Monday, July 31, 2006

Senator Dorgan drinks the Kool-Aid

A former ec 10 student emails me:
I am a Democrat, but I read this short book review about a new book from a North Dakota Senator and found it just a bit scary.
The article he refers to is in today's Washington Post. An excerpt:

A Rallying Cry for Democratic Populism

What would happen if the opposition party actually chose to oppose the one in power? Not just on the margins, but by rejecting outright the majority party's fundamental beliefs on trade and tax policy?

Sen. Byron L. Dorgan (D-N.D.) urges Democrats to take on Republicans in just that way in his new book, "Take This Job and Ship It: How Corporate Greed and Brain Dead Politics Are Selling Out America." He makes a politically compelling -- if economically questionable -- case....

The title of his final chapter says it all: "Flat World? No, Flat Wrong!"

To Dorgan, big corporations are the villains and labor unions the saviors. "I understand that big is not always bad, and small is not always beautiful," he writes. But, he adds: "If the shoe fits, wear it. And it damn well better be American-made."

Forever Young

God of the Machine observes:

Maybe it's just the glasses, but certain übergeek types — Bill Gates, Greg Mankiw, new Google CEO Eric Schmidt — seem to have found, if not exactly permanent youth, at least permanent pre-adolescence. It is given to no one to look forever twenty, and only to a few to look forever twelve.
I think it is time for me to look into lasik surgery.

Ray Fair on Policy Stimulus

A friend calls to my attention a paper by Yale economist Ray Fair, a well-known builder and user of large-scale macroeconometric models. Fair assesses the impact of monetary and fiscal policy during the recovery from the recent recession. An excerpt:
Had there been no tax cuts, employment would have been 2.2 percent lower by 2004:3 than it actually was; had there been no large increases in federal purchases of goods, employment would have been 1.2 percent lower; and had there been no fall in short-term interest rates, employment would have been 2.5 percent lower. These effects are roughly additive in the model (fourth experiment), and the combined estimate is that employment would have been 5.6 percent lower in 2004:3 than it actually was.
According to Fair, monetary and fiscal policy played roughly equal roles in the stimulating aggregate demand during the recovery.

Fair's conclusions seem broadly consistent with the recent Treasury report:

Treasury found that, without enactment of the Economic Growth and Tax Relief Reconciliation Act of 2001, the Job Creation and Worker Assistance Act of 2002, and the Jobs and Growth Tax Relief Reconciliation Act of 2003: (1) by the second quarter of 2003, the economy would have created as many as 1.5 million fewer jobs and GDP would have been as much as 2 percent lower, and (2) by the end of 2004, the economy would have created as many as 3 million fewer jobs and real GDP would be as much as 3.5 to 4.0 percent lower.
This passage summarizes the Treasury's short-run business cycle analysis, which like Fair's model emphasizes aggregate-demand effects. The Treasury's long-term analysis appropriately emphasizes aggregate-supply effects.

Saturday, July 29, 2006

Summers on Antidumping

Larry Summers is one the smartest economists I know. He has had an amazing career as Harvard professor, chief economist at the World Bank, and Secretary of Treasury. While he was Harvard President, he taught popular courses on globalization. Recently, he was asked about antidumping laws at a Brookings event, and he gave a shocking answer:

I am not an expert on many things, and I have the self-knowledge to know in particular that I am not an expert on countervailing duties and antidumping. I guess the only thing I would say is that I do think there is a tendency in the trade debate to underemphasize the longer-run and less immediately salient aspects of trade policies.

In particular, that goes to two sets of issues. Lots of people have worried that their job might be lost because a plant might move to China or to Mexico. Virtually no one except a few members of the American Economic Association has ever said, Isn't free trade great? I was able to buy twice as many toys for my kid at the holiday as I would have been able to if we had not had free trade. And I think the consumer benefits of trade tend very much to be underplayed in political discussion.

I also think we do need to take some stock of the fact that the United States is not currently enjoying an excess of goodwill in other parts of the world, and that the question of how we do or do not open our market is not irrelevant to the quality of our relations with many of these countries. And I think in some cases for really very small economic benefit, even measured in purely mercantilist terms, we sacrificed very substantial goodwill.

So I think it is appropriate for us to be looking carefully at those policies.

What is so shocking about this? I agree with Larry as far as he goes, but, shockingly, he does not go very far.

Larry is famous for being forthright about his views. He knows enough about our trade laws to know that they make little sense. So instead of feigning ignorance, why doesn't he call for repeal of the antidumping laws?

I wonder: Is Larry avoiding the third rail of trade policy because the leading Democratic presidential hopeful has been applauding the application of these inane laws?

Friday, July 28, 2006

Boudreaux on the Minimum Wage

GMU econ prof Donald Boudreaux writes about the minimum wage. His bottom line:

We don't know exactly how, or exactly by how much, employers as a group respond to higher minimum wages -- but the theoretical case that they do respond in ways unfavorable to low-skilled employees is too powerful to dismiss.
This sounds right to me.

But Boudreaux's arguments will not convince a hard-core egalitarian. Suppose these unfavorable responses are small in magnitude. Isn't it possible that the minimum wage on net helps poor families because the direct effect of higher wages more than offsets the adverse response from employers? Since Boudreaux is making a theoretical argument, he has to admit that it is possible. The minimum-wage debate will not be resolved with an appeal to theory alone.

In the end, there is no good substitute for an appeal to facts. What the facts show is that the minimum wage is poorly targeted as an anti-poverty program. Moreover, while the evidence is controversial, some studies find significant long-term adverse effects. As a result, most economists prefer more efficient and better targeted anti-poverty tools, such as the EITC, which has grown significantly over the past few decades.

Thursday, July 27, 2006

Favorite Blogs

A econ professor friend of mine emails me some comments on this blog, as well as a request to its readers:

I now think of the blog, including the comments, as the equivalent of a bunch of people with common interests sitting down in a coffee shop and discussing topical economic issues, with the discussion topics chosen by you. I see this as very valuable. Many of us live in places where it's hard to find a group of people with whom to regularly and frequently have such discussions.

Yours is the first blog I've read regularly. But of the trillion or so other blogs out there, there must be a few good ones that serve this function as well. I'm wondering which are the better ones....Would you entertain the idea of posting a new item at your blog asking your regular readers for recommendations on what other blogs they regularly read, and why they like them?

Readers are encouraged to post their views in the comments section. This will give other readers places to go during August, when blogging here will be slow.

My goal for the coming month: Spend more time on the beach than in front on my computer.

Wednesday, July 26, 2006

The Fight Against Global Poverty

MIT economist Abhijit Banerjee has a good article on foreign aid. Princeton economist Angus Deaton responds. (Thanks to Tyler Cowen for the pointer.)

How to improve your love life

Having trouble satisfying your girlfriend? A reader of this blog emails me his remedy for the problem:

You'll be pleased to know that I managed to persuade my girlfriend (a biologist) to buy a copy of your "Principles of Microeconomics" recently here in the UK, so that we could have more informed discussions about interesting economics problems.

The Growth Effects of Tax Policy

From today's Wall Street Journal:

Dynamic Analysis
By Robert Carroll and N. Gregory Mankiw

Does tax relief mean more economic growth? Many people believe the answer is yes, and now they get strong support from the staff of the U.S. Treasury.

Most press reports on the Mid-Session Review of the federal budget, released by the Bush administration a couple of weeks ago, focused on the good news about expanding tax revenues and the shrinking budget deficit. But for tax-policy geeks, the most intriguing part of the report was an easily overlooked box on page 3: "A Dynamic Analysis of Permanent Extension of the President's Tax Relief." Over the past six months, the Treasury Department staff has been studying the dynamic effects of tax cuts on the economy. The results of this analysis, previewed in this box, were released yesterday in more complete form (available at

A bit of background: Most official analysis of tax policy is based on what economists call "static assumptions." While many microeconomic behavioral responses are included, the future path of macroeconomic variables such as the capital stock and GNP are assumed to stay the same, regardless of tax policy. This approach is not realistic, but it has been the tradition in tax analysis mainly because it is simple and convenient.

