Economics, Financial Services, Pethokoukis, U.S. Economy

Study: Breaking up the megabanks isn’t a silver bullet for ending bailouts

meagankirk /

meagankirk /

In the new Minneapolis Fed paper, “Too Correlated to Fail,” V.V. Chari and Christopher Phelan argue attacking “Too Big To Fail” and moral hazard by limiting bank size won’t by itself end the moral hazard problem caused by financial institution anticipating government bailouts:

In this paper, we argue that the anticipation of bailouts creates incentives for banks to herd in  the sense of making similar investments. This herding behavior makes bailouts more likely and potential crises more severe. Analyses of bailouts and moral hazard problems that focus exclusively on bank size are therefore misguided in our view, and the policy conclusion that limits on bank size can effectively solve moral hazard problems is unwarranted.

It is an intuitive conclusion. What good is many smaller banks and fewer big banks if herding results in the risk profile of the broader financial system remaining unchanged? Banks of whatever size will be encouraged to take the sort of macroeconomic risks (mortgages rather than small business) that would result in bailout if they went bad. Indeed, Chari and Phelan highlight how the securitization process “ensures that all banks end up holding very similar portfolios and thus have highly correlated risk.”

All this very much syncs with what Ashwin Parameswaran has written on how the “Greenspan Put” and its emphasis on supporting asset prices and thus the banking system — think Long-Term Capital Management — negatively affected the financial system by encouraging herding and the real economy by encouraging financialization:

If you protect a system from the effects of any particular risk, actors within the system will take on more of the protected risk assuming rationally that the system manager (in this case the Fed) will protect them. The Greenspan Put regime drove down the risk of being exposed to broad macroeconomic market risk. Market participants rationally took on more macroeconomic asset-price risk and substituted for the risk they had been relieved of by the Fed with more leverage. …

And this is exactly what the financial sector proceeded to do. Far from being a neutral channel of monetary policy from the Fed to the real economy, the deregulated yet too-big-to-fail financial sector that was also protected from new entrants realigned itself to take on macroeconomic risk by lending to housing and large established firms. The attractiveness of this strategy meant that banks shunned lending exposed to non-macroeconomic idiosyncratic risks such as lending to small businesses or new firms. … The doctrine also encouraged firms in the real economy to become as bank-like as possible. No firm took advantage of the new regime like General Electric(GE) did. GE under Jack Welch transformed itself into an industrial firm whose profits came largely due to its financial arm, GE Capital which lent to its industrial customers (amongst others). So successful was this transformation that by the time the 2008 crisis hit, GE had also become too-big-to-fail thanks to GE Capital and was found to be eligible for a bailout.

In “Room to Grow,” I mention a couple of policy approaches including forcing banks to hold vastly more capital and increase financial industry startups.

Follow James Pethokoukis on Twitter at @JimPethokoukisand AEIdeas at @AEIdeas.

Pethokoukis, Economics, U.S. Economy

Why big box retailers are good for worker wages


Some people really don’t like “big box” retailers. The openings of new stores, particularly in cities, are frequently accompanied by protests. Recall that Occupy Wall Street targeted retailers, including Wal-Mart, Target, and Best Buy. Critics knock these companies for a variety of reason, including low wages, meager benefits, and their effect on local “mom and pop” stores.

But a new study suggests the big boxes are good for wages and upward mobility. From the new NBER working paper “Do Large Modern Retailers Pay Premium Wages?” by Brianna Cardiff-Hicks, Francine Lafontaine, and Kathryn Shaw:

Over the last forty years, modern retail firms, those with the modern products and  processes that support large chains, have become a large segment of the retail sector. Using  worker-level panel data on wage rates, we show that the spread of these chains has been  accompanied by higher wages. Large chains and large establishments pay considerably more than small mom-and-pop establishments. Moreover, large firms and large establishments give  access to managerial ranks and hierarchy, and managers, most of whom are first-line supervisors,  are a large fraction of the retail labor force, and earn about 20 percent more than other workers. A good part of these wage gains are returns to ability – large firms and large establishments hire and promote the more able.

