August 15, 2011 - Conversable Economist

Here are the opening paragraphs of article I wrote for the Opinion section of the Minneapolis Star Tribune on Sunday, August 14. The complete article is at the link, and also below the fold:

\”Not that many years ago, a lot of middle-class Americans felt as if they had built a close and personal relationship with Mr. or Ms. Economy (depending on your gender preference).

Do these things, the understanding was, and the Economy would reciprocate — with rising income, reasonable job security and a comfortable retirement.

Of course, no long-term relationship is perfect. The Economy might occasionally lash out: perhaps with a dot-com boom, followed by a stock market crash, a recession and higher unemployment. Many of us misbehaved in this relationship, too. Sometimes we ran bloated credit cards bills and didn\’t save the way we should have. Yet even in the hard times, this relationship was supposed to be long-term.

But in this grim and prolonged aftermath of the Great Recession of 2007-2009 — some economists are calling it the Long Slump — millions of Americans are feeling that they have been dumped by the economy.\”

The economy is like a bad marriage

Article by: TIMOTHY TAYLOR

Not that many years ago, a lot of middle-class Americans felt as if they had built a close and personal relationship with Mr. or Ms. Economy (depending on your gender preference).

The rules of the relationship were clear: Get skills and training, and after spending young adulthood sampling jobs, buckle down to a long-term career choice. Borrow heavily to buy a house early in life, and then benefit from rising house prices. Save for the long term by putting money in the stock market. Do these things, the understanding was, and the Economy would reciprocate — with rising income, reasonable job security and a comfortable retirement.

Yet even in the hard times, this relationship was supposed to be long-term. But in this grim and prolonged aftermath of the Great Recession of 2007-2009 — some economists are calling it the Long Slump — millions of Americans are feeling that they have been dumped by the economy.

A national CNBC survey in late June found that 63 percent of Americans are pessimistic about both the current and future state of the economy and its future, while only 6 percent are optimistic about both. The stock market swoon of that began in late July, fueled by grim economic signs and the floundering attempts of our political system to head off a national debt crisis, have further shaken many Americans\’ confidence in their long-term prospects.

Getting dumped — whether by the Economy or an actual person — brings a sad parade of disappointed expectations. After it has happened, it doesn\’t mend a broken heart when you recognize that you never should have believed some of the promises you thought you heard.

As housing prices skyrocketed in the mid-2000s, rising by more than 10 percent per year for several years, no one actually promised the trend would last forever. Still, it has been stunning to watch as the total value of real estate owned by U.S. households dropped by $6.3 trillion over the last five years — from $22.7 trillion in 2006 to $16.4 trillion by the end of 2010, according to Federal Reserve data. Even worse, back in 2006, 56 percent of the value of real estate was owners\’ equity; by the end of 2010, only 39 percent was owner\’s equity.

No one actually promised that unemployment would stay low forever. But the spikes in the unemployment rate from recessions had been falling, from 10 percent in the recession of 1982, to not quite 8 percent after the recession of 1991, to 6.3 percent after the recession of 2001. This time, unemployment went over 8 percent in February 2009 and probably won\’t get back below that level until 2012. In 2010, 43 percent of the unemployed had been without jobs for more than 26 weeks — by far the highest level since the Great Depression.

Those who trusted their long-term retirement savings to the stock market have been running in mud. The Standard and Poor\’s 500 index, for example, was 1,427 in 2000 but recently has been hovering around 1,200. All the economic news sounds grim. Gas prices, though moderating lately, recently flirted with $4 per gallon. Food prices are up: A ton of hard red winter wheat was selling for $182 in May 2010 and $354 in May 2011.

Since early 2009, the Federal Reserve created money to buy $1.1 trillion in U.S. Treasury securities and another $900 billion in mortgage-backed securities, presumably because it was concerned that no one else was going to buy them. Many pension funds don\’t have enough money to cover the promises they have made; neither do Social Security or Medicare.

After being dumped, mood swings follow. This relationship is actually a love/hate triangle — us, the Economy and Government. For some, Economy is the deceiver who trifled with our affections and betrayed us, and Government is the new love. Others see Government as the troublemaker, and dear old Economy as a victim like the rest of us.

But we have met the Economy, and the Government, and it\’s all us. We all need this three-way relationship to work.

In the short term, the economy is struggling because too many households, companies and financial institutions borrowed far too much, and it takes years for an economy to work through the aftermath of a severe financial crisis. Forecasters like the Congressional Budget Office predict that unemployment rates won\’t fall back to the 5 percent range until 2016.

In the long term, the formula for economic growth is straightforward: It\’s an economy that invests in human capital, physical capital and innovation — and which does so in the context of a decentralized, market-oriented environment that provides incentives and rewards for these activities. The U.S. economy faces severe challenges in all of these areas.

We aren\’t improving the skills of workers. A review of the education statistics by Nobel laureate economist James Heckman found that U.S. high school graduation rates peaked at about 80 percent in the late 1960s and have declined 4 to 5 percentage points since then. Too many undergraduate and graduate students are running up enormous debts without the career prospects to justify it. High unemployment means that many workers aren\’t building skills.

