Some Economics of Pharmacy Benefit Managers

It is a common belief, applicable across many different kinds of markets, that if you could just “cut out the middleman” and “pass the savings along to consumers,” everyone would be better off. Pharmacy benefit managers are quintessential middlemen. Thus, when it comes to addressing high drug prices, going after them has considerable political appeal. Matthew Fiedler, Loren Adler, and Richard G. Frank offer some useful background in “A Brief Look at Key Debates About Pharmacy Benefit Managers” (Brookings Institution, September 7, 2023).

What do pharmacy benefit managers (PBMs) do? The authors put it this way:

A PBM is an entity that administers a health insurance plan’s prescription drug benefit. One core function of a PBM is to negotiate drug prices with manufacturers; when negotiating prices, a PBM generally offers a drug a place on the plan’s “formulary” (which specifies which drugs the plan covers and on what terms and, thus, determines how much enrollees use the drug) in exchange for below the
manufacturer’s “list price.” PBMs also negotiate with pharmacies, generally offering the pharmacy a place in the plan’s network (which increases how many of the plan’s enrollees use the pharmacy) in exchange for accepting specified prices to dispense drugs. And PBMs perform administrative functions, notably processing pharmacy claims. Most of these functions (e.g., setting coverage terms, negotiating prices, establishing networks, and processing claims) parallel functions that insurers perform for non-drug benefits, but PBMs’ specialized knowledge of drug markets may allow them to perform them more effectively.

Who are the main PBM companies? Here’s a list. Note that about 75-80% of all claims are handled by three companies.

The list probably oversimplifies the role of PBMs. As the Brookings authors note, the PBMs are typically integrated with major health insurance companies. Here’s a chart showing major health insurance companies across the top, and who they use as PBMs for various purposes below.

What are the specific complaints against PBMs? Given that the big three control a huge share of the market, there is concern that the lack of competition might give them power to raise prices. Some concerns are more detailed. “The prices that PBMs charge payers for pharmacy claims often differ from the prices that PBMs pay the pharmacies that fulfill those claims,” so there is a “spread” that might be reduced. Sometimes, the rules that require patients to share costs for a certain drug are calculated in a way that is based on the original price of the drug, not on the discounted price negotiated by the PBM. When there is a manufacturer rebate for use of a certain drug, this money can sometimes flow to the PBM, rather than directly to patients. Overall, the notion is to find a way to squeeze these middlemen, and get lower drug prices for consumers as a result.

In their essay, it seems to me that Fiedler, Adler, and Frank are managing expectations about how much this approach is likely to achieve. For example, they point out: “Pre-tax operating margins for the three largest PBMs averaged a bit more than 4% of their revenues in 2022. Since PBMs’ revenues encompass both the
administrative fees charged to PBMs and payers’ net payments for claims, this implies that even completely eliminating PBMs’ margins would only modestly reduce payers’ drug-related costs.”

The potential cost savings from some of the steps being discussed are uncertain. For example, if you favor more competition among a larger number of PBMs, it’s important to recognize that a bigger PBM has more negotiating leverage. If you are in favor of the US government using its considerable financial clout to negotiate lower drug prices for Medicare and Medicaid patients, you understand the principle that a small-scale PBM will have less leverage when negotiating with pharmaceutical producers and with pharmacies than a larger one. It turns out that PBMs on average retain about 9% of rebates from manufactures, so reducing this to zero percent will not have much effect on final prices.

As in most economic discussions about the role of middlemen, it’s important to remember that they (usually) don’t just sit around with their hands out, collecting money. Some entity needs to negotiate on behalf of health insurance companies with drug manufacturers and pharmacies. Some entity needs to process insurance claims for drug prices. I do not mean to defend the relatively high drug prices paid by American consumers compared to international markets, nor to defend the costs and requirements for developing new drugs, nor to defend some of the mechanisms used by drug companies to keep prices high. But while it might be possible to squeeze some money out of PBMs for slightly lower drug prices, and it’s certainly possible to mess up PBMs in a way that leads to higher drug prices, it doesn’t seem plausible that reform of PBMs is going to be a powerful lever for reducing drug prices.

Initial Reactions to the Amazon Antitrust Case

The Federal Trade Commission and 17 state attorneys general have sued, as the FTC press release says, “alleging that the online retail and technology company is a monopolist that uses a set of interlocking anticompetitive and unfair strategies to illegally maintain its monopoly power.” The FTC complaint filed with the US District Court for Western Washington is here. A first reaction from the bigwigs at Amazon is here. I’m still digesting the arguments, but here, I’ll offer some initial reactions about what to watch as the case–and the reporting on the case–proceeds.

