Julian Simon\’s "Almost Practical Solution to Airline Overbooking"

As the topic of passengers being hauled off of airplanes hits the headlines, spare a moment to remember how an economist pioneered the idea that if you had a ticket, and the airline wanted to bump you off the flight, the company needed to hold an auction and offer compensation to find a passenger willing to stay back.

It\’s been almost a half-century since Julian Simon wrote \”An Almost Practical Solution to Airline Overbooking,\” which was a two-page note in the May 1968 Journal of Transport Economics and Policy (pp. 201-2). Here\’s how Simon described the idea in 1968:

Perhaps the reader has suffered a fit of impotent rage at being told that he could not board an aeroplane for which he held a valid ticket. The explanation is clear, and no angry letter to the president of the airline will rectify the mistake, for mistake it was not. The airline gambles on a certain number of cancellations, and therefore sometimes sells more tickets than there are seats. Naturally there are sometimes more seat claimants than seats.

The solution is simple. All that need happen when there is overbooking is that an airline agent distributes among the ticket-holders an envelope and a bid form, instructing each person to write down the lowest sum of money he is willing to accept in return for waiting for the next flight. The lowest bidder is paid in cash and given a ticket for the next flight. All other passengers board the plane and complete the flight to their destination.

All parties benefit, and no party loses. All passengers either complete their flight or are recompensed by a sum which they value more than the immediate completion of the flight. And the airlines could also gain, because they would be able to overbook to a higher degree than at present, and hence fly their planes closer to seat capacity. …
But of course this scheme will not be taken up by the airlines. Why? Their first response will probably be \”The administrative difficulties would be too great\”. The reader may judge this for himself. Next they will suggest that the scheme will not increase net revenue. But the a priori arguments to the contrary make the scheme worth a trial, and the trial would cost practically nothing and would require no commitment.

What are the real reasons why this scheme will not be adopted? Probably that \”It just isn\’t done\”, because such an auction does not seem decorous; it smacks of the pushcart rather than the one price store; it is \”embarrassing\” and \”crass\”, i.e., frankly commercial, like \”being in trade\” in Victorian England.

Simon\’s idea seemed a little ridiculous to a number of commentators back in 1968, the sort of hypothetical, unworldly, and impractical idea that only an economist could favor. After being enacted and around for a few decades, of course, it now seems obvious. In the classroom, it\’s a nice practical real-world example of what is arguably a Pareto gain.

As Cass Sunstein and others have recently written, the obvious solution to the overbooking problem–at least if you are thinking like an economist–is to change the regulations that limit how much airlines are allowed to pay so that a few passengers can take a later flight. Of course, airlines dislike the idea. When Simon asked why the scheme wouldn\’t be adopted in the first place, he left out one reason: \”The airline already has the money you paid for a ticket, and don\’t want to return any of it to you if at all possible.\” But there\’s a social and political tradeoff here: if airlines want to keep having the freedom to overbook their flights, then they need to face the reality of paying a compensation level so that when a few ticketed passengers can\’t be accommodated on a given flight, those passengers are willing to postpone their flight voluntarily.

A Truckload of Tips for Teaching Economics

Back in 1990, William McEachern started editing a semiannual newsletter that he called \”The Teaching Economist.\” Each issue had a handful of pithy article, with a heavy emphasis on concrete suggestions linked to actual experience. After 26 years and 52 issues, McEachern has decided to that the Spring 2017 issue, #52, will be the last. However, all the past newsletters are freely available online, and they offer many nuggets for teachers willing to mine the archives. 

For his work as a teacher and textbook author, as well as in editing \”The Teaching Economist,\” McEachern has earned the right to offer some lessons and myths. Here they are:

Students learn by organizing new information into a coherent mental structure, integrating that with their prior knowledge and experience, then retrieving that information repeatedly from memory. Here are four key findings from cognitive science.

Finding # 1: Students are much more likely to recall information that relates somehow to what they already know or have experienced. Spell out how new material relates to existing knowledge or experience. Use examples from student life, current events, and popular culture. Ask students to generate their own examples from personal experience. All this makes new material more memorable.

Finding # 2: The key to long-term learning is practicing retrieval. Many experiments have found that learning improves when students actively retrieve information from memory rather than passively reread class notes or textbooks. Information that’s actively retrieved thereby becomes more accessible in the future and is therefore more transferable to other situations.

Finding # 3: Raise key ideas again and again over time. Retrieval and testing sessions that are spaced out over time are effective for long-term retention and transfer. The long-term benefits of spacing retrieval over time have been found for more than a century of controlled research into human memory. Teachers should align their presentations, assignments, and tests so that key ideas are recalled frequently throughout the term. And students should space their retrieval sessions over time.

Finding # 4: “Desirable difficulties” foster engagement, which helps students learn. Desirable difficulties are challenges introduced during instruction that seem to benefit long-term learning, challenges such as presenting material in different contexts and in different formats. Desirable difficulties may seem to slow the apparent rate of learning in the short run, but they boost long-term retention and transfer. Presentations that challenge students engage them more, and this helps them learn.
And Four Myths

Although cognitive scientists have been studying teaching and learning for decades, not many teachers and fewer students rely on this research even second or third hand. Some teaching and learning practices have no empirical support— they are simply myths. Here are four.

Myths# 1: The mind works like a memory machine. Students believe they sit in class and soak up the knowledge. They read a chapter and absorb the material; they read it again and encode it. The very familiarity of a second reading persuades them that they know the stuff. But test results tell them otherwise. Instead, new information enters long-term memory only if linked to what’s already known, then retrieved repeatedly over time.

Myth# 2: Testing is not learning but is a mere yardstick to measure how much has been learned. Most students don’t like taking tests and most instructors don’t like preparing, administering, and grading them. So testing is usually not a valued activity in itself. Tests, however, are forced retrieval, and this helps students learn and remember. Dozens of studies demonstrate the power of testing as a learning tool, particularly in pointing out weaknesses. Frequent, low-stakes, classroom quizzes may be one of the best ways you can help students learn new material.

