Category Archives: Mark Thoma is Indispensable

Another System for Doctors to Game

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Thomas D. Campbell writes,

Vermont is now taking steps to address problems that can arise from this opaque system, including rising health care costs. The state will soon implement an “all-payer” health care plan that requires Medicare, Medicaid, and private payers to reimburse health providers at the same rate, based on performance and patients’ recovery.

My prediction is that if this is implemented, health care costs will be higher than they would have been otherwise. Regulatory systems are made for gaming, and the more formulaic the system, the more effective the gaming.

Protectionism Equals Charity

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Russ Roberts writes,

the only way to get him his job back was to keep people from buying cars they preferred to buy elsewhere and force up the prices of those cars and have him share in that. It’s a form of charity, you just don’t see it. That’s the problem with protectionism as a way of helping those out of work workers. It’s a form of charity. And it destroys the expansion of opportunities that trade and innovation create.

Pointer from Mark Thoma. Read the entire piece.

The one element that I think that Roberts could have added is what I might call “Protectionism for me but not for thee.” Many white-collar professionals have protection in the form of occupational licensing. That’s a lot of charity for people who think of themselves as elite.

Oliver Hart on Vertical Integration

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He says,

if I’m Firm A, I’m acquiring control over all the non-human assets that Firm B had, which might be machines, land, buildings, but also less physical things like patents, copyrights, existing contracts that Firm B had with other firms. The name of Firm B, all sorts of things like that.

To the extent that the initial contract was incomplete, and will always be incomplete, whatever contract we write will be incomplete. Having, owning those things now means that I can get to decide how they are used to the extent that the contract was silent about that. Whereas previously, it was the owner, Firm B, that wasn’t me, who had those rights. That’s a real change. That, we would argue, is one of the key reasons that Firm A is acquiring Firm B, to get those residual control rights.

Pointer from Mark Thoma.

The whole interview is interesting. Hart shared the 2016 Nobel Prize. Of the last 10 years of Nobel Prizes, I could make a case that 6 have been awarded for the study of institutional arrangements.

2007 Hurwicz, Maskin, and Meyerson: mechanism design
2008 Krugman: agglomeration
2009 Ostrom, Williamson: governance
2012 Roth, Shapley: mechanism design
2014 Tirole: industrial organization and regulation
2016 Hart and Holmstrom

That is a notable trend, and I think it is a good one. When you focus on institutional arrangements, there is more of a tendency to say that the economist’s first challenge is to understand how things operate in the real world. A lot of other areas of focus tend to find the economist creating a hammer (a particular mathematical technique, or a model that is fun to work with) and looking around for nails in the real world that may or may not exist.

Noah Smith on Labor Supply and Demand

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He writes,

What is a better theory of the labor market? Maybe general equilibrium (which might say that immigration creates its own demand). Maybe a model with imperfect competition (which might say that minimum wage reduces monopsony power). Maybe search and matching theory (which might say that frictions make all short-term effects pretty small). Maybe a theory with very heterogeneous types of labor. Maybe something else.

Pointer from Mark Thoma.

This is the middle of the movie, so to speak. At the start of the movie, Smith looks at two stylized facts about the short run. One is that an immigration surge has little effect on wages. This suggests that labor demand is highly elastic. The other is that a minimum wage increase has little effect on employment. This suggests that labor demand is highly inelastic. It cannot be both.

Of course, you do have the option of denying the veracity of one or both stylized facts. But I do not want to go there. I vote for “very heterogeneous types of labor.” There is no such thing as “aggregate labor demand” in the labor market. There are patterns of specialization and trade. And these tend to be sticky, both in terms of wages and the quantity of each type of worker employed.

The “labor market diagram” makes it appear that you can have either a sticky wage or a sticky quantity of labor, but not both. Behind this (false) theorem lies the presumption that it is very easy to substitute among workers. This is an instance in which mathematical modeling serves to confound rather than help the modeler.

In fact, workers are specialized. Even relatively unskilled workers have been trained to perform their particular tasks. The substitutability that is implicit in the labor market diagram does not exist in the real world.

