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This quarter's Milken Institute Review is filled with interesting articles. For example, in a round table discussion that includes four Nobel Laureates, economic historian Robert Fogel reminds us about the effects of productivity.

In the United States in 1800, it took five people working on the farm to support one person working off the farm. Today, 2 percent of the labor force not only feeds--and overfeeds--the United States, but another 300 million people around the world...

The share of the labor force in manufacturing today in the United States is lower than it was at the time of the Civil War--again, because productivity in that area has just leaped along.

Fogel argues that we can afford to shift resources into health care because of higher productivity in these other sectors.

Discussion Question. Fogel forecasts that the share of health care in GDP will rise from 14 percent to 21 percent. In 1993, the Clinton Administration viewed the increase to 14 percent of GDP as a "crisis" that required an overhaul of the nation's health care system. Why would Fogel disagree?

Steve Roach, like me, has been worried for a long time about the possible deflationary consequences of the end of the stock market bubble.

History tells us that when major asset bubbles burst, deflation is often the result. That was true of the United States in the 1930's and Japan in the 1990's. Most are quick to claim that America is not Japan — that its more flexible, dynamic economy stands in sharp contrast to Japan's economic inertia. But the United States is already a lot closer to the deflationary edge than most concede — and it could go further.

I simply cannot understand why this is not a policy priority. It seems to me that in the absence of more stimulus, the best the economy can hope to do is to muddle through. The worst case scenario is, as Roach describes, a stubborn, long slump, as is taking place in Japan. Surely, the balance of risks warrants trying to err on the side of giving the economy more fiscal and monetary stimulus.

Discussion Question. If the economic stimulus does not come from U.S. fiscal and monetary policy, where else might it come from?

When it was first enacted, the Alternative Minimum Tax was supposed to catch rich people who were taking advantage of too many tax deductions. However, a study by the Urban Institute shows that by 2010 many people will be paying this tax.

By the end of the decade, when the tax cuts pushed into law by the Bush administration in 2001 become fully effective, 85 percent of taxpayers with two or more children will be forced off the regular income tax and onto a separate system known as the alternative minimum tax. The additional burden will fall largely on families with incomes of $75,000 to $500,000. Just three years ago fewer than one million taxpayers, most at the upper reaches of the income spectrum, were subject to the complex separate tax. But if nothing is changed, by 2010 about 36 million taxpayers will face it. Indeed, virtually all taxpayers earning $100,000 to $500,000 will fall under its sway.

Also, by 2010, because of economic growth and inflation a large percentage of taxpayers will be making incomes in those ranges. My guess is that abolition of the alternative minimum tax is a potentially hot political issue for the party that seizes it.

Discussion Question. Assuming that incomes grow and more people become eligible for the AMT, will only the Bush tax cuts be affected, or will it also negate tax benefits enacted under President Clinton for education and other causes?

Paul Krugman could not find room in his twice-weekly Bush-bashing column for this interesting piece of economic analysis by a macroeconomic policy consultant, so he forwarded it to Brad DeLong. The issue under discussion is a possible "liquidity trap," in which the main Fed instrument, the Federal Funds rate, falls to zero. With low or negative inflation, this might not be expansionary. However,

"We do not have a zero bound problem except at the federal funds frontier," one official said, "and the Fed is perfectly capable of operating all along the yield curve. We can expand our balance sheet and buy all down the curve." Of course. And as another official put it, "we are looking at the Federal Reserve Act again to see what our options are. They are actually quite powerful."

That is, if the Federal Funds rate drops to zero, the Fed could still buy long-term bonds. For that matter, it could buy mortgage-backed securities or corporate bonds. The point is that a liquidity trap may not be a constraint on the Fed's ability to conduct expansionary operations.

Discussion Question. Even though the Fed may have room to reduce interest rates, an old economic debate is whether lower interest rates can increase investment in a depression. The phrase used is that the Fed is "pushing on a string." Can one be confident that lower interest rates would be sufficient to pull the economy out of a deep slump?

I'm starting to plow the a series of papers from a conference on economic policy in the Clinton years. The first one, by David Cutler and Jonathan Gruber, covers health care. Describing the thinking behind the original Clinton health care proposal, they write

The judgment that price inflation was the source of medical cost increases contributed to the view that costs could be reduced without substantial adverse impact on health--just stop providers from raising prices so much. Economic research began early in the decade but particularly afterward suggests that this conclusion is wrong...

No kidding. But you did not need to do research--all you needed to do was arithmetic. At the time, I calculated that if we drove doctor salaries down to British levels, drove drug company profits to zero, and eliminated all administrative costs for health insurance that you still could not produce the savings that the Clinton health care plan promised. Anyway, Cutler and Gruber continue,

Medical care cost increase[s] are now seen as predominantly, if not exclusively, a result of increased service utilization.

In other words, the only way that government can hold down health care spending is by rationing health care.