True, the retail sector pays less than manufacturing. But employment in that sector has declined because of offshoring and automation. That means more workers have flowed into retailing. And thanks to the growth of modern big box chains, retail wages and promotion opportunities have increased.

The authors also suggest an alternative to the current obsession with boosting manufacturing employment (either by bringing back outsourced factory jobs to the US or by improving worker training for modern manufacturing jobs).

First of all, advances in automation will make it hard to counter the long-term and global decline in manufacturing employment. Second, as the authors note, retail managers actually make more than manufacturing workers:

Managers in retail are more highly skilled than operatives in manufacturing: managers have some college education and likely have unobserved personal skills, such as people management skills or organizational skills. But expending resources on education to increase preparation for managerial jobs in the retail sector could be a viable alternative to expending resources on education for manufacturing work, because wages are higher for managers in retail than they are for non-managers in manufacturing … retail firms employ a larger proportion of managers than manufacturing firms do. Also, large firms, who need managers, have been growing fast in the retail sector.


Follow James Pethokoukis on Twitter at @JimPethokoukisand AEIdeas at @AEIdeas.


Maybe CEOs are to blame for weak US business investment

Image Credit: Shutterstock

Image Credit: Shutterstock

Neil Irwin in The New York Times: “Five years into the economic recovery, businesses still aren’t plowing much money into big-ticket investments for the future.” One possible culprit is the weak job market. When labor is cheap, why should CEOs spend money on productivity-enhancing machines? In a recent Harvard Business Review article, Clayton Christensen and Derek van Bever offer a similar query as Irwin:

One phenomenon we’ve observed is that, despite historically low interest rates, corporations are sitting on massive amounts of cash and failing to invest in innovations that might foster growth. That got us thinking: What is causing that behavior? Are great opportunities in short supply, or are executives failing to recognize them? And how is this behavior pattern linked to overall economic sluggishness? What is holding growth back?

One reason, Christensen and van Bever write, is pervasive short-term thinking in Corporate America driven by shareholders:

Many managers yearn to focus on the long term but don’t think it’s an option. Because investors’ median holding period for shares is now about 10 months, executives feel pressure to maximize short-term returns. Many worry that if they don’t meet the numbers, they will be replaced by someone who will. The job of a manager is thus reduced to sourcing, assembling, and shipping the numbers that deliver short-term gains.

And it is not just external pressure to think quarter to quarter. Executive pay plays a role, according to Andrew Smithers in the FT:

If we wish to improve the UK and the US economies by encouraging investment and the consequent growth of productivity, we must recognise that management remuneration systems need to be revised. This is a necessary part of making capitalism work well and is therefore very similar to the need to ensure that we have a competitive rather than a rent-gouging economy. The key is not the size of management’s pay, but the incentives that come from bonuses, options and other additions to basic salaries. Things would be greatly improved if chief executives’ incomes were limited to their basic salaries. Suggesting this would produce such a howl of rage that even putting the idea into the public domain would be a useful ploy. Faced with the threat, it may be possible to introduce a code of best practice in which bonuses were dependent on things other than profits. For example, minimum levels of growth in output and investment could be required before bonuses based on profit achievements would be payable.

Follow James Pethokoukis on Twitter at @JimPethokoukisand AEIdeas at @AEIdeas.

Economics, Pethokoukis, U.S. Economy

The simple case for more high-skill immigration

From Stanford’s Vivek Wadhwa in Politico:

Skilled immigrants are more important to the United States than ever, because it is on the verge of a major reinvention. Its scientists and entrepreneurs are setting the wheels in motion to solve humanity’s grand challenges—in areas such as health, energy, food, education and water. Advances in fields such as computing, sensors, medicine, artificial intelligence, 3D printing and robotics are making this possible. Foreign-born engineers, scientists and entrepreneurs are helping lead the charge in all of these areas.

The cost of these technologies has, however, dropped exponentially, and anyone anywhere can build a world-changing innovation. And, as returnees to other countries are learning, it doesn’t have to occur in the United States. They can achieve the same success back home where they are with their friends and family and are not made to feel unwelcome. America is losing its near- monopoly on technological innovation.

