Pethokoukis, Economics, U.S. Economy

Has Washington severed the US economy’s roots?

Image Credit: shutterstock

Image Credit: shutterstock

The last three months of 2013 were not as strong as first thought. The Commerce Department now says real fourth-quarter US GDP was up 2.4%, not 3.2% as first estimated. For the year, then, RGDP was up 2.5% (fourth quarter over fourth quarter) vs. 2.0% in 2102. Some explanation from Paul Ashworth of Capitol Economics:

 … Federal government shutdown resulted in a 5.6% drop in public sector spending, which subtracted more than 1.0% ppts from overall GDP growth. Durable goods consumption is now estimated to have increased by a more modest 2.5% in the fourth quarter, down from the initial 5.9% estimate. …  Net exports are now assumed to have added 1.0% ppt to GDP growth, rather than the initial contribution of 1.3%. Inventories added 0.1%, down from the initial 0.4% estimate. The good news is that business investment increased by 7.3%, revised up from the initial estimate of a 3.8% gain. That gain helped to offset an 8.7% decline in residential investment, which was hit by the drop back in existing home sales that has reduced brokers’ commissions.

Still not so bad given a year of tax-heavy fiscal austerity, But not great either. So as we move forward through this fifth full year of an anemic recovery/expansion after the Great Recession, where do things stand? A new Congressional Budget Office blog post offers two key stats from its calculations:

1. CBO estimates that GDP was 7½% smaller than potential (maximum sustainable) GDP at the end of the recession; by the end of 2013, less than one-half of that gap had been closed.

2. Employment at the end of 2013 was about 6 million jobs short of where it would be if the unemployment rate had returned to its prerecession level and if the participation rate had risen to the level it would have attained without the current cyclical weakness.

A ways to go before we return to the old normal. Of course 2014 was supposed to be a year of acceleration, one that may have slipped on the ice thanks to a severe winter. Spring cannot come to soon. As Chance the gardener put it in the film, Being There:

In the garden, growth has it seasons. First comes spring and summer, but then we have fall and winter. And then we get spring and summer again. As long as the roots are not severed, all is well. And all will be well in the garden. There will be growth in the spring!

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.


Society and Culture, Education, Pethokoukis

Underwhelming universal pre-k

Image Credit: shutterstock

Image Credit: shutterstock

To proponents, the public policy case for universal preschool is air tight. Studies of numerous pre-k programs demonstrate a high return on public investment, they say.  Higher graduation rates, lower incarceration rates.

But are these studies valid? Are they structured so that it’s possible to demonstrate the program had a causal effect on the kids? Were they, for instance, randomized controlled trials? So “internal validity” is one factor.

Second, does the study have a high level of external validity? Can you generalize from the results of a policy experiment to the broader setting in which the policy will be applied. When applying these two tests, Grover Whitehurst of Brookings finds the results underwhelming:

Not one of the studies that has suggested long-term positive impacts of center-based early childhood programs has been based on a well-implemented and appropriately analyzed randomized trial, and nearly all have serious limitations in external validity.  In contrast, the only two studies in the list with both high internal and external validity (Head Start Impact and Tennessee) find null or negative impacts, and all of the studies that point to very small, null, or negative effects have high external validity.  In general, a finding of meaningful long-term outcomes of an early childhood intervention is more likely when the program is old, or small, or a multi-year intervention, and evaluated with something other than a well-implemented RCT.  In contrast, as the program being evaluated becomes closer to universal pre-k for four-year-olds and the evaluation design is an RCT, the outcomes beyond the pre-k year diminish to nothing. I conclude that the best available evidence raises serious doubts that a large public investment in the expansion of pre-k for four-year-olds will have the long-term effects that advocates tout.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.


