Year: 2013

I\’m always hesitant to proclaim that economic growth is finding a foothold in sub-Saharan Africa. There were just too many reports in the 1960s, 1970s, 1980s, and even the 1990s that growth in Africa was on the verge of taking off–only to see disappointment a few years later. But Africa\’s economic and social statistics in the last decade or so do look genuinely promising. The World Bank puts out an \”Africa\’s Pulse\” report twice per year, and the most recent edition offers some statistics.

Here are some rates of real GDP growth for sub-Saharan Africa, shown by the yellow line. The blue bars, for comparison show the annual growth rates for real GDP among the other developing economies of the world, although excluding China, which is now classified by the World Bank as an \”upper-middle-income\” economy. The red line leaves out South Africa, which is also classified as an \”upper-middle-income\” economy by world standards, and which has been lagging the growth rates of the rest of sub-Saharan Africa for most of the last decade. There\’s clearly a hiccup with the global financial and economic woes of 2009, but a rapid and quick bounce-back in the last few years.

Africa\’s faster-than-average-for developing-countries growth rates are paying off in lower poverty rates. The share of the population in resource-poor countries in sub-Saharan Africa that is below the $1.25/day level of consumption fell from 65% in the late 1990s to 49% in the last few years. Rates of inequality as measured by the Gini coefficient are down as well. More detailed data also show gains in a wide variety of areas: child mortality, life expectancy, school attendance, access to sanitation, and others.

Perhaps the main overall question about Africa\’s growth performance in the last decade is how much it has been driven by higher global prices for raw materials and commodities–and thus if Africa\’s growth will again plummet if these prices sag.  As the report says:

\”Continued demand for Africa’s natural resources as well as the recent discoveries of oil, gas and minerals in, among others, Ghana, Uganda, Kenya, Tanzania and Mozambique, together with an improved macro-economic environment, sustain prospects for robust economic growth. The pertinent question is how more of the new found resource wealth can be converted into fiscal revenues and effective public spending to foster sustainable development, improve human welfare, and generate more rapid income poverty reduction. In other words, how can we avoid another “resource curse.”  …  Three core legs of natural resource management, each embodying their own political dynamics, are highlighted: 1) extraction—transparency regarding terms of contracts; 2) taxation—efficiency in tax collection; and 3) investment of resource rents—careful prioritization of public investment.\”

This figure divides economic growth between resource-rich and resource-poo countries of sub-Saharan Africa. Clearly, growth has been faster in the resource-rich economies. But the future also shows that compared with Africa\’s truly dismal economic record in the 1980s and 1990s, the last decade doesn\’t look so bad.

The question for Africa is to build broad-based growth: that is, not just economic growth based on higher prices for natural resources and commodities, but growth more broadly based on raising productivity in agriculture and manufacturing, on connections in global markets, on provision of services in expanding cities, on expanding infrastructure, and more. Maybe Africa\’s time in the economic sunshine is coming.

The Spring 2013 issue of my own Journal of Economic Perspectives has two main symposia: one on \”The Growth of the Financial Sector,\” and one on \”Early and Late Interventions.\” It also has several individual articles on topics like the the political reasons why good economics can make for bad policy outcomes, Latin America\’s social policy challenge, and the investment strategies of sovereign wealth funds. The back of the issue has my own \”Recommendations for Further Reading\” column, and some correspondence about neuroscience and economics.

I\’ll probably do some blogging about specific articles in the next week or so, but for now, here\’s a list of the articles, with abstracts and links. Like all issues of JEP back to the first issue in 1987, this issue is freely available on-line compliments of the American Economic Association. It\’s also possible to go to the JEP website and download the journal in a format that works on an e-reader.

Symposium: The Growth of the Financial Sector

 \”The Growth of Finance,\” by Robin Greenwood and David Scharfstein

The US financial services industry grew from 4.9 percent of GDP in 1980 to 7.9 percent of GDP in 2007. A sizeable portion of the growth can be explained by rising asset management fees, which in turn were driven by increases in the valuation of tradable assets, particularly equity. Another important factor was growth in fees associated with an expansion in household credit, particularly fees associated with residential mortgages. This expansion was fueled by the development of nonbank credit intermediation (or \”shadow banking\”). We offer a preliminary assessment of whether the growth of active asset management, household credit, and shadow banking — the main areas of growth in the financial sector — has been socially beneficial.
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\”Finance: Function Matters, Not Size,\” by John H. Cochrane

It\’s fun to pass judgment on waste, size, usefulness, complexity, and excessive compensation. But as economists, we have an analytical structure for thinking about these questions. \”I don’t understand it\” doesn\’t mean \”it\’s bad,\” or \”regulation will improve it.\” That attitude pervades policy analysis in general and financial regulation in particular, and economists do the world a disservice if we echo it. I will not offer a competing black box [to explain the size of the finance industry]. I don’t claim to estimate the socially optimal \”size of finance\” at, say, 8.267 percent of GDP. It\’s just the wrong question. Hayek and the failure of planning should teach us a little modesty: Pronouncing on socially optimal industry size is a waste of time. Is the finance industry functioning well? Are there identifiable market or government distortions? Will proposed regulations help or make matters worse? These are useful questions.
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\”Moore\’s Law versus Murphy\’s Law: Algorithmic Trading and Its Discontents,\” by Andrei A. Kirilenko and Andrew W. Lo

