Year: 2012

I recently ran across this historical data from the Neilson company for the time American households spend watching television, per day.

I rarely watch 8 hours of television per week, much less per day. I had a conversation the other day in which someone was incredulous that I have never seen an episode of Seinfeld, or Friends, or actually any sitcom in the last decade or so. I told them that I used to watch M*A*S*H now and then, and they looked at me with pity.

Economists sometimes quote the old proverb: \”De gustibus non est disputandum.\” There\’s no arguing over taste. We tend to accept consumer tastes and preferences as given, and proceed from there. I suppose that those of us who blog, and then hope for readers, can\’t really complain about those who spend time looking at a screen. I certainly have my own personal time-wasters, like reading an inordinate number of mysteries. I assume that for many people the television is on in the background of other activities. But at some deep level, I just don\’t understand averaging 8 hours of television per day. I always remember the long-ago jibe from the old radio comedian Fred Allen: \”Television is a medium because anything well done is rare.\”

Note: Thanks to Danlu Hu for downloading the data and creating this figure.

When teaching about the effects of an unexpected surge of inflation, I always point out that those who borrowed at a fixed rate of interest benefit from the inflation, because they can repay their borrowing in inflated (and less valuable) dollars. And sometimes I toss in the mock-cheerful reminder that the U.S. government is the single biggest borrower–and thus presumably has a vested interest in a higher rate of inflation. But presuming an easy connection from higher inflation to reduced government debt burdens is actually a more problematic policy than it may at first appear.

Menzie Chinn and Jeffry Frieden make a lucid case for how higher inflation could ease the way to a lower real debt burden in an essay in the Milken Institute Review (available on-line with free registration). They point out that after World War II the U.S. government had accumulated a total debt of more than 100% of GDP, but that it cut that debt/GDP burden in half in about 10 years with a combination of economic growth and about 4% inflation. They are at pains to point out that they aren\’t suggesting a lot of inflation. But as they see it, given the fact that debt/GDP ratios are extremely high by historical standards in the U.S. and in a number of other high-income countries, a quiet process of slowing inflating away some of the real value of the debt is far preferable to the messy process of governments threatening to default. They write:

\”Creditors, of course, receive less in real terms than they had contracted for – and probably less than they expected when they agreed to the contract.  That may seem unfair. But the outcome is little different than what happens to creditors when they are forced to accept the restructuring of their claims through one form of bankruptcy or another. …It’s important to remember, though, that
we are not suggesting a lot of inflation – certainly nothing like the double-digit rates that
followed the second oil shock in 1979 to 1981. Rather, we believe the goal should be to target
moderate inflation, only enough to reduce the debt burden to more manageable levels,
and adjust monetary policy accordingly. This probably means something in the 4 to 6 percent
range for several years. … We’re not claiming that inflation is a painless way to speed deleveraging. We are claiming,  though, that it is less painful than the realistic alternatives. … Unusual times call for unusual measures.\”

The counterargument, which holds that inflation may not do much to reduce debt/GDP ratios, starts from this insight: Yes, inflation reduces the outstanding value of past debt, and in a situation like the aftermath of World War II when large debts were incurred, but the borrowing then stops. For example, the U.S. government ran budget surpluses four out of the five years from 1947-1951. But if fiscal policy is on an unsustainable path of overly large deficits, then inflation isn\’t going to fix the problem. In an essay appearing in the Annual Report of the Federal Reserve Bank of Richmond, \”Unsustainable Fiscal Policy:Implications for Monetary Policy,\” Renee Haltom and John A. Weinberg make an argument that inflation would not actually offer much hope of reducing the current U.S government debt burden.

\”It is useful to consider how much inflation would be required to adequately reduce current debt levels. … To consider how much inflation would be required today to address current debt imbalances, Michael Krause and Stéphane Moyen (2011) estimate that a moderate rise in inflation to 4 percent annually sustained for at least 10 years—in effect a permanent doubling of the Fed’s inflation objective—would reduce the value of the additional debt that accrued during the 2008–09 financial crisis, not the total debt, by just 25 percent. If the rise in inflation lasted only two or three years, a 16 percentage point increase—from roughly 2 percent inflation today to 18 percent—would be required to reduce that additional debt by just 3 percent to 8 percent. Such inflation rates were not reached even in the worst days of the inflationary 1970s. The reason inflation has such a minimal impact on debt in Krause and Moyen’s estimates is that while inflation erodes the value of existing nominal debt, it increases the financing costs for newly issued debt because investors must be compensated to be willing to hold bonds that will be subject to higher inflation. This effect would be greater for governments such as the United States that have a short average maturity of government debt and therefore need to reissue it often.

\”With these estimates in mind, it is worth recalling the CBO’s projection that debt held by the public may triple as a percent of GDP within 25 years. The estimates cited above suggest that inflation is simply not a viable strategy for reducing such debt levels. In addition, it is important to remember that inflation is costly on many levels. Inflation high enough to significantly erode the debt would inflict considerable damage on the economy and would require costly policies for the Fed to regain its credibility after the fact. Inflation that was engineered specifically to erode debt would provide a significant source of fiscal revenue without approval via the democratic process, and so would
raise questions about the role of the central bank as opposed to the roles of Congress and the executive branch in raising fiscal revenues. Ultimately, the solution to high debt levels must come from fiscal authorities.\”

In a similar spirit, the IMF wrote in Chapter 3 of its most recent World Economic Outlook that inflation at low levels often seems to have little effect in reducing government debt: \”The relationship between inflation and [government] debt reduction is more ambiguous. Although hyperinflation is clearly associated with sharp debt reduction, when hyperinflation episodes are excluded, there is no clear association between the average inflation rate and the change in debt.\”

In short, if federal deficits are first definitively placed on a diminishing path, then a quiet surge of unexpected inflation could help in reducing the past debts. But on the current U.S. trajectory of a steadily-rising debt/GDP ratio over the next few decades, inflation isn\’t the answer–and could end up just being another part of the problem.

