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On Monday, Jim Pethokoukis appeared on CNBC to discuss recent statements by Hillary Clinton, the middle class, and the income gap. Watch the video below to hear his thoughts on how Clinton will approach income inequality.
View related content: Pethokoukis
I sometimes ask people how far back in time they would be willing to live. Most certainly don’t want to live before anesthesia. Pre-telephone and pre-television also seem to be no-go zones for most people, too. Along the same lines, the WaPo’s Matt O’Brien offers this thought experiment as way of framing the issue of middle-class income stagnation:
Adjusted for inflation, would you rather make $50,000 in today’s world or $100,000 in 1980’s? In other words, is an extra $50,000 enough to get you to give up the internet and TV and computer that you have now? The answer isn’t obvious. And if $100,000 isn’t enough, what would be? $200,000? More? This might be the best way to get a sense of how much better technology has made our lives—not to mention the fact that people are living longer—the past 35 years, but the problem is it’s particular to you and your tastes. It’s not easy to generalize.
This gets at the economic issue of consumer surplus, or the “monetary gain obtained by consumers because they are able to purchase a product for a price that is less than the highest price that they would be willing to pay.” A recent Goldman Sachs note made mention of this in relation to whether the rise of the digital economy means we are mismeasuring GDP:
How important is this issue for GDP measurement? Hard evidence is again hard to come by, but Erik Brynjolfsson and Joo Hee Oh estimated in 2012 that the growth in time spent on free internet sites between 2007 and 2011 created incremental consumer surplus worth ¾% of GDP each year. Although the uncertainty around these types of estimates is obviously very large, as the authors acknowledge, we do think it is plausible that increased new products bias could be holding down the measured real GDP growth rate by a meaningful amount.
I think the consumer surplus from the Internet is quite high. Is an additional $50,000 enough for me? Given how much the IT revolution helps me do my job and live a more intellectually stimulating life — and a more convenient life — I don’t think so. Then again, my own answer to that first question, “Last week.”
During her presidential announcement speech yesterday, Hillary Clinton offered this interesting explanation for the Financial Crisis:
We’re still working our way back from a crisis that happened because time-tested values were replaced by false promises. Instead of an economy built by every American, for every American, we were told that if we let those at the top pay lower taxes and bend the rules, their success would trickle down to everyone else.
What happened? Well, instead of a balanced budget with surpluses that could have eventually paid off our national debt, the Republicans twice cut taxes for the wealthiest, borrowed money from other countries to pay for two wars, and family incomes dropped. You know where we ended up.
Tax cuts? Inequality? Budget deficits? I have heard this story before. It is highly unpersuasive, as I argued in a 2012 blog post with one of my favorite ever headlines, “Obama didn’t end the Great Recession that Bush didn’t cause.” Don’t believe me? Trying reading any of the opinions in the Financial Crisis Inquiry Commission report. They seems to blame banks and regulators and government agencies and credit raters and so forth. Interestingly, here is one of Time magazine’s “25 people to blame for the financial crisis”:
Bill Clinton. President Clinton’s tenure was characterized by economic prosperity and financial deregulation, which in many ways set the stage for the excesses of recent years. Among his biggest strokes of free-wheeling capitalism was the Gramm-Leach-Bliley Act, which repealed the Glass-Steagall Act, a cornerstone of Depression-era regulation. He also signed the Commodity Futures Modernization Act, which exempted credit-default swaps from regulation. In 1995 Clinton loosened housing rules by rewriting the Community Reinvestment Act, which put added pressure on banks to lend in low-income neighborhoods. It is the subject of heated political and scholarly debate whether any of these moves are to blame for our troubles, but they certainly played a role in creating a permissive lending environment.
A decade after U.S. home sales peaked, 15.4 percent of owners in the first quarter owed more on their mortgages than their properties were worth, according to a report Friday by Zillow Inc. While that’s down from a high of 31.4 percent in 2012, it’s still alarmingly above the 1 or 2 percent that marks a healthy market, said Humphries, the chief economist at the Seattle-based real-estate data provider.
Worse yet: The pace of healing is losing steam. The blotch stains the economy by restraining the housing recovery and by preventing the job market from becoming even more vigorous. It also will probably exacerbate wealth inequality for years to come as homes valued in the bottom third of the market are more likely to be underwater.
Right. Six years into the Not-So-Great Recovery and we are still feeling the effects of the downturn. Recall this recently from Ken Rogoff:
However, there has been far too much focus on orthodox policy responses and not enough on heterodox responses that might have been better suited to a crisis greatly amplified by financial market breakdown. In particular, policymakers should have more vigorously pursued debt write-downs (e.g. subprime debt in the US and periphery-country debt in Europe), accompanied by bank restructuring and recapitalisation. In addition, central banks were too rigid with their inflation target regimes. Had they been more aggressive in getting out in front of the Crisis by pushing for temporarily elevated rates, the problem of the zero lower bound might have been avoided. In general, failure to more seriously consider the kinds of heterodox responses that emerging markets have long employed is partly a reflection of an inadequate understanding of how advanced countries have dealt with banking and debt crises in the past.
