Problems With GDP?

In a New York Times opinion piece, Eric Zencey has written a thought-provoking criticism of gross domestic product as a key measurement of economic activity. If you read this, you’ll see that many of the criticisms are familiar. GDP is inexact, it excludes certain things and activities, it doesn’t take into account certain costs and benefits, it may not accurately reflect economic gains to society, etc., etc., etc. But here’s the deal – we know and almost all economists agree that GDP is a flawed measurement of economic activity. However, the weaknesses and limitations are known, consistent, and predictable. As long as GDP is measured consistently, it is a useful tool for comparisons within a country of economic activity from one time period to another or to a lesser extent comparisons of one country to another.I say to a lesser extent because once we expand beyond a single country, we can’t be as certain that the GDP's were calculated in a similar manner.

Mr. Zencey’s main point seems to be that GDP is not a perfect measurement of a country’s economic well-being. Well duh. That’s why, especially when we talk about economic development, we focus on other measurements such as the Human Development Index, the Poverty Index, measurements of education, health, gender equality, political liberty, and more. Economists know GDP isn’t a perfect indicator of an economy. Again, remember that in basic macroeconomics, we use real GDP, inflation rates, and unemployment rates to get more of a composite view.

I think the big tip-off is that the author isn’t an economist – he’s a professor of historical and political studies.

Hiring Rates and the Recession

Because of this article, I ran across a new statistic called the “hires rate”. It’s compiled by the Bureau of Labor Statistics and is defined as “number of hires during the month divided by the number of employees who worked during or received pay for the pay period that includes the 12th of the month.”


The hires rate is currently at the lowest level ever. So what? It means businesses are afraid. Businesses aren’t hiring. Why not? I suggest two primary reasons: fear of unknown but negative legislation, and already increased costs (taxes) related to hiring. Payroll taxes have risen and are expected to rise more. Unemployment insurance costs borne by businesses are high and go up as businesses hire and then have to lay off employees. So what do businesses do? They avoid the potential costs by not hiring and doing more with fewer employees. Oh well.

And before you blame the greedy employers, weren’t the employers also greedy when the hire rate was at higher levels? Corporations don't just become "greedy" when times are bad. Greed, or self-interest, or the profit motive, is what drives economic activity in good times and bad. You need to be very careful about using the convenient but questionable attack on those “evil” corporations. By the way, didn’t those greedy corporations make the computers you’re using?

The Now Renamed "Health Insurace Reform"

I could basically post multiple things a day about this topic, but it would beat us down and probably interfere with what I want this blog to become. So I'm imposing voluntary self-restraint until such time as news events absolutely compel me to bring it up. On the other hand, it is a hugely important topic and one that will impact our country's economy for a long time to come. So feel free to comment on your own or ask me to comment on specific issues or topics.

My Shiba Inu is Apolitical, Too

Jonah Goldberg, writing today at National Review Online:

The wonderful thing about dogs — and yes, cats too, I suppose — is that they are beyond the reach of ideology. Not only does affection for dogs have no significant correlation to politics, but politics holds no interest whatsoever to dogs.

Talk about health-care reform to Cosmo and he’ll tilt his head, yawn, and walk away just as quickly as he would if you opted to discuss the assassination of Trotsky or the Defenestration of Prague. But if you say the words “tennis ball” or “squirrel,” he will be utterly fascinated.

And that’s what I love about dogs. They just don’t care about such things, and they encourage you not to care either — at least while you’re with them. You can’t say the same thing about children, because they grow up and inherit the society we leave behind. Being a good parent requires caring about politics. Dogs, meanwhile, keep their innocent doggy goodness from kennel to grave, obviating the need to explain to them why tax cuts are awesome.

Nonetheless, I think Krista the Shiba is a supply-sider. If not I may have to make her pay attention to the SmartBoard.

Celebrate! The Recession's Over!

According to a survey of economists (hmm, should I be hurt they didn't ask me?), the Wall Street Journal has declared the recession over. Pardon my skepticism. I realize unemployment is a lagging indicator, but I am still troubled by the unemployment data released this week. The rate went down 0.1%, within the scope of sampling error, but the number of unemployed is increasing. If you remember this is like disinflation - unemployment is still getting worse, but it's less bad than it was. Furthermore, increasing numbers of unemployed coupled with a falling unemployment rate suggests invreasing numbers of "discouraged workers," not exactly a sign of economic health and strength.

