Life in Kibera

I try to do a little more than just link to other people's writings, but this is one of the best articles I've read in a while:

Upwardly Mobile Africa: Boomtown Slum

And the correspondent undoubtedly knows a lot more on the subject than I do. The article tells the story of a day in Kibera, the largest shanty town slum in Africa. It is part of Nairobi, the capitol of Kenya. Around 1 million people live informally (i.e. as squatters), without a sign of the government, in one square mile.

The point of the article is that this is not a pit of humanity festering in poverty. It is a very poor place, but has a very entrepreneurial and growing economy. Signs of growth can be found all over, and new residents come from the country side to seek a better life. Many in Kibera have incomes above the poverty threshold (of $1.25 a day), many residents are counted among the middle class according to the World Banks threshold of $10 a day.

Before anyone gets too libertarian about it, the government can make these people better off. Their richer neighbors in Nairobi pay less for water and electricity because they don't rely on informal businesses to tap into the grid. But what can a cash-strapped government do? Formalizing the shanty town and giving property ownership to the residents would immediately boost their wealth and give the countless entrepreneurs access to capital. 

Ayn Rand

A random thought hit me today. It’s about Ayn Rand, but don’t let that stop you from reading this. Ayn Rand argued that true morality was to not care about anyone’s interest but your own. Everyone pursuing self-interest would end up maximizing their own benefit. And if everyone’s benefit is maximized, society is best off. This logic comes from the First Fundamental Theorem of Welfare Economics, which holds that “competitive equilibrium is Pareto Efficient”. Competitive equilibrium means markets are perfectly competitive (no one firm has market power), and all in equilibrium (supply equals demand, no shortages or surpluses). Pareto Efficient means that no one person can be made better off without making someone else worse off. 

There you have it, one paragraph. So if you were considering reading Atlas Shrugged, don’t worry about it. But there are a few essential requirements for the First Fundamental Theorem to work; and they can't possibly exist in the real world:

1. All markets are in equilibrium – The economist Leon Walras proved that if all but one market is in equilibrium (say, theoretically, 9 out of 10) the remaining unstudied market must also be in equilibrium. The flip side is that if any one market isn’t in equilibrium, other markets must also be in disequilibrium. Which sounds more likely?

2. No externalities/market failures/public goods – This condition can’t possibly be true in the real world. Think of pollution, without government regulation a coal power plant suffers no cost for pollution, but the wider public does. This means from the point of view of society, the power plant over-produces because its monetary cost of production is less than the true cost of production. This externality breaks the no surpluses condition of equilibrium. There are clearly market failures, asymmetry of information being a classic example. There are clearly public goods, such as education.

3. No interdependent utility – This is the condition Rand was so in to[1]. It means no one’s utility, or personal well-being, depends on anyone else’s. Parents don’t care about kids, friends don’t care about friends, etc. It clearly isn't the case.

So it’s impossible for the First Fundamental Theorem to exist in the real world, though it is a very useful model for studying economics theoretically. And it’s a shame people can’t distinguish between a thought experiment and legitimate policy. Pareto’s theories were eagerly adopted by supporters of planned economies because they can show that optimal efficiency can never be brought about by purely unregulated markets (which will not be perfectly competitive)[2].

The reason I bring this up is the last condition, no interdependent utility. Rand argued that an individual’s utility shouldn't be influenced by other individuals. She spent a lot of time on it, wrote rambling monologues on it, yelled “compromiser!” at Friedrich Hayek the only time they met. She cared that he wasn’t as much an ideologue as she was[3]. She cared about spreading her ideas, and convincing people to believe them. You could say that part of her utility depended on what other people thought and did. This of course violates the 3rd condition for the theory she espoused to be true. It simply can never exist; humans just don’t act that way. 

Update on the Federal Reserve

This week the Federal Reserve has taken further unconventional action to attempt to stimulate the economy. In September the Fed announced it would buy bonds and other securities with newly created money to increase the money supply (more details here). With not much sign of things getting better yet, the Fed has expanded its asset purchasing (as in money creation) from $40 billion to $85 billion per month.

But that is only half the story. In September the Fed said it would continue making new money until unemployment falls back to "normal" levels, but only if inflation stays low. The limitations and thresholds were somewhat vague, which dulls the effect of the policy. However, this time, the Fed explicitly stated that it will continue creating money until unemployment goes below 7%, and keep interest rates near 0% until it goes below 6.5%. And even when it does they will not stop immediately, but rather gradually wind down the program. This is conditional on inflation staying near or below 2.5% in the short run[1]. The benefit of this policy is that the Fed is now committed in a clear manner to its stimulus. And as conditions change economic actors will know at what point the Fed policy will change.

