Year: 2013

In the world of economic theory, and sometimes in the minds of employees, the chief executive officer of a company is an all-seeing, all-knowing planner with a ruthless eye on the bottom line. However, it appears that the average CEO has a typical career trajectory: spend a few years cleaning up the past investment mistakes of the firm, then start expanding the firm\’s investments again, and finish off by over-expanding–so that the next income CEO has a bunch of investment mistakes to clean up, and the cycle can start anew. Yihui Pan, Tracy Yue Wang, and Michael S. Weisbach provide the evidence in \”CEO Investment Cycles,\” which was published as national Bureau of Economic Research Working Paper #19330. NBER working papers are not freely available online, although some readers will have access through library subscriptions, but a readable summary of the paper is available here.

Pan, Wang, and Weisbach collect data on 5,420 CEOs who took office in 2,991 publicly traded US firms between 1980 and 2009. They gather data on whether a departing CEO does so for reasons of age or health, or under some particular pressure. They also have data on whether the CEO is hired from inside or outside the firm. They don\’t look at the profits reported by firms, in part because profit data is at least as much an outcome of past decisions rather than current ones, and in part because profit data is often so massaged by corporate tax attorneys that it actual economic meaning can be unclear. Instead, they look at the annual patterns of investment by firms.

\”We estimate the magnitude of the CEO cycle in terms of the differences in disinvestment, investment, and firm growth, between the first three years of a CEO’s tenure and the later years, holding other factors constant. The magnitude of the changes in firm investment and growth over the CEO cycle is substantial. For example, the annual investment rate (investment-to-capital-stock ratio) tends to be 6 to 8 percentage points lower and the asset growth rate tends to be 3.2 percentage points lower in the first three years of a CEO’s tenure than in his later years in office. Given that the median investment rate in our sample is 24% and the median asset growth rate is 7.6%, the differences in investment and growth between the earlier and the later parts of the CEO cycle are clearly non-trivial. The effect of CEO cycle on investment is also of the same order of magnitude as the effects of other factors known to influence investment such as the business cycle, political uncertainty, and financial constraints.\”

Their preferred explanation is that when CEOs are first appointed, they are under pressure from the board of directors to be the ruthless profit-seekers of legend. But over time, as the CEO appoints more members of the board of directors, the CEO feels less of this pressure and has a tendency to over-invest.

\”First, when a CEO takes office, he will have incentives to divest poorly performing assets that the previous CEO established and was unwilling to abandon. Second, for many reasons, CEOs usually prefer their firms to grow, potentially at the expense of shareholder value maximization. The board of directors is an important constraint on CEOs’ ability to deviate from the shareholders’ interest. However, as the CEO becomes more powerful in the firm over time, he will have more sway over his board and will be able to undertake investments that maximize his utility, potentially at the expense of value. Eventually, when the CEO steps down, the process is repeated by the next CEO. … We measure the CEO’s capture of the board by the fraction of the board that is appointed during his tenure, and find that the increasing CEO influence on the board over his tenure explains the positive relation between CEO tenure and investment. … In addition, we find that the quality of a firm’s investments, measured by the market reaction to acquisition announcements, decreases with CEO tenure and becomes negative during the later portion of his time in office. The deteriorating investment quality is also related to the CEO’s control of the board.\”

They also seek to evaluate some of the possible alternative explanations. But they find, for example that this pattern holds even when the turnover of the CEO is due to death, illness, or retirement–and thus it just that boards fire CEOs who aren\’t performing well. They also find this effect both for CEOs hired from inside and from outside the firm, and for firms where the industry is being hit by big positive or negative surprises.

To me, the analysis makes CEOs sound a bit like coaches of sports teams: they arrive to clean up the mistakes of the past regime, but over time many of them gradually drift into their own set of mistakes. It also suggests that firms should think seriously about the independence of their boards of directors and about rotating the CEO on a semi-regular basis. One suspects that the cozy relationships between CEOs and the directors they have appointed is not just manifested in the firm\’s investment choices, but may well show up in executive compensation and other firm decisions, too.

To calculate a worldwide measure of income inequality, you need to work with data on the distribution of income for the population in every country–and for many countries, this data is mismatched and helter-skelter. You need to convert the income data for all countries into a common currency, like U.S. dollars.  You then add up all the people in the world who fall into each income category. To do comparisons over time, you need to find data for different countries over time, and then also adjust for inflation. Christoph Lakner and Branko Milanovic of the World Bank take on this task in \”Global Income Distribution From the Fall of the Berlin Wall to the Great Recession,\” published this month as Policy Research Working Paper 6719.

Here\’s how the global distribution of income has shifted over time. It used to be said back in the 1960s that the global distribution of income was bi-modal–that is, it had one hump representing the large number of people who were very low-income and then a smaller hump representing those in the high-income countries. In the blue line for the global distribution of income 1988, the remnants of that bimodal distribution are still visible. But over time, the highest point in the income distribution is shifting to the right, and by 2008, the world has moved fairly close to having a unimodal or one-hump distribution of income.

An obvious question here is to what extent these changes are about what has happened in China and in India, which after all combine to include about one-third of the world\’s population. Here\’s a figure showing the shifts over time, with the population of India and China  shaded separately. You can see that the shift in the shape of the global income distribution an largely be traced to India and China. In particular, you can see that the hump to China is pretty much centered over the hump for India in 1988 and 1993, but by 2008, the hump for China is now shifting to the right more than the hump for India, reflecting China\’s faster rate of economic growth.