America’s ‘too big to fail’ financial system in one chart


Thomas Hoenig, vice chairman, Federal Deposit Insurance Corporation, on TBTF, Dodd-Frank, and the megabanks:

The chart shows that in 1984, the control of assets among the different bank groups was almost proportional. Also, within each group if a single bank failed, even the largest, it might shock the economy, but most likely would not bring it down. Today this distribution of assets is dramatically different. Banks controlling assets of more than $10 billion have come to compose an overwhelming proportion of the economy, and those with more than a trillion dollars in assets have come to dominate this group. If even one of the largest five banks were to fail, it would devastate markets and the economy.

Title I of the Dodd-Frank Act is intended to address this issue by requiring these largest firms to map out a bankruptcy strategy. This is referred to as the Living Will. If bankruptcy fails to work, Title II of Dodd-Frank would have the government nationalize and ultimately liquidate a failing systemic firm.

While these mechanisms outline a path for resolution, success will be determined by how manageable large and complex firms are under bankruptcy and whether under any circumstance they can be resolved without major disruption to the economy. This is a daunting task, and increasing numbers of experts question whether it can be done given current industry structure.2 Two impediments are most often highlighted to organizing an orderly bankruptcy or liquidation for these firms.

First, it is not possible for the private sector to provide the necessary liquidity through “debtor in possession” financing due to the size and complexity of the institutions and due to the speed at which crises occur. There simply would be too little confidence in bank assets and the lender’s ability to be repaid, and too little time to unwind these firms in an orderly fashion in a bankruptcy. Under the current system, it would have to be the government that provides the needed liquidity, it is argued, even in bankruptcy to avoid a broader financial meltdown.

Second, when a mega banking firm goes into bankruptcy, capital markets and cross-border flows of money and capital most likely would seize up, intensifying the crisis, as happened following the failure of Lehman Brothers, for example. International cooperation is critical in such circumstances, and it would be ideal if creditors, bankers and governments acted calmly and rationally in a crisis. It would be ideal also if all contracts were honored and if collateral and capital were free to move across borders. But, experience suggests otherwise. Panic is about panic, and people and nations generally protect themselves and their wealth ahead of others. Moreover, there are no international bankruptcy laws to govern such matters and prevent the grabbing of assets, sometimes known as ring-fencing.

This raises the important question of whether firms must simplify themselves if we hope to place them into bankruptcy. This is no small question, and it must be addressed.

A further sense of the importance of these unresolved issues can be gained by working through the annual report of any one of these largest firms. These reports show that individual firms control assets close to the equivalent of nearly a quarter of U.S. GDP, and the five largest U.S. financial firms together have assets representing just over half of GDP. The reported composition of firm assets represents a further challenge in judging their resolvability, as it is opaque and the relationship among affiliate firms is sometimes unclear. A host of assets and risks are disclosed only in footnotes, although they often involve trillions of dollars of derivatives that are not shown on the balance sheet. Inter-company liabilities are in the hundreds of billions of dollars and if any one link fails, it can initiate a chain reaction of losses, failure and panic. And should crisis emerge, liquidity is sought through the insured bank, not through the provisions of bankruptcy. One failure means systemic consequences.

These conditions mean “too big to fail” remains a threat to economic stability. They necessarily put the economic system at risk should even one mega bank fail. And they allow these mega banks to operate beyond the constraints of economies of scale and scope, and provide the firms an enormous competitive advantage — all of which is antithetical to capitalism.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.


Is ‘uncertainty’ really holding back the US economy? Maybe not



Despite record corporate profits and superlow interest rates, business equipment spending has been growing more slowly in this recovery than previous ones. But the problem is really just technology-equipment spending. Spending on non-tech equipment is meh but not miserable.

Tech, however? Kind of a disaster, up only 0.4% over the past year and up at an average annual pace of only 1.6% over the past three years, according to JPMorgan. The bank’s economics team provides some context:

Spending on high-tech equipment had been a dynamic high-growth sector in previous decades, with annual real growth averaging more than 20% per year though much of the 1990s and 10% to 15% per year in the expansion last decade. Over the past few years high-tech spending has been growing even more slowly than over- all GDP All high-tech spending, on both equipment and software, has also been slipping as a share of GDP, falling from the equivalent of 4.7% of GDP in 4Q00 to 3.4% of GDP in 4Q13.

