September 9, 2009

Productivity, Unemployment, and the End of the Recession-Becker

On October 7, 2008 I wrote an op-ed piece for the Wall Street Journal ("We're Not Headed for a Depression") in which I said there would not be a depression, certainly nothing at all resembling the Great Depression of the 1930s. As the economy continued to decline after that I began to worry that my predictions were going to look foolish, and become famous as one of the many absurdly bad forecasts.
Fortunately for me, and even more so for the world, the forecast turned out to be basically correct. I recently claimed in a post on this blog on August 9th that the current world recession is over, and many economists and official organizations since then have come to the same conclusion. The recession was big and world wide, but it was far from a depression-a rule of thumb is that a contraction is a depression only if the fall in output is at least 10%. The output fall in the US and the world has been less than 5%. Indeed, this recession is hardly more severe in the US- the epicenter of the financial crisis - than a couple of previous recessions, such as the one from 1973-75 brought on by the first oil shock, and the one in 1981-83 resulting from the Fed's successful efforts to squeeze inflation out of the system.
During the Great Depression American unemployment peaked at 25% and was high during the whole of the 1930s, while output declined by more than 20%. During this present (or past) recession, output has fallen by a little over 4%, and unemployment so far has remained under 10%-the latest figure gives an unemployment rate of 9.7%. Since a world of difference exists between the two events, the prevalent fear of a major depression was never realized.
Those who are more pessimistic about this recession point out that unemployment is still rising, and may reach a much higher level than its present rate. They also rightly indicate that total unemployment and underemployment is much higher than 9.7% because some persons have only found part time jobs, while others have been so discouraged by the weak labor market that they quit looking for work, and so are not counted as unemployed.
I will take up both aspects of this pessimism in turn. To understand what has been happening to unemployment, it is crucial to recognize that employment has declined, and unemployment has risen, much more relative to output during this recession than in past recessions because labor productivity-measured by output per worker or per hour of employment- has continued to grow during the recession. Productivity grew by 0.3% during the first quarter of 2009, and by a whopping 1.8% during the second quarter. Typically, measured productivity falls during serious recessions because of excess capacity of capital and the many employed workers who are underutilized. Basic arithmetic indicates that for any given fall in output, the greater the rise in measured labor productivity, the greater the fall in employment, and the greater the increase in unemployment.
Unemployment is typically a lagging indicator in the sense that it usually begins to fall only months after output has started to increase again. Since I expect output to rise only a little in the US during the third quarter that will be over at the end of September, unemployment should continue to rise for a while, almost certainly surpassing 10% at its peak. However, if, as I expect, the growth in productivity will continue into the future at a good pace because of the many innovations and inventions coming on line, that will lead to greater, not a lesser, growth in employment. For at some point, the economics of the positive relation between productivity and employment becomes more powerful than the short-term arithmetic negative relation that occurs during recessions.
In the longer run, advances in productivity are partly produced by investments in R&D and other innovations that generate new products and new processes. Both new products and new production methods typically require investments in both physical and human capital. They also stimulate the use of more workers of various skills that utilize the greater capital stock. This is why over longer time periods, productivity advances and robust labor and capital markets in different economies are strongly positively, not negatively, related. For this reason, the continuing advances in productivity in the US and elsewhere will at first limit and then reverse the falls in employment and rises in unemployment.
It is true that the total underemployment rate during this recession would be well above the official unemployment rate of 9.7%. Some estimates put total underemployment at over 16%, which includes individuals who are reluctantly working only part-time, and also persons who have given up looking for work. However, apples have to be compared with apples, and in judging this recession relative to prior ones, the same calculations have to be made for these past recessions as well. Exactly the same type of growth in underemployment was operating in these prior recessions, and especially for the severe recession of the 1930s. Perhaps the fractions of reluctant part timers and persons who stopped looking for work are greater during the present recession than recessions than say in 1973-75, or 1981-83, but I have not seen any demonstration of this. My guess is that whatever differences exist, they are not enough to reverse the ordering of the severity of different post-war recessions.
My overall conclusion is that productivity advances will lead the world out of the recession, and after a while toward a decent rate of growth in world GDP. These advances will occur even if the financial sector is not fully recovered from its crisis. As productivity advances continue at robust levels, that will stimulate the demand for labor, and begin to reduce unemployment and produce sizable rates of growth in employment.

Posted by Gary Becker at 2:05 PM | Comments (6) | TrackBack (0)

Unemployment and Depression--Posner

I am not bold enough to make forecasts about economic recovery, given the unusual economic situation that the country is in. The recovery may be fast or slow, shallow or steep, continuous or interrupted--and if fast and steep may set the stage for inflation and other economic troubles. So I am neither an optimist nor a pessimist.