Labor market adjustment comes primarily from changes in the patterns of sustainable specialization and trade. Because it takes time for old patterns of trade to become unsustainable and for new sustainable patterns to form, neither wages nor quantities change as much in the short run as they do in the long run.

The effect of the minimum wage in the short run on existing firms can be small. They mostly just suck it up and pay the higher wage. However, over time, there will be a tendency for processes that use low-skilled workers to be less profitable and processes that instead use capital and high-skilled workers to be relatively more profitable. So the patterns of specialization and trade that break up will tend to be those that have been employing low-skilled workers, and the new ones that form will tend to employ fewer low-skilled workers than would have been the case otherwise.

As for immigration, what Noah calls general equilibrium I call creating new patterns of specialization and trade. There is no “lump of labor demand” that immigrants and natives are competing to fill. Firms do not say, “Oh, goody. Now I can now fire my native workers and hire immigrants for $1 an hour less.” Instead, entrepreneurs who are thinking of starting firms ask, “Where can I get the best workers for the least cost?” And in many cases immigrants are the answer. As this process plays out, my guess is that the main wage-depressing effect is on native workers just entering the labor force. But of course a lot of them have specialized skills that insulate them from competition from immigrants. So the effect on natives’ wages is limited in scope and stretched out in time.

Will Trump Revive Liberal Economists?

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Justin Wolfers writes,

you should think of the economy as being in a state of constant churn. The economist Joseph Schumpeter used the now-famous phrase “creative destruction” to describe this process by which new firms push out the old. The result can be cruel, but an extraordinarily fluid labor market, many economists argue, is the secret of American dynamism.

Wolfers tells a PSST story using a metaphor of a parking garage. The metaphor works a bit awkwardly in my view, but it will suffice.

Mr. Trump is focusing his resources on existing firms — the cars already parked there — rather than on the millions of potential entrepreneurs who might open the next generation of businesses.

Pointer from Mark Thoma.

If Mr. Trump can get more center-left economists talking about the seen and the unseen and describing the economy in the way that I do in Specialization and Trade, then he will have done a great service to the profession.

WaPo Watch

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The idea would be to have regular analysis of the bias in the Washington Post. One reader emailed encouragement but suggested that the New York Times is more influential.

My guess is that I do not want to take this on as a regular job. Instead, I might try it for a few weeks to try to develop a model for how it ought to be done. Then we can think about creating some sort of franchise to do it.

The goal is to create something that editors the Post might look at and recognize that there are reasonable indications of bias. Ideally, editors would start to think about how their priorities, headlines, and lead paragraphs could be altered to be less biased.

Below is a first pass at a weekly analysis. For the main news section, the emphasis will be on stories and op-eds related to Donald Trump. For stories, I will tally positive, negative, and neutral, based on bias or spin. As long as there is no spin involved, then I consider the story neutral, even if it reflects on Mr. Trump very favorably or very unfavorably.

For op-eds, I don’t begrudge the paper running negative op-eds on Mr. Trump. I think that the job of the op-ed writer is often to complain and “speak truth to power.” The Post showed bias, in my view, by regularly running op-eds favorable to the Administration with Mr. Obama in office. I will make note of any op-eds that are favorable to Mr. Trump. I expect that in many weeks that tally will be zero, and I am not saying that it should be otherwise.

I will look at other biases in the front section, as well as in the Style section that covers arts and culture and in the Metro section that covers local news. For the Sunday Outlook section of op-ed essays and book reviews, I will tally the slant of non-Trump pieces. I will count the number that appeal to closed-minded progressives, the number that appeal to closed-minded conservatives or libertarians, and the number that offer something to people with open minds.

Read below the fold for the first week’s analysis.
Continue reading →

Consequences of Internal Free Trade

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Dietrich Vollrath writes,

The scale of the relative job changes, though, indicates that more of the losses have to do with free trade within the US than free trade outside of the US. The areas with relative decline lost 13 million jobs compared to the 1990 distribution of jobs. In total the US shed 6 million manufacturing jobs from 1990 to 2015 (18 million to 12 million, roughly). So this relative decline cannot possibly be a function only of manufacturing and international trade in manufactured goods. There is just too much relative movement out of the declining counties to attribute to this. This is a sloppy way of thinking about how this would work counter-factually (I’m ignoring spillovers entirely), but if you magically added 6 million extra jobs to those counties in relative decline, they would still be in relative decline compared to the Sunbelt in terms of jobs. They’d have 84.4 million jobs (as opposed to 78.4 million), but you’d expect them to have 95.6 million based on the 1990 distribution, so they would still be 11.2 million jobs off the pace.

