November 23, 2009
Should China Allow its Currency to Appreciate? Becker
By all accounts, President Obama's visit to China last week was pretty much a failure on all the major issues, which include China's contributions to climate change, nuclear weapons, and various aspects of the world economy. I will concentrate my discussion on two of the most important and closely related economic issues: the valuation of the Chinese currency, the renminbi, and the huge assets accumulated by China that are mainly held in the form of US Treasury bills and other US government assets.
The Chinese central bank held the value of the renminbi fixed relative to the US dollar at a little over 8 renminbi per dollar during the 1990s, and until 2005. It then allowed the renminbi to appreciate gradually to less than 7 per dollar until 2008, when it again fixed the rate of exchange between these currencies at about 6.9 renminbi per dollar. This exchange rate is considerably above a free market rate that would be determined in a regime of flexible exchange rates. So there is no doubt that China is intentionally holding the value of its currency below the rate that would equate supply and demand.
The dollar has depreciated substantially relative to other currencies since May of 2009. Since the renminbi is tied again to the dollar, the renminbi has depreciated by the same amounts, including 16% against the euro, 34 % against the Australian dollar, 25% against the Korean won, and 10 % against the Japanese yen. This substantially depreciation of the Chinese currency has made many other countries angry at China's policy of locking it to the US dollar.
President Obama apparently complained to Hu Jintao, President of the People's Republic of China, about the low value of the renminbi, and urged China to allow it to appreciate substantially. The US and other countries worry that the undervaluation of the Chinese currencyi increases the demand for Chinese exports, and reduces China's demand for imports from countries like the US because China keeps the dollar and the currencies of other countries artificially expensive relative to their currency. America and other countries hope that greater demand from China for their exports resulting from a higher value of the renminbi will help these countries resume sizable economic growth as they recover from this severe recession. They especially want to help reduce the high levels of unemployment found in many of these nations.
Indeed, in good part due to the low value of its currency, China has run substantial surpluses on its current trade account as it imports fewer goods and services than it exports. The result is that China has accumulated enormous reserves of assets in foreign currencies, especially in the form of US government assets denominated in dollars. As of September of this year, China had the incredible sum of over 2 trillion dollars in foreign currency reserves, such as US Treasury bills. This is by far the highest reserve in the world, and it amounts to the enormous ratio of more than one quarter of China's GDP of about $8 trillion (purchasing power parity adjusted).
I am dubious about the wisdom of both America's complaints about China's currency policy and of China's responses. On the whole, I believe that most Americans benefit rather than are hurt by China's long standing policy of keeping the renminbi at an artificially low exchange value. For that policy makes the various goods imported from China, such as clothing, furniture, and small electronic devices, much cheaper than they would be if China allowed its currency to appreciate substantially in value. The main beneficiaries of this policy are the poor and lower middle class Americans and those elsewhere who buy Chinese made goods at remarkably cheap prices in stores like Wal-Mart's that cater to families who are cost conscious.
To be sure, US companies that would like to export more to China are hurt by the maintenance of the Chinese currency at an artificially low value relative to the dollar. As a result, employment by these companies is lower than it would be, so that this may contribute a little to the high rate of US unemployment. But I believe the benefits to American consumers far outweigh any loses in jobs, particularly as the US economy continues its recovery, and unemployment rates come back to more normal levels.
Since the opposite effects hold for China, I cannot justify their policies from the viewpoint of their interests. Their consumers and importers are hurt because the cost of foreign goods to them is kept artificially high. Their exporters gain, but as in the US, that gain is likely to be considerably smaller than the negative effects on the wellbeing of the average Chinese family.
I reach similar conclusions about China's accumulation of their excessive reserves. The US has little to complain if China wants to hold such high levels of low interest-bearing US government assets in exchange for selling goods cheaply to the US and other countries. China's willingness to save so much reduces the need for Americans and others to save more, but is not differences in savings rates also part of the international specialization that global markets encourage? To be sure, why China is willing to do this is difficult to understand since they are giving away goods made with hard work and capital for paper assets that carry little returns.
One common answer is that China hopes to increase its influence over economic and geo-political policies by holding so many foreign assets. Yet it seems to me just the opposite is true, that China's huge levels of foreign assets puts China more at the mercy of US and other policies than visa versa. China can threaten to sell large quantities of its US Treasury bills and other US assets, but what will they buy instead? Presumably, they would buy EU or Japanese government bills and bonds. That will put a little upward pressure on interest rates on US governments, but to a considerable extent, the main effect in our integrated world capital market is that sellers to China of euro and yen denominated assets would then hold the US Treasuries sold by China.