I am uncomfortable with the way in which modern economists discuss economic downturns. Before the 1930s depression, economic busts were called--"depressions." As far as one can judge from the incomplete nineteenth-century economic statistics, that depression was of unprecedented severity, and hence came to be called the "Great Depression." Which is fine. But thereafter, for reasons I can't fathom, economic busts, instead of being called "depressions" (though of course not "Great Depressions," because they were much less severe), came to be called "recessions." The current downturn, because it is the worst since the Great Depression, is now being called the "Great Recession." I find this lexical nitpicking distracting and unhelpful. Why not just say, we're in a depression, severe by postwar standards but mild compared to the Great Depression?

I also question the convention that says that a depression (or recession, if one insists on retaining that word) ends when GDP growth resumes. Actually, that is not the official (National Bureau of Economic Research) position; its business-cycle committee looks at other factors as well, such as employment. It would be a nonsensical convention applied to the Great Depression; it would imply that the Great Depression ended in March 1933, when output and employment began to rise from their respective one-third and one-quarter decline from 1929.

I would prefer to say that a depression ends either when economic output returns to its pre-depression level or, better, when it returns to the GDP trendline of average annual growth, which is about 3 percent in real terms. So this depression has not ended.

This depression was never likely to be as severe as the Great Depression. One reason is the automatic stabilizers, such as unemployment benefits and other social-welfare programs, and progressive income tax. Another reason is changes in the composition of the workforce. Manufacturing and construction, two of the industries most likely to respond to a fall in demand by laying off workers, account for a much lower percentage of the U.S. workforce today than in the 1930s; and services (which had a low unemployment rate even in the Great Depression) account for a much higher percentage. In addition, there is federal deposit insurance, and a clearer understanding that in a depression the government should try to increase the money supply, and indeed should try to create at least a mild inflation. The Roosevelt Administration did both things as soon as it took office and they probably were responsible for the rapid improvement in the economy that began soon after his inauguration, though it was later interrupted by the economic dive in 1937 and 1938--what has been called the "second depression."

Nevertheless this depression resembles the Great Depression in one respect that makes forecasting particularly chancy--it has been accompanied and made worse by a financial crisis. The normal depression comes about either from something that happens in the nonfinancial economy, such as a big increase in productivity which causes unemployment, or by the action of a nation's central bank in raising interest rates to stop or head off inflation. In both cases, as shown in research by Christina Romer and others, the depression can be effetively treated by the central bank's reducing interest rates, which stimulates economic activity by increasing lending.

But we are in a depression in which interest rates are very low. Indeed, the Federal Reserve is maintaining the federal funds rate at just a shade over zero percent and has been for many months. There are other interest rates, and the effect of the federal funds rates on them is complex, but nevertheless there is nothing further the Fed can do, or at least that it wants to do (because it's beginning to worry about a future inflation), to lower interest rates, though credit remains very tight because the banks remain undercapitalized and demand for loans is weak because people and many businesses are overindebted.

It's because monetary policy, though in combination with bailouts it has saved the banking industry from bankruptcy, cannot do anything to stimulate economic activity that we have the $787 billion stimulus program and other programs, such as the federal subsidies that are keeping GM and Chrysler in business. These programs may be responsible for the recent improvement in the economy, at least in part, though there is no good evidence.

The consumer price index is lower than it was a year ago, which means we're in a deflation. It's a mild deflation, but any deflation increases the burden of debt, which in turn reduces personal consumption expenditures and investment. The unemployment rate is high and rising, and the underemployment rate, 16.8 percent in August, is very high. Housing prices remain very low, which increases indebtedness because a house is the principal asset of most people, and mortgage debt obviously does not fall when the value of the mortgaged property falls. The fall in housing prices, by wiping out the housing equity of milliions of people, exacerbates unemployment by making it more difficult for the unemployed to seek jobs in different parts of the country--they can't afford the down payment on a house if their existing house is worth less than the unpaid balance of their mortgage.

Another factor retarding recovery is the reluctance of older workers to retire, because their retirement savings are impaired. Employers are reluctant to lay them off for fear of being accused of age discrimination, which is illegal. With fewer workers exiting the work force, there is less room for the thousands of people who each day are looking for a job.

There are factors pushing in the opposite direction--toward a rapid recovery. As manufacturers work off their inventories, production restarts; as people's incomes fall, they divert more income to consumption and less to savings; when their incomes fall really far, they start spending their existing savings; and as durables wear out, the demand for durables increases. (It's the fact that the purchase of durable goods is postponable that leads to such drastic falls in manufacturing in a depression, compared to services.) And as economic conditions improve in other countries, U.S. exports will rise, which will stimulate U.S. output.

I don't know how these factors balance out, and I suspect no one knows. After the economists and the businessmen alike were caught by surprise by the housing and credit bubbles and ensuing financial crisis, all macroeconomic forecasts should be treated with a measure of skepticism.

Posted by Richard Posner at 1:58 PM | Comments (8) | TrackBack (0)

September 6, 2009

Notice

We will blog on Tuesday or Wednesday of this week, rather than today.

Posted by Richard Posner at 12:17 PM | Comments (7) | TrackBack (0)

August 30, 2009

Do We Need More Regulation of Mortgages to Protect Consumers?--Posner

The Treasury Department in its "white paper" of June 17 recommended the creation of a "Consumer Financial Protection Agency," and later followed up with a detailed legislative proposal for a "Consumer Financial Protection Agency Act of 2009." The proposal is pending in Congress.

