Monday, October 24, 2016

What Else Can Central Banks Do?

Central banks all over the world took dramatic actions during the Great Recession and its aftermath. For example, the US Federal Reserve took the "federal funds" interest rate down to near-zero in December 2008 and left it there until the small upward bump in December 2015, and also through its "quantitative easing" program has bought about $4 trillion in US Treasury debt and mortgage-backed securities. Other central banks have also dropped their policy target interest rates to near-zero and carried out quantitative easing. As a results, have central banks used up most of their ammunition, potentially leaving them with an inability to act if and when the next recession arrives? Laurence Ball, Joseph Gagnon, Patrick Honohan and Signe Krogstrup make the case that central banks continue to have considerabke power to engage in a loose monetary policy, should they wish to do so, in their monograph What Else Can Central Banks Do?, published as #18 in the Geneva Reports on the World Economy series.

The authors discuss an array of possibilities for central banks (forward guidance, helicopter money, higher inflation targets, and others), but the main focus is on two policies: additional quantitative easing and negative interest rates.  Here are a few of their comments that caught my eye:

On the topic of quantitative easing, Ball, Gagnon, Honohan and Krogstrup give this overall perspective:
"In the United States, for example, it is estimated that QE purchases of long-term bonds between 2008 and 2015 had macroeconomic effects equivalent to those of a sustained reduction of about 200 to 250 basis points in the policy rate. With a greater volume of purchases, the effects could have been almost proportionately greater. Another approach adopted by some central banks is subsidised and targeted lending to the banking system. QE could be expanded further by widening the range of assets that central banks purchase to include risky assets such as corporate debt and equities. For given quantities of asset purchases, this broader version of QE could well have stronger effects on asset prices and costs of funds, and hence on economic activity, than purchases of government bonds." 
Here are a couple of piece of evidence from their discussion. They offer a summary of research evidence that QE does reduce interest rates on long-term bonds. They write: "Table 3.1, taken from Gagnon (2016), displays estimates of the effect of a purchase of long-term bonds equivalent to 10% of GDP on a country’s 10-year government bond yield."

The other piece of evidence, just to give a sense of where their thoughts are tending, is a table that compares central bank assets to the total securities in an economy. In the US, for example, the assets at the Fed are about 25% of GDP, while all financial securities are 300% of GDP. The authors draw the inference that quantitative easing can be expanded quite substantially. They also point out that such policies might involve targeted lending of various kinds, not just purchases of existing securities.

On the topic of negative interest rates, the authors point out that negative real interest rates are not actually an innovation, in the sense that there have been lots of times in the past in lots of countries when the rate of inflation exceeded the nominal interest rate, so that the real interest rate was negative. The change is making the negative interest rates explicit. Here's a figure showing some monetary policy interest rates in five countries:

As the authors discuss, the graph oversimplifies how these policies are conducted. In a number of cases, the negative rates are "tiered," meaning that they apply to some types of deposits rather than others. In some countries, banks are now charging negative interest rates to some corporate and institutional investors.The evidence on whether these negative policy rates cause banks to reduce the interest rates at which they lend seems mixed: sometimes those interest rates drop, but at other times, it has looked as if banks are trying to make up for the money they are losing from negative interest rates on their deposits at the central bank by keeping their lending rates up. So far, the negative rates mostly haven't been passed along to retail bank depositors. As the authors explain:
"However, there is little evidence so far that banks are passing negative interest rates through to their retail depositors. Insured retail deposits are an attractive source of financing for a bank in normal times, and a retail customer can often be cross-sold many other value-added banking products. Banks are reluctant to lose market share for insured deposits, which they may not easily regain when interest rates turn positive. Moving to a negative interest rate could be a salient event that would cause retail customers to ‘shop around’. Given the inertia normally characterising retail bank relationships, the bank that makes the first move into negative deposit rates for retail customers could experience a hard-to-reverse loss of market share.
My own reading of the evidence is that the case for how quantitative easing reduced interest rates is fairly strong, but the evidence for the merits of negative interest rates is at this point less strong. For example, there are a variety of concerns that at a time when a main concern has been to require banks to hold more capital against losses, having the central bank charge negative interest rates may work in the opposite direction. For small open economies like Switzerland or Denmark, negative policy interest rates or negative rates on certain government debt can be a way of keeping their exchange rate low, which for their economies can be quite important. But what works for the Bank of Switzerland or Denmark's central bank doesn't necessarily extrapolate to the much larger Fed or the European Central Bank. After all, not all currencies can be reduced in value relative to each other at the same time. The authors also point out that the public is likely to be quite averse to explicitly negative nominal interest rates. They write:
"Perhaps the strongest de facto impediment to cutting rates further into negative territory is the lack of public acceptance and understanding of such measures. Partly due to pervasive money illusion, negative interest rates seem counterintuitive to the general public and are perceived in many countries as an unfair tax on savings. Taking measures to allow negative retail deposit rates could sharply increase public animosity. A lack of acceptance and understanding of a monetary policy measure can negatively affect confidence in the central bank’s ability to pursue its mandate, and might adversely affect transmission to demand. This constitutes an important communication challenge for central banks as they try to explain why the tool is needed, how it works, and how negative nominal rates will affect real life-time saving and real incomes of regular citizens, once growth and inflation developments are taken into account." 
I'm happy not to be the central bank person working on the public relations campaign for why negative interest rates are a good idea! I worry that these authors are a little too too sanguine about how negative interest rates will not cause other economic problems, but they make their case strongly and clearly, in a way that's worth reading.

When thinking about the much more aggressive use of these kinds of monetary policy tools, I find myself of several minds. In particular, are we talking about what monetary policy should have been enacted back in 2009 and 2010? Or maybe what the European Central Bank should be doing now, given that it unemployment rates in the euro-zone have been above 10% for essentially the entire period since late 2009? Or are we talking about what the US Federal Reserve should be doing today with an unemployment rate that has now been at about 5% or less during the last calendar year?

In looking backward at 2008-2010, researchers can make a technical case that a more aggressive monetary response might have been helpful. But in thinking back to the extreme uncertainty of that time, it isn't obvious to me that if, say, the Federal Reserve had cut the federal funds interest rate to a negative 2 percent (as proposed in one of the authors' scenarios) or had announced that it was going to buy a few trillion dollars worth of US stocks that it would have calmed or quieted the financial markets. In the context of that time, such actions could well have been perceived as desperate gambles, and might even have made a dire situation worse.

But in looking forward, the question of alternative ways of conducting expansionary monetary policy issues raised by this essay are likely to be long-lasting. In the middle term, it seems likely that  real interest rates and rates of inflation are likely to remain low. But in the past, when a central bank has wanted to fight recession, it has often cut its target interest rate by 3-4 percentage points or even more. The problem is that if nominal interest rates are already low, it becomes impossible for central banks to cut interest rates by 3-4 percentage points in the next recession unless the rates become negative. Another alternative is more extensive quantitative easing. There are new and difficult policy questions with negative interest rates and quantitative easing, but these kinds of monetary policy tools in this report are what central banks are going to be discussing when (and it's "when", not "if") the next recession comes.

Friday, October 21, 2016

Will the US Become a Nation of Renters?

The United States has long been a nation of homeowners, but in the aftermath of the housing bubble and the Great Recession, the rate of homeownership has been falling. Are we headed toward becoming a nation of renters. Cityscape, which is published three times each year by the US Department of Housing and Urban Development, asked four groups of experts to argue for or against this claim in its first issue of 2016: “By 2050, the U.S. homeownership rate, currently about 64 percent of households, will have fallen by at least 20 percentage points.”