Follow James Pethokoukis on Twitter at @JimPethokoukisand AEIdeas at @AEIdeas.

Economics, Pethokoukis, U.S. Economy

Less US economic growth means fewer American babies — and then even less economic growth


Interesting piece by WaPo reporter Todd Frankel on US fertility rates and the bad economy. Here is the hed:  “They want a baby. The economy won’t play along: America’s birth rates are still near a historic low. One couple’s lesson in the new economics of having a child.”  And here is the gist:

Last year, the nation’s fertility rate hit a historic low — 62.9 births per 1,000 women ages 15 to 44, according to the Centers for Disease Control and Prevention. Some of that decline comes from a long-term shift toward smaller families. But finances also play a pivotal role. A Gallup poll last year found the main reason Americans were delaying parenthood was worries about money and the economy — even as the stock market rallied and broad indicators pointed to a brighter future, highlighting a disconnect felt by many Americans. A report by Pew Research Center showed birth rates in many states rise and fall in tune with personal income.

Births have slowed so sharply that researchers note that future economic growth could be stunted by a smaller labor pool. Immigration is often seen as a fix. But the downturn crimped supply lines for both babies and new foreign faces. The change was so dramatic that the Census Bureau in 2012 was forced to revise the 2050 U.S. population projection it made just four years earlier, dropping it by 9 percent, to just under 400 million.

The languishing economy has caused people to doubt if they can afford to be parents.

Frankel goes on to tell the story of a mid-30s Missouri couple who has a fertility problem. IVF treatments — at $15 grand a pop — seem the best option, but their finances are uncertain. While she has a steady gig at a prison health-care company, he is a union electrician with an unpredictable paycheck. As the economy slowly — ever so slowly — recovers, time for them is quickly slipping by. Would, say, a $4000 child tax credit to be applied against their income and payroll taxes changes their minds? Perhaps it would be just enough of a nudge. But certainly a generally stronger economy and labor market would also help. I guess what I really take from this is that the impacts of the Great Recession and Not-So-Great Recovery may affect American life in unexpected ways for decades to come.

Follow James Pethokoukis on Twitter at @JimPethokoukisand AEIdeas at @AEIdeas.

Economics, Monetary Policy, Pethokoukis, U.S. Economy

Do rising food prices mean the Fed’s been out of control?


Some folks on the right, such as Ben Domenech and Sean Davis of The Federalist, seem oddly desperate to make the case that inflation is dangerously high, and the Federal Reserve is to blame. Now it is certainly a neat political argument, one that combines the “end the Fed” meme with the “Barack Obama is Jimmy Carter” meme. Some proponents are so desperate to make this case, in fact, that they will even cite questionable data sources to prove their point.

So what is the reality of inflation right now? Over the past 12 months through June, the headline Consumer Price Index has increased by 2.1%. The core CPI, excluding food and energy, has increased by even less, just 1.9%.

But wait, say the inflation alarmists, what really matters for middle-class America is food inflation. Well, food prices have increased a lot this year, as the above chart shows. Maybe not last month, but certainly in the months before. They rose just 0.1% in June, after rising at least 0.4% in each of the previous four months. As IHS Global Insight puts it today: “Food at home prices were flat, offering relief to many lower and middle income households; meat price increases were the weakest so far this year.”

So what explains the food price surge that abated last month? Here is Goldman Sachs:

The rise in food prices has been driven by a combination of weather and politics. Severe droughts in Brazil, Mexico, and West Africa have had large impacts on coffee, fruits and vegetables, and cocoa production. In addition, California–which produces a large share of the US’s fruit and vegetables and about 1/6 of its farm output–is currently experiencing a record drought. Finally, tensions in Ukraine have raised concern about its major export crops: corn, wheat, and sunflower oil.

Another take:

Food prices have been on the rise across America in recent months as a deluge of detrimental factors has descended on key sectors of the agricultural industry.

