Next Merger Wave Coming? Hart-Scott-Rodino 2011

The Federal Trade Commission has released the Hart-Scott-Rodino Annual Report 2011.  Each year, it summarizes the number of  mergers and acquisitions, their size, and some trends in antitrust enforcement. At least in my reading, the data in the report hints that a new wave of mergers may be on the way.

The Hart-Scott-Rodino legislation requires that when businesses plan a merger or an acquisition above a certain price–typically $66 million in 2011–it must first be reported to the Federal Trade Commission. The FTC can let the merger proceed, or request more information. Based on that additional information, the FTC can then let the merger proceed, block it, or approve it subject to various conditions (for example, requiring that the merged entity divest itself of certain parts of the business to preserve competition in those areas).

Here are the total mergers reported for the last 10 years. You can see the wave of mergers and acquisitions that peaked in 2007–and what appears as if it could be the start of a new merger wave in the last couple of years.

The total value of merger transactions reported under Hart-Scott-Rodino isn\’t completely comparable across years, because the threshold at which transactions need to be reported has risen over time. But for what it\’s worth, here\’s the pattern of the total dollar value of reported transactions since the late 1990s.

\”The total dollar value of reported transactions rose dramatically from fiscal years 1996 to 2000, from about $677.4 billion to about $3 trillion. After the statutory thresholds were raised, the dollar value declined to about $565.4 billion in fiscal year 2002, and $406.8 billion in fiscal year 2003. This was followed by an increase in the dollar value of reported transactions over the next four years: about $630 billion in fiscal year 2004, $1.1 trillion in fiscal year 2005, $1.3 trillion in fiscal year 2006, and almost $2 trillion in 2007. The total dollar value of reported transactions declined to just over $1.3 trillion in fiscal year 2008, and to $533 billion in fiscal year 2009, increased to $780 billion in fiscal year 2010, and $979 billion in fiscal year 2011.\”

And here\’s a table showing the size distribution of the reported mergers in 2011. About 28% of the transactions exceeded $500 million; 11% exceeded $1 trillion in size.

The FTC allows most mergers to proceed, which makes sense in a competitive market economy. As a general rule, those who run businesses are in a better position than government economists to plan strategies for their firms. In 2011, about 4.1% of the mergers reported to the FTC has a request for additional information. At the end of the day, the FTC actually challenged 20 mergers in 2011. Thirteen of these challenges went to court; 11 were settled by consent decree. Perhaps the best-known of these cases in 2011 was the FTC decision to block AT&T’s proposed acquisition of T-Mobile. With the other seven, two of the deals were abandoned, and the other five led to restructuring of the deal or changes in conduct.

There are a number of reasons to suspect that a new wave of mergers may be coming, nicely reviewed in an article in the Economist magazine of May 19 called \”Surf’s up: Merger waves mean that markets can consolidate rapidly. The next one is coming.\”\’ Mergers often happen when there are lots of struggling firms and excess capacity, which creates lots of willing sellers and good deals for possible buyers. When firms have a lot of cash on their balance sheets, like now, mergers start to look attractive. When interest rates are low, borrowing money to finance a merger or acquisition looks more attractive, and the alternative possible investments for corporate funds look less attractive.  
Waves of mergers often happen in waves. Once a few mergers happen in an industry, other companies start to feel as if they need to find a merger partner as well. In short, the broad economic conditions are ripe for a wave of mergers and the data for 2011 suggests that such a wave may just be getting underway. The FTC and the antitrust division over at the U.S. Department of Justice should be on their toes. 

Wealth by Distribution, Region, and Age

The Federal Reserve has published results from the most recent Survey of Consumer Finance, the triennial survey that is the canonical source for looking at the wealth of households. The results are in an article in the June 2012 issue of the Federal Reserve Bulletin called \”Changes in U.S. Family Finances from 2007 to 2010: Evidence from the Survey of Consumer Finances,\” by a team of authors led by Jesse Bricker, Arthur B. Kennickell, Kevin B.Moore, and John Sabelhaus.

The headline finding from the report is that the median household wealth level fell from $126,000 in 2007 to $77,000 in 2010. Mean wealth is of course far higher than median wealth. It fell from 584,000 in 2007 to $499,000 in 2007. During a three-year period when housing prices and the stock market declined, a fall in wealth is expected. I\’m still trying to digest the data, but here, I\’ll focus on three patterns in the evolution of wealth that just happened to catch my eye: changes across the distribution of wealth, across regions, and across age groups. Here\’s a table with the mean and median household values for the 2001, 2004, 2007, and 2010 surveys.

Changes in the Distribution of Wealth

Those in the 90-100th percentiles of the wealth distribution have median wealth of $1,864,000, and mean wealth of $3,716,000 in 2010. That\’s also the part of the wealth distribution that had the smallest percentage decline in the median and the mean from 2007 to 2010. 

