties to a financial contract can just as easily sign and enforce the contract in the Cayman Islands as in New York or London, there is little point in US or UK policymakers imposing a Tobin tax. Unless, of course, moving the finance industry offshore is the policy goal.



In his column today, Paul Krugman raises and then dismisses this issue as follows:

On the claim that financial transactions can’t be taxed: modern trading is a highly centralized affair. Take, for example, Tobin’s original proposal to tax foreign exchange trades. How can you do this, when currency traders are located all over the world? The answer is, while traders are all over the place, a majority of their transactions are settled — i.e., payment is made — at a single London-based institution. This centralization keeps the cost of transactions low, which is what makes the huge volume of wheeling and dealing possible. It also, however, makes these transactions relatively easy to identify and tax.

This passage left me scratching my head. Even if most transactions are now settled in one place, that need not be the case in the future after a significant change in the policy environment. It is not as if London has some large, natural comparative advantage in financial settlement that would persist despite a tax on transactions there. The finance industry is set up to take advantage of very small price differences. If London became ever so slightly more expensive, wouldn't contracting and settlement quickly migrate elsewhere?



Update: NYU finance prof Aswath Damodaran reaches similar conclusions.

Please Resend

A student (from abroad, I believe) sent me an email query this morning, which I inadvertently deleted before replying. If you are that student, please resend. Everyone else: Never mind.

How Little We Know

Economist Russ Roberts opines on financial reform.

Take Out Your Pencils 3

In my most recent Ec 10 lecture, I discussed Arrow's Impossibility Theorem. Here, from my favorite textbook, is a fun problem based on it:

A group of athletes are competing in a multi-day triathlon. They have a running race on day one, a swimming race on day two, and a biking race on day three. You know the order in which the eligible contestants finish each of the three components. From this information, you are asked to rank them in the overall competition. You are given the following conditions:

• The ordering of athletes should be transitive: If athlete A is ranked above athlete B, and athlete B is ranked above athlete C, then athlete A must rank above athlete C.
• If athlete A beats athlete B in all three races, athlete A should rank higher than athlete B.
• The rank ordering of any two athletes should not depend on whether a third athlete drops out of the competition just before the final ranking.

According to Arrow’s theorem, there are only three ways to rank the athletes that satisfy these properties. What are they? Are these desirable? Why or why not? Can you think of a better ranking scheme? Which of the three properties above does your scheme not satisfy?

---
If you enjoy this kind of thing, click here for the previous installment in this series. And let me note, before anyone asks, that I will not post the answer, so instructors can use the problem as homework.

Now it all makes sense

Click on the graphic to enlarge. Source.

Healthcare Reform and the Big Tradeoff

David Brooks gets it right today about the debate over healthcare reform. The fundamental question is, Should Americans embrace a more robust social safety net at the cost of much higher marginal tax rates, reduced work incentives, and a smaller economic pie?

From a strictly economic perspective, there is no right answer to this question. Arthur Okun said long ago that the big tradeoff in economic policy is between equality and efficiency. The pending healthcare reform bill moves us along that tradeoff. Let's just not pretend, as some healthcare reformers would have us do, that we can easily get more equality without paying the price in efficiency.

Put simply, the healthcare reform bill would make the United States more like western Europe. That may mean more security about healthcare, but it also means that future generations of Americans will likely spend more time enjoying leisure.

The Changing Face of the World Economy

Source: Mark Perry. Click on graphic to enlarge.

New Research on Fiscal Policy

From Harvard's Alberto Alesina and Silvia Ardagna:

Large changes in fiscal policy: taxes versus spending

We examine the evidence on episodes of large stances in fiscal policy, both in cases of fiscal stimuli and in that of fiscal adjustments in OECD countries from 1970 to 2007. Fiscal stimuli based upon tax cuts are more likely to increase growth than those based upon spending increases. As for fiscal adjustments, those based upon spending cuts and no tax increases are more likely to reduce deficits and debt over GDP ratios than those based upon tax increases. In addition, adjustments on the spending side rather than on the tax side are less likely to create recessions.

Steering into an Iceberg

Former CBO director Douglas Holtz-Eakin opines on fiscal policy.

What makes a nation rich?

The answer from MIT economist Daron Acemoglu.