Although the Commission's remit would not be limited to mortgages, risky mortgage lending is the Act's principal target. The supporters of the Act maintain that quite apart from instances of fraud, which are punishable under existing law, many consumers were unable to deal sensibly with the terms of the mortgages that were offered to them during the housing boom of the early 2000s, which peaked in March 2006 and then deflated, bringing down much of the rest of the economy with it, as we know. The mortgage bankers and other sellers of residential mortgages often did not require that prospective buyers demonstrate that they had the financial wherewithal to be able to repay the mortgages; mortgages that required no down payment were sold, often to people of quite limited financial means; prepayment penalties were common, which make it costly to refinance a mortgage if interest rates fall; and many mortgages were "ARMs"--adjustable-rate mortgages, which specified low "teaser" rates for the first few years followed by higher rates when at the end of the teaser period the rates were "reset."

A recent, and very thorough, article, by Oren Bar-Gill, "The Law, Economics and Psychology of Subprime Mortgage Contracts," 94 Cornell Law Review 1073 (2009), argues that many consumers made themselves worse off by taking out mortgages during the boom (in fact the bubble) period because they could not respond rationally to the offers by the sellers of mortgages. Many of them could not compare the terms of alternative mortgages (say a conventional 30-year mortgage and an ARM) because the terms were not stated in an intelligible fashion. In addition many consumers were afflicted by "myopia" and "optimism." "Myopia" in this context means inability to give proper weight to future costs--for example, higher interest rates when the mortgage resets; they do not look behind the "teaser" rates even though the reset rates are disclosed. "Optimism" in this context refers to exaggerating one's future economic prospects--unrealistically believing that either one's income will increase or housing prices will continue rising and by doing so enable one to refinance the mortgage on attractive terms--one's equity will have increased because the amount of the mortgage is fixed.

Bar-Gill's concern with inadequate disclosure of the annual percentage interest rate of mortgages does not present a novel regulatory issue. The Truth in Lending Act requires disclosure of the annual percentage interest rate of a mortgage or other consumer loan (APR), and if the requirements are inadequate (Bar-Gill believes that the APR is not required to be disclosed early enough in the negotiations over the mortgage), or violations not punished severely enough to deter, the Act can be amended. But neither the Truth in Lending Act nor any other statute or regulation, so far as I know, requires that mortgage offers be designed to discourage choices based on myopia or optimism. Bar-Gill himself recommends only requiring earlier and clearer disclosure of APR, though he describes this as a first step in purging the mortgage market of irrationality, rather than a complete solution to the problems he sees.

His analysis is based, as he explains, on findings by behavioral economists, who investigate departures from rationality in economic decision making. But like them, he does not make clear what he means by "rationality." It cannot mean full information, or the ability to process information flawlessly, because these condtions are rarely met in any area of human activity. It does, however, imply consistency and the avoidance of fallacies that cause serious harm, financial or otherwise, to people who harbor them.

It is unclear that either myopia or optimism in the sense in which Bar-Gill uses these terms is irrational. It might seem that if the discounted annualized present cost of an ARM is higher than that of a fixed-rate mortgage, anyone who prefers the former is irrational: he is paying more than he has to. But that conclusion depends critically on the discount rate, which differs from person to person. Some people have very low discount rates; they save a lot of money, or they incur substantial costs in an education that will yield a commensurate increase in earnings only after many years. Other people have high discount rates; they live for the present. These people are not irrational. The difference between them and people with low discount rates is a matter of personality rather than of cognition.

If you have a high discount rate, the low teaser rate in an adjustable-rate mortgage may be a good deal more attractive than the high reset rates. You are "irrational" only from the perspective of low-discount-rate persons, such as Professor Bar-Gill, who has two doctorates, two masters degrees, and a total of 13 years of education after high school.

Optimism is also a personality trait, and, as it happens, one essential to human progress. As I have argued elsewhere with reference to our current economic situation, what Keynes called "animal spirits" and, alternatively, confidence or optimism are essential to entrepreneurship because of the great uncertainty of a business environment. Someone who invests in building a factory that will not produce anything for years is taking a big risk of failure, and because it is a risk that cannot be reliably quantified he is taking a leap of faith, and he will not do that unless he happens to have an optimistic outlook. It is not that rationality implies such an outlook, but that rationality is not inconsistent with it. Optimists are often disappointed, but sometimes are richly rewarded for the risks they take; and as long as the prospect for such rewards confers on them greater ex ante utility than more cautious, pessimistic decisions would do, they are not behaving irrationally. "Nothing ventured, nothing gained" is the credo of the optimist and the terror of the pessimist, but neither reaction is irrational. The optimist and the pessimist just have different personalities. Bar-Gill has made a value judgment rather than an economic judgment.

