Thursday, May 31, 2007

The Wisdom of the OECD

The OECD has released its latest survey of the U.S. economy, and I am impressed. Let's look at a few highlights. First, on employment:
The trend growth rate of GDP has slowed, mainly because of tighter limits on how quickly employment can grow. In particular, the labour force participation rate, which used to be rising quickly, is now trending down. Against this background, this chapter considers three policies that bear on long term employment trends. Raising the age at which workers become eligible for full social security benefits would discourage premature retirement and make the social security system more financially secure. The disability insurance system is discouraging a rising share of the population from staying in the workforce and should be made less generous and more selective. Substantial increases in the federal minimum wage are planned; however, increases in the Earned Income Tax Credit would achieve the same objectives more effectively and with less risk of job losses.
Next, on tax reform:
On the revenue side, it may be difficult to sustain the recent reductions in marginal tax rates, while meeting the fiscal burden from entitlement programmes, although this would be clearly desirable. To the extent that revenues have to be raised, the tax base should be broadened, rather than reversing reductions in marginal tax rates. Since the comprehensive tax reform in 1986, which broadened tax bases and reduced marginal rates, most of the resulting gains in simplicity and efficiency have been lost through a renewed expansion in tax expenditures. To be sure, not all of them are undesirable. However, tax expenditures, which are distorting, ill targeted and ineffective, should be reduced or abolished. The President’s Advisory Panel for Federal Tax Reform has recommended, inter alia, that tax preferences for mortgage interest payments, employers’ contributions to health insurance plan premiums, and state and local tax payments should be reduced. But, in addition to the Panel’s proposals, consideration should also be given to shifting the tax burden from direct taxes to consumption based indirect taxes – such as a national sales tax or a value added tax. This would produce efficiency gains, including reducing disincentives to saving. Furthermore, higher taxation of carbon based energy consumption would help reduce greenhouse gas emissions.
Has an international bureaucracy ever made so much sense in so few words? If so, I missed it.

Hubbard endorses a carbon taxe

Some Republicans believe it is best to avoid the word "tax," unless immediately followed by the word "cut." To them, my advocacy of higher Pigovian taxes is a sure sign that I am another one of those pantywaist Harvard liberals. Most Republican economists bend over backwards to avoid the same fate.

In today's Wall Street Journal, here is what my friend Glenn Hubbard says about policy toward global climate change:

The NCEP proposal meets this test of taking serious action while not imposing economic risks greater than the threat of climate change itself. It comprehensively addresses all U.S. emission of CO2 and other climate change-related gases. It does this using one system: tradable permits. In such a system, the use of coal, oil and natural gas will require permits in proportion to their CO2 emissions, typically sold along with the fuel -- so individuals need not deal with the permit market.

Those businesses and individuals who can reduce their fuel use and emissions most inexpensively will do so. Those who cannot will end up purchasing more permits and supporting those who can. In this way, the program flexibly encourages the least-expensive efforts to reduce emissions without constraining any individual or business. And revenue from the auction of a portion of these permits could be used to reduce the corporate income tax, blunting adverse economic consequences.

All true, but at what price? Permit markets can be uncertain and volatile, especially when they are first introduced, making it hard to gauge the economic impact of the program. Meanwhile, the alternative of an equivalent tax on carbon dioxide offers certainty about the price faced by businesses. In this sense, it is important that the NCEP proposal includes a "safety valve" mechanism -- an upper boundary on the price of tradable permits that limits the cost of the program to the businesses and individuals.

The title of Glenn's article is Capitalism Against Climate Change, but the proposal being discussed here is essentially a carbon tax. The government is getting revenue by auctioning permits, and it is setting the price of those permits via the so-called safety value mechanism.

Why use all these euphemisms? Why incur the expense of setting us a trading market in permits at all? Why not just call a tax a tax? Because, in some circles, "tax" is a four-letter word.

Wednesday, May 30, 2007

Two from the Fourth Estate

Both make a lot of sense.

Preschool Pays

Tuesday, May 29, 2007

Quick Math Review

A student at Oklahoma State writes the following on my facebook wall:
Your blog on which mathematics classes to take is very helpful and is guiding me through graduate school. There is a Schaum's outline book, introduction to math econ, by edward t. dowling that is a workbook with fully solved problems i have found, that is a complement to your blog, and EXTREMELY helpful! I showed it to our graduate director and he is now recommending it to all grad students!
I have never seen the book, but I thought some blog readers might appreciate the recommendation.

Monday, May 28, 2007


One study found that a college professor's kids hear an average of 2,150 words per hour in the first years of life. Working-class children hear 1,250 and those in welfare families only 620.
From the Economist.

Glaeser on Immigration

My Harvard colleague Ed Glaeser comments, favorably and sensibly, on the immigration bill.

Another Reading for the Pigou Club

From the LA Times.

Addendum: Larry Summers confirms his membership.