In his 2007 budget, President Bush directed the Treasury staff to develop a dynamic analysis of tax policy, and we are now reaping the fruits of those efforts. The staff uses a model that does not consider the short-run effects of tax policy on the business cycle, but instead focuses on its longer run effects on economic growth through the incentives to work, save and invest, and to allocate capital among competing uses.

The Treasury report describes what will happen to the economy if the tax relief of the past few years is made permanent, compared to the alternative scenario of reverting back to the tax code as it was in 2000. Specifically, the report analyzes the effects of lower taxes on dividends and capital gains, the effects of lower taxes on ordinary income, and the extension of other tax cuts, including the new 10% bracket, the expanded child credit and marriage-penalty relief. Here are three main lessons.

Lesson No. 1: Lower tax rates lead to a more prosperous economy.

According to the Treasury analysis, a permanent extension of the recent tax cuts leads to a long-run increase in the capital stock of 2.3%, and a long-run increase in GNP of 0.7%. In today's economy, such a GNP expansion would mean an extra $90 billion a year that the nation can spend on consumer goods to raise living standards, or capital goods to maintain prosperity. More than two-thirds of this expansion occurs within 10 years.

Lesson No 2: Not all taxes are created equal for purposes of promoting growth.

Some tax rate reductions have a profound impact on incentives and economic growth, while others have minimal or even adverse effects. The Treasury staff reports particularly large bang-for-the-buck from the reductions in dividends and capital-gains taxes. Even though these tax cuts account for less than 20% of the static revenue loss from permanent tax relief, they produce more than half of the long-run growth.

At the opposite end of the spectrum are the tax reductions from the 10% bracket, child credit and marriage-penalty relief. These tax cuts put money in people's pockets when, during the recent recession, the economy needed a short-run boost to aggregate demand. They also fulfill other objectives, such as making the tax system more progressive. But they illustrate that not all tax cuts promote long-run growth. Treasury estimates that without the tax reductions from the 10% bracket, child credit and marriage-penalty relief, the long-run increase in GNP would be larger -- 1.1% rather than 0.7%.

Lesson No 3: How tax relief is financed is crucial for its economic impact.

Like all of us, the government eventually has to pay its bills. In technical terms, the government faces an intertemporal budget constraint that ties the present value of government spending to the present value of tax revenue. This means that when taxes are cut, other offsetting adjustments are required to make the numbers add up.

The Treasury's main analysis assumes that lower tax revenue will over time be accompanied by reduced spending on government consumption. But the report also shows what happens if spending cuts are not forthcoming. In this alternative scenario, a permanent extension of recent tax relief is assumed to lead to an eventual increase in income taxes.

The results are strikingly different. Instead of increasing by 0.7% in the long run, GNP now falls by 0.9%. Tax relief is good for growth, but only if the tax reductions are financed by spending restraint. One exception: Lower taxes on dividends and capital gains promote growth, even if they require higher income taxes.

These Treasury results are sure to spark debate and further research. While the Treasury report is not the last word on dynamic analysis, it is a big step toward a more realistic view of tax policy.

Mr. Carroll is the Treasury Department's deputy assistant secretary for tax analysis. Mr. Mankiw, a Harvard professor, was chairman of the Council of Economic Advisers from 2003 to 2005.

Update: The Treasury report is also discussed in a Washington Post story today.

Tuesday, July 25, 2006

Should blogging be rewarded?

Brad DeLong writes about academic blogging in the Chronicle of Higher Education:
Are our deans impressed? Not so far, but they should be.
Brad is surely right that most deans are not impressed. In fact, some may be put off by it: "Why is he wasting his time on that activity?"

I have long thought that academia rewards too narrow a range of activities. At research universities, even teaching is given inadequate weight. I will fight for the good teachers before I fight for the bloggers.

My prediction: Brad will have to wait a long time before blogging is going to earn him a raise.

On Exercise

I have long wondered whether exercise passes a cost-benefit test. That is, if one does not enjoy exercise for its own sake, does it yield benefits that outweigh the costs?

My colleague Ben Friedman recently drew my attention to an ariticle in the NY Times (June 20) with this piece of news:

Over all, each hour spent exercising (up to 30 hours a week) adds about two hours to a person's life expectancy, according to the Harvard Alumni Study, which has tracked deaths among 17,000 men for more than two decades.
This sounds like a good deal. But there are two problems with this information, both of which are familiar to economists.

The first problem is discounting. The cost of exercise is paid today. The benefit of a longer life is obtained at the end of life--at my age, about 30 or 40 years from now. Even with a discount rate of 3 percent, that two hours of future benefit is worth less in present value than the one hour of present cost.

The second, more serious issue is the identification problem. This was aptly summarized in a letter to the Times a few days later:

If those who run regularly are less likely to have a heart attack, does that prove that running regularly is good for the heart? Or does it simply indicate that those with a strong heart and good health otherwise are more likely to enjoy running and do it more regularly? Your advice is probably right. But to know for sure is probably one of the most difficult problems in epidemiology. It would require telling one randomly selected group, ''You run,'' and another similarly selected group, ''You be a couch potato.'' Tricky to organize and tricky to avoid defectors' messing up the study.
Absent a controlled experiment, it is hard to know if vigorous exercise is the cause of good health, or good health is the cause of vigorous exercise.

Some years ago, while I was applying for life insurance, I had the chance to chat with a cardiologist about the issue. I was on a treadmill at the time, and his job was to check on my heart to make sure I wasn't likely to die right after the policy was approved. Because he was a captive audience, I took the opportunity to quiz him about the identification problem. He essentially agreed with the point raised in this letter. Running the right controlled experiment, he said, is too costly. As a result, it is almost impossible to know if the derivative of two asserted in the Times article is really the right number. It seems very likely that this estimate is biased upward.

By the way, I did get the life-insurance policy, and it has not turned out to be a good investment so far. Maybe I am getting too much exercise.

Monday, July 24, 2006

Something to make Nicholas Kristof smile

Can we stop arguing about sweatshops now?
A new U.S. Department Of Labor study revealed that Martha Stewart Living housewares, Tommy Hilfiger clothing, iPod music players, forks, diapers, telephones, and every other conceivable consumer good in existence is manufactured by people laboring in sweatshop conditions.

"Long hours, low wages, and unsafe work areas are involved in producing everything our civilization uses," Labor Secretary Elaine Chao said at a press conference Tuesday. "It is now literally impossible for anyone anywhere in this country to purchase any single thing that doesn't infringe on someone's human rights."
From The Onion. Here is Nicholas Kristof on the topic.

Sunday, July 23, 2006

Defending Pharma

As an economist, I often find myself defending "bad guys"--companies outsourcing American jobs, gas stations gouging consumers with high prices, Wal-Mart undercutting small retailers with low prices, Mexican immigrants sneaking into our country, the Chinese fixing their exchange rate, American companies opening sweat shops abroad, foreign companies dumping cheap goods onto our markets, and pharmaceutical companies profiting off other people's sickness and misfortune. Sometimes I feel like a defense attorney for economic criminals.

Unlike real defense attorneys, however, I get clients that are mostly innocent. The study of economics provides a cogent defense for these alleged evil doers.

In this month's Commentary, Peter Huber has a good defense of Big Pharma. I am happy to outsource the job to him for a change. (Thanks to Newmark's Door and Marginal Revolution for the pointer.)

Saturday, July 22, 2006

Fan Mail

Sharath Rao posts a letter he wrote to me today. This line will interest a few readers:
The players in the comments section notably isocrates, mvpy, happyjuggler etc. are now household names (at least in my one-man household :)).
By the way, if any of you regular players want to reveal your true identity to me via email (as a few of you have), I will protect your privacy.

Nature vs Nurture

Among a group of adopted sons, which is a better predictor of high education and high earnings?

(a) Having highly educated biological parents.
(b) Having highly educated adoptive parents.
According to results in a new study of Swedish data from Anders Björklund, Markus Jäntti, and Gary Solon , the answer is (a).

The results in this paper seem broadly consistent with those of Dartmouth economist Bruce Sacerdote, who examines a completely different data set in which adopted children were assigned randomly to parents.

In both papers, nature is stronger than nurture for determining the educational attainment of adopted children, although both nature and nurture have some role. And in both papers, nature completely dominates over nurture for determining income. (See Table 3 in the Sacerdote paper and Table 3, column 6, in the Björklund et al. paper.)

