There was an article written recently in the Wall Street Journal that touched on the subject of the weakening dollar contributing to higher gas prices.
If you look at the price of oil in the last 10 years in terms of dollars- it went up 350%.
In terms of the Euro- oil went up 200%.
Interestingly, if you look at oil in the last 10 years in terms of the price of gold- it has stayed flat.
The prices of soybeans and wheat increased by 75% in 2007, far outperforming oils increase of 57% in 2007. Neither OPEC, China, or any global cartels were responsible for this increase. The weakening of the dollar is the main factor.
If the dollar had kept pace with the euro these past 10 years, a barrel of oil would cost roughly 57$ compared to over 100$.Given our weakening economy, the Fed is under pressure to cut interest rates and provide banks with some liquidity. If this continues to weaken the dollar, we will continue to see the price of oil and other commodities rise.
Wednesday, May 21, 2008
Sunday, May 18, 2008
Economic Analysis of the War in Iraq
Obama prides himself on the fact that he was the only one who opposed the war in Iraq to begin with it, claiming he will bring the troops back home promptly . Hillary and McCain, on the hand, are more concerned about withdrawing from Iraq to soon. From a purely economic perspective, which of the presidential candidates' policies is superior?
I came across an interesting paper that conducted a cost-benefit analysis of the war in Iraq. I will refer to this paper during my presentation on the presidential candidates' foreign policy, so if you have some spare time feel free to peruse it so that we can have an interesting discussion on Wednesday.
In a nutshell, the paper points out that while the U.S. treasury allocated $212 billion, there are also direct economic costs to the war not included in this budgetary allocation (for example, the costs of lives lost, injuries, and lost civilian productivity of the reserve troops). On the hand, believe or not, the war generated cost savings, mainly the costs associated with enforcing UN sanctions and Saddam Hussein's brutal regime.
The paper thus monetize the direct and avoided costs of the war through 2015. These are rough estimates, but nevertheless can provide useful figures when analyzing policy regarding the Iraqi war.
In terms of figures, the researchers estimated that the total cost of the war for the US during the first two years reached $225 billion, with avoided costs estimated around $32 billion (Net Present Value adjusted to 2005 dollars). That is quite expensive, more than $100B year. However, the authors estimated the costs of the war from 2005 to 2015 to be $349 billion, with avoided costs of $85 billion. That is, a net cost of $260 Billion over a 10-year period, or roughly speaking $26 billion a year in 2005 dollars.
From a purely economic point of view, policy makers should consider the costs already incurred in Iraq as sunk costs. In addition, policy makers should consider what is the cost of the alternative, that is, withdrawing from Iraq. It might certainly be the case that withdrawing from Iraq will cost American tax-payers more than $26 Billion a month.
Thus, the future president should consider what is the return on investment (ROI ) associated with $26 billion a year over, say, a 10-year period. Put differently, given the costs of the alternatives and disregarding sunk costs, Americans should ask whether bringing the troops home without delay is really the most efficient, prudent policy that will yield the highest ROI?
This is where I should point out that the paper fails to monetize the indirect costs of the Iraq war. It doesn't consider other intangibles like macroeconomic impacts, the effects on oil price, the value of a stable democracy in Iraq, etc. So I guess it all comes down to how much we value and what probability we assign to a prosper, democratic Iraq (or alternatively what will be the costs associated with withdrawal).
Going back in History to 1945, I think the coalition forces did an outstanding job transforming what used to be a Nazi dictatorship into one of the world's strongest democratic nations and a close ally to the US. Moreover, this democracy has also spread out the values of freedom, respect, and the rule of law, bringing about other democracies in the region (Eastern Germany, Romania and other Eastern European countries, even Russia ). For me, the prospect of rapid democratization process in the middle east, similar to the one we are now witnessing in Eastern Europe, is priceless. But I am not a presidential candidate.
McCain Outlines Broad Proposals for U.S. Economy
This article shows that numerous changes to the tax system will be a central component of "McCainomics." Specifically, Senator McCain favors reducing corporate tax rates from 35 to 25%, doubling dependency deductions from $3,500 to $7000, eliminating the alternative minimum tax, and allowing citizens to file a simpler tax form. He also plans to make current President Bush's tax-cuts for the upper income-brackets permanent.
In promoting such a drastic reduction in the corporate tax rate, Senator McCain is already drawing fire from both Senator Obama and Clinton's electoral campaigns as well as liberal voters. Both democratic candidates have publicly chastised his proposed break for corporations, arguing that middle-class Americans, not corporate entities, need help. While this plan might directly cost left votes, it might also indirectly add support for his campaign by allowing him to continue adhering to his strict free-trade policies.
His consistent support for open trade policies has draw criticism from those particularly sensitive to offshoring. McCain favors reducing and eventually eliminating nearly all trade barriers - a move likely to send American manufacturing jobs to other countries. Although it's entirely possible that workers in these affected sectors will be able to transition to other well-paying jobs in different industries, the issue is still highly controversial.
The corporate tax cut will help combat opposition to his free-trade stance. Specifically, Senator McCain believes that a reduced corporate tax rate will make it more profitable for companies to remain in America, thereby directly reducing offshoring. Thus, while supporting a reduction in corporate taxes from 35% to 25% might indeed cost votes from those in favor of high corporate tax rates, it might also add support from workers in industrial sectors who are wary of losing their jobs.
In promoting such a drastic reduction in the corporate tax rate, Senator McCain is already drawing fire from both Senator Obama and Clinton's electoral campaigns as well as liberal voters. Both democratic candidates have publicly chastised his proposed break for corporations, arguing that middle-class Americans, not corporate entities, need help. While this plan might directly cost left votes, it might also indirectly add support for his campaign by allowing him to continue adhering to his strict free-trade policies.
His consistent support for open trade policies has draw criticism from those particularly sensitive to offshoring. McCain favors reducing and eventually eliminating nearly all trade barriers - a move likely to send American manufacturing jobs to other countries. Although it's entirely possible that workers in these affected sectors will be able to transition to other well-paying jobs in different industries, the issue is still highly controversial.
The corporate tax cut will help combat opposition to his free-trade stance. Specifically, Senator McCain believes that a reduced corporate tax rate will make it more profitable for companies to remain in America, thereby directly reducing offshoring. Thus, while supporting a reduction in corporate taxes from 35% to 25% might indeed cost votes from those in favor of high corporate tax rates, it might also add support from workers in industrial sectors who are wary of losing their jobs.
Clinton Details Premium Cap in Health Plan
During the class discussion on the health care policy positions of presidential candidates, we saw that affordability of health coverage is a central qusetion in health care reform. All three candidates - Clinton, Obama and McCain - came up with measures that would reduce the cost of health care, including tax credits to purchase insurance, government subsidies for low-income households and safe re-importation of drugs from Canada.
According to the article "Clinton Details Premium Cap in Health Plan" in New York Times, Hillary Clinton proposed that individuals and families should pay no more than 5 to 10 percent of their income on health insurance. This proposal for "premium cap" definitely makes Clinton's universal health care plan seem more reasonable; she is going to control the cost before making everyone purchase health insurance.
However, this proposal raises some questions. The article states that the average cost of a family policy bought by an individual was $58,526 in 2006 and 2007, or 10 percent of the median family income of $58,526, although some policies cost up to $9,201. If Clinton sets the cap at around 10 percent of income for everyone, how would this affect the median family that is typical of the American household, if it is already suffering from high cost? Also, Clinton prefers to set the limit at a single level for all Americans rather than varying it by income. Although it might seem fair, lower-income families will have harder time paying 10percent of their income on health insurance than more affluent families do. This problem may be alleviated if government subsidies work well enough to cover the insurance costs for lower-income families.
The article also quotes Jonathan Gruber, a health economist at the Massachusetts Institute of Technology, in speculating that Clinton's plan is realistic at close to 10 percent, but not at 5 percent. While Clinton talks about covering all 47 million uninsured people and requiring insurers to cover every applicant regardless of age or health status, insurers might respond to the cap by crafting cheap policies with less benefits. Clinton does not address the issue of controlling and maintaining the insurance quality.
