Should-Read: Roberto Bonfatti and Kevin Hjortshøj O’Rourke: Growth, Import Dependence and War

Posted on by Brad DeLong

Should-Read: Roberto Bonfatti and Kevin Hjortshøj O’Rourke: Growth, Import Dependence and War: “Existing theories of pre-emptive war typically predict that the leading country may choose to launch a war on a follower who is catching up…

…since the follower cannot credibly commit to not use their increased power in the future. But it was Japan who launched a war against the West in 1941, not the West that pre-emptively attacked Japan. Similarly, many have argued that trade makes war less likely, yet World War I erupted at a time of unprecedented globalization. This paper develops a theoretical model of the relationship between trade and war which can help to explain both these observations. Dependence on strategic imports can lead follower nations to launch pre-emptive wars when they are potentially subject to blockade.

The importance of equitable growth to absolute mobility in the United States

Posted on by Bridget Ansel
Earning more than your parents is far less likely today than it was half a century ago.

A new study released today by several researchers, led by Raj Chetty of Stanford University reveals a large and significant decline in economic mobility in the United States. The paper shows a precipitous decline in the probability that a person will earn more than their parents, what researchers call “absolute mobility.” Specifically, Chetty and his coauthors look at income levels when a worker is 30 years old, for both parents and children. (For more details on the paper, check out the authors’ summary for Equitable Growth as well as a piece on the new paper from David Leonhardt at the New York Times.)

The paper by Chetty and his co-authors has many interesting findings that researchers and policymakers will certainly dig into. For now, let’s examine the role of relative mobility—the movement up and down the income distribution—in determining absolute mobility. The results of the paper shows a path toward boosting mobility that points toward stronger, more equitable economic growth

One way to think about absolute mobility is that depends on two trends. First, how quickly has income grown at different points in the income distribution for those 30-year-olds from when their parents were 30? Second, how likely it is for the younger generation to be at a point in the income spectrum that is different than their parents? We call the second “relative mobility” because a child could move up or down the income spectrum relative to their parents, but still earn more or less than their parents. We can think absolute mobility is a function of relative mobility, the strength of income growth, and the distribution of income growth.

Whether absolute mobility is higher or lower depends on where the child ends up and how income growth has been at that position. When there is a low level of relative mobility, a child’s absolute mobility is essentially tied to the rate of income growth at their parent’s income level. When there is more relative mobility, it’s less tied.

Previously, Chetty and his co-authors in another project did the work of figuring out the trends in relative mobility for the United States going back to children born in the early 1970s. What they found is that relative mobility hasn’t changed that much—that a parent’s income position has the same relationships with their children’s as it did 40 years ago. With this information in hand, the authors of this new paper can directly calculate absolute mobility for groups of children born after the early 1970s. They find that it’s been on the decline since that time.

But it’s the data before the 1970s where their story gets even more interesting. The researchers have data on income growth going back to the cohort born in 1940, but no data on relative mobility for that era. Any calculation of absolute mobility would have to make assumptions about the levels of relative mobility during the years between 1940 and 1970.

Yet Chetty and his coauthors show that regardless of the assumption one makes about relative mobility during this time, absolute mobility fell. They calculate what absolute mobility would have been for children born in 1940 for every possible level of relative mobility. The result is that absolute mobility would have ranged from 84 percent to 98 percent, depending upon the level of absolute mobility. Regardless of the level of relative mobility, the average worker had at least an 84 percent chance of earning more than their parents. That entire range is well above the level of observed average absolute mobility for the generation born in the early 1970s of about 60 percent.

Why does relative mobility not seem to matter for the trend in absolute mobility for the generation born in the 1940s? Well, the level of income growth was so high and broadly shared during the period between 1940 to 1970 that almost all positions on the income distribution of 1970s were richer than those in the 1940 distribution. A worker could stay at, for example, the 20th percentile of income like their father and still see absolute mobility rise because overall income growth in the United States was so strong and equitable.