On the other hand, the US can threaten to inflate away some of the real value of its dollar denominated assets-not an empty threat because of the large US government fiscal deficits, and the sizable growth in US bank excess reserves. Inflation would lower the exchange value of the dollar, and also of the renminbi, as long as China keeps it tied to the dollar. That would further increase the current account surpluses of China, and thereby induce China to hold more US and other foreign assets, not a very attractive scenario to China.
So my conclusion is that the US in its own interest should not be urging China to appreciate its currency- countries like India have a much greater potential gain from such an appreciation. On the other hand, I see very little sense at this stage of China's development in maintaining a very low value of its currency, and accumulating large quantities of reserves. Paradoxically, President Obama and President Jintao should each have been arguing the others positions on these economic issues.
Posted by Gary Becker at 10:06 AM | Comments (0) | TrackBack (0)
China's Currency and Reserves--Posner
Becker's analysis is impressive, but I hesitate to state with confidence that China would be better off to revalue its currency. As Becker points out, China has pegged its currency to the dollar at a rate of exchange that greatly undervalues its currency relative to ours. As a result China sells goods to U.S. producers and consumers at very low dollar prices and buys goods from U.S. producers at very high prices. In consequence it exports a lot to the U.S. (and to other countries as well, for its currency is undervalued relative to other currencies besides just the dollar, notably the euro) and imports little. Since it receives more dollars than it pays, it has accumulated huge dollar reserves--accumulated them rather than giving them to its people. It has more than $2 trillion in foreign reserves, mostly U.S. dollars. The dollar has been falling lately, and the value of China's dollar reserves with it.
Could China have sensible reasons for such an odd, old-fashioned policy ("mercantilism"--the maximization of a nation's cash or cash-equivalent reserves--famously attacked by Adam Smith more than two hundred years ago)? It could. The immense exports that China's skewed exchange policy has fostered provide employment for a large number of Chinese. Their wages are low, but at least they have jobs. Of course they might have jobs if the dollar were cheaper relative to Chinese currency. China would import more and export less. It would manufacture less, because many workers would be required for the expanded system of domestic distribution that would be necessary if domestic consumption (both of Chinese manufactures diverted from export to internal markets and of imported goods). It would manufacture a different mixture of goods, because of competition from imported goods, but above all it would need a much more elaborate system of wholesale and retail distribution, and perhaps a different commercial culture. The transition to a modern consumer society with its credit cards and product warranties and malls and the rest would be difficult. In the interim there might be widespread unemployment; shifting employees from manufacturing to distribution, or from one type of manufacturing to another, doesn't happen overnight. And China doesn't have the kind of social safety net that we do, to catch the unemployed before they reach the bottom. Because of the limitations of domestic consumption, Chinese are great savers, and this relieves the pressure the government would otherwise feel to provide social services. That provision might strain the government's administrative abilities.
China has a long history of political instability, and there is tension between its dictatorial communist government and its largely free-enterprise economy. It is naturally reluctant to take chances on changing its economy from one of producing manufactured goods for export to one of manufacture and distribution primarily for domestic consumption.
And there is value to China in those trillions in foreign reserves that it has accumulated. They magnify its global power. China is our major creditor. It finances our deficit. Like any dependent debtor, we must be very careful not to offend our major creditor. It is true that our relation with China is one of bilateral monopoly: if we devalue the dollar (which we may be doing) in order to lighten our debt burden, we hurt China; but if China in retaliation stops buying our Treasury bonds, we are badly hurt.
For all these reasons, while China is likely to abandon mercantilism in the long run, it probably is sensible for it to do so gradually.
Would we benefit from China's abandoning mercantilism? As Becker points out, our consumers benefit from the artificially low prices at which Chinese goods are sold in this country. At the same time, our dependence on China's financing our public debt weakens our ability to influence Chinese policy on issues of urgent concern to us, such as the threat of nuclear proliferation posed by North Korea, Iran, and Pakistan, and the need to take effective steps to limit global warming.
Then too it seems that the only way in which we can buy those cheap goods from China is to borrow from China. We buy more from China than we sell to it and so China accumulates dollars to bridge the gap, dollars that it then lends to the U.S. Treasury. The effect is to reduce pressure on our government to pay down our immense and growing public debt either by raising taxes or by cutting spending. We cannot continue along the path of ever-growing debt unless our economy grows very rapidly, which is not assured. So I am not sure that I agree with Becker that China's policy is good for us and bad for it. The reverse may be truer.