Myth# 3: Learning depends on a student’s learning style. According to this myth, some students learn visually, others by hearing, others by reading, and so on. Each student’s brain is a lock that’s accessed only with the right key, the right learning style. Although some students seem to have preferences about how they learn, there is no evidence that customizing instruction to match a student\’s preferred learning style leads to better achievement. Because interest flows from variety, instructors should offer material using a mix of learning styles.

Myth # 4: Your classroom presentation determines how much students learn.What you do in class matters less than what you ask and expect students to do in your course. Student effort determines how much is learned, how well it\’s remembered, and under what conditions it\’s recalled and applied to new situations. Remember, it’s less what you teach and more what students do for themselves to learn.

US Polling on Attitudes Toward Trade

Here\’s the overall pattern from Gallup based on February 2017 polling:

Graph 1

And here\’s the breakdown by political affiliation:

Graph 2

Poll results are always open to interpretation, and this is obviously no exception. For example, it\’s possible that anti-Trump forces are rallying to the defense of trade because it seems to them imperiled under the Trump administration. It\’s also possible that pro-Trump forces are rallying to the defense of trade because they believe that the Trump administration will be cutting much more advantageous trade deals, so that unlike in the past, trade can now help the US economy.

There\’s also a an NBC News/ Wall Street Journal poll about attitudes toward trade, which asks respondents whether they believe that free trade helps or hurts the country. Here\’s a figure from the NBC reporting on the poll:

How does one interpret this? The NBC story notes the swing since 2010:

\”Looking back to 2010, many Democrats didn\’t sound unlike their Republican counterparts on the subject of free trade. An NBC News/ Wall Street Journal poll taken that year showed that just 21 percent of Republicans and 27 percent of Democrats thought that free trade helped the country. Fifty-two percent of Republicans and 43 percent of Democrats considered it harmful.  Fast-forward to 2017, and a whopping 57 percent of Democrats say they root for free trade policies, while just 16 percent say that they are harmful. Meanwhile, Republicans, after a burst of comparatively pro-trade sentiment in 2014 and 2015, are back to their 2010 levels.\” 

Overall, as the Wall Street Journal article on this poll notes, \”The poll this month showed the highest portion of Americans who said free trade helped more than hurt since the Journal/NBC News pollsters started asking that question in 1999.\” In that sense, the findings from the Gallup and NBC/WSJ surveys are congruent with each other, despite the different wording. 
But these survey results may also suggest that US opinions about trade are just not very deeply rooted, and are more expressions of transient emotions and political partisanship. After all, for anyone who was watching either Democrats or Republicans during the presidential primaries, it\’s not obvious that there was a large supply of latent support for trade. The Wall Street Journal report on the NBC/WSJ survey included this comment: \”Essentially what this says is how partisan the world is,\” said Peter Hart, a Democratic pollster who worked on the survey. \”If Trump says the world is flat, the Democrats are going to say it\’s round.\”

Finally, it\’s worth a reminder that the US public attitude toward trade are considerably less positive than those in many other countries around the world. For example, here\’s a table from the IMF, World Bank, and World Trade Organization report, \”Making Trade an Engine of Growth for All: The Case for Trade and for Policies to Facilitate Adjustment\”  (March 2017), which I discussed in yesterday\’s post. The share of Americans who think trade is good is lower than in most advanced economies, and most emerging market and developing economies, too. This international pattern has always struck me as little odd, given that trade represents a relatively small share of the US economy–given the huge size of the US domestic market–and a relatively larger share of GDP for most of these other countries.

Addressing Dislocation Costs of Trade: IMF, WTO, WB Weigh In

International trade disrupts the economic patterns that would otherwise exist, and both the benefits and costs of trade flow from such disruptions. The IMF, World Bank, and World Trade Organization have come together to write \”Making Trade an Engine of Growth for All: The Case for Trade and for Policies to Facilitate Adjustment,\” which was published for an international meeting held March 22-23 in Germany.

A lot of the report is about gains from trade, public attitudes toward trade, size of barriers to trade, and possibilities for reducing barriers to trade through negotiations. Here, I\’ll focus on some points related to the costs of trade disruption and potential policies to address it.

Patterns of global trade in manufacturing have changed substantially since the 1990s. This figure shows that in from 1990-94, 63% of all merchandise trade as between advanced economies. By the 2010-2015 time period, this had dropped to 38%, while 45% of merchandise trade was between advanced economies (AE) and \”emerging markets and developing economies\” (EMDE), and the remaining 17% was between emerging market and developing economies.

The share of GDP related to manufacturing shifted during this time as well, but perhaps it wasn\’t always advanced economist that saw declines nor always emerging market and developing economies that saw raises. For example this figure shows that the manufacturing share of GDP decline in the US from 1995-2014, but the decline was smaller than in Canada or the UK–and Germany saw an increase in manufacturing as a share of GDP. Among the emerging market and developing economies, China saw a rise in manufacturing as a share of GDP during this time, algon with Thailand, Vietnam, and Poland, but Brazil and South Africa (abbreviated ZAF) saw declines in manufacturing as a share of GDP during this time.

The report notes that the freedome to import from the world economy is a benefit to consumers: in particular, cheap imports are a huge benefit for those with lower incomes. The report offers a figure drawn from a recent paper by Pablo D. Fajgelbaum and Amit K. Khandelwal, \”Measuring the Unequal Gains from Trade,\” Quarterly Journal of Economics, 2016, 131: 3, pp. 1113-1180. The horizontal axis shows how much the real income (that is, the buying power of income) would fall without trade for the lowest decile by income, while the vertical axis shows how much the real income of the top decile would fall. As the graph shows, for all 40 countries in the study, the loss of income for the poor would be greater than for the rich: for example, in the US cutting off trade would reduce the real income of the bottom decile by almost 70%, but of the top decile by less than 5%. 