I previously spoke of how large a change outlining policy in this manner is for the Fed. This is the first time ever the Fed has set an unemployment rate target[1]. Past efforts have involved set dollar amounts and calendar deadlines. Now the policy is still clear and predictable, but flexible and limited only by the accomplishment of its goals (you can find information on how monetary stimulus helps the economy here and here). I am a huge supporter of the Feds recent policy changes. While its no magic bullet and the magnitude of the effect is a matter of debate, it speaks well of our monetary institution that the Fed has been so able to adapt and act to economic conditions. 

My only present concern is the focus on keeping inflation near or below 2.5%[2]. I've posted about why inflation is not a threat in this weak economy here and here. We would not be hurt by inflation in the 3 - 4 % range, inflation has been that high numerous times in the past two decades. Keeping inflation relatively low will dull the stimulative effect because the Fed can only reduce inflation by slowing down the economy. The low inflation ceiling could lead people to expect that stimulus will be withdrawn too early. Metaphorically, the Fed is giving the economy more gas while still keeping a foot slightly on the breaks.

November Jobs Report

Middling is a good way to put it. 146,000 jobs were added in November, which is pretty close to average. In the face of the uncertainty of the fiscal cliff, depending what effect that uncertainty has, average could be better than it seems. According to the BLS, hurricane Sandy had little effect on employment. 

But the situation looks a bit worse once one looks deeper. The labor force participation rate declined, off-setting October's increase. This, and the added jobs, has brought the unemployment rate down to 7.7%. The data for the months of September and October were revised down by a combined 49,000 jobs, the first downward revision since April. The revision brings the monthly average job growth so far this year to 151,000, compared to 2011's 153,000. 

Politics

Guess which continent wasn't politically important enough for UN Secretary Dag Hammarskjöld's head to not block in this posed picture.

That's a bit unfair. He died in a plane crash in Africa on his was to the Democratic Republic of the Congo to negotiate a cease fire between factions that were tearing the country apart in the "Congo Crisis". Granted, UN members such as the United States, Belgium and the Soviet Union were using it as a playground for the Cold War, and completely undermined anything a neutral member of the UN could do. Also Dag was an economist so he couldn't have been that bad. Then again:

Fiscal Cliff Update

Because of the timing, I’d like to expand on a previous post about the fiscal cliff, seen here.

The CBO has released a new report about how terrible the fiscal cliff will be unless congress acts to prevent it. The basic story is the same, but there are a few key details worth dwelling on. The figure below provides a nice summation of them. The column on the left is dollars of GDP lost per dollar cut; the column on the right is essentially how many full time “equivalent” jobs will be lost per million dollars of cuts. 

The first thing noticeable is that the spending cuts that were part of the deficit ceiling deal will be the most damaging to the economy and employment. This is because discretionary spending (spending subject to the annual appropriations process in congress) is below its 40 year average, each additional cut will damage the economy more. The mirror of this is that tax increases will have less damaging effects per dollar of the deficit reduced. This is because taxes are below their 40 year average.

Furthermore, when “Extend Most Expiring Tax Provisions and Index the AMT to Inflation” is compared to the same policy “Except for the Lower Tax Rates on Income Above Certain Thresholds” (or, let the Bush Tax Cuts expire for the rich) there is little effect. In terms of GDP, the average difference in growth will be $0.10 per tax dollar forgone – notice though that the estimated range for increasing or not increasing taxes on the rich is the same. In terms of employment, increasing taxes on the rich is estimated to have no effect. It’s almost as if “the Job Creators” will keep working even if they keep a few percent less of their incomes each year. 

Poverty

Here's a simple post. There's a lot that's wrong in the world; but we should keep things in context. Poverty world wide is decreasing at the most rapid pace ever observed. It shows what good can be done when markets work, as opposed to corporatism masquerading as capitalism. No system has a better track record.

At the same time, this raises the question of what is happening in the United States. Whereas global inequality is decreasing, in the United States it is increasing. Whereas global poverty is decreasing, in the United States it is increasing (mostly due to the Great Recession but considering that it is at least not decreasing). As the graph below shows, while the United States has a lower poverty rate than many countries, it has a higher rate than pretty much every other developed country. And in a country of 310 million-ish people that results in a very large population in poverty.

