Advice for Harvard Students

From the student newspaper, The Harvard Crimson:

even if you are not an Economics concentrator, Social Analysis 10 (i.e., Ec 10) is a good bet for some useful knowledge, as Bush-lover Greg Mankiw has made the problem sets and exams much more straightforward and manageable. You also never know if you are going to apply for that job with Morgan Stanley.

Cutler on Health Spending

My Harvard colleague David Cutler gets some attention in today's Washington Post:

Study Finds Health Care Good Value Despite Costs

The dramatic increase in health-care spending in the United States since 1960 is a major reason that Americans are living longer, making the world's most expensive health-care system a good value despite its high costs, according to an academic study being released today.

The study notes that a baby born in 2000 can expect to live for 76.9 years, compared with 69.9 years for a newborn in 1960. While some of the gain is because of declines in rates of smoking and fatal accidents, it is reasonable to attribute at least half of it to more and better health care, said Harvard University economist David M. Cutler, the study's lead author.

By the way, David will once again give a lecture on health economics this fall in ec 10.

Are long-term jobs disappearing?

Economist Ann Huff Stevens punctures another media myth:

For some years it has been that reported that employees in the United States experienced widespread, substantial declines in job security or stability over the past several decades. Various newspaper articles have suggested that big structural changes in labor markets mean that job security is a "myth," that lifetime employment with a single employer is far less likely than it was, say, thirty years ago. Workers themselves worry that their prospects for keeping a job for a long period have shrunk, that they may need several jobs during their careers. "There is, however, a striking lack of solid empirical evidence to support these claims," writes economist Ann Huff Stevens.

In The More Things Change, the More They Stay the Same: Trends in Long-Term Employment in the United States, 1969-2002 (NBER Working Paper No. 11878),Stevens sees stability in the prevalence of long-term employment for men in the United States, contrary to popular views. "Long-term relationships with a single employer are an important feature of the U.S. labor market in 2002, much as they were in 1969," she writes. So, the likelihood is that most workers will have some job during their working lives that lasts for more than 20 years.

Stevens uses data from surveys of men aged 58-62 who were quizzed at the end of their working careers. She finds that in 1969 the average tenure for men in the job they held for the longest period during their careers was 21.9 years. In 2002, the comparable figure was 21.4 years, not much different. Just more than half of men ending their careers in 1969 had been with a single employer for at least 20 years; the same was true in 2002.

From the September 2006 NBER Digest.

Update: Loyal reader mvpy calls attention to lecture notes in which superstar MIT economist Daron Acemoglu makes a similar point. Here is Daron:

there is basically no evidence for greater churning in the labor market. First, measures of job reallocation constructed by Davis and Haltiwanger indicate no increase in job reallocation during the past 20 or so years. Second, despite the popular perception to the contrary, there has not been a large increase in employment instability. The tenure distribution of workers today looks quite similar to what it was 20 years ago. The major exception to this seems to be middle-aged managers, who may be more likely to lose their jobs today than 20-25 years ago.

Daron's lecture notes on "Technology and the Structure of Wages" look like they are well worth reading in their entirety--all 154 pages of them!

California tackles global warming

A student emails me some kind words and also some news about California's latest environmental policy:

I took Econ 110 here at BYU over the Summer and we used your excellent book (Principles of Economics) as the text for our class. It is probably one of the very few texts that I will be keeping around with me as I graduate and move on.

On a less "brown-nosing note" I thought you might be interested in this article from the Guardian regarding California and Arnold's deal with the Dems to create an exchange for companies to buy/sell/trade pollution permits; they call them emission credits... same thing. I guess my home state (one of the most polluted) is finally coming around and smelling the roses... or at least making it possible for everyone else to smell them! :-)

Based on the article (and a similar one at the Washington Post), the proposed new system for carbon emissions appears to be exactly the sort of pollution permit market discussed in chapter 10 of my Principles text and which economists have long endorsed.

The article does not say how these permits would be allocated. Ideally, they would be sold. A sale provides the government nondistortionary revenue that can be used to reduce distortionary taxes. If that is the case, I will make Arnold honorary president of the Pigou Club.

In many similar cases, however, the permits are given out for free to established firms. This is surely second-best from the standpoint of economic efficiency. And it is questionable on the grounds of equity: Why should established polluters get a free ride while future polluters have to pay for the right?

News for Emily Litella

All of us who work with macroeconomic data have learned, sometimes the hard way, that conclusions based on preliminary data are subject to change. Here is a good example.

The NY Times two days ago in a front-page, above-the-fold article:

wages and salaries now make up the lowest share of the nation’s gross domestic product since the government began recording the data in 1947.

The NY Times online today, presumably to be reported in tomorrow's paper (on what page? [update: page C1]):

Perhaps the biggest surprise in today’s report was a surge in wage-and-salary income during the first half of this year. Between the fourth quarter of last year and the second quarter of 2006, it grew at an annual rate of about 7 percent, after adjusting for inflation, up from an earlier estimate of 4 percent, according to MFR, a consulting firm in New York.

As a result, wages and salaries no longer make up their smallest share of the gross domestic product since World War II. They accounted for 46.1 percent of economic output in the second quarter, down from a high of 53.6 percent in 1970 but up from 45.4 percent last year.

Total compensation — including employee health benefits, which have risen in value in recent years — equaled 57.1 percent of the economy, down from 59.8 percent in 1970. Still, compensation makes up a larger share of the economy than it did throughout the 1950’s and early 60’s, as well as during parts of the mid-1990’s and the last couple of years.

As Emily Litella would say, "Never mind."

Update: My friend Jason Furman emails me his observations on the matter:

Greg,

Measured properly wages and salaries in the first half of 2006 were the lowest as a share of economy since WW II.

The proper denominator for factor shares is gross domestic income (GDI) or national income. Using either denominator, wages and salaries are the lowest since World War II. CEA's Economic Report of the President always shows incomes as a fraction of GDI as does NIPA Table 1.11.

You are correct that as a share of gross domestic product (GDP) wages and salaries are no longer the lowest since WW II. But this is an apples-to-oranges comparison -- which is why neither the very careful CEA nor the very careful BEA would do it. (It is, alas, a common practice to use GDP in the denominator -- one that many excellent economists and reporters, including the New York Times -- follow.)

Specifically, the statistical discrepancy between GDP and GDI shows up in the denominator but not in the numerator. In 2006-Q2, GDP was $76 billion lower than GDI. If you're using GDP in the denominator, then this $76billion should be subtracted from some combination of wages, profits, rents, etc. Conversely, in 2005 GDP was $71 billion higher than GDI. As a result, to use GDP in the denominator you should also add this $71 billion to incomes.

Since we don't know how the statistical discrepancy breaks out between different factor incomes (that's why it's a "statistical discrepancy") we use GDI in the denominator. Or to avoid screwy results from depreciation, I generally prefer to use national income. Either way, the Times headline holds up.

Best, Jason

P.S. I should say I'm not that interested in wage shares, compensation shares are the relevant metric for most important questions. And the upward revision in wages certainly is a good sign and helps make sense of the revenue surprises we experienced this year -- and might suggest they'll be somewhat more durable than the potentially more ephemeral capital gains and corporate profits. But since you were being picky, I thought you might as well help your Ec 10 students to learn some national accounting arcana.

Blurb from Brad

Brad DeLong has nice things to say about my macroeconomics textbook:

Certainly the clearest introductory macro book.

Now I just have to figure out how to convince Brad to order it for his course at Berkeley, rather than using the book by DeLong and Olney.