However, trade can also disrupt jobs. The discussion of the report on this point isn\’t extensive, but here are a few snippets (footnotes omitted for readability):

\”According to simulation exercises, adjustment frictions in AEs [advanced economies] can lead to transition periods of up to 10 years and reduce the gains from trade by up to 30 percent (Artuç and others, 2013, Dix-Carneiro, 2014). …  

\”An unusual period of sharply increased import competition that began around 2000, along with other factors, appears to have negatively impacted regional labor markets in some AEs. Evidence on most episodes of trade increases suggests that the impact on aggregate labor market outcomes has been mild. When EMDEs [emerging market and developing economies] began to play a greater role in global manufacturing trade, in part reflecting the impact of pro-market reforms in China, a series of studies examined the impact on local labor markets during that period (Autor and others, 2016; Pierce and Schott, 2016a). These studies show that areas more exposed to competition from Chinese manufactures due to their industrial structure saw significant and persistent losses in jobs and earnings, falling most heavily on low-skilled workers. …

\”When switching industries within manufacturing, workers in developed countries have been estimated to forego in terms of lifetime income the equivalent of 2.76 times their annual wage (Artuç and others, 2015). Switching occupations may have similar costs, although these costs vary substantially across occupations and skill levels, with college-educated workers experiencing on average lower costs (Artuç and McLaren, 2015).\”

What policies are likely to be most useful for workers dislocated by trade? As the report notes, many of the policies help workers dislocated by trade are the same policies that will help an economy overall to be growing and vibrant. After all, a dynamic and evolving market economy will always experience a churning labor market, with some people losing jobs or leaving jobs and others finding new jobs. Sometimes trade will be the reason, but it can also occur when a suffers domestic competition, or because it falls behind the new technological trends, or because it\’s poorly managed, or because it misses a shift in consumer tastes.

But going beyond broadly sensible economic policies, are there more focused particular policies that might help adjustment? It\’s common to discuss \”passive\” labor market policies like unemployment insurance or early retirement, and to draw a contrast with \”active\” labor market policies like job search assistance, retraining, incentives for private-sector hiring, and public employment. What\’s striking from an American perspective is that the US does relatively little of either one compared with many higher-income countries. In this figure the US is the third set of bars from the bottom, just above Chile and Mexico.

The report describes active labor market policies this way: \”Generally, displaced workers are required to participate in interviews with employment counselors, apply for identified job vacancies, formulate individual action plans, accept offers of suitable work, and attend training programs if deemed necessary. A recent OECD study found that these activation strategies helped increase re-employment rates, especially in the case of those that are hard-to-place and the long-term unemployed, as may be the case with trade-displaced workers ,,,\”

There are a variety of other recommendations, all hedged about with concerns about appropriate design and administration. For example, job training can work well, but it tends to work better if if is closely connected to an actual job, or even on-the-job training. \”Housing policies may be necessary to facilitate geographical mobility.\” \”Credit policies can facilitate the overall adjustment process.\” \”`Place-based\’ policies can help revive economic activity in harder-hit regions.\”

The report seems still more hesitant about the potential tradeoffs from employment protection and higher minimum wage policies:

\”Other aspects of labor-market policies, like employment protection and minimum wage legislation, could be revisited. While employment protection legislation can reduce displacements, it can also impede the needed reallocation. There is broad consensus that employment protection should be limited, and that low hiring/firing costs coupled with protection through unemployment benefits is preferable, as in the case of Nordic countries (Annex E on Denmark). Similarly, minimum wage policies can protect low-skilled workers from exploitation and ensure that they earn a basic level of income (Blanchard and others, 2013).34 However, the policies will need to be designed carefully to avoid potentially negative employment and efficiency effects. An overly high minimum wage, coupled with high payroll taxes, can hinder employment prospects of vulnerable groups (OECD, 2006).\”

What about policies targeted in particular at those who have lost their jobs specifically because of import competition, not for other reasons?

\”Well-designed and targeted trade-specific support programs can complement existing labor-market programs. … The effectiveness of these trade-specific programs has been mixed, however, and their coverage and size tends to be very small.\”

From a US perspective, my own sense is that the US economy should do considerably more in the area of active labor market policies, retraining, and encouraging mobility, and should be experimenting with other local and regional programs. But the reason for these policies isn\’t primarily about trade. in the US economy, the dislocations from technology and domestic competition are  considerably bigger than the dislocations from trade. Greater mobility and flexibility across the labor market should tend to benefit all employees, whether they are switching jobs by choice or involuntarily.

Afterword: The IMF/WB/WTO report starts with a quotation from the British historian and occasional political figure Thomas Babington Macauley, who wrote in 1824: “Free trade, one of the greatest blessings which a government can confer on a people, is in almost every country unpopular.” There\’s no citation in the report, and as regular readers know, I prefer to quote only what I can cite.

In this case, the quotation appears in Macauley\’s 1824 review, \”Essay on Mitford\’s History of Greece,\” where a fuller version of the quotation reads: \”The people will always be desirous to promote their own interests; but it may be doubted whether, in any community, they were ever sufficiently educated to understand them. Even in this island, where the multitude have long been better informed than in any other part of Europe, the rights of the many have generally been asserted against themselves by the patriotism of the few. Free trade, one of the greatest blessings which a government can confer on a people, is in almost every country unpopular. It may be well doubted whether a liberal policy with regard to our commercial relations would find any support from a Parliament elected by universal suffrage.\”

US Health Care Costs: Same Items, Compared with Other Countries

There are a variety of reasons why the US spends so much more on health care than other countries, but one of them is that prices for many procedures, diagnostic tests, and drugs are higher in the US. Here are some illustrative figures from a set of powerpoint slides produced by the International Federation of health plans in July 2016, called \”2015 Comparative Price Report Variation in Medical and Hospital Prices by Country.\”

It\’s probably useful here to say where this price data comes from: basically, for each of the non-US countries the price is from a single private provider: for the US, the price data is from four major health insurance firms representing hundreds of millions of medical claims. This suggests that the comparisons should be taken as meaningful, but not precise. Prominent health care economists like Uwe Reinhardt have used the comparisons for that purpose.

