Year: 2013

Reinhilde Veugelers investigates the patterns of worldwide research and development spending in a Policy Contribution for the European think-tank Bruegel: \”The World Innovation Landscape: Asia Rising?\”  The results are a useful reminder that thinking of China and the rest of the emerging economies as depending on low wages to drive their economic growth is so very 20th century. In this century, China in particular is staking its future economic growth on R&D spending and innovation.

As a starting point, consider snapshots of global R&D spending in 1999 and in 2009. The share of global R&D spending done by the United States, the European Union, and Japan is falling, while the share done by China, South Korea, and other emerging economies is rising.

Looking at individual countries, China has now outstripped Japan for second place in global R&D spending, and China\’s R&D spending is similar to that of Germany, France, and Italy combined. 
Veugelers looks more closely at the group of seven countries that together account for about 71% of global R&D spending. Here is how much they spend on R&D as a percentage of their economies: by this measure, the U.S. economy does not especially stand out.

Veugelers also takes a more detailed look at government and private R&D spending in these seven countries, and finds some intriguing differences in priorities. For example, more than half of all U.S. government R&D spending goes to defense, a far higher share than any of these other countries. The U.S. government also commits a larger share of its R&D budget to health. South Korea and Germany stand out for having a greater share of their government R&D focuses on industrial production and technology. And a number of countries devote a larger share of their government R&D to the \”Other\” category, which includes \”earth and space, transport, telecommunications, agriculture, education, culture, political systems.\”

In the private sector, a greater share of the U.S. private-sector R&D happens in the services sector, while the private sector in other countries focuses more of its R&D spending on machinery and equipment.

It\’s worth remembering that there\’s a lot more to innovation than just research and development spending. Yes, a nation that is the home of new innovation probably receives a disproportionate share of the gains in productivity as a result. But innovative discoveries can flow across national borders.The true economic gains from innovation are not from a discovery in a laboratory, but rather from the economic flexibility that translates the discovery into new products and jobs.

One of the puzzles and frustrations of the sluggish economy since the official end of the Great Recession in June 2009 is that U.S. firms are holding enormous amounts of cash–about $5 trillion in 2011. A considerable number of pixels have been spent wondering why corporations seem so reluctant to spend, and how we might entice them to do so. But I had not know that the trend toward corporations holding more in cash very much predates the Great Recession; indeed, it was already apparent back in the 1990s. Thus, along with thinking about why events of the last few years have led corporations to hold more cash, we should be thinking about influences over the last couple of decades.

Juan M. Sánchez and Emircan Yurdagul lay out the issues in \”Why Are Corporations Holding So Much Cash?\” written for the Regional Economist magazine published by the Federal Reserve Bank of St. Louis.  The first graph shows \”cash and short-term investments,\” which include all securities transferable to cash, going back to The second graph focuses just on nonfinancial, nonutility firms–thus leaving out banks, insurance companies, regulated power companies, and the like.There are some differences in timing, but the overall upward pattern is clear.

Of course, one reason for the rise in cash assets could just be overall growth of the economy. Thus, an alternative measure is to look at the ratio of cash to net assets of the firm. By this measure, which is probably more revealing, the growth of cash starts off around 1995, accelerates in the early 2000s, takes a step back in the Great Recession, and now has rebounded.

Broadly speaking, there are two reasons for firms to hold more cash: precautionary motives and repatriation taxes. Precautionary motives refer to the notion that firms operate in a situation of uncertainty, including uncertainty about what stresses or opportunities might arise, and whether they will be able to get a loan on favorable terms when they want it. Cash offers flexibility. The authors explain repatriation taxes this way: \”[T]axes due to the U.S. government from corporations operating abroad are determined by the difference between the taxes already paid abroad and the taxes that U.S. tax rates would imply. Importantly, such taxation only takes place when earnings are repatriated. Therefore, firms may have incentives to keep foreign earnings abroad.\” To put it a little differently, if firms are thinking that they may wish to reinvest foreign profits in foreign operations, then the tax code gives them an incentive not to repatriate those profits.

Both of these factors surely make some difference, but Sánchez and Yurdagul also seek some insight into the question by looking at which industries, and which size firms, are more likely to be increasing their cash holdings. For example, information technology firms and firms focused on tech and hardware equipment are holding noticeably more in cash, although since the end of the housing bubble, building product companies have been sitting on a lot more cash, too.

When looking by size of firm, it\’s smaller firms that hold more cash. In part, this surely reflects that smaller firms are more vulnerable to ups and downs, and less likely to be confident that they have access to a loan when they want it. But interestingly, it\’s the second-smallest quintile of firms, not the smallest, that has seen the biggest rise in cash/asset ratios.

