Lawrence Summers Says to Focus on Growth

Lawrence Summers argues in an op-ed piece in the Washington Post that since we can't agree on the debt variable in the debt-to-GDP ratio, we should focus on the GDP variable by trying to increase growth:

Spurring growth is an area where neither side of the political spectrum has a monopoly on good ideas. We need more public infrastructure investment, but we also need to reduce regulatory barriers that hold back private infrastructure. We need more investment in education but also increases in accountability for those who provide it. We need more investment in the basic science behind renewable energy technologies, but in the medium term we need to take advantage of the remarkable natural gas resources that have recently become available to the United States. We need to ensure that government has the tools to work effectively in the information age but also to ensure that public policy promotes entrepreneurship.

So what would the details of such an agreement look like? It's tough to say for sure, and there's a lot of moving parts; so I'm going to examine the proposal piece-by-piece, starting with public infrastructure:

Remember when the president proposed $50 billion in infrastructure spending? The Treasury does! Probably because they had to do a whole analysis of it. The most game-changing part of this proposal was the National Infrastructure Bank. How would it work? The White House explains here. Essentially, Congress would create the bank. The bank would identify projects that lacked funding and provided clear benefit to taxpayers (don't worry, the bank exists outside of Congress' appropriations process and the decisions would be made by a seven-member board - no more than four of whom could be from the same political party). Loans made by the bank for the projects would be matched by local government funding or by private investors. The project would generate revenues and provide a return on investment. The White House also provides a bonus fact in their explainer (which I find hilarious [the concept of the bonus fact, that is]): the AFL-CIO and the Chamber of Commerce both support the infrastructure bank. Unions get jobs. Big Business gets money. Governments save money. Everybody* wins! *everybody does not include investment banks that deal with state and municipal bonds

The Brookings Institution also has some infrastructure bank-related suggestions: the top suggestion being to establish the bank as an independent government-owned corporation outside of any government agency (note: this is not the same as a GSE). The main advantage of existing outside of an agency would be budgetary flexibility and the ability to fund different types of projects. For example: ideally, you would want the infrastructure bank to fund improvements to highways, airports, and railways, among other things. This would touch upon the bureaucratic turf of the FHA, FAA, and FRA (all located within the Department of Transportation) - not to mention the fact that telecommunication infrastructure investments wouldn't even be in the same department (if you're looking for telecommunications infrastructure, I would suggest your neighborhood-friendly Department of Commerce).

Brookings fills in more details about the bank here, and it's definitely worth a read if you're interested in minutiae of a legislative proposal that won't pass Congress for the foreseeable future.

Of course, all of this begs the question of how an infrastructure bank would affect growth. The Treasury analysis lists a lot of positive effects: demand-side, supply-side, and everything in-between (such as an increased feeling of national community). Regarding demand, Treasury points to the obvious fact of under-utilized resources (remember those construction workers that were building houses in Arizona before the housing bubble burst? Turns out they can build roads, too!) Also, less congestion means less money spent on gas which means higher consumer demand for other things. However, demand-side issues have usually proven pretty irrelevant to winning over the votes of Republicans, so let's focus on some supply-side benefits that Treasury laid out.

First, better public infrastructure means decreased shipment time and costs. This helps make American exports more competitive. Another bonus for Republicans: this disproportionately helps Middle America since they are geographically the farthest from a port. Second, transportation agglomeration increases property values. The White House points to an example of Dallas and its experience with DART. Third, transportation agglomeration also makes businesses more efficient. The White House points to businesses taking advantage of Chicago's position in the national transportation infrastructure. A more illicit example, however, may be drug dealers taking advantage of Chicago's position in the national transportation infrastructure. Lastly, more efficient transit solutions means more efficient workers. Or, if you're a Family Values Republican in the mold of Rick Santorum, less time spent in traffic means means more time spent at home with the family.

I'm going to close out with a quote of one part from a blog post by the Treasury Department that really brings to life what infrastructure improvements would look like (the whole post is worth a read):

When the Port of Seattle improves its connection with local freight railroads, it creates construction jobs for local workers – but the project’s benefits extend far across the heartland. By making it cheaper to transport cargo, this improvement will allow cattle ranchers in rural Montana to ship their beef to new markets across the world.  Consumers who purchase imported goods and American businesses that are expanding their exports enjoy lower prices and improved access to new markets and goods.

