McDonalds and the minimum wage

Recently, on a long car trip returning from a glider contest, I did something unusual among our liberal elite: I actually went to a McDonalds and ate there.

The lady who took my order must have been about 19, as were all the other employees I could see, and pretty clearly new on the job.  Getting the order right took some effort.  I made the mistake of paying cash. The bill was something like $7.62. I first offered a $10, and she rang it up. Then I found 12 cents in my pocket, and offered it. This was a big mistake, as the cash register had already computed my change, and adjusting to my offer of 12 cents was beyond her abilities.

Most people might have been annoyed, but as an economist and an educator, I’m happy to see human capital building. OK, I was a little annoyed.

Which brings me, of course, to the proposals for a sharply increased minimum wage.

In the end, there really isn’t much argument about what a substantially higher minimum wage will do.

Let us not deny the benefit. For the few people who work at minimum wage, but have worked their way up the ladder enough that they will keep their hours; who are actually trying to support themselves and a few children on these meager wages, it will mean a modest rise in income. The rise may be more modest once you account for taxes and reductions in transfers.  There weren’t any such people at my McDonalds, but NPR and the New York Times seem able to find them.

That transfer comes from somewhere. Some of it comes from a wealth levy on existing McDonalds shareholders. If a regulation lowers a company’s profits, the stock price declines. Then the rate of return going forward is the same as always. So it’s a one-time wealth tax on the existing shareholders. Economists are supposed to like wealth taxes, with an asterisk that it makes future investors a bit skittish.

Some of it comes from higher prices. I read estimates that a big mac might go up from about $3.00 to about $3.50, and dismissed those price increases as a small burden to bear.  Looking around my McDonalds, I found this argument less persuasive. Because, of course, the kind of people who work at McDonalds are also the same kind of people who eat at McDonalds. If you’re working at minimum wage in the middle of Oklahoma, you don’t go out to a nice Greenwich Village restaurant to sample organic free range locally grown non-GMO gluten-free artisanal nuts and berries. McDonalds is a treat. And a pretty nice one at that. It’s clean, healthy – yes, some offerings are  full of sugar and fat, but not of e coli, and you can get the grilled chicken if you want – and reasonably tasty. Raising prices from $3.00 to $3.50 is not a small matter if you earn under $10 per hour and you’re feeding a few kids too.

Still, that is the benefit.

The cost is just as easy to forecast. McDonalds cuts hours, and uses its most experienced and efficient workers more, and fewer people like my hapless server. And they don’t get the oh-so-needed on-the-job training. The biggest impact of minimum wages is not so much on existing workers, but on new workers entering the labor force. (See a nice new NBER working paper by Jonathan Meer and Jeremy West.)

The effects fall heaviest on low-skill teenagers, especially minorities. Tom Sowell is eloquent on this point, for example in a recent New York Post OpEd. I was unaware until reading it that minimum wage laws were initially backed in part as conscious efforts to discriminate against minorities and preserve jobs for white people. Sometimes, I guess, policies do have their intended effects.

This much is pretty obvious. Looking around my McDonalds, though, I could see a deeper possibility – an unexplored avenue for substitution away from low-skill labor.

source: chownow.com

Why, I wondered, after 10 minutes in line and the third effort to get my simple order right, did I not simply enter my order on my iphone, and then it’s ready for me when I step up to the counter? Or why not enter it on a tablet provided right there? Why should ordering at McDonalds be any different than getting money from a bank, or getting a boarding pass at an airport? High end restaurants answer this question by saying they think their customers value the personal attention of a waiter. Maybe, but certainly not at McDonalds.

The answer, for now, is certainly that it’s cheaper the way it is. But not for long.. At the left is the first image that popped up when I googled “restaurant ordering app.”

And McDonalds is also reportedly testing an ordering and cellphone payment app. “Currently being tested at locations in Salt Lake City and in Austin, Texas, the app lets users order a meal remotely then collect it in person from a store or drive-thru window.” My server’s job days are already numbered.

Looking more inquisitively behind the counter, it struck me that the technology overall has changed little since the 1960s when my parents took me there as a child. The fry-o-lator beeps,  a teenager picks the basket up and dumps it out, sprinkles salt, and uses a cute little piece of aluminum to neatly line them up in bags, just as they did back then. The main change I could see is that they annoyingly don’t let you put your own sugar in your coffee any more.

It’s clearly only a matter of time before this whole thing is automated.  Industrial robots can assemble cars; designing a robot to operate the fry-o-lator, or even to cook and assemble the whole hamburger doesn’t look that hard. Mechanization usually increases quality: your burger and fries could easily be cooked to order. Swipe your phone or card to pay and off you go. Or, a little drone helicopter delivers it automatically to your table.

(Update: The machine is here already. And planning a new chain to use it, rather than sell to McDonalds, as predicted. Thanks to Michael Ward for pointing it out.)

Reflecting on it, though, it’s unlikely to be McDonalds. McDonalds has an amazing technology when you look hard at it: They have figured out how to run restaurants in a way that dramatically conserves on the world’s scarcest resource, human capital. To run a McDonalds, you don’t have to know how to cook, how to order food, how to buy kitchen equipment, or all the other hundreds of bits of tough knowledge and skill that it takes to run a restaurant. Hamburger U trains the rest.