More on alternative policy in this post: “Was not massively helping underwater homeowners a massive mistake?”
Is there really a Great Stagnation? The problem of measuring economic growth in America’s digital economy
Last month, Goldman Sachs economists Jan Hatzius and Kris Dawsey put out a research report arguing US government statistics understate GDP growth because they understate productivity growth. Over the past five years, productivity growth has averaged 0.6% annually vs. 2.6% over the prior 15 years. Here’s the gist of Goldman’s argument in “Productivity Paradox v2.0”:
— Measured productivity growth has slowed sharply in recent years, and we have reduced our working assumption for the underlying trend to 1½%. This is the same sluggish rate that prevailed from 1973 to 1995 and stands well below the long-term US average of 2¼%. The proximate cause of the slowdown is a slump in the measured contribution from information technology.
— But is the weakness for real? We have our doubts. Profit margins have risen to record levels, inflation has mostly surprised on the downside, overall equity prices have surged, and technology stocks have performed even better than the broader market. None of this feels like a major IT-led productivity slowdown.
— One potential explanation that reconciles these observations is that structural changes in the US economy may have resulted in a statistical understatement of real GDP growth. There are several possible areas of concern, but the rapid growth of software and digital content—where quality-adjusted prices and real output are much harder to measure than in most other sectors—seems particularly important.
— Specifically, we see reasons to believe that the well-known upward biases in the inflation statistics related to quality changes and the introduction of new products are particularly severe for software and digital content. Quantifying the effects is difficult, but it is not unreasonable to think that they could offset a substantial portion of the measured productivity slowdown.
— Our analysis has three practical implications. First, confident pronouncements that the standard of living is growing much more slowly than in the past should be taken with a grain of salt. Second, given the uncertainty around GDP, it is better to focus on other indicators—especially employment—to gauge the cumulative progress of the recovery and the remaining amount of slack. And third, true inflation is probably even lower than measured inflation, reinforcing the case for continued accommodative monetary policy.
Yesterday, JPMorgan economist Michael Feroli and Jesse Edgerton offered a direct counter in the cleverly titled “Do androids dream of electric growth?”:
— Slowing economic growth has prompted speculation that the data aren’t capturing the digital economy
— For this explanation to work one needs to demonstrate that measurement issues are getting worse over time
— There is evidence that there are measurement issues, but little evidence thus far that they are getting worse
— The conjecture that the recent growth slowdown is due to mismeasurement has little empirical support
So two big issues for Goldman. First, calculating the “overall amount of “consumer surplus” for new products is hard. This is an especially troublesome measurement when dealing with “free” digital content. Hatzius and Dawsey: “How important is this issue for GDP measurement? Hard evidence is again hard to come by, but Erik Brynjolfsson and Joo Hee Oh estimated in 2012 that the growth in time spent on free internet sites between 2007 and 2011 created incremental consumer surplus worth ¾% of GDP each year. Although the uncertainty around these types of estimates is obviously very large, as the authors acknowledge, we do think it is plausible that increased new products bias could be holding down the measured real GDP growth rate by a meaningful amount.”
Second, inflation statisticians are better at doing quality-adjustments for computer hardware rather than software. Measured prices of the latter have declined only fraction of the former. [See chart below.] As Hatzius and Dawsey memorably put it, “How much better is Grand Theft Auto V than Grand Theft Auto IV?” Tough to know.
JPMorgan sees things differently. First, while Feroli and Edgerton concede we may be chronically undermeasuring productivity, they are skeptical that bias is getting worse. Cellphones, email, and Internet existed before the Great Recession. The digital economy is not new, but the productivity slowdown is. And do today’s technological advances present “thornier challenges for price measurement than did the introduction of televisions, air conditioning, washer/dryers, electric guitars, dishwashers, microwaves, VCRs, game consoles, and all the rest of the decades-long parade of once-amazing new products that have continually improved living standards”?
Second, why focus on how, say, Uber is an undercounted quality improvement but ignore opposite examples like how airline seats are smaller and delayed departures have increased? Feroli and Edgerton: “Quality-adjusted airfares have likely been increasing much faster than the reported data. Other examples abound. We should be cautious about cherry-picked arguments.
Third, the productivity slowdown is also seen in industries that are eaier to measure, such a manufacturing.
So who is right? I think the honest answer is that we aren’t really certain, though I do know that Goldman’s conclusion syncs with the innovation and productivity research of AEI’s Stephen Oliner. More research is needed and, thankfully, is on the way. Policymakers should hope that Goldman is right but act as if JPMorgan is right and pursue needed reforms in areas such as education, immigration, entrepreneurship, and basic research.