1) Being a monopolist is not illegal under antitrust law. If a firm achieves a monopoly by providing a highly desired set of goods and services, that is legal and allowed. However, a firm with a dominant position does become limited in how it seeks to defend its monopoly and to fight off potential new entrants. I’ve seen a number of headlines that refer to the case as an “anti-monopoly” case, which isn’t quite right. Instead, it’s about actions to block potential competitors. As the FTC press release notes: “The complaint alleges that Amazon violates the law not because it is big, but because it engages in a course of exclusionary conduct that prevents current competitors from growing and new competitors from emerging.” Or as the legal complaint says more formally: “This case is about the illegal course of exclusionary conduct Amazon deploys to block competition, stunt rivals’ growth, and cement its dominance.”

2) Thus, this antitrust case is not about “breaking up Amazon.” It is about whether Amazon needs to stop certain business practices.

3) What does the FTC point to as the “exclusionary practices”? As best as I can tell, it boils down to alleged actions that discourage third-party firms that sell on Amazon from selling at a lower price on other websites, and pressures from Amazon to have third-party firms use Amazon’s “Prime” shipping service and to advertise on Amazon.

4) Many retailers offer some form of “price match guarantee,” in the form of “if you find the same item for a lower price, we will match that lower price.” But economists have observed for some time that price matching can have anticompetitive aspects. Consider the case of an incumbent airline with most of the traffic between two cities. A new airline starts up, offering a lower price. The incumbent airline matches the lower price, so the new airline can’t attract customers. And when the new airline goes out of business, the incumbent firm can then raise prices again.

In its original form, Amazon sold Amazon-branded goods. Starting in 1999, it started selling third-party goods as well. The Amazon response says that these third parties now consist of 500,000 companies that account for 60% of total sales on the Amazon website. Thus, in some cases, it seems possible that Amazon-branded goods would be in competition with third-party goods. A scenario could unfold where, if Amazon continually matches any price cuts from others, the others would learn that there isn’t any business to be gained by cutting prices.

5) Because Amazon (of course) controls the formatting of the website, it has the power to list third-party sellers either higher or lower in the search results. It can list firms more highly if they pay Amazon for advertising. It also can offer links to its “Prime” shipping service, so that customers may find it easier to buy from a firm that is directly linked to Prime shipping, and harder to buy from firms that use other shipping. In other words, Amazon has some power to levy charges on its third-party sellers. The FTC complaint asserts: “For example, Amazon has hiked so steeply the fees it charges sellers that it now reportedly takes close to half of every dollar from the typical seller that uses Amazon’s fulfillment service.” (It’s worth noting that the word “reportedly” carries some heavy weight in that sentence.)

6) Putting these pieces together, the FTC claim is that many small retailers feel that they have to be on Amazon, because it’s where the customers are. However, many small retailers also feel mistreated by Amazon: discouraged from cutting prices, and under pressure to pay fees to use Amazon-owned shipping and advertising. As a result, the argument goes, these retailers are constrained from offering lower prices and perhaps a wider range of services to customers. But it seems fair to say that the primary focus of the complaint is not on customers directly, but on how third-party sellers are unfairly treated by Amazon.

7) In some ways, this case is about the multiple kinds of fees that Amazon charges its third-party sellers, and the interaction of these fees. The FTC complaint says: “Amazon charges sellers four primary fees to sell on its Marketplace. First, Amazon requires sellers to pay a selling fee, which can be a monthly fee or a fee for each item sold. Second, Amazon charges all sellers a commission or “referral fee” based on the price of each item sold on Amazon. Third, Amazon charges sellers for the use of Amazon’s fulfillment and delivery services. Fourth, Amazon charges sellers for advertising services.” So, if a firm pays Amazon the basic selling and referral fees, but doesn’t advertise with Amazon, then is it “unfair” if firms that do advertise are featured more prominently?

8) At least some of these accusations seem to me may eventually be illuminated by the factual record. For example, Amazon says: “The FTC’s allegation that we somehow force sellers to use our optional services is simply not true. Sellers have choices, and many succeed in our store using other logistics services or choosing not to advertise with us. We also enable sellers to use the trusted Prime badge when other logistics services are able to meet our Prime customers’ high expectations for fast, reliable delivery.” I’m sure that third-firms selling on Amazon technically have the ability to use methods of delivery other than Prime, and that they are not technically required to advertise on Amazon. But it would be interesting to know how many firms exercise those choices–and to see some systematic evidence on whether Amazon uses its power over formatting the website to pressure third-party sellers.

9) Amazon also argues that in exchange for fees, its third-party sellers receive an array of other business management services: “We have invested billions of dollars in people, resources, and services to support sellers at every stage of their journey. We regularly provide them with new data and insights about selling on Amazon, the capability to tailor products and listings to customer needs, and recommendations and advice to help grow their businesses. We also offer features that help sellers create and manage product listings, track sales, fulfill orders, respond to customers, and more.” Again, I’m sure all of these services are available, but it would be interesting to see evidence on how widely such services are used and valued by third-party sellers.

