conversableeconomist

Enforcement: Immigration Policy #4

This is the fourth of five posts on immigration policy. For the first post and an overview, start here.

Discussions of enforcing limits on immigration often seem to begin and end with border security: how many guards, how long a fence, how many arrests and deportations. Such policies have been pursued with vigor since the 1990s, and they appear to have been effective.For example, here\’s a figure from Pia M. Orrenius and Madeline Zavodny showing that southwest border apprehensions peaked back around 2000, and have had a generally downward trend since then.

Edward Alden sums up the current situation in \”Immigration and Border Control.\”

\”For the past two decades the United States, a country with a strong tradition of limited government, has been pursuing a widely popular initiative that requires one of the most ambitious expansions of government power in modern history: securing the nation’s borders against illegal immigration. Congress and successive administrations—both Democratic and Republican—have increased the size of the Border Patrol from fewer than 3,000 agents to more than 21,000, built nearly 700 miles of fencing along the southern border with Mexico, and deployed pilotless drones, sensor cameras, and other expensive technologies aimed at preventing illegal crossings at the land borders. … [T]the U.S. borders are far harder to cross illegally than at any time in American history, and the number of people entering illegally has dropped sharply. Evading border enforcement has become more difficult, more expensive, and more uncertain than ever before. …

The United States will never again be a country with loosely guarded borders. The political coalition in favor of tough border control is strong and probably durable; the threats from terrorism or other transnational crime are severe enough to necessitate effective border measures; and the desire by many to migrate illegally to the United States will remain strong enough that deterrence through enforcement is essential. The challenge, therefore, is how to make border security compatible with a sensible immigration system that strengthens the U.S. economy rather than weakens it.\”

My own sense of the evidence is that it is time to stop this continually increasing spending on border security and instead move to other ways of discouraging illegal immigration, including better tracking of those who legally enter the country on temporary visas, and steps to assure that employers can reasonably be held accountable for when they hire illegal immigrants.

Many of the writers in the Cato Journal special issue are not enamored of strong efforts to enforce limits on immigration. For example, the Alden essay is insightful on costs and problems of border enforcement, while Jim Harper discusses potential problems with the e-Verify system that lets employers check on the immigration status of potential workers.  However, contributors to the symposium seem often willing to entertain all sorts of alternatives, without a lot of practical skepticism. For example, Bryan Caplan suggests the possibility that how we could allow in very large numbers of immigrants, but make them ineligible to vote? We could also make their descendants ineligible to vote! Or we could not let them vote until their lifetime tax payments reach $100,000. We could impose special higher taxes on immigrants. We could make immigrants ineligible for welfare benefits. We could require tests of English fluency and cultural literacy for immigration. A number of other authors in the issue emphasize the possibilities of large but temporary flows of immigrants, who would sweep back and forth across the border in waves.

I understand the intellectual rationale for these sorts of proposals, but they seem to me overly clever, and thus likely to be impractical. Jagdish Bhagwati likes to quote the Swiss novelist Max Frisch on the subject of how western Europeans let in lots of guestworkers, on the explicit understanding that they could be sent home, but then found that in practical and political terms they could not be deported. Frisch said: \”We imported workers and got men instead.\” The idea of making immigrants and their descendants unable to vote works fine if the immigrants are just \”workers,\” but not so well if they are also human beings. A vision of crowds of immigrants arriving and departing as needed by the economy views those people solely in their role as workers, not as people with a wide range of goals–like falling in love with people and communities, or getting a better education for their children. Ultimately, it does not seem credible to me that such policies will be enforced in the long term. When it comes to practical enforcement, I place my trust in good old-fashioned policies like continued border security, along with visa enforcement and mechanisms for employers to be able to check whether they are hiring U.S. citizens.

conversableeconomist

Government Budgets: Immigration Policy #3

This is the third of five posts on immigration policy. For the first post and an overview, start here.

A common and plausible concern about immigration is that many immigrants don\’t pay much in taxes, but the government faces costs for education of the children of immigrants, health care of those with low incomes, and law enforcement. Thus, it is feared that immigrants contribute to the fiscal problems of government. To be clear, this concern over the effect on government budgets is really about immigrants with low skill levels and about illegal immigrants. Everyone accepts that legal high-skilled immigrants are on average a net plus for government in terms of the taxes they pay and the government benefits they receive. Daniel Griswold tackles this question head-on in \”Immigration and the Welfare State.\”

Griswold points out that immigrants–even illegal immigrants–do typically have taxes withheld from paychecks, as well as paying sales and property taxes. Recent legal immigrants aren\’t eligible for welfare benefits, and many illegal immigrants don\’t dare try to claim such benefits. For the federal government, immigration is almost certainly a net plus. However, certain state and local governments with high levels of immigration do face high costs of education, health care, and law enforcement related to immigration. He notes the straightforward policy fix: \”If Congress wants to more equitably share the fiscal benefits of immigration, it could distribute funds to states and localities based on the impact of immigration on health and education spending. This need not, and should not, require an overall increase in government spending and taxation, but merely a transfer of resources from the federal level, where immigration represents a net fiscal gain, to state and local governments, where it often imposes a net fiscal loss.\”

Griswold also makes the insightful point that low-skill immigrants are not choosing to locate primarily in high-benefit states–which strongly suggests that gaining access to such benefits is not their primary motivation. (Citations and references to tables omitted from the quotation.)