Posted by Richard Posner at 9:45 AM | Comments (0) | TrackBack (0)
November 15, 2009
Will We Go the Way of Japan?--Posner
Japan spent the 1990s unsuccessfully trying to recover from a collapse of the Japanese banking industry caused by the bursting of a housing bubble, despite aggressive monetary and fiscal policies. As a result of those policies, Japanese national debt soared, but was financed mainly internally because of the very high Japanese personal savings rate. With its large surplus of exports over inputs, moreover, Japan accumulated dollars (and other currencies), which also reduced the debt burden. Interest rates remained very low, in part because of chronic deflation. The low interest rates stimulated the "carry trade": investors would exchange Japanese yen for local currencies in countries that had high interest rates. This is a form of arbitrage, but tends not to erase international interest-rate differences, as one might expect arbitrage to do.
Japan was hard hit by the current economic crisis, in part because of its dependence on exports. It responded with aggressive monetary and fiscal measures, as before--with what appear to be potentially disastrous results, if one may judge from data in a recent article in the Wall Street Journal (Richard Barley, "Japan: The Land of the Rising CDS," Nov. 11, 2009, p. C20). The International Monetary Fund predicts that next year Japan's ratio of national debt to GDP will be an astronomical 2.27, forcing Japan to continue borrowing heavily abroad. Interest rates remain very low, in part because Japan is again experiencing deflation. Rating agencies have reduced Japan's bond rating to AA-, yet the government, lulled by low interest rates, apparently has no sense of urgency about the country's mounting debt burden, a burden aggravated by the rapid aging of Japan's population. International financial markets believe that there is some probability that Japan will default on its debt. The "CDS spread" (the percentage of a debt that someone desiring insurance against the debt's defaulting must pay for the insurance) on Japanese government debt is almost 1 percent (.75 percent).
The United States differs in many respects from Japan, but is beginning to look more and more like it. We too experienced a banking collapse in the wake of the bursting of a housing bubble, and our monetary and fiscal responses, though aggressive, may not have been highly effective. The fiscal stimulus--the $787 billion federal spending program enacted in February--was enacted late and is poorly designed, and some think too small. And there is concern that, like Japan, we are babying our weak banks by allowing them to overvalue the assets and underestimate the liabilities on their balance sheets. The stress tests conducted last spring, for example, both underestimated the stress the banks were under (by assuming an unemployment rate--unemployment being highly correlated with bank-loan defaults--substantially lower than it became within a couple of months after the tests) and disregarded likely defaults of bank loans that will mature after 2010.
Our government, too, is lulled by low interest rates into believing that we can continue to run huge deficits without raising taxes or cutting spending significantly, simply by borrowing. Our public debt (the amount of federal government debt that is contractually obligated, as distinct from accounting reserves for entitlement programs such as Medicare and social security), of which almost half is owned by foreign governments and other foreign investors, has reached $7.5 trillion, which is more than half our GDP, and is on course to increase by at least a trillion dollars a year for the indefinite future. Like Japan, we have an aging population, which is pushing up entitlement costs. Our government seems not to have any economically realistic or politically feasible plans either to raise revenue or cut spending, but instead plans ambitious new spending programs (notably but not only on revamping health insurance). Proposed economies seem tokens. There is an air of complacency about deficit spending and public debt--again like Japan.
Because of our low inflation rate (it is close to zero) and the Federal Reserve's "easy money" policy (as a result of which our banks are holding a total of $1 trillion in excess reserves), the dollar has now become a favorite currency for the carry trade: dollars exchanged for local currencies earn interest more or less effortlessly, though not without risk. The carry trade may be a factor in the recent rises in commodity prices; indeed there is fear of additional asset-price inflation (bubbles) as a result of all the dollars sloshing around in the world economy.
Should the U.S. economy grow more rapidly than the public debt, we'll be okay. But the government's focus appears to be not on economic growth, but on redistribution (the major goal of health reform) and on creating at least an aura of prosperity, at whatever cost in deficit spending and future inflation, in time for the November 2010 congressional elections.
