Category Archives: Economics

Some Wisdom from Henry Kaufman

Sometimes, when you write history, you can end up feeling old. I had that feeling a couple of weekends ago, when Henry Kaufman ventured to Baltimore to talk to the Business History Conference, an organization of historians.

I’ve known Kaufman for many years, and when my neighbor in the audience said, “I don’t know who this person is,” it was hard to explain how important he was on Wall Street in the second half of the twentieth century — how he, then head of research at Salomon Brothers, and Albert Wojnilower, the chief economist at First Boston, presciently warned in 1981 that Ronald Reagan’s economic policies would drive interest rates and the dollar sky-high, or how Kaufman’s pronouncement in August 1982 that interest rates had entered a long-term downward trend awoke the stock market from years of slumber. Since then, Kaufman has come in for a good bit of criticism: he was insufficiently bullish on the stock market in the 1990s, it is said, and as a board member bears responsibility for the collapse of Lehman Brothers, a venerable investment bank, in September 2008. He remains bitter about his experience with Lehman, and he blames the Treasury and the Securities and Exchange Commission for telling the directors Lehman should declare bankruptcy. “I think it was partly a political decision to allow Lehman to fail,” he says, recalling the pressure on the Fed and the Bush Administration to force someone on Wall Street to lose big.

Kaufman is 90 now, and he continues to cast a skeptical eye on the markets. He has always been a bond guy, and bond guys, by nature, worry about risks more than opportunities. His greatest worry is the financial system itself. He thinks that regulators missed the boat in the 1990s when they phased out the rules that separated commercial banking from investment banking; they expected deregulation would lead to greater competition among banks, he recalls, but instead it brought large-scale consolidation. The Dodd-Frank law and the other reforms that followed the 2008-2009 crisis, he thinks, have reinforced that trend. “It preserved the enormous financial concentration that had taken place and even accelerated concentration. That was a mistake,” Kaufman says. The result, in his view, is a system that is even riskier, with rules that are too complicated for bank supervisors to enforce.

His recommendation is to force financial institutions to specialize. The advantage in having companies that deal only in insurance, or consumer banking, or money management, he says, is that managers and regulators could better understand their finances. “I dare anyone to tell me they can go into a large financial institution [today] and tell me the details,” Kaufman insists. “You can’t,” he says, because the companies are too complicated to comprehend. The idea that “living wills” will enable them to disentangle their affairs in the event of crisis, as Dodd-Frank commands, is fatuous, Kaufman adds. Even with a living will, the markets will devalue a troubled institution’s assets, spreading pain widely.

Kaufman knows the world has moved on, and he is not optimistic about bringing the old times back. But he distinctly remembers how, back when Wall Street firms were partnerships for which partners bore personal responsibility, they behaved differently than they do today. When he was hired at Salomon in 1962, he recalls, he was told, “Go home and tell your wife you’re going to be liable for $2 billion.” Answering to shareholders isn’t the same thing at all.

Dirty Laundry and High Productivity

Not too long ago, on a visit to Copenhagen, I took several shirts to a laundry. The proprietor greeted me brusquely with the words, “I can’t do express.” He wanted four days to wash and press my shirts, longer than my remaining time in the city.

That evening, on my way to dinner, I walked down the same street and saw the owner still at work, surrounded by piles of clothes. Suddenly, his disinterest in my patronage made sense. Denmark’s economy is strong, unemployment is negligible, and there aren’t many workers willing to accept low-paying, low-productivity jobs in laundries.

I’ve replayed this incident lately as the I’ve heard complaint after complaint about the purported shortage of labor in the U.S. economy. Trucking companies, manufacturers, fast-food restaurants, and retailers all say they can’t hire enough help. The truth, though, is that the supply side of the labor market–prospective employees–responds pretty quickly to economic signals. The reason firms can’t hire enough help is that the compensation they offer is too low. The reason for that, simply enough, is that the way the firms plan to use those workers won’t result in sufficient productivity to justify higher wages.

