Category Archives: Timothy Taylor is my Favorite Blogger

Annuities

Posted on by

Timothy Taylor writes,

Annuities may turn out to be one of those products that people don’t like to buy, but after they have taken the plunge, they are glad that they brought. One can imagine an option where some degree of annuitization of wealth could be built into 401(k) and IRA accounts. For example, it might be that the default option is that 30% of what goes into your 401(k) or IRA goes to a regular annuity that kicks in when you retire, another 20% goes to a longevity annuity that kicks in at age 80, and the other 50% is treated like a current retirement account, where you can access the money pretty much as you desire after retirement. If you wanted to alter those defaults, you could do so. But experience teaches that many people would stick with the default options, just out of sheer inertia–and that many of them would be glad to have some additional annuity income after retirement.

The theory of an annuity is that you insure against the risk of outliving your money. Economists tend to be big fans of annuities, and they view the reluctance of people to buy annuities as a behavioral economics puzzle.

I actually think that it is perfectly rational to shun annuities. My reasons:

1. You are charged more than the actuarially fair premium. Part of that is overhead and profit, and maybe part of that is adverse selection–the insurance company has good reason to fear that you are in better health than someone else your age. In any event, the result is that an annuity reduces your consumption possibilities by as much as would be the case if you over-estimated your lifespan by several years and budgeted accordingly.

2. Taylor notes that

people fear that they might need to make a large expense in the future, perhaps for health care or to help a family member, and if they have annuitized a large share of their retirement wealth they would lose that flexibility.

This is a very reasonable fear. An annuity is risk-reducing if the only risk you face is additional longevity. In fact, other risks may be more serious. You could easily find yourself needing to take out a loan if your savings are tied up in an annuity and your spouse requires a home health aide. (Speaking of which, long-term care insurance is something that I think does make sense, but you should buy it to get through age 75 and then self-insure thereafter).

3. It is reasonable to think in terms of declining consumer expenditures as you age. Will I really spend as much at age 90 as I spend at age 60? Medicare will cover many health expenses, and if I need to spend more of my own money on health care it is likely that I will have much less interest in vacation travel or buying a new car.

4. It is possible to substitute inter-generational insurance. If my mother-in-law had outlived her money, we could have supported her. From our family’s perspective, self-insuring in this way was cheaper than buying an annuity.

Canadian Banking and U.S. Banking

Posted on by

Timothy Taylor writes,

Clearly, the U.S. has a larger share of financial activity happening in the “other financial institutions” area, while Canada has a larger share of its financial activity happening explicitly in the banking sector. The Canadian economy is of course closely tied to the U.S economy. But the recession in Canada was milder than in the U.S., perhaps in part because Canada’s financial sector was less exposed to the issues of shadow banking.

Two interesting possibilities:

1. The Canadian shadow banking sector is underdeveloped. Canada is an ok place to get a mortgage or a commercial loan, but for more sophisticated financial transactions you have to go elsewhere.

2. The American shadow banking sector is overdeveloped. Our financial institutions are playing a game of hide-and-seek from the regulators, and shadow banking has emerged to enable banks to produce balance sheets that appear (to regulators) to be safer than they really are.

Of course, both of these could be true to some extent. I am more inclined to believe (2).

As an aside, I have no idea how one could measure the size of the shadow banking sector with any precision. I picture large books of derivatives, and do you look at gross or net exposure, current market value or potential value at risk, etc.?

A Rant on Narrative vs. Reality re the Financial Crisis

Posted on by

1. Narrative: Subprime mortgages were a consumer protection failure. Thus, we need the Consumer Financial Protection Bureau.

Reality: By a strict definition, predatory lending is when the loan is made with the intent of going to foreclosure and allow the lender to take possession of the house. This was not a factor in the subprime boom, which was fueled by the originate-to-distribute model. In the originate-to-distribute value chain, there is no one whose goal is to take the house from the borrower.

I think you could accuse loan originators of Ponzi lending. That is, lending to borrowers who could only avoid defaulting on the loan by taking out a new loan. Taking out a new loan in turn required continual increase in home prices, so that the borrower could use the equity in the house as collateral. But I would say that the biggest pushers of Ponzi lending were the “affordable housing” lobby, and I think that the last thing we will ever see is the CFPB take on the affordable housing lobby.

2. Narrative: The 1980s deregulation in banking was driven by the free-market ideology of Reagan and Greenspan.

Reality: The three main regulations that were dropped were the restrictions against banks paying market rates for deposits, the restrictions on interstate banking, and the restrictions on combining commercial banking with investment banking. I do not recall any pushback by the left on any of these–until 2008, when they made the retroactive claim that getting rid of Glass-Steagall caused the financial crisis.

In fact, these three regulatory boats had started sinking in the 1960s. The legislation that was passed in the 1980s and 1990s was simply the final order to abandon ship.