Now it is possible that the kind of wet-blanket regulation that he might favor if he thought it feasible--which is the kind of regulation that the sponsors of the Consumer Financial Protection Agency Act very much do favor--could be defended on macroeconomic grounds, as conducing to economic stability. Had there not been in the early 2000s a strong market for risky mortgages, there would have been fewer defaults when the housing bubble burst and therefore less damage to the solvency of the banking industry. But whether the proposed Act would do anything to limit risky mortgage lending is unclear. It would authorize the Consumer Financial Protection Agency to require that a prospective mortgagor be shown, and entitled to choose, a "plain vanilla" mortgage that would be very short and easy to read and would alert the mortgagor to the various risks created by different mortgage terms. But if people have high discount rates and (or) are highly optimistic, disclosure of alternatives will not affect their choice.

So the stability issue narrows to how many mortgagors there are who, if only the alternatives to a risky mortgage were presented clearly to them, would forgo the risky option. Doubtless there are some; Bar-Gill cites persuasive evidence of that. But enough to prevent another housing bubble? That seems unlikely, but is in any event unproven.

Posted by Richard Posner at 5:04 PM | Comments (46) | TrackBack (0)

More Regulation of Mortgages would Likely Hurt Consumers-Becker

No doubt many consumers made mistakes in their credit decisions during the past few years, perhaps especially in the mortgages they chose. It is equally clear that many lenders wish they had never given the mortgages they gave since they lost their shirts by doing so. Does any of this mean that a commission to protect consumers would be a welcome piece of legislation?
I am first of all dubious that consumers would have behaved much better if they had simpler contracts, or had the terms better explained to them. The fundamental problem is that consumers are generalists who must make thousands of decisions in highly different areas. As a result, they rely not only on their own limited knowledge, but also on competition among producers to help protect their interests. When that breaks down, as in the housing bubble, many consumers get hurt, but overall it is an excellent strategy for those who must make so many decisions based on quite limited information.
Even if we agree on the above analysis, some will argue that a consumer "czar" would help protect the interests of consumers who make mistakes that markets fail to correct. For after all, the czar and other members of her commission would be specialists in consumer issues that might enable them to discover and correct consumer mistakes. This type of analysis is behind the "libertarian paternalism" in the book "Nudge" by Cass Sunstein-a former colleague and the present regulatory czar-and Richard Thaler, a colleague at the University of Chicago.
A realistic view of the political process casts strong doubts on whether this is how such a commission would actually operate. Many political decisions are the result of a fierce contest between interest groups with different positions, as we are seeing clearly now in the fight over how health care delivery in the United States should be changed. In these battles, producers, like health insurance companies and doctors in the health care case, are much better organized politically than consumers.
Producers can more easily coordinate their actions politically since they are usually either relatively few in numbers- as with health insurance companies- or they have effective trade associations that push their agendas, as with the farm lobby or the American Medical Association. Moreover, since what gets passed can greatly affect the livelihood of producers, they have a strong financial interest in getting legislation that helps them, or at least does not do much damage.
The emphasis on consumer ignorance and mistakes makes it harder, not easier, for consumers to act as an effective political counterweight to the political power of producers since they supposedly do not fully know their own interests. So I would expect producers, such as issuers of mortgages or credit cards, to be able to manipulate in their own favor any attempt by the Commission to push regulations to help consumers. These advantages that producers gain from regulations have been called the "capture theory" of regulation in the political economy literature. In the case of consumer ignorance, capture by producers of the regulators is even more harmful to consumers since consumer regulations are likely to end up exploiting, rather than combating, this ignorance in order to benefit producers, the way a private monopoly exploits consumer mistakes.
The cigarette settlement with the State Attorney Generals is a good example. Cigarette manufacturers paid billions of dollars to the states based on present and future production, even though they were being penalized for the harmful effects of past smoking. They got a settlement that also taxed potential new cigarette producers, so that cigarette producers were able to raise prices in response to the tax. In fact, prices went up by considerably more than the additional tax per unit. This enabled producers to recoup most of their payments to the state governments. But smokers paid a lot for the settlement through the much higher prices they had to pay. Perhaps that was desirable in order to cut smoking, but producers got off quite cheaply, and the poorer individuals who tend to smoke a lot were hit heavily by the settlement.
I am dubious about this proposed regulatory commission for all the reasons Posner gives. In addition, I have argued that the Commission, whatever the intentions of Congress, the President, and members of the Commission, is likely to end up furthering the interests of mortgage companies, credit card issuers, and other producers at the expense of the very consumers it is supposed to be protecting.

Posted by Gary Becker at 4:46 PM | Comments (9) | TrackBack (0)

August 24, 2009

The Cash for Clunkers Program: A Bad Idea at the Wrong Time-Becker

The cash-for-clunkers program of the federal government began in late July, and will end this evening. It provides a credit of from $3500-$4500 for anyone who trades in an older car to buy a new fuel-efficient car. When measured by its popularity, this has been a highly successful program, for about 500,000 applications have been submitted under the program during these few weeks. The strong demand caught the government by surprise, so that it had to add a couple of billion dollars to the one billion dollars initially allocated to the program. Officials are far behind in the paperwork required to compensate dealers for the cars bought under the program.
Unfortunately, that the subsidies are popular is no measure of its public value, and I am afraid there is little to be said at any level in defense of a cash-for-clunkers program. Hundreds of thousands new cars will be purchased under the program, but many of these purchases would have occurred later in 2009 or in 2010 instead of during the five week window of the clunkers program. There is little value to the economy in subsidizing consumers to buy cars a few months earlier than they would have bought them anyway.