One final thought: In interpreting these charts, it\’s important to remember that the horizontal axis measures income on a logarithmic graph. That is, instead of each horizontal distance representing the same absolute gain in income, it represents the same proportional gain income. Starting from the left, the horizontal distance from $50 to $100 is the same as the distance from $100 to $200, which is the same as the distance from $200 to $400, or if you look off to the right, the sqame as the distance from $10K to $20K. In other words, relatively small movements to the right on this graph represent large changes in absolute value of incomes, especially as you get to the center and far-right of the graph.

Note: Hat tip to Howard Schneider at the Washington Post Wonkblog, where I saw the Lakner-Milanovic working paper mentioned.

Back in the late 1970s, when I was first shaking hands with economics, the standard dividing line in macroeconomics was phrased as “monetarists” vs. “Keynesians.” But that distinction was already becoming obsolete. Robert Hall stakes a claim to rephrasing the main dividing line in macroeconomics back in 1976 a way that has largely stood the test of time, as between “freshwater” and “saltwater” macroeconomists. As Hall wrote at the time:

“As a gross oversimplification, current thought can be divided into two schools. The fresh water view holds that fluctuations are largely attributable to supply shifts and that the government is essentially incapable of affecting the level of economic activity. The salt water view holds shifts in demand responsible for fluctuations and thinks government policies (at least monetary policy) is capable of affecting demand. Needless to say, individual contributors vary across a spectrum of salinity.”

In a footnote, Hall offers a few examples which will give a smile to academic economists, if no one else:

“To take a few examples, [Thomas] Sargent corresponds to distilled water, [Robert] Lucas to Lake Michigan, [Martin] Feldstein to the Charles River above the dam, [Franco] Modigliani to the Charles below the dam, and [Arthur] Okun to the Salton Sea.”

For those not up on their southern California geography, the Salton Sea is the largest lake in California. It is formed by the occasional long-ago overflow of the Colorado River, but it has no natural outlet–except for evaporation. Thus, as various kinds of salinity wash through the soil and into the Salton Sea, its salinity kept rising, making it saltier than the ocean.

As Hall points out, the old-style differentiation between monetarists and Keynesians was based on views about the effects of monetary and fiscal policy. Keynesians back in the 1950s typically believed that the supply of money and credit was not an important factor in determining the business cycle. Monetarists like Milton Friedman argued that it was. By the mid-1970s, the monetarists had won that argument and Keynesian thinking of that time often discussed both fiscal and monetary policies. As Hall wrote in 1976: “The old division between monetarists and Keynesians is no longer relevant, as an important element of fresh-water doctrine is the proposition that monetary policy has no real effect. What used to be the standard monetarist view is now middle-of-the-road, and is widely represented, for example, in Cambridge, Massachusetts.”

At a more detailed level, Hall attributed much of the difference between the freshwater and saltwater macroeconomists to their views on expectations. In the freshwater view of that time, it was typically argued that economic actors had excellent foresight about the future effects of various policies–what is often called “rational expectations.” In certain economic models with rational expectations, adjusting the money supply has no effect, because all economic actors can see what is happening and adjust all prices and wages accordingly. As Hall wrote in 1976: “By now, everyone more than a few yards from the ocean’s edge bows in the direction of rational expectations.”

But how much rationality was really likely? As Hall drily noted, some of the models seemed to presume that all economic actors had rationality “[e]qual to that of an MIT Ph.D. in economics with 9 years of professional experience.” But even at that time, economists were experimenting with other perspectives on macroeconomic behavior. Some economists used information lags, in which people might take time to develop their rational expectations. Others thought about “adaptive expectations,” in which people looked backward at what had  happened, but didn’t make forward-looking predictions in the way that true rational expectations would require. Still others looked at reasons why prices or wages might not adjust, with a particular focus on contracts or other kinds of “sticky prices,” which would later grow into a “New Keynesian” saltwater view of the economy.  As Hall wrote: “Macroeconomists of more brackish persuasions are skeptical of the explanatory value of information lags, and have developed a major alternative within the framework of rational economic behavior. The basic idea is that buyers and sellers of labor services rationally enter into contracts that fix the wage in money terms for some time into the future.”

There was a time, not all that long ago back in the mid-2000s, when a number of economists thought that they had successfully put together a consensus macroeconomic model. It built on the freshwater ideas that macroeconomic models should be built on microeconomic behavior and the important of expectations of individual agents, while still allowing for the possibility of saltwater ideas like the stickiness of prices, the economic losses from recessions, and a role for government policy in ameliorating recessions.  For one explanation of these efforts at building a consensus model, see the article by Jordi Galí and Mark Gertler in the Fall 2007 issue of the Journal of Economic Perspectives,  “Macroeconomic Modeling for Monetary Policy Evaluation.” Just to be clear, a shared model doesn’t mean that macroeconomists would all agree. It means that economists with differing perspectives can use the same overall structure for analysis and argue about whether certain parameters have high or low values. This focuses the intellectual disputes in a useful way. But this consensus model, like pretty much all existing macroeconomic models, failed the test of providing a useful framework for understanding the Great Recession. The freshwater and saltwater camps separated again.

Here is one quibble with what Hall wrote back in 1976.  He argued: “As I see it, the major distinguishing feature of macroeconomics is its concern with fluctuations in real output and unemployment. The two burning questions of macroeconomics are: Why does the economy undergo recessions and booms? What effect does conscious government policy have in offsetting these fluctuations?” At the time when Hall was writing, this statement seemed accurate to me. The very idea of macroeconomics as a distinctive field grew out of that extraordinary recession called the Great Depression, and in the following decades up to the mid-1970s, the concern over economic fluctuations largely defined the field of macroeconomics.