Milton and Rose Friedman

Today's Wall Street Journal has an interview with Milton and Rose Friedman. Here are two notable excerpts. The first on their favorite economists:
If they were to throw a small dinner party -- indoors! -- for Mr. Friedman's favorite economists (dead or alive), who'd be invited? Gone was his tonguetied-ness of a moment ago, as [Milton] reeled off this answer: "Dead or alive, it's clear that Adam Smith would be No. 1. Alfred Marshall would be No. 2. John Maynard Keynes would be No. 3. And George Stigler would be No. 4. George was one of our closest friends."
The second on what ails the Republican Party:

"What's really killed the Republican Party isn't spending, it's Iraq. As it happens, I was opposed to going into Iraq from the beginning. I think it was a mistake, for the simple reason that I do not believe the United States of America ought to be involved in aggression." Mrs. Friedman -- listening to her husband with an ear cocked -- was now muttering darkly.

Milton: "Huh? What?" Rose: "This was not aggression!" Milton (exasperatedly): "It was aggression. Of course it was!" Rose: "You count it as aggression if it's against the people, not against the monster who's ruling them. We don't agree. This is the first thing to come along in our lives, of the deep things, that we don't agree on. We have disagreed on little things, obviously -- such as, I don't want to go out to dinner, he wants to go out -- but big issues, this is the first one!" Milton: "But, having said that, once we went in to Iraq, it seems to me very important that we make a success of it." Rose: "And we will!"

Mrs. Friedman, you will note, had the last word.

Friday, July 21, 2006

Dean Dilbert

This could be a trenchant commentary on university administration.

How to Decentralize Monetary Policy

Today's Wall Street Journal reports:

Federal Reserve policy makers raised interest rates last month in part because markets expected them to do so, and they figured failure to act might hurt their credibility as inflation fighters, minutes of the meeting suggest.
Some people might view this response as wimpy--doing what financial markets want rather than showing real leadership. But one can view this approach as a step toward decentralizing monetary decisionmaking.

Suppose the Fed has a long-term inflation target. And suppose the Fed followed this rule:

Look at the market's forecast of interest rates and inflation over the next few years. If the market expects inflation above target, set a path for interest rates a bit higher than the market expects. If the market expects inflation below target, set a path for interest rates a bit lower than the market expects. If the market expects inflation to come in on target, set a path for interest rates equal to what the market expects.

This might seem circular: The Fed is responding to the market, and the market is responding to the Fed. But there is nothing wrong with that. Economists are used to simultaneity.

Of course, the market will catch on to the policy, but that's okay. In fact, it is ideal. We end up in a fixed-point equilibrium in which the market expects the Fed will hit its inflation target. In this equilibrium, the market's forecast of interest rates will tell the Fed what it needs to do to accomplish what it wants to accomplish.

Thursday, July 20, 2006

Measuring Wages

Economist David Altig opines about measures of labor earnings:
If I had my way, appeals to the BLS average hourly earnings series would be banished from commentary about wages and the fortunes of the workers -- unless the the commentator explains why that measure is a truer measure of labor compensation than those that include in-kind payments to employees (that is, benefits).
Good point.

I am always surprised when I see economists compare wages and productivity using wage measures that exclude fringe benefits. Theory says that productivity should determine total compensation, not cash earnings.

Update: Some comments asked about data on fringe benefits. There is no doubt that the data can be hard to come by, which makes it tempting to ignore the issue and focus on cash wages. That is ill advised, in my view.

To gauge the importance of the issue, one can look at the national income accounts and compare "Supplements to Wages and Salaries" to "Compensation of Employees." One learns that fringe benefits as measured by this series rose from 8.0 percent of employee compensation in 1960 to 16.5 percent in 2000 and then to 19.7 percent in 2005.

Part of the explanation for this increase is the rising cost of health care. The value of employer-provided health insurance is a key part of many workers' compensation. It is a benefit that gets more valuable as improvements in medical technology drive up the cost of insurance.

I am in good company

Today's Washington Post tells us:

"The average blogger is a 14-year-old girl writing about her cat," said Alexander Halavais, an assistant professor of interactive communications at Quinnipiac University in Connecticut.

Have I told you about Tobin? Oh, yes, I have.

Demography and the Business Cycle

The most intriguing hypothesis I heard today:
changes in the age composition of the labor force account for a significant fraction of the variation in business cycle volatility observed in the US and other G7 economies.
From a paper by Nir Jaimovich and Henry E. Siu.

Buy My Books!

An anonymous commenter says:

Greg, how about soft-pedaling the textbook mentions in the blog? I'd say that once a month would be more than enough.

Have you noticed there are no ads on this blog? That's because this blog is an ad. It's the blogosphere version of the infomercial.

Inequality and Stochastic Human Capital

I have been pondering the interaction between inequality and the return to human capital. I haven’t fully figured out what I think about the issue, but I thought blog readers might enjoy seeing some initial ruminations, presented in the form of a numerical example.

There are three people, which I will call P, M, and R. P has no human capital and an income that I will normalize to one. M and R each have 10 years of human capital. Human capital is risky. Initially, human capital has an average return of 7.5 percent per year, but M gets a return of 5 percent and R gets a return of 10 percent. So M has an income of (1+0.05)^10=1.63, and R has an income of. (1+0.1)^10=2.59. P is poor, M is middle-class, and R is rich.

Now suppose that the rate of return to human capital doubles for every individual, and nothing else happens in the economy. P’s income stays the same at 1. M’s income rises to (1+0.1)^10=2.59, which is an increase of 59 percent. R’s income rises to (1+0.2)^10=6.19, which is an increase of 139 percent.

Not surprisingly, inequality has increased. Perhaps more surprisingly, inequality within education groups has increased. R and M have the same amount of human capital, but R is gaining more than M. The rich are getting richer, while the middle-class are getting richer at a slower rate. The poor are being left behind.

Some economists might look at this situation and say, “See, the return to human capital has increased.” Indeed, by construction, the only change is a doubling in the rate of return to education. Yet other economists might say, “The increase in equality cannot be fully explained by the increased education premium, because there is increased inequality within groups. The rich have no more human capital than the middle class, and they getting the biggest gains.”

A key feature of this example is that the increase in the rate of return is proportionate, so those with an initially higher return get a larger increase. The results would be very different if the increase were additive, so that each person’s rate of return rose by, say, 5 percentage points. There are a couple ways to justify the assumption of a proportionate increase.

One way is measurement error in the amount of human capital. Those with high apparent return may actually have more human capital. They might have attended better schools. Or they might have taken courses with low consumption value and high investment value (accounting rather than modern cinema). In this case, even if the return to human capital is the same across people, the apparent return will differ, and it will differ more when the return rises.

A second, more intriguing justification is to draw an analogy to the Capital Asset Pricing Model. Like physical capital, human capital differs in riskiness. Some human capital has a high beta (such as an MBA), and some has a low beta (such as an MD). When the market return to human capital increases, the impact is larger for high-beta capital.

Is the phenomenon illustrated with this example representative of what is happening with the recent increase in inequality in the U.S. economy? I don’t know. In this example, inequality increases more for those with human capital than for those without. That is, the change in inequality is a positive function of human capital. I don't know if this is also occurring in the U.S. economy, but I will bet a nickel it is. If any reader knows the answer, please let me know.

Here is one reason I am intrigued by this hypothesis. According to the Piketty-Saez data, inequality was particularly low in the early 1970s. That was the time when my Harvard colleague Richard Freeman was writing his book “The Overeducated American,” arguing that the return to human capital had fallen so low that we should reconsider its value. Maybe that period was the flip side of the recent phenomenon of increasing inequality and an increasing skill premium.

Wednesday, July 19, 2006

Kevin Warsh's Debut

The new Fed governor Kevin Warsh gave his debut speech yesterday, focusing on a fascinating and little understood phenomenon: the striking increase in firms' cash holdings.

The ratio of cash to investment has averaged about 60 percent during the past few decades...[But the ratio] soared to more than 150 percent by year-end 2004.
I got to know Kevin while I was working at the CEA and he was at the NEC. He is very bright and extraordinarily articulate.