A worker born in the 1940s could end up pretty much anywhere in the 1970 income distribution as a 30-year-old and have a very good chance of having a higher income than their parents. Strong, equitable growth resulted in high levels of mobility regardless of the levels of relative mobility. These results indicate that while higher levels of relative mobility may be a good thing in and of itself, it’s not necessary for higher levels of absolute mobility. If we want to insure rising living standards for most Americans, strong and equitable growth across the income distribution seems the best path forward.

The fading American dream: trends in absolute income mobility since 1940

Posted on by Bridget Ansel
Zenobia Bechtol and her seven-month-old baby girl live in the dining room of her mother’s apartment in Austin, Texas, after Bechtol and her boyfriend were evicted from their apartment following the loss of his job.

One of the defining features of the “American Dream” is the ideal that children have a higher standard of living than their parents. We assess whether the United States is living up to this ideal by estimating rates of “absolute income mobility,” or the fraction of children who earn more than their parents, since 1940.

We measure absolute mobility by comparing children’s household incomes at age 30 (adjusted for inflation using the U.S. Consumer Price Index) with their parents’ household incomes at age 30. We find that rates of absolute mobility have fallen from approximately 90 percent for children born in 1940 to 50 percent for children born in the 1980s. Absolute income mobility has fallen across the entire income distribution, with the largest declines for families in the middle class. (See Figure 1.) These findings are unaffected by using alternative price indices to adjust for inflation, accounting for taxes and transfers, measuring income at later ages, and adjusting for changes in household size.

Figure 1

Absolute mobility fell in all 50 states although the rate of decline varied, with the largest declines concentrated in states in the eastern Midwest, such as Michigan and Illinois. The decline in absolute mobility is especially steep—from 95 percent for children born in 1940 to 41 percent for children born in 1984—when we compare sons’ earnings to their fathers’.

Why have rates of upward income mobility fallen so sharply over the past half century? There have been two important trends that have affected the incomes of children born in the 1980s relative to those born in the 1940s and 1950s: lower Gross Domestic Product growth rates and greater inequality in the distribution of growth. We find that most of the decline in absolute mobility is driven by the more unequal distribution of economic growth rather than the slowdown in aggregate growth rates.

When we simulate an economy that restores GDP growth to the levels experienced in the 1940s and 1950s but distributes that growth across income groups as it is distributed today, absolute mobility only increases to 62 percent. In contrast, maintaining GDP at its current level but distributing it more broadly across income groups at it was distributed for children born in the 1940s – would increase absolute mobility to 80 percent, thereby reversing more than two-thirds of the decline in absolute mobility.

These findings show that higher growth rates alone are insufficient to restore absolute mobility to the levels experienced in mid-century America. Under the current distribution of GDP, we would need real GDP growth rates (after accounting for inflation) above 6 percent per year to return to rates of absolute mobility in the 1940s. Intuitively, because a large fraction of GDP goes to a small fraction of high-income households today, higher GDP growth does not substantially increase the number of children who earn more than their parents. Of course, this does not mean that GDP growth does not matter: Changing the distribution of growth naturally has smaller effects on absolute mobility when there is very little growth to be distributed. The key point is that increasing absolute mobility substantially would require more broad-based economic growth.

We conclude that absolute mobility has declined sharply in the United States over the past half century primarily because of the growth in inequality. If one wants to revive the “American Dream” of high rates of absolute mobility, one must have an interest in growth that is shared more broadly across the income distribution.

—Raj Chetty is an economics professor at Stanford University. David Grusky is a sociology professor at Stanford University. Maximilian Hell is a Ph.D. student in sociology at Stanford University. Nathaniel Hendren is an assistant professor of economics at Harvard University. Robert Manduca is a Ph.D. student in sociology and social policy at Harvard University. Jimmy Narang is a Ph.D. student in economics at the University of California-Berkeley.

This column is a summary of the authors’ findings in their working paper originally published here.

Will the U.S. Economy Boom?