But although this change wasn’t yet visible in 1976 when Hall was writing, the U.S. economy had just entered a lengthy period of productivity slowdown. We were in the process of witnessing a period of enormous economic catch-up from Japan, soon to be followed by Korea and other nations of East Asia, and now in turn being echoed by rapid growth in China, India, and other emerging economies. Looking ahead, the U.S. economy faces challenges about whether it can return to and sustain a strong rate of growth into the future. In the aftermath of the Great Recession, many of the old arguments about causes of business cycles and policies for ameliorating them have obvious relevance.  But to me, macroeconomics should also be about the long-term patterns of economic growth.

Life expectancies are rising, but how healthy will people be in those additional years of life? The debate over \”compression of morbidity\” asks whether people who live longer will experience more years of illness, or the same number of years of illness, or even fewer year of illness. Of course, if people experience fewer years of illness before death, it would have enormous social effects, including lower spending on health care and long-term care services for the elderly, as well as a greater ability of the elderly to participate actively in their families, their communities, and the workforce. There\’s some evidence that compression of morbidity is in fact occurring.

David Cutler, Kaushik Ghosh, and Mary Beth Landrum report \”Evidence for Significant Compression of Morbidity in the Elderly U.S. Population\” in National Bureau of Economic Research  Working Paper #19268. (NBER working papers aren\’t freely available, although many readers will be able to access them through library subscriptions. However, a short readable summary of the paper is available here.) They use data from the Medicare Current Beneficiary Survey going back to 1991 and look at various measures of morbidity: certain diseases, whether the person reports limits on activities of daily living, and 19 measures of functioning that can be affected by health. They summarize their results like this:

\”Health status in the year or two just prior to death has been relatively constant over time; in contrast, health measured three or more years before death has improved measurably. … We show that disability-free life expectancy is increasing over time, while disabled life expectancy is falling. For a typical person aged 65, life expectancy increased by 0.7 years between 1992 and 2005. Disability-free life expectancy increased by 1.6 years; disabled life expectancy fell by 0.9 years. The reduction in disabled life expectancy and increase in disability-free life expectancy is true for both genders and for non-whites as well as whites. Hence, morbidity is being compressed into the period just before death.\”

Here\’s an illustration of one of their findings. The solid blue line shows the rate of Activities of Daily Living (ADLs) and Instrumental Activities of Daily Living (IADLs) for the entire group. ADLs include basic activities like feeding and dressing yourself, or going to the bathroom. IADLs include broader functioning activities like grocery shopping, housework, and phone calls. The top two lines show that the proportion of Medicare beneficiaries who turn out to be within a year or two of death have reporting these disabilities at pretty much the same rate over time. But Medicare beneficiaries who are further from death are reporting these disabilities at a lower rate. The same morbidity in the couple of years before death, but lower morbidity for those further from death, means that compression of morbidity is occuring.  

In December 1938, one of the most eminent economists of the time, Alvin E. Hansen, delivered the Presidential Address, titled \”Economic Progress and Declining Population Growth,\” at the annual meetings of the American Economic Association. Looking at the economy of the late 1930s, Hansen wrote:\”This is the essence of secular stagnation–sick recoveries which die in their infancy and depressions which feed on themselves and leave a hard and seemingly immovable core of unemployment.\” The idea of \”secular stagnation\” has received considerable attention in the last month after it was involved in a talk given by Larry Summers at an IMF conference as a framework for thinking about the discomfiting state of the economic recovery. A round-up of some commentary and responses to the Summers talk is available here. In this post, I\’ll sketch out what Hansen actually said, give a sense of why the \”secular stagnation\” hypothesis was widely disregarded in recent decades, and suggest how I see the modern lessons.

(Note: Hansen\’s speech was published in the American Economic Review in March 1939. The AER isn\’t freely available on-line, but many readers will have access through a library subscription to JSTOR or through their own membership in the American Economic Association. Full disclosure: I have worked since 1986 as the Managing Editor of the Journal of Economic Perspectives, which is another journal published by the AEA.)

Hansen argued that an economy needed strong and healthy levels of investment if it was to maintain full employment. He wrote: \”For it is an indisputable fact that the prevailing economic system has never been able to reach reasonably full employment or the attainment of its currently realizable real income without making large investment expenditures.\”

Hansen listed three factors that he thought had been especially important in encouraging the needed levels of investment in earlier decades of U.S. history: \”[F]or our purpose we may say that the constituent elements of economic progress are (a) inventions, (b) the discovery and development of new territory and new resources, and (c) the growth of population. Each of these in turn, severally and in combination, has opened investment outlets and caused a rapid growth of capital
formation.\” Hansen pointed out that population growth had slowed down and that US territory was no longer expanding. Thus, he argued: \”We are thus rapidly entering a world in which we must fall back upon a more rapid advance of technology than in the past if we are to find private investment
opportunities adequate to maintain full employment. … It is my growing conviction that the combined effect of the decline in population growth, together with the failure of any really important innovations of a magnitude sufficient to absorb large capital outlays, weighs very heavily as an explanation for the failure of the recent recovery to reach full employment.\”

Indeed, Hansen argued that in some cases, new technologies might even lead to less need for invention: \”Moreover it is possible that capital-saving inventions may cause capital formation in many industries to lag behind the increase in output.\” In a modern context, one can imagine certain ways in which the growth of information technology makes capital investment more effective and efficient–and thus reduces the need for certain other kinds of investment spending.