\”If we consider changes in the foreign born populations in individual states, for example, we can see that the largest gains have generally been in states that are relatively stingy in offering public assistance. … The 10 states with the largest percentage increase in foreign-born population between 2000 and 2009 spent far less on public assistance per capita in 2009 compared to the 10 states with the slowest-growing foreign-born populations—$35 vs. $166 …. In the 10 states with the lowest per capita spending on public assistance, the immigrant population grew 31 percent between 2000 and 2009; in the 10 states with the highest per capita spending on public assistance, the foreign-born population grew 13 percent. If immigrants were primarily concerned with collecting welfare, they would not be flocking to such states as Kentucky, Tennessee, North Carolina, South Carolina, and Georgia. Instead, they would be drawn to such states
as Michigan, Rhode Island, and Vermont, which in fact have seen very slow growth in their immigrant populations.

Undocumented immigrants are even more likely to self-select states with below-average social spending. Between 2000 and 2009, the number of unauthorized immigrants in the low-spending states grew by a net 855,000, or 35 percent. In the high-spending states, the population grew by 385,000, or 11 percent. One possible reason why unauthorized immigrants are even less drawn to high-welfare spending states is that, unlike immigrants who have been naturalized, they are not eligible for any of the standard welfare programs. A second reason is that illegal immigrants are less likely to be well-educated and thus are not as attracted as more highly skilled immigrants to higher-income urban centers in such states as New York, Illinois,
and California. The higher-skilled immigrants gravitate to those states, not because of the higher social spending, but because of the higher rewards for skilled labor.\”

conversableeconomist

The Low-Skilled: Immigration Policy #2

This is the second in a series of five posts on immigration policy. For the first post and an overview, see here.

The effect of immigration on wages seems as if it must be obvious from Econ 101: increase the supply of something and you drive down its price. So immigration must reduce wages, right? The issues isn\’t that simple, for a number of reasons. Four such reasons are laid out by Giovanni Peri in \”Immigration, Labor Markets, and Productivity.\” Peri points out that immigrant labor is often focused on providing home services, in a way that has tended to free up high-skilled native women to enter the workforce or to work more hours.

\”In the United States (and in many European countries) one sector in which the presence of the foreign-born has been large and growing fast is that of home services (cleaning, food preparation, gardening, and similar) and personal services (child and elderly care). These are often characterized as “household production” services. This has allowed a significant share of female workers, often highly educated, to afford these services and to join the formal labor force outside the home or to increase their hours worked.\”

But even if low-skilled immigrant labor may be complementary to high-skilled native labor, surely it must depress wages of low-skilled native workers? Peri argues that this conclusion need not follow, because of ways in which firms and the economy respond to an influx of immigration. He writes (citations omitted): \”In summary, an economy will respond to immigration along several margins—through increased investment by firms, specialization of natives, complementarities between natives and immigrants, technological response by firms, and job creation. …This explains why a long tradition of empirical economic studies has found very small to no effect of U.S. immigration on native wages and employment at the national and at the local level.\”

Here is a bit more detail on each of Peri\’s four margins for economic adjustment in response to low-skilled immigration.

1) Investments

\”As a consequence of the availability of more workers firms invest: existing firms expand their capacity, and new firms are born. Returns to capital increase when more workers are available, and firms take advantage of this by investing.\”

2) Differences among Workers: More and Less Educated

\”Workers are not homogeneous. In terms of their labor market skills and productive activity there is a large difference between workers with high levels of schooling (tertiary education) and those with secondary or less. They use different skills and take different jobs. … In the United States as a whole, however, because of the combination of immigrants at the top and at the bottom of the schooling distribution, if we consider two groups of workers (more and less educated), immigrants have a distribution similar to that of natives. Hence their inflow did not alter much the relative supply of the two groups.\”

3) Specialization and Technology: Job Upgrades

\”Even more interesting is the differentiation of skills and productive characteristics between natives and immigrants within each of the two schooling groups. One very strong tendency among immigrant workers with low schooling is to concentrate in manual jobs. In manufacturing, construction and agriculture, for instance, they work as farm laborers, construction workers, roofers, drivers and so on. In services they work in food preparation, house services, child and elderly care. In contrast, similarly educated natives work in jobs which
use more intensively communication and interaction skills such as cooks, construction supervisors, farm coordinators, or clerks. In Peri and Sparber (2009) we show that, due to the limited knowledge of the language, immigrants have a comparative advantage in manual type of jobs. Hence they specialize in those, and in firms and sectors that hire immigrants, this produces higher demand for jobs of coordination and interaction typically staffed by natives, whose language skills are superior. This dynamic specialization in tasks according to skills pushes natives to upgrade their jobs (as communication-intensive occupations pay better than manual intensive ones) and protects their wages from competition with immigrants. By taking the manual jobs that natives progressively leave, immigrants often push a reorganization of production along specialization lines that may also increase effectiveness and efficiency of labor  … In some studies the mechanism described here, combined with the other effects described earlier in this section, results in a small positive effect of immigration on wages of less educated native workers.\”

4) Lower Wages of Immigrants: An Opportunity for Cost Cutting and Job Creation

\”One common empirical finding in the literature is that immigrants are paid less than natives with similar characteristics and skills. This is in part due to the fact that many immigrants, because of less attractive outside options (such as having to go back to their home country), have lower bargaining power with the firm. In this case firms pay immigrants less than their marginal productivity, increasing the firms’ profits. Such cost-savings on immigrants act as an increase in productivity for firms. Ottaviano, Peri, and Wright (2010) show that if a firm can cut costs in some productive tasks by hiring immigrants, this allows the firm to expand production and employ more people in the complementary tasks, many of which are supplied by natives.\”

In short, the economy is not a static mechanism with a fixed number of jobs that require a predetermined set of skills. Instead, the number of jobs moves over time. Even among those with low skills as measured by education, there can be vast differentiation of skills between, say, those who are proficient in English and those who aren\’t. Low-skilled native workers can in many ways be complements with low-skilled immigrants, not substitutes. Firms can and do adjust their methods of production in many ways. An economy is a flexible organism. That flexibility can be difficult for workers, who need to change and adapt, and will sometimes find their old jobs altered or even ended. But the flexibility is also the source of a gradually rising standard of living over time.

conversableeconomist

The High-Skilled: Immigration Policy #1

U.S. Immigration policy  is a combustible topic, so I\’ll just list five of my main beliefs up front.