The short answer to the question is that an additional fall of 10 percentage points in rates of US homeownership is plausible, according to some projections, but a fall of 20 percentage points seems quite unlikely. But let's put that answer in context. Here's the homeownership rate in the US since 1980. The housing boom and corresponding fall are clear. But is the recent decline just part of a cycle, or a sign of what is to come in the next few decades? Answering this question means trying to look past the recent housing bubble and to consider what might affect homeownership in the longer term.

For example, Arthur C. Nelson writes "On the Plausibility of a 53-Percent Homeownership Rate by 2050." He points out that the homeownership rate for white non-Hispanic was 72.5% in 2015, while the homeownership rate for everyone else, who Nelson calls the "New Majority" because this group is expanding as a share of the US population, is 47.1%. Details of his projections are in the paper, but here's the upshot : "I estimate that, by 2050, America’s homeownership rate may be 53.5 percent or roughly what Germany’s rate was in 2015." Nelson also points out that the US homeownership rate was at about 53% back in the 1950s, so such a rate is clearly not unprecedented in US experience.

Dowell Myers and Hyojung Lee instead emphasize, in "Cohort Momentum andFuture Homeownership:The Outlook to 2050,"  that homeownership rates evolve over time with the aging of the population. Older households are more likely to own homes. But it then follows that if younger households are over time becoming less likely to be owners than their predecessors in the same age groups, then as time moves forward the rate of homeownership will fall. They write:

Homeownership for ages 35 to 39 topped out at 69 percent in the 1980 census. From that point forward, homeownership attainment began to very slowly recede, likely under the pressure of growing affordability problems and also the effects of declining marriage and increasing diversity, both of which added people from groups with historically lower homeownership. The decline accelerated dramatically, however, following the financial crisis. Between 2008 and 2015, the homeownership rate of this age group fell from 64.6 to 55.1 percent (-9.5 points). Meanwhile, for those ages 70 to 74, the rate declined only slightly in the same time period, from 81.7 to 80.7 percent (-1.0 point). The low rates among today’s young adults, unless they were to accelerate well beyond the normal pace of increase in future years, have potential to depress the U.S. homeownership rate as these cohorts begin to replace their elders later in the century.
Their mid-range projection, based on this cohort analysis, is for a US homeownership rate below 55% by 2050. But in their pessimistic projection, in which the last few years mark a permanent change in the willingness or ability of younger cohorts to purchase homes, the homeownership rate could fall below 45% by 2050.

The other papers are not as pessimistic about a fall in homeownership. In "A Renter or Homeowner Nation?", Arthur Acolin, Laurie S. Goodman, and Susan M. Wachter offer a projection based on evolution of age and race/ethnicity, and offer a mid-range projection of the homeownership rate falling to 57% by 2050.  In "The Future Course of U.S. Homeownership Rates,"  Donald R. Haurin offers a similar estimate, along with some other insights. He writes:
Why has the homeownership rate recently declined and will it continue to fall? Consider six causal factors. (1) The underlying preference for homeownership or privacy could have decreased—but no evidence supports this hypothesis. (2) The risk premium associated with house price volatility has increased, raising user costs; however, the premium should fall in the future as house prices stabilize. (3) Although mortgage lending practices tightened following the Great Recession, they changed little after 2012. Households take time to adjust to requirements for higher credit quality and larger down payments, but a decade should be sufficient for this adjustment to occur. (4) An increase in households’ expected mobility raises the transaction cost component of user costs, but recent changes indicate mobility has fallen in both the general and the young adult populations. (5) Rents have risen recently, but this rise should increase homeownership rates. (6) Perhaps the most important factor causing the recent decline in agespecific homeownership rates is the hangover of negative credit events, such as foreclosures, short sales, and bankruptcies. The impact on credit scores of these derogatory credit effects, however, is unlikely to last beyond 2020. Consideration of these six factors suggests that age-specific homeownership rates will stabilize no later than 2025, then will rebound, but not to the previous, boom-inspired peaks.
These estimates are all sensible enough in their own ways, but they felt a little unsatisfying to me, because they paid relatively little attention to some other factors that seem likely to shape the future of homeownership. For example, here's some Census Bureau data on differences inside and outside metro areas, and across regions. Notice that homeownship rates tend to be much lower in large cities: indeed, if a homeownership rate below 50% seems implausible to you, you might reflect on the fact that this is already a reality in US cities. Notice also that homeownership rates in the Northeast and West regions are already below 60% (of course, this is in substantial part because there are more large cities in these regions). Thus, one's belief about the future of homeownership is in some ways a statement about where people choose to live in the future.

