Relevant and even prescient commentary on news, politics and the economy.

Brad Delong does not see a sign for low path of potential GDP

Brad Delong wrote today…

“There are no signs in the pace of technological progress, in the level of investment, in the pace at which the American labor force educates itself, in measures of capacity utilization, in signs of upward wage pressure due to labor quality bottlenecks, or in surging commodity prices due to supply bottlenecks to suggest that the path of growth of U.S. sustainable potential GDP is materially lower today than was believed back in 2007.”

But there is a sign and I have showed this before on Angry Bear blog (and here too)… A lower labor share of income will result in a lower equilibrium level of GDP. It does not matter if the economy is functioning perfectly. A lower labor share of income will create a dynamic to lower the equilibrium level of GDP.

Brad Delong is completely missing this…

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Another Mail Provider Shuts Its Doors

Following the lead of Lavabits, Silent Circle is closing down its business. Unlike Lavabits, it has not been told to provide access to customer data; but, Silent Circle sees the handwriting on the wall. It can no longer provide secure and private.

As an article within Silent Circle points out, metadata cannot be encrypted or protected. The header of all email includes such unprotected data as the name of the host that connected, the IP address of the sender as well as the IP address of the receiver, the encryption status of the message, the type of cipher and its size, date and time sent, etc…. Assuming the actual message was not viewed–a perhaps unwarranted assumption–, the problem is that the size and scope of the snooping is so enormous that a great deal of information can now be inferred by simply knowing, for example, the number of times you emailed specific persons, the size of the emails….and so forth.

With the tapping of backbone internet providers, interested parties can now see all traffic on the internet

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The Elderly May Not Be As Taxing As Generally Thought

by Linda Beale

The Elderly May Not Be As Taxing As Generally Thought

One of the common assumptions about health care costs (and the costs of benefit programs like Medicare) has been that the increasing life spans of Americans will result in significantly greater health care expenses.  It is common knowledge that much of the highest cost medical care occurs near the end of life, as the elderly need more medicines and assistance in daily living.  So speculation has suggested that as Americans live longer, health costs will increase correspondingly.

A recent study provides a glimmer of good news–apparently, most of the highest medical care costs occur in the last year of life, even for those that are living longer.  That means that the longer lifespans aren’t translating into more time in intense medical care, but rather more years of generally healthy and active lifestyle followed by a similar duration of end-of-life care.  See Michael Fitzgerald, Old Age May Not Ruin Medicare Budgets After All, (Aug. 22, 2013).

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What’s wrong with Economath ?

Well here goes. I am going to claim that Paul krugman’s work on imperfect competition, increasing returns and trade was a step backwards from the earlier literature. I will attack Krugman from what is considered the left. In any case, I am definitely criticizing him for excessive orthodoxy. I base my case on the work of notorious red Larry Summers (OK really on the work of the less notorious red Larry Katz). This radical way beyond Krugman stance is a description of a paper written by my two PhD supervisors.

Krugman (my bold)

Yes, there was an old tradition arguing that increasing returns made the case for infant-industry protection; underlying this tradition was the intuitive notion that increasing-returns industries are the “good stuff” you want to get, and keep away from other countries.

But that was not at all the point of New Trade Theory, which ended up suggesting that concentration of production due to increasing returns is generally beneficial to importers as well as exporters of increasing-returns goods, that it generally reinforced the case for open trade, rather than undermining it. (See the summary here (pdf)). And while there were a few people who got that point before the models — Bela Balassa was right on point — there weren’t many. It turned out — and still turns out — that people’s economic intuition, if untutored by models, missed a major possibility that is in fact probably the main story.

Ah “probably” may be a word rather like “might”. The discussion might be improved if people were required to write a number when they write probably as in “probably (by which I mean the probability is at least 70%)”. Most of the time the word is used, it has nothing to do with mathematical probability. Basically it has two meanings “plausibly” and “approximately certainly”. Roughly it is used to argue that if I can explain how something might be true, I can assume that it is true and consider the claim it is false to be an error.

Note how Krugman’s claim that a little math improves thought is all argued with weasel words (bolded). There is no reference to evidence. There is certainly no claim that no model can be written in which the older view makes sense. Such models have been written (for example by Krugman).

My main objection is that Krugman’s models included the assumption that the labor market clears. This means there is full employment (because the question being addressed is not unemployment) but also that the same worker would get the same wage if he or shee worked in a different sector. One mostly harmless assumption is that there are no compensating differentials (all work is equally unpleasant). The key assumption is that there aren’t labor market rents — that there aren’t good jobs which pay good wages and bad jobs which pay bad wages (so either workers are indifferent between working in an auto plant and a McDonalds or McDonald’s workers lack some skill needed to assemble autos).