  1. Allowing substantially higher immigration from high-skilled labor–in particular, by finding ways to let those who complete science and technology degrees or graduate programs in the United States remain in the country–should be a no-brainer. 
  2. Allowing higher levels of low-skilled immigration is admittedly a tougher call, although I would favor this as well. 
  3. When it comes to government budgets, immigration is an overall benefit to government budgets, but certain state and local governments that suffer losses.
  4. Increasing enforcement at the border may have reached diminishing returns–that is, high costs for relatively little benefit in limiting enforcement. However,  but other ways of enforcing immigration limits could be increased, like keeping better tabs on those with temporary visas and discouraging employers from hiring illegal immigrants. 
  5. Immigration is a much smaller policy issue for the United States than it potentially could be for the world as a whole.

    For some additional background, see my post of July 29, 2011, Thoughts on Immigration. But here I take my text from the most recent issue of the Cato Journal, which is devoted to the subject \”Is Immigration Good for America?\” The essays go beyond my five points, to tackling issues like birthright citizenship and future U.S. demographic trends. There is reasonable support for my points 1-3 and 5, but some disagreement when it comes to enforcement issues. To avoid making this post of encyclopedic length, I\’ll divide it into five parts: one for each of my five themes.

    The U.S. higher education system is widely acknowledged as the best in the world, and especially at the graduate level, it attracts top-notch students from all over the world. We invite them in, we provide financial support for their education, we often connect them to industry–and then we make it hard for them to stay. In a world economy where future economic growth depends largely on science and technology, U.S. immigration policy essentially chases away tens of thousands of highly qualified workers each year. Whatever one thinks about reducing illegal immigration or overall immigration, this policy of chasing away the high-skilled is hugely counterproductive.

    Here is Gordon Hanson making the point in \”Immigration and Economic Growth\” (references omitted for readability):

    \”Each year, U.S. universities conduct a global talent search for the brightest minds to admit to their graduate programs. Increasingly, foreign students occupy the top spots in the search. Data from the National Science Foundation’s Survey of Earned Doctorates show that between 1960 and the late 2000s, the share of PhDs awarded to foreign students rose from one fifth to three fourths in mathematics, computer science, and engineering; from one fifth to three fifths in physical sciences; and from one fifth to one half in life sciences. U.S. university departments that have more foreign graduate students produce more academic publications and have their work cited more frequently. Once they graduate, U.S.-educated foreign workers patent at a significantly higher rate than U.S.-born workers. As a consequence, U.S. cities that attract these workers produce larger numbers of patents in electronics, machinery, pharmaceuticals, industrial chemicals, and other technology-intensive products. Simply put, high-skilled immigration promotes innovation. An additional benefit is that high-skilled immigrants are likely to pay far more in taxes than they use in public services, generating a positive net contribution to government fiscal accounts. …

    \”Today, the difficulty is not in attracting top foreign students to America but in keeping here them after they graduate. High-skilled immigrants have three primary channels for obtaining permission to work in the United States. The H-1B visa, which targets highly trained professionals, permits holders to work in the United States for a period of three years. It is renewable once, with the annual number of visas capped at 65,000. Employer-sponsored green cards permit holders to live and work in the country indefinitely. The annual number of new visas is capped at 150,000. The third channel is a family-sponsored green card, which requires marrying a U.S. citizen (visas for which there is no cap) or having a close relative already in the country legally (visas for which are capped at 640,000). Because of the limited number of work-based visas, the family visa route remains the most common path to legal residence for skilled workers. Rosenzweig (2007) reports that in the early 2000s among immigrants who entered the United States on student visas and ultimately obtained green cards, 55 percent did so by marrying a U.S. citizen. To make it in America, foreign students not only need to be smart enough to get into a U.S. university. They also need to be proficient at dating.\”

    Hoping for proficiency in dating is not a well-conceived immigration policy. It used to be, not that long ago, that foreign graduate students from places like India or China or Brazil would remain in the U.S. after graduation in part because they didn\’t see attractive professional opportunities back in their home countries. Those days are behind us. The U.S. is highly attractive to footloose global talent–it just needs to make it straightforward for that talent to locate here.

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    Tax Expenditures: A Way to End Budget Gridlock?

    Back in 1987, the very first issue of my own Journal of Economic Perspectives had a symposium on the just-passed Tax Reform Act of 1986, which famously (among economists, at least) reduced various exemptions, exclusions, deductions, and credits in the tax code, and then used the extra money to reduce marginal tax rates. In that issue, Nobel laureate James Buchanan offered a trenchant analysis of the political economy behind such legislation. He argued that politicians love to hand out tax breaks to specific groups, but as they do so, it becomes necessary to raise tax rate on remaining income that isn\’t getting a special break. Eventually, the tax rates get so high, and the tax breaks get so numerous, that Congress girds up its loins and passes a bill like the Tax Reform Act. However, Buchanan continued, it would be imprudent to view this bill as proof that Congress actually believe in a simpler tax code with lower rates. Instead, it is just politically necessary to pass such a bill from time to time, so that the political cycle of more tax breaks and higher rates can unwind again.(My journal is freely available on-line back to 1994, but the first issue is not yet freely available. However, it is available through JSTOR, and many academics will have access in that way.)

