The Rise and Fall of World House Prices

The Bank for International Settlements has a great chart of house prices in its latest annual report (p. 39):

The rise and fall of U.S. house prices (red) is painfully familiar. The U.K. (brown) outdid the U.S. on the upswing, but hasn’t corrected quite as much. (Some other European nations also saw strong booms, but they are averaged into the figures for the Euro area (green)).

House prices in Canada (black) and Australia (olive green) have been showing notable strength. But is it sustainable? Or are some places (e.g., Vancouver) in bubbles?

And then there’s Japan (blue) and its persistent declines. If you worry that the U.S. is turning Japanese (an increasingly popular view with 10-year Treasury rates below 3%), you may want to ponder what a continuing, relentless decline in house prices would do the American financial system.

Consumer Spending is 60% of the Economy, not 70%

Early Friday, the Bureau of Economic Analysis released its third look at economic growth in the first quarter. The results were disappointing: BEA now estimates that Q1 growth was only 2.7%, down from the prior estimate of 3.0%. A key reason: consumer spending was weaker than previously thought.

As I noted in May, the monthly release of GDP data is inevitably followed by commentators claiming that “consumer spending makes up 70% of the U.S. economy” (see, for example, here). Unfortunately, that isn’t right. Consumer spending appears to be about 70% of the economy based on a seemingly obvious calculation (consumer spending divided by GDP), but that ignores the way that macroeconomic accounting handles imports. For reasons detailed in my earlier post, careful analysis suggests that the actual ratio is about 60%.

One reason the 70% error is so common is that doing the correct calculation requires a great deal of work; for example, you need to estimate the fraction of consumer purchases that come from imports. If we want commentators to start using the right figure, we need an easier way to get the idea across using the information reported in the headline GDP release.

Here’s one idea: Compare consumer spending to a measure of overall demand. To do so, we start with the usual macroeconomic identity:

GDP = C + I + G + X – M,

which says that GDP equals Consumer spending, Investment, Government spending, and eXports minus iMports (which are subtracted to avoid double-counting). Looking at this identity, you see that C, I, G, and X can be viewed as measures of demand from consumers, businesses, governments, and overseas markets, while M is a measure of supply from overseas producers.

To get a more reasonable measure of the importance of consumer spending, we can calculate what share of “overall demand” (C + I + G + X) comes from consumers. As shown in the chart, that measure (in red) has been roughly 60% for decades. The usual, misleading measure of consumer spending’s importance (in blue), however, has been up around 70% over the past decade, but used to be lower back when imports were smaller.

The C / (C + I + G + X) measure of consumer spending’s importance is hardly exact. For example, it doesn’t consider how much consumer spending actually comes from imports. However, it’s the simplest measure I could think of that comes close to the right answer. But maybe readers have an even better idea?

P.S. Thanks to Cornelia Strawser for helpful discussion of this measurement challenge.

Gaming the Budget Window

Faced with continuing gridlock over a soup-to-nuts extenders bill, congressional leaders have gotten creative in their legislative strategy. Exhibit A is a stripped-down bill that passed the Senate by unanimous consent on Friday. This bill would temporarily reverse the 21% cut in Medicare physician payment rates that took effect earlier this month. The price tag for this six-month “doc fix” is a bit more than $6 billion over the next ten years.

To appear fiscally prudent, lawmakers want to pay for that spending by raising new revenues or reducing other spending. About $4 billion would come from changes to Medicare. The other $2 billion would come from allowing businesses to postpone contributions to their underfunded pension plans.

Yes, you read that correctly. In the strange world of Washington budgeting, lawmakers can pay for new spending by making it easier for corporations to underfund employee pensions.

You might think this move would worsen the budget situation since the government insures pensions through the Pension Benefit Guarantee Corporation. And you would be right. If firms put off needed contributions to their plans, the PBGC will be exposed to more losses, and future government spending will be higher (even if PBGC collects somewhat higher premiums because of the underfunding). Many of those losses won’t occur for years, however, and thus fall outside the 10-year window that Congress uses to evaluate the budgetary impacts of legislation.

And that’s not all. When companies make pension contributions, they get to deduct that money from their income. Lowering pension contributions for a few years would thus temporarily raise taxable corporate income and boost corporate tax revenues. But those tax gains would reverse once firms have to fund their pension plans. That’s why the pension provision would increase corporate tax revenues by about $6 billion through 2016 and then would lower revenues by about $4 billion in 2017 through 2020.

Over ten years, the net revenue gain would total about $2 billion, enough to cover the remaining costs of the six-month doc fix. But that’s only because we’d also lose about $2 billion in revenue outside the budget window. Taking those losses into account, the bill would generate essentially no net revenues.

The doc fix/pension underfunding bill would be “paid for” only because Congress would have managed to push both future spending increases and future revenue losses outside the budget window. Let’s hope such budget gaming isn’t the norm when Congress finally confronts our larger budget challenges.

This post first appeared on TaxVox, the blog of the Urban-Brookings Tax Policy Center.

Expeditionary Economics

The U.S. military is now a major player in economic development. In Iraq and Afghanistan, for example, economic stabilization is a core tenet of its counterinsurgency strategy. Which makes good sense, in theory, but raises a troubling practical question: does the military actually know anything about economic stabilization and development?

In a recent essay in Foreign Affairs (Expeditionary Economics: Spurring Growth after Conflicts and Disasters), Carl Schramm answers in the negative. The U.S. military does not have these skills in anywhere near the measure that it should. He then recommends that:

[P]ostconflict economic reconstruction must become a core competence of the U.S. military. … It is imperative that the U.S. military develop its competence in economics. It must establish a new field of inquiry that treats economic reconstruction as part of any successful three-legged strategy of invasion, stabilization or pacification, and economic reconstruction. Call this “expeditionary economics.”

