Weekend reading

Posted on by Nick Bunker

This is a weekly post we publish on Fridays with links to articles we think anyone interested in equitable growth should be reading. We won’t be the first to share these articles, but we hope by taking a look back at the whole week, we can put them in context.

Links

Matt Levine digs into the argument that index mutual funds reduce corporate competition and what this says about the role of the financial system. [bloomberg view]

Kevin Carey argues that universities, at least as unified institutions, are illusions. [the upshot]

Izabella Kaminska draws out the connection between the decline in “petrodollars” and global currency reserves. [ft alphaville]

We often use the Great Depression in the United States as the benchmark for the worst recession in history. But is that true? Frances Coppola looks at the data. [coppola comment]

Noah Smith worries that the decline of manufacturing will take away of key source of growth for low-income countries. [bloomberg view]

Friday figure

lfpr-testimony-02

 

Figure from “The Declining Labor Force Participation Rate: Causes, Consequences, and the Path Forward” by Elisabeth Jacobs

Things to Read on the Evening of July 23, 2015

Posted on by Brad DeLong

Must- and Should-Reads:

Must-Read: Peter Gosselin: Obama Is in a Bind on Drugs That Could Cost Consumers Billions of Dollars

Posted on by Brad DeLong

Must-Read: Peter Gosselin: Obama Is in a Bind on Drugs That Could Cost Consumers Billions of Dollars: “The Obama administration is caught in a trap as it tries to bring home a trade deal with its Pacific Rim partners…

…Some of the chief beneficiaries may be big drug companies like Novartis AG, Roche Holding AG, and Pfizer Inc. while the losers could be consumers in both the U.S. and the region.
The administration says it’s bound by congressionally imposed instructions to try to get as much current U.S. law as possible into trade accords–including stringent protections for patented drugs that it’s repeatedly tried to ease at home to encourage more cost-saving generics.

The disconnect has put U.S. negotiators in the position of pushing provisions in the 12-nation Trans-Pacific Partnership that would preclude the administration from making further attempts to win the legal changes. It also has negotiators pressing the region’s developing countries to sign onto a schedule for adopting the stronger rules, reversing previous exemptions to allow them easier access to cheap medicines.

Even though U.S. Trade Representative Michael Froman says the talks are ‘in a closing mode,’ American proposals for tough intellectual-property protections for drugs are meeting resistance from Australia, New Zealand, Canada and other Pacific Rim nations. Chile’s foreign minister, for one, has said flatly that his country won’t accept some key provisions.”

Must-Read: Joschka Fischer: The Return of the Ugly German

Posted on by Brad DeLong

Must-Read: Joschka Fischer: The Return of the Ugly German: “On July 12-13, something fundamental to the European Union cracked…

…Since then, Europeans have been living in a different kind of EU…. The path that Germany will pursue in the twenty-first century–toward a ‘European Germany’ or a ‘German Europe’–has been the fundamental, historical question at the heart of German foreign policy for two centuries. And… during that long night in Brussels… German Europe prevail[ed] over European Germany. This was a fateful decision for both Germany and Europe. One wonders whether Chancellor Angela Merkel and Finance Minister Wolfgang Schäuble knew what they were doing….

Germany has been the big winner of European unification, both economically and politically. Just compare Germany’s history in the first and second halves of the twentieth century…. The foundation of the second, unified German nation-state in 1989 was based on Germany’s irrevocable Western orientation and Europeanization. And the Europeanization of Germany’s politics filled–and still fills–the civilization gap embodied in German statehood. To allow this pillar to erode–or, worse, to tear it down–is a folly of the highest order. That is why, in the EU that emerged on the morning of July 13, Germany and Europe both stand to lose.

Must-Read: Philippe Legrain: The Eurozone’s German Problem

Posted on by Brad DeLong

Must-Read: Philippe Legrain: The Eurozone’s German Problem: “Germany’s beggar-thy-neighbor policies and the broader crisis response that the country has led have proved disastrous…

…Seven years after the start of the crisis, the eurozone economy is faring worse than Europe did during the Great Depression…. As long as German Chancellor Angela Merkel’s administration continues to abuse its dominant position as creditor-in-chief to advance its narrow interests, the eurozone cannot thrive–and may not survive. Germany’s immense current-account surplus–the excess savings generated by suppressing wages to subsidize exports–has been both a cause of the eurozone crisis and an obstacle to resolving it… fueled German banks’ bad lending to southern Europe and Ireland… is [now] exporting deflation….

Germany breaks rules with impunity, changes them to suit its needs, or even invents them at will…. Loans by eurozone governments to Ireland, Portugal, and Spain primarily bailed out insolvent local banks–and thus their German creditors…. In exchange for these loans, Merkel obtained much greater control over all eurozone governments’ budgets through a demand-sapping, democracy-constraining fiscal straitjacket…. Merkelism is causing economic stagnation, political polarization, and nasty nationalism…. The eurozone’s members are trapped in a miserable marriage, dominated by Germany. But fear is not enough to hold a relationship together forever. Unless Merkel comes to her senses, she will eventually destroy it.