    In our current impasse over crafting middle-run and long-run ways to reduce budget deficits, many conservatives would like to have a tax code with lower marginal tax rates and with fewer government efforts to micro-manage aspects of the economy, while many liberals would like to have a tax code that raises more revenue–in particular from those with high incomes. Reducing the reach of tax deductions, credits, exemptions, and exclusions–which collectively go under the name of \”tax expenditures\”–could offer a way to provide some satisfaction for all sides.

    Daniel Baneman, Joseph Rosenberg, Eric Toder, Roberton Williams discuss \”Curbing Tax Expenditures\”  in a paper just published by the Tax Policy Center. They point out that a George W. Bush tax commission back in 2005 proposed limits on tax expenditures, as did more recently President Obama\’s President Obama’s National Commission on Fiscal Responsibility and Reform  and a commission from the Bipartisan Policy Center.

    Tax expenditures comprise large sums. The authors of the TPC paper point out: \”Despite significant variation over the years, tax expenditures impose substantial costs on the federal budget and will continue to do so. In 2011, they were projected to cut revenues and raise outlays by $1.1 trillion, more than we collected from individual income taxes and nearly half of total federal revenue collections for the year.\”

    Of course, the problem with altering tax expenditures is that people are used to them, and don\’t want to see them disrupted. By far the biggest tax expenditure is the fact that employer-provided health insurance isn\’t taxed as income: if it was, the U.S. Treasury would collect about $174 billion per year more. The second-biggest tax break is the deductibility of mortgage interest, which costs the Treasury about $89 billion per year. Other big-ticket tax expenditures include deductibility of state and local taxes, deductibility of charitable contributions, lower tax rates for capital gains and dividend income, and others. You can make all the tough-minded policy arguments you want about how in a U.S. economy where rising health care costs are a major policy concern, maybe having a $174 billion tax break subsidizing health insurance isn\’t the best idea, or in a U.S. economy that has just seen the destructive power of a housing price bubble, maybe a tax break to make it easier to spend more on houses isn\’t a great idea. But it\’s tilting at windmills to attack these sorts of provisions one at a time.

    Instead, the TPC authors point out:  \”While an ideal tax reform process would comprehensively evaluate each tax expenditure on its merits, eliminating some and restructuring or retaining others, broad-based limitations on tax expenditures may be easier to enact and would still produce net benefits. This paper examines alternatives for implementing across-the-board limits applied to a selected group of the largest and most widely utilized tax preferences.\” Thus, they offer proposals like converting most tax expenditures into a single tax credit at a 15% rate, or putting a cap (as a share of income) on the total tax expenditures that could be claimed on any tax return, or even just reducing the cost of all tax expenditures across-the-board by a fixed percentage amount. In other words, don\’t tackle individual tax expenditures head-on, but instead try to rein back on many tax expenditures all at once.

    Such proposal would mostly affect the tax bills of those with high incomes, because tax expenditures mainly flow to those with higher incomes. On their calculations, 41% of the total value of tax expenditures goes to the top 5% of taxpayers by income, and 24% of the total value goes to the top 1%. Remember, those in the upper part of the income distribution are far more likely to itemize deductions. And because those with high incomes face higher marginal tax rates, the amount of taxes they save from tax expenditures is also higher.

    The next figure shows effective (that is, average) tax rates for different income levels, and then shows what the tax rates would be without tax expenditures. The federal income tax is progressive: on average those with higher incomes do pay a higher share of income in taxes than those with lower incomes. But at the upper income levels, the presence of tax expenditures reduced the extent of that progressivity.

    Reducing tax expenditures would arguably reduce certain ways in which the government is influencing economic outcomes. It would free up revenue both to pay for reducing marginal tax rates, and also to pay for some reduction of long-germ budget deficits. I believe there is a deal waiting to be cut, although I\’m admittedly dubious as to whether the current crop of politicians can achieve it.

    For a previous take on tax expenditures with some additional background and argument, see my post of last August 3, \”Tax Expenditures: One Way Out of the Budget Morass?\”

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    The "Instant Economist": Early Reviews and Reactions

    Last week my book The Instant Economist: Everything You Need to Know About How the Economy Works was published by Penguin/Plume. For a description of the book, see my January 31 post here.
    To buy copies for yourself, as well as for those in your family, club, company, or community,  head for a local or click here for Amazon or here for Barnes and Noble–or just check a copy out of your local library. Here are some early reviews: 

    In the February 2012 issue of Better Investing, Angele McQuade has written a view called \”Fun With Numbers–Making Economics Make Sense.\” It\’s not freely available on-line at this time, but here are a few excerpts: 

    \”If your only exposure to economics was a class so boring you yawn at even the memory of it, you’re missing out on a lot of useful — and even fascinating — information, says author Timothy Taylor. With so much election year talk of budget deficits, health care costs, wealth disparity, foreign trade and unemployment, it’s not surprising that economic statistics and theories are flying fast and hard. No better time to brush up your knowledge of economics, especially with the help of Taylor’s latest book, The Instant Economist: Everything You Need to Know About How the Economy Works. …\”

    \”What I liked: That Taylor branches beyond a purely domestic viewpoint into the heavily interconnected world of international economics. There’s a reason economists care so much about international trade, and Taylor does an excellent job explaining its importance. …\”

    \”What I loved: How truly relevant Taylor’s lessons are.Yes, we all hear and read economic statistics all the time, but how often do we stop to think about their meaning in our daily lives? Taylor seems to delight in pointing out the many ways economics matters, as well as the ways we can put the knowledge he’s offering to use. …\”