According to the article "Clinton Details Premium Cap in Health Plan" in New York Times, Hillary Clinton proposed that individuals and families should pay no more than 5 to 10 percent of their income on health insurance. This proposal for "premium cap" definitely makes Clinton's universal health care plan seem more reasonable; she is going to control the cost before making everyone purchase health insurance.
However, this proposal raises some questions. The article states that the average cost of a family policy bought by an individual was $58,526 in 2006 and 2007, or 10 percent of the median family income of $58,526, although some policies cost up to $9,201. If Clinton sets the cap at around 10 percent of income for everyone, how would this affect the median family that is typical of the American household, if it is already suffering from high cost? Also, Clinton prefers to set the limit at a single level for all Americans rather than varying it by income. Although it might seem fair, lower-income families will have harder time paying 10percent of their income on health insurance than more affluent families do. This problem may be alleviated if government subsidies work well enough to cover the insurance costs for lower-income families.
The article also quotes Jonathan Gruber, a health economist at the Massachusetts Institute of Technology, in speculating that Clinton's plan is realistic at close to 10 percent, but not at 5 percent. While Clinton talks about covering all 47 million uninsured people and requiring insurers to cover every applicant regardless of age or health status, insurers might respond to the cap by crafting cheap policies with less benefits. Clinton does not address the issue of controlling and maintaining the insurance quality.
People are starving, but I need Iowa
The recent food crisis has hit the world with full force--prices have risen dramatically, hunger is all too common, and political regimes are growing increasingly vulnerable as violent riots continue to erupt. The effects have even reached the U.S., with the price of organic milk now as high as $7. And yet the candidates have paid little attention. Politics--and agricultural lobbyists in particular--cloud their eyes and the routine of campaign topics lets them off too easily.
Though analysts have occasionally referenced supply factors (like Australia's recent drought) as the source of rising prices, most food experts agree that this crisis is the result of shifts in demand. The rise of bio-fuel production, the fall of the dollar, and China and India's economic growth (which leads to increased direct demand for grain, and also significantly increases indirect demand through rising meat consumption) have influenced demand most. Though Bush has looked to the third factor for a solution, unrealistically and perhaps even offensively hinting that India should decrease its grain consumption to help lower prices, the 2008 candidates have wisely chosen tofocus on domestic ethanol policy instead.
The current US ethanol policy is ludicrous. We require a high level of production for this relatively expensive good and simultaneously subsidize the producers involved. Production quotas and subsidies are economically suspect in general as they alter incentives in the relevant market and generally move it away from efficiency. In this case, however, the effect reaches beyond the ethanol market, hurting the food market as well. Ethanol production quotas and subsidies convince farmers to shift land towards corn production and therefore away from other staple crops, changing supply significantly. More importantly, because that corn is used for ethanol--which is more expensive than the corn itself--and is also subsidized, its price rises sharply. This then bleeds into other grain prices (which can be treated economically as corn substitutes). Thus, the overall price of food must rise.
The economic case for changing ethanol policy is therefore clear. The political one, however, is anything but.
McCain, the bravest of the three candidates when it comes to this issue, was the first to criticize ethanol subsidies and production requirements. Obama held to pro-ethanol arguments for longer, heralding it as a cleaner energy source and framing the issue as an environmental one in an effort to justify a position that would keep him popular in Iowa. Recently, however, he has changed his tune, finally acknowledging the link between ethanol and food prices. Clinton, though edging ever closer to Obama's position, still lags behind.
The rising food prices represent a dire crisis. The U.S. has the power--and perhaps even the responsibility, given the significant market distortions our farm policy creates--to curb it. And yet politics, and particularly the power of the American farmer, are eerily close to keeping the candidates quiet.
More attention needs to be paid to the crisis, both by the politicians and the voters. And credit--as well as support--must be given to those candidates that do address the issue effectively. It's the least we can do to counterbalance the strength of the agricultural lobby.
Though analysts have occasionally referenced supply factors (like Australia's recent drought) as the source of rising prices, most food experts agree that this crisis is the result of shifts in demand. The rise of bio-fuel production, the fall of the dollar, and China and India's economic growth (which leads to increased direct demand for grain, and also significantly increases indirect demand through rising meat consumption) have influenced demand most. Though Bush has looked to the third factor for a solution, unrealistically and perhaps even offensively hinting that India should decrease its grain consumption to help lower prices, the 2008 candidates have wisely chosen to
The current US ethanol policy is ludicrous. We require a high level of production for this relatively expensive good and simultaneously subsidize the producers involved. Production quotas and subsidies are economically suspect in general as they alter incentives in the relevant market and generally move it away from efficiency. In this case, however, the effect reaches beyond the ethanol market, hurting the food market as well. Ethanol production quotas and subsidies convince farmers to shift land towards corn production and therefore away from other staple crops, changing supply significantly. More importantly, because that corn is used for ethanol--which is more expensive than the corn itself--and is also subsidized, its price rises sharply. This then bleeds into other grain prices (which can be treated economically as corn substitutes). Thus, the overall price of food must rise.
The economic case for changing ethanol policy is therefore clear. The political one, however, is anything but.
McCain, the bravest of the three candidates when it comes to this issue, was the first to criticize ethanol subsidies and production requirements. Obama held to pro-ethanol arguments for longer, heralding it as a cleaner energy source and framing the issue as an environmental one in an effort to justify a position that would keep him popular in Iowa. Recently, however, he has changed his tune, finally acknowledging the link between ethanol and food prices. Clinton, though edging ever closer to Obama's position, still lags behind.
The rising food prices represent a dire crisis. The U.S. has the power--and perhaps even the responsibility, given the significant market distortions our farm policy creates--to curb it. And yet politics, and particularly the power of the American farmer, are eerily close to keeping the candidates quiet.
More attention needs to be paid to the crisis, both by the politicians and the voters. And credit--as well as support--must be given to those candidates that do address the issue effectively. It's the least we can do to counterbalance the strength of the agricultural lobby.
Saturday, May 17, 2008
Innovating Our Way to Financial Crisis
This article illustrates one point that I brought to the class discussion; whether the financial innovation leads to a financial crisis. I somewhat agree and disagree with Pual Krugman, the writer of this article.
I disagree with him about financial innonvation as a cause of the crisis. It is not the financial innovation itself that causes the crisis but rather the people who use them. For example, the aim of the mortgage-back securities is actually to reduce the risk of the mortgage holders by pooling many mortgages together to diversify the default risks on the loans. Nevertheless, many people purchase them for the sake of speculation.
However, I agree with him that one way to reduce the chances of misuses in such financial innovation is to always make the regulation about the financial systems up-to-date. This may be infeasible and require a massive cost on monitoring the whole financial system. The more possible way is to not allow the creation of new financial products at all. This may reduce potential problems in the future, but it also limits the use of good financial innovation as well.
I disagree with him about financial innonvation as a cause of the crisis. It is not the financial innovation itself that causes the crisis but rather the people who use them. For example, the aim of the mortgage-back securities is actually to reduce the risk of the mortgage holders by pooling many mortgages together to diversify the default risks on the loans. Nevertheless, many people purchase them for the sake of speculation.
However, I agree with him that one way to reduce the chances of misuses in such financial innovation is to always make the regulation about the financial systems up-to-date. This may be infeasible and require a massive cost on monitoring the whole financial system. The more possible way is to not allow the creation of new financial products at all. This may reduce potential problems in the future, but it also limits the use of good financial innovation as well.
Pop Economics
I was looking for something to disagree passionately with for my final blog post when I came across this little beauty of an opinion piece from the National Review, an eminent conservative journal. It was well-written and sobering, but it was another example of the kind of thinking that's been upsetting me for some time now: the use of simplistic Econ 1 concepts to explain the real world.
Everyone knows you can't directly apply Econ 1 concepts to actual situations. The real world is just much too complex. For example, in today's global economy, there is no such thing as an "exogenous" upward shift in demand (a shift in demand that comes from outside the system) because there is NO "outside the system." Rising demand for staple crops is linked to rising energy demand through ethanol. Free trade agreements and commodity deals have effects that reverberate differently depending on the institutions of the countries in question. To quote a speech in the fantastic 1975 movie Network, the world is a "holistic system of systems, one vast and immane, interwoven, interacting, multivariate, multinational dominion of dollars. Petro-dollars, electro-dollars, multi-dollars, reichmarks, rins, rubles, pounds, and shekels." Economics is complex, and policy analysis is hard.