Rogoff on World Trade and Central Banking

My Harvard colleague Ken Rogoff has a nice piece in today's FT. He argues:

one should think of the modern era of rapidly expanding trade and technology progress as providing a spectacularly favourable milieu for monetary policy. With hugely positive underlying trends, central banks have been able to establish and maintain low inflation while delivering growth results that have often outperformed expectations.... But precisely because globalisation has produced such a steady stream of upward surprises, there is an element of illusion to central banks’ success.

Ranking Economics Papers

In a new paper titled "What Has Mattered to Economics Since 1970," economists E. Han Kim, Adair Morse, and Luigi Zingales identify the most cited articles published in economics journals since 1970. I will link to it as soon as the paper is posted. [Update: You can now click on the link.] Meanwhile, here are a few fun facts from the paper.

First, the winners:

The Most Cited Paper is Hal White's "A Heteroskedasticity-Consistent Covariance-Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica 1980, with 4318 citations in the Social Science Citation Index.

Next comes Kahneman and Tversky's 1979 article on "Prospect Theory - Analysis of Decision under Risk," Econometrica 1979, with 4085 cites.

In third place is Jensen and Meckling's "Theory of Firm - Managerial Behavior, Agency Costs and Ownership Structure," Journal of Financial Economics, 1976, with 3923 cites.

Next, the reliable home run hitters:

Only 146 journal articles published since 1970 have been cited more than 500 times. Within these 146 articles, an elite group of 11 economists authored or co-authored at least three. Robert Barro, Eugene Fama, and Joseph Stiglitz have six each. Michael Jensen follows with five; Robert Lucas and David Kreps with four; and Robert Engle, Lars Hansen, Robert Merton, Edward Prescott, and Stephen Ross have three each.

Finally, some naked self-promotion:

The author of this blog has one paper on the list, coauthored with David Romer and David Weil. Our paper, "A Contribution to the Empirics of Economic Growth" in the Quarterly Journal of Economics 1992, has 792 citations and is ranked number 65.

When I was writing this paper, I had no idea that it would become my most cited work.

Which inflation rate?

As the FT reported a couple days ago, economist Charlie Bean raises an important question:

The US Federal Reserve is wrong to focus on core measures of inflation that exclude energy prices, Charles Bean, chief economist at the Bank of England, has suggested. It should focus instead on headline inflation, which is much higher, he argued. Including energy and food costs, US consumer price inflation is running at an annual rate of 4.1 per cent, against 2.7 per cent for core inflation.

Mr Bean told the Fed’s annual Jackson Hole symposium at the weekend that energy prices were rising for the same reason the price of many manufactured goods were falling: the rise of China and other emerging market economies. Since both price trends had a common cause, he said it makes little sense to focus “on measures of core inflation that strip out energy prices while not stripping out falling goods prices as well.”

Even though many economists endorse some form of inflation targeting, there is no consensus about how inflation is best measured for purposes of such a policy. The Fed's tradition of focusing on a consumption deflator excluding food and energy is plausible, but it is only one of many plausible choices. As far as I know, this particular choice has never been fully justified over others. Some members of the FOMC may share Charlie's judgment on this question.

The bottom line: This is yet another reason to think that for the foreseeable future the Bernanke Fed's commitment to inflation targeting is likely to be vague and informal. Monetary policy will remain more discretionary than rule-based.

Update: A reader calls to my attention an August 29 speech by Dallas Fed President Richard Fisher in which he addresses the issue:

In preparing for our deliberations at the FOMC, I have come to rely upon what is called the Trimmed-Mean PCE Deflator....The business of getting it right on inflation is not an easy task. I keep a close eye on all of the inflation measures.

This statement can be seen as further confirmation that there is no consenus on which price index to use. Until monetary policymakers settle on a price index, inflation targeting cannot possibly become the rule-based monetary policy that some people would like it to be.

How are wages and productivity related?

Motivated by an article in yesterday's NY Times, a reader asks me to clarify the linkage between real wages and productivity as a matter of economic theory. Here is the basic logic taught in economics textbooks:

Economic theory says that the wage a worker earns, measured in units of output, equals the amount of output the worker can produce. Otherwise, competitive firms would have an incentive to alter the number of workers they hire, and these adjustments would bring wages and productivity in line. If the wage were below productivity, firms would find it profitable to hire more workers. This would put upward pressure on wages and, because of diminishing returns, downward pressure on productivity. Conversely, if the wage were above productivity, firms would find it profitable to shed labor, putting downward pressure on wages and upward pressure on productivity. The equilibrium requires the wage of a worker equaling what that worker can produce.

Why don’t real wages and productivity always line up in the data? There are a several reasons:

1. The relevant measure of wages is total compensation, which includes cash wages and fringe benefits. Some data includes only cash wages. In an era when fringe benefits such as pensions and health care are significant parts of the compensation package, one should not expect cash wages to line up with productivity.

2. The price index is important. Productivity is calculated from output data. From the standpoint of testing basic theory, the right deflator to use to calculate real wages is the price deflator for output. Sometimes, however, real wages are deflated using a consumption deflator, rather than an output deflator. To see why this matters, suppose (hypothetically) the price of an imported good such as oil were to rise significantly. A consumption price index would rise relative to an output price index. Real wages computed with a consumption price index would fall compared with productivity. But this does not disprove the theory: It just means the wrong price index has been used in evaluating the theory.

3. There is heterogeneity among workers. Productivity is most easily calculated for the average worker in the economy: total output divided by total hours worked. Not every type of worker, however, will experience the same productivity change as the average. Average productivity is best compared with average real wages. If you see average productivity compared with median wages or with the wages of only production workers, you should be concerned that the comparison is, from the standpoint of economic theory, the wrong one.

4. Labor is, of course, not the only input into production. Capital is the other major input. According to theory, the right measure of productivity for determining real wages is the marginal product of labor--the amount of output an incremental worker would produce, holding constant the amount of capital. With the standard Cobb-Douglas production function, marginal productivity (dY/dL) is proportional to average productivity (Y/L), which is what we can measure in the data. (See Chapter 3 of my intermediate macro text for a discussion of the Cobb-Douglas production function.) Keep in mind, however, that the Cobb-Douglas assumption of constant factor shares is not perfect. In recent years, labor’s share in income has fallen off a bit. (Between 2000 and 2005, employee compensation as a percentage of gross domestic income fell from 58.2 to 56.8 percent.) From the Cobb-Douglas perspective, this means that the marginal productivity of labor has fallen relative to average productivity. This modest drop in labor’s share is not well understood, but its importance should not be exaggerated. The Cobb-Douglas production function, together with the neoclassical theory of distribution, still seems a pretty good approximation for the U.S. economy.

Update: If you want to look at data on factor income shares, go to the BEA. Click on "List of All NIPA Tables." Then click on Table 1.11. You can then judge for yourself whether the changes in income shares are large or small.

Update 2: Economists Russell Roberts and David Altig also blog on this topic.

Ranking Economists

The lead article in the Spring 2006 issue of the Journal of Economics and Finance asks, "Which economists have written the most articles in eight top academic journals in the half century from 1954 to 2003?"

Answer:
Number one is Joe Stiglitz.
Number two is Martin Feldstein.

The author of this blog is number 146.
My excuse: I wasn't born until 1958.

Thanks to Division of Labor for the pointer.

Collier on Africa

The Wall Street Journal's Washington Wire, reporting from the Fed's Jackson Hole conference, suggests that Paul Collier is unlikely to be invited to join the new Sachs administration:

Paul Collier of Oxford University made a persuasive case that nowhere more than in Africa has geography undermined economic progress. Statistically, a country’s growth is more likely to lag if it is landlocked, resource-poor or small, and Africa, which is divided into over 40 countries, has an unusually large number of countries that are all three.

