Category: Equitablog

Must-Read: Mark Thoma: This Nobel Prize for Economics Is Well Deserved

Posted on by Brad DeLong

Must-Read: Mark Thoma: This Nobel Prize for Economics Is Well Deserved: “Most people have probably never even heard of “contract theory”… Oliver Hart and Bengt Holmström…

…When should workers be paid a bonus based on performance? What’s the best way to structure the contract specifying the terms for paying a bonus? Should managers have stock options as part of their contracts, or is some other arrangement preferable? When should insurance companies require co-payments, and what’s the best co-pay schedule?… People often find themselves in situations in which they must trust that someone else will act in their best interest, so contracts are a way of creating incentives that avoid conflicts of interest and specify how to share any risks…. The optimal construction of these “pay for performance” contracts is a harder problem than it might appear at first glance…. Holmström’s work has wide application… whenever contracting arrangements between people or firms are needed. 

Hart’s… main contribution is more difficult to describe…. It’s not possible to specify all possible contingencies… “incomplete contracting” theory….

The main idea is that a contract that cannot explicitly specify what the parties should do in future eventualities, must instead specify who has the right to decide what to do when the parties cannot agree…. In complex contracting situations, allocating decision rights therefore becomes an alternative to paying for performance.

Since decision rights and ownership rights go hand in hand, Hart’s contributions also deliver a theory of property rights that has wide applications…

How much bigger can the U.S. labor force get?

Posted on by Bridget Ansel

The U.S. labor market continues to recover from the still lingering effects of the Great Recession, but the question on the minds of many economists and analysts is how long can the healing continue? Or, in other words, has the U.S. economy hit “full employment,” where all the workers who can be drawn into the labor market by a stronger economy are now finding jobs? Understanding trends in the labor force participation rate is key for answering this question. Knowing whether the share of the population actively participating in the labor market can grow much further or whether it will trend down can help determine how low the unemployment rate might go.

First, a quick reminder on how the labor force participation rate affects the unemployment rate. The unemployment rate is calculated by taking the number of unemployed workers and dividing it by the labor force, the sum of the number of unemployed and those with a job. So knowing how much the denominator in that situation is going to change will impact the overall unemployment rate. For more on this, read Equitable Growth Senior Director for Policy Elisabeth Jacob’s testimony on trends in the labor force participation rate.

Views on labor force participation today vary on the extent to which structural forces or cyclical effects from the Great Recession of 2007-2009 are still affecting the participation rate. Many economists and analysts point to the role of structural forces or trends that long predate the Great Recession. But the long-term trend that gets cited the most is the aging of the working population as the Baby Boomer generation reaches retirement. The estimates on the effects of aging can vary quite a bit, but an estimate by the White House’s Council of Economic Advisers puts about half of the decline in participation from 2007 to 2014 into the “aging” category. When it comes to a policy response, it’s hard to change the age distribution of the population in the short run.

The importance of structural forces and demographics might give an impression that labor force participation or other trends are immutable and have to simply be endured. Regardless of how much slack remains in the labor market (the recent slight increase in the rate may be a sign of remaining slack), several structural factors can be addressed through policy actions.

Consider a new paper by Princeton University economist and former Council of Economic Advisers chairman Alan Krueger. The paper takes a direct look at the labor force participation rate and tries to understand what is depressing participation for men and women who are in prime working ages of 25 to 54. When it comes to prime-age men, health problems seem to be a huge barrier to labor market participation. According to the paper, almost 50 percent of men in this age group are taking medicine to control pain, and about 40 percent of this group say health issues are preventing them from taking a job. This is structural force that is not directly related to the Great Recession, but it certainly is amenable to a policy response.

As Krueger notes, such a trend means increased health insurance may help this trend or policymakers may want to look at pain-management interventions. When it comes to trends for prime-age women, there’s research pointing to the importance of family-friendly policies, or rather the lack thereof. Other countries have seen rising labor force participation rates for women, but we haven’t seen that in the United States as Krueger points out. Policies that help provide childcare and paid family and medical leave seem likely to help push back against these trends, as Equitable Growth’s executive director and chief economist, Heather Boushey, details in her recently published book, “Finding Time: The Economics of Work-Life Conflicts.” And paid leave may also help male employment by allowing workers to take time off for their own health problems.