Ultimately, these arguments made me less confident that any particular policy was going to shake loose a big share of the $5 trillion cash hoard of U.S. firms. It\’s not quite clear to me why smallish-sized tech firms feel the need to hold so much cash, but they clearly have felt that way for a couple of decades now. In an globalizing economy, more U.S. firms are going to have foreign operations and to be focused on expanding those operations, so it\’s not clear to me that a much larger share of those foreign profits will be repatriated. The cash hoard of U.S. firms isn\’t just, or even mainly, a post-recession phenomenon.

One recent local environmental cause, especially popular in California, has been to ban or tax plastic grocery bags. The expressed hope is that shoppers will instead carry reusable grocery bags back and forth to the grocery store, and that plastic bags will be less likely to end up in landfills, or blowing across hillsides, or floating in water. The problem is that almost no one ever washes their reusable grocery bags. Reusuable grocery bags often carry raw meat, unseparated from other foods, and are often stored for convenience in the trunk of cars that sit outside in the sun. In short, reusuable grocery bags can be a friendly breeding environment for E. coli bacteria, which can cause severe illness and even death.

Jonathan Klick and Joshua D. Wright tell this story in \”Grocery Bag Bans and Foodborne Illness,\” published as a research paper by the Institute for Law and Economics at the University of Pennsylvania Law School. As their primary example, they look at E. coli infections in the San Francisco County after it adopted an ordinance severely limiting the use of plastic bags by grocery stores.

As one piece of evidence, here\’s a figure showing the number of emergency room visits in San Francisco County related to E. coli for the 10 quarters before and after the enactment of the ordinance, where zero on the horizontal axis is the date the ordinance went into effect. (The shaded area around the line is a 95% statistical confidence interval.)  Clearly, there is a discontinuous jump in the number of emergency room visits.

For comparison, here\’s the same measure of emergency room visits related to E. coli infections for the other counties in the San Francisco Bay Area in the 10 quarters before and after the ordinance was enacted. These counties don\’t see a jump.

Klick and Wright flesh out this finding in a variety of ways. They look at other measures of foodborne illness, like salmonella and campylobacter, and also find a rise associated with the ordinance limiting plastic bags. They look at other cities in California that have enacted such bans, and although it is harder for them to track health effects for individual cities–because the health statistics are collected at the county level–they find negative health effects as well. (The city of San Francisco is consolidated with the county of San Francisco.)

Overall, they find that San Francisco typically experiences about 12 deaths per year from intestinal infections, and that the restrictions on plastic bags probably let to another 5-6 deaths per year in that city–plus, of course, the personal and social costs of some dozens of additional hospitalizations. With these costs taken into account, restrictions on plastic bags stop looking like a good idea.

Of course, a possible response to this problem is to launch a public information campaign to encourage people to wash their reusable grocery bags. But that response then leads to two other issues.  First, if public information campaigns can be effective on the grocery bag issue, the campaign could simply focus on the need to dispose of plastic bags properly and recycle them where possible–without a need to ban them. The argument for an ordinance sharply limiting the use of plastic grocery bags is, in effect, based on an implicit assumption that public information campaigns about grocery bags don\’t work well.  Second, if reusable grocery bags are washed after each use, then any cost-benefit analysis of their use would have to take into account the costs of water and detergent use. I have no idea if these costs alone would outweigh the benefits of reusable grocery bags, but it might be a near thing.

 Like most economists, I have a mental file drawer of \”good intentions aren\’t enough\” stories. The push to ban plastic grocery bags is one more example.

Added February 14, 2013:  For a short memo challenging the findings of this study from the San Francisco Department of Public Health, see here.

The Winter 2013 issue of my own Journal of Economic Perspectives is now available on-line. Like all issues of JEP back to the first issue in 1987, it is freely available here, courtesy of the American Economic Association. I will probably put put some posts about individual articles in the next week or so, but here is an overview. The issue has two symposia of four papers each: one on the economics of patents and the other on tradeable pollution allowances. There are a couple of individual papers, one on the empirical work about prospect theory 30 years after that theory was formulated, and the other a look back at the famous RAND health insurance experiment. My own \”Recommendations for Further Reading\” rounds out the issue. Here are abstracts for the papers, with links to the text.

Symposium on Patents

\”The Case against Patents,\” by Michele Boldrin and David K. Levine

The case against patents can be summarized briefly: there is no empirical evidence that they serve to increase innovation and productivity, unless productivity is identified with the number of patents awarded—which, as evidence shows, has no correlation with measured productivity. Both theory and evidence suggest that while patents can have a partial equilibrium effect of improving incentives to invent, the general equilibrium effect on innovation can be negative. A properly designed patent system might serve to increase innovation at a certain time and place. Unfortunately, the political economy of government-operated patent systems indicates that such systems are susceptible to pressures that cause the ill effects of patents to grow over time. Our preferred policy solution is to abolish patents entirely and to find other legislative instruments, less open to lobbying and rent seeking, to foster innovation when there is clear evidence that laissez-faire undersupplies it. However, if that policy change seems too large to swallow, we discuss in the conclusion a set of partial reforms that could be implemented.
Full-Text Access | Supplementary Materials