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The red ink is drying up. The WSJ:
The U.S. budget deficit narrowed further in May as revenue continued to rise faster than expenses have in the past year, the Treasury Department said Wednesday.
The budget picture has improved this year amid higher tax revenue and stronger economic growth, even though government spending has also increased. Revenue for the fiscal year, which began in October, is running 9% ahead of the year-earlier levels, while government spending is up 6%.
In the past 12 months, the budget deficit has fallen to $412 billion, down from $460 billion in April and $491 billion a year earlier. That marks the lowest 12-month deficit since August 2008.
The brighter budget outlook means the deficit could come in below projections made by analysts just a few months ago. The Congressional Budget Office forecast in March that the federal deficit would rise to $486 billion this year, from $485 billion last year.
The U.S. ran an $82 billion deficit in May, a month in which the government has almost always run a deficit in recent decades. The government collected $212 billion in receipts, up 6% from a year earlier, and spent $295 billion, essentially unchanged after adjusting for calendar differences.
An interesting point from Potomac Research:
FEDERAL RECEIPTS CONTINUE AMAZING TREND:Budget data released yesterday showed a sharp drop in the deficit in May compared to last year, but some of that was because of a calendar quirk. The big news is that that receipts have grown by 8.6% in the first eight months of the fiscal year — an astonishing rise, obviously not anticipated by the clueless Congressional Budget Office. The bean counters soon will revise their deficit estimates downward; red ink will fall to 2.5% of GDP this year, and is headed even lower in the next few years. Yes, spending is rising — but revenues are surging, that’s the real news.
View related content: Pethokoukis
At AEI’s recent event, “The science of early learning,”Dr. Jack Shonkoff, director of Harvard University’s Center on the Developing Child, proposed that the current discussion of early education is stuck on universal pre-K for 4-year-olds, partisan funding squabbles, and a demand for instant results. Instead, he observed, we ought to approach closing the achievement gap the way medical researchers developed effective treatments for childhood leukemia, which turned it from a death sentence into a treatable disease. Although the process of creating successful early education programs is in many ways more complicated than treating a disease, we must nevertheless behave like medical researchers by focusing on innovative scientific research, persevering through failures, and refusing to declare victory too quickly.
Science is nonpartisan, Shonkoff pointed out as he presented the basics of childhood brain development. According to empirical evidence, young children learn through “serve and return interactions” where they internalize and eventually mimic adults’ behavior. During this process, neural circuits connect and strengthen with use, while unused circuits are pruned away. According to Shonkoff, children require a positive relationship with an adult for the growth and reinforcement of the neural circuits that which memory, language, and literacy are based on.
This child-adult relationship matters even more to children in high-risk environments. Toxic stress, or the continuous activation of the stress response system that many low-income children experience, spells disaster for brain development. When the stress response system is activated, the heart rate increases and adrenaline and other hormones are sent through the body. Ideally, a caring adult will calm a stressed child, but in situations of neglect and abuse, a child’s stress response system will remain activated, and the continuous stream of stress hormones will damage valuable neural circuits. Therefore, the presence of at least one supportive adult in a child’s life is absolutely necessary to a child’s brain development, especially in high-stress environments.
According to Shonkoff, evidence points to a need for early childhood programs (such as parent education or offering quality childcare) that create supportive, consistent child-adult relationships for low-income, at-risk children, so that those children will develop the neural pathways upon which literacy and language are built. Scientific research must become our common ground. Innovators require an environment where they can take risks without fear of losing funding. In such an environment, researchers will assess their mistakes and move forward, rather than ignoring their studies’ shortcomings in order to stay in business.
According to Dr. Shonkoff, programs that survive the refining research process should not be universally expanded, but scaled in communities and among populations for which they work. We need a “portfolio of interventions,” he says, that are scientifically-based, innovation-driven, and under constant revision.
Natalie Runkle is an editorial intern at AEI.
View related content: Pethokoukis
Not long ago, BlackRock boss Larry Fink wrote a really good McKinsey essay about the plague of “short-termism” in both the public and private sector. The former is perhaps more obvious than the latter, what with America’s massively unfunded entitlement system, inadequate infrastructure, and anti-investment tax code. But Fink didn’t spare Corporate America, focusing on the trend of companies choosing to return cash to shareholders — either as dividend payouts or share buybacks—rather than reinvesting those funds in research or new capital equipment. Fink seems to see both activist investors and the tax code as complementary factors driving this trend:
This wholesale return of cash to shareholders helps explain why equity markets are outpacing the economy. In the short run, we are rewarding shareholders, which causes the stock to spike. But to the extent that those cash expenditures starve corporate investment, the economy suffers. In particular, people who are riding the current wave will pay for it later when the ability to generate revenue in the long term dries up because of the lack of investment in the future.