Financial markets have undergone a remarkable transformation over the past two decades due to advances in technology. These advances include faster and cheaper computers, greater connectivity among market participants, and perhaps most important of all, more sophisticated trading algorithms. The benefits of such financial technology are evident: lower transactions costs, faster executions, and greater volume of trades. However, like any technology, trading technology has unintended consequences. In this paper, we review key innovations in trading technology starting with portfolio optimization in the 1950s and ending with high-frequency trading in the late 2000s, as well as opportunities, challenges, and economic incentives that accompanied these developments. We also discuss potential threats to financial stability created or facilitated by algorithmic trading and propose \”Financial Regulation 2.0,\” a set of design principles for bringing the current financial regulatory framework into the Digital Age.
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\”An International Look at the Growth of Modern Finance,\” by Thomas Philippon and Ariell Reshef

We study the rise of finance across a set of now-industrial economies. The long-run pattern of the growth of the income share of finance from the nineteenth century to current times in the United States is similar to some economies, but not all economies reach the same size and instead reach a plateau. The relationship between financial output and income is nonhomothetic and changes three times in this sample. Most of the increase in real GDP per capita from 1870 occurred while financial output and the income share of finance were smaller than their size in 1980. After 1980 the elasticity of income with respect to financial output falls significantly. We find considerable heterogeneity in the size of finance in recent times. There is no evidence for an increase in the unit cost of financial intermediation. We find that information technology and financial deregulation can help explain the increase in relative skill intensity and in relative wages in finance, while common trends, which may be related to financial globalization, also play a role.
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\”Asset Management Fees and the Growth of Finance,\” by Burton G. Malkiel

From 1980 to 2006, the financial services sector of the US economy grew from 4.9 percent to 8.3 percent of GDP. A substantial share of that increase was comprised of increases in the fees paid for asset management. This paper examines the significant increase in asset management fees charged to both individual and institutional investors. One could argue that the increase in fees charged by actively managed funds could prove to be socially useful if it reflected increasing returns for investors from active management or if it was necessary to improve the efficiency of the market for investors who availed themselves of low-cost passive (index) funds. But neither of these arguments can be supported by the data. Actively managed funds of publicly traded securities have consistently underperformed index funds, and the amount of the underperformance is well approximated by the difference in the fees charged by the two types of funds. Moreover, it appears that there was no change in the efficiency of the market from 1980 to 2011. Thus, the increase in fees is likely to represent a deadweight loss for investors. Indeed, perhaps the greatest inefficiency in the stock market is in \”the market\” for investment advice.
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Symposium on Early and Later Interventions

\”Investing in Preschool Programs,\” by Greg J. Duncan and Katherine Magnuson

We summarize the available evidence on the extent to which expenditures on early childhood education programs constitute worthy social investments in the human capital of children. We provide an overview of existing early childhood education programs, and then summarize results from a substantial body of methodologically sound evaluations of the impacts of early childhood education. The evidence supports few unqualified conclusions. Many early childhood education programs appear to boost cognitive ability and early school achievement in the short run. However, most of them show smaller impacts than those generated by the best-known programs, and their cognitive impacts largely disappear within a few years. Despite this fade-out, long-­run follow-ups from a handful of well-­‐known programs show lasting positive effects on such outcomes as greater educational attainment, higher earnings, and lower rates of crime. It is uncertain what skills, behaviors, or developmental processes are particularly important in producing these longer-­‐run impacts. Our review also describes different models of human development used by social scientists, examines heterogeneous results across groups, and tries to identify the ingredients of early childhood education programs that are most likely to improve the performance of these programs.
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\”What Can Be Done to Improve Struggling High Schools?,\” Julie Berry Cullen, Steven D. Levitt, Erin Robertson and Sally Sadoff 

In spite of decades of well-intentioned efforts targeted at struggling high schools, outcomes today are little improved. A handful of innovative programs have achieved great success on a small scale, but more generally, the economic futures of the students at the bottom of the human capital distribution remain dismal. In our view, expanding access to educational options that focus on life skills and work experience, as opposed to a focus on traditional definitions of academic success, represents the most cost-effective, broadly implementable source of improvements for this group.
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\”Beyond BA Blinders: Lessons from Occupational Colleges and Certificate Programs for Nontraditional Students,\” by James E. Rosenbaum and Janet Rosenbaum

Postsecondary education mostly focuses on the four-year BA degree. Community colleges are often promoted as the first step toward the ultimate goal of a four-year degree. However, community colleges have extremely poor degree completion rates. There is evidence suggesting better results for their private, two-year counterparts — particularly for certificate completion. We will focus on occupational colleges — private accredited colleges that offer career preparation in occupational fields like health care, business, information technology, and others. These institutions challenge many of our preconceptions about college. They are less wedded to college traditions, which raises some interesting questions: Do private colleges offering certificates or AA degrees use different procedures? Should community colleges consider some of these procedures to reduce student difficulties and improve their completion rates? For many community college students, earning a more likely, quick sub-BA credential — perhaps followed by a four-year degree in the future — will be preferable to the relatively unlikely pathway from a community college program directly to a four-year BA. In sum, this paper suggests that nontraditional colleges and nontraditional credentials (certificates and AA degrees) deserve much closer attention from researchers, policymakers, and students.
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Individual Articles