\”Patents and Innovation: Evidence from Economic History,\” by Petra Moser

What is the optimal system of intellectual property rights to encourage innovation? Empirical evidence from economic history can help to inform important policy questions that have been difficult to answer with modern data: For example, does the existence of strong patent laws encourage innovation? What proportion of innovations is patented? Is this share constant across industries and over time? How does patenting affect the diffusion of knowledge? How effective are prominent mechanisms, such as patent pools and compulsory licensing, that have been proposed to address problems with the patent system? This essay summarizes results of existing research and highlights promising areas for future research.
Full-Text Access | Supplementary Materials

\”The New Patent Intermediaries: Platforms, Defensive Aggregators, and Super-Aggregators,\” by Andrei Hagiu and David B. Yoffie

The patent market consists mainly of privately negotiated, bilateral transactions, either sales or cross-licenses, between large companies. There is no eBay, Amazon, New York Stock Exchange, or Kelley\’s Blue Book equivalent for patents, and when buyers and sellers do manage to find each other, they usually negotiate under enormous uncertainty: prices of similar patents vary widely from transaction to transaction and the terms of the transactions (including prices) are often secret and confidential. Inefficient and illiquid markets, such as the one for patents, generally create profit opportunities for intermediaries. We begin with an overview of the problems that arise in patent markets, and how traditional institutions like patent brokers, patent pools, and standard-setting organizations have sought to address them. During the last decade, a variety of novel patent intermediaries has emerged. We discuss how several online platforms have started services for buying and selling patents but have failed to gain meaningful traction. And new intermediaries that we call defensive patent aggregators and superaggregators have become quite influential and controversial in the technology industries they touch. The goal of this paper is to shed light on the role and efficiency tradeoffs of these new patent intermediaries. Finally, we offer a provisional assessment of how the new patent intermediary institutions affect economic welfare.
Full-Text Access | Supplementary Materials

\”Of Smart Phone Wars and Software Patents,\” by Stuart Graham and Saurabh Vishnubhakat

Among the main criticisms currently confronting the US Patent and Trademark Office are concerns about software patents and what role they play in the web of litigation now proceeding in the smart phone industry. We will examine the evidence on the litigation and the treatment by the Patent Office of patents that include software elements. We present specific empirical evidence regarding the examination by the Patent Office of software patents, their validity, and their role in the smart phone wars. More broadly, this article discusses the competing values at work in the patent system and how the system has dealt with disputes that, like the smart phone wars, routinely erupt over time, in fact dating back to the very founding of the United States. The article concludes with an outlook for systematic policymaking within the patent system in the wake of major recent legislative and administrative reforms. Principally, the article highlights how the US Patent Office acts responsibly when it engages constructively with principled criticisms and calls for reform, as it has during the passage and now implementation of the landmark Leahy-Smith America Invents Act of 2011.
Full-Text Access | Supplementary Materials

Symposium on Tradeable Pollution Allowances

\”Markets for Pollution Allowances: What Are the (New) Lessons?\” by Lawrence H. Goulder

About 45 years ago a few economists offered the novel idea of trading pollution rights as a way of meeting environmental goals. Such trading was touted as a more cost-effective alternative to traditional forms of regulation, such as specific technology requirements or performance standards. The principal form of trading in pollution rights is a cap-and-trade system, whose essential elements are few and simple: first, the regulatory authority specifies the cap—the total pollution allowed by all of the facilities covered by the regulatory program; second, the regulatory authority distributes the allowances, either by auction or through free provision; third, the system provides for trading of allowances. Since the 1980s the use of cap and trade has grown substantially. In this overview article, I consider some key lessons about when cap-and-trade programs work well, when they perform less effectively, how they work compared with other policy options, and how they might need to be modified to address issues that had not been anticipated.
Full-Text Access | Supplementary Materials

\”The SO₂ Allowance Trading System: The Ironic History of a Grand Policy Experiment,\” by Richard Schmalensee and Robert N. Stavins 

Two decades have passed since the Clean Air Act Amendments of 1990 launched a grand experiment in market-based environmental policy: the SO₂ cap-and-trade system. That system performed well but created four striking ironies: First, by creating this system to reduce SO₂ emissions to curb acid rain, the government did the right thing for the wrong reason. Second, a substantial source of this system\’s cost-effectiveness was an unanticipated consequence of earlier railroad deregulation. Third, it is ironic that cap-and-trade has come to be demonized by conservative politicians in recent years, as this market-based, cost-effective policy innovation was initially championed and implemented by Republican administrations. Fourth, court decisions and subsequent regulatory responses have led to the collapse of the SO₂ market, demonstrating that what the government gives, the government can take away.
Full-Text Access | Supplementary Materials

\”Carbon Markets 15 Years after Kyoto: Lessons Learned, New Challenges,\” by Richard G. Newell, William A. Pizer and Daniel Raimi