Laibson in Ec 10

Every year, one of the most popular guest speakers in ec 10 is David Laibson, who gives students a clear and compelling introduction to behavioral economics. David is giving that lecture today at noon in Sanders Theater. If any other Harvard students want to attend, feel free. (If any other local blog readers want to join us, email me; we can accommodate a few others.)

Take Out Your Pencils 2

Readers seemed to enjoy my recent post of an introductory economics problem. Here is a new one for you. (I won't post the answer, so instructors can assign the problem as homework.) This one is in honor of Professor Pigou.

The town of Wiknam has 5 residents whose only activity is producing and consuming fish. They produce fish in two ways. Each person who works on a fish farm raises 2 fish per day. Each person who goes fishing in the town lake catches X fish per day. X depends on N, the number of residents fishing in the lake. In particular,

X = 6 – N.

Each resident is attracted to the job that pays more fish.

a. Why do you suppose that X, the productivity of each fisherman, falls as N, the number of fishermen, rises? What economic term would you use to describe the fish in the town lake? Would the same description apply to the fish from the farms? Explain.

b. The town’s Freedom Party thinks every individual should have the right to choose between fishing in the lake and farming without government interference. Under its policy, how many of the residents would fish in the lake and how many would work on fish farms? How many fish are produced?

c. The town’s Efficiency Party thinks Wiknam should produce as many fish as it can. To achieve this goal, how many of the residents should fish in the lake and how many should work on the farms? (Hint: Create a table that shows the number of fish produced—on farms, from the lake, and in total—for each N from 0 to 5.)

d. The Efficiency Party proposes achieving its goal by taxing each person fishing in the lake by an amount equal to T fish per day and distributing the proceeds equally among all Wiknam residents. Calculate the value of T that would yield the outcome you derived in part (c).

e. Compared with the Freedom Party’s hands-off policy, who benefits and who loses from the imposition of the Efficiency Party’s fishing tax?

Happy Birthday, Professor Pigou

Arthur Cecil Pigou was born 132 years ago today.

Flier on Healthcare Reform

Jeffrey Flier, the Dean of Harvard Medical School, opines on pending healthcare reforms.

A Rational Loss for Bill Belichick

Chapter 2 of my favorite textbook has a box on David Romer's work on 4th down strategies in football. One fan of this work is Patriots' coach Bill Belichick, who recently applied Romer's analysis. Click here to learn more.

It did not work out well in this particular case, and Belichick is coming under some heat for his call. This does not mean Romer and Belichick are wrong. Some strategies that fail ex post might be optimal ex ante. Randomness is a fact of life, even if Patriots' fans do not fully appreciate it.

The Actuary on the House Bill

Click on the graphic to enlarge.

Keith Hennessey summarizes the actuary's report on the House healthcare reform bill:

• The bill would mean almost 30 M new people in government-run insurance, more than four times as many as would be newly insured through private coverage.

• By far the largest effect of the bill would be to enroll more than 23 M new people in two existing government programs, Medicaid and S-CHIP. Medicaid is today widely regarded as fiscally unsustainable before adding more people.

• Foster estimates that 18 M people would remain uninsured and have to pay the penalty tax. These people are clearly worse off than they would be under current law.

News for New Econ PhDs

If you are an economics graduate student on the job market this year, click here. Everyone else: Never mind.

Supply, Demand, and Healthcare Reform

Let's review some basic principles of supply and demand: If a government policy increases the demand for a service, the price of that service tends to rise. If the government prevents prices from rising, shortages develop. The quantity provided is then determined by supply and not demand. In the presence of such excess demand, the result could be a two-tier market structure. Consumers who can somehow pay more than the government-mandated price will be able to purchase the service, while those paying the controlled price may be unable to find a willing supplier.

Those principles lie behind this story from the Washington Post:

A plan to slash more than $500 billion from future Medicare spending -- one of the biggest sources of funding for President Obama's proposed overhaul of the nation's health-care system -- would sharply reduce benefits for some senior citizens and could jeopardize access to care for millions of others, according to a government evaluation released Saturday.

The report, requested by House Republicans, found that Medicare cuts contained in the health package approved by the House on Nov. 7 are likely to prove so costly to hospitals and nursing homes that they could stop taking Medicare altogether.

Congress could intervene to avoid such an outcome, but "so doing would likely result in significantly smaller actual savings" than is currently projected, according to the analysis by the chief actuary for the agency that administers Medicare and Medicaid. That would wipe out a big chunk of the financing for the health-care reform package, which is projected to cost $1.05 trillion over the next decade.

