Category: Uncategorized

The Legacy of the Economic Crisis

In its recent Going for Growth report, the OECD concludes that the economic and financial crisis will leave an unwelcome legacy: a permanent reduction in economic activity. This loss averages about 3% of potential GDP across the 20 member countries for which the OECD was able to make these estimates.

As the following chart shows, those losses differ greatly across countries:

Ireland and Spain are the clear losers, with the crisis cutting economic activity by more than 10%. Despite being a catalyst for much (but by no means all) of the crisis, the United States faces one of the smallest losses. The 2.4% reduction in potential U.S. GDP is a sobering hit, but is less than that faced by 16 of the other nations.

Why does the United States appear to be on track for comparatively moderate output losses? Continue reading “The Legacy of the Economic Crisis”

Budget Thoughts from Steny Hoyer

House Majority Leader Steny Hoyer is building a reputation as one of our most thoughtful leaders when it comes to budget matters. Thus I commend to you the speech on fiscal responsibility he gave at the Brookings Institution today.

Highlights include his criticism of “selfish” budget choices:

[W]hen it comes to budgeting, what is politically easy is often fiscally deadly. It is easier to pay for tax cuts with borrowed money than with lower spending; easier to hide the true costs of war than to lay those costs before the people; easier to promise special cost-of-living adjustments than explain why an increase is not justified under the formula in law; easier to promise 95% of Americans that we won’t consider raising their taxes than to ask all Americans to contribute for the common good. Those kinds of easy choices are so often selfish choices—because they leave the chore of cleaning up to someone else. Easy choices may be popular—but the popularity is bought on credit.

And his discussion of budget options:

On the side of entitlement spending, an agreement might recognize that Americans are living longer lives and raise the retirement age over a period of years, or even peg the retirement age to lifespan. Another option is to make Social Security and Medicare benefits more progressive, while strengthening the safety net for low-income Americans. That could preserve those programs as a central part of our social compact, while protecting their ability to help those of us in the greatest need.

On the side of revenues, President Obama was correct in refusing to take any options off of the commission’s table. No one likes raising revenue, and understandably so. But if you’re going to buy, you need to pay. … If need be, I am hopeful that both parties will agree to look at revenues as part of the solution—not as a gateway to higher spending, but as part of a compromise that cuts spending and balances the budget.

I don’t agree with everything Leader Hoyer has to say in his speech (e.g., I am much more concerned about the budget impacts of the pending health bills, and I view the recent PAYGO bill less favorably because of its many exceptions). But I appreciate how seriously he takes these issues.

P.S. Bruce Bartlett also recommends the speech.

The Tragedy of the Guacamole

One of the themes of this blog is that economics is everywhere in daily life. Property rights, for example, are at the heart of everyday battles over overhead bins, shoveled-out parking spaces, and food in shared refrigerators.

Continuing in that vein, a friend recently sent me a link to an amusing piece about sharing guacamole. I hesitate to link to it, since this is a family oriented blog, and the piece is decidedly R-rated and NSFW. So I will hide the link under the fold. The basic set-up is that a sort-of-advice columnist named Chris provides humorous answers to reader questions.

In slightly edited form, here’s the bit about sharing guacamole:

[Dear] Chris: My fiancée makes amazing Guacamole, but it leads to the following problem: she only makes one bowl of it, which we then share. The issue is, I like to utilize small amounts of Guac on each chip in order to maximize the amount of time I get to enjoy the sweet green stuff, while she likes to heap massive amounts on each chip, in an effort to eat less chips (which […] I find laughable). This drives me crazy as I always end up with the short end of the Guac stick, and so lately I have been separating the Guac into two equally-sized bowls once she’s made it, in an effort to preserve my fair share. She thinks this qualifies as me being [a jerk] and says I “must have failed sharing in Kindergarten”, but on the contrary, I think it’s her poor sharing that’s lead to the whole situation.