Kevin also has a key credential for holding a high position in economic policy: He was once a section leader in ec 10.

Tuesday, July 18, 2006

Textbooks and Related Material

If you are an economics professor planning to teach either a principles course or an intermediate macro course, have I got a deal for you!

All versions of my textbooks have come out in new editions during the past six months. 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 freebie, you will have to fork over the cash and help put the Mankiw children through college.

Monday, July 17, 2006

Posner vs Tilghman

Here is legal scholar Richard Posner, in his blog post from yesterday, on the gender gap:
the mean performance of women in college and university is superior to that of the men, but the variance of male performance is greater and as a result there are more male geniuses. There is no reason why the difference in variance should result in higher average male earnings; that higher average is probably the result of women's spending less time in the work force because of pregnancy and child care. Women's greater proclivity for child care may well have a biological basis, as may the difference in variance that I mentioned. In the "ancestral environment"--the term that anthropologists use to describe the prehistoric period in which human beings reached approximately their current biological state--women who were "steady" would have tended to have the maximum number of children, while natural selection might favor variance in male abilities because variance would produce some outstanding men who would tend to reproduce more than other men (including the "steadies") in the polygamous conditions of prehistoric society. If the explanation based on evolutionary biology is correct, women will continue to be "underrepresented" in high-achievement positions in many fields; why anyone should care is beyond me.
And here, from today's Wall Street Journal, is Princeton University President Shirley Tilghman:
There are 25 years of good social science that demonstrate the many cultural practices that act collectively to discourage women from entering and continuing careers in science and engineering. The research is overwhelming, and it is there for anybody to see. On the other hand, the data that would suggest there are innate differences in the abilities of men and women to succeed in the natural sciences are nonexistent.
I think it might be a good idea to get these two together for a debate.

Bloomberg TV

I am scheduled to be on Bloomberg TV's show Open Exchange tomorrow from 11 am to noon, EST. Set your TiVo.

But don't let this exciting programming lure you into excessive TV watching. In a new paper using data from East and Central Java, Ben Olken reports that

better signal reception, which is associated with more time spent watching television and listening to radio, is associated with substantially lower levels of participation in social activities and with lower self-reported measures of trust. I find particularly strong effects on participation in local government activities.
I wouldn't want to promote distrustful, antisocial behavior.

The Peltzman Effect

Sam Peltzman taught us that wearing a seatbelt induces people to drive less safely--a study discussed in the first chapter of my favorite economics textbook. Now the Sydney Morning Herald tells us that driving a large 4WD vehicle has a similar effect:

4WD drivers were almost four times more likely than car drivers to be using a mobile phone, ....[and] using a mobile phone while driving is associated with a fourfold increase in the risk of having an accident.....

"Although 4WD vehicles are safer in a crash, their owners may be placing themselves and other road users at increased risk of injury," she said. "They take the risk because they are higher up, they feel they can see better... but the person in a car or the pedestrian on the road has a much worse outcome."

Here is the study. Thanks to John Chilton for the pointer (via Newmark's Door).

Bonus: Mistaken inference

The Sydney Morning Herald reports the following inference from the two facts given above:
That means drivers of four-wheel-drives are 16 times more likely to have an accident than other drivers.
This conclusion, however, does not follow from the premises. Here is a numerical example.

Suppose that 1o percent of car drivers use cell phones and that 1 percent of car drivers not using cell phones have accidents. Then out of 100 car drivers, we get 1.3 accidents (0.9 accidents from the 90 cell non-users and 0.4 from the 10 cell users).

Now consider 100 4WD drivers. We have 60 drivers not using cell phones and 40 drivers using cell phones. The first group generates 0.6 accidents and the second group generates 1.6 accidents, for a total of 2.2.

So, in this numerical example, the total number of accidents per 100 drivers rises from 1.3 to 2.2, which is not a factor of 16.

Sunday, July 16, 2006

On Eliot Spitzer

From today's NY Times:

Spitzerism, as the author details, came to mean leaking information about pending cases, using the threat of public humiliation to cajole defendants into settling, and never seeming to actually win a case at trial.

Rather than fostering cooperation with the S.E.C., on whose turf he was encroaching, Mr. Spitzer childishly hogged the spotlight. His outburst against S.E.C. lawyers — he said they were unfit to handle a “house closing” — was not, one thinks, the sort of manners they teach at Princeton.

More troubling was his tactic of litigating “reforms” that went beyond the abuses in question. For instance, convinced that mutual fund fees were excessive — an opinion that the Legislature could have acted on had it chosen to — Mr. Spitzer pressured a fund organization to settle an unrelated charge by reducing its fees.

FYI, Spitzer was one year behind me at Princeton and in my class at Harvard Law School. (I don't recall meeting him at the time, but we once met briefly since then.) As far as I can remember, neither school offered a course in manners.

Saturday, July 15, 2006

Lazear vs Krugman

CEA Chair Eddie Lazear in May 2006:
While there is no doubt that some people have been left behind, and that those left behind are certainly a major concern for all of us, there is some good news in this picture. The good new is that most of the inequality reflects an increase in returns to “investing in skills” – workers completing more school, getting more training, and acquiring new capabilities.
NY Times columnist Paul Krugman yesterday:
There's a persistent myth, perpetuated by economists who should know better -- like Edward Lazear, the chairman of the president's Council of Economic Advisers -- that rising inequality in the United States is mainly a matter of a rising gap between those with a lot of education and those without.
I am not sure what other "economists who should know better" Krugman is referring to. Maybe Daron Acemoglu, MIT professor and winner of the John Bates Clark award. Daron wrote in the Journal of Economic Literature a few years back:

The recent consensus is that technical change favors more skilled workers, replaces tasks previously performed by the unskilled, and exacerbates inequality. This view is shaped largely by the experience of the past several decades, which witnessed both major changes in technology, including the rapid spread of computers in workplaces and in our lives, and a sharp increase in wage inequality. In the United States, for example, the college premium—the wages of college graduates relative to the wages of high-school graduates—increased by over 25 percent between 1979 and 1995.

My understanding is that there is a widespread consensus that the returns to education have risen substantially over the past few decades. But the education wage premium is not the whole story, as wage inequality within education categories has also increased substantially. Here is an attempt to explain the second piece of the puzzle, from Thomas Lemieux in the most recent issue of the American Economic Review:

This paper shows that a large fraction of the 1973-2003 growth in residual wage inequality is due to composition effects linked to the secular increase in experience and education, two factors associated with higher within-group wage dispersion. The level and growth in residual wage inequality are also overstated in the March Current Population Survey (CPS) because, unlike the May or Outgoing Rotation Group (ORG) CPS, it does not measure directly the hourly wages of workers paid by the hour. The magnitude and timing of the growth in residual wage inequality provide little evidence of a pervasive increase in the demand for skill due to skill-biased technological change.
That is, part of the increase in inequality is measurement error, and part of the increase is attributable to the fact that the labor force is older and more educated--characteristics that are associated with higher residual variance.

Update: A comment points out this relevant quotation:

The causes of this increase in equality [from 1979 to 2003] are a subject of some controversy, but probably the most important cause is rapid technological change, which has increased the demand for highly skilled or talented workers more rapidly than the demand for other workers.
Source: Microeconomics, by Paul Krugman and Robin Wells, page 512.

I suppose that Paul has changed his mind since this book (copyright 2005) was written. It is a bit harsh, however, for Paul to be so hard on Eddie for believing what Paul believed not very long ago.

Perhaps Paul would reconcile the apparent disparity here by drawing a distinction between acquired skills and inherent talent. Eddie suggests that the increased inequality is mostly from higher returns to acquired skills, and Paul may think it is more from increased returns to inherent talent. But that is just conjecture on my part.

Update 2: Brad DeLong tries to explain what Paul might have been thinking:
The big rise in inequality in the U.S. since 1980 has been overwhelmingly concentrated among the top 1% of income earners....It's hard to attribute this pattern to a rise in the premium salary earned by the well-educated by virtue of the skills their formal education taught them. Such a rise in the education premium would produce a much smoother rise in relative incomes among the whole top tenth of the income distribution.
I am not convinced that the conclusion follows from the facts presented. I would guess that the top 1 percent of income earners (those earning more than $276,945) are disproportionately very well educated--doctors, lawyers, MBAs, etc. So the rise in the income of the top 1 percent could well represent in large part a higher education premium.