There are also changes in family structure. For example, US birthrates declined in the 1960s. The share of US family households who have a child living there was about 57% in the early 1960s, but has declined since that time to about 45%. Although fewer households have children, a larger share of young adults are living with their parents. As these young people move toward becoming few-child or no-child families on their own, it's not clear to me that they will be looking to own rather than rent.

Finally, the level of homeownership is in some ways a social choice, related to policies affecting supply of different kinds of homes (like the zoning decisions that affect large detached homes, small detached homes, condos, or rental apartments get built) and demand for homes (like whether the financial and tax system is set up in a way that encourages buying homes. Haurin writes: "Cross-sectionally, the homeownership rate varies substantially among developed countries (2013 data), ranging from 83.5 percent in Norway to 77.7 percent in Spain, 64.6 percent in the United Kingdom, and 53.3 percent in Germany." If the US wants a higher homeownership rate--and doesn't want to go through another housing price bubble (!)--it needs to think about the policies that might move toward that goal.

Thursday, October 20, 2016

Arnold Harberger: Is Growth Yeast or Mushrooms?

Economic growth would be a socially easier process if it was smooth and even across society: that is, if most people could just get steady raises for doing their same jobs a little better each year. When growth benefits some and not others, or even benefits some while imposing losses and costs of transition on others, then controversies arise.

Arnold Harberger offered a nice metaphor thinking about this difference in his Presidential Address to the American Economic Association back in 1998, entitled "A Vision of the Growth Process" and published in the March 1998 issue of the American Economic Review.  Harberger discusses whether economic growth is more likely to be like "mushrooms," in the sense that certain  parts of a growing economy will take off much faster than others, or more like "yeast," in the sense that economy overall expands fairly smoothly overall. He argues that "mushroom"-type growth is more common. Harberger writes:
"The analogy with yeast and mushrooms comes from the fact that yeast causes bread to expand very evenly, like a balloon being filled with air, while mushrooms have the habit of popping up, almost overnight, in a fashion that  is not easy to predict. I believe that a "yeast" process fits best with very broad and general externalities, like externalities linked to the growth of the total stock of knowledge or of  human capital, or brought about by economies of scale tied to the scale of the economy as a whole. A ''mushroom'' process fits more readily with a vision such as ours, of real cost reductions stemming from 1001 different  causes, though I recognize that one can build scenarios in which even 1001 causes could  work rather evenly over the whole economy. Personally, I have always gravitated toward the "mushrooms" side of this dichotomy. I remember being impressed, when I first saw some early industry estimates of TFP [total factor productivity] improvement, by their tendency to industry concentration."
To put this another way, a lot of the policies for encouraging economic growth--like investing in human capital, technology, infrastraucture, and a supportive institutional environment for innovation--seem to suggest the possibility of broadly shared economic gains. But the economic growth that results will often be often mushroom-like and disruptive, affecting certain industries, localities, and kinds of workers more than others.

Paul Romer, who recently accepted the position of Chief Economist at the World Bank, recently  offered on his blog a summary of the social problem that then arises in a pithy aphorism: "Everyone wants progress. Nobody wants change."

Wednesday, October 19, 2016

How Do the French Do it?

From an economic point of view (and doubtless from other points of view, as well), the French present a puzzle. France is often perceived as having a government that practices heavy-handed intervention into the economy, sometimes known as dirigisme, but it is also obviously a high-income economy and has been a high-income economy for decades. So does this mean that France is less heavy-handed in economic interventionism than its reputation suggests? Or that the French have discovered an especially growth-friendly version of heavy-handed interventionism? How does France manage this balancing act?