Carbon markets are substantial and they are expanding. There are many lessons from market experiences over the past eight years: there should be fewer free allowances, better management of market-sensitive information, and a recognition that trading systems require adjustments that have consequences for market participants and market confidence. Moreover, the emerging market architecture features separate emissions trading systems serving distinct jurisdictions and a variety of other types of policies exist alongside the carbon markets.This situation is in sharp contrast to the top-down, integrated global trading architecture envisioned 15 years ago by the designers of the Kyoto Protocol and raises a suite of new questions. In this new architecture, jurisdictions with emissions trading have to decide how, whether, and when to link with one another. Stakeholders and policymakers must confront how to measure the comparability of efforts among markets as well as relative to a variety of other policy approaches. International negotiators must in turn work out a global agreement that can accommodate and support increasingly bottom-up approaches to carbon markets and climate change mitigation.
Full-Text Access | Supplementary Materials

\”Moving Pollution Trading from Air to Water: Potential, Problems, and Prognosis,\” by Karen Fisher-Vanden and Sheila Olmstead

This paper seeks to assess the current status of water quality trading and to identify possible problems and solutions. Water pollution permit trading programs have rarely been comprehensively described and analyzed in the peer-reviewed literature. Including active programs and completed or otherwise inactive programs, we identify approximately three dozen initiatives. We describe six criteria for successful pollution trading programs and consider how these apply to standard water quality problems, as compared to air quality. We then highlight some important issues to be resolved if current water quality trading programs are to function as the \”leading edge\” of a new frontier in cost-effective pollution permit trading in the United States.
Full-Text Access | Supplementary Materials

Individual articles

\”Thirty Years of Prospect Theory in Economics: A Review and Assessment,\” by Nicholas C. Barberis

In 1979, Daniel Kahneman and Amos Tversky, published a paper in Econometrica titled \”Prospect Theory: An Analysis of Decision under Risk.\” The paper presented a new model of risk attitudes called \”prospect theory,\” which elegantly captured the experimental evidence on risk taking, including the documented violations of expected utility. More than 30 years later, prospect theory is still widely viewed as the best available description of how people evaluate risk in experimental settings. However, there are still relatively few well-known and broadly accepted applications of prospect theory in economics. One might be tempted to conclude that, even if prospect theory is an excellent description of behavior in experimental settings, it is less relevant outside the laboratory. In my view, this lesson would be incorrect. Over the past decade, researchers in the field of behavioral economics have put a lot of thought into how prospect theory should be applied in economic settings. This effort is bearing fruit. A significant body of theoretical work now incorporates the ideas in prospect theory into more traditional models of economic behavior, and a growing body of empirical work tests the predictions of these new theories. I am optimistic that some insights of prospect theory will eventually find a permanent and significant place in mainstream economic analysis.
Full-Text Access | Supplementary Materials

\”The RAND Health Insurance Experiment, Three Decades Later,\” by Aviva Aron-Dine, Liran Einav and Amy Finkelstein 

Between 1974 and 1981, the RAND health insurance experiment provided health insurance to more than 5,800 individuals from about 2,000 households in six different locations across the United States, a sample designed to be representative of families with adults under the age of 62. More than three decades later, the RAND results are still widely held to be the \”gold standard\” of evidence for predicting the likely impact of health insurance reforms on medical spending, as well as for designing actual insurance policies. On cost grounds alone, we are unlikely to see something like the RAND experiment again. In this essay, we reexamine the core findings of the RAND health insurance experiment in light of the subsequent three decades of work on the analysis of randomized experiments and the economics of moral hazard. First, we re-present the main findings of the RAND experiment in a manner more similar to the way they would be presented today. Second, we reexamine the validity of the experimental treatment effects. Finally, we reconsider the famous RAND estimate that the elasticity of medical spending with respect to its out-of pocket price is -0.2. We draw a contrast between how this elasticity was originally estimated and how it has been subsequently applied, and more generally we caution against trying to summarize the experimental treatment effects from nonlinear health insurance contracts using a single price elasticity.
Full-Text Access | Supplementary Materials

\”Recommendations for Further Reading,\” by Timothy Taylor
Full-Text Access | Supplementary Materials

After recessions, the U.S. economy has typically had a period of bounce-back growth, which then catches the economy up to the path of \”potential GDP\” it would have been on prior to the recession. One of the imponderable questions in the aftermath of the Great Recession that lasted from 2007-2009 was when–or if–this bounceback growth would arrive. The nonpartisan Congressional Budget Office offers a prediction in its just-released \”The Budget and Economic Outlook: Fiscal Years 2013 to 2023\” that \”economic activity will expand slowly in 2013 but will
increase more rapidly in 2014.\” In other words, the long-delayed period of bounceback growth is now at least visible on the horizon. Here\’s the forecast in pictures.

\”Potential GDP\” refers to how much an economy could produce with full employment of workers and productive capacity. The blue line shows growth in potential GDP; the gray line shows the actual course of the economy during the recession and its aftermath. Notice the catch-up growth, bringing the economy back to potential GDP.