9) A standard issue in antitrust cases is an argument over the size of the market. For example, way back in 1987 there was a merger between two intercity bus companies: Greyhound and Trailways. The government antitrust authorities argued that this would give the merged company a monopoly over intercity bus traffic. The companies argued that the relevant market for their case was not intercity bus traffic, but all methods of intercity transportation: private car, rental car, charter bus, limo, taxi, rail, and plane. Within this much broader context of all intercity transportation, the merged Greyhound-Trailways firm had only a small share of the market.

In the Amazon case, the FTC asserts at several points that Amazon is a monopolist; in particular, that it has monopoly power in the “online superstore market.” Amazon seems certain to argue for a broader conception of the retail market as a whole. As Amazon writes in its response: “Consumers today still buy over 80% of all retail products in physical stores. And as any shopper knows, you can buy the same products at any number of different retailers that compete vigorously with each other, including brick-and-mortar stores, online stores, and quickly growing hybrid models like buy-online-pick-up-in-store.” I expect Amazon to argue that even within the “online superstore market” it has serious competitors like WalMart, and in the overall market for retail sales, Amazon is a relatively small player.

10) What is Project Nessie? The FTC legal complaint refers at a number of places to how Amazon uses “Project Nessie” as part of its pattern of exclusionary conduct. However, when the FTC releases a legal complaint, the subject of the complaint can request to have certain parts of the complaint that might provide information about the inner workings of the firm redacted. Thus, when you look at the section of the FTC complaint about Project Nessie, it looks like this:

At the TechCrunch website, Devin Coldewey looks for clues to answer the question, “What is Amazon’s [redacted] ‘Project Nessie’ algorithm?” As Coldewey notes, it seems likely to be an algorithm that either manipulates prices (maybe up a little and down a little when profitable) or search (to favor Amazon products or third-party firms that advertise with Amazon)–but perhaps could be something more arcane. In the next few weeks, and especially it the case eventually goes to trial, we are likely to learn more about Project Nessie.

11) I wouldn’t be at all surprised if, when all is said and done, the FTC case causes Amazon to announce that it is altering some of its business practices. Given the internal pressures at Amazon (as at any company) to increase profits, I wouldn’t be at all surprised if some of the algorithm designers did things that–when viewed in the cold light of day–qualify as “exclusionary conduct.” I also wouldn’t be at all surprised if such actions happen in the form of a settlement in which Amazon does not admit any guilt. In Amazon’s relationship with its third-party sellers, it has power to adjust multiple fees, multiple services, along with search results and website presentation. My guess is that even when or if the FTC pressures Amazon to change some of its practices, it will be able to pivot to other choices that have similar effects.

Remember the major antitrust case against Microsoft, settled in 2001? Here in 2023, Microsoft is the second-largest company in the world by market capitalization, a tick behind Apple and a tick ahead of Saudi Arabian Oil. After all the sound and fury, I don’t expect that this particular lawsuit will have much affect on Amazon a few years down the road, either.

US Capital is Depreciating Faster

Gross investment refers to the total amount invested. However, in any given year, part of gross investment just goes to replace capital that has depreciated and worn out. Thus, the US Bureau of Economic Analysis also calculated net investment, which is the addition to the overall US capital stock after taking replacement of depreciated capital into account. What’s interesting, and disturbing, is that the gap between gross and net investment is rising.

Here’s a figure showing the patterns for the US economy. Gross investment has typically been 20-25% of GDP overt time, although in recent years it’s been closer to the lower end of that range. From the 195os up into the 1980s, net investment was (very roughly) 10% of GDP. Thus, it was plausible to say that in a typical year, a little more than half of gross investment went to replace capital that was wearing out, and a little less than half of gross investment was actually new, net investment growing the capital stock.

But in the last decade or so, gross investment has been about 20% of GDP, and net investment has fallen to about 5% of GDP. In other words, gross investment as a share of GDP has fallen a bit, but not too much. The real change is that about three-quarters of investment is now going to replace capital that has worn out, so net investment is much lower.

What’s going on here, as I understand it, is that the life expectancy of capital investment has been declining. If a firm bought a large piece of physical equipment for a factory back in the 1960s or 1970s, it was probably hoping to get at least 10 or 20 years of use from that investment. But if a modern firm makes a major investment in new computers, databanks, and software, that investment will depreciate over a much shorter time period.

In short, it’s not just how much an economy invests in capital equipment, but also how long that equipment can reasonably be expected to last. The data shows that the typical US capital investment, with its greater emphasis on rapidly evolving information technology, is depreciating faster than it used to.

HBCUs: The Evolving Challenge

As recently as 1967, about 80% of all black college students graduated from “historically black colleges and universities.” But the ground was shifting. The 1954 Supreme Court desegregation decision in Brown v. Board of Education, along with the Civil Rights Act of 1964, helped lead to a surge in high school graduates and then rapid growth in black college graduates: “The University of Washington for example, saw its black student enrollment increase from 136 in 1967 to 1,110 in 1971.” As enrollments of black college students expanded dramatically, the share of black students attending the historically black colleges and universities has dropped dramatically, now to about 9%. Of necessity, the role of such institutions is evolving.