Posted on by Brad DeLong

The very sharp Ken Rogoff predicts a boom over the next four years: “The biggest missing piece… is business investment, and if it starts kicking in… output and productivity could begin to rise very sharply…. You don’t have to be a nice guy to get the economy going…. It is far more likely that after years of slow recovery, the US economy might at last be ready to move significantly faster…”

I really can’t see it as likely. Rogoff talks about:

  • “the prospect of a massive stimulus, featuring a huge expansion of badly needed infrastructure spending…” but Trump’s stimulus proposal as of now is for tax subsidies to projects that would be built in any event coupled with privatization to restrict use. There is definitely space for fiscal stimulus and infrastructure–and we should lobby and argue hard to use that space–but what appears to be on Trump’s agenda is a bunga-bunga Berlusconi-like policy.

  • “a massive across-the-board income-tax cut that disproportionately benefits the rich… [although it] hardly seems as effective as giving cash to poor people… tax cuts can be very good for business confidence…” but I haven’t seen cases in which this is true–rather, rich people say that tax cuts are very good for business confidence and then skip town with the money.

  • “repealing Obama-era regulation… businesses will be ecstatic, maybe enough to start really investing again. The boost to confidence is already palpable…” but I can’t see a bigger carbon-energy boom than we have had, I don’t notice other labor or environmental regulations binding–certainly not in the Seattle restaurant industry–and, this morning, Boeing is really not ecstatic about a president Trump.

  • “the huge shadow Obamacare casts on the health-care system, which alone accounts for 17% of the economy…” but ObamaCare is primarily a source of money for health care, not a regulatory drain. Repeal of ObamaCare would be–as every hospital and insurance company is right now telling everyone on Capitol Hill who will listen–a major downer. Who is Rogoff talking to? When he made this point earlier, he referred to the “substantial regulatory burden of ObamaCare on small business”. But there never was any. Small businesses–those with less than fifty employees–face no burden. Those few larger businesses–those with fifty employees or more–that do not offer employer-sponsored health insurance face a not-yet-implemented and often-postponed 2% of payroll tax. That’s a cost to them, but a benefit to their many, many competitors who have been offering employer-sponsored insurance.

And:

  • “Even steadfast opponents of President-elect Trump’s economic policies would have to admit they are staunchly pro-business (with the notable exception of trade)…” Enough said.

By saying that a boom is “far more likely” than the opposite, I think Rogoff is playing a 20% chance as if it were a 60% chance. And I do not understand what makes him see the world this way. Tax credits for already-planned infrastructure projects are not fiscal stimulus, ObamaCare is not a substantial regulatory burden on small business, etc. Or do I not live in the real world?

Kenneth Rogoff: The Trump Boom?: “Under President Barack Obama, labor regulation expanded significantly…

…not to mention the dramatic increase in environmental legislation. And that is not even counting the huge shadow Obamacare casts on the health-care system, which alone accounts for 17% of the economy. I am certainly not saying that repealing Obama-era regulation will improve the average American’s wellbeing. Far from it. But businesses will be ecstatic, maybe enough to start really investing again. The boost to confidence is already palpable.

Then there is the prospect of a massive stimulus, featuring a huge expansion of badly needed infrastructure spending. (Trump will presumably bulldoze Congressional opposition to higher deficits.) Ever since the 2008 financial crisis, economists across the political spectrum have argued for taking advantage of ultra-low interest rates to finance productive infrastructure investment, even at the cost of higher debt. High-return projects pay for themselves.

Far more controversial is Trump’s plan for a massive across-the-board income-tax cut that disproportionately benefits the rich. True, putting cash in the pockets of rich savers hardly seems as effective as giving cash to poor people who live hand to mouth. Trump’s opponent, Hillary Clinton, memorably spoke of “Trumped-up trickle-down economics.” But, Trumped-up or not, tax cuts can be very good for business confidence.