Rizzo vs Thaler

Economists Mario Rizzo and Richard Thaler debate the proper scope of government in a world with imperfect people and imperfect governments. The interchange ends where this kind of debate ends all too often--with a slippery slope argument, which I rarely find convincing.

Sunday, May 27, 2007

Sunday Reads

Saturday, May 26, 2007


Suppose the U.S. President were to propose the following policy: "My fellow Americans, I have just asked the Congress to increase taxes on all of us. After they pass my tax increase, I will instruct the Treasury to lend the additional tax revenue to the government of China."

Most Americans would, I suspect, be opposed to this proposal. They would see it as beneficial to China but without much benefit to the United States. With America eager to lend, China would enjoy lower interest rates. Why should Americans pay higher taxes to finance Chinese borrowing and spending?

I agree that this would be a strange and not very sensible policy for the U.S. government to pursue. But isn't it a bit odd that many Americans today are objecting to precisely the opposite of this policy. China is not borrowing from the U.S. government but is instead lending to the U.S. government by buying large quantities of Treasury bonds. The money used to buy these bonds could be returned to Chinese citizens in lower taxes. In other words, Chinese taxpayers are financing American spending and keeping our interest rates lower than they otherwise would be. And many Americans, including the President and Treasury Secretary, are complaining.

Unlike Matthew Slaughter, I would not argue that Chinese policy is incapable of affecting the real exchange rate. In a world of imperfect capital mobility, Chinese policy can affect international capital flows and thus the real exchange rate that equilibrates trade in goods and capital. But I am skeptical that their policy intervention is adverse to broad American interests. What the Chinese are doing, to boil it down to its essence, is buying U.S. government bonds (and some other American assets). The U.S. government is in the business of selling these bonds. There is no good reason to object when a willing buyer steps into the market.

These purchases most likely affect the exchange rate to some extent--and indeed the effect on the exchange rate could well be motiviating the purchases. It is crucial to keep in mind, however, that the exchange rate is a price, and a change in a price has opposite effects on different sides of the market. Cheap Chinese goods are bad news for U.S. producers that compete with those goods, but they are good news for U.S. consumers who buy these goods.

The more difficult question is whether the Chinese are acting against their own self-interest by saving so much and investing in foreign assets. Perhaps they are worried about potential future crises and want a large reserve fund for such a contingency. One can argue that the fund is now excessive. But it harder to argue that their saving and investing in our economy is a problem for us.

Before you say, "They are stealing our jobs," let me point out two things. First, while some jobs are lost to import competition, other jobs are gained because of lower interest rates and greater investment spending that capital inflows finance. Second, the U.S. unemployment rate is now low by historical standards. Based on either theory or evidence, the canonical political refrain of "jobs, jobs, jobs" makes little sense in this debate.

Friday, May 25, 2007


It's official: The Brookings Papers on Economic Activity has a new set of editors.

Justin Wolfers

Here's a nice profile of economist Justin Wolfers, a Harvard PhD and one-time coauthor of mine.

Pay at the Top

Lots of interesting facts about income inequality can be found in a front-page story in today's NY Times. For example:
the share of concert ticket revenue taken by the top 1 percent of pop stars — measured by sales per concert — rose to 56 percent in 2003 from 26 percent in 1982.

Thursday, May 24, 2007

Arbitrage Opportunity?

A blog reader identifies a strange pattern over at Tradesports:
For the 2008 elections, tradesports has approximately a 40% chance of Hillary being President and a 50% chance of her being the democratic nominee. With the Democrats having about a 57% chance of winning the election and with Obama and Gore having above 50% chances of winning, the 80% (40/50) that Hillary has looks awfully suspect and I assume someone is manipulating the 40% number to make Hillary look better. With the efficient market hypothesis in mind, is this at all possible or is an arbitrage opportunity available?
The numbers look odd to me as well. Here is an apparent arbitrage:

Sell Clinton (bid is now 38.3), Obama (16.5), Gore (7.3), and Edwards (3.6) for a total of 65.7. Buy a contract for a generic Democratic win (ask is now 56.8). You pocket the difference (65.7-56.8=8.9). You have to pay out on the first contract if one of these four candidates wins, but in that case you are covered by the second contract. The only contingency in which you lose is if Clinton, Obama, Gore, or Edwards end up president as an independent or Republican candidate, which seems completely unlikely.

So why am I giving away this arbitrage opportunity for free? I must be either unsure of my analysis, or motivated by the search for truth rather than money. Your call.

How not to pick a money manager

Tuesday, May 22, 2007

More Competition

George Borjas is blogging. George is an economist at Harvard's Kennedy School of Government who writes frequently on immigration.