The pig-farming industry was hit hard by deadly disease. Oranges, limes, peppers and other produce experienced price spikes as the West Coast suffered through epic drought. And a surge in the prices of beef, cheese pork and avocado made headlines last week when the Chipotle burrito and taco chain announced that it would hike its menu prices for the first time in three years.

“It has been nearly three years since our last company-wide price increase, and while we want to remain accessible to our customers, we are at a point where we need to pass along these rapidly rising food costs,” said the company’s chief financial officer, Jack Hartung, Reuters reported.

The Fed hasn’t caused a sudden surge in food prices — just like monetary policy isn’t responsible for rising college costs. Now this sort of inflation is painful for many Americans, especially when wages have been going nowhere. But the financial state of middle-class America would be even worse off if the US had followed the deflationary, hard money policies that the inflationistas would apparently prefer. The European Central Bank hasn’t engaged in the sort of monetary easing that the Fed has and that many on the right detest. The result has been a eurozone unemployment rate near 12%, and a recovery (including a double-dip recession) that makes America’s look like the Reagan boom. It is also worth noting that Americans “budget less of their spending on food prepared at home last year than consumers in any other country in the world,” according to my AEI colleague Mark Perry.

The Federalist’s Davis says America needs a “gas and groceries” agenda. (Let’s put aside for the moment the the average US gas price is 25 cents lower today than four years ago.) Actually, what it needs is a modern economic agenda capable of producing plentiful high-wage jobs, as well as one that reduces government distortion in areas such as healthcare and education. But devising such policies should begin with a fair appraisal of the data as they are, not as we might wish them be.

Follow James Pethokoukis on Twitter at @JimPethokoukisand AEIdeas at @AEIdeas.

Economics, Pethokoukis, U.S. Economy

Should government expand school breakfast programs?

Image Credit: shutterstock

Image Credit: shutterstock

From “Expanding the School Breakfast Program: Impacts on Children’s Consumption, Nutrition and Health” by Diane Whitmore Schanzenbach and Mary Zaki:

School meals programs are the front line of defense against childhood hunger, and while the school lunch program is nearly universally available in U.S. public schools, the school breakfast program has lagged behind in terms of availability and participation.

In this paper we use experimental data collected by the USDA to measure the impact of two popular policy innovations aimed at increasing access to the school breakfast program. The first, universal free school breakfast, provides a hot breakfast before school (typically served in the school’s cafeteria) to all students regardless of their income eligibility for free or reduced-price meals. The second is the Breakfast in the Classroom (BIC) program that provides free school breakfast to all children to be eaten in the classroom during the first few minutes of the school day.

We find both policies increase the take-up rate of school breakfast, though much of this reflects shifting breakfast consumption from home to school or consumption of multiple breakfasts and relatively little of the increase is from students gaining access to breakfast. We find little evidence of overall improvements in child 24-hour nutritional intake, health, behavior or achievement, with some evidence of health and behavior improvements among specific subpopulations.

Now the authors take great pains to emphasize their study should not be used a reason to slash school lunch programs. Rather, policymakers should consider the cost and effectiveness of expanding their programs. This a key bit from later in the paper: “These results indicate that much of the increase in program participation induced by program expansions represents substitution from consumption of breakfast at home to school.”

Follow James Pethokoukis on Twitter at @JimPethokoukisand AEIdeas at @AEIdeas.

Pethokoukis, Economics, U.S. Economy

Hillary tries to say Reaganomics was a failure — and totally different than (Bill) Clintonomics

Image Credit: kyle tsui (Flickr) CC

Image Credit: kyle tsui (Flickr) CC

It appears a Hillary Clinton presidential campaign would attempt to persuade the public that a Hillary presidency would (a) be Bill’s de facto third term and (b) that Bill’s first two terms were not part of the pro-market turn in US economic policy that began under Ronald Reagan. Because, you know, President Obama says the Reagan presidency marks when America went off course. All Reaganomics did was increase income inequality. Here is Hillary on last night’s Charlie Rose show:

[I]f you look … at two Republican two-term presidents, Ronald Reagan and George W. Bush, and two Democratic two-term presidents, Bill Clinton and now Barack Obama, and if I just were to compare Reagan’s eight years with Bill’s eight years, it’s like night and day in terms of the effects, the number of jobs that were created, the number of people lifted out of poverty — 100 times more when Bill was president. And did policies have something to do with that? I would argue that they did.”