More specifically, the report states: \”The International Federation of Health Plans is the leading global network of the health insurance industry, with 80 members in 25 countries, … Prices for each country were submitted by participating federation member plans, and are drawn from public or commercial sectors as follows: • Prices for the United States were derived from over 370 million medical claims and over 170 million pharmacy claims that reflect prices negotiated and paid to health care providers. • Prices for Australia, New Zealand, Spain, South Africa, Switzerland and the UK are from the private sector, with data provided by one private health plan in each country. Comparisons across different countries are complicated by differences in sectors, fee schedules, and systems. In addition, a single plan’s prices may not be representative of prices paid by other plans in that market.\” The US data apparently come from the Health Care Cost Institute, which in turn gathers data from  Aetna, Humana, Kaiser Permanente, and UnitedHealthcare and makes it available (suitably anonymous, of course) to researchers.

Because the US data comes from a wider variety of sources and from all over the country, the US figures can show the 25th percentile and 95th percentile price: that is, if you ranked all the prices for a given procedure or diagnostic test, what was the price in the 25th and the 95 percentile of that distribution. The overall pattern is that the average US price is often well above the price in the other countries, but in some cases, the 25th percentile price in the US isn\’t all that different from the other countrries.s

Here are a few patterns that emerge. For hospital prices, the US is the highest, although Switzerland isn\’t far behind.

A similar pattern holds for hospital-related prices, like coronary bypass surgery and hip replacement

For diagnostics, the US doesn\’t always lead the way in cost. For example, the cost from a private sector provider in the UK and New Zealand for angiograms and colonoscopies either exceeds or is close to the US average.

For drugs, it\’s no surprise that the US prices are higher. Here are a couple of examples: Xarelto and OxyContin.

There are some insights from the dots showing the 95th and 25th percentile prices in the US. Especially when you look at the 95th percentile price levels in the US, you can see why the idea of medical tourism is growing. If you are a health insurance company in the US, would you rather pay $57,000 for a hip replacement in a US facility, or, say, $15,000-$17,000–plus some kind of bonus or special treatment for the person receiving the service–to have the procedure done in New Zealand, the UK or Switzerland?  

It\’s also interesting that the 95th and 25 percentiles are very close together for drugs, compared to the hospital-related or diagnostic services.  In a well-functioning market, competition between providers will tend to drive prices to similar levels.This suggests that drug prices are set in a national market, while the prices for other health services are set in local or perhaps regional markets. I\’ve discussed this pattern before: for example, in Variability in Health Care Prices and Malfunctioning Markets (January 4, 2016). The key point is that there are lessons both in looking at the often-large differences in US health care prices to those of private providers in other countries, but also lessons in looking at the prices differences across the United States–which can be even larger than the differences in cross-national averages.

Interview with Angus Deaton on Death Rates, Inequality, and More

The Knowledge@Wharton website at the University of Pennsylvania has posted a 36-minute podcast interview with Angus Deaton, titled \”Is Despair Killing the White Working Class? Ask Angus Deaton.\” Deaton has been writing on this subject for several years: a recent example is \”Mortality and morbidity in the 21st century,\” coauthored with Anne Case, and written for the Spring 2017 Brookings Papers on Economic Activity. There\’s lots of good stuff and detail in the interview, but here are a couple of passages quote from the edited transcript of the interview that caught my eye.

Rising death rates for less-educated midlife white Americans

\”[I]f you look at white, non-Hispanics in midlife, in their early 50s for example, their mortality rate after 100 years of declining had turned the wrong way or at least flattened out. This is not happening to other groups in the U.S. It’s not happening to Hispanics. It’s not happening to African-Americans. And it’s not happening in any other rich country in the world. This is happening to both men and women. Perhaps the most shocking thing is that a lot of the deaths come from what you might think of as behavioral factors, which are alcohol – alcoholic beverages – from suicides and from drug overdoses. Many of those drug overdoses are accidental overdoses from prescription drugs. People often think the health system is responsible for our health. In this case, the health system is responsible for killing people, not actually helping them. … It’s like there are two Americas out there: the people with a B.A., and people without a B.A. The mortality rates of white non-Hispanics without a B.A. are going up faster than the average. They’re much more subject to opioid abuse, suicides, alcohol-related liver disease and heart disease, which has been a major cause in mortality decline. Mortality from heart diseases stopped declining and started rising. There’s a lot of really bad stuff going on, especially for this group without a B.A.\”

Some graphs, one with US data and one with international comparisons, help to tell the story

figure-1-1

figure-NEW-1-3


On the concerns about inequality inequality 

\”There’s literature out there claiming that income inequality is bad for everything, including health. I’ve argued against that for many years. It’s not clear why Mark Zuckerberg, or someone who develops Facebook or does some other thing that benefits many people and gets very rich in the process, is responsible for the poor health of people at the bottom who are not doing as well as he is. That’s really important because otherwise you get led to the thing where the cure for the bad things that are happening to health is higher taxation and redistribution, and I don’t endorse that for that purpose. I might endorse it for other reasons ..

\”I think that if you’ve got two people, one of whom is richer than the other, and neither is in distress in any way, I don’t see why it makes the world a better place to bring them closer together. … I just don’t think inequality by itself is bad. That puts me at odds with a lot of economists, a lot of people on the left, a lot of liberals. But that doesn’t mean the inequality that we have is a good thing. The issue is if instrumentally inequality is bad. So, if someone gets very, very rich and other people don’t, that person might use that wealth to hurt those people, and it might not even be in an income space. It might be what I said about schools, or they might undermine the health system or nullify your votes, or that Congress only listens to rich people. That’s a concern that goes back to the Greeks, which is that rich people might effectively take over the state and, at worst, enslave poor people or have poor people acting totally in their interests. That’s the sort of thing I think is really bad about inequality.\”

\”You asked about rent-seeking, and that is part of it. I think a lot of the inequality that we get in the U.S. today comes through people seeking special favors from the government by lobbying, by getting special deals, getting the rules changed. A lot of that is going on now. We’re supposedly having a bonfire of regulations, but a lot of these regulations are to prevent rich people stealing stuff from poorer people or from the nation as a whole, which is sort of the same thing. So if you just contrast what Mark Zuckerberg did with rent-seeking, I think, as I’ve said elsewhere, I think it’s okay to get rich by making things. It’s not okay to get rich by taking things by theft, as it were.\”

There\’s also a shorter interview by Jeff Guo with both Angus Deaton and Anne Case at the \”Wonkblog\” run by the Washington Post (April 6, 2017).  

