## Monday, August 31, 2009

### Test Scores and Biological Father's Income

MIT's David Cesarini sends me the above chart with this note:

Dear Professor Mankiw,

I prepared a graph which I think nicely illustrates the simple point you made in your blogpost on the spurious association between SES and test scores. The graph is attached. The dataset is comprised of a large sample of men born in Sweden between 1955 and 1970 who took an IQ test at conscription, at the age of 18. Income is measured as the biological father's income in the 1970 census.

The red line is the average measured IQ of the non-adoptees, plotted against the biological father's income decile. The blue line shows the same relationship for adoptees and their biological fathers. The patterns are remarkably similar,even though the biological fathers of adoptees did not raise these children.The fact that the biological father's income is almost an equally strong predictor of a child's test scores even when the biological father was not present in the household clearly suggests that most of the association between income and test scores does indeed arise because of omitted variable bias. Of course, an important caveat here is that it is quite likely that non-random assignment of adoptees may explain some of the similarity between the two lines.

I hope you find this useful.

Best wishes,
David Cesarini

Thanks, David.

N.B.: What David has provided us is the complementary graph to the one I proposed in my post. I conjectured that if we graphed adopted kids' test scores against their household income--that is, against their adopted parents' income--the curve would be "a lot flatter" than it is for non-adoptees. David graphs adopted kids' test scores against their biological father's income and finds it is almost as steep as for non-adoptees.

I am teaching a Harvard freshman seminar this semester (in addition to ec 10), and one of my first tasks is to choose the 15 students. About 200 applied. That means that getting into my seminar is about as hard as getting into Harvard--except that you first have to get into Harvard before you can even apply!

Having spent much of yesterday reading through the applications, I fully recognize how difficult and somewhat random such admissions processes are. I could fill almost the entire seminar with kids with perfect SAT scores (2400), but I won't, as there is more to life than test scores. I am looking also for passion about the subject, interesting life experiences, and a balance among the group of students to promote good discussion. But judging that from a few brief essays is very, very hard. To those students I do not pick: I am sorry, and it is my loss as well for not having the opportunity to get to know you better.

For those blog readers who might be interested in what the seminar will be reading, here is the list of books:
• The Worldly Philosophers, by Robert Heilbroner
• Spin-Free Economics, by Nariman Behravesh
• Capitalism and Freedom, by Milton Friedman
• Equality and Efficiency: The Big Tradeoff, by Arthur Okun
• Nudge, by Richard Thaler and Cass Sunstein
• The Return of Depression Economics, by Paul Krugman
• Animal Spirits, by George Akerlof and Robert Shiller
• The Myth of the Rational Voter, by Bryan Caplan
• Economic Gangsters, by Raymond Fisman and Edward Miguel
• The Price of Everything, by Russell Roberts

All the students will be taking ec 10 concurrently (or have already passed the Advanced Placement exam in economics).

Update: At the students' behest, Superfreakonomics by Stephen Dubner and Steven Levitt was added to the list of readings.

## Saturday, August 29, 2009

### And I thought I was being boring

My previous blog post on SAT scores and income generated a surprising amount of blogosphere pushback. See, for example, this post by Paul Krugman.

I say "surprising" because I almost did not post the piece at all, thinking that it was a bit pedantic and pedestrian. In other words, a big yawn. I did not think my point about omitted variable bias was particularly new or controversial.

In essence, what I said was

1. People vary in their innate talents, as measured by, say, IQ tests.

2. More talented people tend to earn higher incomes.

3. More talented people tend to have more talented biological children--that is, talent is partially heritable.

4. As a logical implication of the above three points, the raw correlation of kids' SAT scores and family income conflates the true effects of family income with the biological transmission of talent.

I would be curious which of the above four statements Paul does not agree with.

Paul himself is a good case illustrating my point. He is smart, and he has high income. I don't think those two facts are a mere coincidence. Instead, his innate talent is a large element of his success. I would bet that if he had had children, they would likely have been smart as well, even if he spent only average resources rearing them (such as, for example, if he put them up for adoption).