Schramm goes on to argue that expeditionary economics should emphasize entrepreneurship and “messy” capitalism, not just large-scale infrastructure efforts that often get the most attention. If you are interested in these issues, his essay is definitely worth a read.

For more context and other views, you should also check out the conference that Kauffman held to discuss these issues. You can read highlights from the conference here.

Some excerpts (not attributed to any of the specific participants):

The core idea behind the Marshall Plan was to stimulate the private sector through direct financial support of businesses rather than distribution through local government institutions, and it continues to serve as a potential model for efforts today, especially insofar as it deeply considered the nature of the war and the pre-existing institutional conditions in Europe.

Stability and economic development operations in Iraq and Afghanistan have been problematic for quite different reasons. In Iraq, the United States squandered the opportunity to demonstrate a real concern for the welfare of the Iraqi people in the months after the invasion because it failed to adequately plan for stabilization and reconstruction activities after major combat operations—as a result, both the economic and security planning systems failed. Many government agencies were complicit in this failure, including the military. In Afghanistan, the rush to respond and the limits of time constrained stabilization and reconstruction planning along with a desire to maintain a light footprint. Military, political, and development strategy was cobbled together as the conflict progressed. This meant the United States began trying to catch up with ideas, and has been trying to acquire and deploy resources ever since. As part of a “peacebuilding” strategy for the future, the military should address these core challenges to improve its stabilization operations

One pre-requisite of a market economy might be the rule of law, although China’s success over the past few decades offers an interesting challenge to that premise.

There is debate and uncertainty over what we mean by the phrase, “rule of law,” and whether it simply includes a justice system, courts, and efficient policing or extends beyond that to contracts, finance, commerce, and beyond. The answer is no one knows, and the rules of the game don’t have to be perfect—they just have to be certain and perceived as fair. The two things businesses always look for are stability and certainty.

In war, just as there are human casualties, there also are financial casualties, and we need to accept this reality. Some dollars will be misappropriated, and some will go to the enemy, to criminal networks, to ineffective local leaders, and to bad projects. This doesn’t make it okay, but we need a productive dialogue to determine what is a reasonable level of these financial casualties.

Some disagree that economics is … a soldier’s job. Yet, economics is required to win, and a soldier’s job is to win. The military has no choice but to use economics as a weapon in stability operations, so let’s be as good as possible at it. What we need to be thinking is, “What are the appropriate economic principles we can teach military leaders so they can use them to accomplish their mission?”

Vuvuzelas, Afghanistan, and Fannie and Freddie

Updates on some previous posts:

The Budget Uncertainties of Health Reform

Back in March, the Congressional Budget Office (CBO) estimated that the new health legislation would reduce the federal budget deficit by about $140 billion over the next ten years and by about 0.5% of gross domestic product in the decade after that. Ever since, analysts have been debating whether we should believe those estimates. Some say the legislation will deliver much larger budget savings than those modest estimates suggest, while others insist it will greatly increase future deficits.

That debate reflects two types of uncertainty about the legislation’s fiscal impact.

The first is technical. As physicist Niels Bohr (not Yogi Berra) once said, prediction is difficult, particularly about the future. CBO had to make hundreds of educated guesses about future health costs and how consumers, employers, providers, insurers, state governments, and federal officials will respond to dramatic changes in the insurance market. Some of those assumptions will be wrong. But observers disagree on which ones and in what direction.

The second uncertainty is political. The new law will change the landscape for future health policy debates. Those changes (which rightly fall outside the scope of CBO cost estimates) may make it easier or harder for future policymakers to address our long-run budget challenges. I suspect that these political uncertainties are the main reason that optimists and pessimists disagree so strongly on the law’s budget impact.

Pessimists argue that to pay for coverage expansions, the legislation ate up budget savings that could otherwise have been used to address our long-run fiscal challenges. By “emptying the quiver” of some desirable policy options, the health law thus indirectly worsened the long-run budget outlook in a way CBO could not capture.

The pessimists also predict that future Congresses will water down or eliminate some budget savings. To make the budget numbers work, lawmakers combined a large helping of dessert (most notably health insurance for an additional 31 million Americans) with a large serving of spinach (for example, a new excise tax on “Cadillac” insurance plans and cuts in Medicare provider payments). History suggests, however, that policymakers often lose their appetite for the greens (see, for example, physician payments in Medicare).

The optimists believe that the fiscal impact will turn out better than CBO predicted. They note the law includes numerous experiments aimed at uncovering ways to rein in health costs while maintaining or improving quality. Among them: restructuring provider payments, increasing funding for comparative effectiveness research, and creating a new independent board to review Medicare payments. We don’t really know how to reduce medical costs today, but by trying many different approaches and learning from their results, the law will eventually enable future Congresses to adopt the most promising reforms.

Successful health reform may also improve future budget politics. Some past proposals to reduce federal involvement in health care – such as increasing the Medicare eligibility age or rolling back the enormous tax subsidy for employer-provided health insurance – have foundered on fears that some people would lose insurance. But by covering millions of uninsured, the health law reduces that risk, and policymakers may be able to take hard steps that until now have been politically impossible.

It’s hard to know how these political uncertainties will balance out. The law did indeed remove some arrows from the policy quiver, and it is easy to imagine policymakers backing down from scheduled spending cuts or tax increases. So the pessimists have a strong case. But the optimists are also right that if the new law succeeds, it will open new ways to rein in federal health spending. I certainly hope so.

This post first appeared on TaxVox, the blog of the Urban-Brookings Tax Policy Center.