Further, Hansen was skeptical about whether either monetary or fiscal policy could provide a long-lasting answer. He was skeptical that lower interest rates could encourage the large and vigorous investment levels that he felt were needed: \”Less agreement can be claimed for the role played by the rate of interest on the volume of investment. Yet few there are who believe that in a period of investment stagnation an abundance of loanable funds at low rates of interest is alone adequate to produce a vigorous flow of real investment. I am increasingly impressed with the analysis made by Wicksell who stressed the prospective rate of profit on new investment as the active, dominant, and controlling factor, and who viewed the rate of interest as a passive factor, lagging behind the profit rate. This view is moreover in accord with competent business judgment. … I venture to assert that the role of the rate of interest as a determinant of investment has occupied a place larger than it deserves in our thinking. If this be granted, we are forced to regard the factors which underlie economic progress as the dominant determinants of investment and employment.\”

Hansen also considered the possibility of what we would today call expansionary fiscal policy: tax cuts and increased government spending, especially on infrastructure. While he cautiously favored such steps, he also worried that continual rises in government debt were troublesome, too. \”Consumption may be strengthened by the relief from taxes which drain off a stream of income which otherwise would flow into consumption channels. Public investment may usefully be made in human and natural resources and in consumers\’ capital goods of a collective character designed to serve the physical, recreational and cultural needs of the community as a whole. But we cannot afford to be blind to the unmistakable fact that a solution along these lines raises serious problems of economic workability and political administration. … Public spending is the easiest of all recovery methods, and therein lies its danger. If it is carried too far, we neglect to attack those specific
maladjustments without the removal of which we cannot attain a workable cost-price structure, and therefore we fail to achieve the otherwise available flow of private investment.\” 

Thus, a short summary of Hansen\’s theme was that a healthy full-employment economy needs strong profit-oriented incentives for investment spending, and  because he was not confident that the economy of his time could produce such incentives, secular stagnation was the result.
When we look back at Hansen\’s speech of late 1938, we see the issues of his time a little differently. Of course, Hansen does not have access to the luxuries of 20:20 historical hindsight and modern economic statistics. For example, Hansen discusses a slowdown in population growth, which was certainly a fair reading of the trends at that time, but completely missed that US fertility rates were about to take off less than a decade later at the start of what we call the \”baby boom.\” 

Hansen was concerned that technological progress had slowed in the 1930s, and that the age of new inventions driving forward the economy was over. In retrospect, the notion that technological innovation stopped in the 1930s seems clearly incorrect. Indeed, Alexander Field makes a very plausible case in his 2012 book, A Great Leap Forward: 1930s Depression and U.S. Economic Growth, that the 1930s experienced a great deal of technological growth. At a macro level, Field points out that essentially the same number of people were employed in 1941 as in 1929, using what seems to be the same value of capital stock, and yet real output was one-third or more higher in 1941 than in 1929–implying substantial productivity growth even with the period of the Great Depression taken into account. If one just looks from 1933 to 1941, real U.S. GDP gained 90% over those eight years. At the micro level, Field points to high and rising R&D investment during the 1930s, dramatic improvements in roads and rail, and a long list of technological improvements in areas like chemicals, electricity generation, cars, planes, and many more. Here\’s an readable interview with Field laying out his views.

In contrast, Hansen seemed to perceive the later 1930s as nothing but the long aftermath of the the Great Depression. But current dating of business cycles suggests that that the Great Depression ended in March 1933. After a few years of fairly vigorous recovery, the Federal Reserve, chasing a premonition of a shadow of a ghost of possible inflation that no one else could see, decided to raise interest rates, triggering a severe recession starting in May 1937 that lasted through June 1938. Field and others have argued that the U.S. economy was on a strong and healthy path of recovery before and after the Fed-induced recession of 1937-38. By the late 1960s, when unemployment was less than 5% from March 1965 through June 1970, the idea that the U.S. economy was necssarily trapped in secular stagnation looked plain unrealistic. 

Yet here we are in late 2013, more than four years after the Great Recession technically ended in mid-2009, but without a real resurgence of catch-up economic growth that has followed other recessions. We also have the disturbing example of Japan\’s economy, which suffered a financial crisis and melt-down in real estate prices back in the early 1990s, and has now been stuck in slow growth for more than two decades. Hansen\’s spirit would surely point out that a surge of population growth or an expansion of territory are unlikely. Thus, much turns on investment spending. 

Here\’s a figure generated by the ever-useful FRED website maintained by the St. Louis Fed. It shows Gross Private Domestic Investment (GDPI) divided by GDP. Investment often drops during recessions, and sometimes between recessions, but the investment drop during the Great Recession was especially severe, and the bounceback even to usual levels is not yet complete. Moreover, the investment surge of the mid-2000s was largely in residential real estate, and whatever the other virtues of such investments, additional houses don\’t do much to raise future rates of productivity growth. 



From Hansen\’s secular stagnation point of view, the key problem of the U.S. economy is how to make it more likely that firms will invest heavily in expectation of large profit opportunities. This perspective doesn\’t rule out using monetary or fiscal policy to stimulate the economy in the short run, but neither does it see these as long-term answers. Such an economy would of course rely on strong government support of R&D spending and educational achievement. It would also be an economy where a large share of profits flowing to the financial sector would be troubling, because it suggests that nonfinancial firms are not perceiving profitable opportunities for real investments in plant, equipment and technology. It\’s an economy where we would think seriously about finding ways to ease the tax and regulatory burdens on investment. Here are some words from Hansen\’s 1938 speech that ring true to me today:

\”The problem of our generation is, above all, the problem of inadequate private investment outlets. What we need is not a slowing down in the progress of science and technology, but rather an acceleration of that rate. Of first-rate importance is the development of new industries. There is certainly no basis for the assumption that these are a thing of the past. But there is equally no basis for the assumption that we can take for granted the rapid emergence of new industries as rich in investment opportunities as the railroad, or more recently the automobile, together with all the related developments, including the construction of public roads, to which it gave rise. Nor is there any basis, either in history or in theory, for the assumption that the rise of new industries proceeds inevitably at a uniform pace. The growth of modern industry has not come in terms of millions of small increments of change giving rise to a smooth and even development. Characteristically it has come by gigantic leaps and bounds. Very often the change can best be described as discontinuous, lumpy, and jerky … And when giant new industries have spent their force, it may take a long time before something else of equal magnitude emerges. … [A] vigorous recovery is not just spontaneously born from the womb of the preceding depression. Some small recovery must indeed arise sooner or later merely because of the growing need for capital replacement. But a full-fledged recovery calls for something more than the mere expenditure of depreciation allowances. It requires a large outlay on new investment, and this awaits the development of great new industries and new techniques. But such new developments are not currently available in adequate volume …\” 

I worry that the current U.S. economic policy agenda is all about fiscal and monetary policy, along with financial regulation and health insurance. I hear relatively little discussion focused directly on an agenda for creating a supportive environment for private domestic investment.

The U.S. unemployment rate has been dropping, from its peak of 10% in October 2009 to 7% in November 2013. But the labor force participation rate–that is, the share of U.S. adults who either have jobs or are actively looking for jobs–has also been dropping. It was 66.4% in January 2007 before the start of the recession, and has now fallen to 63%. Thus, is the fall of three percentage points in the unemployment rate really showing that roughly three percentage points of adults have become so discouraged by the dismal labor market prospects of the last few years that they have stopped looking for work?  Shigeru Fujita offers some facts and trends in \”On the Causes of Declines in the Labor Force Participation Rate,\” a \”Research Rap\” from the Federal Reserve Bank of Philadelphia.

To orient oneself among the arguments here, consider this graph showing the unemployment rate and the labor force participation rate since 1995. The fact that both have decline in the last few years is apparent on the right-hand side of the graph. But what is also apparent is that the decline in the labor force participation rate seems to speed up in the aftermath of the Great Recession, but it actually started back in the late 1990s.

Just to be clear about these concepts, measures of unemployment always have some fuzziness because it\’s necessary to separate out those who lack jobs and want jobs from those who lack jobs and aren\’t looking for a job. In some cases this distinction is quite clear: a happy 75 year-old retiree who isn\’t looking for work, or someone who is choosing to be a stay-at-home parent, is clearly out of the labor force. But in other cases, the distinction can be fuzzy. Maybe someone decides to retire a year or two earlier than expected, or to apply for disability payments, or just to stop looking for a job, because the job market in their area looks so dismal. The person would then not be technically counted as \”unemployed,\” but only \”out of the labor market.\” However, their choices were clearly shaped by the poor labor market.

What\’s the evidence on why adults are not participating in the labor market, and how it has changed over time? This figure shows that retirement doesn\’t account for a lower rate of labor force participation up to about 2010,when it starts rising. Disability has been accounting for a highe rate of labor force participation since the late 1990s, as has \”other.\”

The \”other\” can include a lot of  possibilities, from a contented stay-at-home parent, to someone with health or transportation problems, or someone who has become too discouraged by the poor labor market even to look for work. But one way to divide up the \”other\” category is to ask them whether they want a job. The figure shows that the share of those in the \”other\” category who want a job is mostly declining from 1995 to the start of the recession in late 2007, and bumps up only slightly after that.

So what conclusions can be drawn from this?

1) If one looks back at the drop in labor force participation rates from 1995 to the present, the main factors during most of that period are the rise in the \”other\” category that isn\’t looking for work–which presumably is not a public policy problem–and the rise in disability claims. I\’ve posted fairly recently with some thoughts on the \”The Disability-Industrial Complex\” (October 23, 2013).

2) If one focuses on just the recent drop in the labor force participation rate, only a modest share can be accounted for by those who are out of the labor force but say they want a job. Fujita writes: \”[I]t is true that there were more discouraged workers during the post-Great Recession period than before the recession (roughly 0.5 percentage point more in terms of the working age-population). However, the size of this group has been roughly flat since 2011. In this sense, it is misleading to attribute the decline in the unemployment rate in the last few years to discouragement.\”

3) It\’s not obvious how to think about the interaction between more retirees and the falling labor force participation rate. Fujita writes: \”[T]he decline in the [labor force] participation rate since the beginning of 2012 is entirely due to retirement.\” Surely, some of these retirees are premature, in the sense that the people would have preferred to work a few more years but couldn\’t find jobs. On the other hand, the \”Baby Boom\” generation started right after World War II, and as members of that generation reach their mid-60s, it\’s been obvious for a long time that labor force participation rates were likely to fall starting around 2010 or so.

The bottom line, as I see it, is that the drop in the unemployment rate is not just a smokescreen for a labor market that hasn\’t really improved since 2008. Relatively few of those who are retired, disabled, or too discouraged to seek a job are likely to return to the labor force. Instead, most of the drop in the unemployment rate in the last few years is a meaningful indicator that the U.S. economy is gradually improving and returning to health.

Homelessness in America has apparently declined in the last few years despite the effects of the Great Recession. This unexpectedly welcome news is from the annual Point-in-Time survey of homeless carried out by Abt Associates for the U.S. Department of Housing and Urban Development, and reported in  \”The 2013  Annual Homeless  Assessment  Report (AHAR)  to Congress.\” A national survey of homeless across the country is conducted for a single night in late January. Here\’s one figure summarizing the results:

The report includes lots more detail of the survey results: for example, nearly one out of every five homeless people are either in Los Angeles or New York. About one-third of the homeless are children About 109,000 of the homeless are classified as \”chronically\” homeless.