So when Michael Novak simplifies and caricatures the Democrats' economic policies using exactly the kind of univariate, static-world thinking I disparaged above, my hackles go up a little bit. Novak argues that raising income taxes on the wealthiest 2% to their 1990s levels "will give them enormous incentives to alter their behavior, so as to show lower income." He forecasts "dramatically lower" revenues, a financially hamstrung and chronically deficit-plagued federal government, and the end of civilization as we know it. Obama, he says, "will learn the hard way" about the disastrous results of his tax-hiking policy.
No one's denying the existence of incentive effects, but substantial questions exist as to their magnitude. While "enormous" reads well, it may be an overstatement--I don't remember tax receipts being dramatically lower before the 2001 and 2003 tax cuts. In fact, they were higher. And guess what? We still had economic growth. In fact, we look back on the 1990s as a period of enormous productivity growth! Despite the fact that marginal tax rates for the top 2% were higher in the 1990s, the economy prospered and America, somehow, endured. But there is no mention of that fact in Novak's piece, because Novak is no economist--just a guy using the words "incentive effects" and praying no one remembers the counterexample of a decade ago.
If Obama is elected, there is reason to believe that Novak will have to learn the hard way that you can't forecast the future of the federal budget, the economy, or the country solely from a simplistic univariate analysis.
Everyone knows you can't directly apply Econ 1 concepts to actual situations. The real world is just much too complex. For example, in today's global economy, there is no such thing as an "exogenous" upward shift in demand (a shift in demand that comes from outside the system) because there is NO "outside the system." Rising demand for staple crops is linked to rising energy demand through ethanol. Free trade agreements and commodity deals have effects that reverberate differently depending on the institutions of the countries in question. To quote a speech in the fantastic 1975 movie Network, the world is a "holistic system of systems, one vast and immane, interwoven, interacting, multivariate, multinational dominion of dollars. Petro-dollars, electro-dollars, multi-dollars, reichmarks, rins, rubles, pounds, and shekels." Economics is complex, and policy analysis is hard.
So when Michael Novak simplifies and caricatures the Democrats' economic policies using exactly the kind of univariate, static-world thinking I disparaged above, my hackles go up a little bit. Novak argues that raising income taxes on the wealthiest 2% to their 1990s levels "will give them enormous incentives to alter their behavior, so as to show lower income." He forecasts "dramatically lower" revenues, a financially hamstrung and chronically deficit-plagued federal government, and the end of civilization as we know it. Obama, he says, "will learn the hard way" about the disastrous results of his tax-hiking policy.
No one's denying the existence of incentive effects, but substantial questions exist as to their magnitude. While "enormous" reads well, it may be an overstatement--I don't remember tax receipts being dramatically lower before the 2001 and 2003 tax cuts. In fact, they were higher. And guess what? We still had economic growth. In fact, we look back on the 1990s as a period of enormous productivity growth! Despite the fact that marginal tax rates for the top 2% were higher in the 1990s, the economy prospered and America, somehow, endured. But there is no mention of that fact in Novak's piece, because Novak is no economist--just a guy using the words "incentive effects" and praying no one remembers the counterexample of a decade ago.
If Obama is elected, there is reason to believe that Novak will have to learn the hard way that you can't forecast the future of the federal budget, the economy, or the country solely from a simplistic univariate analysis.
Gas Price Worries - Are Policy Changes Necessary?
The continued increases in gas prices has sparked a considerate amount of political talk because of its widespread impact on almost every single American. This article by Nelson Schwartz from the NY times looks at reasons why the oil prices continue to hit record highs.
Schwartz believes that the basics of demand and supply cannot account for the steady climbing of prices by citing adequate supply of oil available. He finds that the answer lies in the falling dollar. The depreciation of the dollar is causing investors and traders to move their investments into crude commodities such as oil to hedge their portfolio risks. Since the oil market is a global market that is not being affected by domestic currency devaluation, investments in these goods are more stable in comparison to the dollar. The same story goes for gold prices. Since the dollar depreciation, gold prices have continued to raise, also hitting record highs. The institutional shifts of investments, by large investment institutions, into oil has caused informal investors and less informed traders to also move in this commodity. This signaling has only exacerbated the problem of inflated gas prices.
The blame for this exacerbation has been placed on these informal "speculative" traders. Therefore, the potential political response to these bad traders is to raise margin requirements for these trades. Higher requirements would force traders to take less risk because they would be forced to back up their positions with more equity. Schwartz doesn't seem convinced that these traders are the fundamental reasons why prices are so high; however, he believes that it is still worth trying.
Personally, I don't believe that speculative trading is the core reason for the price hikes in oil prices. It does, however, provide a convincing scrape goat and a easy solution. Seeing how politicians are more adverse to inaction than to actual efficacy, this seems that this policy response is adequate to keep them happy - even if it doesn't actually solve the problem. Yet, I remain skeptical that there is even a pricing mismatch problem in the case of oil as Schwartz outlines.
My gut feeling is that current oil prices are anticipating higher costs in the future due to more regulation on carbon emission. The internalization of these externalities is necessary and universally understood in economics as the best way to move towards better efficiency. However, no one said it would be an easy, painless process. These high prices will be born by everyone in the economy and are just the beginning of what is necessary to move the nation, and eventually the world, to a more efficient frontier.
Quick solutions now might cause politicians and their constituents to feel better about themselves. But, in the end, I believe that higher prices of goods are just what we should expect in the horizon because we are in the painful process of internalization of previously unaccounted externalities.
Schwartz believes that the basics of demand and supply cannot account for the steady climbing of prices by citing adequate supply of oil available. He finds that the answer lies in the falling dollar. The depreciation of the dollar is causing investors and traders to move their investments into crude commodities such as oil to hedge their portfolio risks. Since the oil market is a global market that is not being affected by domestic currency devaluation, investments in these goods are more stable in comparison to the dollar. The same story goes for gold prices. Since the dollar depreciation, gold prices have continued to raise, also hitting record highs. The institutional shifts of investments, by large investment institutions, into oil has caused informal investors and less informed traders to also move in this commodity. This signaling has only exacerbated the problem of inflated gas prices.
The blame for this exacerbation has been placed on these informal "speculative" traders. Therefore, the potential political response to these bad traders is to raise margin requirements for these trades. Higher requirements would force traders to take less risk because they would be forced to back up their positions with more equity. Schwartz doesn't seem convinced that these traders are the fundamental reasons why prices are so high; however, he believes that it is still worth trying.
Personally, I don't believe that speculative trading is the core reason for the price hikes in oil prices. It does, however, provide a convincing scrape goat and a easy solution. Seeing how politicians are more adverse to inaction than to actual efficacy, this seems that this policy response is adequate to keep them happy - even if it doesn't actually solve the problem. Yet, I remain skeptical that there is even a pricing mismatch problem in the case of oil as Schwartz outlines.
My gut feeling is that current oil prices are anticipating higher costs in the future due to more regulation on carbon emission. The internalization of these externalities is necessary and universally understood in economics as the best way to move towards better efficiency. However, no one said it would be an easy, painless process. These high prices will be born by everyone in the economy and are just the beginning of what is necessary to move the nation, and eventually the world, to a more efficient frontier.
Quick solutions now might cause politicians and their constituents to feel better about themselves. But, in the end, I believe that higher prices of goods are just what we should expect in the horizon because we are in the painful process of internalization of previously unaccounted externalities.
Friday, May 16, 2008
Obama's iPod Government
Initially, hearing the term "iPod Government" you might think it's just another of Obama's catch-phrase ploys, another cheesy attempt to lock-in young voters. In reality, however, it's an intriguing approach to the political challenge of balancing government-knows-best mandates with leave-it-up-to-the-consumer free choice.
Under Obama's iPod Government system, consumers would make their own choices, but the government would clearly lay those choices out. Rather than simply give us options, Obama would give us options we can understand. This approach would change the presentation of several essential consumer decisions, from Medicare prescription drug plans to mortgage terms.
