Month: April 2012

I admit to a bias against Trade Adjustment Assistance, because I fear that it plays to an untrue but common stereotype that if only the U.S. economy didn\’t have to deal with imports, workers would be far more secure. In reality, many factors across the vast U.S. market can cause some workers to lose their jobs: tough domestic competitors, a firm that doesn\’t keep up with shifts of production processes, shifts in popular tastes for goods and services, poor management decisions, and others. I\’ve never seen a serious argument that most of the workers who lose their jobs in the continual churn of the U.S. labor market do so because of import competition. In my mind, the entire category of unemployed workers–especially in the Long Slump following the Great Recession–can use greater assistance from active labor market policies in moving to new jobs. I don\’t see why such assistance should be limited to those who can get the U.S. Department of Labor to certify their claim that their jobs were lost specifically  because of import competition

Trade Adjustment Assistance began with the Trade Expansion Act of 1962, although no one was actually ruled eligible for benefits for the first seven years. It has been repeatedly updated and amended over time, especially in recessions and at times when new trade agreements are being discussed, including in 2002, 2009, and again in 2011. It\’s not a large program. In 2011, TAA included a total of 196,000 participants, about half of whom participated in training programs. The U.S. Department of Labor page describing what kinds of services are provided is here. It\’s a mixed bag of job search assistance, support for retraining, support for costs of relocation, assistance in paying for transitional health insurance while out of work, and wage subsidies for older workers who end up taking another job at a much reduced wage. The key goal is to help dislocated workers find new jobs.
Training and cash benefits under the TAA will be $826 million in 2012, according to the Congressional Budget Office baseline forecast.

Although I\’m not a fan of how Trade Adjustment Assistance is focused on such a limited group, it does offer a testing ground for how these sorts of policies might work. However, results do need to be interpreted with care. Those who are ruled eligible for this program are not a cross-section of American workers across all industries: tend to be heavily in manufacturing jobs, like steel or textiles or autos, where it is more straightforward to make the argument under the law that their jobs were lost due to foreign competition. But these workers also tend to be older and to have lower education levels compared either with other displaced workers in the U.S. economy or with the U.S. workforce as a whole. They may also be more likely to be in communities that depended on a big manufacturing plant, and that have a limited number of alternative job options. For evidence on these points, a useful starting point is \”Does Trade Adjustment Assistance Make a Difference?\” by Kara M. Reynolds and John S. Palatucci, in the January 2012 issue of Contemporary Economic Policy. For an earlier look at the subject,Katherine Baicker and M. Marit Rehavi wrote on \”Policy Watch: Trade Adjustment Assistance,\” for the Spring 2004 issue of my own Journal of Economic Perspectives. 

The Reynolds and Palatucci paper looks at the 150,000 beneficiaries of Trade Adjustment Assistance in 2007, who on average received benefits worth $5,700 from TAA. They compare \”dislocated\” workers who lost their jobs and were eligible for TAA benefits to other dislocated workers. Here are their two main findings:

\”Unfortunately, we find no statistical evidence that the TAA program improves the average employment outcome of beneficiaries over a comparison group of nonbeneficiary displaced workers with characteristics similar to those workers in the TAA program. Our results imply that while the TAA program may provide an income safety net, it does not help the average displaced worker who is enrolled in the program find new, well-paying employment opportunities. …

\”Upon further examination, however, we find strong evidence that those workers who participate in a TAA-funded training opportunity are more likely to obtain reemployment, and at higher wages, when compared to the TAA beneficiaries who do not participate in training. Specifically, participating in the training component of the TAA program increases the likelihood that the average TAA beneficiary will find new employment by 10–12 percentage points, and reduces the earnings losses of the average worker by 8–10 percentage points, when compared to a group of similar TAA beneficiaries who do not participate in the training component. Although the income support, job and relocation payments, and other TAA benefits may not help workers find new, well-paying
employment, training seems to improve employment outcomes for these workers.\”

Again, it could be hazardous to generalize too broadly from these findings, because those eligible for assistance under the Trade Adjustment Act are not a randomly selected group. For example, it may be that this group is less well-situated to take advantage of job search and placement assistance, and but better-situated to benefit from training. But with the unemployment rate above 8% since February 2009, and the Congressional Budget Office forecasting that it won\’t drop much before 2014, there should be a heightened urgency in figuring out how to help the unemployed find job slots. 