This assumption is absolutely standard in the economics literature, with one exception. No ordinary person doubts that there are good and bad jobs and workers in bad jobs qualified to do the good jobs. The glaring exception in economics is the literature on wages and, in particular, sectoral wage differentials. That literature shows evidence for the non-economist’s view which overwhelms everyone except for the genius (Kevin Murphy) who can reconcile any possible data with a market clearing model.

Now imagine a model in which some jobs are better than others because they pay higher wages. Imagine that jobs in heavy industry are better than jobs in light industry (steel mills vs textile mills) In this case, infant industry protection can benefit the protecting country, because it gets more of the good jobs and less of the bad jobs. This is the conventional idea of the economically illiterate man in the street. The key issue is whether jobs in high wage industries are better for the same worker (they would not be if they just compensate for say greater risk or if workers in low wage sectors are not capable of doing the jobs in high wage sectors). The evidence is overwhelmingly on the side of the economically illiterate man in the street.

This is not a new argument, nor is it one that hasn’t been made by famous economists. In this post I can’t pretend to be a daring radical breaking with the orthodoxy which I was taught, because the paragraph above is a summary of a small part of the work of my PhD supervisors Larry Katz (who did most of the work) and Larry Summers (yes that Larry Summers)

Can Inter-Industry Wage Differentials Justify Strategic Trade Policy?
Lawrence F. Katz, Lawrence H. Summers
NBER Working Paper No. 2739 (Also Reprint No. r1308)
Issued in November 1989
NBER Program(s): ITI LS IFM
This paper examines the relationship between labor market imperfections and trade policies. The available evidence suggests that pervasive industry wage differentials of up to 20 percent remain even after controlling for differences in observed measures of workers’ skill and the effects of unions. Theoretical analysis indicates that given non-competitive wage differentials of this magnitude policies directed at encouraging employment in high-wage sectors could significantly enhance allocative efficiency. For the United States and other developed countries, such policies are more likely to involve export promotion than import substitution. Increased international trade flows (at least through 1984) have been associated with increased employment in high-wage U.S. manufacturing industries relative to low-wage U.S. manufacturing industries.

I note in passing the weasel “more likely” hmm Larrys how much more likely ? at least 20% like the wage differentials ? I also note that the question answered “yes” (with data) by Larry & Larry is on the Booth economists questionaire “Question A: The federal government would make the average U.S. citizen better off by using policies that directly focus more on increasing manufacturing employment than employment in other sectors.” The results of the poll 5% agree 51% disagree and 15% strongly disagree. There is view widesread among non economists. The data say it is correct (as far as the data can ever say anything). There is a very clear consensus among economist that it is not correct. In this case the conventional assumption totally stomps the results of analysis of the relevant data.

Economists (other than the one’s who study wages) insist on an assumption which most people find implausible and which has repeatedly led to testable predictions which have been rejected by the data (OK “lead” is a weasel word since always they hypothesis of interest must be combined with auxiliary hypotheses to be tested — this isn’t a problem with the inter-industry wage differential litarature it is a problem with science). Why ? I see three reasons
1) economic debates are settled by authority. A very famous economist made an assumption for convenience. Over time, this becomes a dictate which must be obeyed (the Dixit dixit principle).
2) admitting that economists might be wrong and the man in the street might be right is intollerably humiliating
3) shopping for Occam’s razor at the convenience store. It is understood that any data can be fit (an nothing explained) if one relaxes standard assumptions. Therefore the economists version of Occam’s razor is to fit the facts currently being discussed with the fewest possible deviations from standard assumptions. This may be a necessary rule to make a theoretical discussion work at all. But it gives great power to clearly false assumptions made for the convenience of the economists who first tried to think about the issue

OK so that’s one argument that, I think, justifies the claim that non-free trade policy can increase money metric “welfare” in a country. I am very confident that this is true (I am willing to offer 10 to 1 odds). Also the claim is useless. The fact that there is a non free trade policy does not mean it would be implemented if the pro free trade dogma were relaxed. I am also confident that actually possible deviations from free trade would hurt the USA (OK about 2/3 1/3 on that one). Also, and conventionally for non econmists too. I think protection would lead counter protection and end up bad for everyone.