By the way, the conjecture in the final sentence of my last post about adopted kids was in part based on existing evidence in the nature-nurture debate. See, for instance, this paper.

## Friday, August 28, 2009

### The Least Surprising Correlation of All Time

The NY Times Economix blog offers us the above graph, showing that kids from higher income families get higher average SAT scores.

Of course! But so what? This fact tells us nothing about the causal impact of income on test scores. (Economix does not advance a causal interpretation, but nor does it warn readers against it.)

This graph is a good example of omitted variable bias, a statistical issue discussed in Chapter 2 of my favorite textbook. The key omitted variable here is parents' IQ. Smart parents make more money and pass those good genes on to their offspring.

Suppose we were to graph average SAT scores by the number of bathrooms a student has in his or her family home. That curve would also likely slope upward. (After all, people with more money buy larger homes with more bathrooms.) But it would be a mistake to conclude that installing an extra toilet raises yours kids' SAT scores.

It would be interesting to see the above graph reproduced for adopted children only. I bet that the curve would be a lot flatter.

## Tuesday, August 25, 2009

### How large is the fiscal hole?

Economistmom says the actual budget deficit over the next decade is likely to be close to \$14 trillion:
\$9 trillion (\$9.051 trillion) is the Obama Administration’s 10-year deficit projection based on their own economic forecast and their own estimate of the costs of their policy proposals (as proposed in their FY2010 budget). \$7 trillion (\$7.137 trillion) is the Congressional Budget Office’s 10-year deficit projection based on their economic forecast and policies already in place in current law. If you start with CBO’s more pessimistic baseline budget outlook of \$7 trillion in deficits (by the way, the equivalent pre-policy baseline estimated by the Administration is \$6.259 trillion), then add in the CBO-estimated cost of policies that have a good chance of coming true in the future (but aren’t yet written into law), you can come up with a projection that is perhaps more “plausible” than both the Administration’s (optimistic) \$9 trillion and CBO’s (naive baseline-constrained) \$7 trillion. That’s what we at Concord try to do when we come up with our “Concord Plausible Baseline,” which based on today’s CBO report shows that current policy would lead to \$14.4 trillion in deficits over the next 10 years.

### POTUS makes a wise choice

I am delighted that President Obama has decided to reappoint Ben Bernanke as chairman of the Federal Reserve. While there is certainly room for reasonable people to question some of the specific decisions Ben has made, in general he has led the Federal Reserve System with humility, intelligence, wisdom, and grace.

I extend my congratulations to the President for a fine decision and my condolences to Ben for having to spend the next four years overworked and underpaid.

## Sunday, August 23, 2009

If you are thinking about being a professor, read this (unless it is too late to turn back).

Thanks for Craig Newmark for the pointer.

## Saturday, August 22, 2009

### Preview of the Midsession Review

Before you read this story, here is one number you need to know: the U.S. federal government's debt is now about \$7.4 trillion. That is the accumulation from past budget deficits.

With that number firmly in mind, here is a story from the Washington Post about the path of future fiscal policy:

The nation would be forced to borrow more than \$9 trillion over the next decade under President Obama's policies, the White House acknowledged late Friday, bringing their long-term budget forecast in line with independent estimates.

The new projections add approximately \$2 trillion to budget deficits through 2019. Earlier this year, the administration had predicted that Obama's policies would require the government to spend \$7.108 trillion more than it collects in tax revenue over the next decade.

An administration official, speaking on the condition of anonymity because the report will not be formally released until Tuesday, said the change is due primarily to updated projections of economic growth that are far less rosy than data used when the White House released its first long-term budget outlook in February.

### A Good Read on Health Policy

A long but thoughtful article, recommended by a physician and regular blog reader.

## Friday, August 21, 2009

### We are all supply-siders now

From a great article by David Leonhardt and Geraldine Fabrikant:
In the three decades after World War II, when the incomes of the rich grew more slowly than those of the middle class, the top marginal rate ranged from 70 to 91 percent. Mr. Piketty, one of the economists who analyzed the I.R.S. data, argues that these high rates did not affect merely post-tax income. They also helped hold down the pretax incomes of the wealthy, he says, by giving them less incentive to make many millions of dollars.
Precisely.