\”Economics versus Politics: Pitfalls of Policy Advice,\” Daron Acemoglu and James A. Robinson

The standard approach to policy making and advice in economics implicitly or explicitly ignores politics and political economy and maintains that if possible, any market failure should be rapidly removed. This essay explains why this conclusion may be incorrect; because it ignores politics, this approach is oblivious to the impact of the removal of market failures on future political equilibria and economic efficiency, which can be deleterious. We first outline a simple framework for the study of the impact of current economic policies on future political equilibria — and indirectly on future economic outcomes. We then illustrate the mechanisms through which such impacts might operate using a series of examples. The main message is that sound economic policy should be based on a careful analysis of political economy and should factor in its influence on future political equilibria.
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\”Latin America\’s Social Policy Challenge: Education, Social Insurance, Redistribution,\” by Santiago Levy and Norbert Schady

Long regarded as a region beset by macroeconomic instability, high inflation, and excessive poverty and inequality, Latin America has undergone a major transformation over the last 20 years. The region has seen improved macroeconomic management and substantial and sustained reductions in poverty and inequality. In this paper, we argue that social policy, including human capital and education, social insurance, and redistribution, need special attention if achievements of the last two decades are to be sustained and amplified. Starting in the mid 1990s, many governments in the region introduced a variety of programs, including noncontributory pensions and health insurance, and cash transfers targeted to the poor. Social spending in Latin America increased sharply. These policies have been widely praised, and we believe they have resulted in substantial improvements in the lives of the poor in the region. However, a more nuanced view shows some worrisome trends. Moving forward, we believe it is necessary to pay much closer attention to the quality of services, particularly in education; to the incentives generated by the interplay of some programs, particularly in the labor market; to a more balanced intertemporal distribution of benefits, particularly between young and old; and to sustainable sources of finance, particularly to the link between contributions and benefits.
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\”The Investment Strategies of Sovereign Wealth Funds,\” Shai Bernstein, Josh Lerner and Antoinette Schoar

Sovereign wealth funds have emerged as major investors in corporate and real resources worldwide. After an overview of their magnitude, we consider the institutional arrangements under which many of the sovereign wealth funds operate. We focus on a specific set of agency problems that is of first-order importance for these funds: that is, the direct involvement of political leaders in the management process. We show that sovereign wealth funds with greater involvement of political leaders in fund management are associated with investment strategies that seem to favor short-term economic policy goals in their respective countries at the expense of longer-term maximization of returns. Sovereign wealth funds face several other issues, like how best to cope with demands for transparency, which can allow others to copy their investment strategies, and how to address the problems that arise with sheer size, like the difficulties of scaling up investment strategies that only work with a smaller value of assets under investment. In the conclusion, we discuss how various approaches cultivated by effective institutional investors worldwide — from investing in the best people to pioneering new asset classes to compartmentalizing investment activities — may provide clues as to how sovereign wealth funds might address these issues.
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\”Recommendations for Further Reading,\” by Timothy Taylor 

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Correspondence: Are Cognitive Functions Localizable? Colin Camerer et al. versus Marieke van Rooij and John G. Holden

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I\’m conflicted about big-time college sports. I watch them, I enjoy them–and in a number of ways, they seem inappropriate to me as an activity for colleges and universities. The student-athletes often must make an enormous and year-round commitment of time and energy, in a way inevitably creates tradeoffs with the academic and social dimensions of college life. At many large universities, the football and basketball coaches are the highest-paid employees. The spectacle of middle-aged men, like me, yelling at 19 year-old athletes is not edifying. Neither is the spectacle of inebriated students from one school yelling at 19 year-old athletes from other schools. Frankly, the only participants in big-time college athletics who consistently come off well are the athletes themselves.

The NCAA has just released \”Revenues and Expenses, 2004-2012, NCAA Division I Intercollegiate Athletics Programs Report.\” The report is a bunch of detailed tables with a few bullet points. The NCAA divides its Division 1 schools into three groups. The Football Bowl Series is schools with big-time football programs. In  January, Alabama won the football title for this group, beating Notre Dame 42-14. The Football Championship series is medium-level football programs. Last season, North Dakota State beat Sam Houston State 39-13 in the championship game at this level. And the Division 1 schools without football programs include many well-known universities that have scholarship athletes and prominent programs in other sports: Gonzaga and Marquette are two examples. 

Here\’s a table showing median revenues generated by sports activities, along with total spending for these three categories of schools in 2004 and 2012. Generated revenues increased a lot. Spending increased by about the same amount, or more.

Of course, these figures are medians. Some schools are considerably above the median, while some are below. Here are the medians for each quartile of the Football Bowls Series schools in terms of revenue generated by sports and spending on sports.