The October 2012 issue of Nature Biotechnology offers several articles on the theme of \”Commercializing biomedical innovations.\” The opening \”Editorial\” sets the stage this way: \”Investment in biomedical innovation is not what it once was. Millions of dollars have fled the life sciences risk capital pool. The number of early venture deals in biotech is smaller than ever. Public markets are all but closed, biotech-pharma deals increasingly back-loaded with contingent,
rather than upfront, payments. Paths to market are more winding and stonier. Government cuts are closing laboratories and culling blue-sky research. Never has there been a more pressing need to look beyond the existing pools of funding and talent to galvanize biomedical innovation.\”

Thus, the papers look at a variety of interactions: interactions between universities and the biomed industry; different business models for biomed firms; how venture capital firms often seem to enter biomed start-ups \”too early,\” well before a commercial payoff can be expected; funding research through nonprofit foundations that promote free dissemination of any findings; and others. But my eye was particularly caught by a proposal by caught by three economists,  Jose-Maria Fernandez, Roger M. Stein and Andrew W. Lo, who offer a proposal for \”Commercializing biomedical research through securitization techniques.\”

 These authors point out a paradoxical situation in biomedical research. On one side, the research journals and even the news media are full of breakthrough developments, \”including gene therapies for previously incurable rare diseases, molecularly targeted oncology drugs, new modes of medical imaging and radiosurgery, biomarkers for drug response or for such diseases as prostate cancer and heart disease, and the use of human genome sequencing to find treatments for diseases that have confounded conventional medicine, not to mention advances in bioinformatics and computing power that have enabled many of these applications.\”

On the other side, the existing business structures for translating these developments into new products doesn\’t seem to be working well. \”Consensus is growing that the bench-to-bedside process of translating biomedical research into effective therapeutics is broken. … The productivity of big pharmaceutical companies—as measured by the number of new molecular entity and biologic license applications per dollar of R&D investment—has declined in recent years … Life sciences venture-capital investments have not fared much better, with an average internal rate of return of −1% over the 10-year period from 2001 through 2010 …\”

Fernandez, Stein, and Lo suggest that the fundamental problem is that the technological breakthroughs present a vast array of possibilities, but these possibilities are complex and costly to pursue. A large portfolio of new biomed innovations is probably, overall, a money-maker. But when firms need to think about pursuing just a few of the many possibilities, at great cost, they may often decide not to do so. They write:

\”The traditional quarterly earnings cycle, real-time pricing and dispersed ownership of public equities imply constant scrutiny of corporate performance from many different types of shareholders, all pushing senior management toward projects and strategies with clearer and more immediate payoffs, and away from more speculative but potentially transformative science and translational research. … Industry professionals cite the existence of a ‘valley of death’—a funding gap between basic biomedical research and clinical development. For example, in 2010, only $6–7 billion was spent on translational efforts, whereas $48 billion was spent on basic research and $127 billion was spent on clinical development that same year.\”

What\’s their alternative? \” We propose an alternative for funding biomedical innovation that addresses these issues through the use of ‘financial engineering’… Our approach involves two components: (i) creating large diversified portfolios—‘megafunds’ on the order of $5–30 billion—of biomedical projects at all stages of development; and (ii) structuring the financing for these portfolios as combinations of equity and securitized debt so as to access much larger sources of investment capital. These two components are inextricably intertwined: diversification within a single entity reduces risk to such an extent that the entity can raise assets by issuing both debt and equity, and the much larger capacity of debt markets makes this diversification possible for multi-billion-dollar portfolios of many expensive and highly risky projects. … In a simulation using historical data for new molecular entities in oncology from 1990 to 2011, we find that megafunds of $5–15 billion may yield average investment returns of 8.9–11.4% for equity holders and 5–8% for ‘research-backed obligation’ holders, which are lower than typical venture-capital hurdle rates but attractive to pension funds, insurance companies and other large institutional investors.

Frankly, I have no clear idea about whether the Fernandez, Stein, and Lo approach raising money for biomed companies is viable. One never knows in advance whether an innovation will function well and fulfill real-world needs, whether that innovation is financial or real. But if the markets can put together this sort of deal, it might offer an enormous boost to the process of translating biomedical innovation into actual health care products. In the aftermath of the Great Recession, the words \”financial innovation\” are often spoken with a heavy dose of sarcasm, as if all we need for a 21st-century economy is good old passbook savings accounts. But financial innovation like this Fernandez, Stein and Lo proposal is an example of how financial innovation might save lives by addressing an important real-world problem. This financial innovation seems well worth someone trying it out–with the proviso that if it doesn\’t work, no one gets bailed out!

Every intro class teaches about price ceilings, and I suspect that 99% of them use rent control laws as an example. Of course, the standard lesson from a supply-and-demand diagram is that price ceilings lead to a situation where the quantity demanded exceeds the quantity supplied, and so while the price of rent-controlled apartments is lower, good luck in finding a vacancy!