The National Center for Education Statistics describes term “historically black colleges and universities” this way (citations omitted):

Historically Black colleges and universities (HBCUs) are institutions that were established prior to 1964 with the principal mission of educating Black Americans. These institutions were founded and developed in an environment of legal segregation … In 2021, there were 99 HBCUs located in 19 states, the District of Columbia, and the U.S. Virgin Islands. Of the 99 HBCUs, 50 were public institutions and 49 were private nonprofit institutions. The number of HBCU students increased by 47 percent (from 223,000 to 327,000 students) between 1976 and 2010, then decreased by 12 percent (to 287,000 students) between 2010 and 2021 …

Although HBCUs were originally founded to educate Black students, they enroll students of other races as well. The composition of HBCUs has changed over time. In 2021, non-Black students made up 25 percent of enrollment at HBCUs, compared with 15 percent in 1976. While Black enrollment at HBCUs increased by 14 percent between 1976 and 2021, the total number of Black students enrolled in all degree-granting postsecondary institutions (both HBCUs and non-HBCUs) more than doubled during this period. As a result, the percentage of Black students enrolled at HBCUs fell from 18 percent in 1976 to 8 percent in 2014 and then increased to 9 percent in 2021.

Gizelle George-Joseph and Devesh Kodnani of Goldman Sachs describe several elements of the evolution in “Historically Black, Historically Underfunded:
Investing in HBCUs
” (Goldman Sachs Research, June 13, 2023). They emphasize and complement the main themes developed in the article by Gregory N. Price and Angelino C. G. Viceisza in the Summer 2023 issue of the Journal of Economic Perspectives (where I work as Managing Editor): “What Can Historically Black Colleges and Universities Teach about Improving Higher Education Outcomes for Black Students?” 

For concreteness, here’s a table of the larger and some of the more prominent HBCUs, with enrollments and graduation rates, from Price and Viceisza:

Here are a few of the main themes common in both essays:

Although the HBCU’s now educate 9% of black college students, they “punch above their weight” in terms of impact, especially in terms of science, technology, engineering, and mathematics (STEM) majors. From the Goldman Sachs report:

Moreover, a disproportionate share of black college students who get PhDs from all institutions started out at HBCUs. Price and Viceisza point out:

Almost one-quarter (23.2 percent) of Black graduates who earned a doctorate in science and engineering between 2015 and 2019 earned their bachelor’s degree from a historically Black college or university (National Science Foundation 2021). Historically Black institutions produced particularly large shares of baccalaureate recipients who later earned doctoral degrees in agricultural sciences and natural resources (almost 50 percent of all Black graduates who earned such a degree), computer and information sciences (over 30 percent), and mathematics and statistics (over 30 percent). The top producers were Howard University and Spelman College.

Moreover, HBCUs accomplish these outcomes while enrolling a disproportionately large share of students coming from lower-income households. One measure of this difference is in the share of HBCU students receiving federal Pell grants or student loans. From the Goldman Sachs report:

In their JEP essay, Price and Viceisza discuss the evidence HBCUs are finding ways to overcome the disadvantaged for the socioeconomic background of the students they are admitting. It turns out that if one adjusts for characteristics of students and their families (like income and parental education) and for characteristics of colleges (like selectivity and funding), black students at HBCUs are more likely to graduate and to enter science and technology careers than black students at other institutions. These gains for HBCUs are especially large when comparing black students entering college with lower test scores. In studies that seek to measure what colleges have the biggest effect in leading to intergenerational gains in earnings (a measure that combines both the student’s family background, the chance of graduating, and the after-graduation work experience), HBCUs often rank near the top.

In their evolution during the last few decades, the HBCUs have clearly figured out how to do more with less. The problem of underfunding at the HBCUs is longstanding. It of course goes back to the times of legalized segregation, but persisted after that. As Goldman Sachs authors note: “In 1986, Congress amended the Higher Education Act of 1965 to increase funding for HBCUs in response to their finding that state and federal institutions had engaged in discriminatory practices that had financially disadvantaged HBCUs.”

Whatever the merits of the 1986 law, the financial gaps have persisted. Price and Viceisza write:

Finally, a substantial boost in funding for historically Black colleges and universities seems appropriate and overdue. These institutions were dramatically underfunded on a per-student basis during decades of legalized segregation (Smith 2021). Colleges and universities are long-lived institutions, and underfunding from decades ago will affect the physical inheritance of these institutions today: academic buildings, library resources, greenspaces, athletic facilities, and more. This underfunding has continued up to the present. Lawsuits about underfunding of historically Black institutions have been settled in recent years by Maryland, Alabama, and Mississippi, and a similar lawsuit was recently announced in Florida. Two journalists at Forbes calculated that Black land-grant universities have been underfunded at the state level, relative to their primarily white counterparts in the same states, by $12.8 billion in the last three decades (Adams and Tucker 2022).