Wait, what? “Night and day” — with Reagan as the “night” and Clinton the “day”? Conservatives tend to look at the 1980s and 1990s as one long, pro-market policy continuum of lower taxes and deregulation. Economists generally call this period “The Great Moderation.” Sure, Bill Clinton raised the top marginal income tax rate — although at 40% it was still lower than the 50% rate instituted by Economic Recovery Tax Act of 1981 — but he also lowered investment taxes and signed NAFTA, which was a different kind of tax cut. (And don’t forget the role of the Gingrich-led Congress in pushing those pro-growth policies, including a balanced budget.) Even the policy mistakes were similar. Banks bailouts and TBTF really started in the 1980s and continued through the Clinton years. I am also sure Hillary would like to forget that Bill signed financial deregulation in 1999.

And guess what, Barack Obama also sees the 1980s and 1990s and 2000s as all part of the same grand policy mistake, as he made crystal clear in his 2011 Osawatomie, Kansas speech. He doesn’t give Bill a pass. Clintonomics was as much a part of the problem, as Obama sees it, as Reaganomics. But Hillary is trying to revise history by arguing that Clintonomics was something completely different and apart.

She is also arguing, astonishingly, that Clintonomics was a success, Reaganomics a failure. Really? Even a cursory examination of the data dispels that claim. Reagan took office after more than a decade of economic tumult and raging inflation. America was supposedly in irreversible decline. But from 1981 through 1988, inflation was tamed. Real GDP growth averaged 3.5%, and employment rose by 18% despite the nasty, Fed-induced recession of 1981-82.

Just as important, the more business-friendly tax and regulatory structure — not to mention the restructuring of Corporate America — set the stage for continued growth in the 1990s. Clinton stood on Reagan’s shoulders. Real GDP growth averaged 3.9% and employment increased by 23% from 1993 through 2000. Given the head of steam Reagan gave the 1990s, plus the fall of the Soviet Union and the Internet boom and declining energy prices, it may have been impossible to mess up that decade. Bill started on third base, and Hillary thinks he hit a triple.

One more thing: Hillary Clinton is apparently going to make a big deal about income inequality. So here is a stat for her. The top 1% US income share in 1992 was 13.5%, according to the World Top Income Data Base. When Bill Clinton left office in 2000, the share had risen to 16.5%. Indeed, high-end inequality rose more during the Clinton presidency, 3.01 percentage points, than during the Bush presidency, 1.4 percentage points

No one tell Elizabeth Warren!

Follow James Pethokoukis on Twitter at @JimPethokoukisand AEIdeas at @AEIdeas.

Economics, Pethokoukis, U.S. Economy

An encouraging sign for US tech innovation

"How fast are semiconductor prices falling?"

"How fast are semiconductor prices falling?"

It would be really bad for the US economy and workers if the pace of American innovation sort of petered out. Just search “great stagnation” to find out why (if it’s not intuitive). Less tech innovation would be a particularly worrisome. From “How fast are semiconductor prices falling?” by researchers David  Byrne, Stephen Oliner (of AEI), and Daniel Sichel:

A stalling out of innovation in this sector likely would have broader implications for the economy, as semiconductors are an important general-purpose technology lying behind machine learning, robotics, big data, massive connectivity, and many other ongoing advances. Indeed, adverse developments in the semiconductor sector ultimately would damp the growth potential of the overall economy. … [But] if technological progress and attendant price  declines were to continue at a rapid pace, powerful incentives would be in place for continued  development and diffusion of new applications of this general-purpose technology.

Anyway, whether or not this is happening is difficult to determine. One way: Look at whether the price of tech stuff, like computer chips, is declining, adjusted for quality. According to government data, chip prices haven’t fallen much in recent years — just 9% from 2008 through 2012 — after rapid declines from the mid-1980s onward, especially during the late 1990s and early 2000s.