Here’s another argument. Marshallian spill overs. Here the idea is that there are some industries where being near your competitors is good, because people learn from each other. This can explain the extreme geographic concentration of industries even in cases where access to natural resources isn’t key (that means not just why are steel mills near coal). This argument was made by Marshall, but it was mathed up and rediscovered by uhm Krugman. The key point is that the spillovers are an externality, so the market outcome is not Pareto efficient. Marshallian spillovers provide a justification for infant industry protection.

Krugman’s work on economic geography strongly strongly supports the case for infant industry protection. The argument that knowledge spillovers justify infant industry protection was made vaguely and with words by Schumpeter.

Again and again there have been plausible sounding arguments which don’t work when you do the math — with standard assumptions. Then decades later they do work when you do the math after relaxing an assumption which was always known to be false.

Finally a challenge. Krugman quotes straw man ““Well, government borrowing drives up interest rates, and higher interest rates depress private investment, so increasing government spending in a slump is actually contractionary.” People who try to do economics without any kind of mathematical modeling do indeed say things like that — and it’s very hard to explain why it’s self-contradictory nonsense without a bit of math.

In fact standard models don’t have this effect. The final impact on say GDP of something like a government spending increase has the same sign and smaller magnitude than the impact holding other endogenous variables constant. This is pretty much a requirement if one wants determinate equilibria (so the model yields forecasts). Macro economists don’t like models with indeterminate equilibria (assumptions are often explicitly added to prevent indeterminacy). Note the conclusion follows from what macroeconomists like and dislike. It is simply just not true that the claim that government spending causes lower output by causing lower investment is logically “self-contradictory”.
It is possible to write down such a model and make the math work (in the end real interest rates are lower too). Alessandra Pelloni and I have published such a model

Consider case 2 and assume as is standard in these cases that the spending will be financed with lump sum taxes.

Here the conclusion is the direct result of assumptions made, because they are convnetional and needed to prevent embarassing results. Based on two examples, I claim that this is always the contribution of economic theory to economic thought.

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The White House Finally Takes an Actual STAND on Something That Was Not Dictated by Tim Geithner or the National Security Brotherhood. And It’s the Ethical Position in the Controversy, to Boot!


This isn’t trivial. One of the sweetest dogs I’ve ever met was a waggly-tailed white pit bull that a neighbor of a friend of mine found roaming the street. As soon as the sweetie saw you approaching, she’d wag her tail excitedly and then lie down on her back to invite you to rub her belly.

These dog-breed-ban statutes are abominable.  Now, a Tim-Geithner -White-House-ban statute would be another thing entirely. Maybe when Congress returns after Labor Day?

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Comparing Labor and Capital incomes (Past and Present)

Labor and capital both receive income. How do labor and capital consume products or contribute to savings differently? How have these differences changed over the years? What can we learn from the changes?

To answer these questions, I made a model based on the circular flow of the economy, where I separated labor income from capital income. Then using the official data for the National Income Accounts and other key pieces of data, I deduced the differences between labor income and capital income. Capital income refers to corporate profits and income received from capital ownership. Capital income has a primary function to be invested in maintaining and increasing the productive capacity of capital. Labor income refers to income received by people working. Labor income has a primary function to consume finished goods and services.

In the model, GDI (gross domestic income) starts flowing from firms and is paid to labor and to capital. But how does labor use its money? How does capital use its money?

I divided the use of the income into the standard variables of the national income equation…

  1. Consumption on finished goods and services,
  2. Net taxes,
  3. Saving for economy,
  4. Imports and Exports.

As the income flows through the economy, the financial sector is key through its lending and borrowing to turn net taxes into government spending, saving into investment and imports and exports into net exports. As the national income reaches firms in the form of consumption, government spending, investment and net exports, the result is gross domestic product, GDP. GDP is the product produced for consumption, government spending, investment and net exports.

This model shows an equilibrium state for the economy for one specified quarter in time. All numbers are balanced so that the beginning out-going gross domestic income for that quarter equals the money received by firms for their gross domestic product. In reality, the economy is dynamic, where the final GDP will be different than the beginning GDI. However, reducing the economy to an equilibrium model simulates a snapshot in time and allows the differences between labor and capital to be better determined.

Steps to setting up the circular flow model involved…

  • Getting an accounting format to incorporate all variables.
  • Getting the numbers for national accounts. (source)
  • Getting the effective tax rate for capital income. (source)
  • Government net borrowing/lending as a % of GDP. (source)
  • Getting the effective labor share of national income using my research into effective demand. Effective labor share determines effective demand limit upon real GDP.