Many African countries are resource rich but are unable to efficiently spend those resources because, while democratic, they lack effective checks and balances. By contrast, countries that must rely on taxes are more likely to face demands for accountability. African countries, despite being small, are also ethnically diverse. The more diverse a society, the smaller the share of the population represented by the ruling group, he notes. “A minority in power has an incentive to distribute to itself at the expense of the public good of national economic
growth.”

Finally, he says, Africa has missed the globalization boat: at the time Asia was opening up to foreign investment, Africa was saddled with overvalued currencies, civil war, experiments with socialism, or apartheid. Almost all these problems have been solved, but in the meantime Asia has acquired a formidable critical mass of local skills and infrastructure that make it difficult for Africa to compete for foreign investment....

“African performance has been far worse than that of any other region,” Mr. Collier has written. “The explanation for this is not that African economic behavior is fundamentally different from elsewhere, but rather that African geographic endowments are distinctive.”

He sharply disagreed with economist-celebrity Jeffrey Sachs’s view that disease and climate are the principal reasons for Africa’s underdevelopment. Sachs, he said, is “barking up the wrong tree.”

Mallaby on the New Democratic Party

In today's Washington Post, columnist Sebastian Mallaby takes Democrats to task for the new anti-business, and in particular anti-WalMart, rhetoric. He begins as follows:

Once upon a time, smart Democrats defended globalization, open trade and the companies that thrive within this system. They were wary of tethering themselves to an anti-trade labor movement that represents a dwindling fraction of the electorate. They understood the danger in bashing corporations: Voters don't hate corporations, because many of them work for one.

Then dot-bombs and Enron punctured corporate America's prestige, and Democrats bolted. Rather than hammer legitimately on real instances of corporate malfeasance -- accounting scandals, out-of-control executive compensation and the like -- Democrats swallowed the whole anti-corporate playbook.

A New Job for Jeff

I don't know anything about the Jeff Sachs for President movement, but it's got a website, so it must be serious.

This gets me thinking about who might fill various roles during the administration. Bono for veep? Angelina Jolie for Secretary of State? Brad DeLong for Press Secretary? Bill Easterly for the loyal opposition?

One thing I'm sure of is that Jeff's wife, Sonia, would make a great first lady.

A Joke for Econ Grad Students

A group of macroeconomists are sitting on a panel at a conference discussing developments in the discipline.

In a heated exchange, the New Keynesian says to the Real Business Cyclist: “You guys have put macroeconomics back twenty years with this nonsense!”

The Real Business Cyclist smiles and says “So you DO believe in negative productivity shocks after all.”

Pointer from student Gabriel Mihalache, who remarks: "I don’t know what’s more perverse...that I understand the joke or that I find it really funny."

Warning: Advertisement

Over at myspace.com, Rachel (single, female, libra from California) endorses my favorite economics textbook and the Xtra! online textbook resource:

if you ever choose to take an economics class, make sure the professor assigns a textbook by Mankiw. I swear by this man, people. He is an amazingly good author, which is something 99f economists are NOT. I'm actually reading a different version of the book below (there are 5, i believe- mine is called ...um. wait, maybe it is this one) no.. its not, I don't really have time to look for the version i have but I do have a camera phone so I guess i can post my own picture... heheheh... that makes me feel clever. handy little phone. btw, I found my phone. in case you were wondering.oh- and the Xtra! thing--- so useful, the subscription lasts a year... very neato stuff, but if you're just reading it for your own interests, it not really necessary, its just alternative ways to tell you shit that may be hard to pick up on by reading, especially if math is not your strong point when it comes to economics.

Another one for the "I told you so" file

News flash from the Fed conference in Jackson Hole:

Study: Outsourcing Raises U.S. Wages

Two Princeton University economists claim that job outsourcing increased productivity and real wages for low-skilled U.S. workers.

Princeton professors Gene Grossman and Esteban Rossi-Hansberg debated that salaries for the least-skilled blue collar jobs had been increasing since 1997 as outsourcing pushed productivity....

The Princeton economists say that critics tended to gloss over the productivity benefits that come with offshoring labor.

Update: Here is the Grossman-Rossi-Hansberg paper.

Bernanke on Globalization

In A Letter to Ben Bernanke (published in the May 2006 AER), I wrote:

You should be willing to explain the views of professional economists when there is a consensus. For example, like Greenspan, you should remind us about the benefits of free trade when the protectionists in Congress get restless—which they do often.

Today, in a talk at Jackson Hole, Ben does just that.

The talk gives a great historical overview of globalization and its critics. Ben quotes Martin Luther in 1524:

But foreign trade, which brings from Calcutta and India and such places wares like costly silks, articles of gold, and spices--which minister only to ostentation but serve no useful purpose, and which drain away the money of the land and people--would not be permitted if we had proper government and princes.

I never knew Lou Dobbs was a Lutheran.

On Obesity and Demand Curves

More evidence that demand curves slope downward, from the Wall Street Journal's discussion of the economics of obesity with Carol Graham and Darius Lakdawalla. Here is how Lakdawalla begins the dialogue:

It's no secret that Americans have been getting fatter over the last several decades. But in fact, weight has been rising for more than 150 years, as shown by the economic historians Dora Costa and Richard Steckel. From the Civil War to the 1990s, the weight of a 6-foot-tall American male increased by about 30 pounds on average.

These historical trends are not hard to understand. As we have gotten wealthier and more technologically advanced, food has gotten cheaper and work more sedentary. Both these factors have contributed to rising weight over the time-frame of centuries, and the recent rise in obesity has likewise been fueled by reductions in the price of food.

Since 1976, food has fallen in price by more than 12% compared to other goods. My colleague Tomas Philipson and I have shown that this reduction in price can explain at least half the recent growth in obesity. Shin-Yi Chou, Michael Grossman and Henry Saffer reached similar conclusions about the importance of price. In addition to its overall price, they stressed the increasing availability of food service establishments.

While it is not entirely clear whether restaurants make people heavier, or heavier people attract more restaurants, there is no question that eating is cheaper and easier than it used to be.

As if that were not enough, the most calorie-dense foods have seen the biggest price reductions. David Cutler, Edward Glaeser, and Jesse Shapiro have shown that technological advances have especially lowered the price of processed and snack foods -- like french fries and vending machine treats -- which are particularly high in calories.

The evidence above suggests that obesity is a by-product of prosperity and technological advance. In much the same way that traffic fatalities accompanied the boom in automobiles, roads and freeways, we now face the side effects of our efficient food production system and knowledge-based economy.

Height and Earnings

A new paper by Princeton University economists Anne Case and Christina Paxson says taller people earn more because they are smarter. The abstract:

It has long been recognized that taller adults hold jobs of higher status and, on average, earn more than other workers. A large number of hypotheses have been put forward to explain the association between height and earnings. In developed countries, researchers have emphasized factors such as self esteem, social dominance, and discrimination. In this paper, we offer a simpler explanation: On average, taller people earn more because they are smarter. As early as age 3 — before schooling has had a chance to play a role — and throughout childhood, taller children perform significantly better on cognitive tests. The correlation between height in childhood and adulthood is approximately 0.7 for both men and women, so that tall children are much more likely to become tall adults. As adults, taller individuals are more likely to select into higher paying occupations that require more advanced verbal and numerical skills and greater intelligence, for which they earn handsome returns. Using four data sets from the US and the UK, we find that the height premium in adult earnings can be explained by childhood scores on cognitive tests. Furthermore, we show that taller adults select into occupations that have higher cognitive skill requirements and lower physical skill demands.

Who pays the corporate income tax?