\”Median net worth fell for all percentile groups of the distribution of net worth, with the largest decreases in proportional terms being for the groups below the 75th percentile of the net worth distribution. From 2007 to 2010, the median for the lowest quartile of net worth fell from $1,300 to zero—a 100 percent decline; at the same time, the mean for the group fell from negative $2,300 to negative $12,800. For the second and third quartiles, the median and mean declines in net worth were smaller but still sizable; for example, median net worth for the second quartile fell 43.3 percent. Median and mean net worth did not fall quite as much for the higher net worth groups. For the 75th-to-90th percentile group, the median fell 19.7 percent while the mean fell 14.4 percent. For the wealthiest decile, the 11.0 percent decline in the mean exceeded the 6.4 percent decline in the median for that group; as was discussed earlier in the case of family income, this pattern of the changes in
the median and mean suggests that there was some compression of higher values in the wealth distribution.\”

Changes in Wealth by Region

The drop in housing prices hit especially hard in the western states, and the decline in median wealth was by far the highest in that region. Here\’s the Fed report: 

\”Between 2007 and 2010, median net worth fell dramatically for families living in all regions of the country, but especially for those living in the West—a 55.3 percent decline. This pattern reflects the effect of the collapse of housing values in several parts of the West region. Median wealth in every other region fell 28.2 percent or more. As with the overall population and most other demographic groups discussed earlier, the decline in mean net worth within every region was smaller than the drop in the median. In the South and Midwest regions, the percentage decline in the median was about twice as large as the percentage decline in the mean, but in percentage terms, the median for the West fell four times as much as the mean.\”

Changes in Wealth by Age

The age 35-44 group experienced the biggest falls in net worth. Oddly enough, the over-75 age group saw a modest rise in net worth from 2007 to 2010. This must mean that the over-75s were not as heavily exposed to the drop in housing prices and and the stock market. Here\’s the Fed:

\”The survey shows substantial declines in median and mean net worth by age group between 2007 and 2010, with the exception that mean net worth rose modestly (1.3 percent) for the 75-or-more age group. The 35-to-44 age group saw a 54.4 percent decline in median net worth during the most recent three-year period, and the mean for that age group fell 36.4 percent. The wealth decreases for the less-than-35 age group were also large; the median fell 25.0 percent while the mean fell 41.2 percent. The declines in median and mean net worth for middle-aged families (the 45-to-54 and 55-to-64 age groups) were also large.\”

Eight Bon Mots from Milton Friedman

 Allen S. Sanderson has a nice tribute marking the 100th anniversary of Milton Friedman\’s birth in \”Remembering Milton,\” which appears in the Second Quarter 2012 issue of the Milken Institute Review. (Available on-line, but free registration required.) The article offers a number of nice reminisces from Friedman\’s colleagues and students (two groups that often overlap).
Along with Friedman\’s status as one of the handful of most prominent economists of the 20th century, he also had a nearly wicked rhetorical ability to turn a phrase. Here are a few of Friedman\’s one-liners collected by Sanderson:
Concentrated power is not rendered harmless by the good intentions of those who create it.

History suggests that capitalism is a necessary condition for political freedom. Clearly it is not a sufficient condition.

The problem of social organization is how to set up an arrangement under which greed will do the least harm; capitalism is that kind of a system.

With some notable exceptions, businessmen favor free enterprise in general but are opposed to it when it comes to themselves.

The free man will ask neither what his country can do for him nor what he can do for his country.

The case for prohibiting drugs is exactly as strong and as weak as the case for prohibiting people from overeating.

If you put the federal government in charge of the Sahara Desert, in five years there’d be a shortage of sand.

Only a crisis — actual or perceived — produces real change. When that crisis occurs, the actions that are taken depend on the ideas that are lying around.

U.S. Government: Some International Perspective

I found myself checking some facts about the relative size of U.S. government revenues, expenditures, and debt in the OECD publication \”Government at a Glance 2011.\” Just to be clear, this data sums up all levels of government together, so for the United States, it includes federal, state, and local government.

Revenues

As a share of GDP, U.S. government revenues for all levels of government are well the OECD average in 2009, at a shade over 30% of GDP. Of course, this was a year when the Great Recession hit the U.S economy with particular force and held down incomes and tax payments quite substantially. In this group, the northern European economies like Norway, Denmark, Sweden and Finland lead the way by collecting more than 50% of GDP as government revenue. However, because the U.S. economy is richer on a per capita basis, even though U.S. government revenues as a share of GDP are low, government revenues in absolute dollars per personare actually just a bit above the OECD average–and similar to government revenues per person in Canada and the United Kingdom.