In the 1970s and 1980s, the big fight in bank regulation was not left vs. right, or deregulation vs. regulation. It was interest groups battling it out. Wall Street, big banks, savings and loans, and small banks had divergent interests, and that caused gridlock in Congress until things unraveled so much that Congress had no choice but to act.

If you want a parallel today, look at the battles between Amazon and the book publishers, or between Verizon and Google. You aren’t seeing legislators line up on ideological lines in those contests.

3. Free-market economists wanted to turn bankers loose to take whatever risks they wanted, and they got their wish.

Reality: Free-market economists were the strongest proponents of higher bank capital regulations and the biggest skeptics of the Basel risk-based capital regulations. We see the same thing today, with free-market economists skeptical of Dodd-Frank, and mainstream, establishment types like Stan Fischer saying things like

The United States is making significant progress in strengthening the financial system and reducing the probability of future financial crises.

In other words, this time will be different. Pointer from Timothy Taylor.

Textbooks, Venture Capital, and Pharmaceuticals

Posted on by

Timothy Taylor writes,

It is by no means obvious that a lower-cost book (yes, like my own) works less well for students than a higher-cost book from a big publisher. Some would put that point more strongly.

Yes, I know that professors do not care much, if at all, about the prices of the textbooks they select for their students, but that is not the only reason that prices are so high.

Another factor is that the industry is similar to venture capital and pharmaceuticals. The organizations that fund projects in these areas incur heavy expenses on failures. A lot of textbook projects fail. The author may not even finish the book. Or it will flop in the market.

For a VC firm to stay in business when most of the companies that it funds wind up failures, it has to earn spectacular returns on its successes. For a pharmaceutical firm to stay in business when a lot of its research fails to yield a marketable compound, it has to charge a lot for those drugs that do make it. And for textbook publishers to stay in business when many of their projects flop, they have to charge a high price for the books that do sell.

Advances in technology have made it easier to produce a textbook at low cost. However, by the same token, it has probably increased the probability that any given textbook will fail to get a toehold in the market. So the overall economics of the business still requires publishers to absorb a lot of failed-project costs.

The Wedge Between Compensation and Wages

Posted on by

Mark Warshawsky and Andrew Biggs write,

Most employers pay workers a combination of wages and benefits, the most important of which is health coverage. Economic theory says that when employers’ costs for benefits like health coverage rise, they will hold back on salary increases to keep total compensation costs in check. That’s exactly what seems to have happened: Bureau of Labor Statistics data show that from June 2004 to June 2014 compensation increased by 28% while employer health-insurance costs rose by 51%. Consequently, average wages grew by just 24%.

The kicker:

Health costs are a bigger share of total compensation for lower-wage workers, and so rising health costs hit their salaries the most. The result is higher income inequality.

I don’t think you can blame company-provided health insurance as a first-order cause. Suppose that there were no company-provided health insurance, and everyone instead bought health insurance on their own. In that case, more of the compensation of employees would have been in the form of wages and salaries. If health insurance in the individual market had gone up as rapidly as it has in the company-provided market, then this would have a stronger effect on the cost of living for low-income workers. So even if you did not have company-provided health insurance, you would still have the “wedge” between compensation and disposable income after health insurance.

As a second-order effect, you can argue that company-provided health insurance, and its tax exemption, push in the direction of raising health care costs. But that is not such a compelling argument.

I do think that it is increasingly misleading to speak of a single “cost of living,” when so much of the market basket consists of medical procedures and college expenses that not everyone undertakes. That is, I still believe that Calculating trends in the real wage is much harder than we realize, because every household has different tastes.

Related, from Timothy Taylor:

it’s also intriguing to note that since 1984, the share of income spent on luxuries is rising for each income group, and the share of income spent on necessities is falling for each income group.

He refers to a study by LaVaughn M. Henry.

The Null Hypothesis Strikes Again

Posted on by

Timothy Taylor looks at an OECD report on the effect of making a student repeat a grade. He quotes this sentence:

In practice, however, grade repetition has not shown clear benefits for the students who were held back or for school systems as a whole.

One interpretation of this is that the marginal benefit of an additional year of schooling is zero. However, that interpretation is not something that anyone wants to discuss.

And I could put the same headline on Tyler Cowen’s post about a study in France.

Health Policy Proposals

Posted on by

From a RAND paper.

The first five options would decrease costs and risks of inventing new products or
obtaining regulatory approval for products that would advance our two policy goals.

1. enabling more creativity in funding basic science
2. offering prizes for inventions
3. buying out patents
4. establishing a public interest investment fund
5. expediting FDA review.

The last five options would increase the market rewards for inventing products
that would advance our two policy goals. These options are
1. reforming Medicare payment policies
2. reforming Medicare coverage policies
3. coordinating FDA approval and CMS coverage processes
4. increasing demand for products that decrease spending
5. producing more and more-timely technology assessments.

Pointer from Timothy Taylor, who comments

I confess that as I look over their list of policy recommendations, I’m not sure they suffice to overcome the incentives currently built into the U.S. healthcare system.