Pierre Lemieux tackles this question in his essay "France: The end of the road, again?" in the Fall 2016 issue of Regulation magazine  (pp. 34-41). I was also reminded of an essay by Olivier Blanchard, "The Economic Future of Europe," which often uses France as a specific example an appeared in the Fall 2004 issue of the Journal of Economic Perspectives (where I have labored in the fields as Managing Editor since the first issue in 1987).

Both Lemieux and Blanchard point out that concerns about how the French government has a tendency to overcentralize its power and decision-making go back a long time. Lemieux points out that his was a theme of Tocqueville's back in 1856, in The Ancient Regime and the French Revolution. He also mentioned that in 1970, French sociologist Michel Crozier published The Stalled Society. In 1976, Alain Peyrefitte wrote Le mal français (“the French disease”). Blanchard pointed out that in the year before his 2004 article, two books that made the estseller’s list in France were La France qui tombe (The fall of France), by Nicolas Baverezm and Le desarroi Francais (The French disarray), by Alain Duhamel. Lemieus refers to a book published last year by Gilbert Cette and Jacques Barthélémy published Réformer le droit du travail (Reform the Labor Code).

As a starting point, here's some evidence on the higher degree of regulation in the French economy. Lemieux notes: "Public expenditures amount to 57% of French gross domestic product, the fourth-highest percentage in the OECD, after Greece, Slovenia, and Finland. This compares to 45% for the OECD unweighted average and 39% for the United States." In measures of "economic freedom" for the countries of the world, the US tends to rank around 10th, while France tends to rank around 70th.

However, Lemieux also offers some evidence on the other side: "Not all industries are more regulated in France than in America. The OECD’s Services Trade Restrictiveness index shows France as less regulated than the United States in commercial banking, insurance, broadcasting, and many modes of transport. Even the labor market is less regulated in France with regard to many trades and professions. In the United States, nearly 30% of jobs require a license." Moreover, France (like many other economies) has gradually been moving in the direction of less regulation.

But the area of labor market rules, in particular, is one where France stands out as especially heavy-handed. For example, although only about 8% of French workers are officially union members, 98% of French workers are covered by collective bargaining. Lemieux writes:
"[A]ny firm of more than 49 employees must create a “work council” (comité d’entreprise) chaired by a representative of the owners but composed of trade union representatives and representatives elected directly by the employees. Consultation of the work council is compulsory on many business decisions. Even businesses of 11–49 employees are forced to allow the election of employee representatives. To appreciate the spirit of the 2,880-page labor Code, consider that the French government is currently pushing businesses to negotiate with their workers’ representatives a “right to disconnect,” referring to after-hours work-related electronic communications. The Department of labor, Employment, Occupational Training, and Social Dialogue (why they didn’t add “General Happiness” to the name is a mystery) explains that “the employees of a large firm are not obliged to answer emails outside of office hours.”
As another example, here's a figure about "employment protection" from 2015 OECD Economic Survey of France--basically, how hard it is for a firm to fire or lay off workers. The figure shows the US and Canada off on the far left, with little employment protection, while France is off near the far right.

Lemieux notes: "Because of the cost of firing employees, firms are incited to resort to short-term labor contracts, a loophole that further regulations have tried to limit. In France, a short-term contract may not extend beyond 24 months. The employed work force has thus acquired a dual structure: on one side, the “insiders”—regular workers protected against dismissal; on the other side, the “outsiders,” who survive on short-term contracts and hop fromjob to job. Outsiders make up about 15% of the employed, a proportion that climbs over 50% in the 15–24 age category."

The minimum wage in France is also comparatively high compared to other countries. Here's a figure from a a 2015 OECD report on minimum wages, which shows minimum wages as a percentage of the median wage in the country. Again, the US is off on the left, with a minimum wage about 35% of the US median wage, while France is off near the right, with a minimum wage at about 60% of the median wage.