So, the election, requisite post:

Obama wins, about 52% in the popular vote but barely a dent in his Electoral College count from last time, etc.

Conservatives: will blame Romney for not being conservative enough. One of the few relative "moderates" left has some insight on that:

“If I hear anybody say it was because Romney wasn’t conservative enough I’m going to go nuts. We’re not losing 95% of African-Americans and two-thirds of Hispanics and voters under 30 because we’re not being hard-ass enough.” – Lindsey Graham

But they’ll probably say that anyway despite two senate elections lost due to very conservative candidates' offensive ignorance about women and rape. Also worth mentioning: the states of Washington and Colorado decided to pursue sensible public policy by legalizing and regulating the sale and possession of marijuana.

Anyway, what about Maryland? In Maryland voters upheld a law giving illegal immigrants a pathway to receive in-state tuition rates at public colleges and universities. I’ve recently posted on the benefits of immigration and the difficulties of legal immigration. And education is the ultimate public good, higher levels of education make everyone better off. Additionally, Marylanders voted to uphold the state law allowing same sex marriages, or rather, upheld a law allowing equal access to the legal status given to people who receive marriage licenses. Maryland is indeed a great state, where a majority of people came out to vote for better public policy and the furthering of equality before the law. 

In fact election night was a big night for gay rights and equality. After losing every previous referendum on gay marriage, referendums supported it in Maryland, Maine, and Washington; and a referendum to establish a constitutional ban on gay marriage in Minnesota failed – a veritable sweep. Furthermore, voters in Wisconsin elected Tammy Baldwin to the senate. Unless a current senator comes out in the next couple months she will be the first openly gay U.S. senator. All in all, a good night for progress.

The Fiscal Cliff

The Fiscal Cliff is the popular term given to the scheduled expiration of mostly tax increases and spending cuts that will take effect as certain laws expire this coming January. Expiring tax provisions include the Bush tax cuts, tax cuts enacted as stimulus measures such as the payroll tax holiday and a provision limiting the expansion of the Alternative Minimum Tax[1]. Spending provisions from the Budget Control Act (the debt ceiling deal) will reduce discretionary spending and extended emergency unemployment benefits will expire starting in 2013.

In the coming decade, the expiration of these policies will reduce budget deficits to around 1.4% of GDP per year and debt from 73% to 61% of GDP. Failure to let these provisions expire will result in debt increasing to 93% of GDP by 2022. In the long run growth will be lower if these provisions never expire.

However, in the short run, given the weak state of our economy[2], allowing every provision to expire at once will cause the economy to contract and unemployment to rise. The Congressional Budget Office (CBO) forecasts the fiscal cliff will knock growth down to 0.5% over the next year and increase unemployment to 9.1%. The annual growth of 0.5% breaks down to negative growth of 1.3% on an annualized basis[3] in the first half of the year before recovering to grow by 2.3% annualized by the second half. Put simply, with the fiscal cliff, the worst year of the recovery has yet to happen. I personally find the CBOs non-cliff growth forecast to be too optimistic. But the size of the hit is the same; the CBO provides what is most likely a very best case scenario.

Those who think congress could never be as reckless to let this come to past should think back to the deficit ceiling drama. But even if it’s avoided, we are already suffering due to the uncertainty. The CBO estimates that the uncertainty alone will reduce growth in the second half of the year by 0.5% annualized. J.P. Morgan reports that 61% of its clients say the fiscal cliff is affecting their hiring plans. Economists Sylvain Leduc and Zheng Liu of the Federal Reserve Bank of San Francisco estimate that uncertainty has already added 1% to the unemployment rate.

Given the reality of the situation, simply delaying all elements of the fiscal cliff would be better than letting it happen. But the tax policies should expire first, and for the wealthy first. Even if none of the spending cuts take place, discretionary spending (the spending that is appropriated annually as part of the budget process) will still finish the decade below its 40 year average. And our tax system needs simplifying reforms to raise revenues. But the undeniable truth is that our debt problem cannot be solved by tax increases and discretionary spending cuts alone. Mandatory spending, especially on health programs, such as Medicare, Medicaid, and Social Security, will sink us eventually. If we can’t reform those programs, the only outcomes of the fiscal cliff debate are to ruin our economy now, or delay the inevitable by a matter of years later.