As an economic matter, it’s good if those low-productivity jobs disappear. On another trip to Denmark, many years ago, a labor union leader told me, “We want to be a wealthy economy, and we can’t be a wealthy economy if we have low-productivity jobs.” It was that union leader’s view that Danish businesses should move low-paying jobs abroad and focus on providing high-wage, high-productivity jobs in Denmark.

You won’t find many union leaders suggesting that in the United States–nor business leaders or politicians. We pay far more attention to the number of jobs in our economy than to the quality of those jobs, and we’re reluctant to let low-productivity jobs vanish. Thus, debate over raising the minimum wage revolves around whether this would cause unemployment among hamburger flippers rather than whether higher labor costs would lead fast-food chains to develop new equipment that would raise productivity. Debate over immigration is colored by the assertion that we need immigrants to come and do low-wage jobs U.S. citizens don’t want, an assertion that allows us to avoid discussing why employers aren’t investing in capital equipment that might render those jobs more attractive and better-paid.

Some companies, of course, see profit in employing low-wage workers and don’t want to change that business model. But if we look deeper, tens of millions of us have selfish reasons for cherishing low-productivity work. While we give lip service to higher productivity, we also want an economy in which it’s cheap and easy to find someone to clean the house, babysit the kids, and mow the lawn. We like going out for an inexpensive dinner and paying a few bucks for an Uber ride across town, treats that would be far less affordable if there were fewer workers who have no better alternatives than taking low-productivity jobs with low pay.

If we want to raise living standards for all Americans, we can’t do it with sluggish productivity growth. That means that we may have to make some sacrifices. That’s how I solved my laundry problem in Copenhagen. I tossed my shirts in the washing machine, let them drip dry, and ironed them myself. Admittedly, my ironing skills were a bit rusty. But if having a high-productivity economy means I’ll need to keep them honed, I suppose I can manage.

A Museum Worth 100 Marcs

Economists are forever complaining about the public’s ignorance of economics. You can’t really blame the public: most of what academic economists produce these days is incomprehensible to anyone who hasn’t earned an A in advanced econometrics, and far too much of what economists say in less technical settings is driven more by political biases or commercial interests than by conclusive research. There’s a lot economists don’t know, and too often you won’t find them admitting it.

That said, there are some important economic concepts that people need to grasp to reach their own judgments about economic issues. Many U.S. high schools now seek to teach such things, with mixed success. On a recent trip to Mexico City I saw what might be a more promising approach than classroom lectures, the Interactive Museum of the Economy, known by its Spanish acronym as MIDE.

MIDE, housed in an eighteenth-century convent in the center of Mexico City, claims to be the world’s first museum dedicated to economics. Its target audience is high school students, large numbers of whom come to visit each week. Costs are covered by a modest admission fee and substantial contributions from the Banco de Mexico, the central bank, and private financial institutions.

The museum is short on artifacts, long on hands-on activities that introduce such concepts as scarcity, division of labor, comparative advantage, and the trade-off between consumption and investment. Exhibits don’t just talk about the role of banks in society and the effects of inflation, but offer screens students can use to explore how bank deposits are invested and see how prices for different commodities change at different rates. Docents barely older than the visitors roam the exhibit halls, answering questions and drawing together small groups to play table games that also teach economic ideas, while more experienced educators offer brief programs in screen-filled rooms just off the exhibition floor. After you’ve learned about the role of money in society, you can order up a hundred-peso note issued by the Bank of the Bethlehemites–the religious order that formerly owned the building–and featuring your own image.

Mexico, of course, is a vast country, and most high school students will never have the opportunity to visit the museum. MIDE is now developing an app to make itself accessible to students all over the country.

I’ve never come across a museum quite like this before. Sure, many central banks operate their own museums, but most of them are, to be polite about it, places a teenager would never think of setting foot in. There’s much to be said for making learning about economics a fun social activity rather than an unpleasant obligation. Washington, where I live, has museums about everything from the bible to the U.S. Navy. A hands-on museum about how the economy works would be a fine addition.

Waiting for the Tooth Fairy

Four prominent economists at the Hoover Institution have published a new paper claiming that President Trump’s policies could make the U.S. economy grow 3 percent a year. Perhaps it’s just a coincidence, but three of the four authors have been mentioned as people Trump might nominate to head the Federal Reserve Board after Janet Yellen’s term expires next February.

