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Not What You Know or Who You Know, But Where You Work

Since the 2009 World Development Report on \”Reshaping Economic Geography\” was published, I\’ve had the opening paragraphs up on the bulletin board outside my office door, as food for thought for those passing by. 

\”Place is the most important correlate of a person’s welfare. In the next few decades, a person born in the United States will earn a hundred times more than a Zambian, and live three decades longer. Behind these national averages are numbers even more unsettling. Unless things change radically, a child born in a village far from Zambia’s capital, Lusaka, will live less than half as long as a child born in New York City—and during that short life, will earn just $0.01 for every $2 the New Yorker earns. The New Yorker will enjoy a
lifetime income of about $4.5 million, the rural Zambian less than $10,000. A Bolivian man with nine years of
schooling earns an average of about $460 per month, in dollars that reflect purchasing power at U.S. prices. But the same person would earn about three times as much in the United States. A Nigerian with nine years of education would earn eight times as much in the United States than in Nigeria. This “place premium” is large throughout the developing world. The best predictor of income in the world today is not what or whom you know, but where you work.\”

I think I work hard. Lots of Americans think they work hard. But when you compare the economic situation of modern America with the rest of the world, or with long-ago history, then (in a phrase commonly attributed to the old football coach Barry Switzer) we\’re all born standing on third base, congratulating ourselves for hitting a triple. 

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Searching for Plausible Budget Projections

The official federal budget projections are dishonest. They make future budget deficits look smaller by enacting spending cuts and tax increases that won\’t kick in for some years–but then then Congress and the President postpone or eliminate those changes before they actually take place. As a result, the nonpartisan Congressional Budget Office has for some years offered two sets of budget projections: the \”extended baseline scenario\” is based on what current law says will happen in the next 10 years; the \”alternative fiscal scenario\” assumes that certain changes aren\’t going to be made, and thus probably presents a more realistic picture. The CBO\’s 2011 Long-Term Budget Outlook shows the difference.

Start with the basic projection of how much debt the U.S. economy will accumulate in the next 25 years. The \”extended baseline scenario\” says that the rise in the debt/GDP ratio has pretty much topped out at this point, and will rise to a little over 80% of GDP by 2035. The \”alternative fiscal scenario\” is much more grim, suggesting that the debt/GDP ratio would approach 200% of GDP by 2035. Just to be clear, this forecast doesn\’t mean that the U.S. government would actually be able to borrow this much–only that we are on a debt accumulation path that looks unsustainable.

What are the different underlying assumptions here? Take a look at the different paths of taxes and spending in the two scenarios.

On the tax side, the \”extended baseline\” scenario has a bunch of tax increases arising in future years: for example, the expiration of the Bush tax cuts of the early 2000s, a gradual rise in the revenues collected by the alternative minimum tax, and others. As a result, it is based on federal taxes collecting 23% of GDP by 2035–far above the level seen in recent decades. In contrast, the \”alternative fiscal scenario\” is that federal taxes in the long-term will be more-or-less at their historical average for the last few decades of 18% of GDP.

On the spending side, both scenarios show that in the future, when you are asked for a short description of what the federal government actually does, the appropriate answer will be \”retirement and health care spending.\” The two scenarios don\’t differ in projected Security spending. In Medicare spending, the \”extended baseline scenario\” incorporates cuts to physician pay in the future; the \”alternative fiscal scenario\” says that physician pay will remain at 2011 levels. Also, in the \”extended baseline scenario,\” CBO explains that \”government spending on everything other than the major mandatory health care programs, Social Security, and interest on federal debt—activities such as national defense and a wide variety of domestic programs—would decline to the lowest percentage of GDP since before World War II.\” In the alternative scenario, these other areas of government spending remain at the current levels as a share of GDP.The other big spending difference is that the \”primary spending\” lines shown here leave out interest payments on past borrowing, which grow MUCH larger with the larger deficits in the the \”alternative fiscal scenario.\”

Of course, one can quibble with the details of what is assumed in the \”alternative fiscal scenario.\” But from where I sit, the official budget predictions in the \”extended baseline scenario\” look intentionally misleading, and the CBO is performing a public service by offering more plausible projections. 

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Will China Catch Up to the U.S. Economy?

Mark A. Wynne of the Dallas Fed asks: \”Will China Ever Become as Rich as the U.S.?\” The standard answer here is that the total size of China\’s economy may well exceed that the total size of the U.S. economy within a couple of decades, but because China has nearly four times the U.S. population, it will take much longer for China to catch up in per capita terms.