Here's the unemployment rate in France during the last couple of decades, from the Trading website. It seemed for a time in the early 2000s as if France was making some progress on its unemployment rate issues, even if the unemployment rate had only fallen to a still-unsatisfactory 7.5%. But now the unemployment rate is back up around 10% again, and has been there for three years. For comparison, remember that in the aftermath of the Great Recession, the US unemployment rate peaked at 10% in October 2009, before starting a long glide down to the current rate of 5%. Try to imagine the political turmoil in the US if the unemployment rate was higher now, seven years after 2009. That's the situation in France.

France Unemployment Rate

If you focus only on the youth unemployment rate in France, it's been roughly at 24-26%  since 2009. Of course, France's labor market regulations aren't the only cause of unemployment and lower labor force participation in France, the generally torpid European economy bears a large share of the blame. But the many labor market regulations aren't helping, either.

The result of these labor market regulations is that France is running a high-powered modern economy for many of those who have jobs, but with high unemployment or temporary work for many others. Blanchard offered an interesting summary of the situation in his 2004 JEP essay. The table shows that when looking at GDP per capita, France went a little backward compared to the US from 1970 to 2000. However, if one looks at GDP per hour worked during this time, France  caught up to the US level, while if one looks at hours worked per capita, France started at above the US level in 1970 but then declined to 71% of the US level by 2000.

In short, the French are very productive during their working hours. But the French now work many fewer hours per capita, in part because the labor force participation rate (the share of adults either employed or looking for work) is lower in France, in part because of continuing high unemployment rates, and in part because a number of jobs have more vacation per year than is common in the US.

A couple of warnings about those  high rates of productivity in France should be noted. One is that in the US, lower-wage and lower-productivity worker are more likely to have jobs than in France. As a result, France's higher productivity is in part because a substantial share of those who would tend be the lower-productivity workers (like young workers, for example) just aren't working at all.

The other concern is that productivity in France has in fact started to lag, starting in the mid-1990s, especially if one looks at "multifactor" productivity, which doesn't just divide output by hours worked, but also adjusts for other inputs like capital investment. Blanchard had raised this possibility in his 2004 essay, noting that while the evidence at the time of his writing was not yet decisive, "most observers now believe that we have indeed seen a change in relative trends [of productivity growth in the US and continental Europe], starting around 1995." Lemieux cites other evidence and writes:
"Since the mid-1990s, France and many other European countries (but not the UK) have suffered a widening gap with the U.S. standard of living. During that period, the culprit was the slowdown of multifactor productivity growth, especially noticeable in France. According to another paper by Cette and Lopez, the underlying causes were a slower diffusion of the new information technologies, structural rigidities in labor and product markets, and a less educated working population. From 1995 to 2012, French GDP per capita grew at a meager 1% per year."
None of this discussion should be read as a prediction of doom for the French economy, which  seems certain to remain a high-income economy. But it does suggest that French dirigisme is not cost-free: specifically, the costs in the last couple of decades are measured in elevated unemployment, lower labor force participation rates, a larger number of temporary jobs, and sluggish growth in productivity and the standard of living.

Tuesday, October 18, 2016

Global Debt Hits All-Time High

Global debt is at an all-time high: specifically, "nonfinancial debt," which is the combined debt of governments, households, and nonfinancial firms in the 113 countries that make up 94% of world GDP. The IMF discusses the situation in its "Fiscal Monitor" for October 2016, which is subtitled "Debt: Use it Wisely." The report starts (footnotes and citations omitted):
"The global gross debt of the nonfinancial sector has more than doubled in nominal terms since the turn of the century, reaching $152 trillion in 2015. About two-thirds of this debt consists of liabilities of the private sector. Although there is no consensus about how much is too much, current debt levels, at 225 percent of world GDP (Figure 1.1), are at an all-time high. The negative implications of excessive private debt (or what is often termed a “debt overhang”) for growth and financial stability are well documented in the literature, underscoring the need for private sector deleveraging in some countries. The current low-nominal-growth environment, however, is making the adjustment very difficult, setting the stage for a vicious feedback loop in which lower growth hampers deleveraging and the debt overhang exacerbates the slowdown. The dynamics at play resemble that of a debt deflation episode in which falling prices increase the real burden of debt, leading to further deflation."