Six Patterns Behind the US Productivity Slowdown

A couple of recent reports review the evidence about the productivity slowdown. Gustavo Adler, Romain Duval, Davide Furceri, Sinem Kiliç Çelik, Ksenia Koloskova, and Marcos Poplawski-Ribeiro have written an IMF Discussion Note called \”Gone with the Headwinds: Global
Productivity (April 2017, SDN/17/04). Over at the McKinsey Global Institute, James Manyika, Jaana Remes, Jan Mischke, and Mekala Krishnan have written a Discussion Paper on  \”The Productivity Puzzle: A Closer Look at the United States\” (March 2017). Both reports offer an overview of the productivity slowdown, along with discussion of possible causes and policy recommendations.

At least for me, the underlying causes of the productivity slowdown, which has now been going on for more than a decade, are not yet clear. Thus, my approach is to compile a bunch of patterns and try turn them over in my mind, trying to figure out a sensible way in which they fit together. In a similar spirit, the authors of the McKinsey report write:

\”We identify six characteristics that provide further insight into the productivity growth slowdown: declining value-added growth, a shift in employment toward lower productivity sectors, a relatively small number of sectors experiencing jumps in productivity, weak capital intensity growth across all types of capital, uneven rates of digitization across sectors (especially the large and often relatively low-productivity ones), and slowing business dynamism.\”

Here\’s some additional description of these six factors: of course, the McKinsey report has more detail.

1) Productivity is output divided by a measure of inputs, like labor hours worked. Changes in the growth rate of productivity can be driven by either the numerator or the denominator. The most recent productivity slowdown seems to be a numerator problem. 

\”Looking closely at productivity growth, we find differences in the role the denominator, hours-worked growth, and the numerator, value-added growth, have played in recent years. For example, the period between 1995 and 2004 is considered an era of high growth with annual productivity growth averaging about 3 percent. However, we have found two  distinct periods within this decade. The first is from 1995 to 2000 when productivity growth spiked, driven primarily by an increase in growth of real value-added output. Value-added output growth for the total economy, which averaged 3.4 percent annually from 1991 to 1995, increased to 4 percent from 1995 to 2000, a period of booming consumer and IT spending. As a result, productivity growth increased from 1.4 percent to 2.0 percent. The subsequent era of 2001 to 2004 was a period of continued high productivity growth, averaging 3.6 percent a year. However, the underlying driver was a decline in hours-worked growth, which fell to negative 0.2 percent partly as a result of the tech crash and the restructuring wave in manufacturing of the early 2000s. So while these two periods are typically treated as a single period of booming productivity growth, we prefer to separate them as the implications for investment, industry evolution, and job expansion are very different. … 

\”What is striking about productivity growth after the recession ended in 2009 has been low value-added output growth compared with past periods.32 Growth in real value-added output has declined to 2.2 percent between 2009 and 2014. This compares to growth of roughly 3 to 4 percent in prior time periods.\”

2) A shift of the economy to sectors with slower productivity growth \”reduced productivity growth by 0.2 percentage points every year for the private business sector between 1987 and 2014, as employment transitioned from high-productivity manufacturing sectors to lower-productivity sectors such as health care and administrative and support services.\”

Of course, this raises a question about how well the \”output\” of these service sector jobs are measured: for example, perhaps certain jobs in health care care do more to improve health than they did 30 years ago, but that benefit is probably not well-captured in the economic statistics.

3) The productivity slowdown has been a time with relatively few sectors showing a rising level of productivity growth–and most of those seem to be in energy extraction. 

\”The productivity boom of 1995 to 2000 was characterized by an exceptional combination of sectors experiencing a productivity acceleration: large employment sectors such as retail and wholesale experienced accelerating productivity at the same time as rapid productivity growth was occurring in sectors such as computer and electronic products. …  During the  boom, the number of accelerating sectors for many years was above 20 out of 60 sectors analyzed, in some years making up as much as 30 to 40 percent of total hours worked. In 1995, for example, these included sectors such as retail trade, wholesale trade, finance, and computer and electronic products. Recently only six sectors recorded significant productivity growth acceleration, and those sectors made up only 2 to 7 percent of total  hours worked, and 5 to 8 percent of value added. These sectors included oil and gas extraction, petroleum and coal manufacturing, and transportation.\”

4) The slowdown of productivity growth has been accompanied by a slowdown in investment. 

\”In the period from 1995 to 2004, there was a boom in capital intensity growth across most assets, particularly in information capital and software. This period is associated with high labor productivity growth. What is striking is that the most recent period, 2009 to 2014, coincides with both exceptionally low productivity growth and low capital intensity growth across all types of assets. Thus, this period has not only been exceptional due to the lack of accelerating productivity sectors, but the low pace at which capital services per hour worked has been rising, across all forms of capital.\”

A slowdown across all types of suggests that the underlying causes are not about a certain kind of technology or industry, but rather are broader in scope.

5) Many low-productivity sectors also lag in digitalization, which tends to be associated with higher productivity. 

\”[W]e calculate that the US economy is realizing only about 18 percent of its digital potential with large sectors lagging behind. Our use of the term digitization and our measurement of it encompasses: the digitization of assets, including infrastructure, connected machines, data, and data platforms; the digitization of operations, including processes, payments and business models, customer and supply chain interactions; and the digitization of the workforce, including worker use of digital tools, digitally-skilled workers, and new digital jobs and roles. While the information and communication technology, media, financial services, and professional services sectors are rapidly digitizing, other sectors such as education and health care are not … Indeed, the largest sectors by output and employment, and often those with relatively low productivity growth, tend to be the ones lagging in digitization.  … Frontier sectors today have four times the level of digitization of frontier sectors 20 years ago. Yet the rest of the economy continues to significantly lag behind even historical digitization levels of frontier sectors; their level of digitization is only 60 percent that of leading sectors 20 years ago.\”

6) The US economy seems to be less dynamic, in the sense that it is doing a less good job of reallocating jobs and capital away from slower-growth sectors and toward higher-growth sectors. 