What might well be true is that the returns to education have become increasingly non-linear: The most educated are now getting a bigger return from a marginal year of education than those with moderate amounts of education. In other words, two years getting an MBA from Harvard Business School may increase a person's income more in percentage terms than does two years getting an Associate Degree from Mass Bay Community College. My understanding from my labor economist friends is that some evidence favors this hypothesis of increasing nonlinearity.

To some extent, the returns to human capital are random (as is true of physical capital). Getting an MBA gives you a shot at being CEO, but it is not a guarantee. This may be part of the Lemieux finding that higher levels of education are associated with higher residual variance. And perhaps it can reconcile the differing perspectives of Krugman and Lazear.

No way, no how

Caveat Bettor says I look "a little like this guy without his glasses."

If he were right, my teaching ratings would be better. Daniel Hamermesh and Amy Parker have established that "Instructors who are viewed as better looking receive higher instructional ratings." To make matters worse (for me), the impact "is larger for male than for female instructors."

With Harvard's endowment, you'd think it could get me to write the lectures and Mr Bloom to give them. That seems the optimal division of labor.

Health and Wealth

I have been attending the NBER Summer Institute this week. The most fascinating hour of the week for me so far has been Daron Acemoglu's presentation of his paper "Disease and Development: The Effect of Life Expectancy on Economic Growth."

From the abstract:

What is the effect of increasing life expectancy on economic growth? To answer this question, we exploit the international epidemiological transition, the wave of international health innovations and improvements that began in the 1940s.... The instrumented changes in life expectancy have a large effect on population; a 1% increase in life expectancy leads to an increase in population of about 1.5%. Life expectancy has a much smaller effect on total GDP both initially and over a 40-year horizon, however. Consequently, there is no evidence that the large exogenous increase in life expectancy led to a significant increase in per capita economic growth. These results confirm that global efforts to combat poor health conditions in less developed countries can be highly effective, but also shed doubt on claims that unfavorable health conditions are the root cause of the poverty of some nations.
The bottom line: Even if reformers (such as Jeff Sachs and Bill Gates) succeed in their admirable goal of promoting better health in poor countries, we should not expect that success to fix the problem of persistent poverty.

Friday, July 14, 2006

New Data on Income Inequality

In today's NY Times, Paul Krugman calls attention to the update of the Piketty-Saez data on income inequality, although Paul describes the data differently than I would.

Here is what I see: After rising substantially from 1986 to 2000, income inequality is essentially the same in 2004 (the most recent year of data) as it was in 2000.

Click on the data and see for yourself.

On Journalists

A journalist emails me to take umbrage at the last couple sentences of my previous post:

Dear Prof. Mankiw,

I happen to be a journalist, a regular reader of your blog and in my own addled way, a student of economics, though admittedly a largely, and thus I'm sure badly, self-taught one. So you probably won't be surprised when I object--gently, I hope--to the final sentence in your posting on breadth vs. depth. I'm confident it was meant as humor. Still, it felt a little gratuitous, even mean-spirited. And that surprised me because that's not the personality that the rest of your blog communicates. In fact, I've often marveled at what a decent sort you seem, given your many accomplishments.

For what it's worth, us journalists--at least many of us--aren't merely "failed" economists or folks consigned to our jobs by our short attention spans (though I happen to have one too). We chose it because it has satisfactions of its own and, every once in a while, lets us feel like we've done a little good, or at least provided a little joy, while plying our trade.

Keep those blog postings coming. You've taught me more than my college professors did.

Many thanks,
[name withheld]

The writer is correct that I meant those sentences as humor, not insult. But I believe they are factually correct. Compared to academics, journalists are broader and more shallow. Compared to journalists, academics are deeper but more narrow.

This is completely appropriate. Everyone has to pick a point on the breadth-depth tradeoff, and journalism typically rewards breadth over depth. If you take one of the best economics journalists (say, David Wessel), he will show astonishing breadth of knowledge: He can have an intelligent conversation about the trade deficit, the Sarbanes-Oxley Act, inflation targeting, the Microsoft antitrust case, the accounting treatment of stock options, health savings accounts, antidumping laws, GSE regulation, the strategic petroleum reserve, fundamental tax reform, and so on. If you want an expert of any one of those topics, you will likely find him at a university, but he will typically know little or nothing about the rest of the topics on the list. (A corrollary: At a dinner party, it is more fun to be seated next to a journalist than a professor.)

Most journalists I know work hard and do the best they can, given the breadth of their assignments and the tight deadlines they have to meet. Of course, some journalists are better than others, and some are quite bad. But some economics professors are quite bad as well. I rue the day when some journalist starts attending economics lectures and writes a blog with titles like, "Why Oh Why Can't We Have a Better Professoriate?"

The Tradeoff Between Breadth and Depth

Via email I get a slightly embarrassing question:

I'm an econ graduate from the Philippines. I am one of your admirers as a professional economist and as an excellent writer as well. I really like your blog, and I wish the answers to my questions here would be published there.

One thing I've noticed, you haven't told anything about your frustrations or hindrances (or even your weaknesses) to getting to where you are now.... Is it all intelligence, or your attitude matters as well? Did you confront career/professional problems, what are those, and how did you deal with them?

Answering this question may require more self-awareness than I am capable of. But let me point out one issue I struggle with, using an excerpt from an old article on My Rules of Thumb:

Throughout my life, I have been blessed with broad interests. (Or, perhaps, I have been cursed with a short attention span.)

As a child, I had numerous hobbies. I collected coins, stamps, shells, rocks, marbles, baseball cards, and campaign buttons. For pets, I had turtles, snakes, mice, fish, salamanders, chameleons, ducks, and, finally, a cocker spaniel. In high school, I spent my time playing chess, fencing, and sailing. I have long since given up all these activities (although I do have a border terrier named Keynes.)

As a college student, I committed myself to a new major several times each semester, alternating most often among physics, philosophy, statistics, mathematics, and economics. After college my path was indirect and largely unplanned....

My broad interests (short attention span) help to explain my diverse (incoherent) body of work. My research spans across much of economics. Within macroeconomics, I have published papers on price adjustment, consumer behavior, asset pricing, fiscal policy, monetary policy, and economic growth. I have even ventured outside of macroeconomics and published papers on fertility with imperfect birth control, the taxation of fringe benefits, entry into imperfectly competitive markets, and the demographic determinants of housing demand. None of this is part of a grand plan. At any moment, I work on whatever then interests me most....

Of course, breadth has its costs. One is that it makes writing grant proposals more difficult. I am always tempted to write, "I want to spend the next few years doing whatever I feel like doing. Please send me money so I can do so." Yet, in most cases, those giving out grant money want at least the pretense of a long-term research plan.

The greatest cost of breadth, however, is lack of depth. I sometimes fear that because I work in so many different areas, each line of work is more superficial than it otherwise would be. Careful choice of co-authors can solve this problem to some extent, but not completely. I am always certain that whatever topic I am working on at that moment, someone else has spent many more hours thinking about it than I have. There is something to be said for devoting a lifetime to mastering a single subject.

But it won’t be my lifetime. I just don't have the temperament for it.

Having broad interests works well for bloggers, undergraduate textbook authors, and White House policy advisers. All three jobs require breadth, compared to most academic research, which is often deep but narrow in scope.

If I had been much broader than I am, I would have been so shallow that I couldn't have managed an academic career at all. I suppose I could have been a journalist.

Shoddy Policy for the Poorly Shod

More managed trade, this time from Europe:
On Monday, the European Commission proposed a 30 per cent anti-dumping duty on leather shoes from China and Vietnam, including imposing import duties for the first time on children’s shoes.

An apology

I owe Jane Galt an apology. She might be pleased to know that I will be spending some of the remainder of the summer at the beach, so my blogging will slow down.

Things will get back to normal, however, when my new flock of ec 10 students appears in middle of September.

Thursday, July 13, 2006

Free Trade in Lumber

The U.S. Trade Representative is pleased to announce an important step toward free trade in lumber, if by "free trade" you mean "trade governed with an byzantine system of taxes and regulations."