We aren\’t saving enough. The personal savings rate was about 10 percent of income in the 1970s and into the early 1980s, but over the last decade, despite a recent upward blip, it\’s typically been less than 5 percent of income. Meanwhile, Congressional Budget Office projections show total federal debt on a path to exceed 180 percent of GDP by 2035. That won\’t happen, because wary investors will stop buying government bonds before that level is reached.

Thus, when America\’s private sector firms look for financial capital to invest in plant and equipment, it\’s harder to find. With low private saving and high public borrowing, the U.S. economy is relying heavily on inflows of foreign financial capital, which won\’t continue forever. America\’s technological advantage remains substantial, but expertise of all kinds is going global.

In the end, economic growth can\’t be legislated or dictated; if it could be, the world would be a much richer place. A wise economist named Arnold Harberger once gave a speech asking whether economic growth was more like yeast or mushrooms. He answered \”mushrooms.\” Harberger wrote: \”[Y]east 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.\”

Thus, the most important advice to the economically lovelorn is to work hard on fundamentals — build education and skills, get our personal and government finances in order, focus on knowledge and innovation — and then get out of the way and give those economic mushrooms a chance to sprout. As the quintessential noneconomist Kahlil Gibran famously wrote: \”If you love somebody, let them go …\”

It\’s hard to watch an intimate partner like Economy going through such dreadful times. I feel especially for those near or just entering retirement, whose houses and retirement accounts are worth so much less than they\’d expected, and for young people trying to start their careers in such a dismal labor market.

But with Economy, a true breakup is unthinkable. There\’s no realistic alternative to working patiently on the relationship.

Timothy Taylor is managing editor of the Journal of Economic Perspectives, based at Macalester College in St. Paul. He blogs at conversableeconomist.blogspot.com.

Social Security and Medicare have both made promises about future benefits that their current sources of financing won\’t allow them to keep. If we moved back the retirement age, would it fix these programs? Short answer: moving back the retirement age could have a large effect in addressing the financial problems of Social Security, but would have a much smaller effect in helping Medicare.

For Social Security, the website of the Office of the Chief Actuary has estimates of the cost savings from a wide variety of proposals. Proposal C2.6, for example, reads: \”Increase the normal retirement age (NRA) 3 months per year starting in 2017 until reaching 70 for those attaining age 62 in 2032. Then increase the NRA 1 month every 2 years thereafter. Note that the NRA would increase from 66 to 67 faster than under current law. Increase the earliest eligibility age (EEA) from 62 to 64 at the same time the NRA would increase from 67 to 69; that is, for those attaining age 62 in 2021 through 2028. Keep EEA at 64 thereafter.\”

Those who will be 62 in 2032 are currently about 41 years old. Telling them now that early retirement will be 64 for them, instead of 62, and that normal retirement will be 70 for them, instead of the 67 years for this group in current law, seems to me completely reasonable. This change alone doesn\’t fix Social Security completely, but it would close about 70% of the projected funding gap for the program over the next 75 years.

For Medicare, in contrast, a higher eligibility age does a lot less. The Kaiser Family Foundation put out a report earlier this summer called Raising the Age of Medicare Eligibility: A Fresh Look Following Implementation of Health Reform. The study assumes that the age of Medicare eligibility is raised from 65 to 67 as of 2014. Most policy proposals, of course, would have a slower phase-in. But the point here is not to analyze a policy proposal, but to get a handle on the changes that would arise when such a change in age was fully phased in. Here are some of the forecasts:

For federal spending, the older age of eligibility saves $31.1 billion for Medicare. However, a number 65 and 66 year-olds who were not eligible for Medicare would lack health insurance, and thus would be eligible for either Medicaid or for subsidized insurance under the new \”health exchanges\” in the health care legislation that President Obama signed into law in 2010. In addition, those 65 and 66 year-olds wouldn\’t be paying premiums into the Medicare system. After these offsets are taken into account, overall federal spending would be reduced by only $5.7 billion.
\”In addition, costs to employers are projected to increase by $4.5 billion in 2014 and costs to states are expected to increase by $0.7 billion. In the aggregate, raising the age of eligibility to 67 in 2014 is projected to result in an estimated net increase of $3.7 billion in out-of-pocket costs for those ages 65 and 66 who would otherwise have been covered by Medicare.\”
\”Medicare Part B premiums would increase by three percent in 2014, as the deferred enrollment of relatively healthy, lower-cost beneficiaries would raise the average cost across remaining beneficiaries.\”

A key underlying issue here, of course, is that health care spending tends to rise with age. Pushing back the age of Medicare eligibility affects the relatively health group a little above age 65, but it doesn\’t affect the health care bills of the more aged, and so it offers relatively small cost savings for the Medicare program. In a study from last year, Gerald F. Riley and James D. Lubitz report on \”\”Long-term trends in Medicare payments in the last year of life\” (Health Services Research, April 2010, 45(2):565-76). They point out that Medicare spending on those who die in a given year is much higher than on those who survive the year: in 2006, Medicare spending in 2006 on those who died in that year was $38,975, while Medicare spending in 2006 on those who survived the year was $5,993. Their estimates show that 25-30% of all Medicare spending is on patients in their last year of life, and that this number hasn\’t changed much over time, and isn\’t much affected by adjusting for changes in age or gender of the elderly over the last 30 years.

Day: August 15, 2011

Feeling Dumped by the Economy