[Dear Letter-Writer:] Well, the obvious solution here is for her to make MORE guac. The other solution? Ask her the recipe, and then begin making it yourself. As head chef of the household, you are in full control of when that guacamole will be presented for consumption. I cook for my wife because it allows me the freedom to eat half of what I’ve made before it even reaches the table.

Furthermore, the strategy of using less guac per chip is fatally flawed. It’s guacamole. All guac is first come, first serve. You must heap as much guac onto one chip as humanly possible (as your fiancée does), only do it at a much faster rate. Think guacamole isn’t a race? IT IS. The faster you eat, the more you get. That’s how it works. And it’s a crucial strategy to exploit when dealing with guacamole, nachos, pizza, wings, and other shared food. Do not hesitate. Don’t even […] chew. You inhale […] until there’s nothing left for her. That’s what I do.

If you were out to eat with your guy friends at a Mexican restaurant, and you ordered guacamole for all to share, would you get [mad] at your friends for digging in too quickly? [Heck] NO. That guac is chum, and you are the sharks. ATTACK ATTACK ATTACK. Never play defense with appetizers.

There you have it, the world’s best explanation of the tragedy of the commons. Garrett Hardin eat your heart out. Let’s just hope we never find ourselves at a Mexican restaurant with Chris.

The letter-writer deserves kudos for endorsing the standard (and effective) economist solution to this problem: well-defined property rights. And his fiancée? Maybe she’s a fan of recent Nobel Laureate Elinor Ostrom.

Continue reading “The Tragedy of the Guacamole”

How Governments Hide Their Liabilities

In my testimony to the Senate Budget Committee the other day, I recommended that Congress set specific fiscal targets for bringing our out-of-control deficits and debt under control. My particular suggestion? Get the publicly-held debt down to 60% of GDP in 2020.

By budgeting  standards, that makes for a great bumper sticker: “60 in 20“.

But as the New York Times points out in two articles today, a measurable target isn’t enough. You also need to make sure that the government doesn’t game the accounting to hide its liabilities.

Exhibit A is Greece. The story was originally broken by Der Spiegel earlier in the week, and is described in the NYT by Louise Story, Landon Thomas Jr., and Nelson D. Schwartz in “Wall St. Helped Greece to Mask Debt Fueling Europe’s Crisis“:

As worries over Greece rattle world markets, records and interviews show that with Wall Street’s help, the nation engaged in a decade-long effort to skirt European debt limits. One deal created by Goldman Sachs helped obscure billions in debt from the budget overseers in Brussels. …

Instruments developed by Goldman Sachs, JPMorgan Chase and a wide range of other banks enabled politicians to mask additional borrowing in Greece, Italy and possibly elsewhere.

In dozens of deals across the Continent, banks provided cash upfront in return for government payments in the future, with those liabilities then left off the books. Greece, for example, traded away the rights to airport fees and lottery proceeds in years to come.

Critics say that such deals, because they are not recorded as loans, mislead investors and regulators about the depth of a country’s liabilities.

The winning quote:

“Politicians want to pass the ball forward, and if a banker can show them a way to pass a problem to the future, they will fall for it,” said Gikas A. Hardouvelis, an economist and former government official who helped write a recent report on Greece’s accounting policies.

Exhibit B are all the contingent liabilities of the United States government, of which Fannie Mae and Freddie Mac have been the most prominent (and expensive). In “Future Bailouts of America,” Gretchen Morgenson interviews budget expert Marvin Phaup (now at George Washington University and previously a colleague of mine at the Congressional Budget Office). She writes:

“If we are extending the safety net, extending the implied guarantee to the debts of a lot of other financial institutions, and we know those guarantees are valuable and costly, then we ought to start budgeting for it,” Mr. Phaup sad in an interview. “We can’t reduce the costs of these subsidies if we can’t recognize them.” …

As the number of firms with implicit government backing has risen because of the crisis, so too have the expected costs of those commitments, Mr. Phaup said. And yet, under current budget policy, those costs will be ignored until the recipient of the guarantee collapses — the precise moment when the guarantee is likely to cost taxpayers the most.

