Month: January 2023

“Quantitative easing” is the name given to when the Federal Reserve buys debt directly–typically debt issued by the US Treasury or mortgage-backed debt that is guaranteed in some way against default by the federal government.

This policy has various rationales. For example, during the Great Recession of 2008-9, there was fear in the markets that, as housing prices fell, mortgage-backed debt would be worth much less. Because many banks and financial institutions held such debt, a drop in the value of that debt risked making a number of financial institutions insolvent. In this setting, Fed purchases of such debt soothed the markets and prevented panic. In addition, quantitative easing can be viewed as a way for a central bank to stimulate the economy, when the central bank had already pushed down its main policy interest rate to nearly zero percent. The idea here is that when the Fed can’t reduce interest rates any further using conventional policy channels, it can still keep interest rates lower than they otherwise would have been by purchasing debt directly and then holding it.

However, a series of quantitative easing policies over time mean that the central bank ends up holding a lot of debt. Back in 2007, for example, the Federal Reserve held about $900 billion in total financial assets, which in terms of a central bank was thought of as a fairly basic amount for carrying out its functions. After three round of quantitative easing in 2008, 2010, and from 2012-2014, the Fed had about $4.5 trillion in assets by the end of 2014. But then the Fed carried out a fourth round of quantitative easing, QE4, during the pandemic, and total Fed assets went from $4.1 trillion at the start of 2020 to almost $9 trillion by March 2022.

The rationale for QE4 at the the start of the pandemic in March 2020 was straightforward. For a few days that month, there was turmoil in the markets for US Treasuries, there was a short period where the market for US Treasury debt seemed to stop operating well. Darrell Duffie described it this way:

The market for U.S. Treasuries has long been viewed as the world’s most liquid and deepest financial market. That presumption was questioned when the COVID-19 crisis triggered heavy investor demands for trading that overwhelmed the capacity of dealers who usually serve as middlemen in this market. Over several tense days in March [2020], yields rose sharply, calling into question the longstanding view that Treasuries are a reliable safe haven in a crisis. Bid-offer spreads widened dramatically, the yields of similar-maturity Treasuries were no longer close to each other, and the number of failures to settle jumped. Although the Fed, through an unprecedented quantity of Treasury purchases and other actions, was able to restore market liquidity, the episode revealed the Treasury market to be overdue for an upgrade.    

But although there were obvious reasons for QE4, both in terms of salving the world roiled financial markets and in terms of supporting the US economy during a very uncertain time, holding debt has risks. In particular, if you own a lot of debt that pays a low interest rate, and then interest rates go up, you are locked into that lower interest rate and the value of the debt declines. This is the opposite effect, for example of being a mortgage-holder who locked in a low interest rate before the pandemic, and now has the advantageous position of paying off that mortgage in a situation where current interest rates are much higher. Andy Levin and Bill Nelson provide an overview of the financial losses of the Fed as a result of building up a portfolio of debt paying low interest rates at a time when interset rates have now risen, in The Federal Reserve’s Balance Sheet: Costs to Taxpayers of Quantitative Easing (Mercatus Center, George Mason University, January 10, 2023).

One way of looking at this situation is that the Fed is receiving a relatively low interest rate from its past asset purchases of debt. However, the main mechanism that the Fed uses to raise interest rates is to pay a higher interest rate to banks on the reserves that banks hold at the Fed–and so the Fed’s financial position is much worse. Another way to look at the situation is to figure out how much the value of the Fed’s low-interest debt would be diminished if the Fed had to sell that debt in today’s market of higher interest rates. Levin and Nelson calculation that the Fed assets have declined in market value by about $760 billion.

As I noted already, there were reasons for the burst of QE4 in 2020. But there was apparently little attention paid to the risk that the higher interest rates would cause the value of the Fed’s debt to fall. Levin and Nelson call the process “opaque and inertial.” For example, if the Fed had originally announced that QE4 was a short-term step to calm markets during a time of turmoil, and then moved ahead to sell of that US Treasury debt when financial markets stabilized by summer of 2020, it could have been holding trillions less in low-interest assets by 2021.