A few thoughts about this situation:

1) As the figure makes clear, the real debt issue here involves the US and China. The red dashed line, which shows global debt/GDP for the world not counting the US and China, shows only a modest rise over this period, from about 205% of GDP in 2002 to less than 215% of GDP in 2015. As economies grow and develop, one of the standard changes is that a financial sector develops, too. But if one includes the US and China, the global debt/GDP ratio rises from about 200% in 2002 to 225% in 2015, which is a quite substantial bump (remember, we're talking relative to global GDP here!) in 13 years.

2)  Of course, global averages will conceal a number of individual countries which are above-average or below-average in substantial ways. Compared with historical experience, the private sector in the US and other high-income countries has not been deleveraging as quickly as usual since the end of the recession, but for advanced economies the rise in private debt (as a share of GDP) at least leveled off back around 2010 and has even declined a bit.

At present, the bigger worry should be about rising private sector debt in some large emerging market economies. China's debt buildup poses some real concerns: from 2008-2015, its private nonfinancial debt increased by about 70% of China's GDP; in Brazil, the increase over that time is about 30% of GDP; in Russia, 25% of GDP. As the report notes: "In a few systemically  important emerging market economies, private credit has expanded briskly in recent years. The speed  of the increase dangerously resembles that in advanced economies in the run-up to the global financial crisis."

3) The sector that is accumulating debt is shifting. Before the Great Recession, it was primarily households; since then, it's been primarily government. However, this is a shift that has some economic justification. When a society has built up a lot of private sector debt, and then the economy slows dramatically, one of the ways to help a share of that debt get paid off is to get the economy growing again--and public debt can be a way to do that, at least for a time.

4) There's no simple way out of a situation where private debt has gotten excessive, as the world economy learned during the Great Recession and its aftermath. Getting the economy growing again is a huge help, because it means fewer borrowers will end up in default. When cutting a deal to address problems of debt overhand and bad loans, there can sometimes be a role for government loan guarantees when private-sector actors agree to take losses, but the government puts some limit on how large those losses will be.  Restructuring banks and financial institutions so that they are required to address problems of bad loans in the past and hold more capital against the risks of future bad loans is a help. Once a debt overhang situation has occurred, then helping get the bulk of the debt problem into the rear-view mirror  is a legitimate goal of public policy.