Wynne writes: \”The simplest approach is to measure GDP in U.S. dollars at 2005 prices and use 2005 exchange rates. Doing so results in estimated 2010 Chinese GDP of $3.88 trillion in 2005 dollars, or just less than 30 percent of U.S. GDP. China\’s economy will exceed that of the U.S. in 2025 if it continues expanding at its past-decade rate of just more than 10 percent a year and the U.S. keeps growing at the 1.7 percent annual rate it experienced during the period. Per capita GDP allows us to compare the relative well-being of residents of the two nations. Based on the 2010 U.S. population of 309 million, per capita GDP was $42,874 last year. China, with a 2010 population of 1.34 billion, had per capita GDP of $2,893 last year, or 6.7 percent of the U.S. figure.\”
Of course, it is not inevitable that China will continue at this rapid rate of growth for the next several decades. Wynne points out that on average, countries with lower per capita GDP have faster growth rates. However, it also seems to be true that as countries reach some level of middle-income, their growth rates slow down. On explanation for this \”middle income trap\” is that the growth policies that help in catch-up growth do not work as well as an economy reaches higher-income levels.  Wynne offers a nice figure to illustrate how the G-7 economies caught up to the U.S. economy since 1950, at least to some extent, but then seemed to stop catching up up when they hit (very roughly) 80% of U.S. per capita GDP. The figure also puts China\’s growth path in perspective. 
  
I wonder whether China isn\’t likely to experience more than one \”middle income trap\” as its economy expands. The Chinese pattern of growth in the last decade or so from a macro perspective has been based on extremely high savings rates, rapid growth in heavy manufacturing, large trade surpluses, and huge internal migration of labor. Over the years and decades to come, as these patterns evolve, China\’s economic growth will almost inevitably have some fits and starts. 

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More on Stagnant Job Growth in the Middle East

I wrote a couple of weeks ago about slow growth and stagnant job creation in the Middle East. In the most recent issue of Finance and Development, Yasser Abdih offers some additional evidence.

Focus on six populous Middle Eastern countries where solid labor market data is available: Egypt, Jordan, Lebanon, Morocco, Syria, and Tunisia. Abdih writes: \”High unemployment in these countries, together with low labor force participation rates, has resulted in very low ratios of employment to working-age population. With less than 45 percent of working-age people actually employed, this regional rate is the lowest for any region in the world.\”

When you look at youth employment in particular, the situation is equally dismal. They write:\”The average unemployment rate among youth in these nations was 27 percent in 2008, higher than in any other region in the world …  In contrast to most of the world, joblessness in many Middle Eastern countries tends to increase with schooling: the unemployment rate among those with college degrees exceeds 15 percent in Egypt, Jordan, and Tunisia.\”

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More on a Vehicle Miles Travelled Tax

Greg Rosston at the Stanford Institute for Economic Policy Research spotted my post a week ago on choosing between the current gasoline tax and a vehicle miles travelled tax as a way of funding highway infrastructure.  He passed along a June 2011 SIEPR Policy Brief by Kumi Harischandra, Justine Isola, Lazeena Rahman, and Anthony Suen on this issue.

They provide a useful table showing different levels of the gas tax, and revenue-equivalent levels of a vehicle-miles traveled tax. For example, the current federal gas tax of 18 cents/gallon is equal to a vehicle-miles traveled tax of about penny per mile. A federal gas tax of $2/gallon would be equal to a vehicle miles travelled tax of about 10 cents per mile.

They make a case: \”Although gas taxes advance environmental stewardship and energy security, VMT fees provide a more sustainable future for funding of transportation infrastructure.\”

My own sense is that there are multiple policy goals here: funding transportation infrastructure, reducing fossil fuel use for a variety of reasons, and addressing traffic congestion. It may take several policy tools–perhaps including a fuel tax and a vehicle-miles traveled tax and congestion pricing–to hit all three goals.

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The Supply of Science Ph.D.\’s

One of the odd patterns in recent years is that there is virtually universal agreement that the future of the U.S. economy is closely tied up with technological leadership. But at the same time, those who get a Ph.D. in one of the hard sciences are finding a very unwelcoming job market. Nature takes an international perspective  on this issue in \”Education: The PhD factory: The world is producing more PhDs than ever before. Is it time to stop?\”

Setting the stage. \”The number of science doctorates earned each year grew by nearly 40% between 1998 and 2008, to some 34,000, in countries that are members of the Organisation for Economic Co-operation and Development (OECD). The growth shows no sign of slowing: most countries are building up their higher-education systems because they see educated workers as a key to economic growth … . But in much of the world, science PhD graduates may never get a chance to take full advantage of their qualifications.\”