The slightly more sophisticated insight is what I call in my own intro textbook the problem of \”many margins for action.\” (Of course, if you are teaching an intro econ class, I encourage you to take a look at my Principles of Economics textbook, a high quality and lower-cost alternative to the big publishers, available here.)  Landlords who face rent control legislation can skimp on maintenance, or hunt for ways to force the renter to bear additional fees or costs. If a large number of landlords act in this way, the feeling of the neighborhood and property values for homes that are not rentals may be affected, too.

Cambridge, Massachusetts, has a rent control law in place from 1970 to 1994. It was ended by a statewide vote that barely squeaked out a 51%-49% majority–and ended despite the fact that Cambridge residents favored the continuation of the law by a 60%-40% majority. The law placed limits on rents for all rental properties in Cambridge built in 1969 or earlier. In \”Housing Market Spillovers: Evidence from the End of Rent Control in Cambridge, Massachusetts,\” David H. Autor, Christopher J. Palmer, and Parag A. Pathak look at what happened. (The paper is published as NBER Working Paper 18125. These working papers are not freely available on-line, but many in academia will have access through institutional memberships. Full disclosure: David Autor is editor of my own Journal of Economic Perspectives, and thus my boss.) Autor, Palmer, and Pathak have data on rents and prices in both controlled rental buildings, uncontrolled rental buildings, and owner-occupied housing. They can also make comparisons to neighboring suburbs that did not have rent controls in place. Here are a few of their more striking findings:

— The rent-controlled buildings in Cambridge, Mass., typically had rents 25%-40% below the level of uncontrolled rental buildings nearby. However, the maintenance of rent-controlled building was often subpar, with a higher incidence of issues like holes in walls or floors, chipped or peeling paint, loose railings, and the like. More broadly, owners of rent-controlled properties had no incentive to do any major fix-ups or renovations, because they would be unable to recoup the costs.

— Rent control laws are still easy to find, if not exactly widespread, in the United States. For example, \”New York City’s system of rent regulation affects at least one million apartments, while cities such as San Francisco, Los Angeles, Washington DC, and many towns in California and New Jersey have various forms of rent regulation.\”

— Not surprisingly, the end of rent control in 1995 meant that prices of the buildings that had formerly been rent-controlled rose. \”Our statistical analysis also indicates that rent controlled properties were valued at a discount of about 50 percent relative to never-controlled properties with comparable characteristics in the same neighborhoods during the rent control era, and that the assessed values of these properties increased by approximately 18 to 25 percent after rent control ended.\”

—  More surprising, it turns out that the end of rent control raised the value of all the non-controlled properties in Cambridge, too. Properties that were in a neighborhood with a higher percentage of rent-controlled properties increased in value by more than those in neighborhoods with a lower percentage of rent-controlled properties. Indeed, when rent control ended, the gains to owners of  uncontrolled properties were greater in total than the gains to the owners of rent-controlled properties. \”The economic magnitude of the effect of rent control removal on the value of Cambridge’s housing stock is $1.8 billion. We calculate that positive spillovers from decontrol added $1.0 billion to the value of the never-controlled housing stock in Cambridge, equal to 10 percent of its total value and one-sixth of its appreciation between 1994 and 2004. Notably, direct effects on decontrolled properties are smaller than the spillovers. We estimate that rent control removal raised the value of decontrolled properties by $770 million, which is 25 percent less than the spillover effect.\”

Taking all of this together, it seems to me like the way to think about rent control–at least in the form that it was enacted in Cambridge, Mass.– is that it creates a situation of low-quality and poorly-maintained housing stock, which then rents for less than uncontrolled properties. If the goal of public policy is to create lower-quality and more affordable housing, there are other ways to accomplish that goal. For example, zoning laws could require that rental complexes include a mixture of regular and small-sized rental apartments, so that the small-sized (and thus \”lower quality\”) apartments would rent for less. Or those with lower incomes could just receive housing vouchers.

But when rent control is enacted in a way that leads to degradation of a substantial portion of the housing stock, the costs are not just carried by landlords of those rent-controlled apartments. In fact, a majority of the costs may be as a result of spillover effects to real estate that isn\’t rent-controlled. When a substantial proportion of the houses in a neighborhood are not well-maintained, everyone\’s housing prices will suffer.

As President Obama and Mitt Romney jostled back and forth about the bailout of General Motors and Chrysler during the debate last night, I was naturally reminded of the 1953 confirmation hearings for Charles E. Wilson for Secretary of Defense. Wilson had been president of GM since 1941, overseeing both the company\’s transformation to wartime production and then its return to peacetime. Much of the confirmation hearing revolved around how he would sell off or insulate his financial holdings from his government job–and more broadly, the difficulties of separating his role at GM from the role of Secretary of Defense.

On January 15, 1953, Wilson had this famous exchange with Senator Robert Hendrickson, a Republican from  New Jersey:

\”Senator Hendrickson. Mr. Wilson, you have told the committee, I think more than once this morning, that you see no area of conflict between your interest in the General Motors Corp. or the other companies, as a stockholder, and the position you are about to assume.

Mr. Wilson. Yes, sir.

Senator Hendrickson. Well now, I am interested to know whether if a situation did arise where you had to make a decision which was extremely adverse to the interests of your stock and General Motors Corp. or any of these other companies, or extremely adverse to the company, in the interests of the United States Government, could you make that decision?