The report sums up some of these patterns by noting: \”[A] total of 23 FBS athletics programs reported positive net generated revenues in both 2011 and 2012. It should be noted, however, that
the 23 profitable programs are not the same for the two reporting years. …The median net generated revenues for those surplus programs was $8,976,000 in 2011 and $5,419,000 in 2012, while the median net deficit for the remaining programs was $12,140,000 in 2011 and $14,645,000 in 2012. The gap between the financially successful programs and others dropped to $20,000,000 in 2012 from $21,000,000 in 2011. … A related observation is the portion of total athletics revenues that
are allocated by the institutions — 20 percent in the FBS; 71 percent in the FCS; 77 percent in DI w/o FB. …  This number representsthe extent to which the institution is subsidizing athletics.\”

A few thoughts follow:

1) For all the rhetoric about how athletics serve the larger purposes of academic institutions, the financial numbers tell a different story. The large revenue gains in recent years from reorganizing conferences, renegotiating TV rights, and the like, are by and large not being shared with the academic side colleges and universities. Instead, the additional revenues are being plowed back into the athletics programs.

2) A couple of dozen of the big-time football schools generate enough revenue from sports to cover their athletic department expenses. The median school does not make money in any direct way from its athletics program: instead, it subsidizes these programs. There is perhaps an argument to be made that athletics can encourage alumni donations to other programs, and there are examples of where donations spike for a time when a school\’s athletics program does unexpectedly well. But I haven\’t seen persuasive evidence that the median school gets more donations to its academic programs because of its sports teams.

College athletics is a sort of arms race, where institutions that define themselves as focused on \”higher education\” aggressively pursue sports revenues, and then spend those revenues on sports activities. Of course, the sports revenues are available because of demand from fans, like me, and it\’s hard to blame colleges for seeking a share of that money. But it\’s easier to blame colleges and universities for not finding a way to funnel a much larger share of that growing pot of money to what is supposed to be the core academic function of their enterprise.

You would expect countries with a higher per capita GDP to spend more on education, and they do. In fact, a graph that plots the relationship across countries between per capita GDP and per student spending on primary and secondary education almost traces out a straight line. But for spending per student on post-secondary education, the U.S. spends far more one would predict based on per capita GDP. Here\’s the graphs from The Condition of Education 2012, published by the National Center for Education Statistics at the U.S. Department of Education, using OECD data.

First, here\’s the relationship from per capita GDP to per student spending on primary and secondary education. The U.S. has higher per capita GDP, and accordingly spends more per student, but the relationship is close to a straight line.

Now here\’s the relationship from per capita GDP to per student spending on postsecondary education. While the relationship remains generally upward-sloping, there are clearly countries that spend less per student than you would expect given their level of per capita GDP, like Iceland, which is labelled, and Italy, which is the unlabelled point more-or-less under Spain. There are also countries that spend more per student than you would expect given their GDP, including Ireland, Canada, and especially the United States. 

One can of course make an argument that that the quality of postsecondary education in the United States is very high, which in turn accounts for much of its higher cost. It\’s a fair point. But for the U.S., the arithmetic of having per student postsecondary education spending so far above the best-fit line with per capita GDP has two difficult implications. First, given these high costs per student, relative to the income level in the economy, it becomes much harder for the U.S. to finance a substantial expansion in the number of students who receive postsecondary education–unless those additional students receive an experience quite a bit less expensive than the current average. Second, the economic payoff to postsecondary education will be harder to justify in the United States, given that the per student costs are so out of line with per capita GDP.

Living in Minnesota, one hears stories about the economic activity happening in the Bakken formation in western North Dakota and eastern Montana. Stories about people who are paid to drive to work from an hour or more away, because there\’s not enough housing nearby. Stories about school bus drivers who triple their salary by moving to that area and driving a shuttle to get workers to work sites. With national unemployment remaining stubbornly high, what are the actual job numbers for this area? Should many more of the unemployed be moving to North Dakota? In a short \”Beyond the Numbers\” briefing paper, Paul Ferree and Peter W. Smith of the Bureau of Labor Statistics review some of the numbers in \”Employment and wage changes in oil-producing counties in the Bakken Formation, 2007–2011.\” 

For those of you who are a little fuzzy on your North Dakota geography, here\’s a map of the counties around the Bakken formation and the job gains in those counties from 2007-2011.

The overall numbers look like this, according to Ferree and Smith: \”From 2007 to 2011, employment in these counties grew from 77,937 jobs to 105,891 jobs, an increase of 35.9 percent. Total wages paid in these counties more than doubled over the same period: in 2007, workers in these counties earned about $2.6 billion, and in 2011 they earned $5.4 billion. Their average annual pay increased from $33,040 to $50,553 for an increase of 53.1 percent. Over the same period, national employment decreased by 4.4 percent, while average annual pay increased by 8.1 percent from $44,458 in 2007 to $48,043 in 2011.\”

Here\’s a breakdown by industry of gains in jobs and wages. It\’s interesting to note that while jobs in mining almost tripled in this time, jobs in \”Professional and Technical Services\” and in \”Transportation and warehousing\” actually more than tripled. Also, the gain in wages for mining jobs was actually below the average wage gain for this area, while wages in the \”Real estate and rental and leasing\” area doubled in this time. 

On one level, maybe the most important level, the economic news from the Bakken area seems to me very positive. People have jobs! People are getting higher wages! Many of those jobs are for blue-collar skills that have not been well-rewarded in the U.S. economy in recent years. Sure, there are environmental issues worth discussing, but they can be managed. In addition, I\’m sure the jobs and wages in the Bakken area are also supporting jobs and wages in other areas for suppliers, transporters, and energy users. Expanded energy production offers a real opportunity for jobs and growth in the U.S. economy, at a time when such opportunities are not thick on the ground.