October Jobs Report

It's the last jobs report before the election, 171,000 jobs were added in October. A number that is only good relative previous jobs reports and the pessimistic expectations of market watchers. If this stayed the level of job growth we would return to pre-crisis unemployment by 2018ish. But the figure is an improvement, and furthermore, the numbers for the previous two months have been adjusted upwards by a combined 84,000 jobs. The unemployment rate increased to 7.9% due to an increase in people actively looking for jobs, a good sign.

As an example of how large future revisions can be, when the August jobs report came out the BLS reported a paltry increase of 96,000 jobs. By this report that number had be revised to 192,000 jobs added.

Legal Immigration

Some opponents of immigration attempt to hide behind an opposition to solely illegal immigration (the "wait your turn" argument). It makes them look civic, rather than xenophobic. 

To supplement my previous post about the benefits of immigration, a nice flow chart of just how cumbersome and lengthy the legal immigration process is can be found here. Many people without direct family in the U.S.A. who would like to immigrate have no legal avenue, especially the poor and unskilled. See also, Franz Kafka's Before the Law.

Migration and its Benefits

Lower barriers to migration is by far the best policy option to increase economic growth, and reduce poverty. Yet there’s still debate and hypocrisy. How can a country, or person, who espouses the benefits of free markets be against the free flow of labor? It’s half the basic production function[1]. Anyway, if you click “read more” I intend to show that the evidence is overwhelmingly in support of freer migration. And opposition is only possible through ignorance, hypocrisy, or malice for the poor. Here are the basic conclusions showing freer migration, of both skilled and unskilled workers, is the single best policy option for the world economy.

1. Complete reduction of barriers would increase world GDP by between 67-147%. Even a small reduction in barriers would lead to welfare gains larger than the complete elimination of remaining barriers to goods and capital flows.

2. Migrants from the developing world themselves are the largest beneficiaries of migration. At the median, a migrant to the U.S. will experience a wage increase of around 4.11 times their pre-migration wage.

3. Immigration increases productivity and employment levels for all workers, including native workers.

4. No study has found large negative effects on GDP, wages, or government finances/service provision due to immigration.

5. Emigration from developing countries puts upward pressure on domestic wages, increases incentives for education, and leads to remittances. All of which make emigration a net benefit for poor countries.

Gender Differences in Developing Countries

Well this is pretty shameful:

Yet...

Innovation and Patent Laws

Believe

September Jobs Report

There's some unusual news in the area of unemployment statistics. First, in late September, the BLS issued a preliminary revision to their March 2011 – March 2012 numbers; they underestimated job growth by about 20%. In a way this is news only a statistician could love, the effect of these job gains won't change because the measurement is more accurate. And it does make the apparent slowing down of the economy look more pronounced. But it's still good news that we weren't doing as poorly as thought. The figure below shows the gains since March starting from where the revision put the total increase in jobs ending March 2012. 

The news for September in particular is complicated. The increase in total non-farm jobs was reported at 114,000. A lame number, not terrible but not any good either. The numbers would be terrible if the government was still shedding jobs, instead government employment is creeping up. On the good side the numbers for July and August were revised upwards by a total of 86,000 jobs. 

Further complicating things is the fact that the unemployment rate dropped, from 8.1% to 7.8%, and not from people leaving the labor force. It is the first time the unemployment was below 8% since January 2009. The unemployment rate is calculated using a different survey, of households rather than businesses. The household survey shows an astonishing 873,000 more jobs than in August. The household survey numbers are volatile, and the two numbers often diverge, but over time are similar in aggregate. As Floyd Norris (Chief Financial Correspondent for the New York Times) points out,
“A year ago, the the establishment numbers were looking better than the household numbers. Now the reverse is true...Over the last 24 months, however, the two reports are virtually identical, showing an additional 3.6 million jobs and workers." 

I really don't have the expertise to shed any more light on the confusing batch of statistics today. But the take away message seems to be that the economy is and was doing better than we thought, but it's still slowing down.

Rating Politicians

I was drunk during the debate, just like in '08. It helps you pay much less attention to what's being said, but notice how it's being said. Mitt Romney said everything better; Obama seemed like he forgot he had the debate that night. Also the format was terrible.

Anyway, to help judge the candidates by what they actually say and do, The Economist has (un-scientifically but whatever) polled hundreds of professional economists in the United States.