Of course, there is still the possibility that cyclical forces are pushing down the labor force participation rate. As Matt Yglesias notes at Vox, wage growth hasn’t been particularly strong during this recovery, which points to continued weaknesses in the demand for labor among employers. He also points out that a stronger economy could make some of these structural forces seem less structural as employers would be less picky about which workers they hire. The only way we’ll really know is if policymakers, especially at the Federal Reserve, continue to be patient and help the current recovery continue.

Must-Read: Boston Fed: 60th Economic Conference: The Elusive “Great” Recovery: Causes and Implications for Future Business Cycle Dynamic

Posted on by Brad DeLong

Must-Read: Boston Fed: 60th Economic Conference: The Elusive “Great” Recovery: Causes and Implications for Future Business Cycle Dynamics

October 14:

  • 7:30 am: Registration & Breakfast
  • 8:30 am: Welcome and Opening Remarks, Eric S. Rosengren
  • Morning Moderator: Joe Peek
  • 9:00 am: Why Has GDP Growth Been So Slow to Recover? James H. Stock, Peter Ireland, Lucrezia Reichlin
  • 11:00 am: Why Has the Unemployment Rate Fared Better than GDP Growth? Robert E. Hall, John G. Fernald, Laurence M. Ball
  • 12:30 pm: Luncheon: The Honorable Janet L. Yellen
  • Afternoon Moderator: Christopher L. Foote
  • 2:30 pm: Where Have All the Workers Gone? Alan B. Krueger, Gabriel Chodorow-Reich, Peter Diamond
  • 4:15 pm: Why Has Consumer Spending Remained Moderate and the Saving Rate Increased? Luigi Pistaferri, Karen Dynan, Atif R. Mian
  • 5:45 pm: Reception
    Saturday, October 15

October 15:

  • 8:00 am: Breakfast
  • Morning Moderator: Ricardo P. C. Nunes
  • 9:00 am: Why Has Inflation Remained Low for So Long? Robert G. King, Truman F. Bewley, Jeffrey C. Fuhrer
  • 11:00 am: J. Bradford DeLong, Olivier Blanchard, N. Gregory Mankiw
  • 12:30 am: Luncheon
  • 1:30 pm: Adjournment

Must-Read: Noah Smith: Don’t Be So Sure the Big Tech Breakthroughs Are Behind Us

Posted on by Brad DeLong

Must-Read: I have never thought that this graph is fair. “College tuition and fees” have skyrocketed in significant part because government subsidies have been withdrawn. (This withdrawal is, I think, a huge mistake.) Medical care costs have exploded because (a) our medical system is uniquely inefficient and (b) medicine today does so much more. Rich people at least would rather have today’s medicine at today’s nominal cost than 1960 medicine at its nominal cost–suggesting that from some points of view medical cost inflation has been negative:

Noah Smith: Don’t Be So Sure the Big Tech Breakthroughs Are Behind Us: “Timothy B. Lee used to be one of the most ardent techno-optimists. But he’s had a bit of a conversion…

Don t Be So Sure the Big Tech Breakthroughs Are Behind Us Bloomberg View

…Lee now broadly suggests that the inventions of tomorrow won’t be as world-changing as those of yesteryear…. There are a number of industries–with health care and education being the most important–where there’s an inherent limit on how much value information technology can add. Because in these industries, the main thing you’re buying is relationships to other human beings, and those can’t be automated…. Manufactured goods have mostly fallen in price, while college and health care have soared. He reasons that these are difficult industries for technology to disrupt, since they rely so much on human-to-human interaction….

[But] there’s a case to be made for continued techno-optimism…. There are a vast number of other goods that also use huge amounts of time and resources to create… intermediate goods… parts and components, but also all the back-office services…. Technology that makes these things cheaper will make the business world more efficient, just like cheaper steel makes manufacturing cars more efficient…. A lot of effort right now is being poured into machine learning and artificial intelligence….

Technology is fundamentally about saving labor, and most of the labor in the typical white-collar work-day consists of thinking. Just as factory tools and vehicles saved physical labor in the Industrial Revolution, smart machines will save more and more mental labor in the Information Revolution…. Of course, there’s also a second possibility–the possibility that many humans might become redundant…. This is the rise-of-the-robots scenario that lots of people are worried about, but it doesn’t have to be a scary thing, if society changes accordingly…

Must-Reads: October 12, 2016

Posted on by Brad DeLong

Should Reads:

Must-Read: Anat R. Admati et al.: The Leverage Ratchet Effect

Posted on by Brad DeLong

Must-Read: Anat R. Admati et al.: The Leverage Ratchet Effect: “Firms’ inability to commit to future funding choices has profound consequences for capital structure dynamics…

…With debt in place, shareholders pervasively resist leverage reductions no matter how much such reductions may enhance firm value. Shareholders would instead choose to increase leverage even if debt levels are already high and new debt must be junior to existing debt. These asymmetric forces in leverage adjustments, which we call the leverage ratchet effect, cause equilibrium leverage outcomes to be history-dependent. When forced to reduce leverage, shareholders are biased toward selling assets relative to potentially more efficient alternatives such as pure recapitalizations.