In the United States: \”To Paula Stephan, an economist at Georgia State University in Atlanta who studies PhD trends, it is “scandalous” that US politicians continue to speak of a PhD shortage. The United States is second only to China in awarding science doctorates — it produced an estimated 19,733 in the life sciences and physical sciences in 2009 — and production is going up. But Stephan says that no one should applaud this trend, “unless Congress wants to put money into creating jobs for these people rather than just creating supply”. The proportion of people with science PhDs who get tenured academic positions in the sciences has been dropping steadily and industry has not fully absorbed the slack. The problem is most acute in the life sciences, in which the pace of PhD growth is biggest, yet pharmaceutical and biotechnology industries have been drastically downsizing in recent years.\”

In Japan: \”Of all the countries in which to graduate with a science PhD, Japan is arguably one of the worst. In the 1990s, the government set a policy to triple the number of postdocs to 10,000, and stepped up PhD recruitment to meet that goal. The policy was meant to bring Japan’s science capacity up to match that of the West — but is now much criticized because, although it quickly succeeded, it gave little thought to where all those postdocs were going to end up. Academia doesn’t want them: the number of 18-year-olds entering higher education has been dropping, so universities don’t need the staff. Neither does Japanese industry, which has traditionally preferred young, fresh bachelor’s graduates who can be trained on the job. The science and education ministry couldn’t even sell them off when, in 2009, it started offering companies around ¥4 million (US$47,000) each to take on some of the country’s 18,000 unemployed postdoctoral students …\”

In China: \”The number of PhD holders in China is going through the roof, with some 50,000 people graduating with doctorates across all disciplines in 2009 — and by some counts it now surpasses all other countries. The main problemis the low quality of many graduates.\”

In Germany:  \”Germany is Europe’s biggest producer of doctoral graduates, turning out some 7,000 science PhDs in 2005. After a major redesign of its doctoral education programmes over the past 20 years, the country is also well on its way to solving the oversupply problem. Traditionally, supervisors recruited PhD
students informally and trained them to follow in their academic footsteps, with little oversight from the university or research institution. But as in the rest of Europe, the number of academic positions available to graduates in Germany has remained stable or fallen. So these days, a PhD in Germany is often marketed
as advanced training not only for academia— a career path pursued by the best of the best — but also for the wider workforce.Universities now play a more formal role in student recruitment and development, and many students follow structured courses outside the lab, including classes in presenting, report writing and other transferable skills. Just under 6% of PhD graduates in science eventually go into full-time academic positions, and most will find research jobs in industry…\”

In India: \”In 2004, India produced around 5,900 science, technology and engineering PhDs, a figure
that has now grown to some 8,900 a year. This is still a fraction of the number from China and the United States, and the country wants many more, to match the explosive growth of its economy and population. … But there is little incentive to continue into a lengthy PhD programme, and only around 1% of undergraduates currently do so. Most are intent on securing jobs in industry, which require only an undergraduate
degree and are much more lucrative than the public-sector academic and research jobs that need postgraduate education.\”

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Comparing Oil Price Shocks

James D. Hamilton has short essay in the \”Research Summaries\” section of the NBER Reporter on \”Oil Price Shocks.\”

In one interesting figure, he compares oil price shocks of 1862-1865, 1973-1981, and 2002-2009. He argues that a common factor in each of these episodes (not the only factor!) was \”declining production from the maturing oilfields on which the world had been depending at the time\”: specifically, the decline of the Pennsylvania oil fields in the 1860s, the decline of U.S. oil production starting in the 1970s, and the fall in oil production from mature oil fields in the North Sea and in Mexico in recent years.

Hamilton also argues that \”in fact all but one of the 11 U.S. recessions since World War II were preceded by a sharp increase in the price of crude petroleum,\” and presents an intriguing table showing some patterns for the five recessions before the Great Recession.

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Medical tourism

John Rosenthal has written an interesting piece for the Milken Institute Review on the phenomenon of \”medical tourism, that is, Americans going abroad to have medical procedures performed. The article has lots of interesting details and anecdotes, but here is some of the big picture.

How many people go abroad for medical procedures? \”In 2009, Deloitte revised its estimates down to 648,000 travelers annually, but forecast 35 percent increases in each of the threesucceeding years. It predicts that more than1.6 million Americans will travel abroad for health care in 2012.\”

What is the assurance of quality? \”Accreditation from the Joint Commission International (JCI) is recognized worldwide as the gold standard for hospitals. JCI screens facilities for the condition of their physical plants, their management of medications, the quality of their surgical care, their commitment to continuous improvement, and their responsiveness to feedback from patients. In the United States, the organization accredits more than 17,000 facilities, from hospitals to laboratories to long-term-care centers. JCI began accrediting hospitals outside the country in 1999. Today, the organization vouches for the quality of care at some 400 institutions in 45 countries from Austria to Yemen.\”

What are some of the potential cost savings?