More generally, the report questions whether the country's network of doctors and hospitals would be able to cope with the effects of a reform package expected to add more than 30 million people to the ranks of the insured, many of them through Medicaid, the public health program for the poor.

In the face of greatly increased demand for services, providers are likely to charge higher fees or take patients with better-paying private insurance over Medicaid recipients, "exacerbating existing access problems" in that program, according to the report from Richard S. Foster of the Centers for Medicare and Medicaid Services.

Though the report does not attempt to quantify that impact, Foster writes: "It is reasonable to expect that a significant portion of the increased demand for Medicaid would not be realized."

Netherlands joins the Pigou Club

A student alerts me to this story about the new Dutch policy to internalize externalities:

The Dutch government said Friday it wants to introduce a "green" road tax by the kilometre from 2012 aimed at cutting carbon dioxide emissions by 10 percent and halving congestion.

"Each vehicle will be equipped with a GPS device that tracks how many kilometres are driven and when and where. This data will be then be sent to a collection agency that will send out the bill," the transport ministry said in a statement.

Ownership and sales taxes, about a quarter of the cost of a new car, will be scrapped and replaced by the "price per kilometre" system aimed at cutting the Netherlands' carbon dioxide emissions by 10 percent.

"Traffic jams will be halved and it helps the environment," the ministry said.

Dutch motorists driving a standard family saloon will be charged 3 euro cents per kilometre (seven US cents per mile) in 2012. That would increase to 6.7 cents (16 US cents per mile) in 2018, according to the proposed law.

Bending the Curve: How's it going?

Jim Capretta has the answer.

Steuerle on Healthcare Reform

Gene Steuerle of the Urban Institute describes the maze of incentives embedded in the pending healthcare reform bill.

The Poverty Trap

Chapter 20 of my favorite textbook has a section on antipoverty programs and work incentives. One basic point is that when multiple income-based programs are piled on top on one another, the implicit marginal tax rate can reach or even exceed 100 percent.

The chart above (source, via Kling) illustrates this phenomenon. It shows income after taxes and transfers as a function of earned income. Notice that as earned income rises from about $15,000 to $30,000, income after taxes and transfers is roughly flat. Indeed, it could even fall. The bottom line: If you are poor, the government is inadvertently ensuring that you have little incentive to try to improve your condition.

Request to CBO: Can you please make and disseminate charts like the one above? Producing this kind of chart correctly is not easy (and I cannot fully vouch for the accuracy of this one) because a variety of different government programs are involved, and their rules are often complex. CBO has the staff to do it right. Moreover, if such a chart came from a high profile, widely respected, and nonpartisan source such as CBO, the problem would get more attention. It certainly deserves it.

I bet there are people in the Obama administration who are quietly worrying about this problem. Why do I say this? Read this old post. The story there is told by Jeff Liebman, a very smart Kennedy School professor now working for President Obama.

Update: Here is some related work by Larry Kotlikoff and David Rapson.

For Extra Practice

A student emailed me today looking for additional practice problems to help him prepare for tests in his introductory economics course. Where did I send him? To the Study Guide prepared by David Hakes to accompany my favorite textbook.

Old Time Recession

More on LHS

Vanity Fair profiles Larry Summers.

Dick Armey on Harvard Economics

Okay, this has got to be one of the goofiest comments from a major political figure in recent weeks:

"I don’t consider Larry Summers a serious economist," [Dick] Armey said. “You can get a Ph.D. from Harvard without ever having seriously considered the subject.” (Source).

If Dick Armey wants to criticize Larry Summers or the economic policy of the Obama administration, there is no shortage of ammunition and easy targets. But saying that Larry is not a serious economist, or that a PhD from one of world's preeminent economics departments doesn't mean much, makes Mr Armey look more than a tad ridiculous.

Unintended Consequences

A surprising effect of the minimum wage:

Growing consumption of increasingly less expensive food, and especially “fast food”, has been cited as a potential cause of increasing rate of obesity in the United States over the past several decades. Because the real minimum wage in the United States has declined by as much as half over 1968-2007 and because minimum wage labor is a major contributor to the cost of food away from home we hypothesized that changes in the minimum wage would be associated with changes in bodyweight over this period. To examine this, we use data from the Behavioral Risk Factor Surveillance System from 1984-2006 to test whether variation in the real minimum wage was associated with changes in body mass index (BMI).... We find that a $1 decrease in the real minimum wage was associated with a 0.06 increase in BMI.... Real minimum wage decreases can explain 10% of the change in BMI since 1970. We conclude that the declining real minimum wage rates has contributed to the increasing rate of overweight and obesity in the United States.