Overall Obama seems to have a lead over Romney when it comes to economic policy. Though Romney is slightly favored by business economists. The results are typically much closer on the specifics, though Obama opens up wide leads on certain issues.

The best part of these polls however, is how the economists identify themselves politically. The largest group, at 50%, is independents, followed by Democrats, with 43%, and only 7% of economists polled are Republicans. This result is nearly identical to when the same polling was done four years ago. It warms my heart to know that half of economists are independents and only 7% Republicans.

Art for Tired Eyes

Economists

"I don't know what to do
But I know what not to do"

- Volcano!

QE3: The Fed Steps In

The Federal Reserve has decided to further stimulate the economy in a bold and unprecedented manner. The Fed announced, in a 12-1 decision, that it would “[purchase] agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate…in a context of price stability.” These purchases will continue so long as “the outlook for the labor market does not improve substantially.” And even if it does “[A] highly accommodative stance of monetary policy will remain appropriate for a considerable time.”

This action is very different from past Fed actions in that it’s theoretically unlimited in its commitment. In previous quantitative easing the Fed committed to specific dollar amounts. The new policy is limited only to $40 billion per month, for a length of time yet to be determined. The Fed buys bonds from banks with newly created money[1], this reduces the cost of lending, and thus of borrowing, which lowers the cost of consumption and investment. The focus on mortgage-backed securities will reduce the cost of mortgages in particular, stimulating housing demand. There are other channels through which QE stimulates the economy; however, if the banks aren’t willing to lend or individuals/businesses willing to borrow the stimulative effects will be lessened.

On the positive side, this action comes just days after the European Central Bank (ECB) made an unlimited commitment to buy bonds of European countries that are in a debt agreement with the EU/IMF. That the Europeans have made a similar commitment increases the simulative effects of Fed action. Economic policy works best when pursued in unison.

Some people are concerned about the inflationary effects of such policies. There are two basic possible outcomes: either it won’t work, in which case inflation won’t be an issue, or it will, in which case the Fed can withdraw the stimulus and reduce inflationary pressure (more details here and here). Inflation has been historically low and stable since before and especially after the recession. And the Fed doesn’t seem too concerned for now, stating, “If inflation goes above target, we take a balanced approach: bring inflation back to target over time but in a way that takes into account deviations of both [unemployment and inflation] from our target.” The Fed has a duel mandate to keep inflation and unemployment low. Currently inflation is below target and unemployment above target, so this policy is very consistent with the Fed’s mandate.

Now it’s up to the politicians, which isn’t as confidence inspiring. The Europeans need a political solution to escape their debt crisis; the ECB can only buy them time. The United States needs a political solution to the “fiscal cliff”, a detrimental combination of tax increases and spending cuts that will take effect in January. The Fed can only soften the blow slightly. Yet whatever happens, it is good to know that, like a good friend, “the Fed will be there to do what it can.”

August Jobs Report

The economy added 96,000 jobs in August. A lower number than last month was expected, by me at least for no other reason than it fits the pattern (see last report). But it seems that the continuing/worsening crisis in Europe and the slow down of Emerging Economies (most notably China) has taken its toll in slowing down US job growth even more.

Worse, the number of people looking for work declined as well, bringing the Unemployment Rate down to 8.1%. Previous month's numbers were revised downward a total of 41,000, as indicated by the red line (which shows figures from before the last revision).

Economist Quotes

''I am often considered almost not a part of the profession of Establishment economists. I am even referred to as a sociologist. And by that economists usually do not mean anything flattering."

- Gunnar Myrdal

Credibility

This is a funny book. I haven't read it, but the cover is so hilarious that the rest of the book has to be[1]. It’s easy with hind-sight, but I can’t imagine how this could have ever been a reasonable theory.

The only way for the Dow to reach 36,000 in the time the authors gave (closer to 36,000 than 10,000 by 2010) would be if the economy was about to experience explosive growth or a massive bubble the developed world has, still, never seen. The Dow currently stands between 13,000 - 14,000[2]. The book was written in 1999; the authors were arguing that stocks were cheap at precisely the time they were overvalued due to the dot-com bubble. 

A common measure of stock valuation is the Price to Earnings (P/E) ratio. It is the price of a share over the annual earnings one would receive from owning the share[3]. A high P/E ratio means either profits will increase in the future or there is a bubble. As the graph below shows, the long run average P/E ratio is around 16.

At the end of 1999 the P/E ratio for the S&P 500 was around 30, for the Dow it was around 27. On top of that record setting overvaluation the authors thought stocks could only go up.