Posted by Richard Posner at 5:41 PM | Comments (0) | TrackBack (0)
Will We Go the Way of Japan? No, Unless US Government Policies Discourage Growth-Becker
Japan has had a very slow rate of growth in its GDP since 1991, averaging just a little over 1 percent. Given this slow growth, and the government's continued failed efforts to prop up their economy by running large fiscal deficits, the ratio of government debt to its GDP has risen from only about 50% in 1995 to by far the highest ratio in the developed world, at about 170% in 2008. Estimates indicate that it could rise to over 200% by next year as the budget continues to spill red ink, and may grow even much further during the next decade. Such a large debt ratio has been manageable so far only because interest rates have been very low, at about a little over 1%. But these rates have recently been rising as concern is growing about the fiscal solvency of the Japanese government.
The danger of any explicit default on this debt is minimal since it is all denominated in the Japanese currency, the yen. Any country can reduce the real value of a debt burden in its own currency by printing money to finance a good chunk of its government spending, and thereby create inflation that destroys part of the real burden of the debt. I do not expect that to happen in Japan unless the debt burden becomes intolerable down the road.
All this is background for comparisons between Japan and the US. As Posner indicates, the American ratio of debt to GDP is now about 50%, where Japan was in 1995. It is also rising rapidly as the government continues to increase its spending on banks, the stimulus package, likely also on health care, maybe subsidizing employment of the unemployed, subsidizing mortgages, and in many other ways. The ratio of federal government spending to American GDP was quite stable at about 20% for about 40 decades, but this ratio has been rising rapidly during the past year, and it is beginning to approach 30%. The government debt is not yet a great burden because, as in Japan, interest rates are low, so that annual interest payments on the debt is not a sizable fraction of total government spending.
It is unlikely that US government spending will decline during the next decade, even though some of the short term spending on banks and stimulating the economy will probably fall sharply. Any spending declines from these directions will be more than replaced by much greater spending on Medicare, Medicaid, and other government financed health programs, on social security, and on various other entitlement programs. The direct impact on the debt burden of such budget deficits can be reduced only by higher taxes or inflation. Eventually, I do expect much greater inflation in the US. The Obama administration has also been vocal about its plan to raise taxes, especially on higher income persons, as soon as the recession is clearly over and the economy is growing again. That would be a serious mistake.
The best solution to reducing the real burden of the public debt is neither inflation nor higher taxes, but more rapid growth of the American economy. This involves lower, not higher, taxes on investments and incomes of small and large businesses. It also requires greater concern about the fact that the US is falling behind many other countries in the proportion of its young population, especially males, who receive a higher education. In addition, much greater attention needs to be paid to correcting the depressing statistic that the fraction of boys who drop out of high school has been stuck at about 25% for several decades, even though the economic and other benefits of finishing high school and going to college have risen dramatically. To its credit, the Obama administration has given high priority to improving the K-12 performance of American students, especially those from minority backgrounds.
In effect, the desirable policies to stimulate growth involve a retreat from the anti-business rhetoric that pervades Congressional Democrats and some of the top players in the executive offices, and a more pro-consumer and pro-business mentality. It is necessary to maintain the minimalist anti-trust policy that developed during the 1980s and 1990s under Democratic as well as Republican administrations, to retreat from the policy that banks and other businesses, such as GM, cannot be allowed to fail when they are mismanaged.
Desirable policies also include the elimination of efforts to restore union power in the private sector, and resistance to the desires of some members of Congress to have the US retreat from a free trade policy> They also want to impose onerous regulations on businesses of all kinds, especially the more successful ones. I am perhaps particularly disturbed by the anti-immigration rhetoric of leading members of Congress since immigrants have contributed so much to the dynamism of the American economy and society.
Sizable advances in productivity and the resulting sharp economic growth can ease the burden of growing government spending, and prevent anything like the expanding debt to GDP ratio and stagnation of the Japanese economy. Can the US do it? Certainly! Will the US do it? Not with the present composition of Congress, and with the tendency of the President to allow some of the more destructive members of his political party to get their way.
Posted by Gary Becker at 4:32 PM | Comments (0) | TrackBack (1)
November 8, 2009
Productivity and Jobs-Becker
Last week two pieces of news about the American economy were disclosed, with important implications for where the economy is going. On Thursday, the Labor Department reported that during the third quarter of 2009, productivity jumped at the remarkable annual rate of 9½%. On Friday, the Labor Department also reported that the October unemployment rate in the United States increased to over 10% for the first time in more than 25 years. The productivity numbers were not entirely ignored, but were on the inside pages of the Financial Times, Wall Street Journal, and most other newspapers. By contrast, the unemployment numbers generally received first page coverage at all the major papers, and led to a lot of hand wringing about the economy. Yet while the figures are rather closely related, the productivity numbers in the longer run are the more important ones.