Now we're just haggling over the price

GMU econ prof Bryan Caplan writes,
If I tried to buy a Harvard co-author, for example, I would expect nothing other than horrified looks. There's the reputational cost if word leaks out, of course. But on top of that, a cash-for-co-authorship deal is so weird that even a cash-hungry professor would be very skittish.
Actually, it is not quite as weird as Bryan suggests. In the textbook market, one often finds a book with a seemingly odd pair of coauthors: Introductory Textbook by famous professor X and unknown professor Y.

Typically in such arrangements, Y does most of the hard work of writing and revising. X is recruited, perhaps by Y's publisher, because his stature will bring attention to the project. Sometimes X demands more than half of the royalties, even though he does less than half of the work. This just goes to show that marketing can be more important than production.

Slaughter on the Yuan

The dollar-yuan exchange rate is an economic fetish of many people unschooled in basic economics (a topic previously discussed here). In today's Wall Street Journal (subscription required), Dartmouth economist Matthew Slaughter, fresh from a stint at the CEA, tries to bring some rationality to the issue. An excerpt:

Yuan Worries
By Matthew J. Slaughter

Fact 1: China runs a large and growing trade surplus with the United States. In 2006, the goods-trade surplus exceeded $232 billion. This was an increase from 2005 of $31 billion, an amount larger than the entire deficit just 12 years ago.

Fact 2: China focuses its monetary policy on fixing the exchange value of its currency, the yuan, relative to the U.S. dollar.

Many policymakers and pundits connect these two facts by asserting that an unfairly low value of the dollar-yuan peg is causing the massive bilateral trade imbalance. The 109th Congress introduced 27 pieces of anti-China trade legislation. The current Congress already has over a dozen such bills, many aiming to force an overhaul of China's exchange-rate regime. And late last week dozens of House members were poised to file a Section 301 petition, asking the U.S. Trade Representative to investigate undervaluation of the Chinese yuan.

These misgivings about the dollar-yuan peg are misplaced. Economic theory and data are very clear here on two critical points. Controlling a nominal exchange rate is a form of sovereign monetary policy. And monetary policy, in turn, has no long-run effect on real economic outcomes such as output and trade flows.

Like all other central banks, the People's Bank of China uses its monopoly power over minting its money to control one nominal price. Since 1994 the PBOC has chosen to closely target the dollar-yuan price. In recent times, maintaining this target has required the PBOC to print yuan to buy dollars and thereby accumulate dollar-denominated assets on its balance sheet.

Many central banks today use their sovereign power to fix a nominal short-term interest rate rather than a nominal exchange rate. The U.S. Federal Reserve targets the federal-funds rate; the European Central Bank targets the main refinancing operations rate; and the Bank of Japan targets the overnight call rate. But exchange-rate targets are by no means uncommon. Indeed, in 2005, 55.6% of the world's countries fixed their exchange rates. And many countries have switched their targets over time. From 1945 to 1971, for example, the Federal Reserve targeted the value of the dollar at $35 per ounce of gold....

But hasn't the nominal dollar-yuan peg unfairly driven the long-run rise in trade imbalances? No. The exchange rate that matters for trade flows is the real exchange rate -- the nominal exchange rate adjusted for local-currency output prices in both countries. Supply-and-demand pressures in international markets can, and do, alter not just nominal exchange rates, but also nominal prices for goods and services. And these pressures driving the real exchange rate, in turn, reflect the deep forces of comparative advantage such as cross-country differences in technology, tastes and endowments of labor and capital.

Monday, May 21, 2007

How to Become Rich

What does it take to become wealthy? Before you answer, let's review a few facts. The first one is no surprise:

It seems that the smarter you are, the more you tend to earn. For each IQ point you have above someone else's IQ, you'll earn between $200 and $600 more.
But this one is more surprising: People with high IQ do not end up with more wealth.

We who are smarter than the average bear (I'm including myself and you) would reasonably assume, then, that smarter people would end up wealthier. But that was not suggested by the study. Instead, people with higher IQs and incomes tended to spend more, maxing out credit cards and paying bills late.
The above two quotations are from a summary of research conducted by Ohio State economics professor Jay Zagorsky. Here is another result from a different study of Professor Zagorsky:

Overweight Americans who lose a lot of weight also tend to build more wealth as they drop the pounds.
And yet another Zagorsky fact:
Regression results show lower net worth is associated with smoking, after holding constant a variety of demographic factors.
Finally, recall this lesson:
Stephen F. Venti of Dartmouth and David A. Wise of Harvard concluded that the primary reason for differences in retirement assets was differences in propensities to save. It is not unusual to see low-income households with high savings rates holding more financial assets at retirement than high-income households who saved a smaller fraction of their income.
The neoclassical theory of distribution teaches us that a person's earnings depend on his or her productivity. But earnings are not the same as wealth. The accumulation of wealth is mostly about the ability to exert self-control.

Ed Glaeser, Environmentalist

My Harvard colleague Ed Glaeser has a nice piece on the environmental challenge.

What would Pigou do?