I don’t want to over-claim what HBCUs can accomplish. After all, their successes come from students who choose to attend these institutions. It’s not obvious to me that they have some secret sauce that would work equally well for all Black students, or for students of all racial/ethnic backgrounds, at other institutions as well. But clearly, they do know something, and the successes of HBCUs in reaching out to student who traditionally have had a lesser chance of flourishing in college makes them a worthy object of increases in both attention and funding.

Rising Coffee Prices: A Story of Supply Shocks

The US produces almost no coffee, other than small quantities from Hawaii. However, the US market imports about 15% of global coffee production each year, and thus is fully exposed to global coffee prices–which have been on the rise. Angela Cantor describes the recent supply and demand patterns in “Historic coffee prices percolated after a bitter global supply crisis” (Bureau of Labor Statistics: Beyond the Numbers, September 2023). I pass them along here because, as Cantor reports, Americans drink more coffee than any other beverage, including tap water. Also, it’s a relatable supply and demand story for students.

Here are prices of coffee imports on the world market since 2007. The current spike is clearly not without precedent, but it’s still pretty abrupt.

A sharply higher price can be the result of either a rapid increase in quantity demanded or a rapid decrease in quantity supplied, and in this case the latter factor is dominant. The supply shock has two causes: weather disruptions that reduced coffee harvests in key producer countries and pandemic-related difficulties in shipping coffee to the US market.

Brazil is the “coffee pot of the world,” by far the world’s producer of coffee. It produces about twice as much as second-place Vietnam, which in turn produced as much as the combination of Columbia and Indonesia, the two countries tied for third.

But the Brazil coffee harvest in 2021 was the lowest in four years, due to a variety of factors like “the tropical storm La Niña and greater variability in temperatures, along with deforestation of the Amazon.” Pandemic-related travel restrictions in Vietnam meant that many workers chose not to travel to the coffee harvest, because they feared being locked-down and unable to return to their permanent homes. Colombia experienced a national strike against a COVID-19 pandemic reform plan proposed by the president, which dramatically hindered coffee production and shipping: for example, the main Columbian port out of which coffee is usually shipped closed for 48 days. Indonesia already had a scarcity of ports and international cargo facilities, which only got worse when containers for shipping became scarce during the pandemic.

Canton concludes:

By the end of 2022, coffee traders were optimistic about seeing some stabilization in the market as they placed their bets on the expectation of the 2022–23 season being an on-year in the coffee production cycle, and the rise of breakbulk shipping as a solution for the lack of containers. At the time, rapidly decreasing prices seemed to confirm that expectation. However, at the start of 2023, prices made an unexpected turnaround to the high levels that were last seen in the fall of 2022. Throughout 2023, high U.S import coffee prices persisted, hovering just below 2022’s high price record, as Brazil continues to deal with the aftermath of the impact of severe frosts, high temperatures, and the below-average-rainfall that occurred in 2021, and as Colombian coffee yields remain low because of growers’ decision to limit fertilizer use due to its price spike. Further, there is now a shortage of coffee laborers in Central America as many have abandoned the region in search of better opportunities.

For a discussion of another part of the coffee supply chain–namely, how coffee that sells for a few dollar a pound ends up retailing in a coffee shop for a few dollars a cup, see “Coffee-nomics: A Supply Chain Story” (January 25, 2020). Those with historical interests may prefer “When Coffee was the Newly Introduced Good Under Attack” (December 24, 2019) when tells the stories of when the governor of Mecca sought to ban coffee in 1511, when a group of priests appealed to Pope Clement VIII to ban coffee later in the 1500s, and when the physicians of Marseilles attempted to discredit coffee drinking in 1679.

Larry Summers and a “New Washington Consensus”

Larry Summers delivered the first annual lecture honoring Richard N. Cooper, with the title “What should the 2023 Washington Consensus Be?” at the Peterson Institute for International Economics (September 18, 2023, video and transcript available). He organizes his discussion around “six major misconceptions.”

First, it is supposed that the idea of economic policy is to maximize the creation of jobs rather than to maximize the availability of goods at low cost to consumers and firms. Both the officials responsible for competition policy and those responsible for international trade have explicitly rejected economic efficiency as a central guide for economic policy. This, I would suggest, is a costly and consequential error. …

The second misconception is that these have not been good decades for the American economy in international perspective. I first got to know my friend Ted Truman well when he was long into his career as the head of the Federal Reserve’s International Economic Section. and I was a new undersecretary of the Treasury for international Affairs. We were involved in making various long term economic projections for the world. None of them would have believed that US GDP as a share of global GDP would have remained robust for the entirety of the next generation. And if we had been told how spectacularly China was going to do over the next 30 years, we would have been that much more pessimistic. … The truth is that the United States has done extraordinarily well. …

Third, the world has fared very well. Relative to the time when I was chief
economist of the World Bank at the beginning of the 1990s, child mortality rates are less than half of what they were then. Literacy rates are more than twice what they were then. Poverty rates, terms of extreme poverty are less than 40% of what they were then. And in some ways most fundamental and important, this month, we celebrate the 78th anniversary of a situation where there has been no direct war between major powers. You cannot find a period of 78 years since Christ was born when that was the case. So, the idea that we’ve been doing it all wrong is, I would suggest, a substantial misconception.