But at least as far as I can tell, the Fed didn’t consider such a policy, because in 2020 the Fed wasn’t expecting interest rates to rise. After all, inflation rates don’t start rising until April and May 2021. Before that, and even for awhile after that, the Fed was focused on keeping interest rates low to support the economy as the pandemic evolved. Thus, the Fed seems to have just flat-out missed the risk that it would be holding a lot of debt paying lower interest rates at a time when interest rates would rise.

The usual pattern for the Fed is that it is self-funding–and in fact, it passes along about $100 billion per year to the US Treasury. However, because of the financial losses the Fed has incurred on its assets, Levin and Nelson write: “The Fed will absorb that cost by completely suspending its remittances to the US Treasury for the next five years and paying minimal remittances in subsequent years. The Fed’s remittances would have exceeded $100 billion per year throughout the coming decade if QE4 had not been conducted.” In that sense, it looks like the decision of the Federal Reserve not to hedge against the risk of higher interest rates–for example, by selling off a substantial share of its QE4 assets by early 2021–will contribute to bigger budget deficits for years to come.

There is a long-standing argument that states should be viewed as “laboratories of democracy,” and thus we should welcome–at least to some extent–variations in policy choices across states. It’s a chance to learn from experimentation.

The table that follows is a list of how state legislators are compensated across the 50 states, as compiled by the National Conference of State Legislatures. It would be unwise to jump to quick conclusions from the table. After all, states vary dramatically in size, population, and the responsibilities and time commitment they expect from legislators. That said, some of the differences are notably large. Presumably, the financial incentives offered to state legislators will influence, at least to some extent, both willingness and financially ability to run.

In California and New York, the “base salary” for a state legislator is over $100,000 per year. (Many states have additional pay for state legislators, often based on their particular responsibilities.) California is the #1 state by population, and New York is #4, so one might expect the pay for their legislators to be fairly high. However, Texas and Florida are the #2 and #3 states by population, and Texas legislators have base pay of $7,200 while Florida legislators are at about $30,000 in base pay. Some states pay by the days the legislature is in session, often at a rate of $100-$300 per day. New Hampshire and New Mexico have a base pay of essentially zero. It seems clear that in most states, the expectation is that most state legislators will not rely on their payments from the legislature as their only source of household income–but the variation across states is wide.

Most states have a travel reimbursement of about 58.5 cents/mile, tied to the federal reimbursement rate. But New Jersey has no mileage reimbursement, and Massachusetts instead has an “office expense stipend” of at least $17,000 per year that can be used in part for travel expenses as well as per diem costs when the legislature is in session. The last column shows session per diem rates across states.

The 20 countries of the Middle East and North Africa region have a population of 486 million, a combined GDP of $3.7 trillion, and a GDP per capita of about $7,600. The questions of politics and armed violence in this region, along with details of how COVID has affected this area, are both obviously important and also beyond my ken. Here, I focus on some of the economic issues that caught my eye in two recent overview reports.

One report is the Arab Human Development Report 2022: Expanding Opportunities for an Inclusive and Resilient Recovery in the Post-Covid Era (United Nations Development Programme, June 2022). The other is Promoting Inclusive Growth in the Middle East and North Africa: Challenges and Opportunities in a Post-Pandemic World, a collection of eight essays edited by Roberto Cardarelli, Mercedes Vera-Martín, and Subir Lall (International Monetary Fund, October 2022).

The Arab Human Development Report describes the fundamental economic challenge in a straightforward way:

Few Arab States have competitive private sectors, particularly for tradables, and the economies that are based on oil and gas are subject to highly volatile prices. The productivity of labour, much of it informal, is relatively low. The capacity of government institutions is generally weak. This persistent equilibrium of low growth–low productivity–low employment–low institutional capacity emerges from a social contract based on a deep-seated rentier state that favours the status quo and rejects truly transformative economic reforms.

The region’s well-known economic fragilities are not destiny, however. They can be corrected with a strong human development approach to tackle the region’s long-term structural challenges. Five priorities stand at the top of the agenda. First is to diversify and transform the Arab States region’s economies to reduce exposure to commodity cycles and macroeconomic volatility. Second is to boost growth to generate decent jobs for poor people and informal workers and for new entrants to the labour force. Third is to improve the investment climate and level the playing field for businesses, large and small, and investors, domestic and foreign. Fourth is to increase access to finance for women and smaller enterprises. And fifth is to pursue regional economic integration to expand markets and deliver regional public goods.