The two numbers are closely related because when productivity increases by a lot, that means much more output is being squeezed out of given inputs of labor and capital. Since during the third quarter the growth in productivity-equal to the growth rate in output minus the growth rate in hours of nonfarm workers- was over 9%, it is arithmetically necessary that hours would decline and unemployment increase since output grew "only" by about 4%. Hours worked did decline by about 5%, and unemployment grew by several percentage points. The very rapid increase in productivity during the third quarter followed a sharp growth in productivity during the second quarter of about 7%. The fast growth in American productivity toward the end of this serious recession is quite unusual because measured productivity often falls during recessions as companies are stuck with excess capacity of their capital. Companies also usually decide to hold on to their best employees, even though they are less than fully occupied with work. American productivity never fell during this recession.i
A rapid growth in productivity is generally a good sign since it means that more is being produced with fewer inputs of labor and capital- it is sort of a "free lunch". However, in a period of reduced employment and rising unemployment, many persons begin to fear that companies are advancing productivity only by laying off employees, and that this process cannot be easily reversed. Throughout history there has been a widespread fear that economies with the most rapid rates of technological progress have trouble generating full employment because jobs are lost as economies become more productive. Such an analysis considers economies to have a fixed number of jobs, so that eliminating some of these jobs reduces the number of workers who can be employed. Recall the Luddite textile workers in early 19th century Britain who attempted to destroy the textile machinery that was being introduced into their industry in an effort to protect their jobs.
Yet over periods more than a quarter of a year or a year, even rapid productivity growth has usually gone hand in hand with growing, not declining, employment. The Internet is providing many jobs, some for reporters who formerly worked at newspapers and magazines. The high tech sectors of Silicon Valley and elsewhere have become major employers of programmers, software engineers, salesmen, and many others. Large growth in employment has also occurred in the biotech field, and the health field more generally, and at other new industries. So while productivity of the global economy increased rapidly during the past century, and also during the past 15 years, world employment also rose rapidly during the past century, and during the more recent period, and world unemployment rates declined rather than increased during both periods prior to this worldwide recession. But the effects of the recession is only a temporary reversal of these longer-term trends.
Nor did the growth in employment come at the expense of earnings since hourly earnings also rose rapidly during the past century along with employment and productivity. This is not at all surprising since higher productivity means that workers and capital tend to produce more output than they did before productivity improved. At the same time that new technologies reduce the demand for worker skills and physical capital made obsolete, the increased productivity of capital raises the supply of other kinds of capital that contributes to a growth in the earnings of workers. The increased productivity of workers also increases their earnings along with their increased employment, although the skill mix of the workers demanded will differ from the mix prior to the growth in productivity.
This is why the rapid growth in American productivity during the past half year is a very good sign for the prospects of the American economy during the next several years. In the very short run, productivity improvements are associated with rising unemployment and reduced employment, but in the somewhat longer run it will raise the demand for workers and earnings. The emphasis on the very short run explains why Friday's unemployment figures received so much more attention than did Thursday's productivity figures, even though the latter are more important for the future prospects of the American economy.
Posted by Gary Becker at 8:03 PM | Comments (0) | TrackBack (1)
Productivity and Unemployment--Posner
Becker is certainly right that growth in productivity is an important driver of economic growth. But we must consider the source of the growth in productivity in order to understand the conjunction in the last two quarters of rapidly rising productivity with rapidly rising unemployment.
If productivity growth is the result of technological innovation (and "technology" in this context need not be limited to engineering--it could include innovations in management, marketing, inventory control, and so forth), then the effect of greater productivity on economic growth will indeed be positive. But it is unlikely that the productivity spurts in the second and third quarters of this year have been due to innovation. More likely they have been due to old-fashioned cost cutting spurred not by technological advances but by economic distress. The only explanations I have seen offered for the productivity surge is cutting wages and working the workers harder. I have found no suggestion of any technological change that might be responsible for such a large, sudden surge in productivity. Facing declining demand and a frightened work force, a firm is under pressure to reduce its costs and it can do that in a variety of ways, including laying off workers, pushing its remaining workers to work harder, reducing wages and benefits, buying cheaper inputs, slowing delivery, paying its bills more slowly, and responding more slowly to customer complaints. Some cost reductions will not increase productivity, as they will be proportional to reductions in output. But others will, such as laying off the least productive workers, or reducing quality in ways that do not show up in statistics on productivity (as they should--a reduction in quality is a reduction in the value of output).