A new working paper from the Congressional Budget Office reminds us that the incidence of the corporate income tax is very different than it first appears. The paper assumes a constant amount of world capital and focuses on how capital owners avoid the corporate tax by investing abroad. Here is an excerpt:

The analysis shows how the domestic owners of capital can escape most of the corporate income tax burden when capital is reallocated abroad in response to the tax. But, as in Bradford (1978), capital owners worldwide cannot escape the tax. Reallocation of capital abroad drives down the personal return to investment so that capital owners worldwide bear approximately the full burden of the domestic corporate income tax. Foreign workers benefit because an increased foreign stock of capital raises their productivity and their wages. Domestic workers lose because their productivity falls and they cannot emigrate to take advantage of higher foreign wages....

Burdens are measured in a numerical example by substituting factor shares and output shares that are reasonable for the U.S. economy. Given those values, domestic labor bears slightly more than 70 percent of the burden of the corporate income tax. The domestic owners of capital bear slightly more than 30 percent of the burden. Domestic landowners receive a small benefit. At the same time, the foreign owners of capital bear slightly more than 70 percent of the burden, but their burden is exactly offset by the benefits received by foreign workers and landowners.

On Inequality and Unions

The blogosphere has been engaged in an intriguing debate about Paul Krugman's conjecture (probably wrong, in my judgment) that increasing inequality over the past three decades has been driven by policy and politics, as opposed to exogenous forces such as technology and demography. Paul writes in an email to Mark Thoma:

So what are the mechanisms? Unions are probably top of the list; I believe that there's a qualitative difference between wage bargaining in an economy with 11 percent of workers unionized, which is what we had in the early 30s, and one with 35 percent unionization, which is what emerged from World War II. That's discontinuous change, partly driven by a change in political regime. And the process went in reverse under Reagan.

I don't know to what extent increasing inequality has been driven by declining unionization (the answer is only 10 to 20 percent, according to this David Card paper, but apparently more according to another David Card paper). But I am skeptical of Paul's suggestion that declining unionization can be attributed to policy. I am more inclined to agree with Princeton labor economist Hank Farber, who writes:

the causes of the divergence in employment growth rates between the union and nonunion sectors are fundamentally related to the structure of the U.S. economy. Employment has shifted away from the sectors in which unions were strongest such as manufacturing, transportation, and communications.

Although I do not pretend to be an expert on this topic, my guess is that declining private-sector unionization is related to the declining share of manufacturing employment, which is attributable to rapid productivity growth in manufacturing, which in turn is attributable to technological advance in that sector. (See this related talk I have given on manufacturing.) So even if declining unionization is part of the story of increasing inequality, this factor should probably be put in the technology-driven column rather than the policy-driven column.

Two other factors come to mind to explain the decline in unions that are, perhaps, more closely related to policy than technology. One is globalization. As the economy becomes more open, firms are increasingly operating in competitive markets. This means they have less economic profit that could be a target for unions. The auto industry is an example.

A second factor is Reagan's famous firing of the air traffic controllers and other policy decisions related to union organizing. Here is Farber on the topic:

Although this decline is often linked to President Reagan's showdown with the air traffic controllers' union (PATCO) in August 1981 and the installation of a Republican majority on the NLRB in May 1983, we find little evidence that either event precipitated the downward trend in organizing activity.

So the decline in unions should probably not be blamed on (or credited to) Reagan et al.

If the decline in unions is related to the person in the White House, it is more likely that they have a common third cause: The voters who vote for conservative Presidents also vote against unionization. Here is a passage from economist Morgan Reynolds writing in the Concise Encyclopedia of Economics:

The degree of union representation of workers has declined in all private industries in the United States in recent decades. A major reason is that employees do not like unions. According to a Louis Harris poll commissioned by the AFL-CIO in 1984 [the year of Reagan's landslide over Mondale], only one in three U.S. employees would vote for union representation in a secret ballot election. The Harris poll found, as have other surveys, that nonunion employees, relative to union workers, are more satisfied with job security, recognition of job performance, and participation in decisions that affect their jobs.

Finally, this discussion raises the issue of whether declining unionization is a good or bad development. The economics profession does not offer a single view on this question. Some economists view unions as a "countervailing power" against the market power of large corporations. Other economists view unions as a cartel aimed at keeping prices high in order to enrich their members, inducing all the inefficiencies and inequities inherent in the exercise of monopoly power.

By the way, any textbook authors out there want to start a union with me to ensure we get a fair price for our efforts? How about it, Paul?

Update: A former student emails me some good observations:

Two other possibilities to add to your list:

(1) Daron Acemoglu, in a series of papers and the J Ec Lit review you once cited in your blog, argues that deunionization is, at least in part, caused by inequality. Specifically, in his model unions compress wages. With larger rewards for skills, this compression becomes less incentive compatible for high skilled workers. So they opt out - or vote for more anti-union policies.

(2) Paul Krugman's Jackson Hole conjecture was that inequality and high unemployment are two sides of the same coin. So Europe and the United States are both subject to the same SBTC [skill-biased technological change] shock. But we have lower unionization, so it manifests itself as inequality, while they have more unionization so it manifests itself as unemployment.

Update 2: A friend who knows this literature better than I do tells me the two Card papers I cited are in fact more consistent than they first appear:

Card still only finds the union decline accounts for about 10 percent of rise in U.S. male wage variance and 0 percent of the action for women in his preferred models....The zero impact for women should raise a red flag for unions as a general explanation since the rise of wage inequality has been at least as great for women as for men.

Jacob Mincer

I am saddened to report that Jacob Mincer, the great empirical labor economist, has died.

Update: The NY Times obituary.

Conservative Fecundity

In today's Wall Street Journal, I learn about the GOP's secret weapon:

According to the 2004 General Social Survey, if you picked 100 unrelated, politically liberal adults at random, you would find that they had, between them, 147 children. If you picked 100 conservatives, you would find 208 kids. That's a "fertility gap" of 41%. Given the fact that about 80% of people with an identifiable party preference grow up to vote the same way as their parents, this gap translates into lots more little Republicans than little Democrats to vote in future elections.

Welfare Reform Ten Years Later

Ten years ago today, President Clinton signed the 1996 welfare reform bill. Here is Robert Samuelson summarizing the results:

Welfare caseloads have plunged. From August 1996 to June 2005, the number of people on welfare dropped from 12.2 million to 4.5 million. About 60 percent of mothers who left welfare got work. Their incomes generally rose. Many qualified for the federal Earned Income Tax Credit, which subsidizes low-income workers. Finally, there were intangible benefits: work connections, self-respect.

One lesson is that what people do for themselves often overshadows what government does for them. Since 1991, for example, the teen birthrate has dropped by a third. The mothers least capable of supporting children have had fewer of them. Welfare reform didn't single handedly cause this. But it reinforced a broader shift in the social climate—one emphasizing personal responsibility over victimhood....

So: we've made a stubborn problem a bit more manageable. It's pragmatic progress, not a panacea. Why can't we do the same for other pressing problems—energy, immigration, retirement spending (Social Security, Medicare)? Here, welfare reform's political lessons apply.

One is the need to overcome a bias against change. We underestimate people's ability to adapt. In 1995, one think tank forecast that the bill would throw 1 million more children into poverty. If Congress had listened, little would have happened. Today we could gradually raise Social Security and Medicare eligibility ages without causing a social catastrophe.

The 1996 bill was one of President Clinton's most significant accomplishments.

Fashion Statement for Classical Liberals

I am not big into accessories, but I ordered this one from the Adam Smith Institute.

POTUS 2008

About two years from now, the two U.S. political parties will be picking nominees. Who should they pick if they want to win the general election the following November? We can glean some insight from Tradesports.com and Bayes Theorem.