Here’s the puzzle: some economists have theorized that economic policy uncertainty is holding back business investment. Remove the uncertainty, and business will start spending. As JPMorgan sees it, this theory does not fit the data. First, uncertainty — as measured by the Economic Policy Uncertainty Index — has been coming down since 2011, but business spending has moderated, too. JPM: “In short, spending trends through this expansion seem at odds with the uncertainty-driven story of capital spending.” Second, why would policy uncertainty affect tech and non-tech equipment spending differently? Weird.

JP Morgan

JP Morgan

So what’s the deal? The bank’s economists theorize the tech-spending slowdown reflects a slowing in the pact of technological advance, thus less reason to buy fancy, new machines:

In the late ‘90s real prices for IT equipment would routinely decline at over a 10% annual pace, more recently that pace of price decline has moderated to between 2-3%. Barring some unforeseen development in IT production technologies, a return to the declines seen in the ’90s seems unlikely. At least for the foreseeable future, business spending on high-tech looks like it will do no better than the trend for old-economy, low-tech capital goods.

Beyond the issue at hand, tech investment trends could be evidence that the “great stagnation,” techno-pessimists are correct. A possible counter would be that tech equipment prices, and perhaps other IT products, are being improperly measured. AEI’s Stephen Oliner:

And one example that reflects the research I’m doing now concerns the prices that we measure in the producer price index, which is the U.S. official price index produced by the Bureau of Labor Statistics for semiconductors, particularly the microprocessors that go into computers, laptops, desktops, tablets, et cetera.

The PPI shows that the price declines for those goods, which were extremely rapid throughout almost the entire history that they’ve been produced, have basically come to a halt — that in the last couple of years there have been no price declines to speak of at all, which is very strange and is in conflict with the fact that innovation in that part of the economy is still proceeding at a rapid rate.  And it raises questions about whether the procedures that are being used to measure those prices are appropriate.  And I personally think that they’re not, that prices are actually falling more rapidly than the official statistics would show.

As a techno-optimist, I would prefer to believe Oliner is correct. But if he is, what is really happening to tech spending?

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.


Why the age of tax cuts is over


It requires a vivid fantasy life to believe Dave Camp’s big tax reform plan has legs in 2014. A typical Washington assessment: “I have no hope for that happening this year,” Senate Minority Leader McConnell told reporters.

But even if the Camp plan — or any comprehensive reform, really — is a political fantasy right now, it isn’t an economic one. Here’s why: some GOP tax plans assume the federal government can permanently return to roughly historical revenue levels despite an aging society that will sharply increase entitlement spending even with the smartest reforms. While some taxes could be cut with minimal to no revenue loss — the corporate tax code is seriously messed up – the overall tax burden will likely need to rise. As AEI’s Alan Viard told me back in November:

I think we will go up to the 20 to 21% of GDP level in the next several decades. Further on, we may have to go higher than that, but it will depend on what we can do on the entitlements side. It’ll also depend upon what happens to just overall medical costs.

And it’s hard to imagine Democrats accepting sweeping entitlement changes without higher taxes. The Camp plan is revenue neutral, at least over the next decade. It’s realistic that way. It doesn’t assume repeal of the New Deal, dismantling of income supports, or evisceration of the Pentagon. We’re not going back to the 19th century-sized government.

Of course Democrats want higher taxes now. Former White House economic adviser Jared Bernstein says the plan’s revenue neutrality makes it “fatally flawed.” But raising lots more revenue without trashing the economy will mean converting the income tax into more of a consumption tax. Doing so would be good for growth. Viard:

The simulations show that you would get an increase in long-run output. Some estimates are by a few percent. Some estimates are by several percent. Some estimates go up around 8 or 9% extra output in the long run. It does depend on the assumptions you make, but the basic story that holds no matter what the exact numbers may be is that you’re no longer penalizing saving and investment, so you really build up more capital and more wealth over time.