Cutler and Gruber point out that one of the lessons that the Clinton Administration learned from its health care debacle was that bringing health insurance to everyone was a political loser. Of course, I would say that bringing health insurance to everyone is probably the one policy objective that most economists would agree is worth trying for. Cutler and Gruber conclude,

[What] we have learned is that the private sector will not guarantee insurance coverage to the vast majority of the uninsured. Unfortunately, we have also learned that the political process is not particularly willing to deal with the issue either. Where that leaves policy in coming years is not entirely clear.

Discussion Question. Why would economists generally like to see some voucher program or universal subsidy for catastrophic health insurance, and why is that not the solution proposed by those who want to expand health care coverage?

'Jane Galt' on liberals vs. conservatives.

The difference between a free market economist and a more pro-regulation one is not that the former is a venal poltroon who is unaware that markets fail, much as the Nation and the American Prospect might wish that this were the case. The difference is that they impute to government different levels of ability to remedy these failures without introducing new, worse failures into the system. Liberal economists have a higher degree of confidence in the workings of regulation.

I agree with this. A liberal will point to a market failure and say "Gotcha! See, we need government intervention." A conservative will raise the question of whether in practice the government will make matters better or worse.

Discussion Question. Should economists be making the political judgement that the government will not make things better, or should we just focus on what an omniscient, welfare-mazimizing government ought to do?

The Washington Post reports on research that suggests that the official poverty line understates the needs of the poor and near-poor.

in almost any city, small town or suburb in America, an annual income of $18,100 -- the 2002 poverty figure for a family of four -- is nowhere near enough to cover housing, food, clothing, child care, transportation and taxes.

The article cites the work of Diana Pearce, a researcher at the University of Washington, who developed a "self-sufficiency standard," which she defines as the level of income needed for a family not to require government assistance. For a two-parent, two-child household living in Washington, D.C., this amounts to $57,289 a year, broken down as follows.

Note that the largest expenses are for child care and taxes. If one parent stayed home to take care of the children, this would reduce the required income to less than $39,000. Net taxes (which I computed by subtracting tax credits from taxes) amount to more than $12,000 a year. I would think that you would compute the point of self-sufficiency as the point where what you pay the government exactly matches what you receive from the government, which in this case would mean no net taxes. Taking away the taxes reduces the self-sufficiency standard to something under $27,000 a year.

I could quibble with some other items in the table (how does this two-income family not have employer-paid health insurance?). However, I think that $27,000 a year is not an unreasonable point at which the head of a four-person household living in the District of Columbia should neither receive a government income subsidy nor pay net taxes.

Discussion Question. Should government transfer payments take into account the fact that the cost of living is higher in some cities, or would this amount to an incentive for poor people to live in expensive areas?

On electricity deregulation, Lynn Kiesling writes,

Fixed, regulated rates insulate customers from the price decreases or increases that excess supply or demand would produce, and from the financial risk that often occurs in markets for commodities like electricity...

Inefficient energy consumption and production is the logical consequence of this disconnect, which means that fixed average rates do not satisfy either static efficiency conditions, or dynamic efficiency conditions that induce optimal capital investment in the electricity system.

California's "deregulation" of electricity maintained this fixed-rate structure, insulating the end-users from market reality. In my opinion that is why it blew up.

Discussion Question.My electric company offered me an alternative to its regular pricing. I pay a lower rate per kilowatt-hour, in exchange for which the utility can shut off my air conditioning for short periods when overall system demand is heavy. How does this approach contribute to static and dynamic efficiency?

Brad DeLong points out a wildly unprecedented characteristic of recent macroeconomic performance.

The growth rate of output per hour between 2001 and 2002 is going to be absolutely huge.

...We know, arithmetically, where this productivity growth came from: output rose in the fall of 2001 and the winter of 2002 even as American businesses shed workers and cut back on hours.

I used to argue all the time with non-economists who would say that higher productivity costs jobs. My comeback is that higher productivity only would cost jobs if output stayed constant. But in fact, output and employment both go up when productivity rises. However, as DeLong points out, this year is going to turn out to be an exception.

Discussion Question. The current situation seems to be what Keynes would have called a shortfall in aggregate demand. Why aren't there more Keynesians calling for deficit spending?

Russia's transition from Communism to capitalism has been at best a disappointment and at worst an outright failure. What went wrong?

Under Communism, the Russians developed black markets which were highly efficient. These markets enabled people to exchange goods and help to alleviate chronic shortages. In a Communist society black markets serve an economic function and improve efficiency.

Under capitalism, however, black markets promote criminality and discourage honest business. If there is an accessible black market in bread, then the employees of a bakery will steal bread to sell on the black market, and the bakery will fail.

On the other hand, if black markets do not exist, then employees who steal from their employers will have no place to sell their stolen goods. This reduces the incentive to steal.

So my hypothesis is that the efficiency of Russia's black markets undermined the transition to private ownership. State-owned businesses, which were not forced to be profitable, could survive widespread employee theft. Private businesses, however, require honesty on the part of employees. Because the black markets continued to thrive after the transition to private ownership, that transition failed. In other words, the successful transition from state ownership to private ownership requires not only the creation of open markets but the destruction of black markets.

Discussion Question. What other factors might account for the failure of Russia to make a successful transition to capitalism?