Productivity gains that are based merely on adaptations to temporarily depressed economic conditions will be lost when conditions improve. As labor markets tighten, a firm will perforce hire workers who are less productive than the workers it had retained in a slimmed-down workforce during the depression; and so productivity will decline.
The productivity gains in the last two quarters could actually signal pessimism about the pace of the recovery. There are costs to reorganizing one's business in order to adapt to a reduction in demand. The shorter the expected reduction, therefore, the less reorganizing a firm will do. Indeed, often during a recession or depression there is the phenomenon of "labor hoarding": if a restoration of normal demand is expected in the near future, a firm may be better off with a workforce larger than it needs to meet the current demand than it would be laying off workers and having to incur the expense of rehiring them, or hiring new workers, when the downturn ends. There has been less labor hoarding in the current downturn than in previous ones, and this may be because employers do not anticipate an early return to normal demand. Their pessimism would be consistent with predictions that unemployment will continue to rise for some months, and thereafter will decline only slowly. For with such a high rate of unemployment (and underemployment--10.2 percent and 17.5 percent at this writing, respectively), demand for goods and services is likely to remain at a low level.
Posted by Richard Posner at 7:03 PM | Comments (0) | TrackBack (0)
November 1, 2009
Fiscal Imprudence, Distributive Injustice: the $250 per Social Security Annuitant Plan--Posner
In October, the President announced that $13 billion (some commentators believe a more accurate estimate is $14 billion) of the $787 billion stimulus package enacted this past February would be used to pay every social security annuitant $250 in 2010, ostensibly to "compensate" for the fact that there will no cost of living (inflation) increase in social security benefits. The social security COLA for year t is based on the increase in the Consumer Price Index between the end of the third quarter of t - 1 and the end of the third quarter of t -2. (t is 2010, t - 1 2009, and t - 2 2008.) There will be no cost of living increase in 2010 for the excellent reason that as of the end of the third quarter of this year (September 30, 2009), the cost of living had fallen 1.3 percent from the end of the third quarter of 2008. Social security has a ratchet: benefits increase when the cost of living increases but do not decrease when the cost of living decreases. There is thus nothing to "compensate" social security annuitants for; on the contrary, they will be receiving a windfall in 2010 by virtue of the increase in their real (as distinct from nominal) benefits: their 2010 benefits will buy more.
Transfer payments, moreover, are a poor device for fiscal stimulus. The idea of a fiscal stimulus as an anti-depression device is to increase employment and by doing so restore business and consumer confidence; we are seeing today how high and rising unemployment is sapping that confidence and retarding recovery from the current depression (and it is a depression, not the "Great Recession" as some are calling it, though that's an issue for another day).
Transfer payments are at two removes from putting unemployed people to work. The amount of the transfer that is saved by the recipient in a savings account or other safe haven is (by definition) not spent, and so does not increase demand and therefore supply and therefore employment. And the amount of the transfer that is spent is spent at a store or other retail outlet to purchase a good that has already been produced. It is buying from inventory. Only when the store's inventory falls to a level at which the store has to order a new supply of goods from the manufacturer is there any stimulation of production, and thus of hiring; and of course the stimulation may not be of production by an industry, or in an area, of high unemployment. The dive that the economy took in the wake of the September 2008 financial collapse was unanticipated, and as a result sellers found themselves with excess inventories; until they were worked down, production would remain depressed. In sum, the effect of a transfer payment on employment may therefore be nil.
Apart from its inefficiency as a contribution to the recovery, largesse for the elderly--whose medical expenses, paid for largely by the taxpayer under the Medicare program--are threatening to bankrupt the country, sends the wrong signal: the signal of fiscal profligacy.
Lawrence Summers, the brilliant economist who heads the National Economic Council in the White House, has publicly endorsed the $250 dollar gift to social security recipients. He claims that it corrects an "anomaly." The anomaly he points is that social security recipients received only one $250 stimulus check this year and will receive no cost of living increase next year, whereas the tax benefits in the stimulus plan will be paid next year as well as this year. But social security annuitants received a 5.8 percent cost of living increase this year, whereas few workers received as large a wage increase; and they will be receiving a real as distinct from nominal increase in benefits next year. The only "anomaly" in the picture is the cynical provision of a windfall to a group that has suffered less from the depression than persons of working age, a group whose only claim to a $250 Christmas gift paid for by the federal taxpayer is that it votes more heavily than the young.