From David Meltzer and Zhuo Chen.

Feldstein on Obamacare

Marty's latest salvo.

Take Out Your Pencils

For those blog readers who fondly recall exams in introductory economics (I am sure there are many), here is a fun problem based on a question from a recent ec 10 test. Enjoy!

Only one firm produces and sells soccer balls in the country of Wiknam, and as the story begins, international trade in soccer balls is prohibited. The following equations describe the monopolist’s demand, marginal revenue, total cost, and marginal cost:

Demand: P = 10 – Q
Marginal Revenue: MR = 10 – 2Q
Total Cost: TC = 3 + Q + 0.5 Q^2
Marginal Cost: MC = 1 + Q

where Q is quantity and P is the price measured in Wiknamian dollars.

a. How many soccer balls does the monopolist produce? At what price are they sold? What is the monopolist’s profit?

b. One day, the King of Wiknam decrees that henceforth there will be free trade—either imports or exports— of soccer balls at the world price of $6. The firm is now a price taker. What happens to domestic production of soccer balls? To domestic consumption? Does Wiknam export or import soccer balls?

c. In our analysis of international trade in Chapter 9, a country becomes an exporter when the price without trade is below the world price and an importer when the price without trade is above the world price. Does that conclusion hold in your answers to parts (a) and (b)? Explain.

d. Suppose that the world price was not $6 but, instead, happened to be exactly the same as the domestic price without trade as determined in part (a). Would anything have changed when trade was permitted? Explain.

Unemployment Update

Click on the graph to enlarge. Click here for my interpretation.

Spreading the Word

My favorite introductory economics textbook comes in many variants. For American students, there are five versions, each with a different subset of chapters, so every instructor can find one that best suits his or her course. Students abroad can use one of these or choose among various editions that have been tailored to particular regional institutions and languages. Yesterday, I learned about two new members of the line-up: the French Canadian editions, available for both micro and macro.

Environmentalism vs Homeownership

My Harvard colleague Ed Glaeser looks at the negative externalities from suburban sprawl.

Assuming a Can Opener

I have previously expressed skepticism about projected Medicare spending assumed in the health reform effort making its way through Congress. If reductions in spending don't materialize as Congress now posits, health reform will not turn out to be deficit neutral but will, instead, add to the large fiscal gap we are bequeathing to future generations. In a recent letter, CBO gives some numbers about projected Medicare spending that shows how wildly unrealistic it is:

The bill would put into effect (or leave in effect) a number of procedures that might be difficult to maintain over a long period of time. It would leave in place the 21 percent reduction in the payment rates for physicians currently scheduled for 2010. At the same time, the bill includes a number of provisions that would constrain payment rates for other providers of Medicare services. In particular, increases in payment rates for many providers would be held below the rate of inflation (in expectation of ongoing productivity improvements in the delivery of health care). Based on the extrapolation described above, CBO expects that Medicare spending under the bill would increase at an average annual rate of roughly 6 percent during the next two decades—well below the roughly 8 percent annual growth rate of the past two decades, despite a growing number of Medicare beneficiaries as the baby-boom generation retires.

Thanks to the blog reader who drew this passage to my attention.

Counting Jobs

How to create or save 9 jobs for $889,

An amusing story about how government statistics are not always completely reliable.

Taking out the Trash

I don't usually respond to illogical cheap shots from around the blogosphere (life is too short). But when the cheap shot comes from a Nobel prize winner in economics, I will make an exception.

Paul Krugman says I should be ashamed of myself for calling into question Obama administration estimates of how many jobs have been "created or saved." Here is what Paul writes on his blog:

The Obama administration’s “jobs created or saved” is just a way of saying “other things equal” in non-economese. Of course it makes sense to ask how many more people are working than would have been the case without a given policy — and every administration makes assertions along those lines. During the 2001 recession and its aftermath, how many times did the Bush administration claim that the recession would have been worse without its tax cuts? And while many of us quarreled with that claim, I don’t think I ever argued that other-things-equal arguments are nonsense on their face.