Fourth, the problems that we have are not due to trade liberalization. … Yes, China’s tremendous economic progress did lead to far more sale of goods in the United States. But it is hard to imagine a less credible approach to the problem [then] the adding up all the losers from the imports without taking any account of the jobs created and the economic impacts of the goods we sold to China, of the lower cost inputs we received because of imports from China, [or] of the enhanced real wages and associated with greater spending caused by those lower prices. And the lower capital costs associated with the inflows of capital that we received from China. When those calculations have been done, as they’ve now been done by Rob Feenstra and several other teams of economists, they show that, in fact, as with NAFTA, the net benefit to the US economy has been substantial.

The fifth misconception is that domestic industrialization and some kind of renaissance of manufacturing is somehow the central issue for US
prosperity going forward. This is simply not a realistic idea. … Rapid productivity growth, relatively inelastic demand, rapidly declining relative prices created abundance without substantial and with declining levels of [manufacturing] employment. And there is nothing in the coming robotic revolution to suggest that these trends are likely to do anything other than accelerate going forward. … The idea that we can build an economy on growing our manufacturing sector is just not realistic and it is potentially counterproductive. I would just note that there are about 100 times as many workers in steel-using industries as there are in the steel industry as evidence of the potential costs of domestic content requirements motivated by the desire to create capacity.

Finally, I would suggest that substantial and accumulating deficits and debts are a substantial threat to national security and national power, contrary to what is often believed in what sometimes seems like a post budget constraint era of economic thinking. … The budget deficits a decade out comfortably in double digits as a share of GDP now seem a reasonable projection … This is without the assumption of the need for vast mobilization for meeting contingencies, military or non-military. And I think it is reasonable to ask the question: How long can or will the world’s greatest debtor be able to maintain its position as the world’s greatest power?

I’ll add the “Washington consensus” in the title of the lecture strikes me as a mischievous use of the term. For the uninitiated, the “Washington consensus” among economists refers to a specific set of policies identified by John Williamson back in 1989, in an effort to spell out what policies were being encouraged at that time by the IMF and the World Bank. But as Summers notes, “Those who speak of a new Washington consensus mostly have never heard of John Williamson.” Among non-economists, “Washington consensus” has often come to mean any policies oriented toward free markets or limited government. For those who would like an overview of what Williamson actually said, and a discussion of the evidence on how well his list of “consensus” policies has performed and aged, a useful starting point is the symposium on the “Washington Consensus Revisited” in the Summer 2021 issue of the Journal of Economic Perspectives (where I work as Managing Editor). The four papers are:

Reality Check on Median Household Income

In studies of voters, politicians, and elections, it’s common to hear a mention of the “median voter,” the voter who is in the center of the distribution. In this admittedly simplified model, if a politician can attract everyone from their side, plus the median voter, then that politician has a majority. Similarly, the household with the median income is at the 50th percentile of the income distribution. If you want to know whether a majority of households are feeling better or worse about their economic situation, median household income is one plausible starting point.

Here’s median household income, measured two ways. The red line shows “nominal” income, which you can think of as the value of income in current dollars at that time. The blue line adjusts for inflation. Thus, the two numbers are identical in for 2022, because both measures are both using current dollars in that year.

The data is from an annual report of the US Census Bureau. The most recent version is Income in the United States: 2023, written by Gloria Guzman and Melissa Kollar, and published earlier this month.

The story for the short-run past period since the pandemic and through the annual data for 2022 is clear enough. Nominal wages are rising for the median household (red line rising), but the wages aren’t keeping up with inflation, so the real wage (blue line) is falling. Real wages peaked in the 2019 data, before the pandemic hit in early 2020.

For a longer-run perspective on median household income, here’s a figure from the Census Bureau Report, which shows income for the median US household as well as for various racial/ethnic groups.

Here, I’ll just point out that over the 55 years from 1967 to 2022, the median household income rose by a little less than 50%. Remember, income gains for the top 1% or 10% or 20% will affect the average level of income, but it doesn’t affect the median household at the 50th percentile of the income distribution. Over the last half-century or so, the median household has seen income gains of less than 1% per year.

KIPP Schools and Lessons for Education Catch-up

One of the biggest problems in K-12 education for a long time is how to help students who are already lagging behind in early grades catch up through middle-school and high-school, so that attending college, if they wish to do so, is a live possibility. As a result of the school closures during the pandemic, the question of how to help students catch up now applies to a substantial majority of students.