Higher marginal income tax rates on the 1% and business won’t get us there. America will eventually need systemic change far bolder and broader than what Camp has proposed. The Age of Tax Cuts is over. But the Age of Tax Reform has yet to arrive.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.


Study: Restricting what nurses do raises healthcare costs but doesn’t improve quality

Image Credit: shutterstock

Image Credit: shutterstock

Economist Peter Orszag recently noted that the healthcare sector is “replete with labor-market inefficiencies.” Reforming scope-of-practice restrictions and allowing nurse practitioners and physician assistants, among others, to do more could be a key way of creating a more efficient and productive US healthcare system.

And a new study agrees. “Relaxing Occupational Licensing Requirements: Analyzing Wages and Prices for a Medical Service” by Morris Kleiner, Allison Marier, Kyoung Won Park, and Coady Wing:

Occupational licensing laws have been relaxed in a large number of U.S. states to give nurse practitioners the ability to perform more tasks without the supervision of medical doctors. We investigate how these regulations may affect wages, employment, costs, and quality of providing certain types of medical services.

We find that when only physicians are allowed to prescribe controlled substances that this is associated with a reduction in nurse practitioner wages, and increases in physician wages suggesting some substitution among these occupations.

Furthermore, our estimates show that prescription restrictions lead to a reduction in hours worked by nurse practitioners and are associated with increases in physician hours worked.

Our analysis of insurance claims data shows that the more rigid regulations increase the price of a well-child medical exam by 3 to 16 %. However, our analysis finds no evidence that the changes in regulatory policy are reflected in outcomes such as infant mortality rates or malpractice premiums.

Overall, our results suggest that these more restrictive state licensing practices are associated with changes in wages and employment patterns, and also increase the costs of routine medical care, but do not seem to influence health care quality.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.


Dave Camp’s mortgage interest reform is maybe the best of his tax reform plan

Image Credit: Shutterstock

Image Credit: Shutterstock

Although some folks on the right are griping about it, House Ways and Means Chairman Dave Camp was right to include reform of the mortgage interest deduction in his big tax reform plan. From the Camp plan:

Under the provision, a taxpayer may continue to claim an itemized deduction for interest on acquisition indebtedness, but the $1 million limitation would be reduced to $500,000 in four annual increments, so that the limitation would be $875,000 for debt incurred in 2015, $750,000 for debt incurred in 2016, $625,000 for debt incurred in 2017, and $500,000 for debt incurred thereafter.

The MID is a $70-billion-a-year, market distorting subsidy for the purchase of expensive homes by high-income taxpayers. It does little to promote homeownership by Americans of more modest means. There is no sound economic reason to use the tax code to artificially advantage the higher-end real estate sector over other sectors of the economy.

What’s more, the MID is a key part of what Northwestern University’s Monica Prasad calls “mortgage Keynesiamism,” an initially Democratic, New Deal effort to funnel the welfare state through housing and consumer credit rather than more directly as in Europe. Except mortgage Keynesian really doesn’t really do much to help the poor and creates economic risk, as we saw during the Financial Crisis.

But won’t the Camp plan kill home prices? Unlikely. A 2008 study of the price reaction to eliminating completely the subsidy estimated only a 4.2% decline in home equity. Now this isn’t to say that Camp’s approach is ideal. AEI’s Alan Viard recommends — accepting the political reality of some housing tax preference — converting the MID into a 15% refundable tax credit available to all homeowners.This approach, Viard writes, “substantially limits the tax preference for expensive homes while increasing homeownership assistance for taxpayers who are less well off.”

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.


Does the GOP have a diagnosis for what ails the US economy other than Obamanomics?