Arthur Brooks, in today's Wall Street Journal (subscription required), highlights an externality without an obvious solution:

The strange fact of the matter is that the hard-core liberals and conservatives in America are actually some of our happiest citizens. According to the National Opinion Research Center in 2004, in spite of all their bile, 35% of people who said they are "extremely liberal" also reported being "very happy" with their lives -- versus 22% of people who were just "liberal" and 28% of moderates. At the same time, a whopping 48% of people who were "extremely conservative" were very happy (compared with 43% of non-extreme conservatives)....

The trouble is that, while radicals may be happy, they undoubtedly lower the happiness of the rest of us through their intolerance and antisocial ways -- spewing out what economists call "externalities" with every insulting bumper sticker and obnoxious street demonstration. Political nastiness is something akin to pollution.

Extreme political views need not go hand in hand with intolerance (Milton Friedman being a good example a tolerant extremist), but unfortunately they often do.

To foster tolerance, what we need is more interaction among people with opposite viewpoints. How about a student exchange program between Harvard and Liberty University? Or an affirmative action program to hire more Republicans for the Harvard faculty? Now that would be real diversity.

Saturday, May 19, 2007

Should the Fed cut rates by 3 basis points?

Bloomberg highlights a much overlooked aspect of monetary policy, at least in the United States:

The People's Bank of China today raised its one-year benchmark lending rate by 0.18 percentage point and its one-year deposit rate by 0.27 percentage point.

Why 18 or 27 basis points instead of the increments of 25 used by most other central banks? The answer has to do with the Chinese calendar and superstition, as well as the ancient Asian counting device, the abacus.

"In China, interest rates are always set to be multiples of nine,'' said Fan Wenzhong, deputy director at the Research Department of the China Banking Regulatory Commission in Beijing.

Because the financial year in China has 360 days, it's easier to compute monthly and daily rates if yearly rates are evenly divisible by nine, as are the current lending and deposit rates. The divisible-by-nine rule was enshrined in accounting standards issued jointly by the central bank and the Ministry of Finance in 1993.

The rule also simplifies interest computation on an abacus, the calculating tool that came into use more than 2,000 years ago during the Han Dynasty and is still used today.

"Rates divisible by nine avoid rounding of interest and allow easier calculation by abacus,'' said Wang Qing, chief China economist at Morgan Stanley in Hong Kong. In addition, the number nine in Chinese shares a pronunciation with the word "longevity'' and has long been considered a lucky number. Chinese wedding feasts have nine dishes; Beijing's Forbidden City has 9,999 rooms.

Maybe the Fed should cut the target federal funds rate from 5.25 to 5.22 (522 = 9 x 58). Given the rapid growth in China in recent years, they must be doing something right.

The Height Tax goes to Alaska

Friday, May 18, 2007

A New Job for Stan?

Here's a long shot I am rooting for. According to bookmakers, the odds are 14 to 1 that my PhD dissertation adviser Stanley Fischer will become the next head of the World Bank. Stan is among the most intelligent, level-headed, and honorable people I know. He would be a great choice.

Solow on Schumpeter

Here is famed MIT economist Robert Solow writing about famed Harvard economist Joseph Schumpeter. Registration required, but it's free.

Thursday, May 17, 2007

Standup Economist in DC

If you enjoyed the Ten Principles of Economics, Translated, and are living in or near Washington, D.C., this summer, you might want to get tickets to this event.

Readings for the Pigou Club

Inequality among Dentists

In Congressional Testimony (via Luskin), Cornell economist Robert Frank discusses his views on economic inequality. Here is an interesting tidbit:

Others have argued that inequality has increased in the United States because globalization has put unskilled American workers in competition with low-wage workers from other lands. Yet the basic pattern of inequality growth has been the same even among dentists, who are largely immune from foreign competition. Most dentists today earn little more than their counterparts from 1979, but the best paid dentists earn almost three times as much.
Somewhat oddly, however, Frank then advocates a superstar theory of increasing inequality.

The basic idea, originally from labor economist Sherwin Rosen, is that technological change now allows the highest quality producers to service a larger share of the markets in which they operate. If Jon Stewart is the funniest guy around, television allows the entire world to enjoy his comedy. This gives Stewart a huge income but leaves little for second-tier comics.

I like the theory as applied to some professions. But it it does not work particularly well for dentists.

Addendum: Tyler Cowen writes about inequality in today's NY Times (although he does not solve the dentist puzzle).

Tuesday, May 15, 2007

Price Gouging

The Associated Press reports:

With gas prices increasing, New Jersey lawmakers moved on Monday toward toughening gas gouging penalties that haven't been changed since Franklin D. Roosevelt was finishing his first term as president.

An Assembly committee released a Senate-approved bill to boost the state's gas gouging penalty to as much as $3,000 per violation, compared to current law, unchanged since 1938, that brings fines as low as $50. The bill can now be considered by the full Assembly. It was approved 35-0 by the Senate in February.