But the survey results raise an obvious puzzle. The number of \”sheltered\” homeless people is essentially the same in 2007 as in 2013. All of the decline is in the category of \”unsheltered\” homeless people. It seems obvious that when the Great Recession hit in late 2007, one should see a substantial rise in homelessness, whether sheltered or unsheltered. The report carefully points to a 2010 \”Federal Strategic Plan to Prevent and End Homeless\” called \”Opening Doors.\” The date of this report is why the year 2010 is shaded in the figure above. But the survey data clearly shows a large change in the \”unsheltered\” homeless before the 2010 plan in 2008 and 2009, in the worst of the Great Recession, before the 2010 plan took effect.

The fact that homelessness has substantially declined does not seem especially controversial. For example, here\’s a chart from the National Alliance to End Homelessness in its April 2013 report, \”The State of Homelessness in America 2013.\” The report uses data from a variety of government sources, including the HUD data, and thus is similar but not identical to the previous report.

This graph shows that if one projects back just a little further, there is a substantial decline in homelessness from 2006-2007. (The AHAR report for 2009 shows the decline from 2006 to 2007, but annual reports since then start with 2007, which seems to me a dubious practice.)

Why has homelessness declines? Of course, it\’s easy enough to make up stories about how the survey might have been done differently over time, or about how the focus on a single night in January might lead to variability in the survey results depending on weather conditions and other factors. But the year-to-year survey results aren\’t showing a lot of variability, and advocacy groups like the National Alliance to End Homelessness are not arguing that the official statistics are misleading or incorrect.

Instead, a more common argument seems to be that policies to reduce homeless have been effective. For example, the drop in homelessness after 2006 has been attributed to a Bush administration \”housing first\” policy that focused on getting the homeless into housing first, and then seeking to address their addiction or health problems. The 2009 fiscal stimulus bill included a $1.5 billion Homelessness Prevention and Rapid Re-Housing Program. Various other government programs to assist those with low incomes, as well as a greater willingness of those with low incomes to \”double up\” in housing, have made a difference, too. Here\’s a figure from the National Alliance to End Homelessness report:

Notice in particular that the number of poor adults accessing safety net resources went way up during the Great Recession, as one might expect. The dark blue line showing the number of \”People Living Doubled Up\” also rises dramatically. Both of these factors have likely helped to hold down the rise in homelessness, too. All this said, it still strikes me as quite remarkable that the number of homeless did not rise much more substantially during the Great Recession and its aftermath.

International portfolio investment is sometimes called \”hot money.\” In contrast with foreign direct investment, where a foreign investor takes some management responsibility for ownership, portfolio investment is a purely financial transaction that can be expanded or liquidated quickly. The IMF publishes the results of its annual Coordinated Portfolio Investment Survey each November. There\’s no big report to accompany this data, but there are summary tables and, if you like, you can easily generate specific tables for different countries in various years back to 1997.

Here\’s an overview of the top players in international portfolio flows.  International holdings of portfolio investment were about $43 trillion in 2012. Just to be clear, this represents international holdings of stock and debt. It doesn\’t include other international financial flows like bank loans, central banks holding reserves, or foreign direct investment.

When I look over this table, part of what catches my eye is the identify of who is listed in the rows and columns–and who is not listed.

For example, it\’s no big surprise that the U.S. economy both receives by far the largest amount of portfolio investment and also sends both the largest amount. The financial sector offers a potentially promising for the U.S. economy in the globalizing world economy, because it combines the sheer size of the domestic US financial markets with a set of legal and regulatory institutions and private-sector expertise concerning financial markets that is open to the world.

It\’s a modest surprise to me that the United Kingdom ranks second in both portfolio investment sent and received. After all, the U.S. GDP is more than six times as large as that of the UK. This data suggests that international finance is a much more important part of the UK economy than the US economy. It\’s no surprise that Japan, as the main financial center for Asia, ranks so highly.

But then I start seeing some unexpected entries. Luxembourg has a GDP of about $57 billion in 2012. But international portfolio investment in Luxembourg was $2.3 trillion, while international portfolio investment holdings from Luxembourg total $3 trillion. About $2 trillion of foreign portfolio investment is in the Cayman Islands, which has with a GDP of about $2 billion. Aruba, Guernsey, Isle of Man, Malta, Vanuatu, and few others also show up as places where the size of international portfolio investment vastly outstrips the size of their national economies. Clearly, these locations offer certain regulatory features (or the lack of them) that are desirable to substantial numbers of investors.

The other striking feature about this kind of table is the countries that aren\’t included. China, which now has the second-largest GDP in the world, about half the size of the U.S.,  apparently doesn\’t participate in this survey. Brazil has the 7th largest GDP in the world, Russia is 8th, and India is 10th. They aren\’t yet showing up among the top origins and destinations for foreign portfolio investment, but in the next decade or so, I suspect that they will. Here\’s a table from the World Bank showing the size of the 20 biggest economies in 2012.

In a speech earlier this week on economic mobility, President Barack Obama quoted Adam Smith in support of a higher minimum wage. Given that minimum wage laws were not a hot topic in 1776 when The Wealth of Nations was published, I went looking for context.

Here\’s the comment from the transcript of President Obama\’s speech:

[I]t’s well past the time to raise a minimum wage that in real terms right now is below where it was when Harry Truman was in office. (Applause) This shouldn’t be an ideological question. It was Adam Smith, the father of free-market economics, who once said, “They who feed, clothe, and lodge the whole body of the people should have such a share of the produce of their own labor as to be themselves tolerably well fed, clothed, and lodged.” And for those of you who don’t speak old-English — (laughter) — let me translate. It means if you work hard, you should make a decent living.