That smells like innovation stagnation. Yet there was also continuing improvement in chip performance. How to explain the disconnect? Well, maybe the government is calculating the numbers wrong. Bryne, Oliner, and Sichel point out that right when price declines slowed, Intel changed how it priced its chip and introduced new models:

Prior to the mid-2000s, Intel generally introduced new chips at the technological cutting edge and lowered the list  prices of existing chips to remain competitive on a price-performance basis. However, by 2006, Intel had shifted to a new paradigm in which it largely kept the list prices of existing chips unchanged and began introducing new chips both at the frontier and at lower performance levels.

So Intel changed how it did business, but government price trackers didn’t change their methodology in response. If they had, by better gauging quality changes, the official stats would look quite different:

Our preferred hedonic index of [microprocessor unit] prices tracks the PPI closely through 2008. However, from  2008 to 2012, our preferred index fell at an average annual rate of 39 percent, while the PPI  declined at only a 9 percent rate. Given that MPUs represent about half of U.S. shipments of  semiconductors, this difference has important implications for gauging the rate of innovation in the semiconductor sector.

None of this means Washington should forget about innovation and its key role in economic policy. Innovation is a critical lens through which proposed tax, regulation, and spending should be viewed. But this new paper does provided an important data point suggesting the era of US economic growth doesn’t need to end anytime soon.

Follow James Pethokoukis on Twitter at @JimPethokoukisand AEIdeas at @AEIdeas.

Economics, Pethokoukis, U.S. Economy

‘Economic patriotism’? How about if Washington stops undercutting US multinationals?

Tax Foundation

Tax Foundation

Some (at least I think it’s “some” rather than “all”) left-wing economists would like to dramatically raise income tax rates. But, you might ask, wouldn’t doing so merely push top incomes into clever tax shelters, like in the 1970s — the end result being a more economically inefficient tax code that raises little extra revenue?

Maybe not, since these economists would also crack down on tax loopholes, to create a tax-hike “straitjacket” of higher rates and fewer tax breaks for wealthier Americans (and small business). No escape for you, the 1%!

Now one can see this reform principle at work in the Obama approach to corporate taxation. From the WSJ:

In a letter to Congress on Tuesday, Mr. Lew called on lawmakers to stop U.S. corporations from merging with foreign corporations and locating the parent company abroad to reduce their taxes.

So rather than create a better, pro-growth US tax environment, Team Obama wants to trap US companies in an uncompetitive domestic situation. Team Obama calls that “economic patriotism.” Michael Graetz, a professor at Columbia Law School, in the WSJ:

To ask, “How do we stop American companies from leaving for more favorable tax jurisdictions?” is asking the wrong question. The right question is “How do we make the United States a more favorable location for investments, jobs, headquarters, and research and development activities?” That will require genuine tax reform.

Ireland, Canada and the U.K. now have emerged as favored places to locate corporate headquarters.  …  They have all recently reformed their business income taxes to lower rates. At 35%, we now have the highest statutory corporate rate in the Organization for Economic Cooperation and Development, which has 34 developed countries as members. And, unlike the U.S., the vast majority of OECD countries do not impose taxes when their companies reinvest their foreign earnings at home. When U.K. or Irish treasury officials talk about their low-rate business-tax systems, they don’t speak about patriotism; they talk about being “open for business.”

The U.S. is the only OECD country that doesn’t have a national tax on consumption. Relying, as we do, so heavily on individual and corporate income taxes to pay for federal expenditures hobbles us in today’s global economy. Political leaders from both parties should demonstrate their own “economic patriotism.” They need to stop just talking about tax reform. The time has come for them to sit down together and enact a tax system that is fair, simple for the vast majority of Americans, and much more conducive to economic growth.

By the way, there is evidence that the US probably has highest effective corporate tax rate as well the highest statutory rate.

Follow James Pethokoukis on Twitter at @JimPethokoukisand AEIdeas at @AEIdeas.