Let’s be clear: 3 percent annual economic growth would be quite an accomplishment. The U.S. economy hasn’t grown that quickly over a full year since 2005. There’s no doubt that Americans would feel much better off if the economy were to soar as the Hoover Institution economists suggest. Personally, though, I think we’re about as likely to get a visit from the tooth fairy.

The authors attribute slow U.S. economic growth to slow productivity growth and a drop in the percentage of adults who are in the workforce. I agree entirely. But they then go on to lay the blame on President Obama, without mentioning him. “Focused primarily on ‘stimulus’ in the short-term, the conduct of economic policy in the post-crisis years did little to reset expectations higher for long-term growth. That policy failure restrained those expectations, adversely affecting consumption and, especially, investment spending,” they say. The authors assert that lower taxes on businesses and on capital investment, less regulation, and slower growth of federal spending “would help turn the recent upswing in animal spirits into a significant improvement in economic activity.”

You may have caught this movie before. Back in the 1980s, President Reagan’s economic experts promised much the same. Tax rates were lowered, regulations scaled back, federal spending curtailed. Yet on average, output per hour worked in non-farm businesses — the most basic measure of productivity — grew more slowly during the Reagan years than it had during the miserable 1970s, when tax rates had been far higher. These policies were supposed to bring miraculous productivity growth, but as Reagan’s former budget director, David Stockman, said in 1986 “The fundamentals that I look at are not a miracle.” 

What’s the issue here? Our four authors claim that “economic policies are the primary cause of both the productivity slowdown and the poorly performing labor market.” But as I show in An Extraordinary Time, the connection between government policy and productivity growth is tenuous. Productivity gains stem mainly from innovations in the private sector, which work their way into the economy in unforeseen ways. Government can help by supporting education, scientific research, and infrastructure, but the productivity payoff from such investments is unpredictable. The evidence that tax rates or government deficits affect productivity growth is quite weak. This is true not only in the United States, but in other advanced economies as well. 

Some productivity experts, notably Robert Gordon, think slow productivity growth is with us permanently, which would mean Americans’ incomes will grow only modestly in the coming years. I’m not so pessimistic. Historically, we’ve seen unanticipated spurts of productivity growth as firms suddenly figure out how to take advantage of new technologies and new ways of doing business. That has happened before, as with the Internet boomlet of the late 1990s, and I think it’s entirely possible that it could occur again. But I’m afraid the claim that the government can give us faster productivity growth just by passing a couple of laws falls into the realm of wishful thinking.

Mismeasuring Mismeasurement

Nobody wants ordinary. That’s why my assertion in An Extraordinary Time that our slow economic growth is merely ordinary growth doesn’t go down easily.  One typical response is that the economy’s performance is much better than official statistics indicate. In other words, we don’t have a slow-growth problem, just a measurement problem. If we were able to measure correctly, the contention is, we’d find that the economy is growing much faster than captured by official statistics and that living standards are rising, not stagnating.

There are a three reasons why I strongly disagree with this claim, which was most recently put forward by Martin Feldstein.

First, the assertion that economic growth is much faster than the data show is generally based on anecdotes claiming that the effects of particular products, such as smartphones and Google search, are undervalued by government statisticians. If we properly accounted for such advances, the argument goes, we’d find the economy to be doing much better than we think. These anecdotes, I find, are almost always accurate–there are indeed a lot of measurement problems–but they tend to be quite one-sided. Consider a counter-example. I think most Americans would agree that the quality of airline flights has deteriorated in recent years, as passengers are required to arrive at the airport well ahead of flight time, stand in long security lines, occupy seats offering less legroom than in the past, and wait at the arrival airport for luggage that is no longer permitted in the passenger cabin. U.S.  statistical agencies probably should adjust estimates of economic growth downward to account for the diminished quality of this product. They don’t. If all such mismeasurement problems were resolved, it’s not obvious that the net result would be a faster-growing GDP.