While the feasibility of this plan is questionable--can such complex decisions really be pared down to a version palatable to the every-day decision-maker without bias or oversimplification?--the benefit is pretty clear. Economic theory would argue that making options clearer will necessarily benefit the consumer, as they will be more educated and face less certainty as a result.
Other aspects of Obama's proposal are more controversial, however. Take for instance his plan to shift the default for many programs from opting in to opting out. The most significant manifestation of this plan, should it come to pass, would be the automatic enrollment of all workers in employer-based savings plans. While today workers must actively enroll in such programs, under Obama's plan they would have to (but easily could) actively drop out. Even if the savings plans themselves were no different than today's, the impact would still be remarkable.
In proposing this over-arching approach to decision-making, Obama has relied heavily on his economic advisors. Abandoning one of the most frustrating assumptions of undergraduate economics--that people are rational actors--Obama's team instead pays significant attention to the field of behavioral economics. In this case, their position is based on the empirically-supported "status quo bias" which suggests that people are likely to stick with the default option, whatever that may be. In other words, if people are automatically enrolled in a savings program, they are significantly more likely to stay in it than if they are automatically not. Regardless of the specifics of the options, the consumer's choice is heavily biased towards the default one.
Deemed "libertarian paternalism", this policy simultaneously allows for consumer choice and pushes that choice in the direction Obama prefers. In my opinion, it's a sound policy. Any way you look at it, some option has to take the default place. And, as discussed in class, the option of non-participation is no less neutral than the automatic enrollment one. So, why shouldn't the default option be the one that experts like Obama and his economic advisers recommend? Sure, in some ways this means the government will be making the decision for some consumers (i.e., those who just stick with the default, regardless of what it may be). But economic theory would likely fall apart with them anyways--if they aren't rational, informed consumers, they are unlikely to independently make the optimal choice regardless.
So maybe this is the best of both worlds: let the people who care make their own well-informed decisions and help those that don't by guiding them in the direction you (and your team of economists and experts) think best.
Under Obama's iPod Government system, consumers would make their own choices, but the government would clearly lay those choices out. Rather than simply give us options, Obama would give us options we can understand. This approach would change the presentation of several essential consumer decisions, from Medicare prescription drug plans to mortgage terms.
While the feasibility of this plan is questionable--can such complex decisions really be pared down to a version palatable to the every-day decision-maker without bias or oversimplification?--the benefit is pretty clear. Economic theory would argue that making options clearer will necessarily benefit the consumer, as they will be more educated and face less certainty as a result.
Other aspects of Obama's proposal are more controversial, however. Take for instance his plan to shift the default for many programs from opting in to opting out. The most significant manifestation of this plan, should it come to pass, would be the automatic enrollment of all workers in employer-based savings plans. While today workers must actively enroll in such programs, under Obama's plan they would have to (but easily could) actively drop out. Even if the savings plans themselves were no different than today's, the impact would still be remarkable.
In proposing this over-arching approach to decision-making, Obama has relied heavily on his economic advisors. Abandoning one of the most frustrating assumptions of undergraduate economics--that people are rational actors--Obama's team instead pays significant attention to the field of behavioral economics. In this case, their position is based on the empirically-supported "status quo bias" which suggests that people are likely to stick with the default option, whatever that may be. In other words, if people are automatically enrolled in a savings program, they are significantly more likely to stay in it than if they are automatically not. Regardless of the specifics of the options, the consumer's choice is heavily biased towards the default one.
Deemed "libertarian paternalism", this policy simultaneously allows for consumer choice and pushes that choice in the direction Obama prefers. In my opinion, it's a sound policy. Any way you look at it, some option has to take the default place. And, as discussed in class, the option of non-participation is no less neutral than the automatic enrollment one. So, why shouldn't the default option be the one that experts like Obama and his economic advisers recommend? Sure, in some ways this means the government will be making the decision for some consumers (i.e., those who just stick with the default, regardless of what it may be). But economic theory would likely fall apart with them anyways--if they aren't rational, informed consumers, they are unlikely to independently make the optimal choice regardless.
So maybe this is the best of both worlds: let the people who care make their own well-informed decisions and help those that don't by guiding them in the direction you (and your team of economists and experts) think best.
Thursday, May 15, 2008
"Paying" Farmers for Votes
Even though no politician would actually endorse this tag-line, it is essentially what increased subsidies to farmers means. The new Farm Bill that is being finalized in congress now aims to do just that.
Both Democratic candidates support this bill in light of its inherent economic problems. Government subsidies would only distort efficient pricing of goods by deflating costs of production. However, the cost of production doesn't magically disappear. It would be financed by the government and, in turn, the American public. Essentially, domestic consumers are still paying higher costs for farm goods. Why not let the American public directly face the higher costs? The indirect nature of this policy takes away the consumer's ability to correctly maximize consumption choices because they are given incorrect prices.
Letting the market resolve the underpricing of farm goods would be the most efficient way of shaping up our highly pampered farming sector. This would allow the best farms to continue while trimming the fat of bad farms. A subsidies program would hinder this "survival of the fittest" idea of efficiency for the dynamic future because farms would have little incentive to change and improve. Basically, the burden of sustaining inefficient farmers is carried by the public when a subsidy is in place.
Subsidies are the fast-food equivalents of solving the problem of the farm industry - instant gratification that hides its long term harms. Obviously, the government does not have the finances to extend subsidies forever. Then, why are politicians so keen on these irresponsible policies that would negatively distort long run stability by rewarding a lack of innovation for improvements? So, how will the fundamental problems of the farm industries be solved?
Perhaps our political system is to blame for this lack of long sight. The short terms of office incentivize politicians to solve short-run problems with slapdash solutions without given much thought to long-run stability.
Still worse, a big chunk of this Farm Bill, "around two-thirds of the bill's cost, would pay for food stamps and other nutrition programs." This coupling of a bad subsidies policy with a stronger social welfare project seems like it is a strictly political move to boost support. These instances cause me to be very disillusioned with our political system and its penchant for confusing the general public. It's essentially equivalent to tagging a "baby protection act" to a bill that allows human torture. To me, it is disgustingly outrageous. However, this blog is to discuss economic issues, not problems of our political system.
I'm interested to see what will happen to bill when it is placed up for vote.
Both Democratic candidates support this bill in light of its inherent economic problems. Government subsidies would only distort efficient pricing of goods by deflating costs of production. However, the cost of production doesn't magically disappear. It would be financed by the government and, in turn, the American public. Essentially, domestic consumers are still paying higher costs for farm goods. Why not let the American public directly face the higher costs? The indirect nature of this policy takes away the consumer's ability to correctly maximize consumption choices because they are given incorrect prices.
Letting the market resolve the underpricing of farm goods would be the most efficient way of shaping up our highly pampered farming sector. This would allow the best farms to continue while trimming the fat of bad farms. A subsidies program would hinder this "survival of the fittest" idea of efficiency for the dynamic future because farms would have little incentive to change and improve. Basically, the burden of sustaining inefficient farmers is carried by the public when a subsidy is in place.
Subsidies are the fast-food equivalents of solving the problem of the farm industry - instant gratification that hides its long term harms. Obviously, the government does not have the finances to extend subsidies forever. Then, why are politicians so keen on these irresponsible policies that would negatively distort long run stability by rewarding a lack of innovation for improvements? So, how will the fundamental problems of the farm industries be solved?
Perhaps our political system is to blame for this lack of long sight. The short terms of office incentivize politicians to solve short-run problems with slapdash solutions without given much thought to long-run stability.
Still worse, a big chunk of this Farm Bill, "around two-thirds of the bill's cost, would pay for food stamps and other nutrition programs." This coupling of a bad subsidies policy with a stronger social welfare project seems like it is a strictly political move to boost support. These instances cause me to be very disillusioned with our political system and its penchant for confusing the general public. It's essentially equivalent to tagging a "baby protection act" to a bill that allows human torture. To me, it is disgustingly outrageous. However, this blog is to discuss economic issues, not problems of our political system.
I'm interested to see what will happen to bill when it is placed up for vote.