Meanwhile, Democratic leaders are pursuing similar efforts at the national level.
On Tuesday, House Speaker Nancy Pelosi(D-Calif.) told the Energy and Commerce Committee to mark up a bill proposed by Rep. Bart Stupak (D-Mich.) that would give the federal government more power to pursue accusations of price gouging.
A student asks me (and I paraphrase), "I understand the arguments that economists like you and Gary Becker make against anti-gouging legislation, but what about more left-leaning economists? Are they also opposed to such regulation?"

I believe the answer is yes, but I could not think of a good reference off the top of my head. Does anyone know of a well-regarded economist of more moderate or liberal views opining on these anti-gouging laws? Please post your citations in the comments section.

Advisers to the next POTUS? A Quiz

Can you guess which presidential candidate is getting advice from Berkeley economists Christina and David Romer? Click here for the answer.

And who is listening to Stanford economist Michael Boskin? Find out here.

If you got those right, try a harder one: Which candidate is getting advice from Boston University economist Larry Kotlikoff? Click here for the answer.

I assume you all know where I stand.

Monday, May 14, 2007

Inequality among Economists

In a previous post, I noted that income inequality among professors across different academic disciplines has been increasing. The same is apparently true within disciplines as well. In some data compiled by Dan Hamermesh on the salaries of full professors of economics, the ratio of the 90th percentile salary to the 10th percentile salary has steadily risen from 1.885 in 1998-99 to 2.057 in 2006-07.

Does anyone have a good explanation of this trend? I wonder if inequality in measures of productivity, such as publications and citations, has also been increasing.

Friday, May 11, 2007

Free Lunch Thinking at Harvard

"There is no such thing as a free lunch" is as good a slogan as any I know. Whenever I hear someone propose a reform and suggest that it does not involve any costs, my first reaction is to think that they aren't being honest. Life is full of hard tradeoffs. If you think otherwise, you probably haven't thought enough.

I see some students being lulled into free lunch thinking when discussing raising wages of low-income workers at Harvard. Even putting aside any possible adverse side effects of above-equilibrium wages, advocates of higher wages need to confront the real question of limited resources. If Harvard is to raise wages above the going market levels, the money to pay those wages has to come from somewhere, such as higher tuition, less financial aid, or fewer faculty. Saying "Harvard has a large endowment" is not an answer--the endowment represents future spending on items the university values.

Harvard administrators are lulled into free lunch thinking when discussing teaching quality. An article in yesterday's NY Times offers this insight into the issue:

The aim of the report is not to de-emphasize research in any way, but to bring about a greater institutional focus on teaching, Professor Ulrich said. “This is not a report that says we’re going to hire teachers who are not also scholars,” she said. “We want both.”
But better teaching is not a free lunch. If the university puts more weight on teaching in its hiring and promotion decisions, it must put less weight on research. Sure, there are some scholars who are great at both activities, but those are not the marginal hires.

You will know the university is serious about increasing teaching quality when it says it is willing to hire scholars with less distinguished research records in order to get better teachers, or when it says it will spend more money to compete more vigorously with Princeton and Yale for the best professors (and tells you where that money will come from). But unless the university says it is willing to confront the hard tradeoffs, it is just posing.


Update: Some commenters point out that sometimes the world does offer Pareto improvements, such as the gains from trade in a Ricardian trade model, and that these are free lunches. True enough. Slogans are more rules of thumb than theorems. Experience suggests, however, that purported free lunches are vastly more numerous than actual free lunches.

I should note that purported free lunches are found on both sides of the political divide. Politicians on the right like to claim that their proposed tax cuts will completely pay for themselves with extra economic growth. Politicians on the left like to claim that their proposed spending programs are investments that will yield returns so great that the spending becomes self-financing. Either outcome is possible in theory, but skepticism is usually the best response in practice.

Wednesday, May 09, 2007

Charles Darwin versus Adam Smith

Emory economics prof Paul Rubin says the forces of evolution have sometimes worked against good economic thinking.

A Fact in Search of a Theory

A few weeks ago, I read the following fact about U.S. and international stock markets in the Wall Street Journal:
During the two-year period that ended in February, correlation between U.S. and other developed markets was 0.63, according to ING Asset Management. That is a big decline from 2003 to 2005, when they practically moved in lockstep, at 0.93. (The figures are based on monthly movements in the Standard & Poor's 500-stock index and the Morgan Stanley Capital International EAFE indexes.)
This fact raises many questions in my mind, which I have been contemplating without much progress. What causes this correlation to change over time? Does it say something about the nature of the shocks hitting the world's economies? What implications does the changing correlation have? Do we observe more efforts at international diversification when the correlation is low? Does a falling correlation mean that risk premiums should shrink because international diversification reduces risk more? Do risk premiums in fact move together with changes in this correlation?