You can also see the catch-up growth in the CBO predictions for the annual growth rate of GDP.

As the catch-up growth arrives, the CBO is also predicting that the unemployment rate will drop briskly.

In addition, some measures of the grim economy will start to reverse themselves. For example, real investment in residential housing (that is, in building and remodeling houses), after several years of negative growth, has moved back to positive territory.

The underlying story here is that when a recession is accompanied by a financial crisis, the economic bounceback can be painfully slow. When households and firms across the economy are all feeling that they have borrowed too much, and need to get their financial houses back in order, it takes time. The depth of the U.S. recession has actually been somewhat shallower and less prolonged than the experience in many other countries when they experienced the double-whammy of financial crisis and recession, as I discussed here. But by fits and starts, the economic bounceback process does eventually work its way forward.

In the last few years, from 80-90% of all e-mail traffic has been spam. This imposes a considerable cost in terms of computer security and people\’s time. In the Summer 2012 issue of my own Journal of Economic Perspectives, Justin M. Rao and David H. Reiley discuss the \”The Economics of Spam\” and conservatively estimate social costs to businesses and consumers of about $20 billion per year.
But in 2012, it looks as if the tide may be turning against e-mail spam, at least a bit. 

Some evidence comes from monitoring of spam done by Kaspersky Lab, a seller of information technology security services. In particular, Darya Kudkova has written  the \”Kaspersky Security Bulletin: Spam Evolution 2012.\” The first bar chart, from the Economist magazine, relies on Kaspersky Lab data to show monthly patterns of spam from 2006 up through 2012. The second bar chart, from Kudkova\’s report, shows monthly spam patterns just during 2012.

The Rao and Reiley paper in JEP offers an extended discussion of how the spam wars have evolved over time. (Here is my post on this paper from last August.) As example, they describe a study in which a group attempted to send 345 million spam e-mails, but three-quarters were blocked when the server was blacklisted. The 82 million e-mails that escaped the blacklist then had to run the normal gauntlet of anti-spam software, and ultimately, there were ultimately just 28 purchases.

However, the Kaspersky report suggests that even better anti-spam software has been the main driver of the decline. \”This continual and considerable decrease in spam volumes is unprecedented….
The main reason behind the decrease in spam volume is the overall heightened level of anti-spam protection. To begin with, spam filters are now in place on just about every email system, even free ones, and the spam detection level typically bottoms out at 98%. Next, many email providers have introduced mandatory DKIM signature policies (digital signatures that verify the domain from which emails are sent).\”

The other big change mentioned in the report is that, partly as a result of the improvements in shutting down spam on e-mail, the spammers are trying to use other pathways to your credit cards.  The Kaspersky report comments:

\”When anti-spam experts answer questions about what needs to be done in order to reduce the amount of spam, in addition to anti-spam legislation, quality filters and user education, one factor that is always mentioned is inexpensive advertising on legal platforms. With the emergence of Web 2.0, advertising opportunities on the Internet have skyrocketed: banners, context-based advertising, and ads on social networks and blogs. Ads in legal advertising venues are not as irritating for users on the receiving end, they aren’t blocked by spam filters, and emails are sent to target audiences who have acknowledged a potential interest in the goods or services being promoted. Furthermore, when advertisers are after at least one user click, legal advertising can be considerably less costly than advertising through spam.

\”Based on the results from several third-party studies, we have calculated that at an average price of $150 per 1 million spam emails sent, the final CPC (cost per click, the cost of one user using the link in the message) is a minimum of $.4.45. Yet the same indicator for Facebook is just $0.10. That means that, according to our estimates, legal advertising is more effective than spam. Our conclusion has been indirectly confirmed by the fact that the classic spam categories (such as fake luxury goods, for example) are now switching over to social networks. We have even found some IP addresses for online stores advertising on Facebook that were previously using spam.\”

\”Advertisers have also been drawn to yet another means of legal Internet promotion: coupon services, or group discount websites where users can purchase so-called coupons. These services appeared several years ago. After a user buys a coupon, he/she presents it when purchasing a product or service and receives a discount. In 2012, coupon services gained a lot of popularity. Many companies around the world are striving to grow their client base, and in turn, clients receive generous offers. … The popularity of coupon services has made the migration of advertisers from spam to other platforms more noticeable. At the same time, the prevalence of coupon services has had an impact on spam. Malicious users have started to copy emails from major coupon services, using the originals to advertise their own goods or services, or to lure users to a malicious website.\”

 In other words, the economics of sending and screening emails, together with the economics of online advertising, is tipping the balance a bit for spammers. Getting people to click on offers in random emails is becoming more costly; getting people to click on random advertisements is becoming easier. Before you send a credit card number, be sure you know who is at the other end.