Here is a quotation from the press release:
The agreement provides for unrestricted trade when prices are over $355 per Thousand Board Fee (MBF), a condition that has existed for significant portions of the past several years. When prevailing prices are less than $355 per MBF, Canadian exports will be subject to a combination of export charges or volume limits that increase in steps the lower the market drops.
One of my former CEA staffers emails me to point out the absurdity:

It's the definition of managed trade, with an export tax that kicks in when U.S. prices get too low (so U.S. consumers pay higher prices but the U.S. Treasury doesn't even get to keep the tariff revenue, which instead stays with Canada)....

This is less well-known than steel, but ranks with it as a deviation from the Administration's stated principles.

Career Advice from Cowen

Tyler Cowen offers some career advice to aspiring economists.

Taylor on Inflation Targeting

Ben Bernanke has long advocated inflation targeting--the policy of a central bank announcing a numerical target for the inflation rate. In today's Wall Street Journal, John Taylor disagrees with him:

Some have argued that the lesson learned from this recent volatility experience is that the Fed should set a specific numerical target for inflation. I disagree; recent experience indicates setting such a target could increase volatility again. First, we do not know what inflation rate to target. If we choose one, we might have to change it later. Second, an explicit focus on the inflation rate may actually take emphasis away from price stability. Focusing on a numerical inflation rate tends to let bygones be bygones when there is a rise in the price level. In recent research, Yuriy Gorodnichenko and Matthew Shapiro of the University of Michigan found that Mr. Greenspan placed relatively greater weight on the price level than on the inflation rate in speeches: He was twice as likely to mention the price level as inflation; Mr. Bernanke was half as likely to mention the price level as inflation.

In sum, powerful lessons can be learned from Mr. Bernanke's start. Keep to the proven principles. Talk about the economy, not about the future of the federal funds rate. Commit to price stability without adding uncertainty about the meaning of a new inflation target.

Taylor seems to suggest that he would prefer a target path for the price level, rather than the inflation rate. The difference between price-level targeting and inflation-targeting is that price-level targeting requires making up for past mistakes. That is, under price-level targeting, if inflation comes in above target during one period, the central bank would need to produce inflation below target in some future period in order to get the price level back on its target path.

References: The Gorodnichenko-Shapiro paper that Taylor mentions can be found at the NBER. Here is my paper (published version) on the topic of price-level vs inflation targeting.

Wednesday, July 12, 2006

The Senate takes on drug reimportation

Should Americans be allowed to buy prescription drugs in Canada, where they are often less expensive? Under current law, the answer is no. Yet the Senate yesterday passed an amendment that may change that.

Some free-market economists, including some at Cato, think the current ban on reimportation is not justifiable. That is no surprise: Free-market economists usually dislike governmental restrictions on free trade. Usually, I line up with the free-traders without reservation.

But the free-market perspective does not yield an easy answer here. Free-market economists believe the government should enforce private contracts. Imagine that drug companies sold inexpensive drugs to Canada with the contract provision that they not be resold to the United States. One could then argue that the government should help the drug companies enforce that contract. But isn't that in effect what the ban on reimportation does? So perhaps one can justify it as a part of the governmental job of enforcing private contracts. (That is the essentially the argument made by legal scholar Richard Epstein.)

Suppose we weren't talking about Canada (which has low drug prices largely because of price controls) but instead we were talking about Africa. Suppose a drug company offered an AIDS drug to a poor African country at slightly above marginal cost. (This is much below the US price, which includes a markup due to the monopoly power granted by the patent). Should American AIDS patients be allowed to buy the drug in Africa and bring it back to the United States? If policymakers allowed this reimportation, arbitrage would prevent the drug company from price discriminating. A single price, or approximately so, would have to prevail worldwide. The likely result: The drug company wouldn't offer the low-cost drug to the poor African country.

Remember a lesson of basic microeconomics: Price discrimination can sometimes make goods available to more consumers and increase the efficiency of market allocations. Nonetheless, those consumers who end up paying more than average can easily see the situation as unfair. This perception is what's driving the issue of drug reimportation.

The situation is complicated by the Canadian government's influence on prices. In some sense, when the Canadian government controls the prices of US-made drugs, it is infringing on US intellectual property rights. Perhaps we should view the Canadian drug price controls like we view the Chinese failure to crack down on bootleg copies of software and other examples of intellectual property theft. Unfortunately, we don't have the policy levers to get other countries to stop controlling prices. A big risk with reimportation is that the United States will in effect end up importing Canadian price controls, reducing the incentive for drug companies to put resources into drug research.

Is later retirement a plausible option?

A report by Alicia Munnell, Steven Sass, and Mauricio Soto of Boston College tells us about employer attitudes towards older workers. Their bottom line:

On balance, the survey paints a reasonably optimistic picture. The overwhelming majority of employers said older workers were at least as attractive as younger employees. It will not always be easy for older workers to extend their careers. But the survey suggests that the potential exists. Pushing back the average retirement age, from 63 to 65 or even 67, is thus an important and "reasonable" option for addressing the nation’s retirement income challenge.

What to Make of Revenue Surprises

A Democratic-economist friend of mine emailed me last night irate at Republicans. Yesterday, when the Administration reported that tax revenues were coming in stronger than expected, many Republicans were quick to argue that this showed that their fiscal policies were working.

My friend pointed out that forecasting tax revenue entails a lot of inherent uncertainty. A surprise even as large as $100 billion is not all that surprising, and we shouldn't make too much of it. It is absurd, he said, to suggest that this revenue surprise tells us much about current policies. My friend thinks it's just a stroke of luck.

We saw a similar phenomenon in the late 1990s, when positive revenue surprises drove the federal budget into surplus. Democrats were then quick to claim credit for Clinton policies. They said, "See, raising taxes did not have all the negative effects that Republicans predicted." Meanwhile, Republicans thought Clinton just got lucky.

Both cases are examples of confirmation bias--the tendency to interpret evidence in favor of one's preconceptions. When there is good news, the party in charge overinterprets the evidence as establishing the rectitude of their policies. The party out of power is too dismissive of the evidence.

A good Bayesian updates priors in response to news. The evidence from the Clinton expansion should have reduced one's estimates of the adverse effects of tax hikes, and yesterday's evidence from the Bush expansion should move one's view in the opposite direction. But remember that we have a lot of data, and each year adds only one more data point.

Tuesday, July 11, 2006

Today's Fiscal News

The Mid-Session Review of the Budget, to be released today, will show surging revenues and a shrinking budget deficit. Today's Washington Post gives us the predictable response of the right and left:

"The supply-side tax cuts of 2003 are working exactly as we would have expected," said Daniel Mitchell, a budget specialist at the Heritage Foundation. "Lower taxes on work, saving and investment leads to more work, saving and investment."...

"This all relates to the widening income disparities between high-income individuals and the rest of the population," said Robert Greenstein, executive director of the liberal Center on Budget and Policy Priorities.
Note that, logically, Mitchell and Greenstein could both be correct. One can simultaneously believe (1) that tax cuts encourage work, saving, and investment, and (2) that because of our progressive tax system, increasing income disparities help bring in tax revenue.

Indeed, the two points may be complementary. Gruber and Saez tell us that high-income people are more responsive to changes in tax rates. If they are right, then the supply-side effects that Mitchell applauds may be one of the causes of the income disparities that Greenstein deplores.

Meanwhile, we should not lose sight of the longer-term fiscal challenge:

"Even if somehow we balanced the budget by, say, 2010, we would look forward to an enormous fiscal problem," said Douglas Holtz-Eakin, a former CBO director and Bush White House economist.

"The projections are that the Social Security surplus will peak in 2010, and diminish every year thereafter, so ultimately, instead of collecting 5 cents on the national dollar and paying out 4 1/2 cents, we will continue to collect 5 cents and pay out 7 cents," Holtz-Eakin said. "And that's the good news. The bad news is Medicare. The demands on the Treasury go from 4 cents on the national dollar to 22 cents in the next 50 years."

These are facts that all economists, right and left, should be able to agree on.

Monday, July 10, 2006

Tax Rates Around the World

In a previous post, I suggested that the women in Europe may work less in the market and more at home because of higher tax rates. After reading some of the comments, I thought that blog readers might like to see some data on tax rates.