My Obama Dream
I want so badly to support Barack Obama. I agree with him on many sundry political issues, and I love his powerhouse economic advising team. But when I look at his spelled-out economic policy beliefs, I am confronted with a deep philosophical dilemma. How can I support a candidate with such stupid ideas?
There are a million reasons, economic and moral, that I don't like unions. They inflate costs by extorting above-market wages, hurting businesses and consumers, and they prevent improvement through their absurdly restrictive policies, their tangled bureaucracy, their rampant corruption, and their general sloth-like nature.
Many of my objections to unions are summarized in this video.
It disturbs me that Obama supports pro-union policies. Of course I understand that he needs to say things he might not mean to get elected, and maybe he is doing so here. But how many times can I give him the benefit of the doubt? I've already tried to ignore his NAFTA-bashing, his "outsourcing" tirades, and his Hillary Clinton-esque corporation slandering. At the end of the day I am left with two competing visions of Obama: either he is a classic liberal (read: socialist) when it comes to economic policy, or he's a devious politician who has concocted a vast, overarching network of lies to cover up his true beliefs. If he's the former, I don't want him as my president, and if he's the latter, then I'm downright scared of him.
There are a million reasons, economic and moral, that I don't like unions. They inflate costs by extorting above-market wages, hurting businesses and consumers, and they prevent improvement through their absurdly restrictive policies, their tangled bureaucracy, their rampant corruption, and their general sloth-like nature.
Many of my objections to unions are summarized in this video.
It disturbs me that Obama supports pro-union policies. Of course I understand that he needs to say things he might not mean to get elected, and maybe he is doing so here. But how many times can I give him the benefit of the doubt? I've already tried to ignore his NAFTA-bashing, his "outsourcing" tirades, and his Hillary Clinton-esque corporation slandering. At the end of the day I am left with two competing visions of Obama: either he is a classic liberal (read: socialist) when it comes to economic policy, or he's a devious politician who has concocted a vast, overarching network of lies to cover up his true beliefs. If he's the former, I don't want him as my president, and if he's the latter, then I'm downright scared of him.
Wednesday, May 14, 2008
Democratic Candidates: Trade Policy on NAFTA
In the last two months, Democratic Presidential candidates Hilary Clinton and Barak Obama fought over Ohio and Pennsylvania, states that suffer from manufacturing job losses. Both candidates resorted to trade-bashing tactics, which is “a time-honored tactic in Democratic race” because the Democratic Party relies heavily on labor unions for donations and votes. [1]
Clinton and Obama have made the following pledges: 1) renegotiate the North American Free Trade Agreements (NAFTA) incorporating more strict labor and environmental standards, 2) oppose pending FTA deals with Columbia and South Korea, and 3) punish China for intervening to artificially devalue their .
While it is well-known that there is a large gap between what a candidate promises during the race, and what the candidate actually does once elected into the Office, to me it seems like as the preliminary race intensifies, each candidate is taking the toughest stance possible against trade, making pledges from which he or she will find difficult to get away once elected. [2]
“Both have given themselves less wiggle room and boxed themselves in,'' said Claude Barfield, a trade expert at the American Enterprise Institute in Washington. “There are all kinds of ways when you're president to get out of campaign promises, but it's going to be tougher this time.” [1]
Both candidates have been trying best to walk the tight rope between free trade and protectionism. While there is no consensus on the net benefit of free trade, in general, economists agree that trade results in a social benefit for the society. Taking this positive view on trade, I take the opportunity to briefly explore the long-term implications of, in particular, a renegotiation of the NAFTA.
In my opinion, the renegotiation will be terribly inefficient, and bring about a significant economic loss because for one, counterparties will also want to reach renegotiate for better terms. The U.S. might end up compromising on its priority access to Canadian oil. Also, Mexico may end up winning more provisions on work visa. [1]
Another problem is tied with political economics. The renegotiation of the NAFTA would allow a small but better organized group in the population to exert influences on the trade policy. The resulting changes would benefit the workers, but most likely reduce the net social gains from the trade.
Lastly, if anything, exports will be hurt and trade balance will worsen. And a further increase in trade deficit is not the best thing the U.S. needs at this time of financial crisis. According to Robert Lawrence, a professor of international trade at Harvard University:
Our economy is being held up by export growth,'' Lawrence said. ``If ever there was a bad time to delay trade negotiations and market-opening measures, it's now.” [1]
[1] Matthew Benjamin and Mark Drajem, “Obama, Clinton Promises May Undo Bill Clinton's Trade Legacy,” http://www.bloomberg.com/apps/news?pid=20601087&sid=anqjPdbTszNk&refer=home
[2] Helene Cooper, “Democrats’ Third Rail: Free Trade,” http://www.nytimes.com/2007/08/12/weekinreview/12cooper.html?fta=y
Monday, May 12, 2008
Anti-Capitalism at its best..
"The other day the oil companies recorded the highest profits in the history of the world. I want to take those profits"- Hillary Clinton
If this statement by Hillary Clinton doesn't scare you, I'm not sure what will.
Hillary Clinton's policy on oil not only undermines capitalism but seems to have come straight out of the Communist Manifesto. It is true that oil companies are seeing record profits, this is only to be expected due to current record demand. Hillary insists that the price of oil is soaring due to market manipulation and will launch investigations into OPEC for price gauging. People have been trying to proove price gauging/price fixing on OPEC for years and have come up with nothing. I don't think Hillary will find anything past administrations haven't.
It is just scary to think that a potential president of the U.S feels they have the power to "take profits" from certain companies they feel are doing too well. This idea certainly seems to have socialist components. The average net profit margin for the S&P Energy sector, according to figures from Thomson Baseline, is 9.7%. The average for the S&P 500 is 8.5%. Oil companies are not seeing profit margins far and beyond what other companies are making. Google, for example, reported a profit margin of 25% in its most recent quarter. Does Hillary want to implement an online search engine windfall profit tax?
Hillary needs to be taught how gas prices arrive at the pump. The price of gas is derived from the price of crude oil which is set on the crude oil futures market. These prices are affected by supply and demand due to the fact that oil is traded on a global market. It is a fact that much of our oil supply is relatively static but world demand continues to grow. If supply isn't changing, but demand is, the price will obviously rise.
It's a dangerous precedent to set by taking profits from companies that are making legal profits. OPEC is the only organization that has any effect on the price of oil, and there isn't any American politician that can change that. The only solution for breaking out of our independence on oil is to invest in other types of fuel (currently, there is little incentive to invest in this sector).
Instead of stealing oil companies profits, why not tell people there free to plunge their savings into these oil companies stocks, or even buy crude oil on the futures market. That is the joy of our financial markets which Hillary is attempting to undermine.
If this statement by Hillary Clinton doesn't scare you, I'm not sure what will.
Hillary Clinton's policy on oil not only undermines capitalism but seems to have come straight out of the Communist Manifesto. It is true that oil companies are seeing record profits, this is only to be expected due to current record demand. Hillary insists that the price of oil is soaring due to market manipulation and will launch investigations into OPEC for price gauging. People have been trying to proove price gauging/price fixing on OPEC for years and have come up with nothing. I don't think Hillary will find anything past administrations haven't.
It is just scary to think that a potential president of the U.S feels they have the power to "take profits" from certain companies they feel are doing too well. This idea certainly seems to have socialist components. The average net profit margin for the S&P Energy sector, according to figures from Thomson Baseline, is 9.7%. The average for the S&P 500 is 8.5%. Oil companies are not seeing profit margins far and beyond what other companies are making. Google, for example, reported a profit margin of 25% in its most recent quarter. Does Hillary want to implement an online search engine windfall profit tax?
Hillary needs to be taught how gas prices arrive at the pump. The price of gas is derived from the price of crude oil which is set on the crude oil futures market. These prices are affected by supply and demand due to the fact that oil is traded on a global market. It is a fact that much of our oil supply is relatively static but world demand continues to grow. If supply isn't changing, but demand is, the price will obviously rise.
It's a dangerous precedent to set by taking profits from companies that are making legal profits. OPEC is the only organization that has any effect on the price of oil, and there isn't any American politician that can change that. The only solution for breaking out of our independence on oil is to invest in other types of fuel (currently, there is little incentive to invest in this sector).