I made two assumptions in the deduction process…

  • Capital’s consumption is 25% more likely than labor income to purchase imports. The reasoning is that capital money is able to purchase luxury items from abroad which cost more. Also, capital income has more ties to foreign countries. 25% as compared to 0% does not make much difference in the final numbers, but a set percentage improves comparison between years. If research is found that compares capital’s propensity to import as compared to labor’s propensity, then those numbers will be factored in.
  • Personal saving rate applies directly to labor income. This model uses effective labor income to determine the part of labor income that establishes the effective demand limit on the economy. I did not attempt to adjust the personal saving rate into an effective personal saving rate for effective labor income. I just kept the official personal saving rate as a commonly accepted rate for household income, as opposed to domestic business income.

The following models seek to give perspective on the economy. They provide an overall view in the bottom half where labor and capital income combine into national aggregate numbers. The models also provide a focused view of the differences between labor and capital incomes in the top half.

Let’s start by looking at 1985… (all dollar values are in real 2009 dollars in order to compare different years.) (The yellow highlighted boxes are marginal propensity to consume (MPC) and marginal propensity to save without imports (MPC) in relation to disposable income. Disposable income = Income – net taxes.)

CF 85-1Q
Graph of 1985

Some numbers to highlight…

  • 8.8% was the personal saving rate.
  • 4.8% government deficit as percentage of GDP.
  • Marginal propensity to consume (MPC) of 91.2% for labor income. (MPC applies to labor income minus labor net taxes.)
  • $446 billion for labor saving. (The $968 billion under labor saving includes labor saving plus the saving created by import dollars. The import dollars do not belong to labor but are created by labor’s consumption of imports. The same applies to capital saving.)
  • Keep note of the effective tax rate of Capital. In 1985 it was 33%.

Now we jump to 1995…

CF 95-1Q
Graph of 1995

A few highlights…

  • MPC of labor increased.
  • Imports are increasing as a percentage of GDP.
  • Government deficit has decreased.
  • Personal saving rate has decreased to 7.1%.
  • Capital was still using about 6% to 7% of its total income for consumption.
  • Capital’s effective tax rate was still over 30%.
  • Labor’s saving rate declined from 7.4% to 6.0% of total income.
  • Investment was still running 15.0% to 15.5% of GDP. Investment is non-governmental domestic investment. (In the early 1970s and 1960s, government spending was around 30% of real GDP. By 1995, the government was spending 22% of real GDP. Private domestic investment rose from 12% to 15% over that same period. The implication is that the government did more investing in productive capacity back in the 1970s and 1960s than in recent decades.)

Now we jump to the 1st quarter of this year, 2013…

CF 13-1Q
Graph of 2013

A few highlights…

  • Labor is actually saving less than it did in 1985 in real dollar terms, $409 billion as opposed to $446 billion, in spite of real GDP being more than double.
  • Capital income has increased its percentage of consumption from around 7% in 1985 to 20% now. That indicates that ownership of capital is currently producing more income in excess of what is needed for saving and domestic investment.
  • Net taxes on capital have fallen from over 30% in the past to around 15% now. This has allowed capital income to increase its percentage of both consumption and saving over time.
  • Savings rate for personal income has dropped to 3.6% of total income in spite of a lower effective tax rate. On the other hand, capital’s percentage of saving to total income has risen to 65.3%.
  • Labor is now having to use over 85% of its income for consumption, as opposed to 76% to 78% in the past. This indicates that labor is liquidity constrained for consumption, and that their income has not kept pace with prices.
  • Imports as a percentage of GDP continue to increase.
  • Investment has increased a little since 1995 going to 15.8% of real GDP.
  • Total net taxes used to be around 19% of real GDP before 1995. By 2013, it had dropped to 12.1%.
  • From 1995 to 2013, total real effective capital income increased by 99% going from %2,052 billion to $4,078 billion. On the other hand, total real effective labor income only increased 42% going from $8,090 billion to $11,521 billion.

The graphs above reveal a story of how financial power has shifted in favor of capital income.

Is there an unhealthy imbalance in the economy when capital income increases its consumption as a percent of total income from 7% to 20%? Has capital income risen beyond healthy levels for society as a whole?

Other years for reference…

link to 2006.

link to 1980.

link to 1970.

In 1970, labor income was very strong. Labor seemed to provide the savings for investment.

ling to 1960.

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Squeezing Hospitals Vs Squeezing Doctors III

ACA misinformation. Just for schadenfreude read Ezra Klein on Peggy Noonan on the ACA. Ouch that has to leave a mark. If Noonan were capable of shame, she should would just shut up forever and a pony.