## Thursday, August 20, 2009

### Barney Frank on the Economics Profession

Via David Wessel, here is a great quotation from congressman Barney Frank:
Not for the first time, as an elected official, I envy economists. Economists have available to them, in an analytical approach, the counterfactual. Economists can explain that a given decision was the best one that could be made, because they can show what would have happened in the counterfactual situation. They can contrast what happened to what would have happened. No one has ever gotten reelected where the bumper sticker said, "It would have been worse without me." You probably can get tenure with that. But you can't win office.

## Wednesday, August 19, 2009

### Blanchard on the Outlook

Regular readers of this blog may remember the following exchange from March:

1. I express some doubt about the administration's economic forecast because it assumes a trend-stationary processs for GDP rather than a process with a unit root.

2. Paul Krugman accuses me of "deliberate obtuseness."

3. I ask Paul to place a wager on the administration's forecast. (He never responds.)

Well, now, the IMF's Olivier Blanchard writes the following:
The historical evidence is worrisome, however. The IMF’s forthcoming World Economic Outlook presents evidence from 88 banking crises over the past four decades in a wide range of countries. While there is large variation across countries, the conclusion is that, on average, output does not go back to its old trend path, but remains permanently below it. The possible good news is that the trend itself appears to be unaffected: on average, crises permanently decrease the level of output, but not its growth rate. So, if past is prologue, the world economy likely will return to its past growth rate. But, especially in advanced countries, the period of above-average growth, characteristic of normal recoveries, may be short-lived or nonexistent.
What Olivier is saying is that the shocks to the level of GDP from banking crises are typically permanent. That is, in econometric terms, there is a unit root. Of course, Olivier could be wrong. But I am pretty sure that he is not guilty of "deliberate obtuseness."

By the way, the administration's midsession review, with its updated forecast, should be coming out soon. Will Team Obama continue to forecast a rebound to the previous trend path, as they did earlier in the year, or will they change their view and take to heart the kind of evidence Olivier describes above? Either way, it will be noteworthy.

## Tuesday, August 18, 2009

### Pigou Club News

The Wall Street Journal reports that a member of the Pigou Club is running for the Republican nomination for Governor of California:
California's fiscal crisis is giving Tom Campbell, an ex-congressman with few resources, a fighting chance to become the state's next governor....Democrats scorn his ideas for permanent cuts to welfare and social services in lieu of one-time fixes, while Republicans strongly oppose his proposal for a steep increase in the state's gasoline tax....Armed with a University of Chicago doctorate in economics and a Harvard Law School degree, he represented Silicon Valley for five terms in the U.S. House, served as business-school dean at the University of California, Berkeley, and also as the state's finance director under Gov. Arnold Schwarzenegger.

## Sunday, August 16, 2009

### Thaler on the Public Option

Here is Richard Thaler on the public option in the healthcare debate. He ends up about where I am on this topic, but I think he is a bit too quick to "assume that the public option does have to break even and can’t make any special deals." I believe that many advocates and many opponents of the public option are making the opposite assumption and, as a result, see the public option as a route toward a single-payer system. (They disagree, however, about whether that is good or bad.) That implicit assumption is why the public option is a bigger issue in this debate than Thaler would have us believe.

### A Diversified Portfolio

The Russian educational system appears to be moving in the right direction:
For Russians, "ekonomicheski krisis" with its conceptual, foreign sounding roots conjures up half-Marxist, half-Mankiw notions gleaned from university cheat sheets.

## Saturday, August 15, 2009

### The Town Pier

Yesterday, I chartered a sailboat so my family and I could spend a couple of hours out on the waters off Nantucket. The captain of the boat met us at the town pier, loaded us onto a small skiff, and then took us to a mooring out in the harbor, where the boat was waiting.

He explained to us that he would prefer to keep his sailboat at the pier, which would make loading and unloading passengers much easier, but he could not get a space there. Every year, he told us, the town has a lottery to allocate the right to rent one of the scare docking slots. For quite a few years, the captain has been putting his name into the lottery, but he has never won. "There are just not enough spaces," he said.

