The Wall Street Journal has revived its Econoblog series, this time with Cal economics professor Brad DeLong replacing Jon Irons in discussing topics with George Mason University economist Tyler Cowen. The subject today is the Bush Administration’s surprising decision to retain John W. Snow as Treasury Secretary. From this first round, Mr. DeLong looks to be a better choice to serve as Mr. Cowen’s counterpart in this discussion. Check it out.
This post from awhile back explored the phenomena that governmental subsidies – even ones that are the product of good intentions – eventually generate obsolescence.
Following up on that thought, the Washington Post’s Steve Pearlstein makes the point in this op-ed that governmental subsidies in college funding, housing, and health care have caused serious distortions in the market place, starting with college funding:
And one of the big reasons [that college administrators] can [continually raise tuition] is the ever-increasing amount of public money pumped into the system in a losing effort to keep college “affordable.” In effect, these well-intentioned subsidies have the perverse effect of shielding colleges from the kind of market discipline that would have forced them to hold down prices by constantly improving their productivity and efficiency, as happens in just about every other industry.
And how about health care?:
In health care, the big culprit is the tax deduction for employer-paid health insurance, which has hard-wired into the American psyche the expectation that companies should pay for their employees’ health insurance. . . Unfortunately, the unintended effect of this $112 billion-a-year tax deduction is to make insured consumers largely indifferent to how much health care they consume or what it costs. And in the face of such indifference, doctors and hospitals and drug companies have done what any profit-maximizing industry would do: push prices and utilization up 7 to 10 percent each year until so many people are priced out of the market that government is forced to pump in even more money, spurring a whole new round of spending increases.
Finally, the home ownership subsidy:
And then there is homeownership, which has somehow become synonymous with “the American dream.” The mortgage interest deduction already costs the Treasury $62.6 billion a year, supplemented by billions more in implicit subsidy provided via Fannie Mae, Freddie Mac and the regional Home Loan Banks. To a large degree, however, this money has rewarded those already with homes while making it harder for everyone else to afford one.
The home mortgage deduction is no different than a monthly rebate. Over time, its effect is to boost the price of the house until it incorporates most of the subsidy. And the more the house appreciates, the bigger the tax deduction, creating a dynamic of ever-increasing house prices.
Read the entire piece. All of which re-emphasizes that government subsidies are strong medicine with serious side effects. As such, they should be deployed infrequently and with great care.
By the way, in case you have not been following the Wall Street Journal Econoblog discussion this week between Marginal Revolutions Tyler Cowen and Argmax.com‘s John Irons, do not miss today’s edition on tax reform. In my view, Mr. Cowen runs rings around Mr. Irons, but decide for yourself.
This week, Tyler Cowen of the Marginal Revolutions blog and Jon Irons of the Argmax.com blog will be debating various economics issues over at the Economics page of the on-line Wall Street Journal, WSJ.com. The Journal page is usually gated for use of paying customers only, but for this week it is open to all visitors.
The first discussion concerns social security privatization. On Tuesday comes outsourcing and trade, followed by the future of Europe and China. Tyler is far more persuasive in the first installment on Social Security, in which Mr. Irons largely ignores the costs of the current Social Security system while waxing eloquent about its hard to value benefits.
Check it the debate this week as it should be interesting.
Ben Stein writes this personal finance op-ed for the NY Sunday Times in which he illuminates the mounting retirement finance problem that is confronting the Baby Boomer generation:
This is the bore of the gun pointed right between the eyes of the baby boomers. With the low interest rates of today and tomorrow, with the lavish way we have come to expect to live, with a stock market that is sluggish, let us say, what on earth are we going to do about retirement?
Unfortunately, this is not just a paranoid fantasy about my own life. This is going to be the reality of millions, maybe tens of millions of baby boomers unless they get their backsides into gear and make some serious changes in their lives.
You can look at it anecdotally, or you can look at it statistically. Anecdotally: If you are a woman in your mid-50’s living on a salary of $150,000 a year, and if you wish to maintain your living standard when you retire at age 65, you will need about $200,000 a year to live on, assuming inflation raises prices by 3 percent a year. If you assume you will get about $15,000 a year from Social Security, you will need about another $185,000 a year. To have that much income with today’s interest rates, you will probably need about $4.6 million in the bank. Do you have it?