Must-Read: Antonio Fatás and Lawrence H. Summers: The Permanent Effects of Fiscal Consolidations

Posted on by Brad DeLong

Must-Read: Antonio Fatás and Lawrence H. Summers: The Permanent Effects of Fiscal Consolidations: “The global financial crisis has permanently lowered the path of GDP in all advanced economies…

…At the same time, and in response to rising government debt levels, many of these countries have been engaging in fiscal consolidations that have had a negative impact on growth rates. We empirically explore the connections between these two facts by extending to longer horizons the methodology of Blanchard and Leigh (2013) regarding fiscal policy multipliers. Our results provide support for the presence of strong hysteresis effects of fiscal policy. The large size of the effects points in the direction of self-defeating fiscal consolidations as suggested by DeLong and Summers (2012). Attempts to reduce debt via fiscal consolidations have very likely resulted in a higher debt to GDP ratio through their long-term negative impact on output.

A Nobel Prize for modeling contracts

Posted on by Bridget Ansel
Finnish Professor Bengt Holmstrom, of the Massachusetts Institute of Technology, left, smiles while speaking with MIT President L. Rafael Reif following a news conference, Monday, Oct. 10, 2016, on the campus of MIT in Cambridge, Mass. The Nobel Memorial Prize in economic sciences was awarded Monday to Oliver Hart and Holmstrom, who will share the prize. The Nobel jury praised the winners “for their contributions to contract theory.”

Economists Oliver Hart of Harvard University and Bengt Holmström of the Massachusetts Institute of Technology on Monday were jointly awarded the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, better known as the Nobel Prize in Economics. The two researchers were cited for their work in contract theory. The committee has provided an overview of the winning research here. Their contributions, which have given economists tools to think through the best ways to structure contracts—including those between employers and employees, shareholders and management, and insurance companies, sparked a range of commentary from their fellow economists:

  • Tyler Cowen’s overview at Bloomberg View
  • A series of posts by Cowen and fellow George Mason University economist Alex Tabarrok on the two winners and the “Performance Pay Nobel”
  • Northwestern University economist Jeff Ely’s appreciation of Hart and Holmström’s research
  • University of Toronto management assistant professor Kevin Bryan dives into the work of Bengt Holmström

These and other commentators note that at a very basic level the cited research on contracts shows they can be very hard to design if it’s hard for the person paying for a service to observe the provider’s effort. If you’re paying someone to produce a certain number of widgets, for example, then setting up that contract is quite easy. If enough widgets are produced, then the provider gets paid the agreed amount of money. But if it’s difficult to see how much effort someone is putting in, then writing a contract can be more difficult. This problem, the potential misalignment between a principal (the person paying) and an agent (the person providing the service) when there is asymmetric information (the agent knows how much work they are putting in and the agent doesn’t) is a problem that Holmström’s work centered around.

A good example of this problem is executive compensation. The shareholders of firms often want to structure the compensation of their chief executives to make sure the incentives of the CEOs are aligned with those of shareholders. This thinking leads firms to make executive compensation tied to the price of company stock. But Holmström’s theoretical work emphasizes that the contract should be based on information that is informative of the executive’s effort and performance. A company’s share price could move due to factors outside the executive’s control—say an increase in oil prices in the case of an oil executive. This thinking can also be expanded to situations where teamwork is important and therefore points toward pay that is more salary-based and less tied to share-price performance.

Hart’s work also involves contracts, but focuses more on what happens when contracts can’t be fully specified and are therefore “incomplete contracts.” The applications of his work often focuses less on contracts between individuals and more on contracts between firms. The most famous application of this thinking is about what services should be provided by the government and which should be done by private firms. The choice being, in Hart’s formulation, that private firms are better at innovation and reducing costs while the government is better at quality. This question has particular relevance for thinking about whether the government or private firms should run prisons, with the theory pointing toward government and its emphasis on quality.