Mr. Wilson. Yes, sir; I could. I cannot conceive of one because for years I thought what was good for our country was good for General Motors, and vice versa. The difference did not exist. Our company is too big. It goes with the welfare of the country. Our contribution to the Nation is quite considerable. I happen to know that toward the end of the war—I was coming back from Washington to New York on the train, and I happened to see the total of our country\’s lend-lease to Russia, and I was familiar with what we had done in the production of military goods in the war and I thought to myself, \”My goodness, if the Russians had a General Motors in addition to what they have, they would not have needed any lend-lease,\” so I have no trouble—I will have no trouble over it, and if I did start to get into trouble I would put it up to the President to make the decision on that one. I cannot conceive of what it would be.

Senator Hendrickson. Well, frankly, I cannot either at the moment, but we never know what is in store for us.

Mr. Wilson. I cannot conceive of it. I do not think we are going to get into any foolishness like seizing the properties or anything like that, you know, like the Iranians are in over there, when they got into —

Senator Hendrickson. I certainly hope not.

Mr. Wilson. You see, if that one came up for some reason or other then I would not like that. I do not think I would be on the job; I think I would quit because I would be so out of sympathy with trying to nationalize the industries of our country. I think it would be a terrible thing. That is about the only one I can think of. Of course, I do not think that is even a remote possibility. I think the whole trend of our country is the other way.\”

I\’ve quoted here from the transcript of the actual hearings as printed in \”Nominations: Hearings before the Committee on Armed Services, United States Senate, Eighty-third Congress, first session, on nominee designates Charles E. Wilson, to be Secretary of Defense; Roger M. Kyes, to be Deputy Secretary of Defense; Robert T. Stevens, to be Secretary of the Army; Robert B. Anderson, to be Secretary of the Navy; Harold E. Talbott, to be Secretary of the Air Force …\” January 15, 1953.

But the hearing had been closed to the public, and the transcript didn\’t come out for a few days. When reporters asked what had been said, they were told that Wilson had simply replied: \”What\’s good for General Motors is good for the country.\” Democrats picked up the phrase on the campaign trail and used it against Republicans for being overly pro-business. The highly popular Li\’l Abner comic strip had a character named General Bullmoose who often said: \”What\’s good for General Bullmoose is good for the U.S.A.!\”

The story goes that for a few years, when the quotation came up, Wilson would try to offer some context, but after awhile he stopped bothering. When he stepped down as Secretary of Defense in 1957, he said: \” \”I have never been too embarrassed over the thing, stated either way.\”

Of course, it\’s interesting that the Democratic party that bashed Charlie Wilson back in 1953 now finds itself in the position of arguing the modern version of \”what\’s good for General Motors is good for the country.\” For those who want details about the actual bailout, my May 7 post on \”The GM and Chrysler Bailouts\” might be a useful starting point.

Here, I would just make the point that while GM remains an enormous company today, it was relatively much larger in the 1950s. In the Fortune 500 for 1955, General Motors was far and away the biggest U.S. company ranked by sales. GM had $9.8 billion in sales in 1955, with Exxon running second at $5.6 billion, U.S. Steel third at $3.2 billion, followed by General Electric at $3 billion. The GDP of the U.S. economy in in 1955 was $415 billion, so for perspective, GM sales were 2.3% of the U.S. economy.

In 2012, GM\’s sales are $150 billion, but in the Fortune 500 for 2012, it now runs a distant fifth in sales among U.S. firms. The two biggest firms by sales were Exxon Mobil at $450 billion in sales, just a few billion ahead of WalMart. The GDP of the U.S. economy is about $15 trillion in 2012, so GM sales are now more like 1% of GDP, rather than 2%. And many of those who argue that it was in the national interest to give GM more favorable government-arranged bankruptcy conditions, rather than the usual bankruptcy court, would likely be quite unwilling to give bailouts to Exxon Mobil or to WalMart–despite how much larger they are.

Birth rates are one of those apparently dry statistics that have profound implications both for public policy and for how we live our day-to-day lives. Here are two figures from the Centers for Disease Control \”National Vital Statistics Reports–Births: Preliminary Data for 2011.\”

Overall, U.S. birth rates are in decline (as shown by the light blue line) have fallen below the levels seen in the Great Depression, which up until recent years had been the lowest fertility level in U.S. history. The 2011 fertility rate of 63.2 per 1,000 women aged 15-44 is the lowest in U.S. history. The number of actual births is actually near a high, but that is because of the overall expansion of population.

This decline in birthrates is not evenly distributed across age groups. The figure below shows only data back to 1990. However, it illustrates that for women age 15-19 (red line), 20-24 (light blue line) and 25-29 (yellow line), birth rates have dropped noticeablyl. Although birth rates have dropped substantially for younger women, they have held steady for women ages and up. For mothers int he three age groups above 30 years, birth rates have been holding steady or rising.

These shifts in birthrates have powerful implications for our lives. Politically, the number of households with a direct personal interest in supporting programs that benefit children–because they have children under age 18 living at home–has declined. Here\’s a figure illustrating the long-term trend up through 2008 from Census Bureau report.  Back in the late 1950s and early 1960s, about 57% of U.S. family households included children under the age of 18. The share has been dropping since then, and is now approaching 45%. When it comes to decisions about everything from school funding and public parks up to pensions, health care, and other payments to those who are retired, it makes a real difference in a majority-rule political system if the share of families with children at home is more than 50% of the population or less.