How much would raising marginal tax rates on those with high incomes cause their level of income to fall? Emmanuel Saez, Joel Slemrod, and Seth H. Giertz tackle this question in the March 2012 issue of the Journal of Economic Literature in \”The Elasticity of Taxable Income with Respect to Marginal Tax Rates: A Critical Review.\” The JEL paper isn\’t freely available on-line, although many academics will have access through their libraries, but a 2010 working paper version is available at Saez\’s website here.

The short answer to the question is .25. That is, a plausible mid-range estimate based on the economics research literature is that raising the marginal tax rate by 10% (not 10 percentage points, but 10% above the previous rate) would lead over the long-term to a reduction in taxable income of 2.5%. The longer answer is that understanding the implications of the question is difficult. The article itself is on the technical side, but here are some of the key issues.

When marginal tax rates rise, people will seek to avoid paying at least some of the increase. But how they seek to avoid the higher taxes matters. For example, one possibility is that people react to the marginal tax rate by working fewer hours or by making less entrepreneurial effort. Another possibility is that they find ways to shift taxable income to future years, in which case a decrease in tax revenue now might be offset by an increase in tax revenue later. Yet another possibility is that they find a way to shift the form of income, perhaps by receiving more income in the form of untaxed fringe benefits or in lower-taxed capital gains. People may also react to higher marginal tax rates by taking greater advantage of tax deductions: for example, they may give more to charity.

Economic studies that consider how revenues changes in response to past tax changes tend to pick up short term effects of these changes, and the most common short-term effects are probably changes in timing of taxable income or shifting it to less taxable income. From society\’s overall point of view, these changes are not of central importance. In fact, if the problem with higher marginal tax rates is that people are finding ways to avoid paying those higher rates legally, then an obvious answer is to combine the higher marginal tax rates with rules and enforcement to make such legal tax avoidance more difficult. The long-term responses are potentially more worrisome, but also in the nature of things much harder to measure with confidence. Consider the difficulties, for example, of figuring out how a change in higher marginal tax rates might (or might not!) affect incentives to get an additional graduate degree or to start a company. Here\’s Saez, Slemrod, and Giertz:

\”One might expect short-term tax responses to be larger than longer-term responses because people may be able to easily shift income between adjacent years without altering real behavior. However, adjusting to a tax change might take time (as individuals might decide to change their career or educational choices or businesses might change their long-term investment decisions) and thus the relative magnitude of the two responses is theoretically ambiguous. The long-term response is of most interest for policy making although, as we discuss below, the long-term response is more difficult to identify empirically. The empirical literature has primarily focused on short-term (one year) and medium-term (up to five year) responses, and is not able to convincingly identify very long-term responses.\” 

It also seems likely that the economic reaction to higher marginal tax rates is not a single constant number, but may vary for different taxpayers, and under different tax regimes (like what is being taxed, and how many opportunities the tax code offers for legally minimizing one\’s tax burden). For example, it\’s plausible that higher-income taxpayers have greater incentives and resources to search for legal ways to minimize their tax burden. For example, it seems clear that after the 1986 tax return, which broadened the tax base and reduced top personal income tax rates, there was a large shift in reported income from corporations to the personal income tax, and a vast reduction in personal tax shelters.

The very top incomes were about 60 percent from dividend payments in the early 1960s, and faced top marginal tax rates of about 80%, which suggest that these investors had little control over the form in which their payments were received. But there has been a huge shift and now top incomes are much more likely to be from partnerships and wage income, which suggests much greater potential for control of the form and timing in which income is received. As they write (citations omitted): 

\”The difficult question to resolve is to what extent the secular growth in top wage incomes was due to the dramatic decline in top marginal tax rates since the 1960s. This question cannot be resolved solely looking at U.S. evidence. Evidence from other countries on the pattern of top incomes and top tax rates suggests that reducing top tax rates to levels below 50 percent is a necessary—but not sufficient—condition to produce a surge in top incomes. Countries such as the United States or the United Kingdom have experienced both a dramatic reduction in top tax rates and a surge in top incomes, while other countries such as Japan have also experienced significant declines in top
tax rates, but no comparable surge in top incomes over recent decades …\”

 Among the goals that they suggest for future research are a greater effort to disentangle the different responses to higher tax rates:

\”[F]uture research that attempts to quantify the welfare cost of higher tax rates should attempt to measure the components of behavioral responses as well as their sum. It needs to be more attentive to the extent to which the behavioral response reflects shifting to other bases and the extent to which the behavioral response comes from margins with substantial externalities. …  [R]esearchers should be sensitive to the possibility that nonstandard aspects of tax systems and the behavioral response to them—such as salience, information, popular support, and asymmetric response to increases versus decreases—might affect the size of behavioral response.\”

As I said at the start, the short answer from economic research to the question of how higher marginal tax rates reduce tax income is .25: a 10% rise in marginal tax rates will tend to reduce taxable income by 2.5%.  But given the current state of research, that answer includes considerable uncertainty over its size and its underlying economic meaning. 