 
Expenditures

When it comes to spending as a share of GDP, the U.S. government at all levels ranks below the average for the OECD comparison group, but in spending, the U.S. isn\’t as much of an outlier as it is in expenditures. For example, expenditures as a share of GDP in the U.S. are quite similar to Canada, and above Japan and Australia. Again, because the U.S. economy is richer on a per capita basis, U.S. government expenditures on a per person basis are higher than the average for the group: for example, higher than expenditures per person in France, Germany, Italy and the United Kingdom.

How are government expenditures in the U.S. allocated differently than in the rest of the OECD comparison group? Not surprisingly, the table shows that 11.9% of all U.S. government spending goes to defense, compared with 3.8% in the other countries. More surprising, to me at least, is that the share of U.S. government spending going to health is substantially higher than the average for the comparison group: 20.5% in the U.S. compared with an average of 14.7%. Health care costs so much in the U.S. that our government ends up spending a larger share of its resources on health than the other countries, even though most of those countries have national health insurance systems. U.S. government as a whole also puts a greater share of its expenditures into education compared with the comparison group: 16.6% to 13.1%. The major area where U.S. government at all levels spends much less is the category of \”social protection,\” which is non-health and non-housing spending to aimed primarily at those with below-median incomes. U.S. government puts 19.4% of its spending into this category, compared with 33.5% for the comparison group.

Debt 

The calculation here is \”gross\” government debt, not \”net.\” The difference is that many governments owe some debt to themselves; in the U.S., for example, the $2.7 trillion or so in the Social Security Trust Fund is invested in Treasury bonds, which means that one part of the government owes the money to another part of the government. In a U.S. context, it is often common to look at \”debt held by the public,\” and thus to leave out the case where government owes a debt to itself. But for purposes of international comparisons, using gross debt is common.

Japan far and away leads the pack on gross debt, at a debt/GDP ratio of about 200%. But Japan is also a special case with an extremely high domestic savings rate, and limited possibilities for Japan\’s consumers to invest those savings outside the country. Japan has financed its own public debt, without a need for an inflow of foreign capital. But not far behind are some of the problem children of the euro area: Greece, Italy, Portugal and Ireland. Spain, despite the recent travails of its banking system, was actually a bit below the average for public debt/GDP ratio in 2010.

The U.S. position in 2010 is uncomfortably high: a bit behind some of Europe\’s problem cases like Greece and Italy and Ireland, but with a higher debt/GDP ratio than Germany, Canada, or the UK. It\’s also interesting to me that the high-tax, high-spending economies of northern Europe–Sweden, Denmark, Norway, and Finland–are all below the average on debt/GDP ratio. Their governments do spend more, but in this comparison group, they do a reasonable job of collecting the revenues to pay for it.

How Digital Check Imaging is Saving $3 Billion Per Year

Back in the 1980s and 1990s, there was an occasional outbreak of controversy around the idea of the check \”float,\” defined as how long after you deposited a check in your account were the funds actually available to you. Banks were often accused of failing to credit deposited checks to accounts as quickly as they could, because if they could hang on to the money for a few days longer, they could earn a bit of additional interest. The Expedited Funds Availability Act of 1987 was passed to limit the ability of banks to hold checks and benefit from the \”float\” (For example, here a 1997 article on some aspects of the check float controversy from the Federal Reserve Bank of Richmond.)

But the events of September 11, 2001, led–along with a host of considerably more important consequences–to a movement away from paper checks and to digital images of checks, thus largely ending the check float controversy. David B. Humphrey and Robert Hunt tell the story in \”Getting Rid of Paper: Savings from Check 21,\” just published as Working Paper 12-12 for the Federal Reserve Bank of Philadelphia.

Here is their description of the past process in clearing checks: \”The Uniform Commercial Code has long required U.S. checks to be physically presented to the banks they are drawn on for payment. … [T]he required physical presentment generated expensive air and land courier transportation costs. It also led to delays in check collection of from 1 to 5 days, averaging 1 day for local or within-city checks and usually 2 to 3 days for non-local items such as checks going from one city to another across the country.\”

But the events of 9/11 led to legislation allowing banks to accept digital images of checks that could be transmitted electronically.  \”On September 11, 2001, planes were grounded and check fl‡oat—–the value of checks in the process of transportation and collection—–rose to $47 billion (about eight times the normal daily level), while electronic payments were unaffected. Although the technology has been available for almost two decades to digitize check images and collect checks electronically on a same-day basis, the legal requirement of physical presentment inhibited its adoption. … The September 2001 disruption spurred the Federal Reserve to ask Congress to allow a paper representation of the digital image of the front and back of a check (called a substitute check) to be legally the same as the original physical item for purposes of collection and presentment. This legislation, adopted in 2003 and known as Check 21 (Check Clearing for the 21st Century Act), along
with other initiatives, currently permits almost all of the 24.5 billion checks paid annually in the U.S. (worth $32 trillion) to be collected electronically on a same-day (or next-day) basis once they are deposited at a bank. The original check is imaged and transported electronically, and a substitute check is printed close to where the paying bank is located. The substitute check is then physically
presented for payment. Since accepting billions of substitute checks is more costly than accepting and paying the electronic image itself, almost all paying banks now receive and pay the image.\”

 As the figure shows, digital images of electronic checks rapidly took over from paper checks between about 2005 and 2008. The figure shows checks processed by the Federal Reserve, but commercial banks have also moved dramatically to using digital images of checks.