We may be at or near the bottom, I'm just not convinced. And I really expect the recovery to be slow to take off, so at best I think we're looking at a very weak economy for many months to come. My IRA hopes I'm wrong.

Are We in a Recession?

One of the educational experiences of my life that has had a lasting and profound effect on my life, philosophical development, and intellectual growth is my law school experience at The University of Chicago Law School. Not only did I get to find out what is was like to live as a Yankee, I was exposed to some amazing and powerful intellects, both among my fellow students and among the faculty. One of my law professors my first year was Richard Posner, who is the intellectual godfather of what is known as the law and economics movement, an effort to analyze legal rules and principles through the lens of economics. During my time at UC Law, he was appointed to the 7th Circuit Court of Appeals, where he still serves while continuing to teach and write prodigiously. One of his outlets is a blog he co-authors with Gary Becker, a Nobel Prize-winning economist at UC. A fascinating thing about their blog is that it is a dialog between them over current topics of interest.

Most recently, Judge Posner posted that while he believes the nomenclature is not important, he feels the current economic situation is severe enough to be considered a depression, not merely a recession. In his view, we are not out of the depression/recession until GDP returns to the long-run trend line (the secular trend line from our economics class) and this may take 2 or 3 more years before we get there. Pointing out what I have said previously about our economic theories' inadequacies, Posner writes:

A number of macroeconomists and financial economists, including leading figures in these important branches of economics, had believed until last September that there could never be another depression, that asset bubbles are a myth, that a recession can be more or less effortlessly averted by the Fed's reducing the federal funds rate, that the international banking industry was robust, and that our huge national debt was nothing to worry about, nor our very low personal savings rate. All these beliefs have turned out to be mistaken, along with influential versions of the rational expectations hypothesis, the efficient-markets theory, and real business cycle theory.

That said he does not fault the government for taking actions inasmuch as we are in uncharted lands where our theories don't fit the facts. But in a sobering conclusion, he writes:

The economy remains imperiled. If the Administration's trillion-dollar health care program is enacted in anything like its proposed form, the costs, on top of the rapidly rising public debt that is the consequence both of the impact of the depression on tax revenues and the costs of the anti-depression programs may create an aftershock to the current depression that will do almost as much harm to the nation as the--I insist on the term--depression itself.

In response though, Professor Becker writes:

The latest output and unemployment figures for the United States indicate that the recession in this country is very probably finally over, given the usual definitions of the turning points of recessions. . . . I am more optimistic about the world and US recovery than the consensus, although I do not expect a sharp expansion during the next few months. . . . So legitimate reasons exist for concern about the speed and strength of the recovery of the American economy. However, I worry much more about various regulations, spending, and controls being introduced by the present Congress and by President Obama than by intrinsic difficulties in the American economy.

Confused? I think this illustrates well how very confusing the current economy is and how difficult it is to chart a course of action when no one is certain what's going on. But the Becker-Posner blog shows how it is possible to have a civil and high-level discourse on the subject.

Inflation or Deflation video

Just found this and I can't stop laughing:

Debt and Deficits

Some of you who know me and endured my classes may remember (if you stayed awake) that I liked to show you the National Debt Clock . (This is a different one, but I think it's pretty cool.) And in class I would generally answer concerns about the size of the debt and deficits to our real GDP, in loose terms the income of the country. My favorite analogy was to compare the country's debt load to that of a homeowner, where higher income people had significantly higher debt loads, particularly on home mortgages, and it was okay because their higher incomes allowed them to adequately service the debt -in other words, they could afford the payments on the debt.

I'm becoming concerned that the National Debt is approaching an unaffordable point. We are now borrowing so much money and running such massive deficits that we may be putting the United States in the same position as the credit card abuser who runs up huge debts and has nno way to erver pay the debts off. And while this trend became somewhat troubling during the Bush Presidency, the acceleration of the spending and piling up of debt which has occurred so far in the Obama Presidency is frightening. Take a close look at this chart:

In today's news, a prominent economist is predicting that the United States will have to default on Treasury Bonds - not pay the debts when they are due. After that, who would lend to us ever again? What about the effect on interest rates? The rate you pay is based in significant part on risk premium, whether the lender believes you'll pay them back. Default, and rates go up. Or do we say this is the US government, let's just print the money? I don't want to become the next Zimbabwe.