If we are going to set an explicit target for the publicly-held debt–60 in 20!–, we need to think carefully about what politicians may strategically omit from the calculation of the 60.


Philanthropy and Innovation

Earlier today, Bill Gates released his second annual letter as co-chair of the Bill & Melinda Gates Foundation. The letter is well worth your time, particularly if you are interested in efforts to improve education and global health.

One passage that caught my eye was his description of the foundation’s strategy:

Melinda and I see our foundation’s key role as investing in innovations that would not otherwise be funded. This draws not only on our backgrounds in technology but also on the foundation’s size and ability to take a long-term view and take large risks on new approaches. Warren Buffett put it well in 2006 when he told us, “Don’t just go for safe projects. You can bat a thousand in this game if you want to by doing nothing important. Or you’ll bat something less than that if you take on the really tough problems.” We are backing innovations in education, food, and health as well as some related areas like savings for the poor. …

We have a framework for deciding which innovations we get behind. A key criterion for us is that once the innovation is proven, the cost of maintaining it needs to be much lower than the benefit, so that individuals or governments will want to keep it going when we are no longer involved. Many things we could fund don’t meet this requirement, so we stay away from them. Another consideration for us is the ability to find partners with excellent teams of people who will benefit from significant resources over a period of 5 to 15 years.

There are five principles here: do things that others won’t do, think long-term, take risks, choose strong partners, and target eventual self-sufficiency. All are important, but the fifth deserves particular emphasis.

The classic “fail” in development efforts is to finance upfront investments–building a school, for example–without giving thought to how beneficiaries will later manage it–e.g., how students will get books, who will teach, etc.

To go for the “win”, Gates thus focuses on investments — creating new vaccines, developing new crop varieties, or inventing new teaching methods–that can be self-sustaining by beneficiaries (or their governments) once the upfront costs have been covered.

The Great Eggo Shortage

Today’s microeconomics question, brought to you by the fine people at Kellogg’s: How will Americans respond to the great Eggo shortage?

According to CNN Money.com (ht Michelle):

Grocery stores will be experiencing a shortage of the waffles until mid-2010 due to problems at two bakeries, a Kellogg’s spokeswoman said on Wednesday.

Flooding at an Atlanta bakery during heavy rains in October forced Kellogg, which makes Eggo products, to shut down production temporarily, said company spokesman Kris Charles. Plus, equipment at Kellogg’s largest waffle facility, based in Rossville, Tenn., needs extensive repairs.

“We are working around the clock to restore Eggo store inventories to normal levels as quickly as possible,” Charles said in an e-mail.

Remaining inventory will be rationed to stores across the country “based on historical percentage of business.”

All you armchair economists will immediately recognize that the looming Eggo shortage exists not only because of Kellogg’s production problems, but also because it’s decided to ration the delectable waffles, rather than raise prices.

My question: How will stores and shoppers respond to this shortage? Will grocery stores raise Eggo prices? If they do, will they be denounced as Eggo price gougers? And if not, will there be empty shelves in the refrigerated breakfast section?

And what about consumers? Will they rush out to hoard Eggos today, thus exacerbating the near-term shortage? Will a black market in Eggos emerge?

I’d be interested to hear what you see when you are next doing field research in a grocery store. Of course, in this day-and-age, there’s an even faster way to gauge the Eggo-consciousness of America: check out the stream of Eggo tweets over at Twitter (btw, you can follow me here). Judging by a quick skim of the several hundred Eggo-related tweets in the past few minutes (!), I would say that (a) some consumers will indeed hoard Eggos, (b) some are joking about hoarding Eggos and then putting them up on eBay, and (c) a few consumers are looking at the bottom of their freezers to see if they have any Eggos to sell. Ah, a good old supply response in the face of a shortage.