The Check 21 legislation has shortened the float, so that it often happens in the same day or in one day, and never in more than two days. \”Since with Check 21 geography no longer matters, all deposited checks must be made available within 2 business days under Regulation CC (which implements the 1987 Expedited Funds Availability Act). Previously, some transit items could have had a maximum delay of up to 5 days when collection was physically difficult.\”

Allowing banks to transmit digital images of checks, rather than paper checks themselves, led to three main areas of cost savings:

  • Savings in the physical cost of processing checks. It cost the Federal Reserve 9.6 cents to process a paper check in 2006, but 2.5 cents to process an digital image of a check in 2010. Applied to the 8.4 billion checks the Fed processed in 2010, and the 7.9 billion more processed by commercial banks, Humphrey and Hunt estimate: \”The total production cost savings from Check 21 for the U.S. payments system during 2010 is thus estimated to have been $1.16 billion.\” 
  • Savings to businesses receiving checks from being able to collect the money a day earlier. \”[B]usiness payees may have saved $1.37 billion in working capital costs by being able to collect checks a minimum of one day earlier because of Check 21.\”
  • Savings to consumers who can hold on to their money for a day or two longer before paying their credit cards or other debts. \”Combining all of this information leads to a rough estimate that consumers may have saved $0.64 billion from Check 21.\”

Along with this $3 billion or so in itemized gains, participants in the financial system would also have benefited from the greater certainty of knowing that your money would be available sooner.

A few weeks ago on May 21, I posted about \”Illustrating Economies of Scale,\” and the conversion from paper checks to digital images offers an example. Humphey and Hunt argue that as digital electronic checks ramped up, they were able to take advantage of economies of scale to reduce averae per-unit costs. On the other side, as paper checks were phased out, they lost the advantages of economies of scale and thus saw per-unit costs rise. Here\’s the figure:

The story of the transition from paper checks to digital checks isn\’t a major economic episode. But it\’s one more nice illustration of how digital technology and the Internet have been transforming the ways in which economic activity is conducted.

Unconventional Natural Gas and Environmental Issues

\”Unconventional\” natural gas production is booming in the U.S.: that is, shale gas, coalbed methane, and \”tight gas,\” which is similar to shale gas but found in low-permeability formations.  However, there are two sets of environmental concerns. One involves protecting the environment while actually extracting this gas. The second involves how finding a substantial new source of energy might affect air pollution, including the carbon emissions that pose a risk of global warming.  The International Energy Agency discusses the issues in \”Golden Rules for a Golden Age of Natural Gas.\” (The IEA is an autonomous international agency with 28 member countries and a staff of 260. It was founded back in 1973-74 as part of the response to the oil price shock at that time.)

As a starting point, here\’s an overview of the U.S. situation, with a map showing where the main deposits are located:

\”Until recently, unconventional natural gas production was almost exclusively a US phenomenon. Tight gas production has the longest history, having been expanding steadily for several decades. Commercial production of coalbed methane began in the 1980s, but only took off in the 1990s; it has levelled off in recent years. Shale gas has also been in production for several decades, but started to expand rapidly only  in the mid-2000s, growing at more than 45% per year between 2005 and 2010. Unconventional gas production was nearly 60% of total gas production in the United States in 2010. While tight gas and shale gas account for the overwhelming bulk of this, shale gas is expected to
remain the main source of growth in overall gas supply in the United States in the coming
decades. The United States and Canada still account for virtually all the shale gas produced
commercially in the world … There are large resources of all three types of unconventional gas across the United States. Of the 74 trillion cubic metres (tcm) of remaining recoverable resources of natural gas at end-2011, half are unconventional; in total, gas resources represent around
110 years of production at 2011 rates.\”

One part of the report tried to enunciate a set of \”golden rules\” that should be followed to protect the environment while extracting this gas. There is a lengthy discussion of these \”golden rules,\” but the overall tone can be discerned from the main headings (each of which has several subheadings): Monitor, disclose and engage; Watch where you drill; Isolate wells and prevent leaks; Treat water responsibly; Eliminate venting, minimise flaring and other emissions; Be ready to think big; Ensure a consistently high level of environmental performance.