Rising life expectancy is a good thing; indeed, Kevin Murphy and Robert Topel estimated in a 2006 paper in the Journal of Political Economy (\”The Value of Health and Longevity,\” 114:5, pp. 871-904) that the 30 years of additional life expectancy gained by an average American during the 20th century was $1.3 million per person. But growing life expectancies also put pressure on public and private retirement programs. What if those programs are underestimating how much longevity is likely to rise? The April 2012 Global Financial Stability report from the IMF tackles this question in Chapter 4: \”The Financial Impact of Longevity Risk.\”

The first step in their argument is to make plausible the claim that government and private retirement plans may well be understating how much longevity is likely to rise (citations and references to exhibits omitted): \”The main source of longevity risk is therefore the discrepancy between actual and expected lifespans, which has been large and one-sided: forecasters, regardless of the techniques they use, have consistently underestimated how long people will live. These forecast errors have been systematic over time and across populations. … In fact, underestimation is widespread across countries: 20-year forecasts of longevity made in recent decades in Australia, Canada, Japan, New Zealand, and the United States have been too low by an average of 3 years. The systematic errors appear to arise from the assumption that currently observed rates of longevity improvement would slow down in the future. In reality, they have not slowed down, partly because medical advances, such as better treatments for cancer and HIV-AIDS, have continued to raise life expectancy …\”

Here are a couple of illustrative figures. The first shows projected life expectancies for the United Kingdom.  Starting at the bottom left, the lines show the projected rise in life expectancies at that time. Notice that the projected increases consistently underestimate the actual rise, which is the black line on top.

The table below shows the typical life expectancy at age 65 used for pension funds  in a number of countries in the first column. The second columns shows the currently estimates of life expectancy at age 65. Notice that in each case, the number used for future life expectancy in the first column is above the current estimates of life expectancy, which is wise. But also notice that for a number of countries, including the United States, the actual increase in life expectancy since 1990 is substantially larger than the difference between columns 1 and 2.

The IMF asks what would happen if life expectancy by 2050 turns out to be three years longer than current projected in government and private retirement plans: \”[I]f individuals live three years longer than expected–in line with underestimations in the past–the already large costs of aging could increase by another 50 percent, representing an additional cost of 50 percent of 2010 GDP in advanced economies and 25 percent of 2010 GDP in emerging economies. … [F]or private pension plans in the United States, such an increase in longevity could add 9 percent to their pension liabilities.  Because the stock of pension liabilities is large, corporate pension sponsors would need to make many multiples of typical annual pension contributions to match these extra liabilities.\”

What\’s to be done? One step could be to build into the benefit formal for public pensions, like Social Security, provisions for an automatic decline in expected benefit levels for future retirees as life expectancy rises. The enormous change that has taken place in private retirement plans, switching from \”defined benefit\” plans in which the employer promises a stream of future payments to \”defined contribution plans where the employee has a retirement account with a certain amount in that account acts as a way of transferring longevity risk from employers to workers. Of course, retirees can then protect themselves from longevity risk and outliving their assets by putting a substantial share of their retirement funds in annuities.

There are also proposals for innovative financial assets like \”longevity bonds.\” Say that a pension plan worried that it has underestimated longevity risk, and thus will have to make higher payments than it expects. The company buys a longevity bond, where the payments that the company receives from that bond would rise if longevity exceeds certain benchmarks. Because the return on the bond would offset some longevity risk, the buyers of the bond would be willing to accept a lower interest rate than they otherwise would demand. However, no longevity bonds have yet been successfully issued.

It\’s not enough just to set an expectation for how much the population will age, and to plan accordingly. We also have to plan for the historically likely possibility that life expectancies may grow faster than we expect.
 