    \”I’m not going to sugarcoat the truth: The Instant Economist isn’t written in a finish-it-over-a-cup-of-coffee style. The content is rich, though, as will be your intellectual reward if you devote even a little effort to it.\”

    In the December 1, 2011, issue of Booklist, Mary Whaley writes: 

     

    \”[T]his handbook on economics is a readable, nontextbook approach on the level of an undergraduate introductory course. … We learn how markets work in the context of goods, labor, and financial capital and also about unregulated markets, including monopoly, the environment, and poverty; he notes that although these issues can attract democratic government involvement, such intervention can fail. He concludes with macroeconomics (an overall view of the economy), with topics including economic growth, unemployment, and inflation. Taylor wants us to respect the power of market forces but understand where those forces fall short; he encourages a belief that government policy can be useful but, in some cases, can be useless or even counterproductive. This guide to the key principles of economics is an important source of information for many library patrons. Excellent book.\”

    From on-line sources, the first review up at Amazon, by Gene Chamson, gives the book five stars and is titled: \”Should be required reading for anyone who wants to participate in the economy. In other words, everyone.\” He adds: 

    \”I am generally not a fan of books that dumb down important subjects, adding a veneer of folksy prose to make them appealing to \”dummies\” or \”complete idiots\”. This is not such a book.
    \”The Instant Economist\”, despite its simplistic title, is a thoughtful, engaging survey of modern economic principles and issues. In 36 short, easy to digest chapters, the author provides a foundation in economic literacy, beginning with the basics of how markets work, then covering the main topics in microeconomics and macroeconomics. … Highly recommended.\”

    From the blogosphere, here\’s Brian L. Belen, a graduate student in economics, writing from the Philippines.

    \”Economics is such an important field of study, yet it is often perceived as too technical and complex for the everyman.  … For this reason, there is plenty of room for accessible books that demistify what economics is all about …  It is in this context that Timothy Taylor makes an important contribution with his new book The Instant Economist: Everything You Need to Know About How the Economy Works.

    From the title alone, it\’s obvious that Taylor seeks to achieve two things: to explain the essentials and to do so in a practical way. He manages both quite ably, beginning with the requisite discussion on demand, supply and pricing, and thereafter branching off into weighty topics in macro- and international economics. When he does so, his presentation is often fairly Socratic: he identifies several specific issues (such as the minimum wage), poses an apparently polarizing question about them (\”Should it be higher or lower?\”), and then proceeds to present both sides, often with some statistics to back up the analysis. As a consequence, readers are left with a very balanced perspective on relevant economic concerns, and are hopefully empowered to make their own judgments accordingly. ….

    In fact, there are several chapters that I particularly appreciated, having taught undergraduate macroeconomics myself. For example, the chapter on the monetary system (i.e. Federal Reserve, to use the U.S. case) is excellent, and I wish I had it as a reference back in my teaching days. Likewise, Taylor very capably devotes a chapter to exchange rates, and it is positively enviable that anyone can write so clearly about the subject.

    The Instant Economist isn\’t your usual introductory economics book, even for casual reading. It\’s a little more than that — a little more advanced, a little more practical, and arguably a little more interesting. For that reason, it\’s material well worth having a look at in order to delve a little deeper into topics from Econ101, whether you took it last semester or years ago.\”

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    Europe\’s Growing Imbalances Before Its Debt and Financial Crisis.

    Europe\’s financial and debt problems were doubtless made worse and brought to a head by the global financial crisis that began in late 2007. But in the U.S., the financial crisis is fundamentally about the bursting of the bubble in housing prices and overborrowing, while in Europe, the current financial and debt problems have different economic roots, tracing to the arrival of the euro as a common currency in the late 1990s.

    Nils Holinski, Clemens Kool, and Joan Muysken  offer many key ingredients of the story in \”Persistent Macroeconomic Imbalances in the Euro Area: Causes and Consequences.\” It appears in the January/February 2012 issue of the Federal Reserve Bank of St. Louis Review. As a useful expository tool, they discuss \”North\” and \”South\” Europe, where North includes Austria, Germany, Finland, and Netherlands, while South includes Greece, Ireland, Portugal and Spain. In the figures that follow, North and South refer to the averages of these groups not weighted by economy or population–because if they were weighted in that way, \”North\” would basically be Germany and \”South\” would basically be Spain. They focus only on the period of time from 1992-2007–that is, the financial crisis has not yet erupted. But their analysis strongly suggests that an eruption of some sort was coming.

    As a starting point, look at trade balances. For the euro countries as a whole, the trade balance has been fairly close to zero in recent years. But as the euro got started, North countries began to run ever-larger trade surpluses, while South countries began to run ever-larger trade deficits. 

    What are the underlying causes of these trade deficits? A standard economic relationship, sometimes called the national savings and investment identity, lays out certain possibilities. If a trade deficit rises, it MUST be accompanied by some combination of the following: more government borrowing, less private saving, or more private investment. Conversely, if a trade deficit falls, it MUST be accompanied by some combination of the following: less government borrowing, more private saving, or less private investment. What was happening in Europe from 1992-2007?

    When it comes to net public savings, both North and South countries were reducing their borrowing in the lead-up to the euro and in the early 2000s. In other words, the large trade deficits in the South weren\’t caused by higher government borrowing.

     

    However, private saving did make a major contribution to the trade deficits in the South. Back in the mid-1990s, gross private saving was about the same in the North and South, at about 22-24% of GDP. It remained at about that level in the North, although there is an increase in the yeas from the arrival of the euro in 1999 up to 2007. But in the South, saving fell by more than one-third to about 14% of GDP by 2007. This drop in saving reflects higher consumption of imports, and thus is linked to the larger trade deficits of the South.