The shift in birth rates represents a dramatic change in our personal lives as well.  In an article in the Fall 2003 issue of my own Journal of Economic Perspectives, economist and demographer Ronald Lee offered one point in particular that has stuck with me: \”In 1800, women spent about 70 percent of their adult years bearing and rearing young children, but that fraction has decreased in many parts of the world to only about 14 percent, due to lower fertility and longer life.\”

More people are going through young adulthood and setting their original template for adult living without becoming parents, but then having children later into their 20s, or their 30s, or their 40s. Many people are raising children not in their 20s or 30s, but instead in their 40s and 50s. And with longer life expectancies, many people will find that while their care-giving responsibilities for children cover fewer years, their care-giving responsibilities for adult parents. Multi-generational family reunions used to follow a pattern of a few older folks of the grandparent generation, a larger number of their adult children and spouses, and then lots of children. In the future, there may be four or five generations in attendance at multigenerational reunions, and with many people having fewer or no children, the \”family tree\” will look taller and skinnier. We are already living our family lives in a substantially different context than earlier generations. The changes are large and getting larger, although sociologists and the science fiction novelists probably have deeper insights than do the economists into how such changes are likely to affect our personal lives.

As the world population continues to climb toward a projected population of 9 billion or so by mid-century, can agricultural productivity keep up? Keith Fuglie and Sun Ling Wang offer some thoughts in \”New Evidence Points to Robust But Uneven Productivity Growth in Global Agriculture,\” which appears in the September issue of Amber Waves, published by the Economic Research Service at the U.S. Department of Agriculture.

Food prices have been rising for the last decade or so. Fuglie and Wang offer a figure that offers some perspective. The population data is from the U.N, showing the rise in world population from about 1.7 billion in 1900 to almost 7 billion in 2010. The food price data is a a weighted average of 18 crop and livestock prices, where the prices are weighted by the share of agricultural trade for each product. Despite the sharp rise in demand for agricultural products from population growth and higher incomes, the rise in productivity of the farming sector has been sufficient so that the price of farm products fell by 1% per year from 1900 to 2010 (as shown by the dashed line).

What are some main factors likely to affect productivity growth in world agriculture in the years ahead? Here are some of the reactions I took away from the paper.

Many places around the world are far behind the frontier of agricultural productivity, and thus continue to have considerable room for catch-up growth. \”Southeast Asia, China, and Latin America are now approaching the land and labor productivity levels achieved by today\’s industrialized nations in the 1960s.\”

The rate of output growth in agriculture hasn\’t changed much, but the sources of that output growth have been changing from a higher use of inputs (machinery, irrigation, fertilizer) and toward a higher rate of productivity growth. \”Global agricultural output growth has remained remarkably consistent over the past five decades–2.7 percent per year in the 1960s and between 2.1 and 2.5 percent average annual growth in each decade that followed. … Between 1961 and 2009, about 60 percent of the tripling in global agricultural output was due to increases in input use, implying that improvements in TFP accounted for the other 40 percent. TFP\’s share of output growth, however, grew over time, and by the most recent decade (2001-09), TFP accounted for three-fourths of the growth in global agricultural production.\”

There\’s no denying that feeding the global population as it rises toward nine billion will pose some real challenges, but it is clearly within the realm of possibility. For more details on how it might be achieved, here\’s my post from October 2011 on the subject of \”How the World Can Feed 9 Billion People.\”

John Pencavel offers an angle on the evolution of American unions that I haven\’t seen recently by looking at the number of unions and their size. Short story: the number of American unions has declined, but the biggest unions have many more members than their precedessors. Pencavel has a nice summary of this work in \”Public-Sector Unions and the Changing Structure of U.S. Unionism,\” written as a \”Policy Brief\” for the Stanford Institute for Economic Policy Research.

As a starting point, the first table shows the top five U.S. unions by total number of members in 1974, and then the top five unions by total number of members in 2007. A couple of patterns jump out. First, back in 1974, most of the biggest unions–except for the National Education Association–were private-sector unions. However, by 2007, most of the biggest unions were public-sector union. BSecond, both the biggest union in 2007 (the NEA) and the fifth-biggest union in 2007 (the UFCW) were substantially larger than the first- and fifth-biggest unions in 1974.

 Pencavel compiles evidence that from 1974 to 2007, the total number of unions declined by 101, much of that due to unions consolidating with others. Unions with more than 1 million members actually had 2.7 million more total members in 2007 than back in 1974; conversely, unions with fewer than 1 million total members had 6.8 million fewer total members in 2007 than in 1974. In other words, union members are much more likely to belong to a very large unions now than a few decades ago.  Pencavel also compiles a longer-run table, going back to 1920, to show the share of unions members belonging to the biggest unions. Notice that most of the shift toward much larger unions has occurred since the early 1980s, and most of it traces to a change in the membership share of the largest unions.

I suppose that one response to all this is \”so what\”? Well, if the largest companies in the U.S. economy in any given industry gain a dramatically larger share of the U.S. economy, it gives rise to comment. When the largest unions gain a dramatically larger share of the union sector, it\’s worth some introspection, too. 