That said, it clearly lacks numerical perspective silly to say that America\’s unemployed should all be headed for Williston, North Dakota. The boom from 2007-2011 added less than 30,000 jobs in this area, while the U.S. economy has about 11.7 million unemployed people. In addition, although some of the job gains are for blue-collar workers, a number of the additional jobs are going to those with specific professional and technical skills–or those with detailed knowledge of the local real estate market.  Ultimately, I suspect that the direct economic effects of the oil shale boom in the Bakken area and elsewhere in North America may be smaller than the indirect effects of those increased domestic energy supplies on the rest of the economy. 

The last few years have been unkind to macroeconomics. Questions that were thought to be largely settled have been reopened. Questions that didn\’t seem relevant to high-income economies with developed financial sectors all of a sudden seem quite relevant. The IMF recently held a conference on \”Rethinking Macro Policy\”: the papers can be downloaded and presentations can be viewed here.
In a background paper, Olivier Blanchard, Giovanni Dell\’Ariccia, and Paolo Mauro pose 12 open questions about macro policy in \”Rethinking Macro Policy II:Getting Granular.\” Here, I\’ll list their 12 questions and say a few words about each.

The first five questions concern central banking.

1) Should Central Banks Explicitly Target Activity?

In the early 2000s, the rough consensus was that central banks should focus on price stability. They write: \”One of the arguments for the focus on inflation by central banks was the “divine coincidence”: the notion that, by keeping inflation stable, monetary policy would keep economic activity as close as possible (given frictions in the economy) to its potential. So, the argument went, even if policymakers cared about keeping output at potential, they could best achieve this by focusing on inflation and keeping it stable. Although no central bank believed that the divine coincidence held exactly, it looked like a sufficiently good approximation to justify a primary focus on inflation and to pursue inflation targeting.\”

There are now a number of proposals that central banks should focus not on price stability, but on either focus on increasing the supply of money and credit in a way that would target nominal GDP or real economic activity. It\’s not clear  how well this would work! But after the last few years, it\’s a reasonable question to ask.

2) Should Central Banks Target Financial Stability? 

In the early 2000s, the general sense was that central banks should treat financial bubbles with \”benign neglect.\” For example, the melt-down of the dot-com bubble in the late 1990s was unpleasant, and a short recession arrived in its aftermath. But a common argument at the time pointed out that having the Federal Reserve try to determine when the stock market (or some other financial market) is \”too high\” or \”too low\” has a lot of dangers, too. Better to let financial bubbles work themselves out, the argument went, and the central bank could focus on the real economy and mitigating recessions when needed.

 But now there are proposals that the central bank should look at some financial markets, at least. For example, there seems to be some evidence that sharp rises in bank credit can be forerunners of a financial bubble that can burst into a recession.

3) Should Central Banks Care about the Exchange Rate?

Large economies like the United States have for the last few decades just let financial capital flow back and forth across their borders, with the exchange rate of their currency be determined in global financial markets. But flows of international financial capital seem to have an increasing potential for causing severe financial dislocation. Remember the east Asian crisis back in 1998, the problems of Russia and Argentina a few years later, and now the more recent experiences of  Iceland, Ireland, Greece, Portugal, Spain, and who knows who\’s next? The practicalities of how to limit the disruptive capital flows while encouraging the productive capital flows are daunting. But they are now in the conversation of macroeconomic policy-makers.

4) How Should Central Banks Deal with the Zero Bound?

In those old pre-2007 days, most central bank policy centered on raising or lowering interest rates. But what happens when an economy is stumbling so badly that the targeted interest rate is cut essentially to zero? Blanchard, Dell\’Ariccia and Mauro write: \”The crisis has shown that economies can hit the zero lower bound on nominal interest rates and lose their ability to use their primary instrument—the policy rate—with higher probability than was earlier believed.\” The evidence on how all the various forms of quantitative easing work is still accumulating, but at present it\’s pretty mixed between what I would label as  \”useful if not enormous effects\” and \”not much sustained effect worth mentioning.\”

5) To Whom Should Central Banks Provide Liquidity? 

In the old days, which refers to anything before about 2007, central banks were sometimes called the \”bank for banks.\” They provided liquidity to banks. Other financial institutions and markets–money market funds, mutual funds, insurance companies, investment banks,  securitized lending–were outside what central banks were expected to do. But in the financial crisis that erupted in 2008 and 2009, central banks around the world made all sorts of short-term loans to all kinds of financial institutions. Having set this precedent,will such loans again be provided in the future? And under what conditions, on what terms?

Their next four questions are about fiscal policy.

6) What Are the Dangers of High Public Debt?

Back in the halcyon times before 2007, very high levels of public debt were an issue for countries that seemed economically shaky for many reasons: countries in Latin America like Argentina, or Russia in the late 1990s, or in southern Europe like Turkey or even Italy, or sometimes highly-indebted countries that needed World Bank or IMF bailout plans. But public debt levels were not a first-order problem for high-income economies. They write: \”At the start of the crisis, the median debt-to-GDP ratio in advanced economies was about 60 percent. This ratio was in line with the level considered prudent for advanced economies, as reflected, for example, in the European Union’s Stability and Growth Pact. … By the end of 2012, the median debt-to-GDP ratio in advanced economies was close to 100 percent and was still increasing. …The lessons are clear. Macroeconomic shocks and the budget deficits they induce can be sizable—larger than was considered possible before the crisis. And the ratio of official debt to GDP can hide significant contingent liabilities, unknown not only to investors but also sometimes to the government itself.\”

7) How to Deal with the Risk of Fiscal Dominance?