My father the mathematician first posed the checkerboard puzzle to me back in grade-school, perhaps on some rainy Saturday. His version of the story went something like this:

The jester performs a great deed, and the king asks him how he would like to be rewarded. The jester is aware that the king is a highly volatile individual, and if the jester asks for too much, the king might just kill him then and there. The jester also knows that the king views his promise as sacred, so if the king says \”yes\” to the jester\’s proposal, then the king will honor that promise. So in a way, the jester\’s problem is how to ask for a lot, but have the king at least initially think it\’s not very much, so that the king will give his consent.

So the jester clowns around a bit and then says: \”Here\’s all I want. Take this checkerboard. On the first square, put one piece of gold. On the second square, two pieces. On the third square, four pieces, and on the fourth square, 8 pieces. Double the amount on each square until you reach the end of the checkerboard.\”

In the story, the king laughs at this comic proposal and says,  \”Your great deed was so wonderful, I would have happily done much more than this! I grant your request!\”

But of course, when the king starts hauling up gold pieces from the treasury, he will discover that 2 raised to the 63rd power, the final spot on the checkerboard requires about 9 quintillion gold pieces (that is, 9 followed by 18 zeros). 

I\’ve had some sense of the power of exponential growth ever since.  But what I hadn\’t thought about is the interaction of Moore\’s Law and economic growth. Moore\’s Law is of course named for Gordon Moore, one of the founders of Intel, who noticed this pattern back in 1965. Back in the 1970s, he wrote a paper that contained the following graph showing how much it cost to produce a computer chip with a certain number of components. Here\’s his figure. Notice that the numbers of component on the horizontal axis and the cost figures on the vertical axis are both graphed as logarithm (specifically, each step up the axis is a change by a factor of 10). The key takeaway was that the number of transistors (\”components\”) on an integrated circuit was doubling about every two years, making computing power much cheaper and faster.

Ever since I started reading up on Moore\’s law in the early 1980s, there have been predictions in the trade press that it will soon reach technological limits and come to and end. But Moore\’s law marches on: indeed, the research and innovation targets at Intel and other chip-makers are defined in terms of making sure that Moore\’s law continues to hold for at least awhile longer. Stephen Shankland offers a nice accessible overview of the current situation in an October 15, 2012, essay on CNET: \”\”Moore\’s Law: The rule that really matters in tech\”  (The Gordon Moore graph above is copied from Shankland\’s essay.)

As Shankland writes: \”To keep up with Moore\’s Law, engineers must keep shrinking the size of transistors. Intel, the leader in the race, currently uses a manufacturing process with 22-nanometer features. That\’s 22 billionths of a meter, or roughly a 4,000th the width of a human hair.\” He cites a variety of industry and research experts to the effect that Moore\’s law has at least another decade to run–and remember, a decade of doubling every two years means five more doublings!

It\’s hard to wrap one\’s mind around what it means to say that the power of microchipo technology will increase by a factor of 32 (doubling five times) in the next 10 years. A characteristically intriguing survey essay  from the January 10 issue of the Economist on the future of innovation uses the checkerboard analogy to think about the potential effects of Moore\’s law. Here\’s a comment from the Economist essay:

Ray Kurzweil, a pioneer of computer science and a devotee of exponential technological extrapolation, likes to talk of “the second half of the chess board”. There is an old fable in which a gullible king is tricked into paying an obligation in grains of rice, one on the first square of a chessboard, two on the second, four on the third, the payment doubling with every square. Along the first row, the obligation is minuscule. With half the chessboard covered, the king is out only about 100 tonnes of rice. But a square before reaching the end of the seventh row he has laid out 500m tonnes in total—the whole world’s annual rice production. He will have to put more or less the same amount again on the next square. And there will still be a row to go.

Erik Brynjolfsson and Andrew McAfee of MIT make use of this image in their e-book “Race Against the Machine”. By the measure known as Moore’s law, the ability to get calculations out of a piece of silicon doubles every 18 months. That growth rate will not last for ever; but other aspects of computation, such as the capacity of algorithms to handle data, are also growing exponentially. When such a capacity is low, that doubling does not matter. As soon as it matters at all, though, it can quickly start to matter a lot. On the second half of the chessboard not only has the cumulative effect of innovations become large, but each new iteration of innovation delivers a technological jolt as powerful as all previous rounds combined.\”

Now, it\’s of course true that doubling the capacity of computer chips doesn\’t translate in a direct way into a higher standard of living: there are many steps from one to the other. But my point here is to note that many of us (myself included) have been thinking about the changes in electronics technology a little too much like the king in the checkerboard story: that is, we think of something doubling a few times, even 10 or 20 times, and we know it\’s a big change, but it somehow seems within our range of comprehension.

But when something has already been doubling every 18 months or two years for a half-century–and it is continuing to double!–the absolute size of each additional doubling is starting to get very large. I lack the imagination to conceive of what will be done with all this cheap computing power in terms of health care, education, industrial process, communication, transportation, entertainment, food, travel, design, and more. But I suspect that these enormous repeated doublings, as Moore\’s law marches forward in the next decade and drives computing speeds up and prices down, will transform lives and industries in ways that we are only just starting to imagine.