Ever the economist, I replied, "It seems to me that the price isn't high enough."

"Well, actually," the captain said, "if you want to pay more, you can go down there." He pointed to the next dock over.

Apparently, next to the town pier is another pier that is privately owned and operated. The price for a docking space there is about five times as high as it is at the town pier. But there is never any significant shortage. Anyone can sign up for a slot, as long as you are willing and able to pay.

What a wonderful illustration of basic economic principles! In one way or another, scarce resources need to be allocated among competing uses. Free markets typically use the price system. Governments, often in the name of "fairness," seem to prefer other mechanisms, which don't always direct resources to their highest value use.

The sailboat ride was a bit of a bust, by the way. The day was warm and sunny, and the captain was a delightful storyteller, but the wind was not nearly sufficient for a good sail. Sadly, there are some shortages even the price system is not able to correct.

Question for Ec 10 students: If the town raised the rental price of a docking slot at the town pier, what would happen to the price at the private pier?

## Thursday, August 13, 2009

### Ken's Dystopia

My Harvard colleague Ken Rogoff writes:
Within a few years, western governments will have to sharply raise taxes, inflate, partially default, or some combination of all three.

### A Reading for the Pigou Club

From the Wall Street Journal:

Economists Behind Original Concept Question the System's Large-Scale Usefulness, and Recommend Emissions Taxes Instead

In the 1960s, a University of Wisconsin graduate student named Thomas Crocker came up with a novel solution for environmental problems: cap emissions of pollutants and then let firms trade permits that allow them to pollute within those limits.

Now legislation using cap-and-trade to limit greenhouse gases is working its way through Congress and could become the law of the land. But Mr. Crocker and other pioneers of the concept are doubtful about its chances of success. They aren't abandoning efforts to curb emissions. But they are tiptoeing away from an idea they devised decades ago, doubting it can work on the grand scale now envisioned.

"I'm skeptical that cap-and-trade is the most effective way to go about regulating carbon," says Mr. Crocker, 73 years old, a retired economist in Centennial, Wyo. He says he prefers an outright tax on emissions because it would be easier to enforce and provide needed flexibility to deal with the problem....

Mr. Crocker, who went on to become a professor at the University of Wyoming, is one of two economists who dreamed up cap-and-trade in the 1960s. The other, John Dales, who died in 2007, was also a skeptic of using the idea to tame global warning.

## Wednesday, August 12, 2009

### Wonky Talk about Carbon Taxes

I appreciate David Leonhardt’s kind words about my recent Times column on the problems with giving away, rather than auctioning, carbon allowances. I thought it might be useful to explain a bit more some of the economics behind what he calls my Rorschach test. Here is the more wonky way of putting some of the arguments.

We can think of the typical household as having to make two decisions. First, the household decides how much to work and consume. This is the standard consumption-leisure tradeoff. Second, the household decides how to allocate consumption between carbon-intensive products and less carbon-intensive products.

Mathematically, we might write utility as

U = u(C) + v(L)

where C is consumption and L is leisure. Consumption is a composite of carbon-intensive consumption C1 and less carbon-intensive consumption C2, which we can write as

C=F(C1,C2).

There are two margins of adjustment: between C and L, and between C1 and C2.

We start in a situation in which each of these margins of adjustment is distorted. Because earnings are taxed via income and payroll taxes, people have too little incentive to work and consume. In addition, because there is a negative externality associated with carbon, people have too little incentive to move their consumption basket toward less carbon-intensive products. In other words, the relative price of consumption compared to leisure is too high, and the relative price of carbon consumption compared to noncarbon consumption is too low.

The trick is how to fix the second distortion without making the first one worse. A tax on carbon with the revenues used to cut income taxes does that. Everyone who thinks there are negative carbon externalities should agree that is the efficient policy.

A tax on carbon with the revenue squandered via lump-sum handouts to powerful special interests, however, fixes the second distortion but makes the first one worse. The good thing about this policy is that it raises the price of carbon-intensive consumption relative to less carbon-intensive consumption. The bad thing about it is that it also raises the price of consumption relative to leisure—that is, it depresses the real wage. The basic problem is that a new tax on carbon-intensive products C1 is also an additional tax on consumption C, unless there is some other offsetting tax change.