Instead of stealing oil companies profits, why not tell people there free to plunge their savings into these oil companies stocks, or even buy crude oil on the futures market. That is the joy of our financial markets which Hillary is attempting to undermine.
Cap & Trade: Making Dollars & Sense
In a further attempt to prove that being a Republican is different from being Dubya, John McCain has called for a mandatory limit on greenhouse gas emissions in the United States and embraced the formation of a cap-and-trade system. McCain, Clinton, and Obama all support some form of cap-and-trade scheme in order to reduce carbon emissions.
As economists, we love this. For tree-huggers, sentiments are a little more mixed.
But first: why cap-and-trade makes economic sense. Because different firms face different marginal costs of abatement, requiring all firms to cut emissions by a given amount will not have the same costs across the board. However, if firms are allowed to trade permits, those facing the lowest costs of abatement will reduce emissions the most, while those facing higher costs will pay them to do so (see figure below).
Note: MBemissions = MCabatement
Type I firms face higher marginal costs of emissions abatement than Type II firms. Assuming an equal number of both types, each type would be required to reduce emissions to E/N if they did not trade permits. With trade, Type I firms would be willing to pay up to a for an additional permit. Likewise, Type II firms would be willing to sell a permit at a price of b. Trades will therefore take place as long as the marginal abatement costs to Type I firms exceed those faced by Type II firms, establishing the equilibrium price Ppermits.
Both types of firms benefit from trading permits—Type I firms pay area D for permits, but save areas C+D in avoided abatement. Type II firms must pay area B in extra abatement costs, but receive A+B for the permits they sell. Therefore, A+C is the net social gain resulting from tradable emissions permits.
A tradable permit scheme therefore minimizes efficiency losses associated with the uncertainty of marginal benefit, but it also ensures that the government does not see large windfalls from rent associated with auctioning, that market forces determine where the allocations end up, and, most importantly, that emissions are reduced to a certain targeted value. The aggregate amount of emissions remains fixed at E*, which is a plus for tree-huggers.
However, because cap-and-trade only puts a limit on total emissions, concerns arise relating to localized pollution. As a result of trading permits, it is possible that certain areas will become more concentrated in terms of emissions. This can impose significant negative externalities on residents in these areas, and the local environment.
In addition, there is the larger issue concerning linkages between money and the environment: can we really put a price on pollution? Can we really grant the right to pollute?
I can't answer those questions, but from an economic standpoint, adopting a national cap-and-trade policy not only maximizes efficiency for firms facing different marginal costs of abatement, but also offers reduction in greenhouse gas emissions that we so desperately need.
As economists, we love this. For tree-huggers, sentiments are a little more mixed.
But first: why cap-and-trade makes economic sense. Because different firms face different marginal costs of abatement, requiring all firms to cut emissions by a given amount will not have the same costs across the board. However, if firms are allowed to trade permits, those facing the lowest costs of abatement will reduce emissions the most, while those facing higher costs will pay them to do so (see figure below).
Note: MBemissions = MCabatementType I firms face higher marginal costs of emissions abatement than Type II firms. Assuming an equal number of both types, each type would be required to reduce emissions to E/N if they did not trade permits. With trade, Type I firms would be willing to pay up to a for an additional permit. Likewise, Type II firms would be willing to sell a permit at a price of b. Trades will therefore take place as long as the marginal abatement costs to Type I firms exceed those faced by Type II firms, establishing the equilibrium price Ppermits.
Both types of firms benefit from trading permits—Type I firms pay area D for permits, but save areas C+D in avoided abatement. Type II firms must pay area B in extra abatement costs, but receive A+B for the permits they sell. Therefore, A+C is the net social gain resulting from tradable emissions permits.
A tradable permit scheme therefore minimizes efficiency losses associated with the uncertainty of marginal benefit, but it also ensures that the government does not see large windfalls from rent associated with auctioning, that market forces determine where the allocations end up, and, most importantly, that emissions are reduced to a certain targeted value. The aggregate amount of emissions remains fixed at E*, which is a plus for tree-huggers.
However, because cap-and-trade only puts a limit on total emissions, concerns arise relating to localized pollution. As a result of trading permits, it is possible that certain areas will become more concentrated in terms of emissions. This can impose significant negative externalities on residents in these areas, and the local environment.
In addition, there is the larger issue concerning linkages between money and the environment: can we really put a price on pollution? Can we really grant the right to pollute?
I can't answer those questions, but from an economic standpoint, adopting a national cap-and-trade policy not only maximizes efficiency for firms facing different marginal costs of abatement, but also offers reduction in greenhouse gas emissions that we so desperately need.
Sunday, May 11, 2008
And now for something completely different...
For the Clinton campaign, things just haven't been looking too hot lately.
After losing her lead in Superdelegates and being generally regarded as out of the race, Hillary Clinton looks to put up a fight in Oregon, where the next close primary will take place on May 20. And this time, its not about gas taxes or mortgages—surprise! Clinton plans to use health care as her weapon of choice.
Although her means are unclear, the end goal of Clinton's proposal is that all Americans be required to purchase health insurance, including the 47 million currently without coverage.
On the surface, the idea of universal health care seems great—when everything from prescription drugs to a five-minute follow-up appointment to brain surgery costs so much, who wouldn't want health insurance? But we have to flex our economic muscles and dig deeper than that to consider the additional costs and benefits of extending coverage.
First, we have to look at the composition of those who currently do not have health insurance, since those are the people most affected by a potential policy change. Current law provides coverage to the elderly, disabled, military families, veterans, children, and the poor via Medicare and Medicaid. Therefore those without coverage are mainly those in the lower middle class bracket who do not qualify for government provisions. Primarily these are people who do not have expendable income. Forcing these people to pay for health insurance may force them to sacrifice in other areas of their budget. Despite the fact that Clinton proposes that the cost will be a fixed percentage of income and subsidies or tax breaks would be available in order to make coverage "affordable," there will still be those who simply do not want to spend on health insurance. This can lead to negative externalities, although the extent of these externalities is dependent on the cost of required health care. For example, if the cost is high enough, cutting the amount of income spent on food could lead to greater fast food consumption and increases in obesity. This would increase the demand for health care, increasing its cost and creating a vicious downward spiral. Cutting on rent may force families to seek cheaper housing in areas with lower-quality public schools, decreasing the rates of return to both physical and human capital. And lastly, if money to be saved was spent on health insurance, savings would decrease.
Secondly, we must take into consideration the problem of moral hazard. This is already a problem: there is the tendency for those with health insurance to seek treatment when it is not needed, or seek treatment beyond what is needed. Moral hazard would only increase with universal coverage. These inefficiencies cause increases in both the costs to doctors and the health industry, and consequently, cause the price of insurance to rise.
Lastly, there is the problem concerning the inability to opt out. Low risk individuals forced to purchase health insurance would be subsidizing the higher risk individuals, and would not be granted the option to discontinue coverage.
In light of these costs, there are benefits to universal coverage that cannot be ignored. First of all, those in need of treatment who cannot currently afford it, will now be capable of getting the medical attention they need. In addition, the costs to the government associated with more expensive emergency care will be reduced as a result of more routine care. In response to the opt-out problem, one could argue that universal coverage prevents low risk individuals from leaving high risk individuals in their own pool.
After considering these costs and benefits, however, I do not believe that every American should be required to purchase health insurance. Obama's health care initiative is not as extreme as Clinton's: he would only require children to have coverage. This is more economically reasonable given that adults without insurance could still opt out and moral hazard would not increase to the same extent as with universal coverage. Obama also proposes the provision of affordable health insurance for all, but does not mandate its purchase. Because the increase in the price of health insurance explains much of the decline in insurance coverage, providing affordable insurance, but giving consumers the ultimate choice to purchase insurance or not, would allow for increased coverage without inefficiencies associated with those who do not want insurance but would be forced to purchase it under Clinton's plan.