In the Fall 2012 issue of Future of Children, Sean F. Reardon, Rachel A. Valentino, and Kenneth A. Shores consider \”Patterns of Literacy among U.S. Students.\”

Of course, \”literacy\” is a somewhat elastic term, ranging from the most basic functional literacy that lets a person handle day-to-day tasks like reading a map or a drive-through menu, up to the ability to read more complex and specialized texts with comprehension of strengths and weaknesses. Here\’s a figure showing various dimensions of literacy and how U.S. children are performing. Nearly all children manage the basics like letter recognition, and beginning and ending sounds, by second grade. But even by 8th grade, a large share of students have real problems with being able to real well enough to evaluate text, especially when faced with nonfiction or with complex syntax.

What are the trends in literacy over time? Performance hasn\’t changed much. Here\’s a figure showing reading and math test scores on the National Assessment of Educational Progress (NAEP) tests, from 1971 to 2008. There appears to be a bit of rise for 9 year-old readers in recent years, but at least so far, that hasn\’t translated to higher reading scores for 13 or 17 year-olds.

Of course, these figures are averages, and it\’s always important to remember the tails of the distribution. \”At any given age, students vary considerably in their literacy abilities. For example, at age nine, students scoring at the 10th percentile can carry out simple discrete reading tasks
(such as following brief written directions), while students scoring at the 90th percentile
are already able to make generalizations and interrelate ideas. … Roughly 10 percent of seventeen-year-olds have knowledge-based competencies lower than those of the median nine-year-old
student.\”

How does the literacy of U.S. students stack up against those in other high-income countries?

\”On international comparisons, American students perform modestly above average compared with those in other OECD countries, and well above average among the larger set of countries for which the PIRLS [Progress in International Reading Literacy Study] and PISA [Programme for International Student Assessment] studies provide comparative data. Moreover, there is no evidence that U.S. students lose ground relative to those in other countries during the middle-school years.
Between ages ten and fifteen, when most students are learning crucial comprehension and evaluation literacy skills, students in the United States appear to learn at a rate that places them at the average among OECD countries. This evidence of average to above-average performance of U.S. students on
literacy assessments is in stark contrast to the poor relative performance of U.S. students on internationally administered math and science assessments.\”

And with that comment the authors touch on a point that nags at me from time to time. Literacy sounds like a  doesn\’t always get the attention of STEM education: that is, science, technology, engineering, and mathematics. Literacy lacks a cute acronym. It\’s a softer subject in some ways: teaching about deeper levels of comprehension can\’t be as black-and-white as balancing a chemical formula or solving a geometry problem.  As the authors suggest at various points, the curriculum pathway to teaching literacy and spoken skills after the most basic level is less clear-cut.

But as I often try to emphasize with students, a national economy is not like an Olympic team, where a few performers can win medals while the rest of us couch potatoes sit at home and watch. In the economy, the vast majority of adults participate, and the economy performs better when workers at all levels have more human capital. For many workers, literacy is much more at the core of their job responsibilities than are specific technical or statistical capabilities. Reardon, Valentino, and Shores offer a useful reminder on the core importance  of literacy:

\”Literacy—the ability to access, evaluate, and integrate information from a wide range of textual sources—is a prerequisite not only for individual educational success but for upward mobility both socially and economically. In addition, because much of the growth in the economy in recent decades has been in areas requiring moderate- to high-level literacy skills, economic growth in the United
States relies increasingly on the literacy skills of the labor force. Finally, in an information-rich age, thoughtful participation in democratic processes requires citizens who can read, interpret, and evaluate a multitude of often-conflicting information and opinions regarding social and political choices.\”

What\’s to be done about Medicare? The Kaiser Family Foundation has usefully pulled together a list of possible \”Policy Options to Sustain Medicare for the Future.\” I especially liked that the report is fairly exhaustive in listing about 130 options (depending on how one counts options, suboptions, and sub-suboptions), and fairly honest in admitting that no realistic cost estimates for many of those options. Here, I\’ll start with a quick reminder of where Medicare is currently headed, and then list just 12 of the choices–those that in the KFF tally would reduce Medicare costs or raise Medicare taxes by at least $4 billion per year over the next  few years.

Medicare spending is taking off for two reasons: as the baby boomer retire, a rising proportion of Americans will become eligible, and continually rising health care costs will push up costs still further. The first figure shows projections for the rising number of Medicare enrollees and Medicare spending as a share of GDP. The second figure shows Medicare spending projected as a rising share of the overall federal budget.