I Refuse to Use Fitch as a Pun in this Title

Fitch put the US government's credit rating on notice, to which the collective response from just about everybody was: "meh." As far as these things go, ratings agencies really don't have any information that the rest of us don't have. Furthermore, Fitch stressed that this was not an economic problem or a problem with the government's finances, but was a political problem. Fitch's full statement can be read here.

One part of Fitch's outlook, though, did jump out at me (the bold is mine):

Fitch's medium-term fiscal projections imply federal and general government (which includes states and local governments) gross debt stabilising next year and over the remainder of the decade at around 72% and 104% of GDP, respectively. This is below the 80% and 110% thresholds that Fitch previously identified as being inconsistent with the U.S. retaining its 'AAA' status.

Not only does Fitch have a threshold for government debt, they have a threshold that is 10 percentage points less than the much maligned Rogoff-Reinhart tipping point. I don't have access to Fitch's rationale for this, and would be very curious to see why they picked 80%. I did a cursory search on the 80% threshold and could only find mention of a correlation between 80% debt-to-GDP and debt crises. And I don't think I'm alone in being completely flummoxed on the use of this number. When European Commissioner Olli Rehn cited 80% as a debt threshold, Brad Delong could not find any reason for why that number was used.

It's a bit disconcerting that ratings agencies are using numbers that were seemingly pulled out of thin air. Even if Fitch used the now-debunked 90% threshold, at least the rationale would have been clear.

The Medical Device Tax Makes Sense

Ezra Klein seems to be against the medical device tax - a 2.3% excise tax on medical devices that's supposed to help pay for the ACA. And sure, he's right about the fact that if you were designing optimal tax policy, the medical device tax would never enter the discussion. But, as the debt ceiling debate illustrates, we don't live in an optimal world. So, instead of comparing tax policy to the optimal, let's compare tax policy to the actual.

When writing the ACA, the House really wanted this to be a bill financed by taxes on the wealthy. However, the Senate wanted this to be a bill financed within the industry. This meant that a bill that aimed to expand health care coverage would be partially financed by the health care industry's stakeholders. The health insurance industry, hospitals, and others, would help partially pay for their increased business via taxes and fees. This included the medical device industry. And that makes sense; if you want to both expand coverage and contain costs, taxing and charging health care stakeholders for increased coverage achieves both of these goals while avoiding the economically strange outcome of redistributing resources from the wealthy to the health care industry. And thus was born the medical device tax.

Klein cites job losses and off-shoring as negative effects of the tax. In addition to these, the industry cites reduced R&D expenditures. However, the CBPP is not so convinced. Since the tax applies to both domestically-produced and imported devices, this tax will not increase the incentive to move production overseas. Additionally, cost-containment measures in the ACA may actually spur R&D spending for medical devices. Furthermore, the study that most people cite about increased job losses used economic models and demand elasticities that don't apply to the medical device industry. In other words, they were bogus.

The only plausible argument against the tax that I've seen is the argument of double taxation: that because hospitals agreed to cut costs and because Medicare is decreasing payments, both of which to help pay for the ACA, and because these cut costs and decreased payments will fall on the medical device industry, then the medical device industry will paying twice for increased business. But until the medical device industry releases a credible study on the effects of the ACA on the demand for their products as well as cuts in spending on their profit-margin, we simply won't know whether or not their argument has merit. My suspicion is that they did do a study and found that the ACA, including the taxes, was a net positive. But why release that study when you already stand a good chance of repealing a tax that negative affects you?

The Cost of House Republicans

We know that recent budget cuts have depressed economic growth. Paul Krugman talks about the Macroeconomic Advisers' estimate on the costs that the House Republicans have inflicted on the US economy via fiscal policy: $700 billion of wasted economic output and an unemployment rate that is 1.4 percentage points higher than it otherwise would have been. But the cost of House Republicans is even higher than that.

Felix Salmon notes the damage that they have done to the financial markets:

Rather, the harm done would be a function of the way in which the Treasury market is the risk-free vaseline which greases the entire financial system. If Treasury payments can’t be trusted entirely, then not only do all risk instruments need to be repriced, but so does the most basic counterparty risk of all. The US government, in one form or another, is a counterparty to every single financial player in the world. Its payments have to be certain, or else the whole house of cards risks collapsing — starting with the multi-trillion-dollar interest-rate derivatives market, and moving rapidly from there.