The whole operation is about taking low-skill teenagers living typically unstructured lives, and training them to what it takes to work.  Peering around the side of the cash register at an earlier trip, I noticed there were pictures on the buttons! You can work at McDonalds and operate its cash registers even if you’re functionally illiterate! To say nothing of not knowing what to do when offered $10.12 to pay a $7.62 bill. And McDonalds has a big investment in that technology.

In the face of technical change, it is seldom the successful incumbents who adapt, even when they innovate. Kodak did not bring us digital cameras, trying to protect their film advantage. Print media did not bring us the internet, and are floundering at it. Walmart tries to go online, but Amazon.com is displacing it. The major airlines flop in every attempt to imitate Southwest.

So, as I gaze around the familiar golden arches, it strikes me that the automated fast food restaurant – and the rapid decline in low-skill employment that it implies –  will likely not come from McDonalds itself. Rather, new competitors will arise that perfect the automated, people-less technology. In the same way that McDonalds displaced the previous era of fast-food restaurants, by perfecting a technology that brilliantly used lots of low-skill people and conserves on scarce human capital. For McDonalds to go automatic would be for it to throw away the key innovation that defines it and has made it such a success.

So we may be past the point that McDonalds sticks with 1950s technology because it’s still cheaper to use people. We may just be waiting for the tipping point.

But robot repair technician is a high skill job. McDonalds provided a positive social externality – it gave young people their first experience of work, of showing up on time, in a uniform, of learning to be pleasant to customers, to work within a heirarchical organization, and so on. Young people who work at McDonalds don’t get internships at NPR, the New York Times, or Goldman Sachs to to develop work experience. As McDonalds goes, so will that process. All that will be left is cleaning.

A sturdy hike in the minimum wage, in today’s economy, is basically an industrial policy subsidizing the transition to low-skill service industry automation.

Job market doldrums

Three recent views on the dismal labor market pose an interesting contrast.

Alan Blinder wrote a provocative WSJ piece on 6/11, Fiscal Fixes for the Jobless Recovery. A week prviously, 6/5, Ed Lazear wrote about The Hidden Jobless Disaster. And John Taylor has a good short blog post Job Growth–Barely Keeping Pace with Population

All three authors emphasize that the unemployment rate is a poor measure of the labor market. Unemployment counts people who don’t have a job but are actively looking for one. People who give up and leave the labor force don’t count. Employment is a more interesting number, and the employment-population ratio a better summary statistic than the unemployment rate. After all, if unemployment falls because everyone who is looking for a job gives up, I don’t think we’d see that as a good sign.

Source: Wall Street Journal

Ed Lazear made this interesting chart. As he explains,

Every time the unemployment rate changes, analysts and reporters try to determine whether unemployment changed because more people were actually working or because people simply dropped out of the labor market entirely… The employment rate—that is, the employment-to-population ratio—eliminates this issue by going straight to the bottom line, measuring the proportion of potential workers who are actually working.

While the unemployment rate has fallen over the past 3½ years, the employment-to-population ratio has stayed almost constant at about 58.5%, well below the prerecession peak. Jobs are always being created and destroyed, and the net number of jobs over the last 3½ years has increased. But so too has the size of the working-age population. Job growth has been just slightly better than what it takes to keep the employed proportion of the working-age population constant. That’s why jobs still seem so scarce.

The U.S. is not getting back many of the jobs that were lost during the recession. At the present slow pace of job growth, it will require more than a decade to get back to full employment defined by prerecession standards….

Why have so many workers dropped out of the labor force and stopped actively seeking work? Partly this is due to sluggish economic growth. But research by the University of Chicago’s Casey Mulligan has suggested that because government benefits are lost when income rises, some people forgo poor jobs in lieu of government benefits—unemployment insurance, food stamps and disability benefits among the most obvious. The disability rolls have grown by 13% and the number receiving food stamps by 39% since 2009.
….

John Taylor makes the point nicely with another graph, which contrasts the labor force participation rate to the BLS’ forecast of what should have happened from demographic effects.

The graph comes from a recent paper Chris Erceg and Andrew Levin.

I part company a bit with Lazear on his conclusions

… the various programs of quantitative easing (and other fiscal and monetary policies) have not been particularly effective at stimulating job growth. Consequently, the Fed may want to reconsider its decision to maintain a loose-money policy until the unemployment rate dips to 6.5%.

If low employment is “structural,” resulting from the worker-side disincentives as well as employer-side disincentives – policy uncertainty, regulatory threats, NLRB, Obamacare, Dodd-Frank, EPA, and so on – then the problem isn’t lack of “demand” in the first place. If the problem has nothing to do with the Fed, and if $2 trillion of QE didn’t do anything to help it, why does the solution have anything to do with the Fed?

The greater surprise is to hear so much agreement from Alan Blinder:

The Brookings Institution’s Hamilton Project, with which I am associated, estimates each month what it calls the “jobs gap,” defined as the number of jobs needed to return employment to its prerecession levels and also absorb new entrants to the labor force. The project’s latest jobs-gap estimate is 9.9 million jobs. At a rate of 194,000 a month, it would take almost eight more years to eliminate that gap.

…. policy makers should be running around like their hair is on fire.

Lazear said “a decade."  More suprising agreement on the impotence of monetary policy:

The Federal Reserve has worked overtime to spur job creation, and there is not much more it can do.