This is where the Rorschach test comes in. A carbon tax without a compensating income tax cut makes one problem better and one worse. The question then is which problem is bigger. I don’t think there is a consensus among economists on this last question. That is why reasonable people can disagree about the bill being debated in Congress.

But there is a consensus, more or less, that we could fix one margin of adjustment without distorting the other margin more. That requires a cut in income or payroll taxes to be a key part of the environmental policy.

## Monday, August 10, 2009

### An Ounce of Prevention

...is expensive, says CBO:
the evidence suggests that for most preventive services, expanded utilization leads to higher, not lower, medical spending overall.
Coverage of the issue here and here.

## Saturday, August 08, 2009

### British healthcare is great

...as long as you walk on four legs:

In the last few years, I have had the opportunity to compare the human and veterinary health services of Great Britain, and on the whole it is better to be a dog.

As a British dog, you get to choose (through an intermediary, I admit) your veterinarian. If you don’t like him, you can pick up your leash and go elsewhere, that very day if necessary. Any vet will see you straight away, there is no delay in such investigations as you may need, and treatment is immediate. There are no waiting lists for dogs, no operations postponed because something more important has come up, no appalling stories of dogs being made to wait for years because other dogs—or hamsters—come first.

The conditions in which you receive your treatment are much more pleasant than British humans have to endure. For one thing, there is no bureaucracy to be negotiated with the skill of a white-water canoeist; above all, the atmosphere is different. There is no tension, no feeling that one more patient will bring the whole system to the point of collapse, and all the staff go off with nervous breakdowns. In the waiting rooms, a perfect calm reigns; the patients’ relatives are not on the verge of hysteria, and do not suspect that the system is cheating their loved one, for economic reasons, of the treatment which he needs. The relatives are united by their concern for the welfare of each other’s loved one. They are not terrified that someone is getting more out of the system than they.

The latter is the fear that also haunts Americans, at least those Americans who think of justice as equality in actual, tangible benefits. That is the ideological driving force of health-care reform in America. Without manifest and undeniable inequalities, the whole question would generate no passion, only dull technical proposals and counterproposals, reported sporadically on the inside pages of newspapers. I have never seen an article on the way veterinary services are arranged in Britain: it is simply not a question.

Nevertheless, there is one drawback to the superior care British dogs receive by comparison with that of British humans: they have to pay for it, there and then. By contrast, British humans receive health care that is free at the point of delivery.

### The Recession in Nantucket

I am vacationing now with my family on Nantucket, the 17th year we've been coming out to this beautiful island. The economy here reflects what is going on in the rest of the nation:
New construction averaged over 200 houses per year until the slowdown started in 2006, providing a high level of income and steady year-round employment in the construction trades.... In 2007 the annual rate was slower than in recent years, at 127. The construction slowdown continued in 2008, with just 64 new homes, the lowest number since building permits were first required in 1972. Thus far in 2009 the rate is less than half that of last year, with 12 permits issued through June.

## Thursday, August 06, 2009

### Free Market Healthcare Reform

Jeffrey Flier, pictured here, is now dean of Harvard Medical School. Little did I know, until recently, that he is also a thoughtful writer about health economics. Here is an amazingly prescient article of his from 1994, in which Dean Flier anticipates many of the key issues people are still debating today. (It is a slow-loading pdf, but be patient; it is well worth the wait.)

I agree with Hal:
“I keep saying that the sexy job in the next 10 years will be statisticians,” said Hal Varian, chief economist at Google. “And I’m not kidding.”

Here is a piece of news I am sure you all have been waiting for: the latest winners of the Australian Awards for Excellence in Educational Publishing.

Congratulations to Joshua Gans, Stephen King, and Robin Stonecash for winning the Tertiary (Adaptation) Teaching and Learning Category for for the Australian adaptation of my Principles book.

### What I've been up to

I went to a great Jason Mraz concert last night. (Great, that is, except for the loud, drunken couple with seats directly behind us--talk about negative externalities!) If you don't know who Jason Mraz is, click here.