I don\’t actually know what \”fiscal dominance\” means. But the actual discussion here is about the ways in which monetary authorities can reduce the costs of debt: keeping interest rates and thus government borrowing costs low; buying and holding government debt directly; creating inflation to eat away at the real value of government debt. All of these policies have their risks, but with public debts in many countries heading to levels that would have been considered sky-high just a few years back, all possibilities are on the table.

8) At What Rate Should Public Debt Be Reduced? 

They write: \”[W]hile fiscal consolidation is needed, the speed at which it should take place will continue to be the subject of strong disagreement. Within this context, a few broad principles should still apply …  Given the distance to be covered before debt is down to prudent levels and the need to reassure investors and the public at large about the sustainability of public finances, fiscal consolidation should be embedded in a credible medium-term plan. The plan should include the early introduction of some reforms—such as increases in the retirement age—that have the advantage of tackling the major pressures from age-related expenditures while not reducing aggregate demand in the near term.\”

9) Can We Do Better Than Automatic Stabilizers?

Automatic fiscal stabilizers help ameliorate the swings of boom and bust. But should they be designed to be larger?  They write: \”Why not design better stabilizers? For instance, for countries in which existing automatic stabilizers were considered too weak, proposals for automatic changes in tax or expenditure policies are appealing. Examples include cyclical investment tax credits, or pre-legislated tax cuts that would become effective if, say, job creation fell below a certain threshold for a few consecutive quarters. Perhaps because the policy focus has been on consolidation rather than on active use of fiscal policy, there has been, as far as we know, little analytical exploration .. and essentially no operational uptake of such mechanisms.\”

The final three questions refer to \”macroprudential\” policies, which is one of those terms invented in the last few years. For an overview of the arguments for macroprudential policies, a good starting point is the article by Samuel G. Hanson,  Anil K. Kashyap, and Jeremy C. Stein, \”A Macroprudential Approach to Financial Regulation,\” in the Winter 2011 issue of my own Journal of Economic Perspectives. They write: \”Many observers have argued that the regulatory framework in place prior to the global financial crisis was deficient because it was largely \”microprudential\” in nature. A microprudential approach is one in which regulation is … aimed at preventing the costly failure of individual financial institutions. By contrast, a \”macroprudential\” approach … seeks to safeguard the financial system as a whole.\” Thus, the traditional microprudential approach looked at each financial institution individually, to see if it had sufficient capital and risk controls. A macroprudential approach would look at overall patterns of leverage and risk, and see whether regulatory changes might be needed across the sector. But again, fresh questions arise.

10) How to Combine Macroprudential Policy and Microprudential Regulation?

Do the normal bank regulators also look at macroprudential issues? If macroprudential policy is going to involve steps like changing how easy it is to get loans, should legislators and Congress become involved? How does the central bank fit it here?

11) What Macroprudential Tools Do We Have and How Do They Work?

They write: \”One can think of macroprudential tools as falling roughly into three categories: (1) tools
seeking to influence lenders’ behavior, such as cyclical capital requirements, leverage ratios, or dynamic provisioning; (2) tools focusing on borrowers’ behavior, such as ceilings on loan-to-value ratios (LTVs) or on debt-to-income ratios (DTIs); and (3) capital flow management tools.\” They also write: \”In practice, however, implementation is not so easy.\”

12) How to Combine Monetary and Macroprudential Policies?

Will monetary policy and macroprudential policy be at adds? What happens when the economy is staggering and financial risks are high? The central bank looks at the staggering economy and cuts interest rates. But the macroprudential policy makers look at the high financial risks and take steps to make it tougher to borrow or to build up leverage.

Many of these policy questions come down to an question that is only answerable with the passage of time. Was what happened in the lead-in to the Great Recession a rare event, or an event that is likely to occur again in one form or another? If it was a once-a-century event, then agonizing over how to adapt macroeconomic policy is not all that useful. We can make a few tweaks, and slowly retreat back to the conventional wisdom circa 2005. On the other side, if the global economy and financial sector are increasingly prone to these kinds of upheavals, then more fundamental changes in policy-making will be needed.

How much do high schoolers know about economics? The National Assessment of Educational Progress did its first economics test in 2006, and the U.S. Department of Education has now released the results of the 2012 follow-up test in \”Economics 2012: National Assessment of Educational Progress at Grade 12.\” NAEP tests are carried out for a nationally representative sample of high school students.

I\’ve never read the actual questions for an NAEP economics test. The report explains that the questions are categorized in three overlapping ways. There are three main content areas: the  market economy, the national economy, and the international economy.  The questions are also divided into three \”cognitive\” categories: knowing, applying and reasoning. And the questions are divided into three assessment contexts: individual and household questions on topics related to earning, spending, saving, borrowing, and investing; business questions related to entrepreneurs, workers, producers, and investors; and public policy questions on domestic and international issues.