According to the betting over at Tradesports, here is the probability that the following individuals will be President of the United States after the 2008 election:

McCain 23.5
Clinton 19.9
Giuliani 8.5
Edwards 4.7

(These are the only four with active betting markets now.) From this information, however, you can't tell who would be the better candidate for a party to pick, because this probability reflects both the probability of being nominated and the probability of being elected if nominated. Fortunately, Tradesports also gives us the probability that each of these individuals will be nominated by his or her party:

McCain 39.5
Clinton 41.2
Giuliani 14.6
Edwards 8.2

Now apply Bayes Theorem. By dividing the first number by the second, we can obtain for each candidate the conditional probability--the probability that the person will win the general election if nominated. Here are the results:

McCain 59.5
Clinton 48.3
Giuliani 58.2
Edwards 57.3

Note the relative performance of Hillary Clinton and John Edwards. Although Clinton is more likely to end up President than Edwards is, Edwards is more likely to win the general election conditional on being nominated. At least that's what the market says.

Addendum: For an introduction to the academic literature on these markets, see Wolfers and Zitzewitz.

Samwick on Krugman

Dartmouth economics professor Andrew Samwick posts a blog entry discussing Paul Krugman's recent commentary on inequality. An excerpt:

What always puzzles me about Paul Krugman and his claims about inequality is why he doesn't seem to realize how silly he sounds when he refuses to acknowledge, and take some pride in the fact, that he is part of that top 1 percent. I find it hard to imagine that Paul Krugman's income in 2004 wasn't above $277,000, between his income from his university, his speaking engagements, his books, his columns, and his investments.

Now, does Paul Krugman think that he was just a tool of the "New Gilded Age" politicos? Does he owe his income gains to the people he despises, those nasty Republicans and that ridiculously centrist Clinton? I'd like to know. I suspect that if you asked him why his income grew to the point where he's in the top 1 percent, he would give some long answer, the shorter version of which is that he's "highly educated" and he's not lazy.

Paul is correct when he says that income inequality has been rising over the past three decades (although he overstates the stagnation for the middle class by relying on numbers that exclude fringe benefits--see this previous post). But I agree with Andrew that Paul is on shaky ground when trying to explain rising income inequality by politics (as opposed to technology, demography, and so on). Policy choices such as tax rates and minimum wages have not been the main causes of increasing inequality. At least that is the consensus, as I understand it, of the professional labor economists who study the issue.

Update: Brad DeLong agrees:

I can't see the mechanism by which changes in government policies bring about such huge swings in pre-tax income distribution.

Exactly.

Piled Higher and Deeper

A reader alerts me to a comic strip aimed at grad students. One recent strip explains the perils of writing with an established professor. Another explains why econ PhDs have to be paid a compensating differential.

I feel the pressure

An anonymous comment on a previous post:

If I don't see a new post each time I visit this blog, I get impatient and restless.

Unfair to Prof. Mankiw, unfortunate for me.

The Fair Tax

A reader asks:

Professor: Could you shed some of your wisdom on the Boortz/Linder tax plan, the FairTax.

As I understand it, the so-called Fair Tax plan calls to raise a substantial fraction of U.S. federal tax revenue with a retail sales tax. It is one form of a consumption tax. Many economists—and I include myself among them—believe that consumption taxes are better than income taxes because they do not discourage saving. (See this previous post on the topic.)

Some tax experts tell me that a large retail sales tax, such as that envisioned by the Fair Tax, may cause problems in compliance. That is, if a retail sales tax has a high rate, retailers will find ways to evade. One solution to this problem is to collect the tax throughout the various stages of production, rather than all at once at the final sale to the consumer. This is what a value-added tax does. From an economic standpoint, a retail sales tax and a value-added tax are equivalent, but the value-added tax may raise fewer problems in compliance.

I should note that there are other ways to implement a consumption tax in addition to a retail sales tax and a value-added tax. Some of these other administrative mechanisms give policymakers more parameters to vary the degree of progressivity. Examples include the Hall-Rabushka version of the flat tax and the Bradford X-tax.

One possible complaint about a retail sales tax or a value-added tax is that these tax systems are proportional (or "flat"), rather than progressive, as a function of consumption. That "defect" can be remedied to some degree by giving people a lump-sum grant financed by the flat consumption tax. In that case, the overall system would be flat in marginal tax rates but progressive in average tax rates.

Sunstein on Global Warming

In today's Washington Post, University of Chicago law professor Cass Sunstein has a good article explaining why a global deal on carbon emissions is likely to prove difficult:

In recent years the United States has accounted for about 21 percent of the world's greenhouse gas emissions. China comes in second at about 15 percent. While many countries have stabilized their greenhouse gas levels, emissions from both nations, but especially China, are growing rapidly. Current projections suggest that by 2025 total emissions from the United States will increase by about one-third. By that year, China's emissions are expected roughly to double.... It follows that if an international agreement requires reductions, China and the United States will have to bear the brunt of the expense.

By contrast, the biggest losers from greenhouse gas pollution are likely to be India and Africa. Some of the most detailed, careful and influential projections have been made by Yale University's William Nordhaus and Joseph Boyer. Nordhaus and Boyer show that in terms of human health and agricultural loss, India and Africa are by far the most vulnerable regions on Earth. Because of an anticipated increase in malaria, Africa will probably be hit especially hard, and India is expected to suffer a large increase in premature deaths as well.

If climate change occurs at the rate expected by many scientists, it will have a much less serious effect on the United States, and even less than that on China. In the United States, agricultural production is expected to suffer relatively little. In China, agriculture is actually projected to benefit from a warmer climate....

The two nations now most responsible for the problem have comparatively little incentive to do anything about it.

The Coase theorem says that, in the presence of such externalities, there is always a deal to be had. In this deal, all actors move to the efficient level of pollution, and appropriate side payments are made to ensure that the deal is Pareto-improving. If Sunstein is right about the facts, in this case the Coasian deal would involve payments from Africa and India to China and the United States. Somehow, it is hard to imagine that happening.

Is low fertility a problem?

The most wrong-headed sentence I have read recently was in yesterday's Wall Street Journal:

Fertility rates have been on the decline in industrialized nations for decades, but they are now becoming a serious economic problem, felt around the globe, from the European Union to China, Japan and South Korea.

Maybe some policymakers are perceiving low fertility as a serious economic problem, but is it really a problem? I doubt it. As a serial procreator, I have never been moved by fears of overpopulation, but I am also not moved by fears of underpopulation.

If you polled top economists and asked them to name the major economic problems facing Europe, China, Japan, and South Korea, I doubt that insufficient procreation would rank high.

Free Publicity

Over the past couple weeks:

• Daniel Gross in the NY Times gives me my 16th minute of fame, including a picture.
• The Economist gives me my 17th minute, including a plug for this blog.
• Andy Mukherjee of Bloomberg gives me an 18th.

Wake-Up Call for Jason

The headline on the front page of today's NY Times:

Eye on Election, Democrats Run as Wal-Mart Foe

Will this be enough to get my Democratic friend Jason Furman to change party?

How To Be Happy

From yesterday's Wall Street Journal, some advice:

Think carefully about how you spend your dollars. While a new car may not boost your happiness for long, maybe a trip to Europe would.

"Money itself doesn't make you happy," [Harvard psychology professor Daniel] Gilbert says. "What can make you happy is what you do with it. There's a lot of data that suggests experiences are better than durable goods."

The car might seem like the better purchase, because it has lasting value. But, in fact, it sits in the driveway, slowly deteriorating. "Experiences don't hang around long enough to disappoint you," Prof. Gilbert says. "What you have left are wonderful memories."

This rings true to me.