The upside of more equity for big financial institutions

Posted on by Nick Bunker

This week marks the fifth anniversary of the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the financial reform law that overhauled the U.S. financial system in the wake of the 2008-2009 housing and financial crises. Although key parts of the law have not yet been implemented, the Federal Reserve finalized one key regulation  this past week. The new rule requires large financial institutions deemed “systemically important” to have a higher share of their funding in the form of equity, including shares in the financial institutions, cash on hand, and savings.

Why do regulators want these big financial institutions to be more equity funded? And does this mean that big firms will have less money to lend to businesses and individuals?

First, a point of clarification. When regulations require financial institutions to increase equity funding, this is often described as requiring them to “hold more capital.” That phrasing invokes an image of banks sitting on their reserves instead of lending out that money to the broader economy. But that’s not what’s going on. This new regulation and others like it are concerned with how banks fund themselves, which has ramifications for their stability and the stability of the entire economic system.

Financial institutions, like other businesses, have a choice when they want to fund an investment or asset purchase. They can fund it via equity (selling more stocks, using their own revenue or savings) or via debt (borrowing). The relative mix of equity and debt financing happening across the economy can have significant effects on how economic swings affect economic stability. Basically, more equity financing dampens economic volatility, and more debt amps it up. The same is especially true for financial institutions, as the recent financial crisis demonstrated.

A simple example can help make this point. Say you purchase an asset, such a house or a bunch of shares in a company, and it costs $100,000. You fund that purchase with $20,000 of your own savings (equity) and an $80,000 loan (debt). If the price of the asset goes up by 20 percent to $120,000, then the extra $20,000 goes to the equity. That’s a 100-percent return on your equity investment. But if the price of the asset goes down by 20 percent to $80,000, then your equity is entirely wiped out—a negative 100-percent return.

But what if equity were a higher percentage of your funding, say doubled to $40,000? In this case, only $60,000 in borrowing is required. Then a 20 percent increase in the asset price would still give a return of $20,000 but that’s only a 50 percent return. But a 20 percent decline would still leave $20,000 left in equity. The return would still be negative, but the equity wouldn’t get entirely wiped out.

This example should make clear why individual financial institutions want to finance themselves via debt and why the overall system might be better served by more equity. The positive returns are amplified with debt, but so are the negative ones. It make sense that we’d want big financial institutions whose collapse would imperil the entire system to be more resilient by funding themselves with more equity.

But what would more equity funding for these big financial firms mean for the broader economy? Some research shows that increased equity funding wouldn’t be a drag on bank lending or economic growth. Economists Anat Admati of Stanford University and Martin Hellwig of the Max Planck Institute have done quite a bit of this research and lay out their arguments in their book “The Bankers’ New Clothes”

Yet, as the Roosevelt Institute’s Mike Konczal points out on Vox, not all equity is the same. The financial system is complex and so capital comes in a variety of flavors depending upon their level of risk and other factors and can be measured in a myriad of ways. Regulators not just in the United States, but across the globe will have to figure out the right mix of different kinds of equity.

Then there’s the matter of from where these big financial institutions will raise the equity and what the opportunity cost of using equity to “backstop” banks is. But the existing research is persuasive that getting banks to use more equity to fund themselves would lead to a more stable economy benefitting the vast majority of the population.

Must-Read: William Easterly: Empirics of Strategic Interdependence: The Case of the Racial Tipping Point

Posted on by Brad DeLong

Must-Read: William Easterly: Empirics of Strategic Interdependence: The Case of the Racial Tipping Point: “The Schelling model of a ‘tipping point’ in racial segregation…

…in which whites flee a neighborhood once a threshold of nonwhites is reached, is a canonical model of strategic interdependence. The idea of ‘tipping’ explaining segregation is widely accepted in the academic literature and popular media. I use census tract data for metropolitan areas of the US from 1970 to 2000 to test the predictions of the Schelling model and find that this particular model of strategic interaction largely fails the tests. There is more ‘white flight’ out of neighborhoods with a high initial share of whites than out of more racially mixed neighborhoods.

Must-Read: Rachel Laudan: Charmingly Unromantic: Measuring Progress in Food

Posted on by Brad DeLong

Must-Read: Rachel Laudan: Charmingly Unromantic: Measuring Progress in Food: “Unless we compare foods of the past to the present we have no way of understanding them…

…And unless we ask whether certain practices led to progress or regress of (say) nutritional quality, gastronomic refinement, equitable distribution, ease of preparation, we risk antiquarian irrelevance…. I’d urge anyone working on the history of cooking and food processing to take a look at a recent blog post by Will Thomas… [who] gives a brief, clear introduction to how some important thinkers have tried to understand and measure technological progress….

The reason, then, that labor productivity became an important means of measuring the benefits of technology is because it is a reasonable way of measuring whether material benefits are indeed accruing to society through the implementation of various new technologies.These economic measures of technological benefit are actually charmingly unromantic….