The quotation appears in Book I, Chapter 8, of The Wealth of Nations. I quote here from the ever-useful version of the book at the Library of Economics and Liberty website. At no point in the chapter is Smith considering the advantages of a minimum wage; however, he points out that in the politics of the time, there were occasionally political proposals to hold wages lower. He argues that the real standard of living for common workers–that is, what a common worker can afford to buy–has been rising, in large part due to technological improvements. Obama\’s proffered quotation comes up when Smith is explaining that this increase in real wages over time should not be viewed as a cause for concern. Here\’s the full passage:

The real recompence of labour, the real quantity of the necessaries and conveniencies of life which it can procure to the labourer, has, during the course of the present century, increased perhaps in a still greater proportion than its money price. Not only grain has become somewhat cheaper, but many other things, from which the industrious poor derive an agreeable and wholesome variety of food, have become a great deal cheaper. Potatoes, for example, do not at present, through the greater part of the kingdom, cost half the price which they used to do thirty or forty years ago. The same thing may be said of turnips, carrots, cabbages; things which were formerly never raised but by the spade, but which are now commonly raised by the plough. All sort of garden stuff too has become cheaper. The greater part of the apples and even of the onions consumed in Great Britain were in the last century imported from Flanders. The great improvements in the coarser manufactures of both linen and woollen cloth furnish the labourers with cheaper and better cloathing; and those in the manufactures of the coarser metals, with cheaper and better instruments of trade, as well as with many agreeable and convenient pieces of houshold furniture. Soap, salt, candles, leather, and fermented liquors, have, indeed, become a good deal dearer; chiefly from the taxes which have been laid upon them. The quantity of these, however, which the labouring poor are under any necessity of consuming, is so very small, that the increase in their price does not compensate the diminution in that of so many other things. The common complaint that luxury extends itself even to the lowest ranks of the people, and that the labouring poor will not now be contented with the same food, cloathing and lodging which satisfied them in former times, may convince us that it is not the money price of labour only, but its real recompence, which has augumented. 

Is this improvement in the circumstances of the lower ranks of the people to be regarded as an advantage or as an inconveniency to the society? The answer seems at first sight abundantly plain. Servants, labourers and workmen of different kinds, make up the far greater part of every great political society. But what improves the circumstances of the greater part can never be regarded as an inconveniency to the whole. No society can surely be flourishing and happy, of which the far greater part of the members are poor and miserable. It is but equity, besides, that they who feed, cloath and lodge the whole body of the people, should have such a share of the produce of their own labour as to be themselves tolerably well fed, cloathed and lodged. 

With his characteristic hard-headedness, Smith is in no doubt that employers want to hold wages low, and are making continual efforts to do so.

Masters are always and every where in a sort of tacit, but constant and uniform combination, not to raise the wages of labour above their actual rate. To violate this combination is every where a most unpopular action, and a sort of reproach to a master among his neighbours and equals. We seldom, indeed, hear of this combination, because it is the usual, and one may say, the natural state of things which nobody ever hears of. 

However, Smith argues that wages for common workers are largely determined by whether the economy is in a \”progressive\” state of expanding, a stationary state, or a declining state.

It deserves to be remarked, perhaps, that it is in the progressive state, while the society is advancing to the further acquisition, rather than when it has acquired its full complement of riches, that the condition of the labouring poor, of the great body of the people, seems to be the happiest and the most comfortable. It is hard in the stationary, and miserable in the declining state. The progressive state is in reality the cheerful and the hearty state to all the different orders of the society. The stationary is dull; the declining melancholy.

Smith grapples here with a difficult question for his time. England was richer than the North American settlements at this time, but wages for common workers  (measured in terms of what they could buy) were much higher in North America. Thus, Smith formulates an argument that when an economy is rapidly expanding, common workers are better off, but if an economy has slow growth–even if that economy has high overall per capita income–then wages for common workers will be flat or even declining.  Smith writes:

It is not, accordingly, in the richest countries, but in the most thriving, or in those which are growing rich the fastest, that the wages of labour are highest. England is certainly, in the present times, a much richer country than any part of North America. The wages of labour, however, are much higher in North America than in any part of England. In the province of New York, common labourers earn three shillings and sixpence currency, equal to two shillings sterling, a day; ship carpenters, ten shillings and sixpence currency, with a pint of rum worth sixpence sterling, equal in all to six shillings and sixpence sterling; house carpenters and bricklayers, eight shillings currency, equal to four shillings and sixpence sterling; journeymen taylors, five shillings currency, equal to about two shillings and ten pence sterling. These prices are all above the London price; and wages are said to be as high in the other colonies as in New York. The price of provisions is every where in North America much lower than in England. A dearth has never been known there. In the worst seasons, they have always had a sufficiency for themselves, though less for exportation. If the money price of labour, therefore, be higher than it is any where in the mother country, its real price, the real command of the necessaries and conveniencies of life which it conveys to the labourer, must be higher in a still greater proportion. 

 But though North America is not yet so rich as England, it is much more thriving, and advancing with much greater rapidity to the further acquisition of riches. The most decisive mark of the prosperity of any country is the increase of the number of its inhabitants. In Great Britain, and most other European countries, they are not supposed to double in less than five hundred years. In the British colonies in North America, it has been found, that they double in twenty or five-and-twenty years. Nor in the present times is this increase principally owing to the continual importation of new inhabitants, but to the great multiplication of the species. Those who live to old age, it is said, frequently see there from fifty to a hundred, and sometimes many more, descendants from their own body. Labour is there so well rewarded that a numerous family of children, instead of being a burthen is a source of opulence and prosperity to the parents. The labour of each child, before it can leave their house, is computed to be worth a hundred pounds clear gain to them. A young widow with four or five young children, who, among the middling or inferior ranks of people in Europe, would have so little chance for a second husband, is there frequently courted as a sort of fortune. The value of children is the greatest of all encouragements to marriage. We cannot, therefore, wonder that the people in North America should generally marry very young. Notwithstanding the great increase occasioned by such early marriages, there is a continual complaint of the scarcity of hands in North America. The demand for labourers, the funds destined for maintaining them, increase, it seems, still faster than they can find labourers to employ. 