Both economic output and investment for the region continue to be dominated by the oil and gas industry. But that industry tends to be capital-intensive, rather than job-intensive. Thus, these economies have not had great success in creating formal jobs outside this sector. Again, from the AHDR:

Structural challenges in the labour markets of the Arab States region stem primarily from the strong divide between “good” formal jobs in both the public and private sectors and “bad” informal jobs in the private sector. This duality has been a direct consequence of the social contract adopted from the 1950s through the 1970s, based on a state-led model of industrialization. The resulting role of the public sector, including both government administration and state-owned enterprises, entrenched the preference for public employment due to its higher wages and nonwage benefits. This social contract began to fray in the 1980s, following exchange rate and budget crises that forced most oil-importing middle-income countries and fragile and conflict-affected countries to move towards neoliberal models of economic development.

The gradual decline of formal public sector employment in subsequent decades was not matched by an increase in formal private sector jobs, leaving new entrants to the labour market at a considerable disadvantage to older cohorts. … The collapse of the social contract has resulted in increased unemployment, as educated workers wait for good jobs, particularly in the public sector. … At 25.3 percent in 2019, unemployment has been particularly high among young people. Youth unemployment in Northern African countries was the highest in the world in 2019, at about 26 percent, and followed by the Arab Middle East, at about 23 percent. … Even more concerning, the share of young people in informal employment reached 87.8 percent in countries with data … The region has the world’s widest gap between young people and adults in formal employment, reflecting the deteriorating labour market conditions for young people, who face increasingly more difficult school-to-work transitions. … Young people who enter the labour market in informal jobs rarely transition to formal employment, regardless of education or experience.

In the IMF volume, Suchanan Tampbunlertchai, Monica Petrescu, and Mahdi Ansari dig into these issues in their chapter on “Fostering Private-Sector- Led Growth in the MENA Region: A New Role for the State.” They write:

The MENA region is at an important crossroad as the state- led growth strategy has begun to reach its limits. In the coming decade, over 100 million people will enter the MENA workforce. Meaningful jobs are vital for their inclusion in economic activities, ensuring their livelihoods, and preserving the social fabric. Strong state involvement may have been a mechanism for nation building in the MENA region in the past, but stagnating growth, high unemployment, and increased inequality in the region point to the need for a different strategy. The average annual total factor productivity growth during the last 10 years has been negative for many countries in the MENA region, and particularly low for oil producers …

Their discussion focuses on possible reforms that would affect state-owned enterprises in the region, many of which are gentle-sounding and obviously hard to do. For example, they suggest that state-owned firms publish financial reports on a regular basis and separate their commercial and non-commercial activities. “It is also important to subject SOEs to the same laws, regulations, and tax provisions that apply to their private sector counterparts, (including on public procurement).” They suggest clarifying red tape and rules, in part because it will reduce the scope for corruption and bribery: “Corruption also favors publicly owned firms: a third of private firms in the MENA region report being expected to give bribes to secure government contracts (compared to less than 10 percent of SOEs [state-owned enterprises]); and one in five private firms (vs. one in nine SOEs) are expected to give gifts to public officials for regular activities.” They suggest that improved access to banking and finance for private firms could matter a lot. They emphasize that a broad-based investment in transportation and communications infrastructure would have substantial spillovers for private firms.

In their chapter, Sidra Rehman and Agustin Velasquez discuss “The Changing Nature of Work: Improving the Functioning of Labor Markets. They point out:

The acceleration in automation and remote work presents both challenges and opportunities for the MENA region in the years to come. We find that its labor force is relatively more vulnerable to automation compared to other regions, but with differences varying across skill, gender, and sector. The overall vulnerability is attributable to the dominance of sectors such as construction and manufacturing—all of which are performed largely by occupations that tend to be routine and noncognitive in nature. The MENA region has not pivoted away from high levels of employment in low- and medium-skill occupations, which tend to be routine and nonanalytical in nature. This reliance is even more prominent in the private sector—a feature that may limit the region’s dynamism.