Monday, October 17, 2016

How Clones Can Experience Unequal Economic Outcomes

A certain amount of economic inequality is just luck. At the extreme, some people win the lottery, and others don't. But there is also the potential for more subtle kinds of luck, like two equally talented entrepreneurs, where one business happens to take off while the other doesn't. Or two equally talented workers who go to work for similar-looking companies, but one company takes off while the other craters. Richard Freeman discusses the research literature on why this final example might be significant enough to play a role in overall economic inequality in the US in his essay, "A Tale of Two Clones: A New Perspective on Inequality," just published by the Third Way think tank. Freeman sets the stage like this (footnotes omitted):
"[C]onsider two indistinguishable workers, you and your clone. By definition, you/clone have the same gender, ethnicity, years of schooling, family background, skills, etc. In 2006 you/clone graduated with identical academic records from the same university and obtained identical job offers from Facebook and MySpace. Not knowing any more about the future than the analysts who valued Facebook and MySpace roughly equally in the mid-2000s, you/clone flipped coins to decide which offer to accept: heads – Facebook; tails – MySpace. Clone’s coin came up heads. Yours came up tails. Ten years later, Clone is in the catbird’s seat in the job market — high pay, stock options, a secure future. You struggle. Back to university? Send job search letters to close friends? Ask distant acquaintances to help? The you/clone thought experiment may seem extreme, but recent research that I have conducted with colleagues finds that the earnings of workers with near-clone similarity in attributes diverged so much by the place they worked that rising inequality in pay among employers has become the major factor in the trend rise in inequality. ... The labor market has been dominated by economic forces that pull the wages of firms further apart from each other, motivating our analysis of the role of employers in increasing inequality." 
In other words, a lot of inequality is about where you work. The rise in equality is linked to differences across what firms are paying employees who appear to be similarly qualified. As Freeman acknowledges, this argument that this is a quantitatively important cause of rising inequality isn't ironclad at this point, but it's highly suggested in several ways of looking at the data: Freeman  writes:
"This implies that 86% ... of the trend increase in inequality [from 1977-2009] occurs among people with measurably the same skills, whereas just 14% of the trend increase comes from changes in earnings among workers with different skills. The big surprise in the exhibit is that the inequality of average earnings among establishments increased by the same 0.147 points [measuring variance of natural log of earnings, a standard measure of inequality of earnings] as did inequality among workers with the same characteristics. This suggests that all of the increase in inequality among similar workers comes from the increase in earnings at their workplaces." 
Or here is a figure suggesting a linkage from firm earnings to individual inequality of earnings. The blue line shows the change in individual earnings along the income distribution from 1992-2007. As one would expect, given the rise in inequality, those in the bottom percentiles of the income distribution do worse, while those in the top percentiles of the income distribution do better. But now, notice that the blue line for individual earnings almost matches the orange line for firm earnings. That is, there has also been widening inequality in firm earnings, with those at the bottom of the earnings distribution also seeing a decline from 1992-2007 and those at the top seeing an increase. Freeman also offers evidence that those who stayed at firms have seen their earnings change with the fortunes of the firm--thus contributing to overall inequality. As he writes; "In sum, changes in the distribution of earnings among establishments affect the change in earnings along the entire earnings distribution and the increased advantage of top earners compared to other workers."

What makes it possible for successful firms to pay workers more? The answer must be rooted in higher productivity for those firms. Indeed, productivity seems to be diverging across firms, too.

Indeed, as Freeman emphasizes, this figure shows that the equality of revenue per worker--a rough measure of productivity at the firm level--is diverging faster than inequality of wages across firms. Moreover, Freeman argues that a similar pattern of productivity divergence across firms is happening within each sector of the economy.

 Freeman's evidence is consistent with some other studies. For example, last year I pointed to an OECD report on The Future of Productivity, which argued that while cutting-edge frontier firms continue to see strong increases in productivity, the reason for slower overall rates of productivity is that other firms aren't keeping up.

Thinking about inequality between similar workers may alter how one thinks about public policies related to underlying determinants of inequality. For example, it may be important to think about how productivity gains diffuse across industries and how that process may have changed. I suspect there is also some element of geographical separation here, where firms in certain areas are seeing faster productivity and wage increases, and so thinking about mobility of people and firms across geographic areas may be important, too.

Saturday, October 15, 2016

A Coffee Store Not Aimed At Economists: Bulletin Board Material

For economists, a "cartel" refers to a group of firms jacking up prices to exploit consumers. Thus, I infer that this Arizona-based chain of coffee shops is not seeking the business of economists.

The company's website features comments like "WE ARE CARTEL" and "JOIN THE CARTEL." I know nothing about the company's thinking in using the term. I suppose the use of "cartel" may be an ironic comment on the really big coffee-store chains; or perhaps it just sounded cool; or perhaps the company is trying to emphasize the cooperative nature of what happens inside a cartel, while deemphasizing the costs imposed on everyone outside a cartel. But for an economist, telling a consumer to do business with a cartel is like telling the sheep that it's time for shearing.

Hat tip: Victor Claar spotted this store at the Phoenix Airport and posted this picture on Facebook.