Both economists have seen their theoretical research cited for their practical applications. Policymakers in particular who are interested in CEO compensation, mergers and acquisitions, and the privatization of government services may want to be on the lookout for applications of this research.

Do extended U.S. unemployment insurance benefits reduce employment?

Posted on by Bridget Ansel
People talk with a recruiter, center, at a job fair sponsored by National Career Fairs, in New York.

During the Great Recession, the federal and state governments extended the amount of weeks unemployed workers were eligible for unemployment insurance. And then, in 2014, as the U.S. labor market recovery started to pick up, those benefits were reduced. Clearly the deep recession of 2007-2009 and the subsequent recovery were the main drivers behind the fluctuations in the health of the labor market. But perhaps the extended unemployment benefits increased the unemployment rate a bit more—and then the reduction in benefits pushed the rate up even more?

Well, some new research should make us skeptical that unemployment insurance had such a large impact. The new paper is by economists Christopher Boone of Cornell University, Arindrajit Dube of the University of Massachusetts Amherst, and Lucas Goodman and Ethan Kaplan of the University of Maryland at College Park. They specifically look at the impact of the expansion and then contraction of extended unemployment benefits from 2007 to 2014, looking specifically at the duration of those benefits. The technique they use should be familiar to anyone who’s followed the debates about the impact of the minimum wage. Because states differ in how long they offer unemployment benefits, the economist can pair bordering counties, which should be similar in many ways expect benefit duration, and see the difference in employment.

Their results show that the difference in the employment rate for bordering counties doesn’t change much in response to increases or decreases in extended unemployment benefits. The paper runs several “robustness checks” to see if the results change if other techniques find different results. And these alternate techniques find very similar results: a very small effect of unemployment benefits on employment. It’s possible that extended benefits induced some unemployed people to hold off on getting a job for a bit longer, but on average a longer period of receiving benefits doesn’t seem to have that big of an impact on aggregate employment.

Now, other recent research on this question finds a large and significant impact of more generous unemployment benefits. Boone and his co-authors replicate the findings of those papers and find two reasons why their results differ so much. One reason is a difference in statistical techniques that is too complex to go into here. Another difference is that the other papers use data from the Local Area Unemployment Statistics series, which is constructed in part by a model. The new paper by Boone and his co-authors instead relies on administrative data from the Quarterly Census of Employment and Wages, which is derived from actual unemployment insurance records.

But another puzzle seems more difficult to solve. The new paper finds that the authors’ macro estimates of the effects of extended unemployment insurance is quite small on overall employment levels, yet other papers that look at the micro effect—or the effect on specific individuals—find a noticeable negative effect that would push up unemployment. Boone, Dube, Goodman, and Kaplan rectify this difference by showing that the micro estimates could be true while the aggregate impact remains small as unemployment insurance injects more demand into the economy. The end result is a U.S. labor market where unemployment hasn’t been pushed upward, but more workers are protected against some of the pains of losing a job.

Must-Read: Matthew Yglesias: We Still Haven’t Recovered

Posted on by Brad DeLong

Matthew Yglesias: We Still Haven’t Recovered: “The long-term structural decline of American men’s attachment to the labor market is an interesting and important issue, [but] it’s not really an alternative to the theory that current low participation rates reflect an overall weak labor market…

…What’s true here is that non-working women are much more likely than non-working men to be spending their time on things like caring for children or for elderly or disabled relatives…. The paucity of jobs for men is arguably cause for a different level–or at least a different kind–of social concern. But in terms of understanding labor market dynamics, there is nothing special happening with American men that isn’t also happening to American women. What’s unique and different… is Americans in general…. Perhaps the best and clearest evidence that the labor market continues to be depressed is that employers have had an easy time getting people to work at a discount…. We have seen meaningful improvement in this metric over the past year, confirming that the labor market really has improved, but we’re still clearly not back to where we were before the crisis hit….

If the “missing” workers are really having so much fun playing video games that they refuse to work or are otherwise unhireable, then employment costs would be rising sharply and the Federal Reserve would have no choice but to tap the brakes to stop an inflationary spiral. The fact that employment cost growth is still on the low side suggests that the opposite is the case. The economy can safely keep adding jobs at the current pace–or, ideally, a faster one–for quite a while, just by drawing workers off the sidelines back into the labor force…. But to get this happy outcome we need patience from American policymakers…