Incidentally, the Milken Institute Review, with Peter Passell  as editor-in-chief, is a consistently excellent source for lively and well-written essays on economic policy. The contents are available free on-line, although you do need to fill out a registration form. 

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An Interview with Joel Slemrod on Tax Policy

Aaron Steelman of the Richmond Federal Reserve interviews Joel Slemrod of the University of Michigan, mainly on tax policy issues. Here are some thoughts from Slemrod:

On current taxation of employer-provided health insurance: \”Well, it certainly reduces the after-tax price of health insurance for people. The problem is that it reduces the price below the true social cost, so that people acting in their own family\’s interest, are, at the margin, buying insurance where the value to them is actually less than the true cost. In a word, we are subsidizing high-deductible, low copay insurance policies and, given the upward trend we are seeing in the fraction of our gross national product that goes to health care, I think we ought to be moving toward reducing or eliminating such subsidies. Not only that, it\’s a very unattractive sort of subsidy, because the subsidy rate is dependent on the household\’s marginal tax rate, so the subsidy rate is highest for the highest-income people. And I just don\’t think that even people who would argue for a subsidy would favor such regressivity if they were designing a subsidy scheme from scratch. The reason to be wary about abandoning the subsidy is that it supports the system of employer-provided health insurance, which spreads risks across employees and offsets the problem of adverse selection that can plague health insurance markets; before we eliminate the subsidy entirely, we need to have other policies in place to prevent a collapse of efficient markets for health insurance.\”

On how high-income people react to high tax rates: \”My own view … is that certainly high-income people notice taxes, and they react to taxes in ways that lower their exposure to taxes. The evidence for taxes substantially affecting what one might call \”real\” behavior, such as labor supply or savings, is not as strong as the evidence regarding another class of behaviors we might label \”avoidance.\”\”

On how saving is affected by fear of nuclear war: \”I have three articles that try to estimate whether, when people seriously think there\’s a chance of a nuclear conflagration, this belief affects their saving behavior. In short, do people believe we ought \”to eat, drink, and be merry, for tomorrow we die?\” To test this hypothesis I looked at aggregate saving over time in the United States, across countries, and micro data within the United States, and in all three cases found that when people think, or profess to think, there\’s a chance of a nuclear war, their saving rate goes down, just as economic theory would predict.\”

On how people time their deaths to reduce estate taxes: \”We looked at estate tax return data from the history of the U.S. estate tax and found that when the estate tax was going to change — go up or down — in an anticipated way, then the distribution of deaths around that date was not symmetric. When the tax rate was going to increase, more people died before the rate rose, and when the tax rate was going to be lowered, people held on and more people died after the decrease. Since we wrote the paper, the general \”death elasticity\” finding has been replicated using data from episodes in Australia and Sweden when they ended their estate taxes. Those studies found evidence that people delayed their death to save their heirs\’ money, in some cases, millions and millions of dollars.\”

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Caballero #3: The Pretense of Knowledge Syndrome in Macroeconomics

This is the third of three posts based on an interview that Ricardo Caballero of  MIT did with Douglas Clement of the Minneapolis Fed.

Caballero on the pretense-of-knowledge syndrome in macroeconomics:

\”[T]he economy is so complex that there is little hope of understanding much without models. I just don’t want these models to acquire a life that is independent from the purpose they are ultimately designed to serve, which is to understand the functioning of real economies…. [T]he current core of macroeconomics has become so mesmerized with its own internal logic that it begins to confuse the precision it has achieved about its own world with the precision it has about the real one.

\”There is absolutely nothing wrong with building stylized structures as just one more tool to understand a piece of the complex problem. My problems with this start when these structures take on a life on their own, and researchers choose to “take the model seriously”—a statement that signals the time to leave a seminar, for it is always followed by a sequence of naïve and surreal claims….

\”My point is that by some strange herding process, the core of macroeconomics seems to transform things that may have been useful modeling short-cuts into a part of a new and artificial “reality.” And now suddenly everyone uses the same language, which in the next iteration gets confused with, and eventually replaces, reality. Along the way, this process of make-believe substitution raises our presumption of knowledge about the workings of a complex economy and increases the risks of a “pretense of knowledge” about which Hayek warned us in his Nobel Prize acceptance speech.\”

The interview questions here are focused on a paper by Caballero called \”Macroeconomics after the Crisis: Time to Deal with the Pretense-of-Knowledge Syndrome.\” that was published in the Fall 2010 issue of my own journal, where Caballero spells out these arguments in greater detail.