These authors suggest improving education levels, especially by thinking seriously about the sorts of skills employers of the region will need, along with moving labor regulation in more flexible directions. At present, the region is not especially well-prepared to shift to participate in the global markets for providing services digitally.

The practical and political difficulty of the transitions described here cannot be overstated. But it seems extraordinarily unlikely that the current path of the oil-and-gas industry, state-owned enterprises, and direct government employment can be the primary source for the future jobs that demographic trends tell us will be needed in this region.

The idea that if society invests in small children, we will see a later social payoff, has a powerful intuitive and humanitarian pull. But what about hard evidence? For example, can we trace a randomly distributed set of benefits given to small children and see evidence of payoffs for those children in later life, compared to the children who did not receive such benefits? The research challenges here are considerable, and a group of studies are beginning to meet them.

As a recent example, consider “Investing in Infants: The Lasting Effects of Cash Transfers to New Families,” by Andrew C. Barr, Jonathan Eggleston and Alexander A. Smith (NBER Working Paper 30373, August 2022). The authors look at tax data going back to 1979. In particular, they look at low-income families having first children in either December or January. The difference is that families with children born in December are eligible for an additional tax deduction and a higher earned income tax credit the following year. For these families, the additional benefits averaged about 10% of household income. If we make the plausible assumptions that the babies born in December are not fundamentally different than those born in January, and that the groups of families are otherwise similar (remember, they are eligible for the same programs), we then have what social scientists call a “natural experiment.” Do the children whose families got the extra income boost during their first year of life do better later in life?

The figure illustrates some of the results. Those children whose families received the additional tax benefit in their first year of life earned more as 26-28 year-olds.

The results over time can be summarized this way: “The additional earnings generate an increase in federal income tax revenues large enough, in present discounted value, to cover the cost of the higher tax credits for parents with newborns.”

Anna Aizer, Hilary Hoynes, and Adriana Lleras-Muney offer an overview of research in this area in “Children and the US Social Safety Net: Balancing Disincentives for Adults and Benefits for Children” (Journal of Economic Perspectives, Spring 2022). They emphasize that, in the past, studies of benefits for low-income families with children tended to focus on how the work incentives of adults might be affected, but often had little or nothing to say about possible long-run benefits from supporting the children in such families.

For example, when the food stamp program was first being enacted in the 1960s, it was not enacted everywhere at once, but instead was rolled out across different counties from 1961 to 1974 in an essentially random way. Thus, some low-income children were randomly born into counties where their families received food stamps, and others were not. Developments in the availability of long-run data make it possible to compare across these groups. Aizer et al. write: “They find that access to food stamps in early childhood leads to increases in completed education, earnings, neighborhood quality, and home ownership as well as reductions in poverty, mortality, and incarceration. In both these studies, the gains are large and increasing in length of exposure between conception and age five, after which there appear to be few effects, suggesting that early childhood may be a sensitive window for nutritional inputs.”

Indeed, an overview of 133 different policy interventions, looking at different age groups, found considerable variation in the effects (Nathaniel Hendren and Ben Sprung-Keyser. 2020. “A Unified Welfare Analysis of Government Policies.” Quarterly Journal of Economics 135 (3): 1209–318). Not everything works well! But when looking at programs for children as a group, spending on child education, child health, and improved college access all ultimately paid for themselves in terms of higher future tax revenues–and this measure leaves out benefits like improved health and lower crime rates that do not directly manifest in the form of higher income earned and tax revenues paid.

Small children don’t have a high public profile. They don’t march in political demonstrations. They don’t vote. They lack power to shape their daily environment. Moreover, the parents of small children are often suffering from a lack of time and sleep, and it’s probably not the most flexible period of their life to devote energy to political activism. But what happens to young children has lasting life effects. As one current policy choice, the Child Tax Credit for low-income families was dramatically expanded during 2021, by enough that the share of children living in households below the poverty declined by one-third. The existing evidence from earlier studies strongly suggests that the additional costs of this program will be repaid in higher tax revenues over time. Greater equality of opportunity for young children pays off.

In addition, there has been a past tendency among economists to look at policies which have an affect on children primarily in terms of how those policies affect parents. For example, discussions of policies like welfare payments or food stamps often focused on how they might affect work or marriage incentives for parents–not on how they affected the long-run prospects of young children.