Intriguingly, the IEA finds that the costs of implementing this \”golden rule\” environmental agenda are quite manageable in the context of the overall cost of these projects: \”We estimate that applying the Golden Rules could increase the overall financial cost of development a typical shale-gas well by an estimated 7%.\”  I would interpret this finding as saying that there is no cost-based justification for not undertaking at least this level of environment projection, if the exploitation of unconventional gas reserves is to proceed. 

The other main environmental issue is the concern that abundant natural gas will add to air pollution, including both conventional pollutants and carbon emissions that bring a risk of climate change. The IEA modelling suggests several effects would take place. Natural  gas will reduce the need for burning coal to generate electricity and burning oil for heating and transportation, which tends to reduce carbon emissions. But on the other side, cheaper natural gas will also slow the deployment of more expensive non-carbon energy sources, and the quantity demanded of natural gas will rise as it gets cheaper. Overall, these counterbalancing effects would lead to a modest reduction in carbon emissions. The IEA writes:

\”[I]t is difficult to make the case that a reduction in unconventional gas output brings net environmental gains. The effect of replacing gas with coal … is to push up energy-related CO2 emissions, which are 1.3% higher [without added natural gas] than in the Golden Rules Case. …  Additional investment in coal-fired generation locks in additional future emissions, since any new coal-fired power plant has an anticipated operating lifetime in excess of 40 years. Though many of those concerned with environmental degradation may find it difficult to accept that unconventional gas resources have a place in a sustainable energy policy, a conclusion from this analysis is that, from the perspective of limiting global greenhouse gas emissions, a Golden Rules Case has some advantages … while also bringing with it other benefits in terms of the reliability and security of energy supply.\”

The IEA immediately goes on to say that a strategy of encouraging development of unconventional natural gas isn\’t enough to ameliorate climate change concerns:

\”[R]reaching the international goal of limiting the long-term increase in the global mean temperature to 2°C above pre-industrial levels cannot be accomplished through greater reliance on natural gas alone. Achieving this climate target will require a much more substantial shift in global energy use, including much greater improvements in energy efficiency, more concerted efforts to deploy low-carbon energy sources and broad application of new low-carbon technologies, including power plants and industrial facilities equipped for carbon capture and storage. Anchoring unconventional gas development in a broader energy policy framework that embraces these elements would help to allay the fear that investment in unconventional gas comes at the expense of investment in lower carbon alternatives or energy efficiency.\”

 My own grand compromise proposal is for the \”Drill Baby Carbon Tax.\” On one side, it calls for making a national commitment to using domestic energy resources including natural gas, coal and oil, for the jobs, the lower energy prices, and the reduced dependence on imported energy. On the other side, it also calls for a carbon tax so that the prices paid by consumers for energy sources that pollute the air reflect the full social costs of that energy production, and thus will also encourage development of cleaner energy sources.  Indeed, one can envision a future for electricity generation where there is increasing reliance on noncarbon sources over time, but when the sun isn\’t shining and the wind isn\’t blowing, we have abundant natural gas as a reliable backup.

Long-Term Budget Outlook from CBO

The Congressional Budget Office has published \”The 2012 Long-Term Budget Outlook.\” It\’s a go-to source for balanced and unheated analysis on this subject. The main focus is not on the annual budget deficits of the last few years or the next few years, but rather on the overall accumulation of federal debt. Here are some points that caught my eye.

Current Federal Debt in Long-Run Perspective
Here\’s a figure showing the ratio of federal debt/GDP from 1790 to the present. Notice that before World War II, the highest points of federal borrowing–the Revolutionary War, the Civil War,  World War I, and the Great Depression–were all below a debt/GDP ratio of 50%. World War II pushed the debt/GDP ratio above 110%, but then it dropped back down after a few decades. Even after the big budget deficits of the 1980s and early 1990s, the debt/GDP ratio didn\’t get above 50%. But the current debt/GDP ratio is now above 70%, higher than any previous episode in U.S. history other than World War II. The federal debt isn\’t in completely uncharted territory, but it hasn\’t visited this neighborhood often before.

Alternative Scenarios for Long-Run Debt
The CBO does two main projections for long-run federal debt. One projection assumes that current law will be followed exactly. Under this scenario, which the CBO calls the \”Extended Baseline Scenario,\” the debt/GDP ratio soon flattens out and fades. But frankly, this current law scenario can\’t be trusted. After all, nothing stops Congress from passing and the President from signing a law that says all federal budgets will be balanced after, say, 2020. On paper, this solves the debt problem! But in practice, if the law is virtually certain to be changed before 2020, it solves nothing.