If anyone knows the answers, please share them in the comments section.

The Danger of Spectator Sports

I have never been a particularly big fan of watching sporting events. I much prefer movies as a pastime. It turns out, I learn in today's Wall Street Journal (subscription required), that this taste has helped keep me in good health:
During the 2002 monthlong World Cup soccer finals, short-term sick leave among Swedish men suspiciously rose by 55%.

Saving on Saving Medicare

In today's Wall Street Journal (subscription required), Thomas Saving sees a way forward on the looming fiscal problem called Medicare:

In general, no reform should be taken very seriously unless it is specifically designed to slow the rate of growth of health-care spending. On the demand side, someone must choose between health care and other uses of money. That is, someone must decide that the next MRI scan or the next knee replacement, for example, is not worth the cost. Such decisions could be made by seniors themselves, by the government (as it is in other countries), or by private insurers operating under government rationing rules. On the supply side, the way health care is produced must fundamentally be changed, replacing cost-increasing innovations with cost-reducing ones.

To examine consequences of beneficiaries making their own rationing decisions, my colleague Andrew Rettenmaier and I estimated the effects of creating reformed Medicare based on a $5,000-deductible Health Savings Account (HSA), beginning with the baby boomer retirees. The size of the deductible and the HSA would grow through time (as health costs grow), and since deposits would be made with after-tax dollars, withdrawals for any purpose would be tax free. In this way, beneficiaries would be encouraged to make their own tradeoffs between health care and every other good or service. We estimate the effects would result in a reduction in Medicare's unfunded liability by between 25% and 40%.

Tuesday, May 08, 2007

Becker and Murphy on Inequality

Gary Becker and Kevin Murphy, two of the most prominent members of the economics profession, tell us about the Upside of Income Inequality. An excerpt:

This brings us to our punch line. Should an increase in earnings inequality due primarily to higher rates of return on education and other skills be considered a favorable rather than an unfavor­able development? We think so. Higher rates of return on capital are a sign of greater productivity in the economy, and that inference is fully applica­ble to human capital as well as to physical capital. The initial impact of higher returns to human cap­ital is wider inequality in earnings (the same as the initial effect of higher returns on physical capital), but that impact becomes more muted and may be reversed over time as young men and women invest more in their human capital....

For many, the solution to an increase in inequality is to make the tax structure more progressive—raise taxes on high-income households and reduce taxes on low-income households. While this may sound sensible, it is not. Would these same indi­viduals advocate a tax on going to college and a subsidy for dropping out of high school in response to the increased importance of education? We think not. Yet shifting the tax structure has exactly this effect.

Learn from Jordi

Advanced undergraduates and beginning grad students who want a good introduction to state-of-the-art monetary theory (or at least one branch of it) should check out this new monograph by Jordi Gali.

Monday, May 07, 2007

The Obama-Bush Plan

Senator Barack Obama gives a major speech to the Detroit Economic Club, and here is what he comes up with:

Obama Criticizes Automakers on Fuel Economy

Senator Barack Obama of Illinois delivered a stern message to Detroit auto companies on Monday, saying they had done little to lessen the nation’s dependence on foreign oil and needed to improve the fuel efficiency of their vehicles....

Under Mr. Obama’s plan, which he said would save 2.5 million barrels of oil a day, he proposed a 4 percent a year increase in fuel economy standards beginning in 2009, or the equivalent of about one mile per gallon per year.

By 2022, the fuel economy standard for both cars and light trucks would be 40 miles per gallon, according to the plan. The Bush administration has proposed a similar method to raise the fuel economy standard over the next few years.

If Senator Obama is going to adopt policy proposals from the Bush administration, I wish he would find something better than this. Here is a CBO analysis of Corporate Average Fuel Economy standards:
This issue brief focuses on the economic costs of CAFE standards and compares them with the costs of a gasoline tax that would reduce gasoline consumption by the same amount. The Congressional Budget Office (CBO) estimates that a 10 percent reduction in gasoline consumption could be achieved at a lower cost by an increase in the gasoline tax than by an increase in CAFE standards. Furthermore, an increase in the gasoline tax would reduce driving, leading to less traffic congestion and fewer accidents. This analysis stops short of estimating the value of less congestion and fewer accidents and, therefore, does not draw any conclusions about whether an increase in the gasoline tax would be warranted. However, CBO does find that, given current estimates of the value of decreasing dependence on oil and reducing carbon emissions, increasing CAFE standards would not pass a benefit-cost test.

Jeremy's Crystal Ball

Economist Jeremy Siegel looks at stock market valuations and concludes that U.S. equities will earn a real annual return of 6 to 6.5 percent.

Living Wage Redux

A group of ec 10 students asked me today about the hunger strike that some students have recently begun to protest the wages of Harvard security guards. A similar issue arose in 2001. Here is what I wrote back then in Harvard Magazine.