Kaufman Foundation

Kaufman Foundation

We know the left-liberal, progressive diagnosis for what ails the US economy, not just today’s woes but longer term: too much income inequality (we need to redistribute from the high-saving 1% to the high-consuming 99%), too little public “investment” (not enough spending on infrastructure.) So that’s Obamanomics, basically. It’s a Keynesian argument about demand.

But what is the GOP theory of the case? Some on the right would say, well, Obamanomics! But consider: from the end of World War Two through the 1980s, it took roughly six months for employment to recover to prerecession levels after each postwar recession. But it took 15 months after the 1990–91 recession and 39 months after the 2001 recession. The current recovery is 57 months old, and we are still some 4 million full-time jobs short of prerecession levels. Moreover, steep recession loses for mid-wage workers have not been matched by comparable gains during recovery. For the labor market overall, then, the Great Recession continues. But not for big business. Corporate profits returned to their prerecession peak in late 2009 and continue to make record highs. While Dodd-Frank, Obamacare, and investment tax hikes have not helped, the US economy’s problems seem to predate Obama.

So here is one possible explanation: these jobless recoveries are the result of an economy now better at generating process innovation (creating cheaper, more efficient ways to make existing consumer goods and services) than what business consultant Clayton Christensen has termed “empowering innovation” (creating new consumer goods and services). Efficiency innovation frees up capital that’s then reinvested in still more efficiency innovation — often machines rather than men — rather than in job-creating empowering innovation as in the past.

Why might this be? Years of government policy protecting incumbent firms from competition and failure present one possibility. As Ashwin Parameswaran has put it: “Incumbent firms rarely undertake disruptive innovation unless compelled to do so by the force of dynamic competition from new entrants. The critical factor in this competitive dynamic is not the temptation of higher profits but the fear of failure and obsolescence.”

Shorter: dynamic innovation is created by maximum competitive intensity. Here is the disturbing conclusion from a recent Kaufman Foundation report:

A number of signs point to a secular decline in U.S. business dynamism, which goes far  beyond the more recent effects of the Great Recession. For example, the rate of new  firm formation—a key element of business dynamism and new job creation—has been  declining steadily for at least the last three decades. Job reallocation—the process that  moves workers away from contracting or closing businesses and toward expanding or  new firms—also has been declining over the same period.

Even the tech industry is not immune. The study notes that the number of technology companies aged five years or younger —  the fast-growing “gazelles” of drivers of job creation — has fallen below 80,000 versus a high of 113,000 in 2001.

Some examples of how the US prevents both startup entry and incumbent exit: a “too big to fail” financial system (made worse by Dodd-Frank) that rewards gigantism and macroeconomic risk rather than lending to small business; occupational licensing and patent laws that reward cronyism rather than promoting the entry of new, entrepreneurial firms; a complex corporate tax code biased against investment and where big companies are able to lobby for favorable tax breaks and subsidies. Reform in all these areas is one way to, as Christensen argues, “to reset the balance between empowering and efficiency innovations.”

So, if you buy this theory: the US needs more creative destruction and more radical innovation, while also fashioning a strengthened safety net and an education system that teaches the technological and entrepreneurial skills that workers will need in the future.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.

Pethokoukis, Economics, Regulation

Is Dodd-Frank harming America’s startup culture?

Image Credit: shutterstock

Image Credit: shutterstock

Talk about a terrible two-fer. First, the Dodd-Frank financial reform law institutionalizes Washington’s “too big to fail” safety net for Wall Street. As AEI’s Charles Calomiris explains, the law explicitly permits bailouts — at government’s discretion — via the law’s resolution authority provision. The bailout would be financed by taxes on surviving banks and then potentially by taxpayers. TBTF is still here. Indeed, megabanks have responded to Dodd-Frank’s TBTF incentives by getting bigger, the industry more concentrated. Fortune points out, for instance, that the six largest banks in the nation now have 67% of all the assets in the US, up 37% from five years ago.