Or, we can look at it statistically. About 77 million baby boomers are racing toward retirement. That’s people roughly between 40 and 60 years old. More than 34 percent of the ones over 55 report having financial savings (not counting their home equity) of less than $50,000. Only 21 percent have more than $100,000. The average Social Security benefit as of 2003 was only $895 a month. Only roughly one in eight workers as of 2001 had a pension with a defined benefit (as opposed to a defined contribution).
We can look at it another way. If you had to retire in 10 years with (now let’s be really generous here) twice the savings you now have, and would receive interest of 4 percent on it, how close would you be to having a living income, i.e. an income you could live on at your present style of life? Be honest.
You can look at it still another way. The average family in the New York area earns roughly (and I mean really roughly) $50,000 a year. You would need to have at least $1.25 million in principal to yield that income at 4 percent. Do you have it?
And the solution?
Major league retirement planning right here and now. Right this second. Make a plan with an adviser you trust and for whom you have gotten superb references. Make it a plan with a lot of diversification of stocks, bonds, mutual funds, foreign, domestic, emerging, variable annuities (but study them carefully – there are immense variations among them), real estate and even cash.
The plan has to allow for expensive, long-term medical care. It has to provide for the possibility of losing your job at some point before you reach retirement age. The plan cannot count on miracle cures from the federal government. The federal government is just a means of transferring money from wage earners to retirees – and the wage earners are not going to want to bankrupt themselves for the baby boomers (who got all of the good music anyway).
In this Tech Central Station essay, Arnold Kling of EconLog does a good job of explaining four myths about Social Security: The Pension Myth, the Transition Cost Myth, the Baby Boomer Myth, and the Medicare Myth.
Vaclav Smil is Distinguished Professor of Geography at the University of Manitoba, Canada, and is the author of many books on energy and the environment. In this Tech Central Station op-ed, he reminds us of something that the mainstream media generally fails to report regarding the recent run up in the price of oil:
The years of the highest oil prices were 1980 and 1981 (thanks to Ayatollah Khomeini and fall of the Pahlavi dynasty in Iran) when the Arabian Light/Dubai crude traded at nearly $36/bbl and when the West Texas Intermediate went for almost $38. In 2004 monies this is, rounded for easy memorization, between $ 70-75. The peak of the last few days — $ 55/bbl — is obviously well above what will be the annual mean for the year 2004 and it is no more than 73-78% of the record averages. But this is a wholly inadequate adjustment. Between 1980 and 2003 the amount of oil that the US economy used to generate an average dollar of its GDP fell by 43% as its oil intensity declined somewhat faster than the overall relative energy use.
And so in order to get an approximate but realistic comparison of how much today’s prices impact an average manufacturer or average household purchases, we should multiply the current high price of $55/bbl by 0.57 to get an effective comparable price of around $30, or no more than 40% of the average record price we paid in 1980. Moreover, between 1980 and 2003 average hourly earnings in services, where most new jobs were created, rose by about 30% and so another adjustment taking into account this higher earning power reduces the comparable price to just over $20. Other, more sophisticated adjustments, are possible but this one is easy to execute and easy to remember: the effective — that is inflation-, oil/$GDP- and earning power-adjusted — cost of oil at $(2004)53-55 is no more than about 30% of the average record price we paid in 1980 and 1981. That is why recent “record” oil prices have not had any substantial effect on the way this continent uses, and wastes, the most convenient of all fossil fuels.
Earlier posts here and here explored the economic absurdity of urban rail systems in modern American cities, which is a hot topic in Houston these days given the recent launch of Metro’s Light Rail System earlier this year.
Now, the long-range empirical data refuting the economic basis of such systems is emerging. In this article, Wendell Cox analyzes the $10 billion cost relating to creation and maintenance of the Washington, D.C. “Metro” rail system over the past 30 years. His findings are insightful:
No US urban area has built more new high-quality urban rail than Washington, DC, which spent $10 billion, most of it from national taxpayers, on a more than 100 mile system. Of course, it would be unfair to have expected Washington?s ?Metro? subway to have made a difference in area-wide traffic, since, as noted above, transit is about downtown. Predictably, at the
metropolitan area level, Metro?s impact has been virtually absent. In 1970, before the first section of the system opened, the Census Bureau reported that 15.3 percent of area workers used transit to get to work. By 2000, transit?s work trip market share number had dropped 29 percent, to 10.9 percent. Perhaps even more astounding is the fact that Census data indicated a five
percent reduction in actual work trip usage from 1990 to 2000, a period during which the system was expanded more than 25 percent.