Here are the marginal tax rates as estimated by Ed Prescott for the 1990s:

Germany .59
France .59
Italy .64
Canada .52
United Kingdom .44
Japan .37
United States .40

These figures include both income taxes and consumption taxes, such as the VAT. Both types of tax distort the consumption-leisure tradeoff (and the tradeoff between market work and home work).

If a person earns a dollar in the marketplace, she gets to consume 60 cents of goods and services in the United States, but only 41 cents in Germany and France, and 36 cents in Italy. These are large differences in incentives to work.

Sunday, July 09, 2006

Lowenstein on the Immigration Debate

Today's NY Times Magazine has a great article by Roger Lowenstein about the debate among economists on immigration.

Lowenstein is one of my favorite economics and business journalists. I much enjoyed his books on Warren Buffett and LTCM.

Saturday, July 08, 2006

Market Work vs Home Work

Heleen Mees says that European women spend less time in market work, but more time in home work, than American women:

While American women work 36 hours per week on average, Dutch women put in only 24 hours per week, while German women work 30 hours. French women with a job work on average 34 hours per week, but the percentage of women who work outside the home in France is almost 20% lower than in the US.

Are European females that much lazier than American females? The answer depends on whether one considers the time women in Europe spend on domestic work. The economists Ronald Schettkat and Richard Freeman have calculated that American women spend ten hours per week less on cooking, cleaning, and childcare than European women do. Instead of performing these household jobs themselves, Americans pay other people to do them. Americans eat more often in restaurants, make ample use of laundry, dry-cleaning, and shopping services, and hire nannies to take care of young infants....

In other words, American women work more hours and use the money they make to hire people to do the tasks that they can’t do because they’re working. By contrast, European women work less and have less money to spend on services. In their “free time,” European women are busy cleaning the house and looking after the children. On balance, therefore, European and American women work about the same amount of hours.

Why such a large difference between the United States and Europe? Higher tax rates in Europe are one reason. Because these taxes apply to work in the market but not to work at home, they distort the allocation of time between the two activities.

Friday, July 07, 2006

Women in the Labor Force

One of the most profound changes in the U.S. labor force over the past half century has been the gradual but substantial increase in female labor-force participation, from 33 percent in 1950 to about 60 percent now.

In today's Washington Post, Nell Henderson says the trend appears to be over:
But women's rush to employment stopped in 2000 and started to decline, as they began to join their male counterparts in retirement, go out on disability and delay paid employment to get more education. Some economists think the high-water mark of female participation in the labor force was in 2000, when it hit 60.3 percent.
A corollary: Growth in potential GDP may well be less in the future than it was in the past.

The (In)justice of Gambling

In a comment on my previous post on gambling, Jacqueline Passey says:

gambling is distributive justice, moving money from stupid people to smart people.
The utilitarian in me points out that Jacqueline gets things exactly backwards: distributive justice demands moving money from smart people to stupid people. Smart people have the potential to make a lot of money and thus have lower marginal utility per dollar, while stupid people have less money-making potential and higher marginal utility.

The moralist in me believes that smart people should not be trying to dupe stupid people out of their money but should instead be using their talents to make the world a better place.

The libertarian in me disagrees with the utilitarian but will support the moralist, as long as the moralist promises to refrain from using the coercive power of the state.

Tax Policy in New Jersey

The budget deal just reached in New Jersey includes a switch from property taxes to sales taxes. According to today's Wall Street Journal,
Under terms of the new budget, the New Jersey sales tax will increase to 7% from 6%, a change many lawmakers initially opposed. But under the terms of the budget pact, voters will be asked to convert half of the sales tax increase into a form of property-tax relief.
Is it a good idea to use higher sales taxes to reduce property taxes?

To some extent, property taxes are taxes on land. Economists have long understood that land taxes are among the most efficient taxes around. (See the box on Henry George in Chapter 8 of my favorite economics textbook.) Lower land taxes will be capitalized into higher land prices. The policy is a gift to current land owners, paid for by a tax on New Jersey workers and consumers.

To some extent, property taxes are taxes on residential capital (that is, structures). Although I generally favor lower capital taxation, residential capital already faces much lower tax rates than other forms of capital. Homeowners get to deduct mortgage interest and do not have to pay tax on the "imputed rent" they earn from owning their own home. So while there is an efficiency argument for lower capital taxation generally, the argument would not apply with much force to the taxation of residential capital.

Instead of using half of the sales tax revenue to reduce property taxes, why not just raise the sales tax by half as much?

Thursday, July 06, 2006

Why economists like immigration

With members of the House and Senate sparring over immigration reform, it is worth summarizing why most economists are sympathetic with the more welcoming approach of the Senate bill.

The study of economics leaves a person with two strong impulses.

The Libertarian Impulse: Mutually advantageous acts between consenting adults should, absent externalities, be permitted. The ability to engage in such trades is how people in free-market economies achieve prosperity. When the government impedes voluntary exchange, it prevents the invisible hand of the market from working its magic.

The Egalitarian Impulse: The market economy rewards people according to supply and demand, not inherent worth. Markets often fail to provide people the ability to adequately insure themselves against the vicissitudes of life and accidents of birth. We should, therefore, look for ways to help those who end up at the bottom of the economic ladder.

Most economists feel both of these impulses to some degree. The difference between right-leaning and left-leaning economists is how strongly they feel each of them. Right-leaning economists have a stronger libertarian impulse, whereas left-leaning economists have a stronger egalitarian impulse.

Although some debates in economics come down to which impulse a person feels more strongly, on immigration the two impulses are reinforcing. The libertarian impulse says, let the American employer hire the Mexican worker, for it is voluntary exchange. The egalitarian impulse takes note that the Mexican immigrant is the poorest person involved in the situation, and he benefits from more relaxed immigration restrictions.

Here is a conjecture: Whenever a policy appeals to both the libertarian impulse and the egalitarian impulse, economists will offer a relatively united view, as they do on the topic of immigration.

Wednesday, July 05, 2006

Doha on Life Support

Econball points out a good LA Times editorial, which says:
Before trade talks completely collapse, Washington should unilaterally slash farm subsidies.
Grade as Policy Advice: A+.
Probability of Being Followed: Zilch.

Why I hate gambling

My personal philosophy is about 50 percent libertarian, 40 percent utilitarian, and 10 percent moralist. The libertarian and utilitarian usually keep the moralist pretty well contained: they have a 9 to 1 advantage, after all. But reading a recent article in Slate from the wife of a professional gambler let the moralist in me escape.

My view is that there are three kinds of gamblers, all of which sadden me.

First, there is the compulsive gambler. When I was growing up, the husband of one of my mother’s coworkers lost all their money in a fit of compulsive gambling. This occurred just as their teenage daughter was getting ready to apply to college. The college savings, as well as all their other savings, were gone. Watching this experience has most likely colored my view of the activity more broadly.

Second, there is the recreational gambler. He spends, say, $20 a week on slot machines or lottery tickets. Some say this is a fun diversion. But given the availability of books, movies, plays, museums, checkers, chess, etc., it is an unfortunate reflection on a person’s imagination when a scratch lottery ticket is the best diversion he can find. (I'll go easy on the person who plays small-stakes poker among friends, because the socializing is a much bigger part of the activity than is the gambling.)

Third, there is the professional gambler, such as the one in the Slate article (or the boyfriend of blogger Jacqueline Passey). In some ways, this case is the saddest of all. I have no doubt that some people can, in fact, make a living gambling. But doing so requires a lot of intelligence and savvy. It is a shame that someone with so much inherent ability wastes it doing something of such little social value.

None of this has much implication for public policy. The libertarian in me says people can waste their lives if they want. The utilitarian points out that governmental attempts to suppress gambling are likely to be fruitless and would foster a large underground economy. But the moralist still makes me sad when I observe the phenomenon.

Okay, I got that off my chest. The libertarian and utilitarian will now put the moralist back in his cage.

Tuesday, July 04, 2006

Samuelson on Mexico

With Calderon the apparent winner in the Mexican election, my thoughts naturally turn to the economic challenges the nation faces. Here is the recent diagnosis of Robert Samuelson:

[Mexico's] economy consists of two vast sectors, each slow to adopt better technology and business practices.