To be sure, some cars would be purchased under the program that would not have occurred during the next 18 months, if at all. But if the goal of the program is to help stimulate the economy by subsidizing consumer spending, why limit it to individuals who own old cars? Why not give vouchers to all consumers that they can spend for a limited time period on many durable goods, such as computers, printers, TV sets, washing machines, and refrigerators? If that seems like too obvious a straight handout, the government could require consumers to turn in old computers or other durable goods in exchange for new ones. Of course, as with the cash-for car clunkers subsidy, many consumers under this more general clunker program would simply alter when they purchased the new durables to take advantage of the subsidy. The net result would again be subsidies that produced little net increase in spending.

Several arguments might explain why the decision was made to concentrate the clunkers program on cars rather than include other consumer goods. A cynical view is based on the fact that the federal government is now a major stockholder of two auto companies, GM and Chrysler. Subsidies to stimulate the demand for cars raises the sales and profitability of these companies, which would help justify the Obama administration's decision to bail out these companies in a big way. Of course, the longer-term effect on GM's and Chrysler's profits would be small if the cash-for-clunkers program mainly redistributed new car purchases from later times into these past five weeks. That the government wants its car ownership balance sheet to look better does not mean that the program makes good economic sense.

Another justification for the program relates to the environment, and argues that carbon dioxide and other pollutants from burning gasoline would be reduced if new fuel-efficient cars replaced old inefficient cars. However, the exchange of clunkers for new cars would raise, not lower, the amount of gasoline consumed to the extent that consumers traded in old cars that they never or seldom drove because the cars were in such bad shape for nice new cars that they would drive a lot.
Even if the older cars were in reasonably good shape but got poor gas mileage, new cars would be driven more miles because, being much more fuel efficient, they would use much less gasoline per mile of driving. On balance, the clunker exchange might result in only a small net reduction, if any, in the amount of gasoline used. According to Sunday's New York Times, the average trade-in got 15.8 miles to the gallon compared to about 25 miles per gallon for the cars that were purchased. If the cars will be driven about 50% more miles per year than the clunkers that were exchanged-not an extreme assumption- there would be essentially no effect on the gasoline consumed.
The main problem I have with the cash-for-clunkers program from the viewpoint of reducing pollution is that the program is such an inefficient way to cut down on gasoline consumption. The obvious best approach, not politically easy to accomplish, would be to raise the federal tax on gasoline. This would encourage owners of all cars to drive fewer miles since the cost of driving would go up for every driver, no matter how fuel-efficient their cars were. Higher gas taxes would especially encourage owners of older inefficient cars to drive much less-as they did when gas prices topped $4 per gallon- and even induce them to trade in their old cars for more efficient cars without offering any special incentives to do so. This criticism of the clunkers program as inferior to a gas tax applies also to the CAFÉ standards approach of the US to raise the miles per gallon of gasoline of the fleet of new cars produced, the cash and tax credit incentives to buy hybrids, and various other approaches that are being used to try to reduce gasoline use.

There is a further major difficulty with the clunkers program that illustrates a much more general problem of fiscal efforts to stimulate the economy. The details of spending programs are so slow for legislators to work out, and the delays in implementing the spending are so long, that the government "stimulus" gets implemented usually only after the economy is already pulling out of a recession. The US economy and that of most other major nations have stopped declining and are beginning to grow again. Yet rather little of the Obama stimulus package has yet been spent.

As Posner indicates, most of this spending has taken the form of transfer payments, but that is for a good reason since government projects are much slower to develop and implement. Even payments to car dealers under the clunkers program are being delayed because of administrative snafus in processing claims. This is a classical argument against using government spending for counter cyclical purposes, but seems to have been forgotten during this recession.

Posted by Gary Becker at 5:23 PM | Comments (39) | TrackBack (0)

Cash for Clunkers--Posner's Comment

I agree with Becker that it's a silly program.

Like the bailout of the auto companies, the program had dual environmental and economic-recovery goals. The environmental goal, to reduce carbon emissions, was trivial; the aggregate improvement in gas mileage from the program is certain to be minuscule. The contribution to economic recovery was probably very small as well--possibly negligible. The program was one of transfer payments, not government investment. The distinction is important to Keynesian deficit spending (what is now referred to as "stimulus") as a method of fighting a depression. The idea behind such programs is to replace deficient private investment with public investment, for example, the construction of a new highway. The government hires a contractor who hires workers and by doing so increases employment, which raises incomes and therefore spending. A transfer payment does not do that, at least immediately.