I don't have a good feeling about this. The answer seems to me that government spending needs to be controlled, and ways of increasing revenue need to be found. And as I've said before, I don't think the revenue increase is going to come from simply raising taxes on the rich.

Disturbed?

Change Nothing? - John Stossel's Take on Health Care Reform

Change Nothing? - John Stossel's Take

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Economic Blog

One of the blogs I read regularly is written by Keith Hennessey. His economic analysis and arguments are impressive and I recommend him highly if you would like to read more detailed economic analysis, theory, and policy.

Cash for Clunkers?

In class, I follow the traditional appraoch to teaching macroeconomics. We teach a little of the Keynesian aggregate expenditures theory, followed by quite a bit of "fiscal policy". The we do quite a bit of monetary policy. Then, almost as an afterthought, we spend about a single class session on supply side approaches. This is in part a reflection of how the material is ultimately tested by the College Board and partly a reflection of our textbooks.

Personally, I have serious questions about Keynesian fiscal policy, and I have seen and studied much evidence supporting the effectiveness of supply side approaches. But let's see if we can spot one of my major misgivings about Keynesian fiscal policy in the current "Cash for Clunkers" program.

A digression: if I see one of you at Sonic, and I ask you to come dig a hole in my backyard and pay you $100, then tomorrow I ask you to come fill it in and pay you another $100, how is our economy enhanced? Where is the economic growth? All we have done is transfer $200 from me to you, without there being any economic substance or growth.

If the government pays you $4,500 for your car so that you can buy a new car and insists that your old car be destroyed, how is that any different in substance from my hole-digging analogy? What have we done other than transfer money from the government to the car manufacturers indirectly through this program? Yes, the auto manufacturers employ workers and pay them, but by destroying the traded in cars, we eliminate the potential of real economic growth. Maybe GDP will grow in the immediate time-frame, but how much of this represents purchases that would have occurred in the future? We are time-shifting economic activity, not creating growth.

That's my fundamental problem with most fiscal policy solutions. By having the government increase its spending, it is spending money that taxpayers would otherwise spend on their own. The money the government spends is taken away from taxpayers (or printed - see the post below on inflation) and therefore the taxpayers don't get a chance to spend it on what they want or need. An editorial I read recently in the Wall Street Journal suggested that the logical extension of this is the government should give us incentive payments for other things we buy so that we'll buy them now rather than deferring our purchases - makes as much sense as paying you to dig and then fill in holes in my yard.

Taxes?

Remember during the Presidential campaign? Remember how then-candidate Obama said 95% of Americans would see a tax decrease?

One of the major disputes between Keynesian and Supply-Side economists is the relative roles of government spending and taxes. Both sides see tax decreases as expansionary, with the arguments over the size and mechanics of how tax decreases work to stimulate an economy. Supply-siders focus on incentives and rely on what is sometimes characterized as "trickle-down" while Keynesians argue that tax decreases increase disposable income, thereby increasing consumer spending (as influenced by the marginal propensity to consume).

I think both economic perspectives would see a tax increase as contractionary, not expansionary. Traditional Keynesians see a government spending increase accompanied by a tax increase as being only slightly expansionary.

In any event, despite claims during the campaign that his planned spending increases would necessitate tax increases which were adamantly objected to and refuted by the candidate, the President has now sent his top economic advisors on a round of Sunday talk shows to float the idea that middle class tax increases may be necessary. Let's see: unemployment is still rising and the recovery, if we have reached bottom, is weak, so let's raise taxes. Campaign on no tax increases, then increase taxes. Does anyone remember George H.W. Bush (Bush 41) and his statement "Read my lips, no new taxes"? After going back on that pledge, he became a one-term President as Bill Clinton pointed out over and over "It's the economy, stupid."

Those who don't remember history are doomed to repeat it. Or is it merely hubris?