Charmingly unromantic, yes, when compared to much of food history that celebrates, deplores, and explores the contribution of food to identity. But crucial because the labor of cooking has been huge, because reducing it has brought relief to those who did it, new opportunities in life, and better food sometimes, not always, for everyone. On a modest scale, this is what I was trying to do in Cuisine and Empire when I tried to establish roughly what percentage of the working population had to pound and grind grain at different periods in history. For thousands of years, preparing grain was the most laborious of all food preparation techniques, consuming the products was the basis of the diet… the creative destruction of thousands of water-driven grist mills and before that hundreds of thousands of hand grinders…

What’s the matter with the federal disability insurance program?

Posted on by Nick Bunker

The White House last week released a report about the current and future condition of Social Security Disability Insurance. The report covers a variety of details about the federal disability insurance program, but the section that jumps out the most is this—the trust fund for the program will be unable to pay full benefits beginning next year. According to the report, benefits could drop by 19 percent if action isn’t taken.

How did the program get to this point? Some researchers and policymakers are concerned that it has become too generous, thus increasing the burden on the trust fund. Perhaps it shouldn’t be a first concern given the financial state of the trust fund itself.

But first, lets turn to the evidence that the program is too generous. Research looking at the rise in disability insurance outlays has analyzed a variety of potential sources of this increase. Economists Mark Duggan, now of Stanford University, and Scott Imberman of the University of Houston, explore a variety of potential causes in a book chapter on the subject. They find that the aging of the U.S. population, changes in health among workers, economic conditions, the increasing replacement rate—the ratio of disability income to overall U.S. labor income—offered by the program, and an expanding definition of disability are the main culprits.

The wider definition of disability – the largest factor according to Duggan and Imberman – might not be unaffected by other trends. Some judges in disability cases might be slightly more willing to grant disability to marginal applicants, as seems to have happened in West Virginia recently, but we have to ask where these marginal applicants are coming from. The economy may be interacting with this factor as well. A worker with a qualifying disability who is able to find a job during a healthy labor market may find it much tougher to find one in a down labor market. Research from University of California-Berkeley economist Jesse Rothstein finds evidence for this: Disability applications increase when the unemployment rate does.

But what about some of the other factors they highlight? The replacement rate for Social Security Disability Insurance is on the rise not because of a concrete policy action, but rather due to the increase in income inequality over the past several decades. As the wages of workers at the top pulled away from those in the middle and at the bottom of the income spectrum, the replacement wage for those declared disabled has increased, while the actual wages for those on the middle and bottom rungs of the earnings ladder stagnated. This happened because the formula sets the level of disability income based on overall income. If low-end wage growth lags significantly behind overall growth, then the base will increase relative to low-end incomes. The program was built assuming wage growth would be widely shared. But it hasn’t been, leading to a rising replacement wage.

On the issue of aging, it’s possible that Duggan and Imberman are underestimating the role of changing demographics. Harvard University economist Jeffrey Liebman notes that the disability rate adjusted for the age of the population has been essentially flat for men since the 1990s, while the rate for women is catching up to levels similar to men. This means that increasing rates of qualifying for disability insurance is driven quite a bit by changes in demographics. Liebman also points out that the Congressional Budget Office projects that spending on disability insurance will decline as the Baby Boom generation reaches the age when they can claim retirement benefits from Social Security.

Let’s now move to the two authors’ finding that disability insurance has become a long-term unemployment program for some workers due to expanded definitions of disability. To the extent this is true would mean that some workers are qualifying for disability insurance and then dropping out of the labor force. A sign of how severe of a problem this is would be how large the decline in the U.S. labor force participation rate would be due to disability.

Economist Monique Morrissey at the Economic Policy Institute shows just how small of a dent in the participation rate disability insurance makes. Using research from the RAND Corporation and the Social Security Administration, Morrissey calculates that if workers who could hypothetically make more than the Social Security Disability Insurance threshold for earnings were denied access to the program, then the participation rate would increase by only 0.2 percentage points. Not exactly a large jump in the rate.

All this isn’t to say that the program itself isn’t in need of some reform, but it’s the long-term financing of the trust fund that is most in need of help. Social Security Disability Insurance shouldn’t be treated as an overly bloated program that’s sowed the seeds of its own destruction. As Liebman puts it in his paper, perhaps the more fruitful avenue is retooling the program given the kinds of workers that now apply for disability.

Maurice Obstfeld to the IMF

Posted on by Brad DeLong

An excellent choice by the IMF: Maurice Obstfeld becomes the new Blanchard: “Living up to Mr Blanchard will be difficult…

…One insider remarked that while Mr Obstfeld should do:

much better than his co-author Rogoff did as Director at the Fund in terms of getting good results [and] influencing the Board… no one is Blanchard. Any economist in the world would have a huge gap to do even part of what Blanchard accomplished.

Not, mind you, that Ken Rogoff did at all badly badly in speaking the technocratic truth that is the IMF Research view of the world to the power that is the IMF Managing Director and Board’s role in global economic governance…