It is true that people who participated in the "cash for clunkers" program couldn't pocket rather than spend the money they received from the government, as they could with the other transfer payments included in the stimulus program; they had to use it to help them buy a new car. But that is different from paying a road contractor to build a new highway. The contractor as I said has to go out and hire people to build it, so unemployment falls (on the assumption, correct with regard to construction, that there is a high rate of unemployment in the industry). The purchase of a new car merely reduces a dealer's inventory, and whether the reduction leads to new production will depend on estimates of future demand. Those estimates are likely to be inverse to the success of the "cash for clunkers" program. For, as Becker notes, the program may to a large extent merely have caused people to accelerate a previously determined intention to trade in their old car.

Timing is important; had the program been put into effect in the winter, the buying spurt that it induced might have had a bracing effect on consumer confidence. But by August the economy had sufficiently improved that the need for confidence-boosting measures that had no other effect on economic activity had waned.

Unlike Becker, I do not conclude from this unhappy episode that the Keynesian approach to fighting depression is misconceived. The problem with the $787 stimulus package that Congress enacted in February, to which the "cash for clunkers" program was a belated addition, was that it was poorly designed and has been lackadaisically executed. Roughly two-thirds of the program consists of transfer payments rather than public works, and because the Administration has failed to push the public-works components (it should have appointed an expediter to try to cut the red tape that smothers public projects), virtually all the stimulus disbursements to date have consisted of transfer payments (including, what are not really transfer payments, tax reductions that don't put cash in people's pockets until they are reflected in reductions in withholding or estimated tax payments, or in increased rebates when one files one's year-end return on April 15).

Keynesians recognize that timing is key to the success of a stimulus program in fighting an economic collapse. The stimulus program should have been enacted last fall and heavily weighted in favor of public works concentrated in areas and industries of high unemployment, with provisions for cutting red tape even at the risk of a higher incidence of fraud and waste, which are constants in government programs.

Posted by Richard Posner at 4:07 PM | Comments (10) | TrackBack (0)

August 17, 2009

Health Care, Cost, and Insurance Theory--Posner

The focus of the Administration's health-care plan, and of its campaign to enlist public support for the plan, is dissatisfaction with health insurance. To see the problem--or whether there is a problem--compare health insurance to fire insurance. Almost everyone has fire insurance (even if he doesn't want it, invariably it is required by the mortgagee, if there is one). The reason is that a fire can wipe out a big part of most people's wealth, and, given declining marginal utility of income, which makes most people prefer a certainty of obtaining a million dollars to a 50 percent chance of obtaining $2 million (and a 50 percent chance of nothing), the cost of fire insurance is a good investment. The insurance company knows how much it may have to pay if there is a fire because the insurance policy has a dollar limit.

If someone is convinced that his house is fireproof and therefore fire insurance would be of no value to him, and therefore refuses to buy it, the insurance premiums charged the buyers of fire insurance will be slightly higher (because his being in the pool would have reduced the expected cost to the insurance company). But no one is concerned with this, because very few people opt out of fire insurance.

Health insurance is different superficially because of the extreme variance in costs of medical treatment; some people have medical conditions that cost literally millions of dollars to treat. But this is a problem in other forms of insurance as well, such as liability insurance in which the insurer undertakes to pay the insured's legal expenses, which can be astronomical; and insurers deal with such difficult-to-estimate risks through reinsurance and large deductibles.

Health insurers, if left to themselves, generally refuse to insure the cost of treating pre-existing conditions; but that is no different from a life insurer that refuses to issue a policy (or charges more for it) to someone whom a medical exam reveals to have a short life expectancy. Prudent people buy life insurance when they're young and in good health.

Health insurers often cancel an insurance contract, or refuse to renew it, after discovering that the insured is in bad shape and likely to cost the company a great deal in the future. Fire insurers and automobile insurers often do the same thing. If people want to have lifetime protection, they have to pay higher premiums but it is hard to see why health insurers would refuse to offer such contracts; in fact some people do have such health insurance.

There are several puzzling aspects to health insurance, one of which, however, is rather easily solved, and that is the fact that a significant fraction of the population has no private health insurance. If your house burns down and is uninsured, tough luck. But if you get sick and have no insurance and no money, you can still get treatment at the nearest hospital emergency room. (You will be billed, and if you have enough money you will have to pay the bill.) If you have no money, you're a free rider, but the amount of free riding is kept down by the cost that emergency rooms impose on patients by making them wait--and a queuing cost is a real cost to the people forced to stand in the queue.

Many of the uninsured are young and healthy; they are like the person with the fireproof house. If they were forced to insure, therefore, premiums for health insurance might fall, though this is highly uncertain. Many of the uninsured, rather than being young and healthy, are uninsured because of pre-existing medical conditions that imply that these people will incur abnormally high costs of treatment in the future.

Medicaid, charity treatment in emergency rooms of hospitals, and Medicare when utilized by indigent people constitute a form of poor relief. There is no reason why Medicare shouldn't be means-tested; people who can afford medical care should pay for it themselves.