As you might imagine, I’m not such a fan of Blinder’s suggested fixes. He starts with traditional simple Keynesian recommendations that  the government should hire people and "spend” more. No need to refight that here. The more interesting recommendations follow as he warms up to his latest clever scheme.

… the basic idea is straightforward: Offer tax breaks to firms that boost their payrolls.

For example, companies might be offered a tax credit equal to 10% of the increase in their wage bills over the previous year. …

Another sort of business tax cut may hold more political promise….Suppose Congress enacted a partial tax holiday that allowed companies to repatriate profits held abroad at some bargain-basement tax rate like 10%. The catch: The maximum amount each company could bring home at that low tax rate would equal the increase in its wage payments as measured by Social Security records.

For example, if XYZ Corporation paid wages covered by Social Security of $1 billion in 2012 and $1.1 billion in 2013, it would be allowed to repatriate $100 million at the superlow tax rate. The reward for boosting its payroll by $100 million would thus be a $25 million tax saving. That looks like a powerful incentive.

…companies could claim the tax benefit only for individual earnings below the Social Security maximum ($113,700 in 2013). No subsidies for raising executive pay.

I find this most interesting at the level of basic philosophy; how we think about economic policy.

There are huge, longstanding, tax and regulatory disincentives to hiring people. Income tax, payroll taxes, health care and other mandates, and NLRB, OSHA, and so on. There are the high marginal taxes to labor implied by social insurance programs, as Mulligan points out.  If we want to increase the incentive for companies to hire people and people to take the jobs, why add another tax break to an obscenely complex tax code, rather than fix some of the existing disincentives? 

Is this really the right way to run a country? When “policy makers” want more employment, they slap on a complex, tax break on top of a mountain of disncentives. Presumably they then will remove this tax break, and pages 536,721 to 621,843 of the tax code describing it, despite the lobbying by large corporations who have figured out how to exploit it for billions of dollars, once the Brookings Institution decides that there is “enough” employment (!), and “policy-makers” no longer need to encourage it? 

How are the existing hundreds of bits of social engineering in the tax code working out? Do we really need more of this?  Isn’t it time to return to a tax code that raises money for the government at minimal distortion?

The contrast between the benevolent “policy-maker” (no dictator ever had such power) and the reality of how the tax code in this country is actually enacted is pretty striking.

I have to say, I’m a bit disappointed in the end by both. They agree that the US economy is about 10 million jobs short. Something big is in the way. Lazear at least mentions some candidates, though many are long-standing. But the stirring conclusion from Lazear is only to continue a loose monetary policy that he says has been ineffective so far, and the conclusion from Blinder is the sort of clever scheme that economists cook up in late-night cocktail parties piling one more quickly-exploitable bit of social engineering on top of a tax code rife with them. Neither recommendation comes close to 10 million jobs, or addressing any sort of clear story why those jobs have vanished.

Two cents on the minimum wage

Once upon a time, the minimum wage, like free trade, was a basic test of whether you were awake in the first week of econ 1. We put a horizontal line in a supply and demand graph. Minimum wages increase unemployment of poor people.

It's  back of course. I won’t review here the debate over Card and Kruger’s provocative results, diff in diff estimators, empirical work without theory (is there really no substitution to capital or high skilled labor? Is the price elasticity really zero?) and so on. This is all low-hanging fruit. (See Greg Mankiw, who asks if $9 why not $20,  David Henderson’s nice post with great quotes from Paul Krugman on just how bad minimum wages were before evil Republicans didn’t like them, the Becker-Posner Blog, and Ed Glaeser, noting how minimum wages are hidden taxing and spending and better ways to achieve the same goals, and this clever Steve Chapman oped asking, why not fix prices lower instead?.)

Let’s presume for the sake of discussion that a rise in the minimum wage would indeed not much change the demand for labor, the costs would just be passed on in the form of somewhat higher prices, with little decline in output – as usual in non-economics, assume that all elasticities vanish.

It still strikes me, that like much of the current policy discussion, we’re asking the wrong question. The question is not “is this great” or “is this terrible” but “does this have anything to do with current problems?”  The fiddling while Rome burns is worse here than the belief in minor economic magic.


President Obama’s state of the Union Address  was to me, an interesting peek into the Administration’s thinking, and a revealing piece of political rhetoric (I mean that in the good sense of “rhetoric,” i.e. “what arguments we use to persuade people”) 

…today, a full-time worker making the minimum wage earns $14,500 a year. Even with the tax relief we’ve put in place, a family with two kids that earns the minimum wage still lives below the poverty line. That’s wrong….

Tonight, let’s declare that in the wealthiest nation on Earth, no one who works full-time should have to live in poverty, and raise the federal minimum wage to $9.00 an hour. This single step would raise the incomes of millions of working families. It could mean the difference between groceries or the food bank; rent or eviction; scraping by or finally getting ahead. For businesses across the country, it would mean customers with more money in their pockets….

What caught my eye is the “family with two kids,”  "…millions of working families.“ It paints a grim picture: mom, dad, two kids, trying to survive one wage earner’s full-time minimum-wage job.