Smith\’s argument is that in a stationary economy, even a stationary economy with high per capita income on average, the demand for common workers won\’t be strong, and even may fall because employers have already hired all the lower-class workmen that they need. He raises the possibility that there might be \”a country where the funds destined for the maintenance of labour were sensibly decaying\”–what we would in modern times refer to as labor\’s declining share of total income. Smith explains:

\”Though the wealth of a country should be very great, yet if it has been long stationary, we must not expect to find the wages of labour very high in it. The funds destined for the payment of wages, the revenue and stock of its inhabitants, may be of the greatest extent; but if they have continued for several centuries of the same, or very nearly of the same extent, the number of labourers employed every year could easily supply, and even more than supply, the number wanted the following year. There could seldom be any scarcity of hands, nor could the masters be obliged to bid against one another in order to get them. The hands, on the contrary, would, in this case, naturally multiply beyond their employment. There would be a constant scarcity of employment, and the labourers would be obliged to bid against one another in order to get it. …\”

There is always an embarrassingly high risk of anachronism when applying eighteenth-century writing to modern policy arguments. After all, Adam Smith was writing before the start of the Industrial Revolution and the two centuries of transformative economic growth that have followed, and he was writing before the development of arguments about how wages are linked to the marginal productivity of labor. But frankly, it is ridiculous to cite Adam Smith in support of minimum wage legislation. A more plausible argument, although still running a real risk of anachronism, would be that Adam Smith believed that rapid economic growth and a tight labor market–say, the situation of the U.S. economy in the mid to late 1990s–was the way to benefit ordinary workers.

For a post on minimum wages in different countries, see my May 2013 post on \”Some International Minimum Wage Comparisons.\” For a post on how the minimum wage affects employment and prices, see my February 2013 post on \”Minimum Wage and the Law of Many Margins.\”  For a post on proposals to raise the minimum wage, see my November 2012 post on\”Minimum Wage to $9.50? $9.80? $10?\” 

For those who like some facts to go with their arguments over redistribution and tax policy, the Congressional Budget Office has just published \”The Distribution of Household Income and
Federal Taxes, 2010.\” Here is some of what caught my eye.

There are several main categories of federal taxes: individual income tax, the social insurance taxes that fund Social Security and Medicare, corporate income tax (which is ultimately paid by individuals), and excise taxes on gasoline, cigarettes and alcohol. This chart shows the average tax rates paid in each category, broken down by income group.

A few observations here:

1) It\’s important to remember that this is the average rate of tax expressed as a share of income. For example, those in the top 1% are almost surely  paying the top marginal tax rate of about 40% on the top dollar earned. But when all the income taxed at a lower marginal rate is included, together with exemptions, deductions, and credits, this group pays an average of 20.1% of their income in individual income tax.

2) Average individual income taxes are negative for the bottom two quintiles. This arises because of \”refundable\” tax credits like the earned income tax credit and the child tax credit, which mean that many lower-income households not only owe zero in taxes, but receive an additional payment from the IRS.

3) In the calculations for effects of the corporation income tax, the underlying assumption is that high-income households end up paying much of the cost, because they are the ones who own most of the stock in these companies. In the calculations for excise taxes, the analysis is that low-income households pay a greater share of their income for these taxes, because they spend a greater share of their incomes on these products.

What if instead of looking at average tax rates, we look at the share of each of these taxes collected from the different groups? The table looks like this:

The top quintile pays 92.9% of all income taxes and 68.8% of all federal taxes. The top 1% pays 39% of all income taxes and 24.2% of all federal taxes.

How have federal tax rates changed over time for various income groups? It\’s true that average tax rates for the top 1% are down from the mid to late 1990s. It\’s also true that tax rates for the rest of the income distribution are lower in 2010 than back in the 1990s. From 2008 through 2010, the federal tax rate as a share of income was at its lowest level during this time period. Of course, this is due in part to people having less income and finding themselves in lower tax brackets, and in part to various tax cuts aimed at stimulating the economy.

Finally, how does the federal tax system alter the distribution of income in the United States? Here\’s a table from the report that I edited to focus on the 2010 data. You can see that in terms of before tax income, the lowest quintile had 5.1% of income before taxes, and 6.2% of income after taxes; the highest quintile had 51.9% of income before taxes, and 48.1% of income after taxes; and the top 1% had 14.9% of income before taxes, and 12.8% of all income after taxes. Because these figures are based on income, they don\’t take into account how spending programs that don\’t provide income directly to people like Medicare, Medicaid, or food stamps affect consumption levels.

I\’ll close by saying that in my experience, presenting these kinds of statistics doesn\’t really change anyone\’s mind about whether the tax system is fair or unfair, or how the tax system should be altered.  Back in 1938, Henry Simons of the University of Chicago wrote a book called Personal Income Taxation, in which he commented: \”The case for drastic progression in taxation must be rested on the case against inequality — on the ethical or aesthetic judgement that the prevailing distribution of wealth and income reveals a degree (and/or kind) of inequality which is distinctly evil or unlovely.\” Most people don\’t alter their \”ethical or aesthetic judgement\” about what is \”evil or unlovely\” based on statistical charts. But I live in hope that the presentation of facts, like water against stone, can at least erode the sharper edges of some of our political disputes.