What's $13 billion at a time when trillions are spent casually? The real significance of the measure is the insight it gives into the Administration's apparent indifference to fiscal prudence. And not just the Administration. The political parties play leapfrog when it comes to spending--each trying to outdo the other in generosity to powerful voting blocs, and specifically to the elderly--the recipients of enormous social security and Medicare benefits, courtesy of the federal taxpayer. The costs of both the Medicare and social security programs are increasing rapidly as the population ages, and as the population ages the voting power of the elderly increases, placing additional pressure on a budget already disproportionately devoted to supporting the least economically productive members of society. (As a septuagenarian, I claim the right to make politically incorrect remarks about the elderly. Moreover, I am speaking of the average; many elderly people are hard-working and productive.)
Posted by Richard Posner at 5:53 PM | Comments (0) | TrackBack (0)
Fiscal Imprudence and Fiscal Stimulus-Becker
The government's preliminary estimate of the growth in American GDP during the third quarter of 2009 is an impressive annual rate of 3.5%. This figure may be revised downward (or upward) as more data on the third quarter become available, but it surely definitely signals that the US recession is over. In my post on August 9th of this year I already expressed my belief that the recession in the US and the world would end during the third quarter. The end of a recession does not mean that an economy is back to where it would have been without the recession-the US economy is certainly not anywhere near that point yet- nor that the recovery from the recession will be rapid.
The rapidity of the recovery in the US or the world is not yet clear, although many economists who follow short term movements of the economy more closely than I do are predicting a slow and drawn out recovery period in the EU, Japan, and the US. I am not convinced by their forecasts because of the rapid recoveries in Asia, Brazil, and some other countries, and as long as American productivity continues to grow at a rapid rate. To be sure, unemployment is likely to continue to increase for a while since it is what is called a "lagging indicator". However, it almost surely will peak below the 10.8% reached at the end of 1982. During the past couple of years the world went through a severe recession, but it was not appreciably worse in the United States, as measured by the effects on GDP and unemployment, than during some other recession in the past 40 years. Of course, without some of the proactive policies of the Fed and the Treasury, this recession probably would have been deeper and longer.
Not surprisingly, these comments lead me to join Posner in taking a negative view of the plan to pay every social security annuitant a $250 bonus in 2010. The reason given to justify this payment is that the elderly will get no cost of living increase in their social security payments since prices fell rather than rose during the past year. As Posner indicates, this is an illogical and basically nonsensical justification for this bonus to social security recipients. Taxpayers already heavily subsidize the elderly through Medicare and to some extent social security payments, and there is little reason to use spurious arguments to add to that subsidy as part of the stimulus package.
More generally, the $787 billion stimulus-spending package of the Obama administration has made little sense since its inception, as I have argued in several blog posts and elsewhere. Business cycle analysts have long known and documented that fiscal spending programs are not very good at helping to fight recessions since they take a long time to implement. By the time fiscal spending actually occurs. the recessions they were supposed to be combating are usually over. Only about one third of the present stimulus package has yet been spent-and much of it not very well spent. Yet, the recession is already over, although to be sure, the recovery is still at the beginning stages.
I do not believe that inflation due to the Fed's rapid increase in bank reserves is yet a major worry, although it will be in a few years as banks spent these reserves by making additional loans and other investments. Nor do I believe that the huge increase in federal government spending, on the stimulus programs and to help the banks, will be a major cause for concern, as long as American GDP will grow at a much more rapid rate during the next decade than will government spending.
However, the much higher interest payments on the much larger government debt will have to be met either by raising taxes, cutting other government spending, rising tax collections from increased output, or inflation that deflates the real value of these interest payments. I am very much worried that it will be impossible to stop the growth of government spending, so that there will be an enormous, and probably irresistible, temptation to inflate to reduce the real value of the debt, and to raise taxes on higher income persons. Both of these will have negative effects on the growth rate of the American economy.
Posted by Gary Becker at 5:05 PM | Comments (0) | TrackBack (0)
October 28, 2009
Notice
Longtime readers of this blog will be pleased to learn that this month sees its migration into book form. Uncommon Sense: Economic Insights, from Marriage to Terrorism, which collects what we believe are the best, most interesting, and most lasting posts from this blog. The posts selected for the book are representative of the wide range of topics we cover here, and, where appropriate, they've been updated to take account of subsequent events.