My thought: What planet do the president’s advisers live on? Come take a look, say, at the south side of Chicago, where I grew up and live, and where President Obama spent many formative years as a community organizer and so knows it even better. Is the first-order problem of these neighborhoods that its residents live in intact families with two kids, one full-time wage earner, trying to live on the wages from a full-time minimum wage job, but  having a tough time making ends meet? Is there anyone like this?

The tragedy of the neighborhoods around where I live, and President Obama used to live, is the vast number of people with no job at all.  How does raising the minimum wage for the few who have a minimum-wage job help the vast majority who have no job at all?

Minimum wages are about teenagers and young adults, most still living at home. It’s about the "dating” phase of work-force attachment, where people learn the skills and habits, and make connections by which they can move up to better jobs when they are ready to have families.

“Families” is an interesting word as well. Marriage among lower-income Americans is rare, as President Obama made clear when he came back to talk to students at Hyde Park High school and made some controversial remarks about the absence of fathers.

For example in zip code 60619, just south of the University, there are “4,967 married couples with children, and 12,745 single-parent households (2,655 men, 10,090 women).” Here’s the marital status chart.

What “family” means in this speech is, by and large, a single woman with children. I’m not starting a Murphy Brown argument, but it is an interesting use of the word. I wonder how many of the Republican ears in the audience listened to “working families” and heard “single women with children and no father in sight?” More worthy of our sympathy, indeed, but a very different picture of what kind of policies might actually work.

And even then, the modern Scrooge (“are there no workhouses?”) might ask, “Is there no earned-income tax credit? Is there no home heating subsidy? Are there no food stamps? Is there no schip or medicaid? Have they not applied for social security disability? Are there no section 8 housing vouchers?”

The point is not to be heartless – government programs or not, life on the lower end of America’s economic and social spectrum is pretty awful.  The point is, if we seriously want to address the problems of the “working poor,” if we want policies that actually work rather than spew a lot of TV time and make us feel good, let us paint a vaguely realistic picture of what their life is like. Absolutely nobody (except perhaps illegal aliens) is trying to support a family on $14,500 from a full time minimum wage job, period.  The actual economic life of the “working poor” is a welter of government programs, transitory employment, and a lot of illegal activity

And, one huge problem facing  people who do work full time and earn minimum wage is the astounding marginal tax rates that our various social programs imply.  In fact, much of the raise from $7.25 to $9.00 will be taken away. Even more of a raise to $20 an hour will be taken away. The structure of our programs that are supposed to help people are instead trapping them. (Previous posts here and here.)

Yes indeed, let us help families to “finally get ahead!” Let us talk about lousy schools, incentive-destroying social programs, horrendous violence, life-destroying incarceration, and the war on drugs run amok. The minimum wage may slightly help the few who can get such jobs, and put such entry-level jobs slightly more out of reach for many others. But it’s just irrelevant to the real, first-order problems such families face.

The final line also caught my eye: “For businesses across the country, it would mean customers with more money in their pockets.”  I wonder who signed off on that one.

Even if the Administration’s theory works, it is exactly the same as a tax on sales of local businesses (i.e. cost passed on as higher prices) to subsidize employment. This is an interesting harbinger of things to come in the politics of budgets: Passing a national sales tax on businesses that employ minimum wage workers, to fund an on-budget subsidy of those workers’ wages, would obviously go nowhere politically, and would count on the budget. But forcing businesses to do it, though economically equivalent, makes it looks as if the government is not taxing and spending as much as it is. 

And of course, that tax comes out of the very pockets it’s going back in.  Back to Greg Mankiw’s question about how much the wage should be: on this theory there is no limit!  If you pay them $20, then customers have $20 more to spend. If you pay them $50, then they have $50 more to spend.

Now we really have crossed the line, from serious economics, to fiddling while Rome burns, to believing in magic.

What's holding back the US economy?

This is a video I did with Steve Davis and Amir Sufi, moderated by Hal Weitzman, part of the new Chicago Booth “The Big Question” series. Youtube link here. I’m actually a lot calmer through most of it than I appear in the cover shot.

Benefits trap art

Two charts from the UK, admittedly sprayed with too much chartjunk, but illustrating the poverty trap in Britain. (A previous post  on high marginal tax rates for low income people has more charts like this.)

Most of UK benefits are not time-limited, so people get stuck for life, and then for generations.

The original article, by Fraser Nelson, “Why the Poles keep coming” in the Spectator, is worth reading.  The article starts with the puzzling fact that

Britain’s employment figures are strong but most of the rise in employment so far under this government is accounted for by foreign-born workers (as was 99pc of the rise in employment under Labour). 

The author had the same epiphany that led me to economics all those years ago. No, it’s not culture, or “laziness.” Treat poor people as intelligent, responding to incentives, just like you and me, but with a lot bleaker choices. Try to look at the world through their eyes if you want to understand their behavior:

 if I was in a position of a British single mother I have not the slightest doubt that I would choose welfare. Why break your back on the minimum wage for longer than you have to, if it doesn’t pay? Some people do have the resolve to do it. I know I wouldn’t.

…Until our policymakers start to see things through the eyes of those ensnared in welfare traps, nothing will change. 

More great quotes:

If you had designed a system to keep the poor down, in would not look much different to the above.

…the cash-strapped British government is still creating still the most expensive poverty in the world.

Hat tip: Dan Mitchell writing at Cato@Liberty. His post is worth reading, as are the links. (Alas, the Spectator only cites the source of the graphs as “ an internal government presentation,” so I don’t know who to properly credit.)