Some clues on what needs to happen come from a recent study by Alicia Demers, Ira Nichols-Barrer, Elisa Steele, Maria Bartlett, and Philip Gleason of Mathematica about “KIPP” schools, in the report “Long-Term Impacts of KIPP Middle and
High Schools on College Enrollment, Persistence, and Attainment”
(Mathematica, September 12, 2023).

KIPP stands for Knowledge Is Power Program (KIPP), which is a network of public charter schools around the country. Because they are popular schools, they are oversubscribed, and because they are public schools, they are required to choose which students to accept by lottery. Because of the location of the schools in urban areas, the students are much more likely to be from lower-income families.

This study has a long enough follow-up period that the researchers can look at students who were randomly accepted to a group of KIPP middle schools with lotteries, and then compare their experience in finishing high school and college compared with students who were not randomly accepted to those middle schools. This particular study involves “2,066 students who applied to enter 21 KIPP middle schools that were popular enough to hold an admission lottery in 2008, 2009, or 2011. As of 2022, all those students were old enough to have attended college for at least three years, and the first two cohorts of students were old enough to have
graduated from a four-year college.”

Here’s a striking takeaway. Those who attended KIPP middle and high schools were 31 percentage points more likely to enroll at a four-year college (77% to 46%) and about twice as likely to graduate from a four-year college (39% to 20%).

This effect is big enough to deserve attention. As the report notes: “An effect of this size, extrapolated nationwide, would be large enough to nearly close the degree-completion gap for Hispanic students or entirely close the degree-completion gap for Black students in the United States.”

What is the secret sauce of KIPP schools? Some of the key ingredients include extra instructional time, like coming earlier in the morning or staying later in the afternoon. A substantial effort is made to assure that students don’t fall behind, including regular testing to evaluate student progress and small-group tutoring to keep students on track. More broadly, there is a culture of high expectations, including academic expectations leading to AP courses as well as behavioral expectations. There is counselling and mentoring to make college attendance thinkable and reasonable for more students.

There are various concerns here, of course. When comparing students who were admitted or not through a lottery system, you are not comparing to students whose families did not apply to the lottery at all. What works for the group of students whose families want them to enter a KIPP school is probably not going to work as well for the group of of students whose families don’t apply in the first place. Another concern is that a study based on about 2000 students can be suggestive and interesting, even if a single study isn’t conclusive proof.

Making all of this work also involves having teachers and principals who bring the training, energy, and commitment to make it happen. Helping students catch up involves substantial changes to the usual styles of teaching and expectations about how a school will operate. But the big point here is the evidence that for many students, middle- and high-schools can facilitate dramatic catch-up.

Partha Dasgupta and Tim Besley Talk Sustainability and Biodiversity

It sometimes feels to me like discussions of environmental issues and sustainability have a tendency to end up being phrased in terms of greenhouse gases and climate change. That’s an important issue, but it’s not the only issue. Indeed, Partha Dasgupta argues that climate change is really a subset of the broader issue of how humans are interacting with natural resources. Tim Besley discusses these topics with Dasgupta in “Biodiversity: A Conversation with Sir Partha Dasgupta” (Annual Review of Economics, 2023, pp. 755-773, video of the interview is also available). Here are a few of the comments from Dasgupta that caught my eye:

Demand for natural resources is more than the planet can bear on a sustainable basis.

Global GDP has grown more than 15 times since 1950, world population has grown from some 2.5 billion to 8 billion, per-capita global GDP has increased nearly fivefold to some 18,000 dollars PPP (purchasing power parity) annually, life expectancy at birth has increased from 46 years to 72 years, and the proportion of people in extreme poverty has declined from 60% to 10%. All this would be unadulterated good news, but for the fact that we have achieved those successes by mining Nature to the point where there is an enormous global overreach into her
goods and services. Crude estimates suggest that the ratio of our global demand for Nature’s goods and services and her ability to meet that demand on a sustainable basis is 1.7 (an almost certain underestimate), whence the refrain that we need 1.7 Earths to support the current global standard of living …

Because the global economy is in a fire-fighting situation, several of us jointly published a paper (Barrett et al. 2020), in which we identified the economic variables that define the global overreach on the biosphere. Our idea was to point to what national statisticians will need to measure if they are to document the demand we make of Nature. We argued that national statistical offices will have to be opportunistic. Instead of moving immediately to estimating inclusive wealth, they should create natural capital accounts to estimate their countries’ ecological footprint. The UK National Statistical Office is active in that direction, and Chile has recently established a Natural Capital Committee connected to the country’s Ministry of Finance. China, Costa Rica, and New Zealand are moving in that direction as well. No doubt other countries will follow.

Does the climate change literature assume, in effect, that it is the only sustainability problem?