Goolsbee on Higher Education

In today's NY Times, economist Austan Goolsbee has a nice piece on why it makes little sense to subsidize higher education as a strategy to promote local economic development.

Letter from Milton

For a classically liberal, applied macroeconomist like me, getting an email from Milton Friedman makes one appreciate what Moses must have felt when God tapped him on the shoulder to deliver wisdom to the masses. A couple days ago, I had a Moses moment, when Milton sent me some comments on my paper The Macroeconomist as Scientist and Engineer.

Two of Milton's commandments show his continued commitment to small government and passive monetary policy: Thou shalt abolish the Federal Reserve. Thou shalt maintain a constant level of high-powered money.

Here is the letter in its entirety, followed by my response:

HOOVER INSTITUTION ON WAR, REVOLUTION AND PEACE
Stanford, California, 942305-6010

August 14, 2006

Professor N. Gregory Mankiw
Department of Economics
Harvard University
Cambridge, MA 02138

Dear Greg:

I enjoyed reading your working paper article on the macroeconomist. It is an excellent survey and well written. But you will not be surprised that I come not only to praise but also to suggest and criticize.

My suggestion has to do with the early work on business cycles. You have omitted the person who I believe played the greatest role in the early work , namely Wesley C. Mitchell whose book Business Cycles was published in 1913. As you know, Mitchell went on to found the National Bureau of Economic Research primarily to study cycles. At the Bureau he published two more books on business cycles, the second jointly with Arthur Burns.

As to comment or criticism, I take a slightly different view than you do of the reason for the better performance in monetary policy over the past twenty years or so. I believe it derives primarily from the recognition by central banks worldwide that they have responsibility for inflation. The Great Depression on the one hand and the inflation of the seventies on the other reinforced earlier theoretical and historical work . My aphorism, “Inflation is always and everywhere a monetary phenomenon,” was converted from an object of derision to a near truism. This experience was of course strongly reinforced by the leadership shown by Alan Greenspan in the United States, but also I believe by the leadership shown by Donald Brash in New Zealand.

New Zealand was the first country to introduce inflation targeting and it arose out of the contract which Donald Brash arranged with the central government under which he committed himself to keeping inflation between I believe it was one and 3 percent. The arrangement was that if he did not do that he could and presumably would be fired. Volcker and Greenspan in the United States brought down inflation without stating any numerical targets. Brash introduced the term “inflation targeting” and succeeded in keeping his position by achieving his targets. The example was followed as you know by Australia, Britain and many other countries.

In the great deflation of the 1930s there were many economists and non-economists who were aware of the deficiency of monetary policy, but it was not the main explanation which was offered for the depressed economic conditions. That was attributed to a market failure. Similarly, in World War II, inflation was attacked primarily by price controls and was not widely attributed to excessive increase in the quantity of money. Of course what is important is not only that the central bankers learned the lesson and came to accept responsibility for inflation, but that the public at large did and will hold the monetary authorities responsible if and when any significant inflation develops.

The role of the theoretical work that you discuss was to provide central bankers with a greater understanding of the process and more tools for deciding what should be done. The Taylor rule is a clear example of the impact of macroeconomics in that respect.

One more side point. I have come to the conclusion that the central bankers did a marvelous job of pulling the wool over the eyes of economists. They led us all to believe that maintaining a relatively stable price level is a very difficult problem that requires the judgment of the wisest of experienced bankers and business people. The ease with which New Zealand, Australia, Britain, etc., have maintained relatively stable prices, have reduced greatly the variability of inflation, suggests that maybe it isn’t such a hard job at all, that the cycles of the past were not attributable to the difficulty of achieving price stability, but to the mistakes of the central bankers in not achieving price stability. Nothing that I have observed in recent decades has led me to change my mind about the desirability of a monetary rule which simply increased the quantity of money at a fixed rate month after month, year after year. That rule would get rid of the mistakes and that is probably about all you could expect to get from a monetary system.

Even better would be to abolish the Fed and mandate the Treasury to keep highpowered money at a constant numerical level.

Best wishes and regards.

Sincerely yours,

Milton
Milton Friedman
Senior Research Fellow

Here is my response:

August 15, 2006

Dear Milton,

Thank you for your comments. I am delighted to hear that you enjoyed the paper, and I appreciate your taking the time to write me.

The paper is already past galleys and on its way into the Journal of Economic Perspectives. However, I would love to share your insightful letter with my blog readers. Would you mind if I posted it there?

You are right that I should have mentioned Mitchell. That was an oversight on my part.

Let me make a few points about monetary policy.

I agree that the historical events of the 1970s taught central bankers about the importance of keeping inflation under control. But, more precisely, what did they learn? Here are two possible lessons:

(1) Central bankers should give inflation a greater weight in their objective functions.
(2) Central bankers can control inflation only with a commitment to a policy rule.

I believe the Greenspan experience argues for lesson (1). Some economists argue for lesson (2). By the way, my paper is being paired in the journal with one by V.V. Chari and Pat Kehoe. They seem to argue for (2) over (1).

Although I agree with you about the importance of controlling inflation, I am not persuaded that the task is quite as easy as you suggest. In another paper, called “A Letter to Ben Bernanke,” I write that Burns’s bad outcomes and Greenspan’s good outcomes were in part attributable to the fact that Burns had to deal with more adverse shocks than Greenspan did. Perhaps Burns played a bad hand badly, and Greenspan played a good hand well. I wonder how Greenspan would have handled the circumstances that Burns faced: volatile food and energy prices coupled with a productivity slowdown and an increasing natural rate of unemployment. (FYI, that paper was published in the May 2006 AER, but you can find it online here.)

Your comments on the virtues of constant high-powered money surprised me. On the one hand, high-powered money is the measure with the clearest definition, especially in light of the growth of many “near monies” that complicate the measure of broader aggregates. On the other hand, I would have thought that the experience of the 1930s argues against such a rule. If I recall correctly, most of the decline in the monetary aggregates during that period was attributable not to high-powered money but to inside money and the money multiplier. If we abolished the Fed and kept high-powered money constant, it seems that a similar set of events could potentially unfold.

Again, thank you for your comments. And please let me know if I can post your letter. I am sure my blog readers, many students and professors of economics, would enjoy reading it.

With best wishes,
Greg

PS Let me thank you and Rose again for the wonderful lunch at your home some years ago. Please convey to her my regards and best wishes for continued prosperity.

Milton emailed me back, giving me permission to share all this with you. I trust you enjoyed it as much as I did.

Siegel vs Bogle on Index Funds

I am a fan of both Jeremy Siegel (Wharton economist and author of "Stocks for the Long Run") and John Bogle (Vanguard founder and index fund pioneer). I am therefore fascinated by the intellectual and financial battle between them. Here it is, as reported in today's New York Times:

According to Mr. Siegel, there is a “revolution” under way, a “new paradigm” in which the traditional indexes like the S.& P. 500 will make way for fundamental indexing, which constructs indexes based on measures like companies that pay dividends, rather than just a company’s size.

Perhaps not surprisingly, the company Mr. Siegel advises, WisdomTree, whose chairman is Michael H. Steinhardt, the legendary former hedge fund manager, has been active in developing these indexes and sponsoring exchange-traded funds based on them....

Mr. Siegel says the central problem with traditional index funds, which are weighted by market capitalization, is that they overweight overvalued stocks and underweight undervalued stocks. Historically, value stocks outperform growth stocks, so an index should be constructed to invest in the cheaper value stocks rather than the expensive growth stocks.

“We should be shifting to another paradigm to look at how markets work,” Mr. Siegel said in an interview. “I don’t think the price of a stock is always in line with fundamentals. I think there are a lot of factors, which helps to explain a lot of what we see in the capital markets.”