It’s hard for even the most dedicated CEO to buck this trend. I do believe most CEOs would rather be making investments for the long-term growth of their companies. I don’t think they’re all motivated just to protect their jobs, but the government is not providing an environment that encourages those very long-term investments.
We should be using the tax code to change this behavior, not reinforce it. For example, another form of short-termism that makes it difficult for companies to focus on long-term strategy is the constant pressure to produce quarterly results. Where does that pressure come from? It comes from investors who are renters, not owners, who are going to trade your stock as soon as they can pocket a quick gain—or sooner if there’s no such gain in the offing. But what if we made three years rather than one the holding period necessary to qualify for capital-gains treatment and at the same time brought down the capital-gains tax for each year an investor held, perhaps reducing it to zero at the end of ten years? And on the other end, what if we taxed capital gains at an even higher rate than for ordinary income if the stock was held for less than six months? These measures could quickly help to enlarge the population of engaged investors willing to ride out short-term slumps to better position the company for the long haul.
The buyback issue is one that Washington is aware of, as a new Goldman Sachs note points out:
Stock repurchases continue to grow and have begun to attract political scrutiny. Buybacks have increased throughout the recovery, totaling over $500 billion in 2014 among S&P 500 companies and representing more than one-third of cash use and about half of earnings . Our equity strategists expect buybacks to rise to around $600 billion in 2015.
Some lawmakers have linked share repurchases with stagnant wages and a lack of business investment and have recently begun to call for regulatory changes to constrain repurchase activity. The two most obvious avenues for policy change would be securities rules related to the transactions themselves, or tax changes that increase the relative cost to corporations of buying back their own stock instead of paying dividends or making investments in productive capital.
What might the politicians do? Well, the Fink solution of tinkering with investment tax rates doesn’t seem to be in play. Some Democrats, such as Elizabeth Warren, want the SEC to consider changing its 1982 rule giving companies “safe harbor” to repurchase their shares without being charged with stock manipulation. Another possibility would be to alter corporate income tax provisions. Goldman notes that some buybacks are funded by debt issuance, and debt interest is tax deductible. In addition, “the increased importance of compensation through stock options may have contributed to the increase in share repurchase activity, as firms repurchase stock to offset the issuance of options-related shares. Stock option related costs are often deducted from taxable income as a compensation expense.” Some Democrats want repeal the tax deductibility of “performance-based” pay in excess of $1 million per year.
The politics here could get more interesting during the presidential campaign, and when the Obama White House nominates two SEC commissioners. Then there’s the question of whether fewer stock buybacks would actually boost investment. Goldman calculations suggest the effect is “unclear” but “seems likely to be small.” Here is how the firm figures it:
… the relationship between capital return and investment in any given period is fairly loose; each percentage point increase in capital returned to shareholders is associated with 0.04pp slower capital investment growth, suggesting that the 13% increase in buybacks and dividends that our equity strategists forecast would be associated with capital investment growth roughly 0.5pp slower than if no payouts were made, or about 0.1pp slower than if companies grew combined dividends and buybacks by 10% as they did in 2014.
Some related reading:
— “The Repurchase Revolution” – The Economist
— “Profits Without Prosperity” – HBR
A new ECB study argues, the Wall Street Journal explains, “that it is generally a good idea for countries that need to enact budget cuts and slash fiscal outlays to get it done quickly, as this can reduce the total fiscal pain and stabilize debt more quickly.”
Now this is more or less the opposite of what the IMF recently argued. Indeed, the ECB study will be portrayed as pro-austerity vs. the anti-austerity IMF report. Germany might like the former, Greece the latter. That sort of thing. But note this bit from the ECB paper:
The medium to longer-term benefits of well-designed fiscal consolidation are typically accompanied by short-term costs in the form of output losses. However, since sound government finances are a prerequisite for price and macroeconomic stability and, consequently, for strengthening the conditions for sustainable growth, the long-term benefits of achieving such goals outweigh the short-term costs.
In other words, although austerity can have longer-term gains, don’t expect to avoid short-term pain through some sort of “cut to grow” or “expansionary austerity” mechanism. This very much syncs with recent research from economist Alberto Alesina, perhaps the most noted proponent of the idea that fiscal retrenchment can boost growth. In the paper “Austerity in 2009-2013,” Alesina finds that austerity measures “based upon cuts in spending are much less costly, in terms of output losses, than those based upon tax increases.”
So if you are looking to cut debt, spending cuts hurt economic growth less than tax hikes. While both pull demand from the economy, one is less distorting of incentives to work, save, and invest. But there is some pain either way, one reason that fiscal austerity should be accompanied by offsetting monetary policy, as seems to have happened in the US in 2013.