Thus, the CBO also offers the \”Extended Alternative Fiscal Scenario,\” which \”incorporates the assumptions that certain policies that have been in place for a number of years will be continued
and that some provisions of law that might be difficult to sustain for a long period will be modified, thus maintaining what some analysts might consider “current policies,” as opposed to current laws.\”

For example, tax cuts enacted by a Republican Congress and signed into law by President Bush in 2001 were scheduled to expire in 2010. But in 2010, a Democratic Congress and President Obama extended those tax cuts through 2012. The CBO \”alternative\” scenario assumes that this lower level of taxes will continue after 2012. It also assumes that Congress will continue to pass \”temporary\” relief from the Alternative Minimum Tax. It assumes that Congress will prevent the large cuts in Medicare now written into current law: a 31% cut in physician payments scheduled for next year, and automatic reductions of 1% per year in other reimbursements over the long term.  The alternative fiscal scenario also assumes that federal spending for activities other than health care and Social Security will remain more or less at their average levels for the last two decades (as a share of GDP), rather than dramatically falling in size over the next decade or two as current law somewhat mysteriously requires. The alternative scenario concludes that when push comes to shove, Congress and the President won\’t let the automatic spending cuts mandated by the Budget Control Act a few years ago take effect.

Under the alternative \”current policies\” scenario, the federal debt takes off.  It hits a debt to GDP ratio around 100% in about 2023, 150% by the early 2030s, and 200% by 2040. Of course, matters are unlikely to go that far. One way or another, the wheels would come off the wagon by then.

Health Care Spending Drives the Long-Run Debt Forecast
Social Security spending is slated to rise as the post WWII baby boomers hit retirement age, rising from 5% now to about 6% of GDP in 2037. However, spending on federal health care programs under current law (that is, assuming the unrealistic cuts in Medicare) would still rise from 5^% of GDP today to 10% of GDP by 2037. The sustained rise in federal spending in the alternative scenario is first due to health care spending and to not assuming that all other federal spending is slashed as current law projects–and then later due to monumental interest costs that build up from the earlier borrowing.

The upper left bar graph compares the average level of Social Security and federal health spending for the average of 1972-2011, and then looks at what it would be 25 years from now in 2037 under the baseline and the alternative scenario. Notice that under the baseline scenario the increase is large, and under the alternative scenario it\’s even larger. Under both scenarios, all other federal spending (except interest payments) decreases. Total revenues are higher in the baseline scenario, which assumes that the Bush/Obama tax cuts will be eliminated and the reach of the Alternative Minimum tax will greatly expand.

Why acting sooner is better than later.
The CBO is careful to take no stand on exactly how soon federal deficits should start coming down.  The report does make the point that sooner is better than later for long-term economic growth. But it also points out that postponing a solution tends to be better for anyone born more than 21 years ago—that is, for most voters!–because it pushes more of the costs of addressing the federal debt on to those who are under 21 or not yet born.

\”CBO’s analysis suggested that, depending on the policy used to stabilize the debt, delaying action for 10 years—which would allow the debt-to-GDP ratio to rise by an additional 40 percentage points under the assumptions used for that analysis—would cause real output to be lower by between 2½ percent and 7 percent in the long run than it would have been if the ratio had been stabilized earlier at a lower level. … Most of the decline in output caused by delaying action would stem from two factors: the crowding out of investment in productive capital, which would reduce the size of the capital stock by between 7 percent and 18 percent; and the effects of higher marginal tax rates (which would ultimately be required under the policy that stabilizes debt by raising taxes) on people’s incentives to work and save.

Another conclusion of CBO’s analysis was that generations born after about 2015 would be worse off if action to stabilize the debt-to-GDP ratio was postponed from 2015 to 2025. People born before 1990, however, would be better off if action was delayed, largely because they would partly or wholly avoid the policy changes needed to stabilize the debt …\”

There is legitimate room for disagreement over how quickly and how severely to try to reduce federal budget deficits, given the continued sluggishness of the economy. But a growing body of research (for example, see here and here) suggests that the ratio of public debt/GDP can reach about 90% of GDP without much negative effect, and then the chances of reduced growth or even a financial crisis become much more severe. Over the next 10 years, or maybe sooner, current federal budget policies are putting the debt/GDP ratio on a collision course with a very hard reality.

U.S. Child Poverty in International Context

UNICEF Innocenti Research Centre has issued its report: \”Measuring child poverty: New league tables of child poverty in the world’s rich countries.  The United States doesn\’t stack up very well, although it\’s important to be clear on just what the comparisons are showing.

For comparability across countries with different income levels, the report uses a working definition of \”poverty\” as half of the median income in that country. This graph shows the share of children in each country who are growing up in families where the income is less than half the median income for that country. The U.S., with 23.1% of its children in such families, ranks 34th out of 35 countries.

It\’s important to be clear on what this graph doesn\’t show. It doesn\’t show that U.S. children are more deprived in absolute terms than children in other countries. The U.S. has a higher level if incomes than these other countries–much higher than some of them. Indeed, the UNICEF report notes that half of the median income for the 10 richest countries in this table is more than the actual median income for the 10 poorest countries in the table.