I think that this is a subtle point that has been missed in the entire debt-ceiling/budget debate but deserves some echo: even in the unlikely event that Republicans recant all of their demands and agree to a clean debt ceiling hike, the mere fact that they even attempted to govern as a minority party via threat of default could increase borrowing costs forever for everybody.

Essentially, Republicans introduced risk into the one risk-free investment. And this one risk-free investment is used as a baseline to price all risky investments. And so, while we may not see it now (because of being up against the zero lower bound), it's entirely possible that in the future we could see a slight risk premium being charged to the US government that will increase the costs of borrowing for everybody else. In other words: priced into all investments is the assumption that Treasury payments are 100% certain; as long as this assumption is questioned in the minds of investors, then borrowing (for everybody) will cost more than it otherwise would have. So congratulations, Republicans! Not only have you stunted economic growth for the past couple of years, you have permanently stunted all future economic growth!

Casey Mulligan Predicts Recession, Blames Obamacare

Chicago economist Casey Mulligan gives us some economic derp in the form of a prediction (prederption?) of a recession in 2014: "Don't be surprised if the second redistribution wave coincides with a recessionary double-dip." Yes, he used the qualifier of "don't be surprised if," but as far as econospeak is concerned, this is the English idiomatic equivalent of "bank on it." What's the cause of the recession? Obamacare, of course.

In his op-ed piece, Mulligan writes a lot of very strange sentences that I just don't get. I don't want to use this post to nit-pick the article, but here are a couple of selected head-scratchers: 1) "The president's health-insurance plan forces those who hire, work and produce to pay full price for health care, while creating generous discounts for practically everyone else;" 2) "This second redistributionist wave of the Obama era will follow a first wave of tax hikes, additional unemployment benefits, food-stamp expansions, waived work requirements for welfare benefits, etc. These measures were supposed to be temporary, intended to help people cope with the recession. The recession officially ended in mid-2009, but many of the administration's measures continue."

1) Apparently, Mulligan is unaware that: 1) it is possible to both have a job and not have health insurance; and 2) health insurance benefits are actually discounted due to the fact that they're nontaxable (in fact, those without health insurance are actually paying for the nontaxable discount that those with health insurance receive [I'm also assuming that by health care, Mulligan really means health insurance]).

2) Either Mulligan is applauding the administration's economic efforts, or he's being very disingenuous. I'm going to go with the latter. More could be said, but this is an old line that has been refuted a bunch of times and just won't die.

But let's move away from the nitpicking and get to the real substance of the article. Why is Mulligan predicting a recession? Because the increase in the marginal tax rate caused by the Affordable Care Act will discourage working to such a degree that the labor supply will shrink to the point where US economic output will decline for at least two successive quarters. The marginal tax rate is calculated by combining both taxes and forgone benefits (such as a subsidy to help you buy health insurance).

Unfortunately, I was unable to access Mulligan's academic paper on this subject, so I don't know exactly how he calculated the marginal tax rate. However, I would imagine that since he uses a population-weighted average for his calculation, that this has the effect of creating an illusion of forgone government benefits for an individual. For example, one does not just choose to get unemployment benefits for 99 weeks. A fairly specific set of circumstances has to arise for that to happen.

But let's assume that Mulligan's calculations are correct. What does economic theory say will happen? Well, given that this is economics, we just don't know. Two effects could take hold: the income effect or the substitution effect. If the income effect takes hold, then workers will respond to their drop in income by working more (resulting in an increase in the labor supply). If the substitution effect takes hold, then workers will respond by substituting labor for leisure (resulting in a decrease in the labor supply). Mulligan seems to be banking on the latter. And he's not entirely wrong.

When the CBO studies the effects from changes in after-tax income on labor supply, they generally assume that the substitution effect is greater than the income effect. See here for a truly awesome explanation on their assumptions. Unfortunately, in their examples, they only look at the effects that explicit taxes have on labor supply; not implicit taxes in the form of forgone subsidies. Fortunately, they estimated the effects of the ACA on the supply of labor. Their conclusion? The amount of labor used in the economy will be reduced by 0.5 percent - primarily through the means of workers choosing to reduce their supply of labor. And that's not necessarily a bad thing. A lot of the decrease in the labor supply will be explained by people whom have the means to live without working but are forced to work because that is the only way that they can obtain health insurance. And it's a safe bet that population growth and labor productivity growth will more than make up for this decrease in labor supply, offsetting any possibility of a recession.