Wonkblog is affordable care act (aka ACA aka Obamacare) anti-missinformation central. Unfortunately, right there at wonkblog, Dylan Matthews links to this fun survey of leading economists (with a feature which says which leading economist the respondent is most like). I was having fun till I got to question 28 which enraged one of the bees in my bonnet (see part II of this series)


The premise of question 28 is highly misleading. The question presents changes in Medicare compensation of hospitals and doctors symmetrically. The premise is not flat out totally false (at say the Peggy Noonan level) because the ACA will affect compensation of doctors (especially hospital house staff). However, the law treats hospitals nursing homes and home health care agencies (Medicare Plan A) and office practices (Medicare plan B) completely differently. This is fundamentally important, because physicians with office practices can and do refuse Medicare patients. In contrast all hospitals obey CMS dictates. One or two might opt out (I am thinking of the Mayo clinic and adding “or two” from an abundance of caution). Deleting the distinction between payments for physicianss services”and other Medicare payments is part of a long standing right wing hack strategy to mislead people about the ACA.

The Booth School (and Chris Said and, sadly, Dylan Matthews) have fallen for a right wing myth.

Importantly, the conflation of the extreme severe squeezing of hospitals nursing homes and home health care agencies (which can and will be squeezed but which will do fine because of the huge increase in insured patients) and a totally mythical nonexistent effort to squeeze doctors with office practices is a major factor in creating confusion and nonsense about Obamacare.

Liking to the survey, you should have noted that the premise to question 28 is highly misleading. Objecting to Peggy Noonan incorrectly describing home health care in Oregon and letting question 28 pass without flagging the highly misleading premise is swallowing an elephant and choking on a gnat.

I have another problem with question 28 (and others). Note the word “may”. “might” makes right and “may” means an extremely unlikely claim is okay. The ACA may lead to an alien invasion. This is not very likely, but the probability isn’t exactly precisely zero.

Given the first amendment questionaire writers may use “may” but they may burn in hell as a result of the asault against truth (I note that I consider it a billion times more likely that they go to limbo and a trillion times more likely that they end up stung by insects chasing the banderuolo in the vestibolo degli ignavi and also a quadrillion times because I am irrational and my subjective probability that any of those places exist is 0)

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Why Are We Rushing To Get Rid Of Fannie Mae and Freddie Mac?

by Barkley Rosser via Econospeak
(reposted with authors permission)

Why Are We Rushing To Get Rid Of Fannie Mae and Freddie Mac?

“How many Virginians does it take to change a light bulb?

Five: One to change the bulb and four to talk about how great the old bulb was.”

I think I am turning into my late father, a conservative in the old traditional way of defending existing institutions and practices.  Here I go, about to defend Fannie Mae and Freddie Mac, whom all Very Serious People know should go as soon as possible.  President Obama thinks they should go, and we have two bills in Congress that will lead to that outcome, one in the Senate co-sponsored by Dem Sen. Warner of VA (my state) and Rep Sen. Corker of TN, both VSPs in good standing, while in the House Banking Chair Hensarling (R-TX) also has such a bill. I mean wow, we have both the president and VSPs from both parties in Congress on this.  It must be great.  I mean, we all know that they were responsible for all the problems in the housing market that led to you know what!

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A New IOM Report Reveals Why Medicare Costs So Much (Hint–It’s Not Just the Prices)

by Maggie Mahar

A New IOM Report Reveals Why Medicare Costs So Much (Hint–It’s Not Just the Prices)

(reposted with authors permission)

George WBush is 67. Chances are Medicare paid for the stent operation that I describe in the post above. For years, medical researchers have been telling us that this procedure will provide no lasting benefit for a patient who fits Bush’s medical profile.   Nevertheless, in some hospitals, and in some parts of the country, stenting has become as commonplace as tonsillectomies were in the 1950s.

Location matters. Last month, a new report from the Institute of Medicine confirmed what Dartmouth’s researchers have been telling us for more than three decades: health care spending varies  across regions. More recently, as Dartmouth’s investigators have drilled down into othe data,, they have shown that even within a region, Medicare spends far more per beneficiary in some hospitals than in others.

In a recent Bloomberg column, former CBO director Peter Orszag notes that “Because this variation doesn’t appear to be reliably correlated with differences in quality, the value [that we are getting for our health care dollars] seems to be much higher in some settings than in others.” He asks the logical question: “What is causing this and what might we do about it?”

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