    When it comes to private investment, the South has done shown a modest rise and the North a modest decline. 

    When an economy runs trade surpluses, it accumulates financial capital to purchase foreign assets; for example, this is why the Chinese have come to own so much in U.S. Treasury bonds. When a country runs trade deficits, on the other side, it experiences an inflow of financial capital from other countries. At least in theory, such inflows and outflows of financial capital can in some cases be a healthy form of economic adjustment. For example, one can imagine the possibility of German investment capital flowing into Spain, being invested prudently, and helping Spain\’s economy grow rapidly while providing a good rate of return to German investors. One can also come up with less-pleasant scenarios, in which German investment capital flows into Spain, is not invested prudently, and leads to a situation where German investors do not receive a good rate of return. As the authors put it:\” In particular, in the presence of integrated real and financial markets, countries with a lower per capita income would be expected to attract domestic and foreign investment since higher productivity and economic growth rates promise above-average rates of return. The productivity of the invested capital ensures that the accumulated foreign debt can ultimately be repaid.\”

    Of course, now that the debt and financial crisis has hit, all earlier expectations have been confounded. But the evidence up to 2007 doesn\’t suggest that the South countries–with the exception of Ireland–were using their inflows of financial capital to increase levels of productivity. Thus, it appears that the inflows of financial capital were either being invested unproductively or were financing a consumption boom.

    Long story short: The situation in the euro zone between North and South was already headed toward severe instability before the financial and debt crisis. Large and unsustainable imbalances of trade and capital flows were already happening within the euro area. This story is a re-telling of what I called in a November 18 post The \”Chermany\” Problem of Unsustainable Exchange Rates. When trading partners are locked together by fixed exchange rates that are generating large surpluses in one country and large deficits in the other–whether in the case of China and the U.S economy, or in the case of Germany and northern Europe as compared to much of southern Europe–substantial economic stresses can be created.

    Holinski, Kool, and Muysken conclude this way: \”In our view, in a common currency area—or an irrevocably fixed exchange rate system, for that matter—fiscal policy in the end will be forced to step in to address unsustainable current account imbalances. This is exactly what experience in the euro area over the past few years shows. To maintain and defend the euro area, northern euro area countries will need to bail out southern countries, willingly or not, and are doing so as witnessed by implicit and explicit guarantees and continuing emergency financial support. And they probably will need to keep doing so for a substantial period ahead.\”

    This perspective emphasizes that Europe\’s debt and financial crisis isn\’t just another chapter of the U.S. financial crisis, but has distinctively European roots. It also emphasizes that Europe\’s imbalance aren\’t something that can be solved by cutting one mega-deal. Either the South needs to increase its saving so that its trade deficits diminish, or else raise productivity so that it can pay off the financial consequences of its trade deficits over time–or else the North will have to pay continued subsidies if it wishes to keep the fixed exchange rate of the euro area.

    conversableeconomist

    What Are the Top Five Global Risks for the Next Decade?

    The World Economic Forum has published Global Risks 2012, the seventh edition of an ongoing report. The report is based on survey data, so what it really reveals is what those at high-levels are worrying about–and how those worries are evolving over time.

    Here\’s a description of the overall project from the report: \”Data and analysis are based on a newly designed survey covering a meaningfully expanded set of 50 global risks across five categories. The assessments of these risks more than doubled as a result of this year’s survey, with 469 experts and industry leaders responding worldwide. The survey captures the perceived impact and likelihood for each risk over a 10-year
    time horizon using a clear and simple five-point scale …\”

    As a starting point, consider the top five risks as rated by impact, and the top five risks as weighted by likelihood, and how they have changed during the last few years. The figures are below. The report sums up the change this way: \”The risk landscape in this 2012 report is based on a refined and expanded set of 50 risks, compared to 37 in previous years. This means that comparisons to the 2011 report are not like-to-like. However, it is clear that respondents’ concern has shifted from environmental risks in 2011 to socioeconomic risks in 2012, as shown in Box 1. Economic risks have displaced environmental risks as those considered most likely. In 2011, the risks perceived as having the highest potential impact were economic and environmental; in 2012, they are economic and societal.\”

    The colors on these figures represent the category of risk: blue is economic, green is environmental, orange is geopolitical, red is societal, and purple is technological. The report itself offers a lot of interesting analysis of how these risks and others are interrelated, and how the risks may cluster into groups or scenarios.

    My own main reaction is that when you are asked each year about risks over the next decade, your answers shouldn\’t change too dramatically. After all, if your answers change a lot in one year, it implies that you are reacting too much to current events, rather than trying to look ahead over the ten-year horizon. Of course, answers will evolve over time as new information arrives. Still, it\’s intriguing to me to look at the concerns that seem to fallen from the top of the lists, and wonder whether they are being underemphasized in the press of current events.

    For example, when looking at the table showing \”Global Risks in Terms of Impact,\” there is a lot of consistency in the answers. There\’s also a lot of blue in the figure, showing that economic concerns appear to loom largest: asset price collapse, fiscal crisis, financial crisis, energy price volatility, a slowdown in China\’s economy. Even some of the geopolitical concerns, like backing away from globalization, are important largely for their economic consequences. In the early years, pandemic and chronic disease hit the top five, but by 2012 food and water supply crises–again often economic in essense–in the top five. Environmental issues are not seen as ranking in the top group, the only green in the figure is \”Climatological concerns\” in 2011, in the aftermath of Japan\’s devastating earthquake, but it then drops off in 2012. There is no purple in the figure: that is, technological concerns are not thought to be in the top five in terms of impact. 