I bring this up because one of the authors, Kevin Hassett, is now a Romney adviser, and recently criticized the Tax Policy Center (TPC) for explaining[4] that Romney’s tax plan would result in a higher tax burden for the poor and middle class, and a much lower tax burden for the rich. For some reason, I just don't trust him to be correct.

July Jobs Report

Better than last month but not good pretty much sums it up. 163,000 non-farm jobs were added in July. Previous months were little revised and the labor force shrank slightly. It's further evidence that this is just what the pace of recovery will be; the jobs market has produced these results for three years now.

It is almost uncanny how repetitive the process has been. Encouraging job growth over the winter followed by months of disappointingly low numbers, followed by a upward blip in late summer before diminishing until winter. This is the late summer blip, last year it came in August, the year before in September. It's slightly good news in that following months shouldn't be as disappointing as previous months, until next spring.

What this means for policy is that nothing will change there either. Policy has remained essentially unchanged since the recovery started. In fact, job growth is slightly higher. Since February 2010 job growth has averaged around 138,000 per month, while in the past year it has averaged 153,000 per month. This certainly means that the Fed won't act, if conditions aren't changing their policies won't change. But the Fed does expect growth to pick up next year, not that their forecasts have been all that accurate. Generally speaking that puts the unemployment rate reaching 2008 levels in 2016.

Inflation, again

About six months ago I posted about the nonsense in worrying about inflation in the middle of a weak recovery. Since the topic keeps coming up as an argument against further monetary stimulus I want to point out that I was right then, and I still am. This is a dangerous thing to do in the economics profession: Irving Fisher, one of the greatest economists of all time, is best remembered for his statements about the “permanently high plateau” of stock prices months before the 1929 crash. But confidence abounds. Inflation won't take hold until capacity utilization is higher than average, driving the cost of production (and then prices) up[1]. The Fed can greatly influence inflation by raising (to lower inflation) or lowering (to increase inflation) interest rates.

It is pretty obvious that capacity utilization is still below average (think about the spare labor capacity). The people who have preached doom about inflation have been wrong now for four years, and have had a detrimental influence on government policy the whole time. In fact, since my original statement on the non-threat of inflation, inflation has dropped by over a percentage point.

Other measures of inflation tell much the same story.

Along with the fear of inflation, the Fed has been criticized for punishing savers and investors by keeping interest rates so low. Jim Demint recently admonished the Fed Chairman that he was costing Americans “about $400 billion a year on lost interest”. I didn’t bother finding out where the figure comes from because, though I understand the logic behind it, it is wrong.

All of this is related because during and after a financial crisis it is deflation that is the true threat. As Irving Fisher pointed out, the sever deflation that set in after the crash caused real debt burdens to increase. That is, deflation increased the value of outstanding debts faster than individuals, governments, and businesses could pay them off. The collective action of reducing spending to pay off debts merely increased the rate of deflation. 

 

The unshaded portions of the "1933" bars represent the amounts in 1929 $s. Notice that while national wealth decreased greatly internal debt actually rose.

The solution was easy, looser monetary policy to bring prices and inflation back to “normal” levels. By acting quickly and unprecedentedly this time around, the Fed stopped deflation and kept the downward spiral from kicking in. Since the average American household had debt of over 130% of disposable income, the Fed’s actions have saved Americans money by keeping their real debt burden from growing uncontrollably.

Economics, Politics, Sailing, and Realism

"The same persons who cry down Logic will generally warn you against Political Economy. It is unfeeling, they will tell you. It recognises unpleasant facts. For my part, the most unfeeling thing I know of is the law of gravitation: it breaks the neck of the best and most amiable person without scruple, if he forgets for a single moment to give heed to it. 
The winds and waves too are very unfeeling. Would you advise those who go to sea to deny the winds and waves - or to make use of them, and find the means of guarding against their dangers? My advice to you is to study the great writers on Political Economy, and hold firmly by whatever in them you find true; and depend upon it that if you are not selfish or hard-hearted already, Political Economy will not make you so."