Discussions of how to fix Medicare often head for happy talk about how, if we all just provide patients and doctors with the right information and incentives, and link them together with the right network of health information technology and thoughtful counselors, we can save billions while improving everyone\’s health. For a recent example, see this report from the United Health UnitedHealth Center for Health Reform & Modernization, which suggests that steps along these lines could save up to $542 billion in Medicare and Medicaid spending over the next decade. It\’s a cheerful story, and I\’m certainly fine with pursuing these kinds of win-win possibilities. But the U.S. health care system has been facing ever-rising costs and talking about win-win solutions for several decades. While we\’re waiting for the cost savings from these kinds of more enlightened and efficient practices to arrive, we need to start thinking about some less pleasant options.

 Here\’s the list of 12 possibilities from the KFF report that would involve Medicare cost savings or revenue increases of at least $4 billion per year. In that report, all the proposals for better information sharing and quality control and improved decision making by patients and providers have the effect on costs and revenues listed as \”Not available,\” which seems fair to me, given historical experience with attempts along these lines as overall health care costs have continues to rise. What\’s left are choices that sting (with the effect on costs or revenues in parentheses). The KFF Report gives a couple of pages of more detailed explanation for each of these, along with the other 100+ choices.

1) Raise the age of Medicare eligibility from 65 to 67 ($113 billion over 10 years)

2) 10% coinsurance payment on all home health episodes ($40 billion over 10 years)

3) Restrict first-dollar Medigap coverage ($53 billion over 10 years)

4) Increasing premiums for Part B and Part D: for example, raise Part B premiums by 2% per year until they cover 35% of total Part B expenses ($231 billion over 10 years)

5)  Increase Medicare payroll tax by 1 percentage point for all workers ($651 billion over 10 years)

6) Require manufacturers to pay a minimum rebate on drugs covered under Medicare Part D for
beneficiaries receiving low-income subsidies ($137 billion over 10 years).

7) Repeal provisions in the Affordable Care Act that would close the Part D coverage gap by
2020 ($51 billion over 10 years)

8) Reduce and restructure graduate medical education payments to hospitals ($69 billion over 10 years)

9) Rebase SNF and home health payment rates: for example, reducing payment updates for post-acute care by 1.1 percentage points ($45 billion over 10 years)

10) Adopt traditional tort reforms at the Federal level ($40 billion to $57 billion over 10 years)

11) Establish a combined deductible, uniform coinsurance rate, and a limit on out-of-pocket
spending, along with Medigap reforms ($93 billion over 10 years)

12) Set Federal contributions per beneficiary at the average plan bid in a given area, including
traditional Medicare as a plan, weighted by enrollment ($161 billion over 10 years)

A few thoughts:

1) One of the policy changes would dramatically increase costs. Congress has been playing a game for years now in which it lowballs the future costs of Medicare by proposing very large cuts  in payments to health care providiers that will take place a few years in the future. Then Congress perpetually pushes back those cuts. To their credit, the official Medicare actuaries have been quite blunt in pointing out \”Why Official Medicare Costs are Understated.\” But if, for example, the currently legislated future cuts in payments to health care providers were replaced with a 10-year freeze on fees and a \”only\” a 5.9% cut in fees for non-primary care services each year for the first three years, Medicare costs would be $200 billion higher over 10 years than the current legislative estimates. If fees for health care providers rise at the rate of GDP growth, or a percentage point or two faster, then Medicare costs will be $300 billion or more higher over the next 10 years. Thus, take your first few hundred billion in cost savings or revenue increases above, and assume that it\’s going to go to sidestepping the huge future cuts to health care providers in current legislation.

2) I did leave out a few proposals on the KFF list for increasing taxes on other items and earmarking the funds for Medicare. For example, one could raise taxes on alcohol, tobacco, soft drinks, or employer-provided health insurance and earmark the funds for Medicare. But one could also raise those taxes and spend the money on deficit reduction or some other program, so at least to me, these are not specifically \”Medicare\” reforms.

3) Just for the record, you can\’t just add up the cost estimates several of these proposals with, because they interact in various ways. For example, option #3 on restricting first-dollar Medigap coverage overlaps heavily with option #11  on Medigap reforms. If the Medicare age was raised to 67, it would alter the cost changes from all of the other proposals.

My bottom line is that too many of the arguments over Medicare spending are magically nonspecific. Sometimes they describe innovations in health care delivery that would improve health and save money and leave everyone with a big rosy smile. I\’m all for such changes, and I\’ll believe in their effectiveness as soon as they are actually effective in reducing costs–but not before. Other time, politicians talk tough about how they will just put a cap on Medicare spending, or just not let it rise at faster than some certain rate. Again, I\’ll believe in the workability of such caps when I\’ve seen them operate for a few years.

In contrast, the list above is not a pleasant one. Some of these proposals reduce coverage for the elderly or require them to pay more. Some reduce payments to health care providers. One raises taxes on current workers. I am fully aware that none of these are popular options! Which options are more palatable is an argument for another day. But these are real choices, and the inexorable arithmetic of Medicare\’s rising costs is likely to force choices among these sorts of options.