The Case against the Living Wage

When a group of students took over an administration building last spring to protest Harvard's wage policy, many people found it easy to sympathize with them. Without doubt, life is hard for workers getting by on $8 or $9 an hour. Moreover, the protest was a welcome relief from the relentless careerism that infects too many students today. The protesters were admirable in their desire to reach beyond their own fortunate cocoons and help those who are less lucky.

Despite the students' good intentions, I cannot support their cause. If any institution should think with its head as well as its heart, it is a university. In my view, there are compelling reasons to reject the students' pleas.

Like most of the prices in our economy, wages move to balance supply and demand. A high minimum wage set by fiat, either through legislation or student pressure, prevents this natural adjustment and hurts some of the people it is designed to help. It is a timeless economic lesson that when the price of something goes up, buyers usually buy less of it. If Harvard has to pay its unskilled workers a higher wage, it will hire fewer of them. Some workers earn more, but others end up unemployed.

Living-wage advocates say that Harvard with its huge endowment can afford to pay higher wages. That's true, but it misses the point. Like all employers, Harvard faces trade-offs. Should extra money be spent hiring more professors to reduce class sizes, or should it be spent hiring more janitors to vacuum classrooms more often? It's a judgment call. If the cost of unskilled labor rises, Harvard faces a new set of trade-offs. Over time, it will respond by hiring fewer of those workers.

A higher wage would also change the composition of Harvard's work force, for wages play a role in supply as well as demand. If the University posts a job opening at $10 an hour, it gets a larger and better mix of applicants than if it posts the same opening at $8 an hour. The person who would have gotten the job at the lower wage is now displaced by a more skilled worker. In the short run, a living wage might benefit those at the bottom of the economic ladder. In the long run, they would be replaced by those who are already a rung or two higher.

Finally, the living-wage protest raises the issue of Harvard's mission in society. The benefactors who give to the University do so to support education, not income redistribution. (And if Harvard were to take up the cause of income redistribution, it would have to acknowledge that even the poorest workers in Cambridge are rich by world standards.) Harvard needs to pay its workers--janitors and professors alike--enough to attract and motivate them. But it shouldn't pay more than it needs to, given the competitive labor markets in which it hires. To do so would compromise the University's commitment to the creation and dissemination of knowledge.


Now is the time of year when professors choose textbooks to use in their fall classes. If you are an economics professor planning to teach either a principles course or an intermediate macro course, please consider mine. Instructors can get complimentary examination copies, as well as copies of related teaching materials, from the relevant publisher.

For any of the five versions of my principles text, the person to contact is Brian Joyner at Thomson. His email is

For my intermediate-level macroeconomics text, the person to contact is Scott Guile at Worth Publishers. His email is
If you would like a copy and are not a professor eligible for a free one, you will have to rely on the invisible hand of the market to satisfy your cravings.

Saturday, May 05, 2007

Blinder on Offshoring

Alan Blinder summarizes his new view of trade in an article in tomorrow's Washington Post. Here is where Alan and I part company:

1. Alan says, "Globalization is good for the world.... [But] these same forces don't look so benign from the viewpoint of an American computer programmer or accountant." Although Alan does not say it, his formulation makes it sound like all the global benefits accrue overseas. He fails to emphasize that many people in the United States benefit as well. An American doesn't need to be altruistic toward China and India to favor an open world trading system.

2. Alan says, "I estimated that 30 million to 40 million U.S. jobs are potentially offshorable." These jobs are equally onshorable. Alan's measure merely means that these services, once nontraded, will become tradable with new technologies. In the new equilibrium, we will be exporting in many of those industries. Indeed, real exchange rates will adjust (either through nominal exchange rates or price levels) so that increased exports go hand in hand with increased imports. Imports can exceed exports only if foreigners continue to be eager to invest some of their saving in the U.S. economy. It is a pedagogical mistake to point out the jobs lost from imports without discussing the jobs gained from exports.

3. Alan says the transition to the new equilibrium will be "large, lengthy and painful." When he spoke at Harvard last week, he said the transition would take about 30 years. But the very length of the transition will make it less painful. Over the course of a generation, workers can gradually retire from shrinking industries, and new workers can be trained for the growing industries that take their place. Of course, some individuals will experience painful transitions, but that is always the case in a dynamic market economy. I don't expect future transitions to be macroeconomically different than past transitions. Even if imports as a percentage of GDP continue to rise as Alan predicts, I would nonetheless expect the average rate of unemployment for the U.S. economy to be about the same over the next thirty years as it has been over the past thirty.

After the Blinder-Bhagwati debate last week, there was a dinner at the Harvard Faculty Club at which Ben Friedman asked Alan a good question: Now that Alan has had this epiphany about offshoring, does he favor economic policies any different than he favored a decade ago? Alan thought about the question for a moment and then said no. I found that answer reassuring. My fear is that many politicians reading Alan's work on offshore outsourcing will not come to the same conclusion.