Bill Belichick and John Maynard Keynes

Worldly wisdom teaches that it is better for the reputation to fail conventionally than to succeed unconventionally. —John Maynard Keynes

Keynes’ insight has a natural corollary, which Bill Belichick, coach of the New England Patriots, learned painfully on Sunday: to fail unconventionally is really, really bad for your reputation.

As described by Steve Levitt over at the Freakonomics blog, Belichick “made a decision in the final minutes that led his team the New England Patriots to defeat. It will likely go down as one of the most criticized decisions any coach has ever made. With his team leading by six points and just over two minutes left in the game, he elected to go for it on fourth down on his own side of the field. His offense failed to get the first down, and the Indianapolis Colts promptly drove for a touchdown.”

As Steve notes, the interesting thing about this decision is that (a) Belichick has endured blistering criticism, but (b) he may well have made the right decision. According to calculations by multiple analysts (e.g., here and here), Belichick’s maximized the chance that the Patriots would win. He just got unlucky.

Belichick must have known that he was risking the wrath of Monday morning quarterbacks if the play didn’t work out. But he chose to play the odds despite that risk. That’s a great attitude. Keynes would be proud.

Climate Change vs. Deficit Reduction?

Next February, President Obama will unveil his 2011 budget. Over the past few days, the news media have begun to speculate about  some of the steps that he might propose in order to tame our growing deficits.

Over at Politico, Mike Allen and Jim Vandehei suggest that one policy casualty ought to be the effort to combat climate change:

The big question for Obama – and the country – is whether the sudden concern about deficits will be more rhetoric than reality once his first State of the Union address concludes.

All presidents promise deficit reduction – and almost always fall short. There is good reason to be skeptical of this White House, too, on its commitment.

For starters, the White House has not dropped plans for an aggressive global warming bill early next year that will be loaded with new spending on green technology and jobs – that would be paid for with tax increases. Democratic lobbyist Steve Elmendorf says the White House focus on deficit reduction could easily kill the cap-and-trade effort. “I think this means cap-and-trade has to go to the backburner,” he said.

This line of argument makes no sense to me. And its mere existence reinforces my concern that the politics of climate change are completely dysfunctional from a budget perspective. As I have noted before, the government could combat climate change in a way that would also combat our out-of-control deficits:

A carbon tax, for example, could raise revenue and reduce carbon emissions at the same time.

Alternatively, the government could auction off allowances under a cap-and-trade system and then designate some or all of the resulting revenues for deficit reduction.

Unfortunately, that is not the way our Congressional leaders are approaching this challenge. The House, for example, passed a climate change bill that would create allowances worth almost $1 trillion over ten years. The net reduction in the deficit? A paltry $9 billion since Congress would give most of the allowances away to industries with good lobbyists and would spend almost all of the rest.

Senate leaders, meanwhile, are touting their climate change bill as “not worsening the deficit” — a ridiculously low standard in this new era of trillion-dollar deficits.

My recommendation to the President is quite different from that in the article. If the President is committed to both climate change legislation and reducing the deficit, he should tell Congress to levy a carbon tax or designate a large fraction of the carbon allowances for deficit reduction.

The Warped Economics of Carry-On Luggage

I just got home from a quick trip to Denver, where I spoke at a Concord Coalition event on our nation’s dire fiscal outlook. That’s a big, complex problem, but today I’d like to share some thoughts on an even more vexing problem: the warped economics of carry-on luggage.

As you probably know, most major airlines now charge fees if passengers want to check luggage. Many travelers object to these fees in principle (as you can easily confirm by surfing around the blogosphere), but what’s most interesting to me is how people respond to them.

Based on my travels, I see three related issues.

1. If you charge fees to check bags, passengers will bring more and larger carry ons. Like everyone else, airline passengers respond to incentives. So if you make it more expensive to check bags, they will bring more carry-ons. The overheads thus fill up more quickly and are often at capacity before everyone has boarded. More travelers thus get to experience the ignominy of losing the carry-on equivalent of musical chairs (and flight attendants have to waste time removing bags and checking them).  (This observation is hardly new; my student Kerry mentioned it to me last week, for example, and others have written about it.)