Pencavel draws his conclusions cautiously. \”[A] union movement concentrated in a smaller number of large unions implies a union movement in which much of its wealth is allocated by a smaller number of decision-makers. …  A serious concern is that a more concentrated union movement dominated by public sector unions may politicize unionism: That is, the focus of union activity will be less on attending to grievances and to the conditions of members at their place of work and more on issues that are the province of politics. … Unions have always been involved in politics so this would be a change of degree, not of kind, but it is an important change because, ultimately, more politicized unionism will not help the typical union worker.\”

 Albert Venn Dicey was a British legal theorist who died in 1922. Pencavel refers to one of his works from 1912, when Dicey was mulling over the issue of freedom of association, both in thinking about association through labor unions and association through product cartels. Pencavel notes that Dicey perceived a \”classic dilemma\” here, and Pencavel writes: \”The principle that working people should have the freedom to form associations that represent and guard their interests is an intrinsic feature of a liberal society. But, if these associations exploit this principle to procure entitlements that expense of others, a new base of authority and influence is created that, at best, enjoys a greater share of the national wealth and, at worst, challenges the jurisdiction of the state. A balance is needed between promoting the principle of free association and avoiding the creation of a mischievous organization.\”

Dicey perceived this dilemma for freedom of association as applying both to the power of large unions and the power of large corporations. Here\’s Pencavel quoting Dicey in 1912: \”In England, as elsewhere, trade unions and strikes, or federations of employers and lock-outs;…in the United States,
the efforts of Mercantile Trusts to create for themselves huge monopolies…force upon public attention the practical difficulty of so regulating the right of association that its exercise may
neither trench upon each citizen’s individual freedom nor shake the supreme authority of the
State.”

The central question about large public sector unions, of course, is whether in their ability to act as an powerful interested group that influences the results of state and local elections and then to have their conditions of employment determined in negotiations with officials of those same state and local governments, they have exploited the freedom of association in a way that creates what Pencavel calls a \”mischievous organization.\” Pencavel ends on a questioning note: \”This is not a prediction; it is a concern.\”

 For more about U.S. union members, see my post \”Some Facts about American Unions\” from last March. 

The official announcement reads this way: \”The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2012 was awarded jointly to Alvin E. Roth and Lloyd S. Shapley `for the theory of stable allocations and the practice of market design.\’\” Thus, the prize seeks to emphasize the interplay between mathematical economic theory and concrete applications. Each year when the Nobel prize is awarded, the Prize Committee puts up some useful background material to explain their choice: their \”Popular Information\” paper is here and the \”Scientific Background\” paper is here. I\’ll draw on both in what follows.

In this duality between theory and application, Lloyd Shapley is cast as the theorist. Indeed, in an interview with the AP on Monday, he said: \”I consider myself a mathematician and the award is for economics. I never, never in my life took a course in economics.\” But of course, economists view their field as a big enough tent to include at least some mathematicians–and in particular those that study game theory, like the 1994 Nobel prize to John Nash and others.

In Shapley and co-author David Gale published a famous paper in 1962 in the American Mathematical Monthly called \”College Admissions and the Stability of Marriage (69:1, pp. 9-15).  It can be read for free (with registration) at JSTOR, or it is available on the web various places like here.

 They begin by offering college admission as an example of the kind of problem they are considering. There are a number of colleges and a number of applicants. Colleges have preferences over who they wish to admit, and applicants have preferences over where they would like to attend. How can they be matched in a way that will, in some sense we need to define, \”satisfy\” both sides? Before going further, notice that this problem of multiple parties on each side, with a problem of matching them so as to \”satisfy\” all parties, is a characteristic of marriage markets–although in that case the two groups are looking for only one partner apiece–and also of employers and potential employees in the job market.

As a starting point, it is clearly impossible to \”satisfy\” all parties in the sense that everyone will get their first choice. The college can\’t assure that all its preferred applicants will want to attend; not all applicants are likely to get their first choice. Thus, Gale and Shapley focused instead on finding a solution that would be \”stable,\” which means in the context of the college admissions choice that once everyone is matched up, there is no combination of a student who would rather be at a college other than the one they are attending AND that college would also prefer to have that student above one of the students it had already attracted. In other words, no student or college will seek to make an end-run around a stable mechanism.

Gale and Shapley proposed a \”deferred acceptance\” procedure to get a stable result to their matching problem. Here is how the Nobel committee describes the process:

\”Agents on one side of the market, say the medical departments, make offers to agents on the other side, the medical students. Each student reviews the proposals she receives, holds on to the one she prefers (assuming it is acceptable), and rejects the rest. A crucial aspect of this algorithm is that desirable offers are not immediately accepted, but simply held on to: deferred acceptance. Any department whose offer is rejected can make a new offer to a different student. The procedure continues until no department wishes to make another offer, at which time the students fi…nally accept the proposals they hold.

In this process, each department starts by making its fi…rst offer to its top-ranked applicant, i.e., the medical student it would most like to have as an intern. If the offer is rejected, it then makes an offer to the applicant it ranks as number two, etc. Thus, during the operation of the algorithm, the department’\’s expectations are lowered as it makes offers to students further and further down its preference ordering. (Of course, no offers are made to unacceptable applicants.) Conversely, since students always hold on to the most desirable offer they have received, and as offers cannot be withdrawn, each student’s satisfaction is monotonically increasing during the operation of the algorithm. When the departments’decreased expectations have become consistent with the students’increased aspirations, the algorithm stops.\”

 Here\’s how the procedure would work in the marriage market:

\”The Gale-Shapley algorithm can be set up in two alternative ways: either men propose to women, or women propose to men. In the latter case, the process begins with each woman proposing to the man she likes the best. Each man then looks at the different proposals he has received (if any), retains what he regards as the most attractive proposal (but defers from accepting it) and rejects the others. The women who were rejected in the first round then propose to their second-best choices, while the men again keep their best offer and reject the rest. This continues until no women want to make any further proposals. As each of the men then accepts the proposal he holds, the process comes to an end.\”