Here\’s an European economy joke with an edge from the Chou Associates Fund Annual Report for 2011. Hat tip to the Stingy Investor website for the link:

\”Pierre, an expensively attired middle-aged French tourist on his first trip to Toronto strolls into the
bar of his 5-star hotel. The elegant hostess smiles, leads him to a table and beckons her prettiest
server to take care of him. They talk, flirt a little and she giggles a bit. When he draws her closer and whispers in her ear, she gasps and runs away.

The hostess frowns then sends a more experienced waitress to the gentleman’s table.They talk, flirt a little and giggle a bit. He whispers in her ear and she too screams, “No!” and walks away quickly.

The hostess is surprised … . Rather than alienate a high-powered customer, she asks Lucille, her seen-it-all, heard-it-all bartender, to take his order. They talk, flirt a little and Lucille even giggles a bit. When he whispers in her ear, she screams, “NO WAY, BUDDY!” then smacks him as hard as she can and leaves.

The hostess is now intrigued, having seen nothing like this in all her years working in bars. … Besides, she has to find out what this man wants that makes her girls so angry. … So she goes to Pierre’s table, wishes him a pleasant evening and tells him she’ll personally take care of his needs. … They flirt a little, giggle a bit and talk. Pierre leans forward and whispers in her ear, “Can I pay in Euros?”\”

The Emerging Market Research Institute at Credit Suisse has an intriguing report out on \”Opportunities in an Urbanizing World.\” From the \”Editorial\” at the start:

\”[T]he world\’s population is migrating from rural areas–accounting for 70% of global population in 1950–to cities–accounting for 70% of global population by 2050 based on United Nations projections. In 2009, the percentage of the planet\’s population living in urban areas crossed the 50% threshold and by 2037 cities in developing nations will contain half the world\’s total population. …. \”

Here\’s a figure to illustrate the point. World population is divided into four groups. As recently as the 1990s, more than half all the world population lived in rural areas of developing countries. The projections are that in 25 years, more than half of world population will live in urban areas of developing countries.

The coming urbanization will be almost entirely a developing country phenomenon: \”Looking at population projections in the world\’s 15 largest urban agglomerations in 2025, we note that just two–Tokyo and New York City–are in developed countries. Not a single one of the world\’s 25 fastest projected growing major cities is in a developed country.\” But even within developing countries, a number of countries are already seeing decelerating urbanization, because their levels of urbanization are already 70-90% of the population, and so there isn\’t much more room to urbanize. For example, Malaysia, Mexico, Peru, Colombia, Turkey, Czech Republic, Russia and Hungary all have urbanization rates already above 66%, and Argentina, Brazil, Chile, South Korea and Saudi Arabia all have urbanization rates already over 80%.

But another group of countries, mostly in Asia and Africa, but also including Poland, are seeing accelerating urbanization: South Africa, Morocco, Nigeria, Poland, China, Philippines, Indonesia, Egypt, Thailand, Pakistan, Vietnam, Bangladesh, India, Kenya. As the report points out, this list includes six of the eight largest countries by population in the world, and about 55% of world population.

The report argues: \”Exploring the relationship between per capita economic growth and urbanization, we find that there is a sweet-spot as countries urbanize (in the range of 30%-50% of total population), accompanied by peak per capita GDP growth.\” It offers a discussion of each these countries of accelerating urbanization.

Here, I\’ll just make the overall point that urbanization creates economies and diseconomies. On one side, it concentrates, consumers, workers, and firms in a way that allows a flow of information, goods, and services that feeds specialization, economies of scale, technological development, and economic growth. On the other side, it also concentrates problems of pollution, crime, poor health, poverty, and corruption, and raises needs for physical infrastructure and working institutions.  The politics and economics of the future are likely to be hammered out, one issue at a time, for better or worse, in the large cities of developing countries. I discussed some of these broader issues of urbanization in \”The Coming Urban World\” in a post last August 29, 2011.

I discovered the Credit Suisse report via a post by Alex Tabarrok at Marginal Revolution. 

The U.S. federal budget is typically measured on a cash basis: that is, how much tax money came in and how much spending went out. But for a more complete picture of any budget, it is useful to look at an accrual budget: that is, including not just current spending, but what spending has already been committed for the future. The federal government takes a stab at providing an overview of an accrual budget each year in a report from the U.S. Treasury called the Financial Report of the United States Government: the 2011 edition is here.