But the real surprise of the night was an excellent warm-up act, K'Naan.

## Wednesday, August 05, 2009

### The Strangest Sentence I've Read Lately

From Megan McArdle:

But the fact that he mistakes his ignorance for a fact about the universe makes me wonder if pharmacoeconomics is what my college boyfriend's roommate used to do with a few grams of cocaine and a copy of Mankiw's Principles.
It is always nice to see my product get new uses.

By the way, the entire post, which is on the benefits of Big Pharma, is worth reading, as is most of Megan's blogging.

### Elmendorf in Action

If you have a spare hour and a half, watch this video to see one of my favorite economists testifying in front of the Senate budget committee on the topic of health reform.

## Monday, August 03, 2009

### Health Reform: Simple or Not?

Contrast the commentary of Paul Krugman and Keith Hennessey.

To Paul, the administration's health plan is simple and straightforward. To Keith, it is a nonstarter.

Why do these two smart commentators reach such opposite conclusions? The essence of the difference, I think, is that Paul is mainly concerned with universal coverage and is happy to put off discussion of the government budget constraint to another day, while Keith is focused on how the reforms will be paid for and, in particular, on the administration's claim that a major goal of health reform is to put the government on a more sustainable fiscal path.

A large part of the policy debate boils down to this: Are you more worried about the problem of the uninsured or about the long-term fiscal imbalance?

Update: Recent polling shows that the Krugman-Hennessey divide is representative of the nation more broadly and that more Americans are siding with Keith:

There is a huge partisan gap on perceptions of the U.S. health care system. Seven-out-of-10 Republicans rate it as good or excellent, but only one-of-four Democrats agree. Among those not affiliated with either major political party, 53% rate the current system as good or excellent while just 18% say it’s poor.

Over the past few months, as the health care reform debate has raged, confidence in the current system has increased significantly among Republicans and unaffiliated voters. There has been little change among Democrats.

Just 28% say they are willing to pay higher taxes so that all Americans can have health insurance. Sixty percent (60%) are opposed. Those figures are little changed since May.

Recent polling has shown that cost, not universal coverage, is the top concern about health care.

## Sunday, August 02, 2009

### A Senator joins the Pigou Club

The club welcomes a new member:

Sen. Bob Corker came out swinging against the climate bill that the House passed in June.

“I didn’t think it was possible, but the Waxman-Markey climate bill appears to be even more problematic than the climate bill that tanked in the Senate last spring,” he said, referring to the Lieberman-Warner bill that he voted against in 2008. “I don’t know of many special interests that don’t receive a pay-off in this [Waxman-Markey] legislation, and if it comes to the Senate floor in this form, I’ll vote against it.”...

Lately Corker has been insisting that he won’t accept anything short of a climate plan that auctions 100 percent of pollution permits and returns the money directly to Americans, and his preferred approach would be a carbon tax.

## Saturday, August 01, 2009

### Obesity and Healthcare Costs

Two facts from the Wall Street Journal a few days ago:

The prevalence of obesity rose 37% between 1998 and 2006....Obese people spent 42% more than people of normal weight on medical costs in 2006.
This is consistent with what I said in a column on healthcare fallacies in the NY Times a couple years ago:

Americans are also more likely to be obese, leading to heart disease and other medical problems. Among Americans, 31 percent of men and 33 percent of women have a body mass index of at least 30, a definition of obesity, versus 17 percent of men and 19 percent of women in Canada. Japan, which has the longest life expectancy among major nations, has obesity rates of about 3 percent.

The causes of American obesity are not fully understood, but they involve lifestyle choices we make every day, as well as our system of food delivery. Research by the Harvard economists David Cutler, Ed Glaeser and Jesse Shapiro concludes that America’s growing obesity problem is largely attributable to our economy’s ability to supply high-calorie foods cheaply. Lower prices increase food consumption, sometimes beyond the point of optimal health.

FYI, here, from OECD data presented in the O'Neill study, are the percentages of the male population with a body-mass index of 30 or more (female obesity rates are similar):

Japan 2.8
France 9.8
Germany 14.4