Debate with Goolsbee

Last Tuesday, Glen Weyl asked me to debate economic policy issues in the current election with Austan Goolsbee, in the famous “rational choice” workshop. Here’s my 10-minute opening statement. Austan did a great job in a tough audience.

Economic Policy and the Election: 

Growth is our number one economic challenge. Here’s how recoveries are supposed to look. We get a period of very strong growth rates, until the economy recovers to “trend,” or potential.”

Here we are. Not only have we failed to bounce back, growth is slowing down. We seem headed for a permanent loss of about 8% and sclerotic 1-2% growth.

I’m not the only one who thinks we should have bounced back. This nice graph comes from the administration’s 2010 budget, to document the same point that we should bounce back. (Note the great depression. It was not 10 years of steady stagnation. It had a strong recovery, then a double dip in 1937.)

And here, I’ve plotted the Administration’s successive forecasts in blue. They thought we should have bounced back, and you can see the tragedy of their slowly diminished expectations. So much for “recessions after financial crises are inevitably [and hence predictably] long.”

Growth drives everything. Before this recession, 63% of population was working. That ratio plunged to 58%, and is stuck there. New “jobs” just match the new people. About 5% of the working-age population – 12 million people – are out of work, apparently, permanently.

Only growth will bring back 12 million jobs. 10 more green energy boondoggles, 100 more job training programs or 100,000 teachers won’t do it. In the short run, capital and technology are pretty fixed, so you hire more people when you produce more output. Or, as Casey Mulligan argues in his great new book, you produce more output when the government stops putting sand in the gears of hiring people.

Our second huge problem is debt. The Federal government takes in about $2 trillion a year, spends $3 trillion and is $16 trillion in debt. This simply cannot last.

To get out, we need growth. The graph shows the surplus/deficit along with detrended GDP. Our government takes in about 18% of GDP year in and year out, no matter what tax rates are. Tax revenue rises when income rises. If income does not rise, we become Greece.

Growth, growth, growth. It’s not a secret. Growth ultimately comes from productivity. New ideas, products, technologies, businesses, and processes. The dismal 1970s coincided with a sharp productivity decline. Following the Reagan recovery, perhaps sparked by deregulation and tax reform, economic growth, trended up for two decades, which, as you see in the previous graph, is what paid off the Reagan deficits.

But we seem ominously set to repeat the 70s.

I’m sure we all have good ideas about what to do. But we’re here to think about what our two presidential candidates are proposing.

Every sensible observer agrees that we need to reform our chaotic tax system. And how: lower marginal rates, but eliminate the forest of deductions, credits, expenditures and subsidies to keep revenue at least neutral.  This is what Mr. Romney is proposing.

No, marginal tax rates are probably not the central thing driving our sluggish growth, and yes, the economy has grown reasonably despite higher rates in the past. But we know the direction of the effect! Margins matter. This is econ 101.

By contrast, the administration has one idea: a monomaniacal focus on raising taxes on “the rich.”

We don’t need to argue about “fairness,” who “made it,” how progressive our tax and benefits system is already. Let’s just ask if it will work.

Even if there is no avoidance or disincentive, this can raise maybe $50 billion, out of $1.2 trillion deficits. No, it will not fund “investments” or bring down deficits, as the President claims. That’s arithmetic, not economics, and it’s off by two orders of magnitude.

And, by what economics is the central key to escaping sclerotic growth that we should sharply raise marginal tax rates on investment and business formation? When, ever, has a society experiencing sclerotic growth restored robust prosperity by a tax-based redistribution? The last time we tried it was 1937. Roosevelt raised taxes on “the rich” to 70% and sent his attorney general off on a “war on capital.” He got a “capital strike” and his big recession became the great depression. President Obama will follow his hero’s footsteps.

The utter chaos of our tax and spending is more important than the rates. The government has not passed a budget in years. Spain and Greece pass budgets! What serious country decides its taxes every year, in late-night sessions in the middle of January, with thousands of special deals up for grabs?

For the first time ever, this administration doesn’t even pretend that it will balance the budget! Despite all the rosy scenario they can muster, they are proposing trillion dollar deficits forever. Forget the games of “scoring” various plans – does anyone really believe that the actual outcome of a Romney administration is going to be higher deficits than under a second Obama term?

Entitlements are the long-run budget catastrophe. Like it or not, at least Ryan and Romney are advocating a serious entitlement reform. The administration promises, not one penny cut from your Medicare and Social security. But we don’t have that money – this promise must be broken. The only question is how.

Rather than get the long-run right, the administration has indulged in a patchwork of short-run meddling. Stimulus. Cash for clunkers, which destroyed the market for used cars that low-income people depend on. Temporary tax breaks, with the constant threat of higher future taxes. 100 mortgage writedown programs that don’t work. Bankrupt solar panel factories, yet Al Gore walks away with $100 million bucks.

I would not mind if any of this worked. It demonstrably did not.

Source: John Taylor

Dodd Frank and Obamacare are the administration’s singular achievements. With the house in Republican hands, it’s clear there will be no big legislative initiatives in a second Obama term.

Thus, the main story of the second Obama term will be Dodd-Frank and Obamacare “implementation,” writing tens of thousands of pages of rules and creating the hundreds of new agencies those measures mandate, along with expansion of the other regulatory agencies.