Here\’s a graphic showing all the assets and debts of the U.S. government from an accrual perspective. Federal debt held by the public, the usual measure of federal debt, is about $10.2 trillion. \”As of September 30, 2011, the Government held about $2.7 trillion in assets, comprised mostly
of net property, plant, and equipment ($852.8 billion) and a combined total of $985.2 billion in
net loans receivable, mortgage-backed securities, and investments.\” The big addition here is the $5.8 trillion in already owed in employee and veterans\’ benefits. Taking these legal obligations into account increases the government\’s liabilities by more than half.
 

What about future obligations for Social Security and Medicare? Legally speaking, these are not legal obligations in the same sense as benefits owed to federal employees and to veterans. The U.S. government can and probably will adjust the revenue and spending side of Social Security and Medicare. That said, the report does offer some estimates of current federal obligations in this area. Here are some numbers for Social Security and the different parts of Medicare. The numbers are \”present values\” over 75 years (that is, how much money in the present, at an assumed rate of interest, would be equal to the sum over 75 years).

Thus, for example, the present value of all the revenues Social Security is scheduled to receive over the next 75 years is $41.6 trillion, the present value of total expenditures over that time is $50.8 trillion, and the current unfunded gap is $9.2 trillion. The multi-trillion dollar gaps for Part A (Hospital Insurance), Part B (Supplemental Medical), and Part D(Pharmaceuticals) of Medicare are also shown. The total gap is about $33 trillion–which for comparison is about twice as large as the $17.5 trillion in legally obligated liabilities in the chart above.

Two main lessons emerge from these figures. First, the debt obligations of the federal government are far larger than the $10 trillion or so in debt owed to the public. Adding what is legally owed in benefits to federal employees and veterans, together with promises already made to Social Security and Medicare, the total amount owed would reach about $50 trillion.

Second, of this $50 trillion in what is owed, about half is because of Medicare. America\’s health care the system is a huge part of what is driving our long-term fiscal problems. Indeed, the numbers in the table probably understate the effect of future rises in health care spending for several reasons. The table shows only Medicare, but Medicaid is also a substantial spending program without any dedicated payroll tax or funding source. Moreover, the estimates of Medicare costs in the table are likely to be far too low. At least, this was the conclusion of  Richard S. Foster, Chief Actuary, Centers for Medicare & Medicaid Services, who wrote in a \”Statement of Actuarial Opinion\” in an appendix to the 2011 Annual Report of the Medicare Trustees:

\”[T]he financial projections shown in this report for Medicare do not represent a reasonable expectation for actual program operations in either the short range (as a result of the unsustainable reductions in physician payment rates) or the long range (because of the strong likelihood that the statutory reductions in price updates for most categories of Medicare provider services will not be viable). … Although the current-law projections are poor indicators of the likely future financial status of Medicare, they serve the useful purpose of illustrating the exceptional improvement that would result if viable means can be found to permanently slow the growth in health care expenditures.\”

There is a raging argument over whether to attack the federal budget deficits now, or whether to wait until the economy recovers further and the unemployment rate falls. Compares with this picture of current federal debt from an accrued perspective — a low-ball estimate of $50 trillion in accumulated obligations — the short-term decisions are relatively small potatoes.

For many people, saying that a little bit of inflation can have good effects is akin to saying that a little bit of leukemia can have good effects. Too much inflation, especially volatile rates of inflation, does operate like sand in the gears of an economy, by making it unclear how much prices throughout an economy are rising or falling in real terms. But But when an economy is trying to climb out of a recessionary episode caused by a wave of overindebtedness, and is suffering sustained high unemployment at the same time, a bit of inflation can grease the transition.

When it comes to overindebtedness, a bit of inflation means that past debts can be repaid in inflated dollars. For the millions of homeowners struggling with mortgages that are worth more than the value of their property, as well as others with high debts, a bit of inflation is a breath of fresh air. In the case of wages, standard price theory suggests that when unemployment is high and a large quantity of labor is available, wages should fall–for the same reason that at when the quantity of apples at an autumn farmers\’ market is high, the price of apples be lower than at other times. But employers are reluctant to cut wages. It decreases morale of existing workers, and encourages the more high-productivity workers–who have better outside options–to look for  other jobs. In contrast, apples don\’t get sulky and inefficient when the price of apples declines.