One sector involves large, modern firms in semi-protected markets that limit the pressure to improve efficiency or lower prices. "Mexico's business sector is risk-averse. It's never had to operate in a true competitive environment," says Pamela Starr, an analyst for the Eurasia Group, a consulting firm. "It's operated with monopolies and oligopolies encouraged by the government."...

The other part of the economy is usually called the "informal sector." It consists of thousands of small firms -- street vendors, stores, repair shops, tiny manufacturers -- that theoretically aren't legal, because they haven't registered with the government and often don't pay taxes or comply with regulations on wages and hiring and firing. Almost two-thirds of Mexico's workers may be employed in the informal sector, according to one rough estimate by the International Monetary Fund.

The sector's size might suggest great entrepreneurial vitality. The trouble is that these firms are virtually compelled to remain small and inefficient. Because they're technically illegal, they can't easily get bank loans and can't grow too large without being forced to pay taxes or comply with government regulations.

In short, the economy consists of big businesses that are excessively protected by the government and small businesses that feel threatened by it. Not a great combination.

The Bicycle vs the PDF File

Many economists have suggested that recent increases in income inequality are largely attributable to technological changes that have reduced the demand for less-skilled workers. The current issue of the Economist gives a striking example:
bike messengers, the freewheeling mavericks whose tattooed calves and daredevil stunts once defined urban cool, are slowly vanishing from America's streets....The reason is straightforward. High-speed internet, PDF files, digital photography and digital audio have been eroding bike-messenger revenues by between 5-10% a year since 2000, or so reckons Lorenz Götte, an assistant professor of economics at the University of Zurich (and a former bike messenger himself). The revenue slump has sent wages tumbling. In 2000, messengers in San Francisco could make $20 an hour. Now the average is closer to $11.

"Invisible Hand" author

Yesterday I asked, who said this?

No people can be bound to acknowledge and adore the Invisible Hand which conducts the affairs of men more than those of the United States.
The answer: George Washington in his first inaugural address.

If you read the speech, you will find that Washington was referring to God, not to the workings of supply and demand. But then Smith may well have thought of the market's "Invisible Hand" as having a degree of divinity as well.

Was it mere coincidence that Washington and Adam Smith both used the "Invisible Hand" metaphor? Perhaps, but consider this story from Princeton professor Alan Krueger:
NOT long ago, I asked my research assistant, Melissa Clark, to track down a passage from "The Wealth of Nations" by Adam Smith. Although I expected her to consult the modern edition, she instead requested the original 1776 edition from Princeton's Rare Book Library. The librarian accidentally gave her the fifth edition, published in 1789, and therein she discovered a remarkable signature: George Washington.
Happy July 4th everyone!

Monday, July 03, 2006

Are you the next Warren Buffett?

In response to my previous post on index funds, some commenters said essentially, “Hey, what about Warren Buffett? He managed to beat the market. Doesn’t that disprove the efficient-market hypothesis?”

Maybe. I have little doubt that Buffett has business, financial, and economic insight that most of us do not have. And this insight helped him amass a huge fortune (which he is now generously giving away). But the existence of a few extraordinary individuals like Buffett does not tell us much about the efficient-market theory as a reasonable approximation to market behavior.

Here is a question to ponder: Suppose you are a young investor. You might be the next investing genius, or you might not. How would you know?

You could try to compile a track record. But doing so would take a long time to produce compelling evidence. Imagine you have produced an excess return over the market with a mean of 2 percent per year and a standard deviation of 10 percent. To confidently conclude that you really are a good stock picker, to reject the hypothesis that you've just been lucky, you would need 100 years of data. (Note to econ geeks: The t-statistic for the mean excess return is 2/[10/sqrt(T)], where T is the number of observations.) Given your life expectancy, testing your ability with statistical methods may not be very useful.

You might try to introspect and ask yourself: Am I really smarter than the market? But that is risky. Most people are overconfident in their own abilities. What makes you think you are any different?

Several decades ago, the young Warren Buffett took a gamble--that he was the real thing, not just a Warren Buffett wannabe. And he lucked out.

Maybe the young Warren Buffett just knew that he had special gift for figuring out businesses. But I bet for every real Warren Buffett, there were hundreds, probably thousands, of would-be Warren Buffetts who also just knew they had special gifts. They tried to beat the market, failed, and ended up with worse returns than they could have gotten in index funds.

Here is my bottom line: The efficient-market hypothesis is not strictly true, but it is close enough to true that most investors are better off believing in it nonetheless.

Who said this?

"No people can be bound to acknowledge and adore the Invisible Hand which conducts the affairs of men more than those of the United States."

Answer tomorrow.

Sunday, July 02, 2006

The Case for Index Funds

Today's NY Times reports more evidence for the efficient-markets hypothesis:

ASSUMING that the future is like the past, you can outperform more than 80 percent of your fellow investors over the next several decades by investing in an index fund — and doing nothing else.

That's the clear implication of a continuing study of investment newsletter performance conducted for the last 26 years by The Hulbert Financial Digest. Returns of model portfolios constructed according to investment newsletters' advice show that fewer than one in seven newsletters was able to beat the Standard & Poor's 500-stock index over the long term....

The results for newsletters are close to those for mutual funds. According to Lipper, the fund-tracking company, just 19 percent of United States mutual funds that have existed since mid-1980 were able to beat the S&P 500 through May of this year. The average return of all such funds was 10.9 percent, annualized, compared with 10.4 percent for the average newsletter portfolio and 13.0 percent for the S&P 500.

These comparisons ignore taxes. On an after-tax basis, the superior performance of index funds would be even greater, because index funds are particularly good at deferring realization of capital gains.

According to Morningstar, over the past 10 years, Vanguard's S&P 500 Fund beat 74 percent of comparable funds on a before-tax basis and 86 percent on an after-tax basis. Even better is Vanguard's Tax-Managed Capital Appreciation Fund, which is essentially an index fund that keeps one eye on the tax system. It beat 90 percent of comparable funds on an after-tax basis.

Kolbe vs Federline

The case against the penny is gaining momentum. The LA Times is on board. So is the San Antonio Express-News. CNN and NPR recently highlighted the issue.

Representative Jim Kolbe is the leading the charge. On the other side of the fight is Kevin Federline, Britney Spears' husband.

Maybe Princeton should cut their pay

Alan Krueger and Daniel Kahneman, two scholars at my alma mater, tell us that the "link between income and happiness is mainly an illusion."

Rational Farm Policy

Today's Washington Post describes U.S. farm subsidies as "a complex web that has little basis in fairness or efficiency." A perfect example of rent-seeking.

Here is the right policy: Not one dime more.

Saturday, July 01, 2006

The Beauty Premium: Puzzle Resolved?

Dennis Mangan brings to my attention a fascinating angle on the Beauty Premium (the fact that more attractive people earn more, test better, etc.). By virtue of mating preference, attractiveness is a proxy for intelligence and other aptitudes.

The Rothschild effect, as you could call it, is well established in sociology research: Men everywhere want to marry beautiful women, and women everywhere want socially dominant (i.e., intelligent) husbands. When competent men marry pretty women, the couple tends to have children above average in both competence and looks. Covariance is everywhere....

The Rothschild effect got its name from the circumstance that the original Rothschild men, though obviously very successful, were, shall we say, not exactly handsome. But their wealth gave them access to beautiful women, and subsequent generations of Rothschilds became markedly better-looking.

The explanation sounds plausible, but it seems inconsistent with some research I discussed in a previous post.

On Lucky Sperm

From two recent articles in the NY Times:
"I don't believe in dynastic wealth," [Warren Buffett] said, calling those who grow up in wealthy circumstances "members of the lucky sperm club."

Susie, Howard and Peter Buffett — who, like their self-effacing father seem little affected by money — spent the week focusing not on what they might have received. Instead, the siblings said in interviews, they were already at work trying to figure out how to manage a gift from their father valued at about $1 billion each that will go to their own charitable foundations.
That will propel them, along with a larger foundation named for their late mother, into the top ranks of philanthropy.
If you really don't need the right sperm, I know a few people who would be delighted to have $1 billion deposited in their own charitable foundations.