- John Stuart Mill

Outsourcing is a Good Thing

Recently the topic of outsourcing has again become popular in the news. The scandal is currently over whether Mitt Romney was working at Bain Capital when they closed down some companies and moved jobs overseas. I would like to point out that if these companies had not either already gotten themselves into trouble or been out-competed elsewhere, a company like Bain wouldn't be buying them. It’s not Bain’s fault the most profitable thing they could do was declare bankruptcy. Second, it doesn’t matter if Romney was at Bain when they outsourced jobs. Outsourcing is in fact good for the world economy, and good for the poor. As economist Paul Krugman put it back when he was still cool:

“The lofty moral tone of the opponents of globalization is possible only because they have chosen not to think their position through. While fat-cat capitalists might benefit from globalization, the biggest beneficiaries are, yes, Third World workers.”

The jobs that have left the United States in search of cheap labor left because wages here are too high relative to destination countries to economically justify keeping them in the United States. This is a good thing; it means we are a developed country. The flip side of this is that the wages outsourced jobs offer to developing country workers are as good or better than the alternatives for those workers, otherwise they would not take the jobs. The increased availability of outsourced jobs increases competition for workers, and increases wages of the world’s poorest. And there is overwhelming evidence of this in the 1 billion people who have been raised out of poverty in the past couple decades.

It gets even better, because outsourcing is good in net for the countries that jobs leave. First, outsourcing, if rational, reduces the cost of production, which inevitably gets passed on to consumers. The effect is upward pressure on the real wages of consumers who can now buy more for the same money. And many of our imports are inputs for final production in the United States, meaning more profitable production, and thus more jobs here.

In spite of all this it could very well be possible that the effect on jobs and wages is negative for developed country workers, but only in the short run. Increasing wages in developing countries eventually reduce the incentive to outsource jobs in the first place. Already thousands of jobs that were outsourced to China are returning to the United States as wages rise in China. And there is much higher domestic demand for products all around the world in developing countries. The United States’ trade deficit has closed considerably in recent years. And despite decades of outsourcing the export sector in the remains one of the bright spots in our economy.

Mitt Romney should stand up for himself. He need not have been motivated by anything more than profits to have brought benefits to the poor in developing countries, and to consumers in developed countries. And the opponents of outsourcing and globalization should realize that their opposition keeps people poor for the benefit of the few, hardly a sound strategy to reduce inequality.

What's the Fed up To?

Given the bad economic news of late, many eyes have turned to the Fed as it seems to be the only institution left with the ability to act. Central Banks the world over have been stepping in: The Bank of England started a new round of Quantitative Easing[1], the European Central Bank, the Bank of Korea, the Central Bank of Brazil, and of China have lowered their target interest rates to ease lending[2]. 

Though it has not made big news, the Fed did recently act by embarking on a second installment of “Operation Twist” (OT). OT is a process where the Fed tries to twist the yield curve for government bonds to push down long term interest rates and push up short term interest rates (see out of date graph below). The Fed does this by selling its short term bonds and buying long term bonds, in this way the action puts no upward pressure on inflation. Basically, when one buys a bond they are purchasing the future stream of interest payments that bond will generate should the borrower not default, therefore, the higher the bond price the lower the real interest rate. Reducing long term interest rates is the more important goal because it will stimulate (in theory) capital investment and housing demand.

But this additional action is more appearance that substance. The effectiveness of the practice in general is still highly debatable. The law of diminishing returns holds that each additional bond sold and bought by the Fed will have less and less of an effect, another round of OT will thus be less effective than the first (which hasn’t exactly fixed the economy). The Feds stock of short term bonds is not infinite and it would be very unwise to sell them all and reduce the diversity of bonds held. According to Macroeconomic Advisers (a consultancy I enjoy referencing), as the Fed sells off its short term bonds it will eventually need to sell off short term bonds of a longer maturity, decreasing its effectiveness further.

So why do it? The Fed has constantly been saying that if the economy slowed further it would take stimulative action. In fact they just yesterday teased at this prospect again. Given their statements, and the poor state of the economy when the first round of OT ended, doing nothing more would have the appearance of withdrawing stimulus. Put simply, the Fed has acted to keep people from noticing that it has not really acted. 

That being said I think the Fed is a great institution. If only other institutions, such as the FDA and EPA were as politically independent with as clear a mandate. 

June Jobs Report

 
Another terrible jobs report, only 80,000 jobs were added in June. The numbers for previous months were barely changed (red line). Just like last year, the economy has stagnated after a strong winter. The trend is now pretty ingrained and growth forecasts the world over are being cut. In other news inflation has decreased and is below the Fed’s low 2% target. So unemployment is above target (ie. “The natural rate”) and inflation is below target. The Fed is now missing on both ends of its mandate rather than just the employment side, yet it doesn’t act. And crazy people continue to worry about inflation.