Help me keep my job

To my ec 10 students:

If you enjoyed the course, please do me a favor and fill out your course evaluation. Go to and click on the "courses" tab.

If you didn't like the course,....never mind.

Friday, May 04, 2007

Some money is not a medium of exchange

This story should help accelerate the Penny Anti Campaign:

Every penny counts. But 10 of them didn’t one recent night in the Bronx, and that’s how the trouble started.

It was about 11:30 p.m. on April 23 when Wayne Jones stopped at the Great Wall Chinese Restaurant in the Soundview section. Mr. Jones, 47, a lieutenant with the Fire Department’s Emergency Medical Service, ordered four fried chicken wings to go. The total was $2.75.

Mr. Jones placed his money on the counter: two $1 bills, two quarters, one dime, one nickel — and 10 pennies.

“The lady behind the counter started yelling, ‘No pennies, no pennies,’ ” Mr. Jones said. The woman told him she would take 3 or 4 pennies, he said, but not 10.

The story continues in the NY Times.

Thursday, May 03, 2007

Varian on Stock Market Investing

From Hal Varian's column in today's NY Times:
The professors look at how a company’s stock responds to a cover story in BusinessWeek, Fortune and Forbes. They find that positive stories follow periods of positive performance and negative stories follow periods of negative performance, which admittedly is not too surprising. More interesting, they also find that the appearance of a cover story tends to signal the end of the abnormal performance.
My advice for most investors: Put your trust in tax-efficient index funds.

Wednesday, May 02, 2007

Discrimination in the NBA

The New York Times calls our attention to a new paper by economists Justin Wolfers and Joseph Price. This is from the abstract:

The NBA provides an intriguing place to test for taste-based discrimination:referees and players are involved in repeated interactions in a high-pressure setting with referees making the type of split-second decisions that might allow implicit racial biases to become evident....We find that—even conditioning on player and referee fixed effects (and specific game fixed effects)—that more personal fouls are awarded against players when they are officiated by an opposite-race officiating crew than when officiated by an own-race refereeing crew. These biases are sufficiently large that we find appreciable differences in whether predominantly black teams are more likely to win or lose, according to the racial composition of the refereeing crew.

Congestion Pricing

The New Yorker has an excellent piece on the proposed congestion pricing plan for New York City. An excerpt:
The case against congestion pricing is often posed in egalitarian terms. “The middle class and the poor will not be able to pay these fees and the rich will,” State Assemblyman Richard Brodsky, of Westchester County, declared after listening to the Mayor’s speech. In fact, the poor don’t, as a rule, drive in and out of Manhattan: compare the cost of buying, insuring, and parking a car with the seventy-six dollars a month the M.T.A. charges for an unlimited-ride MetroCard. For those who do use cars to commute, eight dollars a day would, it’s true, quickly add up. And that is precisely the point. Congestion pricing works only to the extent that it makes other choices—changing the hours of one’s daily drive or, better yet, using mass transit—more attractive.

Height Tax in WSJ

In the online Wall Street Journal, Grep Ip does a good job of summarizing my new paper with Matthew Weinzierl, The Optimal Taxation of Height. Sorry, subscription required. If anyone finds a free link, let me know.

Bernanke on Trade

Ben Bernanke gives a nice talk defending free trade.

Tuesday, May 01, 2007

A Leak via Ken

My colleague Ken Rogoff has just released a top secret memo from Paul Wolfowitz to the World Bank staff.

A Busy Afternoon

Tomorrow (Wednesday), Larry Summers will give an ec 10 lecture on "Global Integration, Economic Development, and the Future of the Global Economy." All Harvard students are welcome to attend. The lecture is at noon in Sanders Theater in Memorial Hall.

In addition, at 2 pm on Wednesday, Alan Blinder and Jagdish Bhagwati will debate "Offshoring of American Jobs: What Response from U.S. Economic Policy?" The event is in Emerson Hall, Room 105, and is free and open to the public.

Consenting Adults

ABC News reports:

The woman charged in a federal indictment with running a high-class Washington, D.C. call girl service says she plans to call her prominent clients to testify at her trial....Also on Palfrey's list of customers who could be potential witnesses are a Bush administration economist, the head of a conservative think tank, a prominent CEO, several lobbyists and a handful of military officials.
I would be surprised if there were a real economist on the list: the conventional wisdom is that all the prostitutes leave town during the American Economic Association convention.

Many economists would, nonetheless, vote to legalize prostitution on general libertarian principles. But if it is to be ruled an illegal transaction, then it is hard to argue with this logic:
None of her male customers is named by the government. "That's very hypocritical," she says. "Why aren't these people under arrest? Why just me?"
Update: The Washington Post reports:
a man who told the escort service he was a White House economist turned out to have engaged in résumé inflation. He actually works across the street as an analyst for the Office of Thrift Supervision.