Second, the slowdown in economic growth in recent decades is visible not just in the United States, but around the world, in wealthy and less wealthy economies, and in many countries where semiconductor manufacturing, on-line advertising, and other hard-to-measure industries are relatively unimportant in economic terms. Identifying a purported shortcoming of U.S. national income statistics fails to explain why slower economic growth, and the slower productivity growth to which it can be attributed, are apparent in so many places.

Third, to claim that we’re now seriously underestimating economic growth, it’s not enough to show that some parts of the economy are mismeasured. Proving the claim requires showing that the mismeasurement problem is substantially worse today than in the past. I’ve seen no evidence to this effect. Consider that life expectancy at birth in the United States rose from less than 50 years in 1900 to 70 years in 1960, but has grown very slowly since. That rapid improvement over the first six decades of the twentieth century undoubtedly raised people’s living standards in a way not captured by the growth rate of GDP. The mismeasurement related to smartphones and social networking services seems trivial by comparison.

So the mismeasurement story doesn’t explain why economic growth in every wealthy economy is much slower today than during the postwar Golden Age–and has been so since the mid-1970s. And it doesn’t refute my assertion that what seems to be painfully slow growth is really just ordinary economic performance.

 

 

 

Pushing Productivity

As I’ve talked to people about An Extraordinary Time, I’ve received a lot of questions about what government can do to improve productivity. Some readers have gone so far as to accuse me of advocating “no-growth economics” — and, not surprisingly, these critics tend to have their own favorite policy prescriptions which, they promise, will reinvigorate productivity growth and raise living standards.

So let me lay out my argument once more. I don’t assert that government is powerless to improve productivity. I do assert that productivity growth comes largely from innovative ideas put to use in the private sector. Government plays an important role in this. It’s very clear that government spending on education is important in developing a more highly skilled workforce. Government support for scientific research can have a payoff in terms of innovation, as Mariana Mazzucato has shown. Government spending on transportation infrastructure, when managed wisely, makes it easier and cheaper for producers and retailers to move goods and expand labor markets, giving workers a greater choice of jobs and allowing employers to draw on a larger pool of potential employees.

The challenge for policymakers, though, is that the timing and magnitude of these effects are highly unpredictable. It’s a good bet that if more students complete university degrees today, we’ll see some payoff in terms of higher productivity in the future. But when? And how much? We can’t answer those questions. With respect to research and development, it’s very clear that scientific discoveries themselves have no direct economic benefits. What matters is turning these discoveries into new products, services, and ways of doing business, and there is no way to predict whether that will happen or how important those innovations will prove to be. In this respect, the U.S. productivity boomlet of the late 1990s and early 2000s is instructive: the unexpected rise in the rate of productivity growth was attributable, in part, to research in computing and communications that had received public funding decades earlier. As president at the time, Bill Clinton was able to claim the credit for stronger economic growth, but he didn’t really have much to do with the public-sector investments that made it possible or with the private-sector innovations that drew on those publicly funded discoveries to bring our economy into the Internet era.

Through history, there have been a handful of developments that have led to extremely large increases in productivity: think of the steam engine, the electric light, the construction of the Interstate Highways. Bob Gordon, in his wonderful book The Rise and Fall of American Growth, highlights the importance of the the public water systems built in the early twentieth century in rapidly improving public health. For the most part, though, productivity improvement arrives slowly due to marginal improvements in technologies and business processes. When it comes to economic growth, lightning does not strike often.

So when a politician promises to make the economy grow faster, beware. Yes, everyone agrees that it’s easy to juice the economy in the short term: a big tax cut, some added deficit spending, or a cut in interest rates all are likely to do the trick, at the risk of unfortunate consequences a year or two hence. But over the long run, higher living standards depend overwhelmingly on the growth of workers’ productivity. Regardless of what governments do, in most times and in most places productivity grows slowly, which means that living standards improve only gradually. Like it or not, this is, as I assert in my book, the trajectory of an ordinary economy.

My Housing Subsidy

It seems the new U.S. administration wants to make a major reduction in housing subsidies. From what I’ve read in the paper, though, it’s not planning to touch ours.