At the end of this year we face what is being appropriately called a “fiscal cliff”. Taxes across the board are going to go up and discretionary spending (the part that isn’t contributing to our unsustainable debt) will be slashed. The combined effect of this will likely put us back into a recession. The CBO recently estimated that the full effect of the fiscal cliff will cut growth to 0.5% of GDP next year (it is currently around 2%). And unemployment will rise above 9%. What CBO projections don't include is psychology. If growth decreases that suddenly and unemployment increases the negative effect on confidence and expectations could easily put the economy into a recession. If politicians continue to fail us, this may be the best economy we'll see for years.

Ethics

In November 1929, a month after the stock market crash, a letter was sent to the American Economic Association asking what its Code of Ethics was for practitioners of economics. The secretary of the association replied, in full:


“You should know that our middle name is “Ethics”, but we have no particular code, consequently, I cannot comply with your request.”

The Economist Formatting Errors pt. 3

May Jobs Report

The May Jobs Report has come out and it’s certainly bad news. Only 69,000 jobs were added in May; the unemployment rate stands “essentially unchanged” at 8.2%. Long term unemployment increased by 300,000. Additionally, the numbers for March and April were revised down. March job growth was revised from 154,000 jobs added to 143,000; April was revised from 115,000 jobs added to just 77,000 (the red line shows the unrevised numbers). The only piece of not terrible news is that the participation rate (people who have jobs plus people who are actively looking for jobs) increased. 

If numbers like these continue, job growth won’t even keep pace with population growth. Factoring in population growth the economy needs to add roughly 200,000 jobs a month to return to levels of unemployment seen in early 2008 by 2015, and recent growth is nowhere close.

Just Saying

Not to risk politics, but this is a useful demonstration of why budget policy matters all the time, even when times are good. Coming out of the 2001 recession, the CBO projected sustained and increasing budget surpluses. Granted, one should never put too much faith in the CBO baseline scenario coming true; it is based on current law continuing unchanged, even if it is highly unlikely.

This graph demonstrates what could have been. Any number of policy changes, especially less tax breaks and wars, could have given the government far more room and flexibly to act in a counter-cyclical manner.

A Follow up on a Follow up on the Futures Market and Gasoline Prices

Gas prices continue to fall, which was to be expected since that's the direction the futures market was going in anyway. But, the futures market is now expecting prices to drop more than before.

April Jobs Report

Job growth continued to slow in April to a disappointing 115,000 jobs added. There is some not bad news: more jobs were added in February and March than originally reported (red line on the graph). Though that isn't all that significant.

The unemployment rate dropped 0.1%, which was due mostly to the fact that around 340,000 people dropped out of the job market.

Commemoration

It’s been a year since Osama bin Laden was killed. So to commemorate, here are some facts: 

Polio still exists. It’s still endemic in Nigeria, India, Pakistan and Afghanistan. Many curable diseases have a strong prevalence in the developing world and continue to hold people in poverty unnecessarily. Even when the cures are available for free, poor people are mistrusting of rich world governments and organizations that typically are seen as uninterested at best. There is a too common conspiracy theory that vaccine drives are just fake CIA plots to steal people’s DNA for whatever crazy reason. Well, that’s exactly what the CIA did to try to get the DNA of bin Laden children who were in the compound. They started a fake Hepatitis B vaccine campaign; they couldn’t even do a real one to cure people while they were at it. They even had the real vaccine, and wasted it by not giving people the full number of doses. 

How many people, with a real world example of the conspiracy theory in hand, lost any remaining trust in public health campaigns? How many diseases will go untreated? How many families will stay or fall back into poverty due to preventable illness? The counter argument is that such actions were necessary for finding Osama bin Laden. The same justification for why we had to torture people, one of whom gave up bin Laden’s courier they say. But I would rather people not think it's ok to torture people and destroy confidence in public health for their own ends. Especially given this:

Bin Laden’s influence and ability to inspire people was already degraded; for whatever reason, his importance had left him. The Arab Spring left him and everything he stood for behind, and ineffective by comparison. Even in Pakistan less than 20% of people thought he was doing “the right thing”. Given this perspective, his killing amounts to simple revenge. And I was just fine with that at first, he certainly deserved to be killed. But on the whole, we are worse off having taken the actions we did to kill him, and I guess that’s the problem with revenge.