2. This effect may get magnified when airlines offer to check bags for free at the gate. As I was waiting to board my flight to Denver, the gate agent announced repeatedly that customers could check bags for free if the overheads ended up being full. I presume that the airlines do this in order to avoid adding insult to injury for the passengers who lose at musical bags. (Imagine the flight attendant telling you: “Sorry, the overheads are full; please give me your bag and $35.” ). This does have the side effect, however, of encouraging even more customers to bring their bags onto the plane to see if they will fit. The worst case (financially) is that they end up avoiding the fees for checked luggage.

The increased competition for overhead space is worsened by the lack of property rights. Just as competing boats can over-exploit a fishery, so do airline passengers overexploit overhead space. In econ-speak:

3. There is a tragedy of the commons as passengers compete for overhead space. Without enforceable property rights, travelers engage in all sorts of inefficient behavior to gain overhead space (e.g., fighting to be among the first in their seating group to get aboard). Perhaps the most galling is when passengers seated in row 35 bring on two over-sized roller bags and stow them in the overheads around row 15. They then saunter, unencumbered and without shame, to their seats in the back of the plane, while the unsuspecting souls in row 15 (who usually board later) face a major nuisance: what to do with their bags. Let me tell you, it’s not a pretty sight when the folks in row 15 have to stow their luggage in the overhead space back in row 35 — if there’s any left at all.

The fees worsen this tragedy of the commons, of course, since even more bags are competing for the limited resource of overhead space.

So what’s the solution?  Well, one option would be to create property rights in the form of assigned overhead space. One roller-bag sized space could come bundled with each seat, for example, or perhaps the airline could sell spaces separately. Maybe there could even be a secondary market in which passengers buy and sell spaces among themselves. Row 35 person: If you really want this space over my seat in row 15, how much are you willing to pay?

OK, that vision is a bit fanciful, and there are a host of challenges (e.g., different size bags and the transaction costs of running a real-time overhead bag space market) that may make it impractical. But it is fun to dream.

Andrew Samwick’s Good Point About Health Insurance

In a recent post over at Capital Gains and Games, Andrew Samwick makes an important point about the debate over health insurance reform. As Andrew notes, many proponents of a public plan (aka public option aka government-run plan) blame the quest for profits for the ills they see in the private health insurance market.

This is one of those claims that is both true and false. What’s true, again echoing Andrew, is that the search for profits can lead to bad outcomes (e.g., efforts to cover the healthy while avoiding the sick) in our current system. That’s because we haven’t adequately addressed some key problems — most notably adverse selection — that arise in health insurance markets.

But that fact does not, of itself, demonstrate that the profit motive is itself the problem. If we can establish rules of the road that limit adverse selection (e.g., by prohibiting exclusions for pre-existing conditions), we may be able to direct the profit motive in the direction we want: finding ways to deliver greater value (i.e., better service and lower costs) to Americans with health insurance.

In Andrew’s words:

The solution to the problems in our health care sector is to make it look more like the retail sector or any other sector in which being voracious and profit-driven drives down costs.  The problems of adverse selection and moral hazard in insurance markets are well known — they are what stands in the way of extending the benefits of competition to health care.  Addressing them should be the central features of the reform, with a risk-adjustment mechanism to address the former and high-deductible plans to address the latter.  All of this discussion of Medicare-for-all in a public option is at best premature, since we have not seen whether a competitive, private system can function under the right form of regulation.

To drive this point home, let me offer the following (admittedly imperfect) analogy: it turns out that the profit motive causes thousands of companies to emit millions upon millions of tons of carbon dioxide and other pollutants. That’s a bad thing. But it doesn’t imply that the solution is a “public option” for electricity production and gasoline refining. The right response is to establish rules that address the market failure — in this case the pollution — and then let the firms do their thing.

That’s what we should do with health insurance.