I would not mind if these had a chance of working. Health care is a mess. And financial regulation needed to be rethought. But Dodd Frank and Obamacare are disasters. Beyond the well-reported costs.

Obama care and Dodd Frank are not really laws or rules. Instead, they send appointed officials off with huge power and discretion, to run businesses and markets as they see fit. (There are “rules” but they are so massive and so vague, that discretion is their effect.)

A microscopic example: “stress tests.” The Fed staffers in charge are not writing rules – they’re open about it: If they write rules, the banks will work around the rules. So each quarter they dream up something new and challenging to surprise the big banks with. And hundreds of billions of dollars hang on the results. George Stigler is turning over in his grave.

Another: Obamacare is so onerous, that thousands of discretionary waivers are already being handed out. Better not contribute too loudly to Republican causes.

Another: the EPA official caught wanting to “crucify” a few businesses. Here’s a guy dispassionately enforcing clear rules, eh?

Now, telescope. There are tens of thousands of these stories. Regulation is not “more or less” it’s smarter or dumber, more or less prone to evasion, economic stagnation, unintended effects, anti-competitive capture, and crony capitalism.

Our only hope is to replace these with clear, simple, rule-based regulations. Individual, portable, renewable health insurance and a competitive health-care market. Simple effective financial regulation. After four more years of Dodd-Frank and ACA metastasis, the chance to do that will have passed.

None of this was a mistake. The last four years of disastrous economic policy came from a deeply ingrained philosophy: that detailed discretionary control by government bureaucrats is the way to run the macro and micro economy. That growth comes from a one-year special tax break for this or that, a $7000 credit for silicon valley tycoons to buy electric sports cars, and sending the staff of HHS to tell each of us what medicine we need and the Fed to tell each bank who it should lend to.

No. Prosperity comes from property rights, rule of law, simple clear and stable taxation and regulation, which is hard to bend to crony capitalism and protection, and competition.

Not everything in Romney’s plan is perfect. I won’t defend “energy independence” and a fairly mercantilist attitude towards trade. But again, our task tonight is to pick from the menu, not to roll our own. The outlines of what Romney is proposing – and more importantly he, Ryan, the economic advisers I know, and what seems likely to emerge from their administration – are a lot closer to that philosophy.

(Notes:  This is more political than what I usually write here, so I turned comments off. I don’t want to fight about politics or deal with moderating the hate-filled comments I know are coming.

Many graphs and points have shown up in previous blog posts with more detailed explanation, especially “Just how bad is the economy?” “Inevitably slow recoveries?,and  Recoveries after financial crises”.

I deliberately kept the graphs simple so the facts would be transparent. Yes, GDP per capita, consumption per capita, etc. might be better measures, labor force should adjust for demographics, I used output per worker to measure productivity, etc.  All can be done better, getting the same basic result, but at the cost of a bit of obscurity.)

CBO and the fiscal cliff

The CBO has released a report warning that a new recession could follow the  “fiscal cliff”

Background: Here’s the CBO report and a Washington Post story  A few snippets from the CBO:

What Policy Changes Are Scheduled to Take Effect in January 2013?…

• A host of significant provisions of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (Public Law 111-312) are set to expire, including provisions that extended reductions in tax rates and expansions of tax credits and deductions originally enacted in 2001, 2003, or 2009. …[“Bush tax cuts expire”]
• Sharp reductions in Medicare’s payment rates for physicians’ services are scheduled to take effect.
• Automatic enforcement procedures established by the Budget Control Act of 2011 (P.L. 112-25) to restrain discretionary and mandatory spending are set to go into effect.
• Extensions of emergency unemployment benefits and a reduction of 2 percentage points in the payroll tax for Social Security are scheduled to expire.

What Is the Budget and Economic Outlook for 2013?

CBO’s Baseline: Taking into account the policy changes listed above and others contained in current law, under CBO’s baseline projections:

• The deficit will shrink to an estimated $641 billion in fiscal year 2013 (or 4.0 percent of GDP), almost $500 billion less than the shortfall in 2012.
• Such fiscal tightening will lead to economic conditions in 2013 that will probably be considered a recession, with real GDP declining by 0.5 percent between the fourth quarter of 2012 and the fourth quarter of 2013 and the unemployment rate rising to about 9 percent in the second half of calendar year 2013…

And from the Post:

The nation would be plunged into a significant recession during the first half of next year if Congress fails to avert nearly $500 billion in tax hikes and spending cuts set to hit in January, congressional budget analysts said Wednesday.

The agency foresees a stronger contraction of 2.9 percent in gross domestic product, “similar in magnitude to the recession of the early 1990s.” [I couldn’t find thi].

“The magnitude of the slowdown we’re discussing next year is significant,” CBO director Douglas Elmendorf said at a morning briefing. He noted that going over the cliff could cost the nation about 2 million jobs.

Elmendorf said the shock of the cliff would be felt for years to come, with the unemployment rate stuck above 8 percent through 2014. And the effects are likely to be felt well before the fiscal cliff hits, according to the budget outlook released Wednesday, as “businesses’ and consumers’ concern about the scheduled fiscal tightening will lead them to spend more cautiously than they otherwise would have” during the remainder of 2012.