The fact that, because of tax subsidy, most health insurance is offered as an employment benefit screws up the health-insurance system considerably. Not only does the subsidy result in giving people more medical benefits that they would want if they had to pay the full, unsubsidized price. They lose the insurance if they lose their job or if the employer cancels the group insurance policy, and when they seek new insurance they may find themselves turned down, or made to pay a very high price, because of their age or because they now have a pre-existing condition.

If people were willing to pay high premiums, and accept high deductibles and copayments, they could buy health insurance policies that would give them lifetime protection against all major medical problems they might encounter. But people are not willing to pay high premiums or (mysteriously) to accept high deductibles and substantial copayments. They prefer to take a chance on their employer-supplied health insurance and on making it to 65 (Medicare eligibility age) without going broke as a result of a medical condition for which they are not adequately insured. And if they have no employer-supplied health insurance they may decide to do without and hope for the best even if they could afford to buy an expensive individual policy.

Repealing the deductibility of employer-supplied medical benefits from federal income tax, and instituting a means test for Medicare, would reduce the demand for, and therefore total cost, of medical services and reduce the federal deficit as well, since Medicare costs the federal government more than $300 billion a year. Since Medicare would cover fewer people, there would be less need to institute procedures designed to limit expense by limiting treatments--something people fear, whether rationally or not.

It is doubtful whether any other measure consistent with American culture and values would reduce medical costs substantially, though one can imagine a series of modest reforms that might add up to a net savings, including limiting liability for medical malpractice, imposing large deductibles for medical treatment for injuries experienced in dangerous recreational activities, reducing highway speed limits, and taxing fattening foods and beverages. None of these is likely to figure in any health reform enacted by Congress at the present time, however.

The opposition to the Administration's health plans is understandable, though some of it is uninformed and even irrational. The Administration's problem is that it wants to expand insurance coverage, and this will increase the cost, including the public cost, of the health-care system, but that the only serious way in which the Administration can imagine limiting the cost increase (as there is insufficient public support for terminating the tax subsidy of employee health benefits, let alone for limiting Medicare to people who can't afford private health insurance) is by curtailing treatment. And that upsets people, since they don't trust the government to decide what medical treatments are cost-justified. (And why should they?)

In all likelihood, moreover, the Administration is underestimating the cost of expanding coverage. It wants to push as many of the currently uninsured as possible into insurance plans, and this will not only cost a lot in subsidies, as well as in higher costs to employers; it will also increase the demand for and thus the aggregate cost of medical services (because supply is inelastic). Once a person is insured, the marginal cost (which includes the queuing to which the uninsured are subjected, as well as monetary cost) to him of treatment drops to the copayment or deductible. The government also wants to forbid insurers to deny coverage on the basis of pre-existing conditions or to rescind policies after paying a large claim to an insured (and foreseeing future such claims). This will increase the cost of health insurance, and the government will doubtless end up picking up the tab, because there is great resistance on the part of the public to paying higher insurance premiums.

The cost of the projected health reforms cannot be estimated. One reason is that no one seems to know what is actually in the literally thousands of pages of health-reform bills drafted by different congressional committees. Or if they know, they are not telling. Another reason for uncertainty about cost is that no one outside government (maybe inside it as well) knows what the Administration is likely to settle for in its negotiations with the various interest groups and legislators.

But worse than not knowing the cost is not knowing how it is going to be paid. Higher taxes, unless trivially higher, seem politically infeasible, which means that health reform if enacted will add to our soaring national debt--and probably add a lot, though we cannot know how much.

Posted by Richard Posner at 9:40 AM | Comments (73) | TrackBack (0)

American Health Care Once Again-Becker

In a recent post (see my discussion on July 28) I explained why the American health delivery system is superior in some important dimensions to health care in most other advanced countries. Americans have considerably longer life expectancies when they contract serious diseases, like cancers and heart conditions, than do persons living in these other nations. That post emphasized that many criticisms of the American system do not sufficiently appreciate its positive effects on both the quantity and quality of life.

Here I address a few of its major shortcomings, and suggests ways to overcome, or at least moderate, these without eroding the strong parts of the system. I recommend to readers the many high quality discussions of health care reform by John Goodman of the think tank, The National Center for Policy Analysis, and also a good op-ed piece in the Wall Street Journal of August 12th by John Mackey, CEO of Whole Foods.