Yet Paul is rebutting claims I did not make, and he is giving Team Obama more credit on this question than it is due. Here is what I wrote on the topic last February:

The 4 million job number is a counterfactual policy simulation of what the stimulus will do based on a particular model of the economy. As such, I have no objection to someone citing it in a policy discussion. In fact, macroeconomists use models to generate figures like this all the time. I have even done it myself.

But as an answer to the question "how can the American people gauge whether or not your programs are working?... What metric should they use?", citing the 4 million job figure is a non sequitur, or more likely a diversion. A metric has to be measurable, and the actual number of jobs "created or saved" by the policy will never be measurable from any data source.

That is, I do not object to claims such as,

A: "Based on our models of the economy, we believe there would be X million fewer jobs today without the stimulus."

But it is absurd to suggest that you can say,

B: "We have measured how many jobs the stimulus has saved or created, and the number is X."

Economists are capable of making statements such as A, but it is beyond our ken to make statements such as B. Statement B is,of course, much stronger than statement A, as it purports to be based on data rather than on models. Unfortunately, we are hearing statements like B much too often from administration officials. A good example is here, where can you "learn" that 110,185.36 jobs have been created or saved in California alone.

Disincentives from Reform: House Edition

In my Sunday Times column, I discussed the marginal tax rates implicit in the Senate Finance Committee version of the health reform bill. CBO has just released some numbers on the version of health reform being considered in the House of Representatives.

The bottom line: The implicit marginal tax rates are even higher in the House bill.

If you are interested in a more specific comparison, here is what I wrote about the Senate Finance bill on Sunday, with the new numbers for the House bill added in brackets:

A family of four with an income, say, of $54,000 would pay $9,900 [$6,200] for healthcare. That covers only about half [a third] the actual cost. Uncle Sam would pick up the rest.

Now suppose that the same family earns an additional $12,000 by, for example, having the primary earner work overtime or sending a secondary worker into the labor force. In that case, the federal subsidy shrinks, so the family’s cost of health care rises to $12,700 [$10,000].

In other words, $2,800 [$3,800] of the $12,000 of extra income, or 23 [32] percent, would be effectively taxed away by the government’s new health care system.

And remember: This implicit marginal tax hike of 32 percent is added on top of the explicit marginal tax rate the family already faces from income and payroll taxes.

Government Motors: Update

President Obama's plan:

What we are not doing -- what I have no interest in doing -- is running GM. GM will be run by a private board of directors and management team with a track record in American manufacturing that reflects a commitment to innovation and quality. They -- and not the government -- will call the shots and make the decisions about how to turn this company around.

So how is that working out for you, Mr President?

In May, even before the government's ownership became official, lawmakers erupted when GM disclosed it planned to produce a new subcompact car at its factories in China. Under congressional pressure, GM dropped those plans and promised instead to retool an existing U.S. facility in Michigan, Wisconsin or Tennessee for the new model.

Lawmakers from those states demanded and received high-level meetings in Washington to quiz GM on the criteria for site selection and to tout their states. GM in the end picked a site in Michigan.

That same month, GM dealer Pete Lopez in Spencer, W.Va., received notice that GM was giving him just over a year to shut down his Chevy, Pontiac and Buick dealership, which he'd acquired two years earlier. GM's move to shutter more than 1,300 dealerships -- about one-quarter of its network -- was central to its restructuring because it cleared out underperforming showrooms and brought the network more in line with its shrunken sales.

With an assist from his mayor, Mr. Lopez took his complaint straight to one of his state's senators, Jay Rockefeller, the Democratic chairman of the powerful Commerce
Committee.

Sen. Rockefeller sent a letter to GM headquarters on Mr. Lopez's behalf, according to a staff aide. He arranged for Mr. Lopez to come testify before a Senate panel in early June, alongside GM Chief Executive Frederick "Fritz" Henderson. The senator introduced the two men, giving Mr. Lopez a chance to make a personal pitch.

"He couldn't have been nicer," Mr. Lopez said of the GM CEO. "He said to me, 'We've made some quick decisions and now we're going to look it all over again.' "

The GM chief executive put Mr. Lopez in touch with Mark LaNeve, then the company's top official for North American sales. The dealer received a response on the last Saturday in June while fishing on a lake near his house.

"Mr. LaNeve called and said, 'I've got some good news for you. We're going to save your dealership,' " Mr. Lopez recalls. He says he owes it all to Sen. Rockefeller.