What do I make of this? I think the fiscal cliff is a big problem – but that the CBO’s analysis is way off.

The CBO’s projections are deeply and explicitly Keyneisan, relying on “multipliers.” If the government borrows a billion dollars and blows it on some useless porkbarrel project, the CBO will project that this raises GDP  to the tune of one and a half billion dollars. In analyzing the “fiscal cliff,” reducing such projects is bad for the economy.  That’s the key source of their estimate that the fiscal cliff leads to recession. If you, like me, think that the government spending less money on useless projects (say, ethanol subsidies) has a positive effect on output, or that taking less money from A and giving it to B has little effect, then you will not be so worried.

It used to be that the first thing you had to understand to call yourself an “economist” is that prices and taxes are first and foremost about incentives, and only secondarily about income transfers. That is especially true when thinking about national output, growth, etc. Income transfers matter a lot to people, but the overall economy really doesn’t care who has the wealth. It cares about incentives.

A really good example: What will the effect on output and employment be of ending 99 weeks of unemploment insurance? That’s part of the fiscal cliff, and the CBO’s analysis (see above) says that reducing unemployment insurance will lower GDP. Really? A standard economic analysis comes to exactly the opposite conclusion. Generous unemployment and disability means that some people choose to stay unemployed rather than take lower-paying jobs, or jobs that require them to move.  So long as you stay unemployed, you get a check from the government. Subsidizing anything produces more of it. So, a standard analysis says that cutting back unemployment insurance lowers unemployment, and raises output and this part of the fiscal cliff analysis should go the other way.

Before you go all nuts on how heartless I am, keep the question in mind. I didn’t say what’s good or bad, I said what raises or lowers GDP and unemployment. The standard analysis of unemployment insurance says, yes, it raises unemployment and lowers GDP, but it provides important insurance for the truly needy and unfortunate. It’s something we do out of compassion even though it hurts us.

But the CBO didn’t score national welfare, or a compassion index. They scored GDP and unemployment, and their model comes to the opposite conclusion, subsidizing unemployment causes more GDP and less unemployment. As well as being compassionate. How do we have our cake and eat it too? Well, that’s the magic of Keynesian economics, on which I will not digress here.  

So, in my view, most of the analysis is simply wrong. 

That doesn’t mean I think the fiscal cliff is has no effect.

As a “standard” economist, I look first and foremost at incentives. Raising marginal tax rates lowers incentives to work, save, invest, start businesses.  That’s not good. So I agree that the tax part of the fiscal cliff will drag down the economy. But not because it reduces Keynesian stimulus, but because it worsens incentives.

The bigger problem with the fiscal cliff is the utter chaos of it all. What serious country decides its tax laws year by year, in one big chaotic crisis during the first few weeks of the year? Will estate taxes be 55% or 0% next year? Who knows?

Moreover, this last-minute crisis atmosphere is ripe for salting the tax code with little goodies which nobody will notice until it’s too late. It’s a fiesta for lobbyists, tax lawyers and crony-capitalists of all stripes.

This is not how any serious country operates, let alone the supposed leader of the free world. And annual tax chaos is certainly not good for GDP.

What will the effects of the fiscal cliff be? I can’t tell.  The incentive and expectations effects that I think matter aren’t in any of the Washington models.

Moving from “scoring the law” to “forecast,” we also have to think if the cuts will actually happen.  The CBO also has to make forecasts based on Congress’ promises. But do you really believe congress’ promises? Not even the CBO does, really, which is why they make “alternative” forecasts.
Congress hasn’t passed a budget in years. Will the supposedly mandatory cuts really happen? Congress can spend money on anything it wants to. It’s not like someone will sue them for violating the sequester, any more than someone can sue them for blatantly violating the budget act.

A great example is the  “reductions in Medicare’s payment rates for physicians’ services” mentioned in the CBO report. I presume their model scores this as having a reduced stimulus effect since doctors will buy fewer BMWs.  I doubt its actual effect of doctors simply refusing to work are in the CBO model.

But in any case, it won’t happen. Congress promises every year that next year it will cut health costs by simply paying doctors less. They then change their minds at the last minute, because, duh, doctors won’t work without getting paid. It seems a sure bet to me that will happen again, with “emergency” reauthorization. Ditto for important priorities like farm subsidies, the export import bank, ethanol subsidies, electric car subsidies and so on. 

So, my guesstimate of the fiscal cliff? Mild drag on GDP from chaos and higher marginal tax rates. Very little effect on spending, which will be restored in a sequence of last minute bills. Therefore, very little reduction in deficit. Continuation of our slide into low-growth sclerosis.
 
Update: As a commenter noticed, I’m being too kind. Jacking the estate tax back to 55% alone should be a great stimulus measure to get old folks to spend money on round the world cruises, private jets and tax lawyers.

I was working on this some more and ran in to the CBO’s supporting documentation here  of which tax provisions are going to expire. To the CBO each of these is a little foregone Keynesian stimulus. To me the list is reminder A of what an obscenity our tax code has become. Yes, let’s drop them all, yesterday!