But here\’s a kicker: Workers strongly dislike cuts in nominal wages, but they are typically less annoyed by cuts in real wages. Here\’s an intriguing figure from Mary Daly, Bart Hobijn, and Brian Lucking at the San Francisco Fed. The  solid thin blue line shows the inflation rate; the thicker red line shows nominal growth in wages; and the dashed black line shows the real wage growth–that is, the growth in the buying power of wages after taking inflation into account.

This data suggests that average wage growth in the U.S. economy was negative for most of the 1980s and half of the 1990s, and then crept into positive territory for a time, before dropping off to negative again in 2011. This graph must be interpreted with care, because it doesn\’t mean that the average real wage of those who held jobs 1982 was falling for a decade.  The workforce changes over time. In the 1980s, for example, there was a dramatic increase in the number of women entering the (paid) labor market, and many of them took relatively lower-wage work. This factor would tend to reduce the rise in \”average\” wages in any given year, even if those who were already in the workforce in the late 1970s saw a rise in their wages over that decade. However, the graph also helps to explain how the U.S. economy adjusted from very high unemployment rates in the early 1980s to low unemployment rates by the mid-1990s: in short, average real wages were lower, which encouraged more hiring.

My point is that a bit of inflation can help an adjustment in real wages across the economy during a time of sustained high unemployment, because it affects all employers and all workers, and doesn\’t require individual employers to cut nominal wages. Those interested in some additional background on the extent of nominal and real wage stickiness at a more technical level might begin with an article from the Spring 2007 issue of my own Journal of Economic Perspectives: \”How Wages Change: Micro Evidence from the International Wage Flexibility Project,\” by William T. Dickens, Lorenz Goette, Erica L. Groshen, Steinar Holden, Julian Messina, Mark E. Schweitzer, Jarkko Turunen, and Melanie E. Ward.

Back in 2008, Cass R. Sunstein wrote a book with Richard Thaler called Nudge: Improving Decisions About Health, Wealth, and Happiness. The focus of the book was to discuss how to take findings from behavioral economics and apply them to affecting behavior. Thus, since President Obama appointed Sunstein to be the  Administrator, Office of Information and Regulatory Affairs, Office of Management and Budget, there has been considerable interest to see how he might put this approach into effect. In the Fall 2011 issue of the University of Chicago Law Review, Sunstein, has written \”Empirically Informed Regulation,\” which discusses his approach and a selection of the policy results.

Sunstein starts this way (footnotes omitted): \”In recent years, a number of social scientists have been
incorporating empirical findings about human behavior into economic models. These findings offer useful insights for thinking about regulation and its likely consequences. They also offer some suggestions about the appropriate design of effective, low-cost, choice-preserving approaches to regulatory problems, including disclosure requirements, default rules, and simplification. A general lesson is that small, inexpensive policy initiatives can have large and highly beneficial effects.\” Here are a few examples of the issues and possibilities that he raises for such an approach:

• \”In the domain of retirement savings, for example, the default rule has significant consequences. When people are asked whether they want to opt in to a retirement plan, the level of participation is far lower than if they are asked whether they want to opt out. Automatic enrollment significantly increases participation.\”
• \”For example, those who are informed of the benefits of a vaccine are more likely to become vaccinated if they are also given specific plans and maps describing where to go. Similarly, behavior has been shown to be significantly affected if people are informed, not abstractly of the value of “healthy eating,” but specifically of the advantages of buying 1 percent milk as opposed to whole milk.\”
• \”When patients are told that 90 percent of those who have a certain operation are alive after five years, they are more likely to elect to have the operation than when they are told that after five
  years, 10 percent of patients are dead. It follows that a product that is labeled “90 percent fat-free” may well be more appealing than one that is labeled “10 percent fat.”\”
• \”In some contexts, social norms can help create a phenomenon of compliance without enforcement—as, for example, when people  comply with laws forbidding indoor smoking or requiring the buckling of seat belts, in part because of social norms or the expressive function of those laws.\”
• \”Many people believe that they are less likely than others to suffer from various misfortunes, including automobile accidents and adverse health outcomes. One study found that while smokers do not underestimate the statistical risks faced by the population of smokers, they nonetheless believe that their personal risk is less than that of the average nonsmoker.\”

The wave of behavioral economics research seems to me one of the most intriguing and fruitful developments in economics in the last few decades.  However, in thinking about its value as a method of improving regulation, I often find myself feeling skeptical. Although there is much to praise in Sunstein\’s essay and approach to regulation, let me focus here on raising four skeptical questions.


1) How big a deal is this combination of behavioral economics and regulation?