Yes, “complexify” is an actual word; it’s the opposite of “simplify.” Current discussions of US antitrust policy often refer to a “before” and an “after.” A common fable goes that in the “before” from the 1930s up through the early 1970s or so, zealous antitrust regulators protected the public interest. But then, a group of recalcitrant free-market academics led a movement to toss out the wisdom of the past, and instead allowed big business to flourish unfettered and unafraid. Now, a brave but embattled group of reformers is struggling to reestablish the old wisdom of protecting consumers from big firms.

However, this fable is oversimplified to the point of deceptiveness. Brian R. Cheffins seeks to complexify the simple before-and-after narrative of how US antitrust enforcement has evolved in “Getting Antitrust and History in Tune” (Accounting, Economics, and Law: A Convivium, published online March 2, 2022, forthcoming in a print edition someday).

An earlier, shorter version of the Cheffins essay appeared in the Winter 2021 Business History Review. I wrote about that version last February, and there’s no need to repeat those points here. Here, I’ll just emphasize that both in the “before” and “after” period, and up to the present day, the issues of how to deal with large dominant firms and assuring that consumers will benefit from competitive market are typically more complex than “nuke ’em from orbit until the rubble bounces.” That certainly wasn’t the common policy during the “before” period up to the 1970s, and it’s unlikely to be a useful answer to the dominant digital firms of today.

Even at a quick glimpse, thinking of the “before” period as one where the antitrust authorities fearlessly confronted and broke up dominant firms was clearly untrue. If one looks back to the Fortune 500 list of largest companies in, say, 1960, you find the US auto industry dominated by General Motors (#1 overall on the list), Ford (#3) and Chrysler (#9). The US steel industry is dominated by US Steel (#5) and Bethlehem Steel (#13). The US oil industry was dominated by Exxon (#2), Mobil (#6), Gulf Oil (#7), and Texaco (#8). Government-regulated AT&T (#11) provided nationwide monopoly phone service. General Electric (#4) dominated in a swath of industries including appliances, engines, and turbines, while DuPont (#12) dominated in chemicals.

Such examples could easily be multiplied, as some social critics pointed out. As one prominent example, John Kenneth Galbraith published a best-seller called The New Industrial State in 1967, which basically argued that the United was no longer a free market economy, but instead had become dominated by large corporations who used advertising to determine consumer demand. Clearly, antitrust actions during this era were not preventing huge and dominant firms. Indeed, many people today now look back on those large companies–the well-paid jobs they provided, the products they produced at that time, and the global technological leadership they represented–as an American success story of that period.

The primary critique of antitrust authorities of that time was not that they were too aggressive with large firms, but that they combined being often too cozy with large regulated firms, helping those firms to avoid new entrants and keep prices high and while being weirdly interventionist with small mergers: for example, the 1966 Supreme Court case of United States v. Von’s Grocery Co. (384 U.S. 270) held that antitrust authorities could block a merger between two US grocery store chains that, combined, would have had 7.5% of the Los Angeles grocery market on the grounds that if there were many additional mergers between many other grocery store chains, the end result of this process of many hypothetical mergers would be anticompetitive. Indeed, in the late 1930s a number of states passed tax legislation that would have had the effect of making any chain grocery stores uncompetitive, and parallel legislation was introduced in the House of Representatives.  A common view of the time was that the role of antitrust was not to assure that consumers received the benefits of competition, but that in certain industries traditionally dominated by small and less-efficient producers, the existing firms deserved legal protection from entry by larger and more-efficient producers.

In the modern economy, perhaps the most publicized antitrust issues involve dominant digital technologies. It’s not obvious to me that these should be the main antitrust issues: for example, the lack of competition in provision of home internet service, or the lack of competition in smartphone platforms outside the Android/Apple duopoly seem potentially more important. But big companies (deservedly) attract big attention, and there has been a wave of essays in the last few years about how or whether antitrust authorities should be confronting these firms (for some previous posts, see here, here, and here). Luigi Zingales offers a nice overview of the central tradeoffs and issues in “Regulating big tech” (December 2022, Bank for International Settlements, Working paper #1063).