A glaring weakness of the American health system is the over 40 million Americans without health insurance. To be sure, they impose much less of a cost on the health care system than is commonly claimed, partly because the majority of the uninsured are young and healthy. Still, in a country as wealthy as the US, this is embarrassing, and should be rectified.
The least bad solution, strangely, opposed by many conservatives, is to require everyone to take out catastrophic health insurance that covers each person against major illnesses. Those individuals and families that lack the means to pay for such insurance would be supported under a version of Medicaid. Such compulsory insurance for everyone would greatly reduce the uninsured problem, in particular their free riding on others when they get seriously sick and go to hospitals for extensive care. Increasing their medical coverage in this way would add to total spending on medical care, but it might well reduce the cost of medical spending to others. Since the uninsured would be forced to take out such insurance, they would pay for any major medical care through insurance premiums rather than imposing the cost of their care on taxpayers and other groups who pay for their hospital care.
Another feature of the present system is that most Americans receive their health insurance through employment. Americans are stuck for political reasons with this system for a while, yet a few important changes may be politically feasible to significantly reduce its cost, inequities, and inflexibilities. To start, a cap should be placed on the amount of employment-based health insurance that is tax-deductible, so that employees would have to pay for so-called "Cadillac" plans out of their own incomes rather than out of taxpayers' incomes. A second reform would be to provide the tax savings from these plans in the form of tax credits rather than tax deductions, so that higher income employees would not have a tax advantage to opt for expensive plans only because taxpayers foot much of the bill.
A third and very important reform of the employment -based health insurance system would be to make the same tax savings available to persons who buy health insurance outside of their jobs. One advantage of encouraging the purchase of non-employment-based health insurance is that persons changing jobs would not risk losing their health insurance. This would also raise the attractiveness of working at small companies that find it too expensive to provide health insurance. This extension would increase the taxpayer burden from health insurance, but that burden would be offset by the elimination of the tax deductibility of Cadillac plans.
Perhaps the greatest problem facing the health care system is the high and rapidly growing cost of Medicare for the elderly as the American population ages, and as new drugs and surgical procedures are developed to treat diseases of old age. I agree with Posner that a means test for Medicare should be implemented, so that older men and women who can pay for their medical care should get a much smaller subsidy. This would reduce the incentive for these persons to opt for expensive drugs and surgeries only because they pay a small share of the cost. I do believe that older persons would still be willing to pay a lot to extend their lives, partly out of their fear of death. But that belief should be put to the test by requiring the elderly who are reasonably well off to spend more of their own money for their medical care.
In order to increase the number of older persons with enough financial means to cover much of their spending on medical care, further encouragement should be given to tax exempt health savings accounts, where unused balances can be carried over to later years. By age 65, families that have made prudent use at younger ages of the monies in these accounts would then have accumulated sizable balances that will prepare them much better financially for the medical risks of old age.
Another way to reduce medical spending by the elderly in the long run is to encourage, not continue to attack, drug and biotech companies, so that they invest more in developing new drugs that treat better the major diseases of old age. The research and development work required to expand significantly the production of new important drugs would add only a very small fraction to the huge total medical spending. Moreover, this cost would be more than offset by the savings from substituting drugs for expensive surgeries or hospital stays, for drugs have the major advantage over these other treatments that they can be used to treat large numbers at relatively small additional cost. The cost structure of drugs- high initial costs and then low costs of extensive use among the population- is especially advantageous to a health care delivery system, like the American one, that has trouble denying available medical care to persons who might benefit only very slightly.
The current Congressional bills on health car reform generally include a public insurance option; that is, a federal government health insurance plan that would compete against private plans. The Obama administration is retreating from its emphasis on the importance of including this option, and the details about the form such an option will take have not been spelled out. Nevertheless, the experiences of other government-run operations strongly indicate that whatever Congress says in these bills, such an option will cause far more harm than good. For one thing, employees of a government-run health plan are likely to be unionized, just as public school teachers and postal workers are unionized. These unions have raised the costs of operating schools and the postal system through their pay structure, and they have reduced the efficiency of these operations through opposition to innovations, merit pay, and other efficiency-raising changes.
Supporters of a government-run plan claim that it will be financially self-supporting, and will provide a standard for private plans. To see how this would work out in practice, consider the postal system, a nominally private but basically a very old government -run business. The postal system is also supposed to be self-supporting, but only recently it once again asked Congress for additional subsidies to cover deficits. It strains credibility to expect that a large government-run health care option will not run huge deficits. Just as part of the postal deficits are caused by government mandates, such as providing Saturday deliveries at no added cost, so Congress will also impose costly and inefficient mandates on the government health care option, in addition to other inefficiencies of such a government health care organization.
The micro details of the way the postal system operates are hardly reassuring about the efficiency or flexibility of a public insurance option. To illustrate, we summer in a small town on Cape Cod that has about a 1,000 year-round population that rises to about 10,000 during the heart of the summer. In responding to this large seasonal change, Fed Ex, a non-union private company, rents delivery trucks from auto rental companies to supplement their own fleet of trucks, adds temporary workers, and extends their hours of operation, so that they often make deliveries long after sunset. By contrast, the local post office maintains exactly the same hours as during the off-season. This includes closing for lunch from 12-1, closing at 4:30PM every weekday, and staying open only for a few hours on Saturdays. Since there is no regular mail delivery because the all year round population is too small, many families rent boxes at the post office. Instead of arranging to allow box-holders to access their boxes at most hours even when the postal window is closed, box access is only marginally better than access to the postal window, including no Sunday box access, and only morning Saturday access.

Posted by Gary Becker at 9:10 AM | Comments (27) | TrackBack (0)

August 16, 2009

Notice

We will be posting tomorrow (Monday).

Posted by Richard Posner at 10:41 PM | Comments (12) | TrackBack (0)