The work on how people\’s savings patterns are affected by whether they face a default rule seems to me the shining success of behavioral economics as applied to policy. It addresses an issue of first-order importance that cuts across macroeconomics, microeconomics, and social policy: Why do so many people save so little? 

However, a number of the other applications seem to me relatively small potatoes. For example, at one point Sunstein lists nine examples of regulations that have been simplified or eliminated. If you add together his estimated cost savings for all nine rules, it\’s about $1 billion per year. I\’m in favor of saving that $1 billion each year! But in the context of federal regulation and the U.S. economy, it\’s not a large amount.

2) Does behavioral economics imply more regulation, or just offer suggestions for better regulation?

Sunstein clearly takes the second position: \”An understanding of the findings outlined above does not, by itself, demonstrate that “more” regulation would be desirable. … It would be absurd to say that empirically informed regulation is more aggressive than regulation that is not so informed, or that an understanding of recent empirical findings calls for more regulation rather than less. The argument is instead that such an understanding can help to inform the design of regulatory programs.\”

3) How well can the government apply these lessons?

There are reasons to doubt how well government can apply these insights as it goes about its regulatory tasks. As Sunstein writes: \”It should not be necessary to acknowledge that public officials
are subject to error as well. Indeed, errors may result from one or more of the findings traced above; officials are human and may also err. The dynamics of the political process may or may not lead in the right direction.\”

Consider for a moment a seemingly simple policy, like improved disclosure requirements. What rule should be followed. Here\’s how Sunstein phrases it:  \”Disclosure requirements should be designed for homo sapiens, not homo economicus (the agent in economics textbooks). In addition, emphasis on certain variables may attract undue attention and prove to be misleading. If disclosure requirements are to be helpful, they must be designed to be sensitive to how people actually process information.
A good rule of thumb is that disclosure should be concrete, straightforward, simple, meaningful, timely, and salient.\”

Just how to apply this perspective in the case of say, the USDA food pyramid or health warnings on cigarette packages or public information on toxic chemical releases is not going to be straightforward. It made me smile that at the back of Sunstein\’s paper, there is an appendix about \”open and transparent government\” that takes 12 pages of bureaucratese to explain what the term means.
 Disclosure requirements and other regulations are going to be the subject of intense lobbying, and there will be pressure from many parties to make people feel as if their politicians are being public-spirited and responsive, while continuing to conceal relevant costs and tradeoffs. 

4) Is overcoming these issues unambiguously beneficial?

An often-unspoken assumption in this literature is that people are always better off if they have better information, or better disclosure rules, or a more accurate perception of risk. This isn\’t necessarily so.  For example, a recent working paper by Jacob Goldin at Princeton\’s Industrial Relations Center tackles the issue of \”Optimal Tax Salience.\”  The paper is technical, but under the math is a basic intuition: if people are unaware that their marginal tax rate is rising, then they will not cut back as much on work effort. In that narrow sense, the costs of higher tax rates would be reduced. Goldin makes a case that having a mixture of taxes that are more and less salient may actually end up being better for society.

There\’s no reason government shouldn\’t be able to learn from the management and marketing literature about how to affect people\’s behavior. If government is going to impose a regulation, it should be designed to work better rather than worse. And yet, the point of departure of behavioral economics is that people don\’t always know very clearly what they want. People are affected by how questions are framed, by what information they have, by default rules, by how risks are perceived, by whether costs and benefits are immediate or long-term, and by social norms. Most of us recognize that private sector actors try to manipulate our decisions through these factors, and we are rightly skeptical that  they are doing so in our own best self-interest.

Thus, I find that I tend to be more comfortable with clear-cut government actions, like readily apparent taxes and subsidies, regulations that set certain standards or forbid certain activities, or default rules where the possibility of opting-out is clearly stated. There is some virtue in having government be clunky and apparent in its actions; conversely, a government that views its task as to be more subtle and manipulative, affecting choices in ways that people can\’t easily perceive, seems to me a potential cause for concern. For example, I\’m more comfortable with a tax on gasoline or on carbon than I am with government attempting to discourage fossil fuel use by providing the public with what some government agency has decided is the relevant, meaningful, timely, and salient information.