Health Care - Reopening a Can of Worms

I'm back, and I think I'm ready to stir things up a bit. So let's talk health care (since Congress is wisely slowing the runaway train of reform down a bit).

It's commonplace to hear how the American health care system is unfair and in need of reform. If you listen to the politicians and major media, you come away convinced that our system is so deeply flawed that we need massive changes, and there is a sense that only government can be trusted to fix it.

From a simplistic economic standpoint, I tend to believe strongly in the efficiency of a free market system, with government involvement only to set fair playing rules for competitors in the market and to deal with what are known as externalities or market failures - situations where for one reason or another the market does not work correctly or efficiently. One of those market failure situations that we all inherently understand is a monopoly - where a single seller controls a market. We instinctively sense that the imbalance of market power causes problems - inefficiency, reduced output, higher prices, "supernormal profits", etc. I'm not sure why we don't have the same instinctive distrust of what is known as a monopsony - a market characterized by a single buyer. The economic arguments for inefficiency are simply the mirror image of a monopoly, yet there is a hue and cry for a monopsony in health care: the "single payer option" with the government as the single payer. In addition to the libertarian distrust of government that I have, I have a further economic problem with such an inefficient solution to a problem that I truly believe is overstated.

Why do I say it is overstated? Consider the following article: http://www.ncpa.org/pub/ba649

I strongly recommend that you read and consider the points being made there before you declare our system irretrievably broken. Some of you have questioned my sources at times - I think the sourcing and documentation of this report are impressive. Don't assume all conservative viewpoints are flawed and incorrect. Read and think for yourselves.

What's the problem with our system? In my opinion the flaws are explainable by my free-market economic approach: for a market to work, consumers and producers must be free to communicate with each other through the market and price mechanism. They aren't, because distortions created by wage controls many years ago and continued by tax laws have led to a system dominated by the insurance companies. In other words, the producer (hospitals, pharmaceutical companies, doctors, etc.) do not deal directly with consumers (patients) because the bulk of payment now is made by the insurance companies. So we have separated the payer from the consumer, a situation which almost always distorts market incentives and responses.

Rather that create a single payer system, we should instead focus on the economic source of the problems, the break created by the insurance companies' dominant role. As for people who are unable to afford or receive adequate healthcare, there are other, less intrusive, less expensive ways to see that they share the benefits identified in the article I linked to above. Let's not throw the baby out with the bath water.

Inflation or Deflation? Pick your Poison.

The Wall Street Journal today has an article titled "Global Deflation Pandemic Begins to Brew". It talks about falling price levels in Europe and even in China. The article concludes by saying:

"But if deflation does take root, it could prove devastating for investors. Deflation can cause stock prices to decline as companies are unable to boost prices; corporate bonds also suffer from rising bankruptcies.

Behind a global deflation virus is a collapse of demand in the U.S. Unless the economic engine in the U.S. can get cranking again, deflation could keep spreading."
As I was told once at the Federal Reserve Bank, "inflation bad, deflation badder." Could we really be facing a worldwide deflation? And if so, what would that mean to our decisions to spend and save? What about mortgages on houses that lose value? If you didn't like what has been called the bursting of the housing bubble and that is a key cause of our current recession, what becomes of the US and world economy when it expands and spreads?

On the other hand, look at this graph:



This is scary. If inflation can be caused by increasing amounts of money chasing a constant amount of goods, and if our national production levels are not increasing, we're building a tremendous monetary pressure that seems to have the possibility of causing hyperinflation. This almost looks like a Zimbabwe situation shaping up.

I wish I had the answers. I just know I get to teach a fascinating subject now and for the next few years, even if none of my theories work anymore.

Granholm Flunks Econ 101

This in from National Review Online's "The Corner":

Granholm Flunks Econ 101

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Global Warming? Cap and Trade?

As many of you might recall, I am something of a global warming/climate change skeptic. While I agree that the climate does change, and I agree that human behavior has some effects on climate, I do not accept the sometimes claimed "consensus" that we are experiencing problematical global warming (hence the change in terminology to the more generic and less restrictive "climate change") or that the major cause of the change is human activity. This is simply too complex for these simplistic approaches, and there is legitimate scientific evidence that there are other, many times naturally-occurring, causes for the reported climate changes.