It is hard to know just how much extra debt Trump’s stimulus program will add, but estimates of $5 trillion over ten years – a 25% increase – seem sober. Many left-wing economics commentators, having insisted for eight years under Obama that there is never any risk to US borrowing, now warn that greater borrowing by the Trump administration will pave the road to financial Armageddon. Their hypocrisy is breathtaking, even if they are now closer to being right.

Exactly how much Trump’s policies will raise output and inflation is hard to know. The closer the US economy is to full capacity, the more inflation there will be. If US productivity really has collapsed as much as many scholars believe, additional stimulus is likely to raise prices a lot more than output; demand will not induce new supply.

On the other hand, if the US economy really does have massive quantities of underutilized and unemployed resources, the effect of Trump’s policies on growth could be considerable. In Keynesian jargon, there is still a large multiplier on fiscal policy. It is easy to forget the biggest missing piece of the global recovery is business investment, and if it starts kicking in finally, both output and productivity could begin to rise very sharply.

Those who are deeply wedded to the idea of “secular stagnation” would say high growth under Trump is well-nigh impossible. But if one believes, as I do, that the slow growth of the last eight years was mainly due to the overhang of debt and fear from the 2008 crisis, then it is not so hard to believe that normalization could be much closer than we realize. After all, so far virtually every financial crisis has eventually come to an end….

At the risk of hyperbole, it’s wise to remember that you don’t have to be a nice guy to get the economy going. In many ways, Germany was as successful as America at using stimulus to lift the economy out of the Great Depression.

Yes, it still could all end very badly. The world is a risky place. If global growth collapses, US growth could suffer severely. Still, it is far more likely that after years of slow recovery, the US economy might at last be ready to move significantly faster, at least for a while.

Comment of the Day: Sherman Robinson: On the Economics of BREXIT

Posted on by Brad DeLong

Comment of the Day: Sherman Robinson: On the Economics of BREXIT: “I largely agree with Simon Wren-Lewis’s comments, and with the quote from Maurice Obstfeld…

…The trade-productivity links they discuss, as Wren-Lewis notes, “all make common sense”.

However, I think it is very important to sort out the empirical relevance of the different causal mechanisms—it is impossible to consider policy choices without doing so. I see four mechanisms at work:

  1. Ricardian movement of factors to exploit comparative advantage from opening to international trade. Clearly true, but forty years of work with computable general equilibrium (CGE) models, both single-country and global, indicates that pure Ricardian effects on productivity are very small. In conferences, we often cite a “theorem” due to Arnold Harberger: “triangles” are smaller than rectangles”.

  2. “Winds of competition” or “challenge/response” models. There is a large literature on such models, all arguing that opening up markets to competition forces firms to move to the production frontier and/or induces investment in technological change. These effects appear to be significant.

  3. Explicit backward linkages between exporting and “learning better techniques”. These are also significant effects in particular cases, but would seem to be limited in coverage and probably not large enough to have much effect at the national/global levels.

  4. Fragmentation of production processes that allows strong specialization and regional diversification of production of intermediate inputs. There are many examples of these value chains across economic activities: agriculture, manufacturing, and services. They allow producers to achieve “Smithian” gains in productivity through fine specialization. They are seen by later stages in the value chain as lowering input costs, which are not measured as, say, a TFP gain by the later-stage producer, but is very significant. I think that these Smithian productivity gains are very large and cover a wide range of economic activity for countries that have taken part in value chains.

These four mechanisms are not mutually exclusive—all are operating and are probably very complementary. For a nice discussion of the empirical importance of fragmentation of value chains, see the new book by Ricard Baldwin: The Great Convergence. He argues, and I agree, that this fragmentation has been a major driver of trade-linked productivity growth.

On Brexit. The UK is embedded in the EU and most of its trade involves imports and exports of intermediate inputs in complex value chains, so mechanism (4) is very important. Policies that interrupt value chains will be very damaging. For example, if the UK leaves the EU customs union, then the EU will have to impose rules of origin conditions that will impede trade. Firms may well prefer to move operations to the EU in order to keep the value chains operating smoothly. There are lots of other issues concerning how to support and foster value chains, beyond the scope of a short comment.