Zingales emphasizes that the dominant digital tech companies display strong economies of scale and scope. These arise because once a firm has dealt with the high entry costs of becoming established in the digital world, and made the investments both in physical capital as well as in intangible capital from software to brand names and the support structures behind them, then serving some additional customers has a near-zero cost. Moreover, these firms often have network effects–that is, a major reason for new users to sign up with the existing firm is that previous users have already signed up. As a result, large digital firms can often provide services at lower cost than new entrants (“economies of scale”), can often expand this range of services relatively cheaply (“economies of scope”), and are protected from new entrants by the size of their existing operation (“network effects).

It’s certainly not impossible for new entrants to come along with a different approach to gaining digital customers, or for dominant firms to make strategic errors that make them unattractive to enough of the existing base that it opens the door for new entrants. But still, new entry may be hard. And when you add the issues involved with collecting and reselling user information, the potential for such firms to take advantage of their entrenched position becomes a real one. As Zingales writes:

Given these characteristics, digital markets are prone to become highly concentrated. With sufficient heterogeneity in preferences (e.g. teenagers prefer not to be on the same social network as their parents), the resulting market structure is an oligopoly, not necessarily a monopoly. In the presence of this tipping tendency, the competitive process shifts from competition in the market to competition for the market. In that case, consumers may only benefit from competition among several firms for the relatively short time period in which the firms compete to be the ultimate winner of very large economic profits.

Not only do consumers only benefit from competition for a very short period of time, the nature of that competition is often very different from the standard one and ends up hurting consumers rather than benefitting them. The assumption that competition is beneficial to consumers obtains in a setting where competition takes the form of products of similar quality offered at lower prices or products offered at the same price but with higher quality. In markets prone to tipping, however, firms have powerful incentive to disadvantage a competitor, because the positive feedback loop described above can turn a small temporary advantage into a large and permanent one

Zingales emphasizes that all of this has global and geopolitical dimensions. Governments would like to have “national champion” digital firms, rather than relying on a provider from another country. Governments also focus on issues of data control: say, over data on financial transactions, or data that might influence public opinion about the government and its actions.

What might be done? Zingales, like all serious observers of this subject, emphasizes that the economic issues like economies of scale and scope, along with network effects, are real issues and provide real benefits to consumers. If consumers lived in a world with, say, 100 different versions of Amazon or Facebook or Google or Apple, these mini-versions of the existing firms would find it much more costly to provide the same services, much harder to expand the range of services they offer, and users would potentially suffer a loss of network effects. For these reasons, the simplistic “break ’em all up” logic is not applicable here. Instead, Zingales sketches a different direction for the antitrust authorities–based on “interoperability” and more data-sharing.

To understand the idea of interoperability, consider the situation of someone using their smartphone to get a ride. The person might click on a cab company, or Uber, or Lyft, or some other option. The individual companies all operate separate portals. But antitrust authorities could require interoperability: that is, if you click on “Need a ride?” then you automatically see all the immediate options from any provider. You can then click on whatever one you prefer–the point is just that you get to see all of them. One can imagine similar rules about ease of posting to different social media sites.

For the idea of additional data-sharing, the key tradeoff is that there are positive and negative externalities from data-sharing. For example, sharing information about traffic flows can help minimize traffic jams; sharing information about web searches can provide quick information about whether a virus is spreading in a local area; and sharing genetic information can even help cure diseases. On the other side, sharing information can involve loss of individual privacy, as well as potential costs of misinformation. Different people and countries may weigh these tradeoffs very differently: for example, in Norway all individual tax returns are public information–an idea that seems quite unpopular in other countries. Zingales suggests that we explore methods of making data on broad groups as broadly and publicly available as possible–after taking strong steps to protect individual privacy. His notion is that this step would remove the benefits to a dominant digital firm from hoarding data, and would also encourage the entry of new firms with innovative ways to use the data.

The ideas about interoperability and data-sharing are only lightly sketched in this paper, and I put them forward more in a spirit of discussion than as hard-and-fact policy recommendations. But these kinds of ideas offer a starting-point for getting beyond reflexive anti-bigness–and beyond myths about past antitrust approaches–and instead move us toward thinking about what rules might help to structure digital industries in ways that improve the benefits for consumers.