Mr. Bogle disagrees. “Beware when you hear about the new paradigm,” he said yesterday. “I think the claims they make are outrageous." He refers to some of the data provided to back up the premises of WisdomTree as “data mining.”

I am placing my bets with Bogle on this one. Bogle's position has the virtue of an economic theory to back it up: the efficient markets hypothesis. The hypothesis is probably not exactly true, but it may be true enough to make it sensible for typical investors to follow its prescriptions.

By contrast, Siegel thinks markets are inefficient. But if that is so, why not advocate active money management? The answer, presumably, is that active money management has historically not done as well as passive management. But that fact seems to undermine the basic premise of the funds that Siegel is promoting.

Siegel's position appears to be that active money managers aren't smart enough to beat the market but his mechanical rule is. I am skeptical. The hubris that makes active management often fail may also infect economists who make up mechanical rules.

Finally, tax efficiency is important in taxable investment accounts. It is hard to beat the market, but it is easier to beat the IRS by a combination of (1) focusing on capital gains over dividends and (2) deferring capital gains realization via reduced portfolio turnover. Tax efficiency argues in favor of the traditional index funds that Bogle recommends.

Movie Recommendation

It is too nice a day outside to be blogging about economics, so I will leave readers with a recommendation that has nothing to do with economics: Little Miss Sunshine. I don't usually enjoy screwball comedies, but this movie is funnier and deeper than most.

Okay, I promised my kids I will turn off my computer now. Here goes: One, two, three....

Some TV is worth watching

From Google Video, we can now watch the classic Milton Friedman television series Free to Choose:

Volume 1: Power of the Market
Volume 2: The Tyranny of Control
Volume 3: Anatomy of a Crisis
Volume 4: From Cradle to Grave
Volume 5: Created Equal
Volume 6: What’s Wrong With Our Schools?
Volume 7: Who Protects the Consumer?
Volume 8: Who Protects the Worker?
Volume 9: How to Cure Inflation
Volume 10: How to Stay Free

Also from Google Video is a cartoon that I bet Friedman would appreciate.

Thanks to The Idea Shop and to The Austrian Economists for the pointers.

Update: Sorry, but these are no longer available.

Business Cycle Dating

Back in 2004, Michael Mandel of Businessweek gave me grief for saying that the 2001 recession began in late 2000, rather than at the official NBER date of March 2001. My view (and the view of the nonpartisan CEA staff) was that the data were substantially revised after the NBER committee made their call, and the March 2001 date no longer seemed right in light of the revised data. Mandel's view was that I was a Republican stooge.

Recently, a friend emailed me a paper on dating business cycles by the prominent time-series econometrician Jim Hamilton and coauthor Marcelle Chauvet. If you look at their Table 6 (page 53), you can find their estimated date for the start of the recession: September 2000.

They write:

The NBER recession dates and the model-based dates are very close, either exactly coinciding or differing by only one month. The one exception is the 2001 recession, in which the estimated probabilities started increasing in 2000, six months before the recession began as declared by the NBER. Our quarterly GDP-based full-sample inferences reported in Table 2 also suggested that this recession actually began in the fourth quarter of 2000.

I am happy to welcome Jim Hamilton into the Republican Stooge Club.

Update: Hamilton weighs in.

Friedman on Education

After my previous post on the Department of Education's desire for more centralized oversight of colleges, readers might enjoy hearing from Milton Friedman about what's wrong with our system of elementary and secondary schools:

“The schooling system was in much better shape 50 years ago than it is now,” says Friedman, his voice as confident as reinforced concrete....Friedman puts much of the blame on centralization.

“When I went to elementary school, a long, long time ago in the 1920s, there were about 150,000 school districts in the United States,” he says. “Today there are fewer than 15,000, and the population is more than twice as large.”

Centralization was caused by urbanization and in turn caused bureaucratization.

From the LA Times. The whole article is worth reading.

Higher Education Report

Today's NY Times reports:

A federal commission approved a final report on Thursday that urges a broad shake-up of American higher education. It calls for public universities to measure learning with standardized tests, federal monitoring of college quality and sweeping changes in financial aid.

The Washington Post notes:

A commission member representing nonprofit colleges declined to sign on, however, saying the report reflected too much of a "top down" approach to reform.... [David] Ward said he supported many of the commission's objectives, but opposed "one-size fits all" prescriptions that fail to reflect the differing mission of colleges.

Ward makes a good point. Higher education in the United States is highly diverse and competitive, and these features are among the strengths of the system. Any attempt to centralize oversight in the federal government is likely to be counterproductive.

I typically support standardized tests. For college admissions, for example, objective measurements of ability and achievement, though imperfect, are more free of bias than are subjective judgments from recommendations and interviews. In my Ec 10 class, multiple-choice questions are a significant part of the evaluation process. But I cannot imagine a standardized test that would be appropriate to test a large number of exiting college students, whose experiences are so heterogeneous.

Small-government Republicans used to call for abolishing the Department of Education. This report seems to call for expanding its powers. If so, it is a step in the wrong direction.

What causes terrorism?

In light of the terrorist plot dominating today's news, some readers might be interested in this article from the Journal of Economic Perspectives: Education, Poverty and Terrorism: Is There a Causal Connection? by Alan B. Krueger and Jitka Maleckova. Their bottom line:

The evidence we have presented, tentative though it is, suggests little direct connection between poverty or education and participation in terrorism.

Sadly, we still know relatively little about the root causes of terrorism.

Update: Other research suggests that educated terrorists are more likely to be successful. So education seems to have negative externalities for this population: It does not reduce participation in terrorist activity, but it increases the efficacy of the terrorists.

Lamont on Jobs and Trade

Most discussion of the Lamont primary victory over Lieberman has focused on the war in Iraq. But the Lamont victory may also signal a shift in the Democratic party toward a more economically isolationist position.

Here, in its entirety, is what the Lamont campaign website says on a page titled Jobs:

Connecticut has lost 75,000 manufacturing jobs in the last six years, many replaced by retail and service jobs which pay less and have reduced healthcare and pension benefits. Today, the middle class is getting squeezed and most people living in poverty or near poverty are employed but not earning enough to get by.

Many of our high-skill jobs are being sent overseas, drawn by low wages and no benefits.

I support strictly-enforced fair trade policies which level the playing field, requiring that American products have the same access to Chinese markets that Chinese products have to American markets. I would support only reciprocal trade agreements which include strong labor and environmental standards.

So Lamont seems to think the U.S. economy is suffering and the primary reason is competition from poor workers in China.

This rhetoric scares me. Wages, benefits, and labor and environmental standards are primarily a function of the level of economic development. Complaining about poor countries' low wages and benefits is essentially blaming the poor for being poor.

Talk about "strong standards" sounds nice, but it is not realistic: Labor and environmental standards cannot catch up to U.S. levels until China is much richer than it is today. Demanding "strong standards" can easily become an excuse for imposing trade restrictions, which will only improvish the world's poor even further, as well as denying Americans the benefits of globalization.

In 2002, when the Senate passed Trade Promotion Authority, Lieberman voted in favor. A majority of Democratic Senators (including Harry Reid, the current minority leader) voted against. Would Lamont have voted for the pro-trade position as Lieberman did, or would he have voted with his party's majority? I don't know, but the campaign rhetoric is not encouraging.

Style Guide

This is not new, but I just noticed it: The Economist magazine has an on-line style guide for its writers. It is worth a read by all economics students.

Oops...Let me put that in the active voice: All economics students should read it.

As long as I am on the topic, let me also recommend William Zinsser's On Writing Well.