Second, by doubling down on TBTF, Dodd-Frank makes life harder for the rest of the banking industry. This is particularly the case for small banks. The Mercatus Center’s Hester Peirce and Robert Greene:

The Dodd-Frank Act … imposes a new set of regulations that are disproportionately burdensome to small banks. Moreover, by designating the largest financial institutions as “systemically important,” Dodd-Frank creates a market expectation that designated firms are too big to fail and generates funding and other competitive advantages for the largest US banks. Since the second quarter of 2010—immediately before the July passage of Dodd-Frank—to the third quarter of 2013, the United States lost 650, or 9.5%, of its small banks. Small banks’ share of US banking assets and domestic deposits has decreased 18.6% and 9.8%, respectively, and the five largest US banks appear to have absorbed much of this market share. Mounting regulatory costs threaten to accelerate the shift towards big banks and away from small banks that have long been important members of the financial industry and the local communities they serve.

Community banks are important particularly to small business. As an AEI paper last year noted, community banks provide nearly half of small-business loans issued by US banks. And small business and startups are the engine of US economic growth. Yet we have devised a capital allocation system that rewards banks for getting bigger and taking on the sort of risk – from, say, mortgage lending — that the Fed and regulators care most about. Starting with the Fed’s reaction to the 1987 stock market crash, says Ashwin Parameswaran:

 … 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. … 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.

And so it continues. Beyond its glacial pace, this recovery is notable for its weakness in the small and young firms which typically have high job-creation rates. In addition to Dodd-Frank’s impact on lending, the Hudson Institute’s Tim Kane noted in a study last year that the rise of occupational licensing is destroying startup opportunities for poor and middle class Americans. Rather than creating barriers to entrepreneurship, government should empower today’s wage earners to become tomorrow capitalists.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.


Here’s exactly how marriage penalties discourage marriage

Family's Economic Mobility in Doubt

Photo Credit: Eric Ward via Wikimedia Commons

How to encourage stable, two-parent families is one of the knottiest public policy problems, but also one of the important. As a recent blockbuster study on economic mobility concluded: “The fraction of children living in single parent households is the strongest correlate of upward income mobility among all the variables we explored.”

As government figures out how to help, it can at least stop harming. For starters, mitigate the marriage penalties embedded in the tax code. AEI’s Robert Doar:

Recognizing that married, two-parent families help poor children succeed, we must address policies that make marriage hard — especially among low-and middle- income Americans.

Marriage penalties can be especially discouraging for those individuals who have the least freedom to forego income. As Eugene Steuerle of the Tax Policy Center and colleagues have explored in det ail, policies aimed at assisting low – and moderate – income households with children often penalize marriage.

Take this example: “A single parent with two children who earns $15,000 enjoys an EITC benefit of about $4100. The credit decreases by 21.06 cents for every dollar a married couple earns above $15040….[I]f the single parent marries someone earning $10,000, for a combined income of $25,000, the EITC benefit will drop to about $2,200. The couple faces a marriage tax penalty of…$1,900.”

Similar penalties are embedded in Medicaid, Temporary Assistance for Needy Families (TANF), food stamps, housing assistance, and child care — all of which apply to low-and moderate-income Americans. Efforts to mitigate marriage penalties have largely taken the form of tax cuts directed toward married couples. But according to Carasso and Steuerle’s analysis, 81 percent of that relief flowed to couples earning above $75,000. A host of reforms could alleviate this burden.

As Carasso and Steuerle describe, implementing a maximum marginal tax rate for low-income families would tamp marriage-induced hikes in rates. Providing a subsidy on individual earnings — not combined earnings (like the EITC) — would enable a low-wage American to marry someone with a child, but do so without sacrificing significant income or transfer payments. And mandatory individual filing, as done in Canada, Australia, Italy and Japan, would either require or allow low-income individuals to avoid income tax penalties.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.