Over the past 20 years, traffic in the Washington area has become the fourth worst in the nation, following only Los Angeles (which has opened a metro, light rail and commuter rail), San Francisco (where BART has made no difference) and Chicago (with the nation?s second most extensive rail system). The problem in Washington is that so many planned freeways were cancelled. In Houston, where capacity has been built to keep up with demand, traffic is better than in 1986, and the area has improved to 10th worst traffic in the nation from having been the worst in 1985.
Read the entire article. As we ponder why these public boondoggles continue to proliferate despite the increasingly clear evidence of their enormous cost relative to their relatively small public benefit, I pass along an astute commentator’s observation regarding the politics of such systems from one of my earlier posts:
Concentrated benefits and dispersed costs are one economic reason for the existence of inefficient public projects. The many who stand to lose will lose only a little, whereas the few who stand to gain will gain a lot. Of course, if other public projects exist where overall costs outweigh benefits, then $6 a year per project could add up to quite a hefty boondoggler?s bill.
Edward Lotterman is a Twin Cities-based economist who writes a smart column for the Twin Cities Pioneer. Earlier posts have referred to his thoughts on the addictive nature of governmental subsidies and the market’s superior ability to react to OPEC’s attempts to manuever the market to its advantage.
In this article, Mr. Lotterman addresses the candidates’ statements regarding economic policy, and he finds little to be enthusiastic about in either candidates’ positions:
This election, most economists are dismayed by the economic positions espoused by Republican President Bush and Sen. John Kerry, D-Mass. Their campaign ads and stump-speech clips frustrate most of us. Many of their proposals would make our nation worse off, rather than better. Still, there are differences in how each man’s proposed policies are harmful.
In 2004, Kerry is wrong on many different economic things, including trade, employment, Social Security and health care, among others. Bush is wrong on one enormous thing: tax cuts and their effects on budget deficits and the national debt. Bush’s positions on some other issues are more pleasing to economists than Kerry’s, but often skirt core questions to focus instead on peripheral matters that have great symbolism but little import.
First, Mr. Lotterman examines the candidates’ positions on Social Security reform:
In response to news about Social Security, Kerry recently thundered, “When I am president there will be no decrease in Social Security benefits and no increase in (Social Security) taxes.” This stand is just another way of saying, “I am a coward who is going to push this issue forward into someone else’s presidency, even if it means any eventual solution will be much more difficult.” I know of few economists who could endorse Kerry’s position.
On Social Security, Bush advocates personal accounts as a panacea for all problems. Many economists see some form of mandatory personal accounts as one component of a reformed retirement system. But the economic arguments for personal accounts are subtle. Moreover, they would do next to nothing in solving the most pressing problem, the impending retirement of tens of millions of baby boomers.
Turning to health care, Mr. Lotterman also does not much like what he hears:
On health care, Kerry says he will do great things: lower health care premiums, cover all uninsured households and lower drug prices. But he presents no realistic plan for financing these expensive options. He implies these are freebies that will spring from reductions in “waste and inefficiency” in health care.
He doesn’t say how he will eliminate such “waste and inefficiency.” This position is as intellectually bankrupt as those borrow-and-spend Republicans who say they will close deficits by eliminating “waste and inefficiency” in government. Somehow, no one ever seems to do it.
Bush wants to broaden health care savings accounts and limit damages in malpractice lawsuits. A majority of economists probably would endorse these measures. Even so, most would see them as tangential to more fundamental factors driving health costs.
And on issues of free trade and environment? Again, Mr. Lotterman is skeptical of the candidates’ positions:
On trade, a strong majority of economists would opt for Bush’s espousal of trade liberalization over Kerry’s implicit protectionism. Yet, many are skeptical of the president’s true commitment to opening trade, given his quick resort to steel tariffs in his first term and their doubts about his willingness to confront domestic sectors such as cotton and sugar that will be hurt in any serious new trade agreements.
While Bush claims credit for much environmental improvement, most objective observers are critical of his administration’s record. Even Russell Train, a Republican who headed the Environmental Protection Agency under Presidents Richard Nixon and Gerald Ford, has come out against him for this reason. Environmental economists also would fault his heavy reliance on poorly targeted subsidies to traditional energy sources. And, like his father, George W. is passing up the opportunity to shift pollution control from command-and-control regulation to widespread use of emissions taxes or tradable permits.