[T]he established economics of climate change supposes that Nature provides us with only one maintenance and regulating service: carbon regulation. It permits analysts to imagine that with only modest investment in the transition to clean energy—say, 2% of global GDP until a net zero economy is attained—we can expect a future of indefinite GDP growth. The presumption is that GDP can grow indefinitely even as humanity dips into the biosphere for its goods and services, transforming what is taken into production and consumption, depositing the residue back into it as waste, but inflicting vanishingly small further pressure on Nature’s ability to decompose that waste. This is to imagine that no matter how large the human economy grows to become, further growth would make but vanishingly small further demands on Nature’s maintenance and regulating services. The vision is of a human economy asymptotically extricating itself from the biosphere while enjoying unlimited GDP growth. That is the sense in which the
established economics of climate change sees the human economy as external to the biosphere. If instead one acknowledges that the human economy is embedded in Nature, the escape route afforded by the idea of asymptotic release from the biosphere does not appear as an option. …

You are right, of course, in pointing to the simplicity of reducing the economics of climate change to ways of controlling a single scalar number, carbon concentration. We do not have that luxury in the economics of biodiversity, but we do have an utterly simple concept on which to rest the subject: productivity of capital. Once we regard ecosystems as capital assets, the economics of biodiversity reduces to a problem (a complex problem no doubt) of asset management. The economics of climate change then becomes a branch of the economics of biodiversity (or of Nature writ large). So, instead of continually finding ways to reduce carbon concentration, as is customary in the economics of climate change, we search for ways to better manage our portfolio of assets in the economics of biodiversity.

Many services of nature are in countries where markets for those services are missing.

It is not an accident that the bulk of the world’s biodiversity is in the tropics and that most of the world’s poorest people live there. Principal exports from those regions are primary products, whose extraction (from mines, plantations, wetlands, coastal waters, and forests) inflicts adverse externalities on local inhabitants. The externalities are not reflected in export prices, meaning that local ecosystems are overexploited; but that amounts to a transfer of wealth from the exporting country to the importing country, from a poor to a rich country. … . Propositions on the benefits of free trade suppose that all goods and services have perfectly competitive markets. The economics of biodiversity is perforce built for a world where markets are missing for many of Nature’s services.

The West has for the most part outsourced its needs for primary products. The United Kingdom, for example, has little biodiversity left, but that does not affect its GDP growth rate; the accompanying losses of biodiversity are felt elsewhere. … Ecological externalities within regions suggest that countries in sub-Saharan Africa should collectively impose export taxes on primary products. That would ease pressure on their local ecosystems such as rainforests and fisheries and would also be a source of income for them.

Reality Check on US Manufacturing Jobs

I seem to run into comments on a semi-regular basis about how the policies of either President Biden or President Trump either are bringing back US manufacturing jobs or have already done so. Thus, a quick reality check seemed in order.

This figure shows total US manufacturing jobs back to 1939. After the dramatic fall in manufacturing jobs in the first decade of the 21st century (for reasons including the dramatic rise in Chinese exports after China joined the World Trade Organization in 2001 and the effects of the Great Recession from 2007-09), There has indeed been a modest bounceback. It started around 2010, and after an interruption from the pandemic recession has continued since.

It’s important to keep the size of this bounceback in perspective. As you can see from the vertical axis, US manufacturing jobs had declined to 11.5 million in early 2010, and have now risen to 13 million. This increase of about 13% in manufacturing jobs is meaningful–although it’s perhaps worth noting that the rise was underway and much of the gain had happened before either the Trump or Biden presidency.

Another useful perspective is to look at US manufacturing employees as a share of all employees. Here’s the figure. On the far left, you can see the jump in US manufacturing jobs during World War II, and the fall immediately after the war. Since then, the long-term story of US manufacturing employees as a share of total US employees has been one of gradual decline, from about one-third of the US labor force back in the 1950s to about 8% of the labor force at present.

In the case of US manufacturing, two insights can both hold true. One is that it’s important to have an active and robust US-based manufacturing sector across a variety of industries, because it’s important for the US economy to be close to the frontier of innovation in a wide range of areas, and being physically close to actual manufacturing is useful in developing and applying new technologies and production techniques.

The other and complementary insight is that a substantial renaissance in US manufacturing jobs, in a way that the become a steadily and substantially rising share of US employment over time, is extremely unlikely. Manufacturing as a share of employment has been declining for the US for a long time, as well as for high-income countries across the world. Jobs in services (including services related to design, management, marketing, transportation, installation, maintenance, and repair of manufactured output) have been a rising share of employment for decades. For low- and medium-income countries, a key question is whether or how they can grow their economies based on a rise service-oriented jobs. Manufacturing across many industries has become increasingly capital-intensive, often making use of very expensive facilities (think semiconductors, for example), along with automation and robots.

So yes, the US needs a healthy manufacturing sector, and that employment option will work well for millions of people. But the other 90+% of the US workforce will need other opportunities for good jobs and prosperity.