However, the problem I find with his plan is that it closely parallels the State Children's Health Insurance Program (SCHIP) that was enacted in 1997 under President Bill Clinton. SCHIP is designed to provide coverage for families with children in the income bracket discussed earlier—that is, the lower middle class who does not qualify for Medicaid. With SCHIP, I fail to see the need to spend resources enacted a policy to cover all children. This is because children in low income families are already covered by Medicaid, children in lower middle income families are covered under SCHIP, and those in middle income or higher income families can afford private health insurance or medical treatment. Therefore, while Obama's plan might be more efficient in comparison to Clinton's and I support any effort to provide more affordable insurance, I find his coverage requirement for all children unnecessary and excessive given programs already in existence. These resources would be better served addressing more pressing issues.
Maybe they should stick to gas taxes and mortgage crises.
After losing her lead in Superdelegates and being generally regarded as out of the race, Hillary Clinton looks to put up a fight in Oregon, where the next close primary will take place on May 20. And this time, its not about gas taxes or mortgages—surprise! Clinton plans to use health care as her weapon of choice.
Although her means are unclear, the end goal of Clinton's proposal is that all Americans be required to purchase health insurance, including the 47 million currently without coverage.
On the surface, the idea of universal health care seems great—when everything from prescription drugs to a five-minute follow-up appointment to brain surgery costs so much, who wouldn't want health insurance? But we have to flex our economic muscles and dig deeper than that to consider the additional costs and benefits of extending coverage.
First, we have to look at the composition of those who currently do not have health insurance, since those are the people most affected by a potential policy change. Current law provides coverage to the elderly, disabled, military families, veterans, children, and the poor via Medicare and Medicaid. Therefore those without coverage are mainly those in the lower middle class bracket who do not qualify for government provisions. Primarily these are people who do not have expendable income. Forcing these people to pay for health insurance may force them to sacrifice in other areas of their budget. Despite the fact that Clinton proposes that the cost will be a fixed percentage of income and subsidies or tax breaks would be available in order to make coverage "affordable," there will still be those who simply do not want to spend on health insurance. This can lead to negative externalities, although the extent of these externalities is dependent on the cost of required health care. For example, if the cost is high enough, cutting the amount of income spent on food could lead to greater fast food consumption and increases in obesity. This would increase the demand for health care, increasing its cost and creating a vicious downward spiral. Cutting on rent may force families to seek cheaper housing in areas with lower-quality public schools, decreasing the rates of return to both physical and human capital. And lastly, if money to be saved was spent on health insurance, savings would decrease.
Secondly, we must take into consideration the problem of moral hazard. This is already a problem: there is the tendency for those with health insurance to seek treatment when it is not needed, or seek treatment beyond what is needed. Moral hazard would only increase with universal coverage. These inefficiencies cause increases in both the costs to doctors and the health industry, and consequently, cause the price of insurance to rise.
Lastly, there is the problem concerning the inability to opt out. Low risk individuals forced to purchase health insurance would be subsidizing the higher risk individuals, and would not be granted the option to discontinue coverage.
In light of these costs, there are benefits to universal coverage that cannot be ignored. First of all, those in need of treatment who cannot currently afford it, will now be capable of getting the medical attention they need. In addition, the costs to the government associated with more expensive emergency care will be reduced as a result of more routine care. In response to the opt-out problem, one could argue that universal coverage prevents low risk individuals from leaving high risk individuals in their own pool.
After considering these costs and benefits, however, I do not believe that every American should be required to purchase health insurance. Obama's health care initiative is not as extreme as Clinton's: he would only require children to have coverage. This is more economically reasonable given that adults without insurance could still opt out and moral hazard would not increase to the same extent as with universal coverage. Obama also proposes the provision of affordable health insurance for all, but does not mandate its purchase. Because the increase in the price of health insurance explains much of the decline in insurance coverage, providing affordable insurance, but giving consumers the ultimate choice to purchase insurance or not, would allow for increased coverage without inefficiencies associated with those who do not want insurance but would be forced to purchase it under Clinton's plan.
However, the problem I find with his plan is that it closely parallels the State Children's Health Insurance Program (SCHIP) that was enacted in 1997 under President Bill Clinton. SCHIP is designed to provide coverage for families with children in the income bracket discussed earlier—that is, the lower middle class who does not qualify for Medicaid. With SCHIP, I fail to see the need to spend resources enacted a policy to cover all children. This is because children in low income families are already covered by Medicaid, children in lower middle income families are covered under SCHIP, and those in middle income or higher income families can afford private health insurance or medical treatment. Therefore, while Obama's plan might be more efficient in comparison to Clinton's and I support any effort to provide more affordable insurance, I find his coverage requirement for all children unnecessary and excessive given programs already in existence. These resources would be better served addressing more pressing issues.
Maybe they should stick to gas taxes and mortgage crises.
Saturday, May 10, 2008
Securitization - more comments from class discussion
I would like to use this opportunity to comment about the opposing viewpoints regarding securitization discussed at class.
First, one needs to understand that the most direct link of subprime loans to the economy as a whole involves the securitization of subprime loans. Local banks and thrifts are no longer the main source of funding for American homeowners who wish to assume mortgages. Once mortgages were securitized the entire spectrum of capital market institutions - pension funds, mutual funds, insurance companies, investment banks, and ultimately foreign investors – provided funding to the U.S. subprime market (Zimmerman, 2007). Thus, a wide range of individual investors and financial institutions worldwide were linked to the U.S. mortgage market. A large amount of subprime defaults translates into major losses on balance sheets that might even lead to bankruptcies.
Second, we all need to realize how investors make their decisions when purchasing securities. Thomas Zimmerman, Managing Director of UBS Investment Bank in New York wrote:
"...This problem is only compounded when subprime
securities are used in CDOs. As we’ve noted, it is difficult
to estimate which bonds (tranches) will be written
down on a single subprime deal. Mezz CDOs contain or
reference (if synthetic) hundreds of individual subprime
bonds and often contain CDOs of other CDOs. Calculating
expected bond losses on Mezz CDOs is a complex,
highly data-intensive task that requires access to a large
database and a large amount of computing power, as well
as knowledgeable analysts. Hence, it is difficult for the
average investor to forecast how a specific level of subprime
losses will impact a Mezz CDO."
Investors just trusted that the amount of risk they are undertaking corresponds to the risk the underwriters and the banks that created the CDOs believed it to be. Asking investors to exercise due diligence is unpractical in this case. Hedge funds, pension funds, insurance companies, and even private investors do not have the resources to examine hundreds of individual subprime loans in a given CDO. In other words, the new financial products have caused a lack of transparency which we can all agree is vital to a healthy, well-functioning market.
A corollary to that is the uncertainty that surfaced in the financial markets. While securitizing subprime loans funneled a large amount of capital into the subprime market and led to the dispersion of risk, it also created a growing uncertainty over the location of risk or, more precisely, losses. Scott Anderson, senior economist in Wells Fargo Bank and member of the ABA Economic Advisory Committee confessed: “while default risks have been widely spread and are unlikely to bring down any one industry, now nobody knows where the risks lie, since traditional financial products like mortgages have been sliced and diced and traded.”[i] In other words, a lack of transparency over the scope and potential losses of many deals created a vast amount of uncertainty in the market. Even if the scope of subprime-related deals were transparent, the average investor lacks the tools and knowhow to calculate the expected subprime-related bond losses.
Since investor do not know which banks, cooperation, hedge funds, and other publicly-traded companies will be affected from subprime-related losses, investors were (and still are) reluctant to invest in a dysfunctioning, uncertain market. The vast amount of uncertainty this situation created not only discourages investors from investing in the financial markets but it also leads to a liquidity crisis – a situation in which investors cannot resell their securities in the open market.
Third, one needs to also understand that securitization created a situation where the originator of a loan did not remain with the burden of the debt ( and the risk associated with). One of the themes coming out of the congressional hearings on subprime loans was the role played by securitization. The premise is that the relationship between loan originator and loan risk was broken due to securitization, and as a result lenders were less responsible in underwriting loans (Zimmerman, 2007). Thus, each party in the mortgage lending business had its own roles and interests. But all had a common goal: to pass the burden of the debt to the next level as quickly as possible. This segmentation had destructive repercussions that resulted in difficulties in determining where responsibility lies.