Kerry essentially promises more of the same regulatory approach that has prevailed in the past four decades. His environmental and energy platforms contain many glowing promises, but no policy specifics. Moreover, when he makes sweeping promises like, “As long as I am president, there will be no nuclear storage at Yucca Mountain,” he is just pushing a growing problem onto someone else’s watch — at a cost to society as a whole.
So, is this a Presidential election in which there is a viable candidate for sound economic policies? Or are we simply left with evaluating which candidate is “less bad” in terms of economic policy?
In his weekly Business World column today, the Wall Street Journal’s ($) Holman Jenkins, Jr. lays out the case that a second Bush Administration may be the one time that realistic reform of Social Security could actually take place:
People become inordinate risktakers to protect something they have. Once voters figure out the true extent of the entitlement morass, even those summering Nantucket editors might be expected to rush to the barricades and, whatever their cultural affinity, cast their vote for Mr. Bush for the simple reason that entitlement reform is inescapably a second-term activity.
. . . President John Kerry would be sure to lay back too while re-election sugarplums still danced in his head, and who’d want to bet on him to beat the Democratic curse and win a second term? If not, nine years would be the soonest reform could start, by which time another $18 trillion in unfunded retirement obligations would have piled up.
Nope, it’s Mr. Bush or bust. Congress is no help. Wonder why, in the dog days of August, GOP House Speaker Denny Hastert became a sudden convert to a flat tax? He was hoping to divert the Bush White House’s attention from Social Security reform. His members, facing re-election every two years, still believe that Social Security is an untouchable “third rail,” notwithstanding a few GOP thrillseekers who’ve lately done handsprings on the third rail and lived to tell the tale.
Democrats, of course, can be expected to resist ferociously, and for reasons going beyond mere sentimental attachment to the FDR/LBJ welfare state. Anything that turns the adult population into wealth holders would change voting behavior forever, and not to Terry McAuliffe’s advantage.
All this makes Mr. Bush’s apparent willingness to tackle entitlements a once-in-a-generation planetary alignment, not to be passed up by a society that cares about its future.
Mr. Jenkins goes on to explain the “creative” accounting that the federal government engages in to mask the true cost of its Social Security obligations:
[A]dvocates need to get busy helping the public master a peculiarity of federal accounting. To wit, promises made to bondholders show up in the national debt. Promises made to future retirees don’t.
Thus the officially recognized national debt is about $3.9 trillion, while the unfunded Social Security obligation alone represents an IOU of $10 trillion in present value. Throw Medicare onto the bonfire and that’s another $62 trillion.
Keep in mind these figures represent only the “unfunded” portion, not the part covered by monies already credited to notional federal trust funds or to be collected in payroll taxes from now till eternity. It would take $3.9 trillion today to retire the visible national debt, and $72 trillion today to pay off unfunded promises to retirees. Yet only the first debt is reported to voters. That’s the kind of accounting “oversight” that, in the private sector, leads straight to a cellblock.
That makes Enron’s shifting of a mere $40 billion of debt into off balance sheet transactions look rather trivial, doesn’t it? And why are these huge hidden costs important to understand? Mr. Jenkins answers:
Because suddenly the $1 trillion in “transition costs” to finance the creation of the Bush-touted private retirement accounts for younger workers doesn’t seem so outlandish compared to the real federal debt, visible and invisible.
Interestingly, Mr. Jenkins then focuses on the main impediment to true Social Security reform — risk aversion:
Unreasoning risk aversion is a hallmark of the human mind, and Democrats and their pet economists are already doing all they can to encourage the stand-pattism of certain voting blocs, especially single women and oldsters. John Kerry never tires of frightening these voters with the Satans of Wall Street and Ken Lay. He says instead a “tweak here, tweak there” will tide Social Security over without any “risky” reforms.
Here we must summon the heavy guns of “behavioral economics,” whose adherents have been winning Nobel Prizes lately. Their most firmly established insight is that real people, as opposed to the rational maximizers of the economic texts, suffer from an excess of caution. “Prospect theory,” pioneered by Daniel Kahneman and Amos Tversky, shows that people overvalue their fear of loss and undervalue the prospect of gain, leaving themselves worse off than they would be if they were willing to entertain reasonable risks.
I agree with Mr. Jenkins that real Social Security reform is more likely in a second Bush Administration than in a Kerry Administration. But given the Bush Administration’s aversion to balanced policy analysis, I question whether there is really much of a prospect for reform even in a second Bush Administration. I guess we can dream, can’t we?