Gale and Shapley prove that this procedure leads to a \”stable\” outcome. Again, this doesn\’t mean that everyone gets their first choice! It means that when the outcome is reached, there is no combination of medical school and applicant, or of man and woman in the marriage example, who would both prefer a different match from the one with which they ended up. But Gale and Shapley went further. It turns out that there are often many stable combinations, and in comparing these stable outcomes, the question of who does the choosing matters. If women propose to men, women will view the outcome as the best of all the stable matching possibilities, while men will view it as the worst; if men propose to women, men as a group will view it as the best of all stable matching possibilities, while women will view it as the worst. As the Nobel committee writes, \”stable institutions can be designed to systematically favor one side of the market.\”

There are many other potential tweaks and twists here. What if monetary payments are part of the match? What if traders are trading indivisible objects? These sorts of issues and many others kept a generation of game theorists busy. But for present purposes, the next key insight is that although I\’ve explained the deferred-acceptance procedure as a step-by-step process, where parties make one offer at a time, an equivalent process can be run by a clearinghouse, if the parties submit sufficient information.

And this is where Alvin Roth enters the picture, bringing in detailed practical implications for analysis. He pointed out in a 1984 paper that the National Resident Matching Program for matching residencies and medical school students was actually a close cousin to the Gale-Shapley procedure. Roth\’s theoretical analysis pointed out that the form of the match they were using allowed the medical schools, rather than the students, to be the \”proposers,\” and thus created outcomes that the medical schools viewed as the best of the stable options and the students viewed as the worst of the stable options. He redesigned the \”match\” both to let students be the proposers, and also to address the issue that in a number of cases a married or committed couple wanted to end up at the same school or in the same geographic location.

Roth then found other applications for what he has called the \”market design\” approach.  (It is ironic but true that the market design approach can include prices if desired, but doesn\’t actually need prices to function.) The key problems in these matching scenarios often involve timing. There is often pressure on various parties–whether marriage or college admissions–to commit early, which can lead to situations where the outcome will \”unravel\” as people seek a way out of their too-early commitments. On the other side, if the process slogs along too late, then \”congestion\” can result when an offer is turned down and it becomes too late to make other offers.

Roth found applications of the Shapley matching approach in a wide variety of academic matching settings, both in the U.S. and in other countries. He also applied a similar process to students choosing between public schools in New York City and Boston. More recently, he has sought to apply these insights to the problem of matching kidney donors with those in need of a kidney transplant. (In fairness, it should be pointed out that Roth has written a number of strong theoretical papers as well, but the Nobel committee emphasized his practical concerns, and I will follow their lead here.) As one might expect, these real-world cases raise various practical problems. Are there ways of gaming the system by not listing your first choice, which you are perhaps unlikely to get anyway, and pretending great enthusiasm for your fifth choice, which you are more likely to get? Such outcomes are sometimes possible in practical settings, but it proves much harder to game these mechanisms than one might think. Usually, you\’re better off just giving your true preferences and seeing how the mechanism plays itself out.

The Nobel prize to Shapley and Roth is one of those prizes that I suspect I will have a hard time explaining to non-economists. The non-economists I know ask practical questions. They want to know how the work done for the prize will spur the economy, or create jobs, or reduce inequality, or help the poor, or save the government money. Somehow, better matching for medical school students won\’t seem, to some non-economists like it\’s \”big enough\” to deserve a Nobel. But economics isn\’t all about today\’s public policy questions. The prize rewards thinking deeply about how a matching process works. In a world of increasingly powerful information-processing technology, where we may all find ourselves \”matched\” in various ways based on questions we answer by software we don\’t understand, I suspect that Alvin Roth\’s current applications are just the starting point for ways to apply the insights developed from Lloyd Shapley\’s \”deferred acceptance\” mechanism. 

The basic economics of patents as taught in every intro econ class is a balancing act: On one side, patents provide an incentive for innovation, by giving innovators a temporary monopoly over the use of their invention. This temporary monopoly rewards innovation by allowing the inventor to charge higher prices, and thus the tradeoff is that consumers temporarily pay more–although consumers of course also benefit from the existence of the innovation. Like any balancing act, patents can tip too far in one direction or the other. On one side, patents can fail to provide providing sufficient incentive (that is, large enough profits) for inventors. But on the other side, patent protection that is too long or too rigid can lock profits for early innovators for an extended period, both at the long-term expense of consumers and also in a way that can cut off possibilities for future innovators.

There\’s is some concern that the balance of patent law has tipped in a way that is overly favorable to earlier innovators. Without trying to make the case in any detail, here are three straws in the wind of this argument that recently crossed my desk.

1) Has the specialized federal appeals court for patent cases run amok?  

Back in the 1970s, it seemed clear that the enforcement by patents was wildly uneven. Thus, in 1982 a United States Court of Appeals for the Federal Circuit, one step below the U.S. Supreme Court was created to hear all appeals of patent decisions from around the country. The difficulties are described by Timothy B. Lee under the (perhaps slightly overstated) title, \”How a rogue appeals court wrecked the patent system,\” appearing in ArsTechnica.