    Remember, the questions in the surveys are about the size of risks over the next 10 years. But in assessing what risks have the largest size, it feels to me as if the lists are being driven pretty heavily by the Great Recession and its aftermath, as well as a few other current economic concerns.

    This pattern is more evident in the lists of the top risks that are most likely to arise. Back in 2007, the most likely risk to occur over the next 10 years was \”Breakdown of critical information infrastructure.\” Then when the recession hits, that concern doesn\’t appear again in the top five from 2008-2012. \”Middle east instability\” is the #2 most likely risk to occur over the next 10 years in 2008–but then it doesn\’t appear again in the top five from 2009-2012. No environmental (green-colored) concerns appear in the most-likely list from 2007-2010–and then environmental concerns are four of the five most likely in 2011. \”Severe income disparity\” isn\’t in the top five most risky issues from 2007-2011–but then is the risk most likely to occur in 2012.

    To me, these sorts of fluctuations are mildly disturbing. They suggest that the high-powered folks answering these kinds of surveys are often reacting to current headlines, and haven\’t actually given a lot of serious thought to what risks are most likely to arise in the next 10 years nor to how bad those risks might be. Of course, that\’s also why reports like this one are useful and potentially important. Taking actions to reduce future risks now can often be much cheaper than cleaning up after they occur. But that requires forcibly lifting our eyes up from the headlines of today and trying to develop a clear-minded vision of future risks over the middle-term and the long-term.

    For the record, here are the 50 risks listed in the survey, by category:

    conversableeconomist

    How Globalization Nearly Exterminated the Buffalo

    M. Scott Taylor (no relation!) offers a new and persuasive explanation of why the American buffalo population declined from 10-15 million in the early 1870s to about 100 by the late 1880s in \”Buffalo Hunt: International Trade and the Virtual Extinction of the North American Bison.\” The article is in the December 2011 issue of the American Economic Review (which isn\’t freely available on-line, but many in academia will have on-line access to it through their library or a membership in the American Economic Association.)

    Taylor summarizes his argument:  \”This paper examines the slaughter using theory, empirics, and first-person
    accounts from diaries and other historical documents. It argues that the story of the buffalo slaughter is surprisingly not, solely, an American one. Instead, I argue that the slaughter was initiated by a tanning innovation created in Europe and maintained by a robust European demand for buffalo hides.\”

    Of course, it\’s not a shock that the buffalo population declined as settlers spread across the western states in the mid-19th century. But the decline seemed to be happening gradually.

    \”By 1830, buffalo were largely gone east of the Mississippi. During much of this early period natives hunted the buffalo not only for their own subsistence needs but also to trade buffalo robes at forts and towns. A buffalo robe is the thick and dark coat of a buffalo that is killed mid-winter. Robes could be used as throws for carriages, or cut to make buffalo coats and other fur items. They were a common item in the 19th century, and they made their way to eastern markets via transport along the Missouri river to St. Louis or overland via the Santa Fe trail. In the 1840s settlers pushed through the Great Plains into Oregon and California. The movement of the 49ers to California and the  Nevada gold rush years brought a steady stream of traffic through the Platte River  valley. Subsistence hunting along the trail plus the movement of cattle and supplies divided the existing buffalo herd into what became known as the Northern and Southern herds.

    \”The division of herds became permanent with the building of the Union Pacific Railroad through the Platte River valley in the 1860s. While subsistence hunting for the railroad crews surely had some effect on buffalo numbers, as did the railroad’s popular day trips to kill buffalo, the harried buffalo herds withdrew from the tracks, creating a corridor centered on the Union Pacific line. The railroads also provided transportation for buffalo products to eastern and foreign markets, but in the 1860s railway cars were not refrigerated, and, hence, buffalo meat was marketed only as salted, cured, or smoked.\”

    \”Despite the railroads, the market for buffalo robes, the increase in subsistence hunting, and the conversion of the high prairie to agriculture, most observers expected the population to decline gradually as it had east of the Mississippi. The force of habitat destruction was minimal on the Great Plains. In 1860, they held only 164,000 people. Farms occupied less than 1 percent of the land area.\”

    This pattern of gradual decline for the buffalo changed abruptly not long after 1870, when tanners in England figured out a way to tan buffalo hides for leather:

    \”The hardest evidence comes from a London Times article reporting from New York City in August of 1872. It reports that a few enterprising New Yorkers thought that buffalo hides might be tanned for leather, and when the hides arrived they were “sent to several of the more prominent tanners who experimented upon them in various ways, but they met with no success. Either from want of knowledge or a lack of proper materials, they were unable to render the hides soft or pliable, and therefore they were of no use to them.”

    The report continues to note “several bales of these hides were sent to England, where they were readily taken up and orders were immediately sent to this country for 10,000 additional hides. These orders were fulfilled, and since then the trade has continued.” Further still, the methods are spelled out: “The hides are collected in the West by the agents of Eastern houses; they are simply dried, and then forwarded to either New York or Baltimore for export… The low price that these goods have reached on the English market, and the prospect of a still further decline, may in time put an end to this trade, but at present the hides are hunted for vigorously, and, if it continues, it will take but a few years to wipe the herds out of existence” (my emphasis). …

    The market for buffalo hides boomed; buffalo hunters already in the field—like George “Hodoo” Brown—started to skin buffalo for their flint (hairless) hides, and hundreds if not thousands of others soon joined in the hunt. Previous to the innovation, hides taken from the Southern herd or hides taken in all but three winter months were virtually worthless as fur items. The only saleable commodity from a buffalo killed in these regions or times was its meat, but this market was severely limited by transportation costs. With the advent of a flint-hide market, killing a buffalo anywhere and anytime became a profitable venture. By 1872, a full-scale hide boom was in progress.\”