Summing it all up, securitization not only incurred losses to careless investors who did not exercise due diligence, but it also had rippling effects that undermined the very foundation of the U.S. and even global economy. The Fed (or any other pertinent policy maker for that matter) must take this fact into consideration when thinking about the future of securitization. Something has to be done to reestablish investors' confidence regarding securitization. Needless to say, if nothing is done about securitization, investors will simply stop investing in such securities in American markets; they will go elsewhere where they can enjoy more transparent, stable, conditions.
That being said, I think the benefits of securitization are too high to simply abandon it. After all, securitization enabled millions of people that would otherwise remain homeless to purchase homes. We just need to rethink how to tackle the current problems that it causes.
[i] Scott Anderson "How a liquidity crisis becomes a credit crunch." American Bankers Association. ABA Banking Journal 99, no. 10 (October 1, 2007): 88. http://www.proquest.com/ (accessed December 19, 2007).
Friday, May 2, 2008
Clinton and McCain - Different Party, Same Ploy
Hillary Clinton's annoying denouncements of the free market have always made me suspect that, deep down, she's a communist. She has gotten tremendous mileage out of her supposed opposition to NAFTA, her love of unions, and her relentless verbal abuse of anyone who dares to make more than $100,000 (besides those in her immediate family of course).
But now comes the best evidence yet of Clinton's economic beliefs. Ms. Clinton was so horrified by Exxon's profits this quarter that she felt the need to issue a press release criticizing the company and the state of our country.
This makes me wonder what exactly Clinton's economic policies are. Apparently making a profit is bad? She continues:
Clinton's concern for middle class families is of course very touching. But the tax itself, first proposed by McCain and now modified by Clinton, is far less inspiring.
Any even semi-rigorous review of the proposed tax shows how worthless it is. As Prof. Mankiw points out in the article, this tax is a clear situation in which the producers will simply pass the tax on to the consumers. The tax will have no appreciable impact on prices whatsoever. Even if the producers did not pass the cost on, analysis suggests that the increase in demand caused by the deflated prices would re-raise the price by most of the proposed 18 cent decrease.
This proposal illustrates the fundamental problem with presidential economics. It is constantly in the candidates' political interests to support economic policies with absolutely no merit, mostly because of the general ignorance of the public when it comes to such proposals. All the press publishes is that Clinton and McCain want to cut gas prices by 18 cents. Who is going to disagree with that?
Shame on McCain and Clinton for supporting this idea and, in doing so, blatantly pandering to public opinion. I find both candidates' stance equally disgusting - McCain for supporting it while trying to pretend some depth of integrity, and Clinton for supporting a do-nothing idea under the guise of saving her beloved middle class, successfully turning the debate into a fake issue of morality. Congratulations to Senator Obama, the only one with enough sense to oppose the idea.
But now comes the best evidence yet of Clinton's economic beliefs. Ms. Clinton was so horrified by Exxon's profits this quarter that she felt the need to issue a press release criticizing the company and the state of our country.
There is something seriously wrong with our economy when Exxon's record $11 billion in quarterly profits are seen as a disappointment by Wall Street. This is truly Dick Cheney's wonderland.
This makes me wonder what exactly Clinton's economic policies are. Apparently making a profit is bad? She continues:
But on Main Street, middle class families are facing devastating choices every day between buying groceries and filling up their gas tanks to get to work. They are being squeezed by a vice grip of record high gas prices, record declines in housing values and an economy that is shedding jobs and tumbling into recession.
I believe these families need immediate relief. That's why I have called for making Exxon and other oil companies with record profits pay the federal gas tax this summer. Now, Senator Obama doesn't believe in any kind of gas tax holiday. And Senator McCain doesn't want to pay for one. I believe we should impose a windfall profits tax on big oil companies and use that money to suspend the gas tax and give families relief at the pump.
Clinton's concern for middle class families is of course very touching. But the tax itself, first proposed by McCain and now modified by Clinton, is far less inspiring.
Any even semi-rigorous review of the proposed tax shows how worthless it is. As Prof. Mankiw points out in the article, this tax is a clear situation in which the producers will simply pass the tax on to the consumers. The tax will have no appreciable impact on prices whatsoever. Even if the producers did not pass the cost on, analysis suggests that the increase in demand caused by the deflated prices would re-raise the price by most of the proposed 18 cent decrease.
This proposal illustrates the fundamental problem with presidential economics. It is constantly in the candidates' political interests to support economic policies with absolutely no merit, mostly because of the general ignorance of the public when it comes to such proposals. All the press publishes is that Clinton and McCain want to cut gas prices by 18 cents. Who is going to disagree with that?
Shame on McCain and Clinton for supporting this idea and, in doing so, blatantly pandering to public opinion. I find both candidates' stance equally disgusting - McCain for supporting it while trying to pretend some depth of integrity, and Clinton for supporting a do-nothing idea under the guise of saving her beloved middle class, successfully turning the debate into a fake issue of morality. Congratulations to Senator Obama, the only one with enough sense to oppose the idea.
Monday, April 28, 2008
The Fiscal Policies of the Candidates... stink
This Times article on the candidates’ lack of fiscal restraint is, for the most part, an insightful reminder that the economic wool is being pulled over the eyes of the American voter. Authors Larry Rohter and Michael Cooper demonstrate that whether the candidate concerned is a tax-cutting war hawk or a free health care-loving liberal, he or she is clearly hoping that the American people will look the other way while the national debt continues to balloon. The only thing that is missing from this article is a concrete explanation of the negative effects of a rapidly-increasing national debt, but I suspect that’s because such a discussion would need to be either overly simple or complex beyond the constraints of the paper.
The first candidate’s fiscal plan to fall under their journalistic knives is McCain’s. The Arizona Senator has proposed to make the Bush tax cuts permanent. Since they are currently set to lapse in 2010, this proposal would cost the government $2.2 trillion in revenue over the next ten years. And McCain doesn’t stop there—he proposes to eliminate the alternative minimum tax, slash corporate taxes, and double the exemption which parents can claim for their dependents. The total price tag of McCain’s other tax-cutting schemes is $225 billion per year. Over a decade, that’s another $2.25 trillion of lost government revenues. McCain claims he’ll pay for the cuts by eliminating earmarks, spending riders that are often attached to important bills to secure the support of one or another congressmen or senators, but it’s ludicrous to think that the savings from those earmarks will be enough to offset the tremendous government losses from these tax cuts. I read in an Economist article that earmarks account for something like .5% of government spending—not enough to make a significant impact.
There’s no question that lowering the marginal tax rate will spur growth in the short run. Indeed, Rohter and Cooper note that McCain and his fellows would have us believe that the growth from these tax cuts will increase the size of the economy so much that while the government will take in a smaller percentage of GDP, the absolute size of federal revenues should remain fairly stable. We should remember that we’ve heard this tune before. This was the same argument advanced by proponents of the Bush tax cuts in 2001 and 2003—but the national debt has nearly doubled since 2001, so it simply can’t be true.
Just because I’m concentrating on McCain’s policies doesn’t mean that the authors let Clinton and Obama off easy. They, too, are guilty of presenting budget numbers that are at odds with figures cited by nonpartisan authorities like the Congressional Budget Office. One example of this is both Democrats’ penchant for promising to “repeal” the Bush tax cuts and count the money saved as new revenue. However, the tax cuts are already set to lapse in 2010; no repeal is necessary and that money has already been included in budget estimates for later years.
The only thing missing from this analysis is a good explanation of why, or even whether, an expanding national debt is a Bad Thing. Does it have adverse consequences? Even at its present all-time high levels, I haven’t read much about how the national debt is hampering growth or hamstringing our government’s ability to do its job. That said, I think that it’s reasonable to expect that there will come a tipping point in the national debt, when interest payments do force higher taxation. As a percentage of GDP, the debt has certainly expanded a great deal during the last 7 years. If the debt’s growth continues as the policies of the candidates imply, it looks like its share of GDP will continue to expand. Although Rohter and Cooper don’t mention it, I think the real danger is that our next president will continue to spend irresponsibly and take us over the edge, beyond the tipping point and into a harsh reality where the debt has severe adverse consequences for the American economy.
Sunday, April 27, 2008
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