Lee tells the stories of the whacky 1970s, when companies that got patents literally raced to file infringement suits in jurisdictions that they thought would be favorable, while competitors raced to file infringement suits in jurisdictions that they thought would be favorable–because who filed first would often determine where the cases would be consolidated, the jurisdiction where the case was heard would largely determine the outcome. Here\’s what happened in the 1970s: \”Every Tuesday at noon, a crowd would gather at the patent office awaiting the week\’s list of issued patents.
As soon as a patent was issued, a representative for its owner would rush to the telephone and order a lawyer stationed in a patent-friendly jurisdiction such as Kansas City to file an infringement lawsuit against the company\’s competitors. Meanwhile, representatives for the competitors would rush to the telephone as well. They would call their own lawyers in patent-skeptical jurisdictions like San Francisco and urge them to file a lawsuit seeking to invalidate the patent. Time was of the essence because the two cases would eventually be consolidated, and the court that ultimately heard the case usually depended on which filing had an earlier timestamp.\”

But unsurprisingly to any student of political economy, the new court ended up being staffed by lawyers who believed in very strong patent enforcement. The share of patents that were found to be infringed went from 20-30% in most of the 1960s and 1970s up to more like 50-80% for most years of the 1980s. Lee tells the story in more detail, but the new court eventually allowed software to be patented, and \”business methods\” to be patented. \”Microsoft received just five patents during the 1980s and 1,116 patents during the 1990s, for instance. Between 2000 and 2009? The company received 12,330 patents …\” Since 2006, the U.S. Supreme Court has overruled at least four major decisions from this lower court.

Lee argues: \”Either way, breaking the Federal Circuit\’s monopoly on patent appeals may be the single most important step we can take to fix the patent system. The Federal Circuit looks likely to undermine other reforms undertaken by Congress, just as it has resisted the Supreme Court\’s efforts to bring balance to patent law. Only by extending jurisdiction over patent appeals to other appeals courts that are less biased toward patent holders can Congress return common sense to our patent system.\”

2)  Why are patent cases being decided in the International Trade Commission?

In May 2012, the International Trade Commission affirmed an earlier decision to ban imports of a number of Motorola Android-based smartphones and other mobile devices because they infringed a Microsoft patent that involves software for scheduling meetings–software that is rarely used and by one estimate is worth 33 cents per phone. The case raises standard difficult issues about how innovation can flourish in an industry like high-tech electronics where products use dozens of overlapping patents, and thus every new product is susceptible to claims that it is infringing on some patent, somewhere.

But for me, the eye-opening part of the case was the decision-maker: Why was the International Trade Commission deciding what was essentially a patent infringement case? K. William Watson tells some of this story in \”Still a Protectionist Trade Remedy: The Case for Repealing Section 337,\” which was published as Cato Policy Analysis #708. It turns out that under Section 337 of the Tariff Act of 1930, the ITC has power to block imports of any products that involve \”unfair means of competition.\” The ITC process is faster than the courts, and has often proven quite friendly to existing patent-holders. The ITC remedy of shutting off imports is very costly. Watson summarizes the argument this way:

\”The current state of the global “patent wars” in the mobile device industry aptly demonstrates the risks posed by Section 337. Courts have been perfectly capable of imposing strong remedies to deal with patent infringement, which sometimes include banning a product from the market. Most of
these disputes, however, are merely part of a business model where competitors must collaborate
to pool together the many patented technologies that make up cutting-edge consumer products such as smartphones and tablet computers. While companies would love to have their competitors’ products forced off the shelf, the truth is that many of the disputes involve patents that are worth
only a tiny fraction of the product’s total value, meaning that injunctive relief is not always appropriate. … There is only one simple and effective solution: repeal the law. The ITC has no business imitating a court of law and is not equipped to do so. The foreign origin of a product does not make it necessary to subject its producer to a separate regime that more quickly and forcefully
settles intellectual property disputes. The existence of two distinct patent enforcement mechanisms disrupts the balance of U.S. patent law and, because one mechanism is only available to challenge imports, violates U.S. trade obligations.\”

 3) When brand-name drug companies compensate generic drug companies to delay in entering the market.  

Brand-name drug companies typically have a patent, and when that patent expires, it then becomes possible for manufacturers of generic drugs to enter that market. But this process isn\’t necessarily smooth, as the Federal Trade Commission explains in a recent amicus brief in U.S. District Court.

When a brand-name firm is expecting the potential entry of a generic producer, a standard strategy for the brand-name firm is that, when its patent expires, it can start selling a generic equivalent of its own drug. The FTC finds that this strategy can cut the cut the profits for the new generic producer by 40-50%. For example, when the brand drug Paxil went off-patent, a company called Apotex was the first to be allowed to sell a generic equivalent, and the first generic company to enter gets a 180-day period of exclusivity as an encouragement to enter. Apotex was expecting sales of about $550 million in that 180 day window, but then the maker of Paxil put out its own generic version, and Apotex generates only $150-200 million in sales during that period.

This scenario creates the possibility for an anti-competitive deal: the original drug seller agrees not to produce its own generic equivalent, and the new generic producer agrees to delay entry into the market. The result is that new competition from the generic is delayed, and as the FTC explains: \”Both effects are harmful to consumers, who face higher drug prices over a longer period.\” The FTC argues in its brief that brand-name pharma firms should not be allowed to compensate generic producers for delay in entering the market–whether that compensation takes the form of a direct payment or the form of an agreement not to start its own line of generics. The FTC also points out that such payments are fairly rare–and thus presumably not necessary in finalizing the switch from a patented product to one that can be sold in generic version.

In short, even what might seem like a simple transition–the act of a patent expiring–can be fraught with practical difficulties and ways for the incumbent firm to extract just a little more in profit. The practical world of patents is vastly more complex and ambiguous than the standard textbook tradeoff.