Near the end of his piece, Mulligan states that "advocates for the recent program expansions have failed to acknowledge that redistribution necessarily increases marginal tax rates and contracts the labor market." I don't think that this is the case. I think that advocates have acknowledged this fact. In fact, here's a paper where advocates do acknowledge that fact. We just put that fact in the context of other facts and conclude that it's really not that big of a deal - let alone recessionary.

Could the ACA Actually Reduce Unemployment?

The New York Times examined claims by Republicans that the Affordable Care Act is "job-killing" and is forcing many employers to convert full-time workers to part-time workers. Republicans point to the greater number of part-time jobs being created as their proof. However, as any economist will tell you (even Greg Mankiw!), this is pretty disingenuous as the trend in part-time job creation following this recession is right in line with the historical trend in part-time job creation following all of the other recessions.

Of course, in fairness to Republicans, the ACA does create a very large disincentive for firms with over 50 employees to have full-time workers in place of part-time workers. Whether or not this disincentive outweighs the benefits a firm gains from having full-time employees remains to be seen. My guess is that firms with over 50 employees that do not currently provide health insurance are concentrated in sectors that overwhelmingly rely on part-time employees anyway. If this is true, we really won't see a significant negative effect in full-time employment.

But let's imagine for a moment that we live in a world where the Republicans are right. In low-skill industries across the country, employers convert full-time employees to part-time employees. What happens? The immediate effect is that these firms then go out and hire more people to work the hours that their former full-time employees were working. Yes, the former full-time employees would be unhappy, but new part-time employees would be very happy. In this scenario, the ACA acts as an incentive for firms to enact a work-sharing program. Work-sharing has been used to great effect in Germany to keep unemployment lower and is actually one of the proposed solutions for unemployment from the American Enterprise Institute, a conservative think tank. This would also mesh well with one of the conservative arguments against raising the minimum wage: that the unemployed should not be discriminated against in favor of the employed.

There are other positive effects that the ACA could have on unemployment as well. Older workers that want to retire before 65 but don't do so out of fear of losing health insurance will be able to retire, opening up jobs to younger workers. People that keep jobs that they don't want because they want to keep their health insurance will leave their jobs, opening up jobs for other workers. Maybe they'll go work at a small business that they couldn't work at before due to lack of health insurance benefits. Or maybe they'll start their own company and create even more jobs.

But let's be realistic. The most probable case is that the number of large firms that currently do not provide health insurance and have a large number full-time employees is small; the number of people whom want to retire but can't because of lack of health insurance is small; the number of people whom want to quit their job but can't because of lack of health insurance is small. Overall, the ACA won't have a huge impact on employment. But if it does, it might be a better impact than Republicans think.

Another Reminder: Health Care Spending = Health Care Revenue

Miles Kimball has a good summary of the ways in which the characteristics of the health care market are not the characteristics of a classical free market system. When talking about how other countries reduce health care spending, Kimball reminds us that other countries

[u]se the fact that most of the money for health care runs through the government as leverage to push down the pay of doctors and other health care workers.

In other words, if we really want to control spending, doctors are going to have to be paid less. The New York Times Economix blog has an excellent piece by Catherine Rampell on doctor pay in the US and other developed countries. After accounting for difference in currency and cost of living, the US ranks 3rd in specialist pay and is an overwhelming number one in general practitioner pay.

Of course, as Rampell notes: 

it’s important to keep in mind, the report notes, that health care professionals in other O.E.C.D. countries pay much less (if anything) for their medical educations than do their American counterparts.

Not to mention, doctors in other countries pay much less in malpractice insurance.

One of the reasons that doctors are paid so much in the US is that they are able to create their own demand. Every time a doctor orders a test or a procedure, that doctor is increasing his/her income. However, this is becoming less common as more and more doctors are forgoing private practice in favor of hospital employment. Unfortunately, this will not directly translate to lower health care costs as the result of this increased concentration in market share, leading to higher negotiated payments to hospitals - which brings me back to my earlier post regarding budget cuts at the Cleveland Clinic. If we're going to control costs, a lot of people are going to have to make less money.