Pointer from Mark Thoma. I recommend the entire post, which is rich in data analysis. One thought that occurred to me in looking at some of the information is that job losses have tended to occur in large metro areas long controlled by Democrats, and job gains seem to be in locations that are a bit more fluid politically.

Regulation and Sustainability

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Concerning a new EPA regulation, Jennifer Ko writes,

many industry and environmental groups have failed to address one important aspect of biofuel regulations—the effect that increased ethanol use will have on dwindling water supplies in the United States. Jay Famiglietti, a senior water scientist at the U.S. National Aeronautics and Space Administration, questions the prudence of policy decisions that drain stressed water supplies to irrigate water-intensive crops. Many of the nation’s top ethanol producing states sit in the “breadbasket” of America where farmers irrigate crops, such as corn, using water from underground aquifers. In Kansas, the main source of water—the largest basin of freshwater in the United States—is dwindling rapidly, in part due to the water used up by massive acres of crops earmarked for ethanol production.

If policymakers fail to consider the relationship between energy and water, Famiglietti warns that “consequences will be huge.”

Pointer from Mark Thoma.

In Specialization and Trade, I argue that market prices tend to do a better job than environmentalist intuition at indicating sustainability. Water tends to be under-priced, in part because agricultural interests lobby for low prices. They also lobby for higher ethanol mandates. And the EPA, which is supposedly here to protect the environment, helps the agricultural interests.

The Minnesota Plan for Big Banks

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Neel Kashkari explains,

Today, banks can enjoy their explicit or implicit status as being TBTF potentially indefinitely. In contrast, the Minneapolis Plan puts a hard deadline on Treasury: Certify banks as no longer TBTF within five years, or else that bank will see dramatic increases in capital requirements. We believe the threat of these massive increases in capital will provide strong incentives for the largest banks to restructure themselves so that they are no longer systemically important.

Pointer from Mark Thoma. TBTF is, of course, too big to fail.

I endorse this approach. However, instead of the threat consisting of dramatic increases in capital requirements, I think that the threat ought to be to have the Treasury break up the banks. In effect, the government would be saying, “Either you break yourselves up, or we do the break-up for you.” I am confident that every large bank would come up with a divestment plan.

Keep in mind that the top financial institutions all grew through mergers and acquisitions. It is not as if any of them just naturally grew larger because of some unique ability to serve customers. As a result of these agglomerations, the largest institutions are too complex to be managed effectively. My guess is that breaking them into “smaller” units (I put smaller in quotes, because even after divestment these institutions would still be gigantic on a world historical scale) would not result in a large loss in total market value. It might very well result in an increase.

I should emphasize that smaller institutions are not necessarily less risky financially. But when they do fail, there are many feasible alternatives to bailouts. When a financial giant is about to fall, no Treasury Secretary can sleep at night unless there is a bailout.

Confirmation Bias in Macroeconomics

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Prakash Loungani writes,

The evidence shows the “cycs” have been proved largely right. U.S. unemployment has fallen pretty much in line with the recovery in output. U.S. states where growth was stronger than the national average had declines in unemployment greater than the national average. And looking across the globe, countries which experienced more rapid growth than the global average — a group which includes the United States and the United Kingdom — had declines in unemployment greater than the global average.

Pointer from Mark Thoma. His point is that this vindicates the theory of aggregate demand. My response: as opposed to what? A theory that output and employment are totally unrelated? Whose theory is that? In fact, employment and output should be correlated whether one is telling a PSST story or an aggregate demand story.

The usual notion of confirmation bias is that people over-rate findings that favor their preferred point of view. But macroeconomists go beyond this. They take findings that are completely neutral in their implications for one point of view vs. another and claim that these findings confirm their preferred point of view.