\”Productivity growth can increase if the share of employment and output in more productive firms increases even while employment and output fall in less productive firms. However, Decker and coauthors find that such a reallocation is happening to a lesser extent in the post-2000 period, particularly in the high-tech sector, with implications for overall productivity growth. Beyond the decline in overall dynamism, there is evidence that the gaps between high- and low-performing companies are widening. Analysis by the OECD finds growing divergence in productivity levels of global frontier firms relative to others since 2001, which the OECD interprets as a symptom of slower productivity diffusion. According to their analysis, frontier firms have continued to raise their productivity levels. This suggests it is a lack of diffusion of best practices that is driving the slowdown in productivity growth, rather than a lack of innovation of the productivity frontier.  …

\”Likewise, digital trends vary widely across firms. Companies are using digital tools to raise the bar in operational efficiency, customer engagement, innovation, and workforce productivity. But they vary widely in how they are pursuing such opportunities, which could be driving large differences in productivity across firms. A McKinsey survey of 150 large companies evaluated respondents on 18 practices related to digital strategy, capabilities, and culture to arrive at a metric called the “Digital Quotient”. The distribution curve of this quotient reveals a striking gap between the digital leaders and laggards. Putting the above findings together would suggest that while the productivity gap between firms has been widening, the reallocation of labor from less to more productive firms has waned.\”

Leniency in Speeding Tickets: Bunching Evidence of Police Bias

Imagine for a moment the distribution of speed for drivers who are breaking the speed limit. One would expect that a fairly large number of drivers break the speed limit by a small amount, and then a decreasing number of drivers break the speed limit by larger amounts.

But here\’s the actual distribution of amount over the speed limit on the roughly 1 million tickets given by about 1,300 officers of the Florida Highway Patrol between 2005 and 2015. The graph is from  Felipe Goncalves and Steven Mello, \”A Few Bad Apples? Racial Bias in Policing,\” Princeton University Industrial Relations Section Working Paper #608, March 6, 2017. The left-hand picture shows the distribution of the amount over the speed limit on the speeding ticket given to whites; the right-hand picture shows the distribution  the amount over the speed limit on the speeding tickets given to blacks and Hispanics.

Some observations:

1) Very few tickets are given to those driving only a few miles per hour over the speed limit. Then there is an enormous spike in those given tickets for being about 9 mph over the speed limit. There are also smaller spikes at some higher levels. In Florida, the fine for being 10 mph over the limit is substantially higher (at least $50, depending on the county) compared to the fine for being 9 mph over the limit.

2) The jump at 9 mph is sometimes called a \”bunching indicator\” and it can be a revealing approach in a number of contexts. For example, if being above or below a certain test score makes you eligible for a certain program or job, and one observes bunching  at the relevant test score, it\’s evidence that the test scores are being manipulated.  If being above or below a certain income level affects your eligibility for a certain program, or whether you owe a certain tax, and there is bunching at that income level, it\’s a sign that income is being manipulated. Real-world data is never completely smooth, and always has some bumps. But the spikes in the figure above are telling you something.

3) Goncalves and Mello note that the spike at 9 mph is higher for whites than for blacks and Hispanics. This suggests the likelihood that whites are more likely to catch a break from an officer and get the 9 mph ticket. The research in the paper investigates this hypothesis in some detail: if your statistics and modelling tools are all shiny and up-to-date, feel free to check out their argument. They summarize their key findings this way:

\”These racial disparities remain after controlling for an array of stop and driver-level characteristics, including speed limit and stop location, age, gender, vehicle type, ZIP code income level, and prior tickets, which we treat as evidence that, on average, officers behave less favorably towards minority drivers. …  [T]he majority of officers exhibit no bias, with the aggregate disparity in treatment explained by the behavior of a small minority of officers composing about 20% of the patrol force. We also explore how bias varies with officer-level characteristics, documenting that officers exhibit own-race preferences and that younger, female, and college-educated officers are less likely to be biased.\”

4) It\’s common in studies of discrimination and bias that use real-world data to discover confounding factors that make it hard to draw crystal-clear conclusions. In this study, one pattern that emerges is that \”the most lenient officers patrol in counties with the fewest minorities – 47% of the white-nonwhite speed gap disappears without bias or sorting of officers across counties.\” Thus, in considering ways of reducing the bias shown in the data, \”Perhaps most effective and easily implemented, reassigning officers across counties within their troops so that minorities are exposed to more lenient officers can remove essentially the entire white-minority lenience gap.\” Of course, this raises the pointed questions of why officers tend to be more lenient in areas with few minorities, and whether the more lenient officers would continue to be as lenient if they were rotated into areas with more minorities.

5) In the big picture, one of the reminders from this research is that bias and discrimination doesn\’t always involve doing something negative. In the modern United States, my suspicion is that some of the most prevalent and hardest-to-spot biases just involve not cutting someone an equal break, or not being quite as willing to offer an opportunity that would otherwise have been offered.

A Stroll through US Trade Statistics, and How It Always Balances

\”America’s commerce with the rest of the world must be and always is balanced when taking into account investment flows as well as the exchange of goods and services. … [O]ne key insight for public policy is that the total outflow of dollars each year from the United States to the rest of the world is matched by an equal inflow of dollars from the rest of the world to the United States. There is no need to worry about a `leakage\’ of dollars siphoning off demand from the domestic economy. Dollars spent on imported goods and services return to the United States, if not to buy US goods and services, then to buy US assets in the form of an inward flow of investment. … When we account for all the dollars flowing into the United States, with an adjustment for the statistical discrepancy, it totals the exact same amount. The difference between dollars flowing out and dollars flowing in each year is zero.\”

Thus writes Daniel Griswold in \”Plumbing America’s Balance of Trade,\” a paper published for the Mercatus Center at George Mason University. For noneconomist readers, Griswold\’s statements may seem ideological or controversial. For those who needed to learn about trade statistics at some point, his statements are so obviously true–true as a matter of how the underlying terms are defined–that even writing them down feels pointless. To steal a phrase from Alan Walters (who was writing about how Milton Friedman\’s effort to revise monetarism was perceived during the 1950s), it\’s like \”flogging a decomposing horse.\”  Here, I\’ll take a stroll through the US trade statistics for 2016 as published by the US Bureau of Labor Statistics, making heavy use of Griswold\’s explanations. Even for those familiar with basic trade statistics, flogging this particular decomposing horse may offer a few insights or surprises.