Lefties' Leg Up

Today's Washington Post reports that southpaws earn more:

"Among the college-educated men in our sample, those who report being left-handed earn 13 percent more than those who report being right-handed," said economist Christopher S. Ruebeck of Lafayette College. Ruebeck and his research partners, Joseph E. Harrington Jr. and Robert Moffitt of Johns Hopkins University, reported the findings in a new working paper published by the National Bureau of Economic Research.

And lefties, stay in school: Those who finished all four years of college earned, on average, a whopping 21 percent more than similarly educated right-handed men. Curiously, the researchers found no wage differential among left- and right-handed women....

"We do not have a theory that reconciles all of these findings," they admit.

The study is the latest to suggest there's something special about lefties. Other researchers have found that left-handers are overrepresented on university faculties, as well as among gifted students, artists and musicians.

The paper can be found at the NBER.

Maybe we right-handed people should demand compensation to remedy this injustice. On the other hand,....

FOMC Voting

There was a dissent at today's Fed meeting: While a majority of the FOMC voted to hold interest rates steady, one person dissented, preferring an increase of 25 basis points in the federal funds rate.

The voting procedure of approval/dissent seems a bit odd in this context. So does the convention of rounding the target rate to the nearest 25 basis points.

Here is an idea: Why not put median voter theory into practice? Let's have every FOMC member state a number for his or her preferred target for the federal funds rate and then make the outcome equal to the median.

The median-voter approach would not lead to very different outcomes, but it would provide a way for each member to express his or her view transparently without seeming like a troublemaker. The approach would be particularly helpful when there are more than two possible outcomes. In some future meeting, maybe not so far away, the Fed may have to choose among cutting rates to promote growth, raising rates to fight inflation, and holding steady. A median-voter rule would automatically arbitrate among the competing viewpoints.

My Party Affiliation

Blogger Evan, apparently a student at Rice, writes:

We used Mankiw's text in my micro-econ class during my first semester of undergrad. My professor (not at Rice; I transferred) was a Democrat who told us several times that Mankiw was also a Democrat. So I was quite surprised when Mankiw accepted a position in the Bush administration.

This has happened to me many times before. In 1993, when Bill Clinton became President, a Harvard dean said to me, "Greg, many of your colleagues are leaving to join the new administration, and I wondered whether you might be one of them. But someone told me you're a Republican. Could that possibly be true?"

Why, before I held a political job, did some people assume I was a Democrat?

One reason is that I have worked on new Keynesian models of the business cycle. For some reason, Keynes is an economist often associated with the left. The influence of Keynes, however, goes well beyond politics and ideology. Indeed, the new Keynesian paradigm is increasingly the standard approach to business cycle analysis.

A second reason is that the people making the incorrect assumption about my party affiliation are reasonable, mainstream economists who happen also to be Democrats. Based on my textbooks and other writings, they viewed me as a reasonable, mainstream economist like them and jumped to the conclusion that I must be a Democrat as well. That is probably what Evan's instructor did.

The reason I am a Republican is that, compared to Democrats, the Republicans tend to favor smaller government, lower taxes, and greater reliance on free markets. On many social issues, I find myself agreeing with the Democrats more than the Republicans, and I know that the Republicans are far from perfect on economic issues. (Don't get me started.) But as a classical liberal in the spirit of Milton Friedman, I find myself rooting for the Republican team more often. The recent debate over the minimum wage is a case in point.

Finkelstein on Health Insurance

Amy Finkelstein, one of the young stars of the economics profession, writes:

the overall spread of health insurance between 1950 and 1990 may be able to explain about half of the increase in real per capita health spending over this time period.

If correct, this conclusion requires a radical revision in the conventional wisdom among economists. The conventional wisdom holds that technological advance is the primary cause of increasing health spending: We now have new and better ways to spend money to save and improve lives.

Finkelstein refrains from normative policy analysis in the article I've linked to above. But if health insurance, rather than exogenous technological advance, is the explanation for higher health spending, the policy implications could be profound. Better designed health insurance could, perhaps, save us a bundle of money.

See Businessweek for more on the topic.

The Problem with Europe

According to Newsweek, the problem with Europe is that students are taught to distrust capitalism:

when Dariani looks back at his high-school days, a decade ago in the west German city of Kassel, he remembers his teachers warning against exactly what he's doing [being an entrepreneur]. "They taught us the market economy was a dangerous wilderness full of risk and bankruptcy," Dariani says. "We never learned how prices affect supply and demand, only about evil managers and unjust wages."

I have long thought that that good economics education is the foundation for good economic policy. In a democracy, people get the government they want. If the people have warped ideas about how economies work, the result is bad policy.

What the world really needs is more people reading my favorite economics textbook. Fortunately, there is now a European adaptation. The economies of Europe should start to look up soon.

Feldstein on the Fed

In today's Wall Street Journal, my Harvard colleague (and former Ec 10 head) Martin Feldstein says the Fed needs to risk recession to keep inflation under control:

A mild slowing of economic growth is generally not sufficient to reverse rising inflation. That generally requires a sustained period of excess capacity in product and labor markets, with GDP growth falling significantly or even turning negative....

The Federal Reserve has a difficult task ahead. It is understandable that it would like to achieve the soft landing of low inflation with continued solid growth. But that may not be possible. And if the Fed wants to convince the markets that inflation will be contained in the future, it must show that it is willing to take the risk of tightening too much.

McArdle on Ben Friedman

Megan McArdle reviews the new book by my colleague Ben Friedman, The Moral Consequences of Economic Growth. My Ec 10 students will recall that Ben gave a lecture on the topic in the spring.

Applying the PIH to Politics

According to the logic of Milton Friedman's Permanent Income Hypothesis, a person's long-run average income is more important than annual income for determining his consumption and living standard. Stephen Rose suggests that the same logic applies to the question of what voters would naturally support the Democratic party:

A single-year snapshot of Census data can show almost 40 percent of the U.S. population making less than $40,000. On paper, that amounts to widespread economic distress. It suggests that something close to a majority of Americans may have a very direct personal stake in supporting social safety net programs for the poor -- the programs that the Democratic Party is most commonly identified with in public opinion surveys -- because they themselves might need government assistance at some point in their lives.

But because people's incomes fluctuate from year to year, the more accurate way to measure their economic wellbeing is to look at their average earnings over a longer period, for instance, 15 years. Analyzed that way, the data show that about 23 percent of adults in their prime working years have average family incomes of $40,000 or less. This is the segment of the population with the most direct interest in social safety net programs for people in economic distress.

Our Insane Farm Policy

You have heard this before, but as Orwell put it, "we have now sunk to a depth where the restatement of the obvious is the first duty of intelligent men."

There are few issues for which the political consensus is so distant from both common sense and expert opinion. Right-wing economists, left-wing environmentalists and almost anybody in-between who doesn't receive a check from the Department of Agriculture or depend on a political donation from said recipients understand that Americans are spending billions to prop up the last of the horse-and-buggy industries.

At this nation's founding, nearly nine out of 10 workers were employed in agriculture. By 1900 that fell to fewer than four in 10. Today, fewer than one in every 100 workers is in agriculture, and less than 1% of gross domestic product is attributable to agriculture. Yet this country spends billions upon billions of dollars subsidizing a system that makes almost everyone in the world worse off....

Subsidies combined with trade barriers (another term for subsidy) prop up the price of food for consumers at home and hurt farmers abroad. This is repugnant because agriculture is a keystone industry for developing nations and a luxury for developed ones. This keeps Third World nations impoverished, economically dependent and politically unstable. Our farm subsidies alone — forget trade barriers — cost developing countries $24 billion every year, according to the National Center for Policy Analysis. Letting poor nations prosper would be worth a lot more than the equivalent amount in foreign aid.

From Jonah Goldberg at the LA Times.