The results are not especially encouraging. About one-fifth of 12th-graders are \”below basic,\” and the median score is \”basic\” rather than \”proficient.\” Here\’s the overall performance in 2006 and 2012.

The modest gains from 2006 to 2012 are mainly at the lower end of the test score distribution.

However, performance on the economics test follows a pattern that is common across subjects: those with more educated parents tend to perform considerably better. I won\’t enter here into the disputes over the extent to which these differences reflect family or social influences or differences in school performance. I\’ll just note that children from families where the parents have lower levels of education are especially in need of a basic understanding of how the economy works at a personal and social level. Also, whatever the cause, education level is clearly one of the ways that families with higher socioeconomic status pass that advantage on to their children.

For those who want more detail on high school classes in economics, here\’s a post from October 2012 on \”High School Classes in Economics and Personal Finance.\”

Since Japan\’s bubble economy burst in the early 1990s, large budget deficits are one policy that the government has used in an attempt to stimulate the moribund economy. Japan\’s budget deficits have been at least 5% of GDP since the late 1990s, and more like 9-10% of GDP in the last five years. The OECD discusses Japan\’s budget deficits, and the rest of its economic situation, in the just-published OECD Economic Surveys JAPAN.  The \”Overview\” for the study is available here; the entire report can be read for free via a clunky on-line browser here.

In terms of gross government debt, Japan is the world leader. This chart shows the five countries with largest ratios of gross debt/GDP. Japan has been the clear leader since about 2000, although Greece has been making a run at the top spot in the last few years.

However, most economists tend to focus on net government debt, which subtracts out debt that the government owes to itself. (For example, in the U.S. context, net debt doesn\’t count debt held by the Social Security trust fund.) Thus, net debt focuses on how much the government has borrowed in global capital markets. By this measure, Italy was the world debt leader through the 1990s and into the early 2000s, but since then, Japan and Greece have been battling it out for the lead.

Japan\’s enormous debt poses a challenge both to those who advocate larger budget deficits, and for those who do not.  For those who advocate larger budget deficits, the challenge is that Japan\’s enormous rise in debt over about two decades has clearly not been sufficient to restore Japan\’s economy to robust health. Of course, one can object that a number of other complementary policies are also needed, and the OECD report discusses monetary policy, deregulation, energy policy, education, labor market policies, and more. But if the truly extraordinary increase in Japan\’s government debt has not been sufficient to stimulate its economy, it suggests that these other policies are of considerable importance.

On the other side, for those who advocate smaller deficits, Japan\’s enormous rise in government debt over two decades, with net debt reaching 150% of GDP,  has clearly not led to a financial crisis either.

The OECD report straddles the fence here. It warns that Japan\’s debt is far too high, and calls this the country\’s \”paramount policy challenge.\” But it also argues that immediate attempts to bring down this debt could keep Japan\’s economy sluggish, and so argues that a \”flexible fiscal policy\” is needed.

Here is the OECD report, dancing: \”The public debt ratio has risen steadily for two decades, to over 200% of GDP. Strong and protracted consolidation is therefore necessary to restore fiscal sustainability, which is Japan\’s paramount policy challenge. … Stopping and reversing the rise in the debt-to-GDP ratio is crucial. Stabilising the public debt ratio by 2020 may require, depending on the evolution of GDP and interest rates, an improvement of the primary fiscal balance from a deficit of 9% of GDP in 2012 to a surplus as high as 4% by 2020. Controlling expenditures, particularly for social security in the face of rapid population ageing, is key. Substantial tax increases will be needed as well, although this will also have a negative impact on growth. Given the size and duration of fiscal consolidation, Japan faces the risk of a marked rise in interest rates, threatening a banking system that is highly exposed to Japanese government debt.\”

Contemplate that for a moment: the recommendation is for moving from a deficit of 9% of GDP in 2012 to a surplus of 4% of GDP by 2020–that is, a swing in the government budget balance position of 13% of GDP in just 8 years. 

The U.S. debt situation differs from that of Japan in two ways: 1) the U.S. debt/GDP ratio is far smaller; and 2) domestic savings in Japan are high enough that the country can finance its government borrowing from domestic sources. In contrast, the U.S. government has depended for years on inflows of foreign investment capital to finance its debts. Thus, Japan\’s government needs to be concerned that its domestic savers will start looking elsewhere for higher rates of return, while the U.S. government needs to be concerned as to whether international investors will continue to put their money in Treasury bonds.

I remember when I was a high school debater back in the 1970s, and the oil price shocks led to arguments over the prospects for solar, wind, geothermal, and other kinds of power.  Here we are more than three decades later, and carbon-based fuels continue to rule. The International Energy Administration surveys the global situation in \”Tracking Clean Energy Progress 2013.\” 

Here is the Energy Sector Carbon Intensity Index. As the IEA report explains: \”The IEA Energy Sector Carbon Intensity Index (ESCII) tracks how many tonnes of CO2 are emitted for each unit of energy supplied. It shows that the global aggregate impact of all changes in supply technologies since 1970 has been minimal. Responses to the oil shocks of the 1970s made the energy supply 6% cleaner from 1971 to 1990. Since 1990, however, the ESCII has remained essentially static, changing by less than 1% …\”

(For the record, I edited this figure from the version in report by cutting off the projections for the future,and stopping with the present.)