    Taylor acknowledges and discusses the standard explanations for the decline of the buffalo: hunting by the United States Army, the presence of the railroads, and changes in native American hunting practices. While each of these may have contributed a bit to the decline, his estimates suggest that demand from the global market played a central role: \”[T]he newly constructed export data support the export-driven slaughter hypothesis, while the evidence for the alternative hypotheses that hold the railroads, the Army, or native Americans responsible is far weaker. The magnitudes of the implied export flows are considerable. My findings suggest approximately six million buffalo hides are exported over the 1871–1883 period, and this represents a buffalo kill of almost nine million.\”

    Taylor boils down three crucial economic factors behind the buffalo slaughter: \”[A] combination of a tanning innovation, open access to buffalo herds, and fixed world prices delivers a punctuated slaughter matching that witnessed on the Great Plains…. The slaughter is not a unique example of resource overuse created by burgeoning demand and poor regulation. It may, however, be unique in its scale, its speed, and the critical role played by international markets.  … Although the bison slaughter was a major event in US history, it was a minor event on the world stage. And being small on world markets meant that some of the typical insulating and signaling properties provided by a market price system were missing.\”

    In short, when smaller countries and economies around the world express concern that combinations of new technology and global demand might devastate their natural habitat or resources, Americans should be willing to listen. In our own history, it\’s what nearly exterminated the buffalo.

    As a coda, the slaughter of the buffalo was one of the events leading to the creation of an American environmentalist movement: \”The slaughter of the North American buffalo surely represents one of the saddest chapters in American environmental history. To many Americans at the time, the slaughter seemed wasteful and wrong, as many newspaper editorials and letters to congressmen attest, but still, little was done to stop it. The destruction of the buffalo and the wanton slaughter of other big game across the West did, however, pay some dividend. The slaughter of the buffalo in particular was pivotal in the rise of the
    conservation movement in the late nineteenth and early twentieth century. Almost all of the important players in the conservation movement experienced the slaughter firsthand—Teddy Roosevelt, John Muir, and William Hornaday. The creation of the national park system in general, and the Yellowstone herd in particular, reflect
    the revulsion many felt to the Slaughter on the Plains.\”

    conversableeconomist

    Recovery Delayed, Says CBO

    Twice a year, the Congressional Budget office puts out \”The Budget and Economic Outlook,\” which provides budget and economic forecasts. After the report last August, I called my blog post Unrequited Economic Optimism from the Congressional Budget Office, because it predicted that in 2012, the fall in housing prices would bottom out and the unemployment situation and growth would improve a bit, which would finally be followed by much better news in 2013 and thereafter. However, the just-released January 2012 report dials back the optimism. Here\’s CBO (footnotes omitted):

    \”CBO’s current economic forecast differs in some respects from its previous one, which was issued in August, as well as from the January Blue Chip consensus forecast (which is based on about 50 forecasts by private-sector economists) and the consensus of January forecasts by Federal Reserve Board members and Federal Reserve Bank presidents. 1 Compared with what it forecast in August, CBO is currently projecting weaker growth of real GDP in 2012 and 2013 but slightly stronger economic growth over the remainder of the decade … The current forecast also includes a higher unemployment rate and lower interest rates through 2021. CBO’s current projections for the growth of real  GDP in 2012 and 2013 are also weaker than those by the Blue Chip consensus and the Federal Reserve— perhaps owing to different assumptions about federal
    fiscal policy—and CBO’s projections for the unemployment rate are higher.\”

    Growth
    Overall, CBO writes: \”A large portion of the economic and human costs of the recession and slow recovery remains ahead. In late 2011, according to CBO’s estimates, the economy was about halfway through the cumulative shortfall in output that will result from the recession and its aftermath.\” Here\’s a figure comparing the projected growth rate of the U.S. economy with a group of leading trade partners of the U.S., where their growth rates are weighted by their shares of U.S. exports. The countries are Australia, Brazil, Canada, China, the euro zone, Hong Kong, Japan, Korea, Mexico, Singapore, Switzerland, Taiwan, and the United Kingdom. A forecast like this one, which suggests the bad news slower growth than the comparison group now and for for several years, but faster growth later on, is inherently discomforting.

    Unemployment

    With bounceback more-rapid growth not kicking in to 2014, the unemployment rate is predicted not to fall much in the near-term, either. \”In CBO’s forecast, the unemployment rate in 2012 and 2013 remains largely
    unchanged from its value last year. However, in the forecast, as growth picks up after 2013, the unemployment rate falls to 6.9 percent by the end of 2015 and 5.6 percent by the end of 2017.\”

    Housing

    CBO continues to believe that housing prices will bottom out in the second half of 2012, which would help a lot of U.S. households feel more secure. However, a historically large share of U.S. housing stock is vacant, which means that the house construction industry won\’t rebound until a few years later.

    Business Investment

    \”Net\” business investment is the amount of investment after depreciation has been subtracted out: that is, it is the amount added to the capital stock after replacing what has worn out. This is a modest bright spot for the U.S. economy, having already turned up, with CBO expecting that it will continue to rise back toward historical averages.

    My standard line about the U.S. economy, as we all buckle our seat belts for the election next fall, is that whoever is elected president in November 2012 is like to be regarded as an economic saviour by the end of his first or second year of office. But a lot of the eventual turnaround won\’t have much to do with whatever policies are enacted between now and then; it will just be that the economy will have finally managed to work through most of the backlog of problems from the Great Recession.