Here is the data for 2016 on the US current account and capital account (terms to be explained in a moment) from the US Bureau of Economic Analysis:

Start in the first row, with imports and exports of goods. In 2016, imports of goods exceeded exports by $750 billion, which is sometimes called the \”merchandise trade deficit.\” Griswold breaks this down into categories and notes that most of this trade in goods is about industrial supplies and inputs, not consumer products:

\”The top two major categories of imports were (1) industrial supplies and materials and (2) capital goods except automotive goods. Together they account for 54 percent of US merchandise imports. Consumer goods account for 24 percent more, and automotive vehicles, parts, and engines were 13 percent of imports. … On the export side, the biggest inflow of dollars from abroad was to buy US industrial supplies and materials, followed by capital goods (except automotive goods); together they account for almost two-thirds of US exports. Consumer goods accounted for another 12 percent, and automobiles and auto parts for about 10 percent.\”

In the category of services, the US ran a trade surplus in 2016 of $249 billion. Tourism is a major industry in the international trade of services: for example, a German tourist visiting the US is the economic equivalent of an export, because someone from another country is buying hotel and travel and tourist services produced in the US. Again, here\’s the breakdown from Griswold:

\”The largest outflow of dollars for services was from Americans traveling abroad: 82 percent for personal travel and the rest for business travel. The next-largest category was “other business services,” which includes business and management consulting and public relations, as well as technical services such as architectural and industrial engineering. A close third for spending on imported services was transportation, primarily ocean freight and air passenger services.10 On the export (credit) side of the services ledger, the largest inflow of dollars was also generated by travel, three-quarters for personal travel to the United States, including travel for education. The next largest generator of inflowing dollars was charges for the use of intellectual property, chiefly for industrial processes, computer software, trademarks, and movies and television programming. Close behind were other business services, primarily business and management consulting and public relations services, research and development (R&D) services, and technical services. Other major service exports are transportation, with almost half of the dollar inflow generated by air passenger services, and financial services such as financial management and credit card and other credit-related services.

Economists also view income from investments made in other countries as a form of trade. Instead of someone from another country buying a good or service, they are paying for the use of US investment capital. As Griswold points out, an interesting pattern here is that the absolute size of foreign investment in the US economy is bigger that the absolute size of US investment in other countries, but the investment income received by US investors is larger that the investment income received by foreign investors. The underlying reason is that foreign investors are more likely to turn to the US markets for fairly safe assets, with a correspondingly low rate of return, while US investors are more likely to take on risk when investing abroad, for which they are compensated with a higher return. Griswold writes:

\”Americans earn a surplus on investment income even though the stock of foreign investment in the United States is about one-quarter larger than the stock of what Americans own abroad. Across all categories of assets, Americans earn a higher rate of return on their overseas investments than foreigners earn on their investments in the United States. In total investment returns, Americans earned 3.3 percent annually on the annual average of $23.4 trillion in assets they owned abroad during the 2011–2015 period. They earned 7.2 percent on their direct investments, 3.2 percent on portfolio investments, and 0.4 percent on all other investments abroad, including bank deposits and loans.15 Compare that to the more modest 1.9 percent that foreign savers earned each year on the stock of $29.1 trillion they owned in US assets on average for each year during the same period. They earned 3.2 percent on their direct investments, 2.4 percent on portfolio investments, and 0.2 percent on all other investments—all lower returns than Americans earned on their overseas investments in the same class of assets. We see the financial and capital accounts offering the same win-win benefits of trade as the current account. Foreign savers are willing to settle for a lower return on their investments in the United States in exchange for the security and liquidity offered by the US capital markets. American savers, in turn, are able to realize greater returns on their investments in exchange for their willingness to take more risk in overseas assets.\”

The category of unilateral transfers refers to both government and private transfers, including foreign aid, charitable donations that cross borders, and remittances that workers in one country send back to family and relatives in another country. Griswold gives details:

\”Year after year since World War II, the United States has unilaterally sent more goods, services, and assets (or their dollar equivalent) abroad than it has received. The one exception was 1991, when the United States received more than $30 billion in contribution payments from allies in the Gulf War, tipping unilateral transfers to a surplus. In the half decade of 2011–2015, the United States sent an annual average of $252 billion abroad in unilateral transfers and received $121 billion, for an annual deficit of $131 billion. More than three-quarters of the outflow of dollars was for private transfers, chief among them insurance-related transfers; withholding taxes paid by US companies; charitable donations by US entities; and remittances, which are personal transfers from US resident immigrants to foreign residents. The rest of the unilateral transfers were US government transfers, primarily nonmilitary and military assistance provided to foreigners in the form of goods, services, or cash under programs enacted by the US Congress. Other government transfers include Social Security and retirement benefits paid to former US residents who live abroad, and contributions to international organizations and commissions to meet the financial obligations of membership and to fund United Nations peacekeeping operations. The smaller inflow of dollars for unilateral transfers is also mostly private receipts. According to the US Department of Commerce, the private inflow consists primarily of insurance-related transfers; pensions and benefits received principally from Canada, Germany, and the United Kingdom; antitrust-related class-action lawsuits; and remittances received by US residents. The rest of the transfers come to the US government primarily in the form of withholding taxes received and fines levied by US government agencies.\”

Add these four lines up, and you get the \”current account balance,\” which is clearly a broader view of the US balance of trade than just looking at the merchandise trade deficit. In 2016, the US had a current account deficit of  -$481 billion.