In addition, income is more unequally distributed in the U.S. than in many of these other countries. As a result, the U.S. will have a larger share of its population living in households that earn less than 50% of the median income compared with countries that have a much more equal distribution of income like Iceland or Finland.  The UNICEF report offers an extended discussion of poverty lines set in absolute terms and those set in relative terms, and the report offers data and examples for both approaches. The argument that it can be useful to look at a relative poverty line, like 50% of median income in a country, goes like this:

\”In sum, a relative poverty line drawn at 50% of median income is an attempt to define a concept of poverty on which there is widespread agreement in principle – a concept which says that the poor are those who do not have access to the possessions, amenities, activities and opportunities that are considered normal by most people in the society in which they live … 50% of the median is a plausible measure of what it is intended to measure – the sense of falling so far behind the norms of one’s society as to be at risk of social exclusion. …

Thus, this argument holds that  the reason why the proportion of children in households below 50% of median income matters is that it represents the share of children missing the \”possessions, amenities, activities and opportunities that are considered normal by most people in the society in which they live.\” As an example of how these forces play out, I posted on May 23 about \”Dimensions of College Attendance,\” One figure in that post shows that for Americans born between 1979 and 1982, of those born into families in the bottom quarter of the income distribution, 9% completed a four-year college degree by age 25, and of those born into families in the top quarter of the income distribution, 54% completed a four-year college degree by age 25. I strongly suspect that this enormous gap has little to do with the cost of college or the availability of loans, but instead is closely linked to how those born into lower-income families get on average less support from family, local community, and the K-12 education system to prepare them for a college degree.

The UNICEF report also looks at the share of children living in households with less than 50% of median income before and after government taxes and transfers are taken into account. The darker blue bars show the child poverty rates from the preceding figure–that is, after government taxes and transfers are taken into account. The lighter blue bars show what the poverty rate among children would have been, if those taxes and transfers had not occurred. For countries at the top of the list, like Ireland, Hungary, the United Kingdom, Finland, and Australia, the overall effect of government taxes and transfers is a dramatic reduction in the proportion of children that would have been living in households below half of the median income. In the U.S., in contrast, the overall pattern of government taxes and transfers lead to a relatively small reduction in the number of children in such households. In Greece, remarkably enough, the overall pattern of government transfers actually increases the share of children living in households below 50% of the median income–which can happen if taxes are tilted toward families with kids and spending is focused on retirees.

The politics of designing government policies that affect children is complex, because only adults can vote. In many countries, including the United States, children are a decreasing share of the population. For example, U.S. Census data from 2010 showed that those under 18 years of age were 24% of the U.S. population–an all-time low. The U.S. Census Bureau (Table AVG1) estimates that America had 118 million households in 2011, which it divides into 78 million \”family\” households with an average of 3.25 people each and 40 million \”nonfamily\” households with 1.25 people each. Of the subset of \”family\” households, only about 46% have children–also an all-time low. No politician attuned to re-election ever says anything negative about \”the children,\” but as the proportion of children in the population and the share of households with children drops, it becomes politically harder to focus spending and tax policy on the concerns of families with children. 
 
Of course, it is always delicate to design government policy in support of children, because a sensible policymaker needs to be concerned about the incentives created when resources typically flow through their parents. But along with thinking about how U.S. tax and spending policy might support families with children in direct ways, it\’s also useful to think about how schools, libraries, community organizations, and public areas like parks and sidewalks can be supportive to the children.

I ran across the UNICEF report at Miles Corak\’s blog here.  In a post called \”The sad, sad story of the UNICEF Child Poverty Report and its critics,\”  Corak offers some pointed commentary on how such reports have been received in the past.

Will Jobs Be Reshored from China?

China is becoming a less attractive place for off-shoring of manufacturing. But the result isn\’t likely to be a large movement of jobs back to the United States. Instead, globally mobile manufacturers are likely to seek out alternative low-cost destinations. Michel Janssen, Erik Dorr, and Cort Jacoby of the Hackett Group discuss these issues in a report called \”Reshoring Global Manufacturing: Myths and Realities.\” The subtitle is: \”By next year, China’s cost advantage over manufacturers in industrialized nations and competing low-cost destinations will evaporate.\” The report is freely available here, with free registration. 