Must- and Should- Reads: December 8, 2016

Posted on by Brad DeLong

Interesting Reads:

Should-Read: Barry Ritholtz: Putting the Minimum Wage Debate into Context

Posted on by Brad DeLong

Should-Read: Barry Ritholtz: Putting the Minimum Wage Debate into Context: “The modern minimum-wage debate traces back to… Krueger and… Card…

…In the fast-food industry… no reduction in job growth in the market where pay was increased…. Many subsequent studies confirmed… [taht] modest increases in minimum wages don’t lead to job losses….The extent to which taxpayers subsidize profitable public companies that game the safety net is serious business. One study noted that U.S. fast-food workers receive more than $7 billion a year in public assistance; another pegged the Wal-Mart taxpayer subsidy at more than $6 billion. Alan Grayson, a former congressman from Florida, observed:

In state after state, the largest group of Medicaid recipients is Walmart employees… the same thing is true of food stamp recipients. Each Walmart ‘associate’ costs the taxpayers an average of more than $1,000 in public assistance.

Politifact reviewed his claims and found them to be “mostly true.” The economic impact of modest increases in the minimum wage may be well-established, but you wouldn’t know this based on the claims of opponents.

Should-Read: Josh Marshall: This Explains How and Why Medicare Will Live or Die

Posted on by Brad DeLong

Should-Read: Josh Marshall: This Explains How and Why Medicare Will Live or Die: “John Boozman (R) of Arkansas…

…’Well, if the president goes first, and then if I see Republicans AND Democrats jump and then if the American people decide they want to jump too… well, then I’ll be right behind you.”… This gives you a map into the essentials of this debate and how Medicare will survive if it does…

Should-Read: Kevin Daly: A higher global risk premium and the fall in equilibrium real interest rates

Posted on by Brad DeLong

Should-Read: Kevin Daly: A higher global risk premium and the fall in equilibrium real interest rates: “Since the turn of the century, the global economy has also been characterised by a rise in the yields on quoted equity…

…a feature for which the standard excess saving story cannot easily account…. An increase in the global risk premium has increased the wedge between risk-free interest rates and the real required return on risky investments…. Although there are differences between the savings glut and secular stagnation theses, a common implication of both is that excess saving has resulted in a generalised decline in yields across all assets, including but not restricted to real government bond yields (sometimes referred to as real ‘risk-free’ rates)…. The excess saving story is incomplete because it fails to account for the rise in the earnings yield on quoted equity from the early 2000s… a secular increase in the global ex ante equity risk premium…

What has driven the rise in the global risk premium since the turn of the century? One explanation is that the increasing importance of risk-averse investors in China and other emerging economies…. Another explanation (which does not exclude the first) is that it reflects the impact of population aging and pension regulation…

A higher global risk premium and the fall in equilibrium real interest rates VOX CEPR s Policy Portal A higher global risk premium and the fall in equilibrium real interest rates VOX CEPR s Policy Portal A higher global risk premium and the fall in equilibrium real interest rates VOX CEPR s Policy Portal

Should-Read: Mark Thoma: How social welfare benefits help the economy

Posted on by Brad DeLong

Should-Read: Mark Thoma: How social welfare benefits help the economy: “Donald Trump has, at times, said he’ll protect Medicare and Social Security…

…But given Trump’s plans to cut taxes and raise the national debt by trillions over the next decade, and the general Republican sentiment about social insurance, it’s hard to see how these programs can be protected if Republicans gain control of Congress and the presidency. Part of the GOP’s objection to these programs is the idea that they take money from those who have earned and deserve it and redistribute it to those who have not. They say that’s unfair. Is that true, or is there an economic basis for social insurance?

The case for social insurance begins with the recognition that capitalist economies are subject to boom-and-bust cycles…. The benefit of a capitalist system is much higher economic growth on average and a more dynamic, innovative and efficient economy. The cost is the instability…