The book is available at all good bookstores, on- and offline, as well as directly from the University of Chicago Press: http://www.press.uchicago.edu/presssite/metadata.epl?mode=synopsis&bookkey=1606474.
Posted by Richard Posner at 10:55 AM | Comments (0) | TrackBack (1)
October 25, 2009
Pay Controls Once Again-Becker
I sympathize with all the people who are upset by the very large bonuses, stock options, and other compensation received by heads of some financial institutions that ran their companies into the ground through bad investments. However, I also believe it is a big mistake to have a pay czar, Kenneth Feinberg, impose sharp cuts over the salaries and other compensation of the seven financial institutions, like Citibank, that received the most government bailout money. The Fed has made matters even worse by proposing to implement pay controls over thousands of banks as part of its regular review of their performance.
General controls over wages have frequently been tried in different countries. The usual motivation for wage controls is to reduce inflation by keeping labor costs, and therefore prices, from rising rapidly, although wage controls are invariably combined with general controls over prices as well. Inflationary fears were certainly behind the wage and price controls in almost all countries during World War II, and in the US under President Nixon from 1971-1973. These measures sometimes succeeded in suppressing inflation temporarily, but they also led to rationing of various consumer and producer goods because of weak incentive to produce or work when prices and wages are kept below their market values.
Companies can still compete for employees when higher pay cannot be offered as inducements by increasing fringe benefits to employees, such as longer vacations and subsidized lunches and other meals. US companies began to offer free health insurance to employees during World War II as a way to get around the wartime control over wages. The American health care system has suffered badly since then from this artificially induced connection between employment and subsidized health care.
In some respects, the effects of controls over pay are even more harmful when they apply only to a small subset of all employees, such as the proposed sharp ceilings on management compensation at the seven companies that received the largest amount of government assistance, or the scrutiny of pay of top executives at the thousands of financial institutions under the Fed's supervision. The most talented individuals at these firms will tend to leave because they will receive much higher compensation packages by financial and other companies that do not have their pay set in Washington. So the financial companies that received much government assistance and other banks would lose many of their best people just when they need talented management to help put their companies under a more solid financial foundations. Without the requisite talent, many of these companies may either go under, perhaps not a bad idea, or more likely the government will bail them out once again-not a pleasant prospect.
o prevent an exodus of whatever talent is left and to attract new talent, Feinberg and the Fed may try to differentiate between more and less able executives, and allow much higher pay for the best of them. But can a czar or the Fed perform that task better than the forces of market competition for talent? History indicates that is highly unlikely.
These controls over pay not only will cap salaries, but they would also reduce bonuses and stock options, and prevent the executives affected to cash in options for several years. The reasoning is that this will force executives to take a longer-term view of the risks and other decisions that they take. One irony is that, as pointed out by Yale's Jonathan Macey in a recent Wall Street Journal op-ed piece, Congress in a 1992 Act prevented corporations from deducting as a normal business expense any salaries that exceeded $1 million. As a result, corporations were encouraged to shift their pay to stock options, which received more favorable tax treatment.
I have not seen convincing evidence that either the level or structure of the pay of top financial executives were important causes of this worldwide financial crash. These executives bought large quantities of mortgage-backed securities and other securitized assets because they expected this to increase the average return on their assets without taking on much additional risk through the better risk management offered by derivatives, credit default swaps, and other newer types of securities. They turned out to be badly wrong, but so too were the many financial economists who had no sizable financial stake in these assets, but supported this approach to risk management.
The experience of other financial crashes also does not indicate that either the level or form of compensation of top financial executives were major factors in precipitating these crashes. Thousands of banks failed during the Great Depression, as did hundreds of American savings and loans institutions during the 1980s, without heads of these institutions in either case getting particularly high pay, or pay that was mainly in the form of bonuses and stock options. My impression is that this same conclusion applies to the Mexican bank crisis of the mid 1990s, and the Asian financial crisis at the end of the 1990s.
The generous bonuses and stock options received by financial executives may often have been unwarranted, but they are being used as a scapegoat for other more crucial factors. Financial institutions underrated the systemic risks of the more exotic assets, and apparently so too did the Fed and other regulators of financial institutions. In addition, large financial institutions may have recognized that they were "too big to fail", and that they would be rescued by taxpayer monies if they were on the verge of bankruptcy because they took on excessively risky assets.
Posted by Gary Becker at 4:36 PM | Comments (0) | TrackBack (0)