\”[T]he manufacturing competitiveness of China compared to advanced economies and low-cost geographies is eroding. Stagnant or declining manufacturing wages in the West, rising transportation costs, concerns about intellectual property protection, and Chinese wage-rate inflation have brought traditional calculations about global manufacturing sourcing strategies to a tipping point  …. Our findings debunk a myth about the future of manufacturing that has been much discussed in the press recently: that manufacturing capacity is returning in a big way to Western countries as a result of rising costs in China. The reality is that the net amount of capacity coming back barely offsets the
amount that continues to be sent offshore. Our study confirms that China’s relative competitive position is indeed eroding rapidly, to the detriment of its overall economy. However, few of the low-skill Chinese manufacturing jobs will ever return to advanced economies; most will simply move to other low-cost countries.\”

Here is their estimate of  the gap in manufacturing costs and in \”total landed cost,\” which includes costs of manufacturing along with costs of raw materials and components, transportation and logistics, taxes and duties, and costs of carrying inventories. China continues to have an cost advantage, but the advantage is no greater than other  emerging markets. Moreover, the Hackett Group argues that when China\’s advantage in total landed cost gap drops to the levels projected for 2013, it starts to make sense to think about shifting production elsewhere.

I was also struck by some comments in the report about Apple\’s labor costs with the iPad and outsourcing to China. They emphasize that in some industries like furniture manufacturing, cost matters most. But in other industries, product quality, protection of intellectual property, time to market and ramp-up speed may matter more.

\”The Chinese labor-cost component of an entry-level iPad retailing for $500 is estimated at $10, or 2% of revenue, while the profit margin is estimated at $150, or 30% of revenue. If Apple were to move production to the USA, and if one assumes that assembly costs would triple (to $30), it is conceivable that Apple could convince customers to pay for a large portion of the price increase based on the appeal of a “made in the USA” product. … Furthermore, …  such a move could substantially boost Apple’s corporate image. However, the U.S. lacks the sheer labor capacity that would be required in order to ramp up production of iPads at the speed needed to maintain the company’s edge in the hyper-competitive tablet and mobile device market. … Thus one may assume that Apple’s manufacturing sourcing strategy is primarily motivated by scalability and supply chain
risk, and only secondarily by total landed cost.\”

Why Official Medicare Costs are Understated

When the Medicare trustees deliver their official forecasts for the Medicare system in their annual report, the actuaries who draft the report are required by law to assume that the law will be followed as written. For example, the current Medicare law says that physician payments will be cut 31% by 2013. For most other categories of Medicare services, 2009 hearth care reform legislation also specifies that the payment rates will be reduced each year by a rate equal to the economy-wide increase in multifactor productivity, which is projected at 1.1% per year. 

However, to their great credit, the Medicare actuaries also produce an annual background which explains why these assumed cost reductions are so implausible. This year\’s version was published on May 18 under the dry-as-dust title: \” Projected Medicare Expenditures under Illustrative Scenarios with Alternative Payment Updates to Medicare Providers.\”

Here are a couple of figures projecting how Medicare reimbursement would compare with reimbursement from private health insurance. The first figure shows what current law projects for Medicare reimbursements for physician services, with comparisons to reimbursement from the Medicaid program and from private health insurance. Notice the 31% drop that is supposed to happen immediately, followed by an additional decline. In short, Medicare reimbursement of physicians is now about 80% of private health insurance, but under current law it is supposed to fall immediately to less than 60% of private insurance, and then over time to about 25% of private insurance.

The next figures shows a similar comparison for reimbursement for in-patient hospital services.  Medicare reimbursement for such services was about 90% of private health insurance reimbursement in the mid-1990s, is now down to about 65% of private health insurance reimbursement, and is projected under current law to continue falling to 40% of private health insurance reimbursement. 
 

Clearly, cost projections based on these continually falling rates of reimbursement can\’t be taken seriously. Indeed, there have been scheduled reductions in physician reimbursement every year since 2003–and Congress has overridden them every year. The scheduled 31% drop in physician reimbursements for next year is supposed to get us back on track for all the reductions that haven\’t happened since 2003, but no one believes it\’s going to happen. These kinds of reductions in reimbursements would either drive health care providers into insolvency, or lead them to stop serving Medicare patients.

As a result, the official current law estimates of future Medicare costs are wildly optimistic. The first column of this table shows that under current law, even with its unrealistic reimbursement reductions, Medicare costs nearly double as a share of GDP over the next seven decades. But under an alternative projection, which doesn\’t assume the immediate cut in physician reimbursements or the long-run slowdown in spending growth, Medicare spending is close to tripling as a share of GDP over the next seven decades. 

The actuaries are about as blunt as their profession allows about what all this means: \”The immediate physician fee reductions required under current law are clearly unworkable and are almost certain to be overridden by Congress. The productivity adjustments will affect other Medicare price levels much more gradually, but a strong likelihood exists that, without very substantial and transformational changes in health care practices, payment rates would become inadequate in the long range. … Thus, the current-law projections should not be interpreted as the most likely expectation of actual Medicare financial operations in the future but rather as illustrations of the very favorable impact of permanently slower growth in health care costs, if such slower growth can be achieved.\”