The Book on SecStag

Posted on by

Timothy Taylor writes,

Coen Teulings and Richard Baldwin, who have edited a useful e-book of 13 short essays with a variety of perspectives on Secular Stagnation: Facts, Causes and Cures. In the overview, they write: “Secular stagnation, we have learned, is an economist’s Rorschach Test. It means different things to different people.”

Read his whole post.

The interesting secular trends include low real interest rates, low productivity growth, and declining labor force participation among prime-age workers.

From a conventional AS-AD perspective, low real interest rates are a demand-side phenomenon. The other two are supply-side phenomena. I wish the secstag folks would get together and sort this out.

I think that the most important secular trends are:

1. The New Commanding Heights. That is, the shift in the economy toward a lower share of goods consumption and a higher share of consumption of education and health care services. The New Commanding Heights are sectors in which productivity is difficult to measure and government interference is rampant.

2. The Great Factor-price Equalization. That is, the ability of workers with a given level of skills in China and India to compete with workers of equivalent skills in the U.S. This benefits the median worker in China and India as well as high-skilled workers in all countries, but it threatens the median worker in the U.S.

3. Vickies and Thetes. Or what Charles Murray calls Belmont and Fishtwon. In the U.S., there is extreme cultural sorting going on. People with high intelligence and conscientiousness are moving in one direction, and people who are low in those traits are moving in the other direction.

I think that (1) explains the low productivity growth. It could be partly a measurement problem and partly a problem of government putting sand in the gears.

I think that (2) and (3) explain the labor force participation problem.

What about low real interest rates? This one has puzzled me for a decade. Is it possible that (1) is the explanation? That is, the New Commanding Heights are not nearly as capital-intensive as the old commanding heights of steel, electric power, and transportation. Also, investment may be deterred because of the way government affects these sectors.

Good Sentences from Timothy Taylor

Posted on by

He writes,

I fear that most people have reacted to Dodd-Frank as a sort of Rorschach test where the word “financial regulation” are flashed in front of your eyes. If you look at those words and react by saying “we need more financial regulation,” then you are a Dodd-Frank fan. If you look at those words and shudder, you are a Dodd-Frank opponent. odd-Frank allowed a bunch of pro-regulation Congressmen to take a bow by passing it, and a bunch of anti-regulation Congressment to take a bow by opposing it. But for those of who try to live our lives as radical moderates, the issue isn’t to be generically in favor of regulation or generically against it, but to try to look at actual regulations and whether they are well-conceived. In that task, the Dodd-Frank legislation mostly used fairly generic language of good intentions, ducked hard decisions, and handed off the hot potato of how financial regulation should actually be written to others.

He points to the fact that many of the rules called for by Dodd-Frank had yet to be written four years after the law passed. He also notes,

A completed rule doesn’t mean that business has yet figured out how to actually comply with the rule. For example, there is a completed rule which requires that banking organizations with over $50 billion in assets write a “living will,” which is a set of plans that would specify how their business would be contracted and then shut down, without a need for government assistance, if that situation arose in a future financial crisis. The 11 banks wrote up their living wills, and the Federal Reserve and the Federal Deposit Insurance Corporation rejected the plans as inadequate. They wrote up second set of living wills, and a few days ago, the Federal Reserve and FDIC again rejected the plans as inadequate.

I have said many times that if the big banks are not going to be contracted and shut down now, then it is not going to happen during a crisis.

The Incentive to Invest

Posted on by

Timothy Taylor writes,

The very slow rebound in investment isn’t obvious to explain.

Read the whole thing. He walks through such explanations as uncertainty, difficulty obtaining financing, low aggregate demand (what Keynesians used to call the Accelerator Effect), and investment that has become less capital-intensive. On the latter, he writes,

it’s often a form of investment that involves reorganizing their firm around new information and communications technology–whether in terms of design, business operation, or far-flung global production networks. As a result, this form of investment doesn’t involve enough demand to push the economy to full employment.

All of these explanations are from a conventional AS-AD perspective. From a PSST perspective, I would look for bottlenecks, particularly in the service sector, where growth is most likely to occur. In the Setting National Economic Priorities Project, the following are considered possible bottlenecks:

–labor-market distortions, including high implicit marginal tax rates embedded in means-tested benefit programs
–the research/FDA approval/patent regime in medicine, given the state of the art in genetics and biochemistry
–the FCC spectrum regime, given the state of the art in spectrum utilization possibilities
–occupational licensing
–regulation of medical practice
–regulation/accreditation barriers to education innovation

The WSJ adds another layer to the mystery.

corporations used almost $600 billion in cash to buy back their own shares in 2013 and the uptrend continues into 2014. While that’s a positive trend for household wealth, it raises questions about companies’ commitment to move ahead with capital spending projects.

Remember the Tobin’s q theory of investment? It says that when stock prices are high relative to the value of existing capital, firms will invest more. Instead, we are seeing firms buy back stock to try to raise q.

This deserves more thought and analysis.