I just ran across a delightful working paper by Daniel Sichel of the Federal Reserve that was presented at several seminars last summer: \”Everyday Products Weren\’t Always that Way: Prices of Nails and Screws since about 1700.\” Here\’s a version presented in July 2011; here\’s a version from an October presentation. I\’ll focus here on the price of nails. Sichel writes:

\”Using the preferred price index developed in this paper, the real price of nails on a quality adjusted basis fell—relative to a broad bundle of consumption goods as measured by the overall CPI—by a factor of about 15 from its peak in the mid-1700s to the middle of the 20th century, averaging a decline of 1.3 percent a year. (Prices have risen some in the past several decades.) …

\”[T]oday, a nail-making machine with a footprint of about three feet square [can]  produce 300 to 450 nails per minute. If we assume that one worker can operate 4 machines at once and that each machine produces 350 nails a minute, then labor productivity of nail production has increased by a factor of 1400 times since the era of hand-forged nails when it took a worker about a minute to produce a nail. With most of this change occurring over the period from 1790 to 1940, the annual rate of increase in labor productivity was nearly 5 percent a year …\”

Here\’s an illustrative figure. The colors show the primary changes in nail technology over time, from hand-forged nails, to a mixture of forged and cut nails, to the predominance of cut nails, to the modern wire nails. (In interpreting the graph, notice that the real price on the vertical axis is a log scale for cents/nail.)

This dramatic change in productivity of nail production has the implication that nails were far more expensive in relative terms back in the 1700s. Sichel offers a number of vivid anecdotes and statistics to support this claim. For example:

• \”[T]he dome of the Maryland State Capitol, completed in 1788 and made largely of wood, was joined together with no nails but rather with wooden pegs and iron straps. Presumably, this choice was made, at least in part, because of the high cost and limited availability of nails at the time.\”
• \”The high value of nails during the 1700s is highlighted by the practice of burning down abandoned buildings to facilitate recovery of the nails …\”
• \”[T]his paper also reports domestic absorption of nails, going back to 1810. At that time—more than 20 years after the Maryland State Capitol was completed—nails are estimated to have amounted to about 0.4 percent of nominal GNP. In today’s terms, this share is similar to that of household purchases of personal computers and peripherals or of airfares. As prices plunged during the 1800s, domestic absorption rose dramatically. But, as a share of nominal GDP, domestic absorption of nails, which once were quite important, have become de minimus. So, while nails appear everyday today, that perception reflects a couple hundred years of significant declines in their relative price.\”
• \”In 1798, a relatively simple house (24’ x 36’ with 7 windows) in Warren, Connecticut was valued at $50. … This house likely was built with few nails, but, as a thought experiment, let’s suppose that it were built primarily with nails rather than other joinery. … Suppose that the 1798 house would have required 50 pounds of nails … Given nail prices in 1789 of $12.00 per hundred pounds, the nails for that 1798 house would have cost $6.00, more than 10 percent of the value of the house!\”

While the price of nails themselves hasn\’t fallen in the last half-century, Sichel makes several interesting points. First, the variety of nails has risen and there have been a number of quality improvements, like rust-proofing nails and adding rings around the shank of the nail to improve holding power. In addition, Sichel argues that the invention of the nail-gun has caused the price of an installed nail to continue falling substantially. He uses back-of-the-envelope calculations to suggest that the price of an installed nail using a nail-gun is about 60% lower than the price of a hand-hammered nail–which suggests that the price of an installed nail is near its all-time low right now.

Back in 2010, the American Economic Association decided to make the articles in my own Journal of Economic Perspectives freely available, ungated and without a password. At present, the issues from the most recent Winter 2012 back to Winter 1994 are freely available on-line.

A new feature is now available. Until now, what has been available is a list of individual articles. However, you can now freely download the entire Winter 2012 issue of JEP in various formats: PDF, Kindle, and ePub. Moreover, if you want entire issues of JEP automatically delivered to your Kindle, it is now possible to subscribe through Amazon. (Amazon doesn\’t provide free distribution service, but the AEA has negotiated to keep the price as low as possible.)

I was strongly in favor of making the JEP freely available, so that the articles could be widely disseminated and easily linked. However, I have had some concern that if a journal becomes just a collection of downloadable articles, readers might be less likely to sample individual articles within an issue, instead of just focusing in on the specific article that they want. But the technology for e-readers is moving faster than my fears. I suspect that in the not-too-distant future, most of us will receive most of our magazines and journals sent straight to the e-reader of our choice, fully formatted, and with graphics and ads included. The potential for serendipity–finding that intriguing article for which you didn\’t know that you were looking–will be maintained.