But the current account balance is still only a portion of the overall picture. It captures flows of goods and services, investment income and unilateral transfers, but it doesn\’t include actual flows of investment themselves. This portion of the statistics on international transactions is called the \”capital account.\” As a matter of definition and logic, the current account and the capital account are yin and yang, inteconnected and interdependent. When an foreign exporter sells in the US, and earns US dollars as a result, there are only two possible ultimate uses of those US dollars: either they are used to purchase dollar-denominated goods and services, or they are invested in a US-dollar denominated asset. Of course, the foreign exporting firm that earns the US dollars may not take these actions itself: it may just trade the US dollars for its home currency in foreign exchange markets. But the party that ends up with these US dollars must make the same choice of either buying US products or investing in US financial assets. Of course, this same process operates when US exporters sell in other countries and earn foreign currency.

The result of this pattern is that any current account deficit is always matched by a capital account surplus, and vice versa. As the quotation at the start said: \”\”America’s commerce with the rest of the world must be and always is balanced when taking into account investment flows as well as the exchange of goods and services …\” So what are these capital account flows for the US economy?

In looking at the different forms of capital account flows, it\’s important to notice that each one is described as a \”net\” flow. When it comes to international investment in stocks and bonds, for example, there are enormous amounts of \”gross investment\” thundering around the world every minute of every day. The capital account measurements don\’t measure these gross flows of capital; instead, they measure at the end of a given time period (a quarter or a year) how the overall size of these investments has changed. If the inflows and outflows of investment capital balance each other, the gross flows can be very large while the net flow is zero.

Direct investment refers to a situation where the investor has a substantial degree of input into the management of the asset. As Griswold emphasizes, foreign direct investment by US firms, or FDI, is typically a way for US firms to expand their sales in foreign markets:

FDI occurs when a foreign investor acquires a controlling interest in the affiliate—defined as an equity stake of 10 percent or more. The gross flows of FDI are far smaller than portfolio investment because FDI investments are longer term, but FDI is hugely important because it represents not only a transfer of capital but also of management expertise and technology. … Contrary to a popular perception, US companies do not locate productive operations abroad primarily to export products back to the United States but instead to reach more customers abroad. A presence in the local market can help US affiliates refine their final products to meet local demand, to reduce transportation costs, and to better protect their brand name and intellectual property. Many types of services cannot be exported but must be delivered in the local market. In today’s global economy, US companies sell far more of their branded goods and services through foreign-based affiliates than by exporting from the United States. In 2014, US-owned affiliates supplied $4.49 trillion in goods to foreign customers compared to $1.63 trillion in exported goods. That same year, US-owned affiliates provided $1.66 trillion in services to foreign customers compared to $743 billion in services exports.29 That means that US producers earn almost three times more from the sale of goods through their affiliates abroad than they do by exporting from the United States, and they earn more than twice as much from the sale of services. Goods and services produced abroad by US-owned affiliates are overwhelmingly sold abroad. Of the more than $4 trillion in goods that foreign-owned affiliates supplied in 2014, 8 percent were sold as imports to the United States while 92 percent were sold in the host country or in third countries.

Here\’s Griswold explaining the next category of portfolio investment, where the US outflow declined substantially from the previous few years: 

\”The financial account measures transactions for portfolio investment, which is passive, noncontrolling ownership of common stocks, bonds, or Treasury bills; for bank deposits or direct loans; and for direct investment, which involves the direct control of an asset by the investor. … Portfolio investment is defined as cross-border transactions and positions involving debt or equity securities other than those included in direct investment or reserve assets held by central banks. In the half decade of 2011–2015, foreign investors increased their holdings of US portfolio securities by an average of $504 billion a year, while American investors increased their holdings of foreign securities by an average of $310 billion, for a net annual inflow of $194 billion. Of the annual inflow of portfolio investment, 90 percent flowed into US debt securities, such as Treasury bills, and the rest flowed into equities, such as stocks and mutual funds. Of the annual outflow of portfolio investment, two-thirds flowed into foreign equity investment and one-third into debt securities.\”

The other substantial category  here is \”other,\” which as Griswold explains is mainly bank deposits and loans. There are also categories for financial derivatives and central bank reserve assets:

Another category of financial flows includes the sale of assets not included in portfolio investment or direct investment. The major sources of these flows are bank deposits and loans. In the 2011–2015 period, the average annual net inflow of dollars for deposits in US institutions or principle for loans from overseas was $42 billion—with a large inflow for bank deposits partially offset by an outflow for loan principle. The net annual outflow of dollars from the United States for loans and deposits during that same period was a negative $218 billion, which represents a net withdrawal from deposits that had been made abroad. That means that a pipe that would normally be expected to carry dollars from the United States to banks and other institutions abroad instead carried a net flow of dollars back to the United States during 2011–2015. Other categories of financial flows outside portfolio and direct investment are financial derivatives and reserve assets. Financial derivatives are instruments whose value is linked to the prices of underlying items, such as an asset or index. In the 2011–2015 period, an average annual net of $21 billion flowed out of the United States to buy financial derivatives. Reserve assets are cross-border assets that are generally owned by monetary authorities for direct financing of payment imbalances. These transactions are a small part of the overall balance of payments, averaging a net annual $1.5 billion in outflows in 2011–2015.

Taking these together, the US ran a capital account surplus of $406 billion in 2016. Conceptually, the capital account surplus should equal the current account deficit. But in the real world, the actual data on trade in goods and service, investment income, transfers, ownership of portfolio assets, foreign direct investment, and international bank accounts all come from different sources, and so it\’s no surprise that they don\’t match up directly. There\’s always a \”statistical discrepancy\” as shown in the table. Griswold explains:

\”The most likely categories contributing to the errors and omissions involve trade in services, delays in payments between reporting periods, interest and dividend receipts, and the temptation companies face to understate the value of exports or to overstate the value of imports in order to reduce tax liability. … In the 2011–2015 period, the average annual net inflow of dollars through the capital account was $1.5 billion and the average net outflow was $0.5 billion. … Statistical discrepancies were a small 1.5 percent of total annual inflows during 2011–2015.\”

I won\’t dive into the arguments about the causes and effects of current account trade deficits or capital account surpluses here. My point here is just that these categories are all inextricably interrelated, and any serious discussion of US international transactions needs to show some awareness of this entire picture.