I’ve got to say that our subsidy is pretty generous. Last year my wife and I sold one apartment and bought another, and with it came a much bigger mortgage. Our monthly payments to the mortgage company went up — but our after-tax costs went down. The reason, of course, is that the U.S. tax code offers a generous deduction for mortgage interest, and lets us deduct our local property taxes from our income as well. By splurging on a more expensive property, we were able to cut our taxes quite a bit.

Looking at it another way, our government encouraged us to behave imprudently. Rather than having a relatively small debt that we could reasonably expect to pay off in a few years, we now have a relatively large debt that may well outlive us. Why the government should want us to go more deeply into debt is a puzzlement. I would not be shocked to discover that it has something to do with the lobbyists who ply their trade daily on Capitol Hill.

In my recent book An Extraordinary Time, I discuss the slowdown in productivity growth that has held back economic growth around the world for many years. I can’t help but wonder whether tax preferences for debts like my mortgage aren’t part of the story. While not all countries provide tax breaks for home mortgages, many countries do provide very favorable tax treatment to debt. In his excellent book Between Debt and the Devil, Adair Turner makes a persuasive case that such tax breaks encourage investment in existing real estate assets, which does nothing for productivity growth, rather than investment in the sorts of equipment and machinery that could make our economies more productive.

And then there is the matter of fairness. After finishing up our federal income tax return, I can report that the federal housing subsidy for my wife and myself is as large as the subsidies for some of the residents of the public housing complex near our home. Their subsidies are apparently on the chopping block because they are deemed government give-aways. Our subsidy, on the other hand, seems quite secure.

 

 

About Economic Arrogance

The other day Paul Krugman took a whack at the Trump administration’s “economic arrogance.” He was referring to the administration’s repeated claims that its policies can supercharge U.S.  economic growth, taking it as high as 3.5% per year for a decade or more.

The idea that the government can make the economy grow much faster than it does today seems to be an article of faith for many Republicans. During last year’s campaign, more than 300 economists signed an open letter insisting that the economy “could and should be growing 3 to 4 percent.” More recently, Kansas governor Sam Brownback told the Conservative Political Action Conference on February 25, “We’ve got to get the national economy growing above this paltry 1.8%, and I think it’s going to be a key measure for Trump.”

Krugman is right to criticize Trump, and many other Republicans, for insisting that their standard economic nostrums, tax cuts and deregulation, are sure to make the economy grow faster over the long run. There’s plenty of evidence about this; as I point out in my book An Extraordinary Time, the “supply-side” policies of the Reagan Administration, which emphasized lower marginal tax rates and less regulation, failed to rejuvenate U.S. productivity growth and produce an economic miracle. On the contrary, productivity growth during the Reagan years was lower than at any time between World War II and 1977.

So I agree with Krugman that when they promise they can make the economy grow faster over the long term, the Republicans are blowing smoke. But it is only fair to point out, as Krugman does not, that many Democrats have done much the same thing. Since at least the 1970s, many Democrats have insisted that the Federal Reserve could make the economy grow faster if only it would, despite ample evidence that Fed policy has little to do with productivity growth. Economists backing Bernie Sanders’s quest for the Democratic presidential nomination last year insisted that his tax and spending plans could make the economy grow 5.3% a year — an even faster growth rate than Trump claims he can achieve. While Hillary Clinton’s campaign offered no specific claims about the extent to which her economic program would bring faster economic growth, the campaign was happy to point to an analysis by Moody’s contending that the Clinton program would add about three-tenths of a percent to annual economic growth over the next decade.

Suffice it to say that I’m skeptical of such claims from any source. Looking more than a couple of years into the future, the main source of economic growth is higher productivity. And as I point out in An Extraordinary Time, productivity grows unpredictably and erratically, due more to private-sector innovations than to government policy. Economists of all stripes often like to pretend otherwise. Arrogance knows no party.

Economic Illusions

In my book An Extraordinary Time, I document the hubris of economists who thought they had discovered the key to economic stability during the postwar Golden Age. Esteemed experts such as Walter Heller, chairman of the President’s Council of Economic Advisers under presidents Kennedy and Johnson, and Karl Schiller, West German economy minister and then finance minister as well, believed economists knew enough to tell presidents and prime ministers how to assure strong economic growth and low unemployment. It was a seductive vision. It also proved to be an illusion: when economic crisis arrived at the end of 1973, the experts were unable to deliver the prosperity they had promised, leaving citizens frustrated and angry.