Just to be clear, the IEA is a cheerleader for clean energy. Not that there\’s anything wrong with that! The report advocates \”at least\” tripling R&D budgets for clean energy. I\’m typically supportive of most R&D efforts, but it\’s important to remember that the U.S. government has spent about $150 billion (in 2012 dollars) on energy R&D since the 1970s, without much effect on moving away from carbon-based energy. R&D spending doesn\’t guarantee effective commercialization. But the report also offers a useful reminder that cleaner energy is about a lot more than trying to force-feed solar and wind power companies. For example:

Greater efficiency in energy consumption. \”Industrial energy consumption could be reduced by around 20% in the medium to long term by using best available technologies (BAT).\” Nearly half of global energy consumption is for either heating or cooling, two activities where efficiency gains are often possible.  The IEA calculates that nearly half of its desired gains in reduction of carbon emissions by 2020 can be achieved by greater energy efficiency.

Deal with Coal. The report notes: \”Coal technologies continue to dominate growth in power generation. This is a major reason why the amount of CO2 emitted for each unit of energy supplied
has fallen by less than 1% since 1990… Coal-fired generation, which rose by an estimated 6% from 2010 to 2012, continues to grow faster than non-fossil energy sources on an absolute basis. Around half of coal-fired power plants built in 2011 use inefficient technologies. … Coal plants are
large point sources of CO2 emissions, so concerted efforts to improve their efficiency can
significantly reduce coal consumption and lower emissions.\” TThus, one step is to make burning coal, where that is going to happen, more efficient.  In addition, natural gas can play a substantial role to lower emissions of carbon and various pollutants by offering a practical alternative to coal-fired electricity generation.

Push Carbon Capture and Storage. Maria van der Hoeven writes in her Foreword: \”I am particularly worried about the lack of progress in developing policies to drive carbon
capture and storage (CCS) deployment.\” The report notes: \”While 13 large-scale carbon capture and storage (CCS) demonstration projects are in operation or under construction, progress is far too slow to achieve the widespread commercial deployment envisioned …\”
 
Smarter electrical grids. Smart grids can operate in a number of ways. They can allow charging higher prices at times of peak loads, to encourage shifting demand. They can be programmed so that heating or cooling can be automatically adjusted when demand is especially high. They are going to be a necessity if the electrical grid is to be based on a wider range of energy sources, some of which may vary with sun and wind.



Those who express concern over consequences of high energy use–from conventional pollutants to the risks of climate change to effects of price fluctuations and geopolitical issues–are sometimes a little too quick to offer a policy prescription that involves waving a magic wand of R&D spending over solar or wind or biofuels. I\’d be delighted if that magic wand actually produced a commercially viable and vast source of clean energy, and maybe it will. But in the meantime, sensible policy-makers need to focus on cobbling together a range of less glamorous but perhaps more practical alternatives.

If skill level is so important in the U.S. economy, then why are the share of low-skilled jobs in labor force rising? The answer lies with the phenomenon of job \”polarization,\” a decades-long pattern in which the share of of medium-skill jobs is falling, while the share of both high-skill and low-skill jobs is rising. Didem Tüzemen and Jonathan Willis examine some aspects of this phenomenon in \”The Vanishing Middle:Job Polarization and Workers’ Response to the Decline in Middle-Skill Jobs,\” published in the First Quarter 2013 issue of the Economic Review from the Federal Reserve Bank of Kansas City.

Tüzemen and Willis describe the underlying dynamics in this way. Workers in high-skill occupations \”are typically highly educated and can perform tasks requiring anallytical ability, problem solving, and creativity. They work at managerial,professional, and technical occupations, such as engineering, finance,management, and medicine.\” In contrast, workers in low-skill occupations, typically have no

Of course, the polarized labor market also means a more polarized income distribution. Intriguingly, they offer a chart of median wages that suggests that it isn\’t the pay of those at different skill levels that has diverged, but rather the number of people working at jobs at these skill levels.

The authors document a number of patterns about job polarization in the last three decades. For example:

\”Given the sharp decline in manufacturing employment in the past three decades, this sector might appear to have been the main driver of job polarization. However, empirical evidence reveals that job polarization has been primarily due to shifts in the skill-composition of jobs within sectors as opposed to the shifts in employment between sectors in the economy. All sectors have experienced declines in the within-sector share of workers in middle-skill jobs. …  This distinction is important for labor market policy as it suggests that the impact of job polarization has been widespread across the economy rather than concentrated in a single sector, such as manufacturing. …\”

\”Job polarization has affected male and female workers differently. In response to the decline in the employment share of middle-skill occupations, employment of women has skewed toward high-skill occupations, while employment of men has shifted proportionally toward low- and high-skill occupations. …\”

\”From 1983 to 2012, the employment share of workers age 55 and older in high-skill occupations increased. This shift was related to the aging of the labor force and the delay in retirement of workers in higest demand – those with higher levels of education. In contrast, among workers ages 16 to 24 the largest increase was in the employment share of workers in low-skill occupations. Compared to the 1980s, younger people have been staying in school longer and postponing their entry into the labor force. These developments have shifted the composition of workers in the labor force and suggest that the retirement of the baby boom workers over the next decade may reduce the supply of highly-skilled workers.\”