Today, I ran across the following: A study challenging the "consensus" and an estimate of how much money we have spent so far on this issue. And we face the potential of even more costs through the costs of the Cap and Trade legislation passed by the House and still on the legislative agenda.

Complex issues deserve careful, serious, deliberate thought; let's be sure we know the problem before we try to fix it in an expensive manner.

Update: And India, after Secretary of State Clinton apologized for America's contribution to global warming, shows it is not impressed: Financial Times says India Widens Climate Rift with West.

You've Got a Raise!

One of today's news stories is that the federal minimum wage increases today to $7.25. Here's one of many links to this story: http://www.ajc.com/business/minimum-wage-hike-kicks-99639.html?cxntlid=homepage_tab_newstab The increase has been scheduled since 2007, and minimum wages are always open to economic debate. Do they help low income workers? Do they lead to layoffs and cut backs in hours? The simple analysis suggests that when the price of labor increases, the quantity supplied will increase. But as the price increases the quantity demanded will decrease, leading to a surplus of low-income labor and layoffs or firings. Then as the higher "bottom wage" increases other wages will have to rise as well, leading to more problems. The current discussion and projections from the government seem to suggest that the higher wages received (by those who are fortunate enough to keep their jobs) will generate so much additional revenue that consumer spending will increase, jobs will be created, and there will be little negative effects from this increase.

In fact, there are those in government already suggesting that the minimum wage needs to be raised and raised until it reaches the $10 per hour range. I wonder if this is a good time for such a move - there is still trouble on the unemployment front: http://www.google.com/hostednews/ap/article/ALeqM5iHJXWDtrvHB8s3w0SfjAJYB0ZVpQD99KA1OG0 This suggests that scheduling these increases to occur in the future without foreknowledge of economic conditions that will be in place is a risky way to pass laws. Who suspected in 2007 that we would be facing these economic conditions in 2009? If anyone did, they should have been able to profit handsomely!

Anybody directly affected by the increase? Did you get a raise? Did you get fired? Did your hours get cut? Too soon to tell? On a broader front, should we have a minimum wage law? Does the underground economy where people will work for less than the legal minimum tell us anything?

What Do We Teach?

A few times last year, I mentioned the difficulty of trying to teach economics, particularly macroeconomics, at a time when all of our theories were falling apart. Economics has always been difficult for many because it is so theoretical and so dependent on simplifying but often unrealistic assumptions. However, it was a subject where the theories worked and made general sense - I'm sure you remember me saying that economics is really all about common sense.

But what do we do when the common sense disappears from the system? What do we teach when none of our theories seem to apply and none of our tidy policy solutions seems to work? In many ways this is a fascinating time for economic study, because it is a time like the 1930's when failures of our theories are causing us to reevaluate and refine our analysis. Does Keynesian fiscal policy work in this environment? Did it really work in the 1930's New Deal, or was that an illusion when the true economic recovery was due to other causes? I often have said the National Debt of the United States seemed manageable and appropriate to the size of our economy - that was before the deficit ballooned to unheard of levels. The past decades gave us confidence in monetary policy solutions to our problems, but the Federal Reserve Bank may have prolonged and enhanced the Housing Bubble as it tried to stave off deflation, while misreading the economic indicators in the first place. How do you conduct expansionary monetary policy when real interest rates are near zero? If the Fed injects massive quantities of money into the money supply to cause the economy to expand, can we really trust them to prevent the inflation that is poised to occur if the economy recovers? Do the facts support a supply-side, neo-classical approach, or were the policies of the past 15 years merely "pseudo-supply-side" and thus not helpful to our analysis? Do the supply side policies lead to social issues and how do we weigh those issues in our cost-benefit framework?

I have a lot of thoughts and ideas, but I certainly don't have the answers. I'm sure that my perspective as a 52 year old is very different from those of you who are very much younger. As I said, I wasn't sure how to teach theories that seemed to be crumbling around me by the minute. The picture above is from the cover of the Economist magazine's July 18th issue. In that issue, it says: " . . . a broader change in mindset is still needed. Economists need to reach out from their specialized silos . . . . For in the end, economists are social scientists, trying to understand the real world. And the financial crisis has changed that world."

What do you guys think?