A reader recently asked whether talk of a “Great Moderation” in the late 1990s and early 2000s was a similar display of hubris. As was the case during the boom of the 1960s, those involved in economic policy in the late 1990s seemed to think they had conquered the business cycle. They had many admirers. Journalist Bob Woodward feted Alan Greenspan, then the chairman of the Federal Reserve Board, as “The Maestro” for orchestrating the economy’s smooth performance. Of course, the Great Moderation ended in the deepest economic crisis since World War II — a crisis that is long since over in the United States, but has yet to come to an end in parts of Europe.

While macroeconomists displayed no lack of hubris in boasting of the Great Moderation, I would submit that there was an important difference between the economic policies of the 1960s and early ’70s and those of the Greenspan era. Walter Heller and his contemporaries didn’t pay much attention to monetary policy. Their version of fine tuning involved manipulating instruments under direct government control, mainly taxes and government spending, to achieve a desired economic outcome. The Fed was an afterthought. This approach to fiscal policy was badly discredited by the economic failures of the 1970s and has never come back into fashion.

During Greenspan’s time at the Fed, in contrast, fiscal policy was in disarray. Deep divisions between Democrats and Republicans and between Congress and President Clinton rendered the U.S. government incapable of changing tax rates and federal spending to achieve any particular economic goal; although the federal budget went into surplus at the end of Clinton’s presidency, this was more the result of unexpectedly high tax receipts during the Internet boom than any deliberate purpose. Greenspan himself was no fan of fine tuning. Rather, he was among the very large number of economists who believed the central bank should use its control over short-term interest rates to achieve price stability, and that other important factors affecting employment, the rate of economic growth, and the prices of financial assets were beyond Fed control.

Yet this point of view involved hubris as well. Macroeconomists in the 1990s overwhelmingly believed that the prices that mattered to the economy’s performance were those paid by consumers. The Fed, they said, didn’t need to worry about certain other prices, such as those of stocks and real estate, because these would not have much effect on employment, incomes, and voters’ other economic concerns. As we learned at considerable cost, that conventional wisdom wasn’t right. The sharp drop in asset prices that began in 2008 left millions of households with depleted retirement accounts and upside-down mortgages, forcing them to pull back spending, leading in turn to a sharp rise in unemployment. By and large, economists missed this connection between the financial economy and the real economy.

Of course, saying that the Fed should worry about asset prices as well as consumer prices still leaves the central bankers to determine when stock prices are reasonable and when they are soaring unjustifiably. Either way, economists must pretend to know something that cannot possibly be known until after the fact. In his masterful biography of Greenspan, Sebastian Mallaby wrote that “The delusion that statesmen can perform the impossible—that they really can qualify for the title of ‘maestro’—breeds complacency among citizens and hubris among leaders.” Unfortunately, he’s right. One of the great challenges facing modern democracies is that their citizens expect more than their governments can possibly deliver.

 

The Truth About “Pro-Growth” Economics

Like every president, Donald Trump has promised to make the economy grow faster. Good luck with that. In an article in Vox, I trace the history of the idea that we know how to make the economy grow faster. As I explain, while politicians love to talk about “pro-growth” policies, a productivity boom is not something Trump’s economic advisers, or anyone else’s, have the tools to bring about. Productivity depends mainly on private-sector decisions, and while government actions clearly influence it, the timing and extent of that influence are impossible to predict.

As I argue more fully in my new book, An Extraordinary Time, until and unless an unexpected productivity boom takes hold we’re likely to be stuck with an ordinary economy. That’s not terrible; at the moment, the United States is pretty close to full employment, and wages are on the rise. But it’s a far cry from the growth of 4 percent, 5 percent, or even 6 percent that Trump and some of his more zealous supporters have promised us. An effort to push the economy faster than underlying productivity improvements will allow is not likely to end well.