 

Cellulosic Biofuel Credit,Credit for Past Minimum Tax Liability,Depreciation of Certain Ethanol Plant Property,Election to Accelerate AMT and R&E Credits in Lieu of Electricity Production Credit for Wind Facilities, Exclusion of Mortgage Debt Forgiveness ,Indian Coal Production Credit,Partial Expensing of Investment Property,Recently Discharged Veterans Eligible for WOTC,Section 179 Expensing, Andean Trade Preference Initiative,Generalized System of Preferences,Deduction for Energy-Efficient Commercial Buildings,Depreciation Classification for Certain Race Horses,Determination of Low-Income Housing Credit Rate,Energy Credit for Nonwind Facilities,Electricity Production Credit for Nonwind Facilities,Partial Expensing of Certain Refinery Property,Liquefied Hydrogen Fuel Incentives,Credit for Motor Vehicles with Fuel Cell,Hydrogen Refueling Property,African Growth and Opportunity Act,Noncommercial Aviation Fuel Rates for Certain Aircraft,AGI Floor for Individuals 65 or Older Remains at 7.5 Percent,Credit for Business Solar Energy Property,Credit for Residential Energy-Efficient Property,Earned Import Allowance Program for Dominican Republic,Haitian Value-Added Rule for Apparel,Increase Excise Tax on Coal,Caribbean Basin Trade Partnership Act,Haiti Trade Preferences,Fuel Surtax on Certain Aircraft,Transfer of Excess Assets in Defined-Benefit Plans…………..

Just how bad is the economy?

The second-quarter GDP numbers came out. The newspapers and Republicans pounced on low growth and anemic job growth. The Democrats rebut growth is growth and tell us of the steady job gains. How bad is the economy?

Economists know that levels matter, and that long-run growth matters more than anything else. I made a few graphs to emphasize these points.

Start with the level (in logs) of real GDP. (This is an update of a graph I saw on John Taylor’s blog.)

Looking at levels you see the current awfulness better than by looking at growth rates. GDP declined almost 5% in the recession, but then started growing at a glacial pace, averaging 2.4% since the trough.  We seem stuck in this slow growth trap.


If you distrust trend lines, you are wise. But this one reflects a solid historical pattern. Here is real GDP and the 1965-2007 trend through postwar history.

You can see that the economy has quite reliably returned to the trend line after recessions.The 1950s had a steeper trend, but there too the small recessions were followed by catchup growth.

Here is what the recovery is supposed to look like (Again, idea stolen from John Taylor, except I’m using trends rather than “potential GDP” which I distrust.) 

To be fair, I fit the trend through 1980, so I would not use ex-post information. You see that after the severe 1980 recession at the even more severe 1982 recession, the economy recovered to trend, by posting a few years of 6% growth.

The tragedy is poorly expressed in growth rates. By 1987, the economy was back on the prior trend line. We are now 14.5% below the trendline, and each year that goes by like this we lose another half a percent. The average person in the economy is producing 14.5% less, and earning 14.5% less, than if we had followed the path following the 1982 recession.

That’s a lot – and a lot more than the litany of quarterly growth rates suggest.

I used trends, rather than the CBO potential output. If you read how they make it, you’re likely to do that too. But here is the same graph contrasting my trend and the CBO’s potential

This is tragic. The CBO is giving up on us. The CBO potential, which goes towards a 2.35% long run growth rate, says that what we are seeing now is the new normal. All we can hope for is a modest recovery, and then anemic, sclerotic growth forever after that. The difference between 2.3% and 3.0% adds up fast as the years go by. (And the CBO has been bending the trend line down steadily as the recession goes on. Back in 2005, it’s “potential” looked like my “trend.” They didn’t see a permanent downward shift in level or reduction in growth rates. Look for “potential” to keep declining.)

Well, perhaps the CBO is doing its job as forecasters, saying “here is what will happen if you continue down the present policy path,” not “here is where the economy would be if you adopted growth-oriented policies.”

What about employment? I find employment more significant than unemployment. Unemployment means job search. It means people answer a survey saying they don’t have a job, and are actively searching for a job. It does not count all the people who gave up, or went on disability (effectively ending their careers), early retirement, or are just living in Mom’s basement and playing video games. (I don’t mean to make light of it. That may be the most tragic, as the chance to accumulate skills is lost.)

Here’s a good summary measure, the ratio of employed people to the population

This is really tragic. Employment declined by about 7 million people, from 63% of the population to about 58%. And it has stayed there ever since. The “job gains” you hear about in the news are just barely keeping up with population. As we are about 14% below trend and slowly losing ground, we are 7 million jobs short and sitting there too.

The link between employment and output is productivity. To keep the numbers simple here, I made plots of output per worker. Output per hour, and corrections for demographics and capital use are better, but this is simpler and works about as well. Here is a graph of productivity.

I crammed a lot of information in this graph. The first thing to notice is the behavior in the recession and now. There was a dip in productivity – output fell more than the number of workers fell. But it has since recovered.

In the short run, capital doesn’t change much, so as a rough guide you make more output when you hire more workers (or increase hours) and vice versa. So, GDP = Productivity x workers. To get more workers, we need to make a lot more GDP. The lackluster GDP growth is the other side of the terrible employment coin.

There’s more in the graph. In the long run, rising productivity is behind everything good in the economy. It’s what gives more income per capita. Rising productivity is the only hope for paying for entitlements and getting out of our deficit trap. It’s the main hope for long-run GDP growth, after the empolyment-population ratio reverts to where it should be. Rising productivity comes from new ideas, new companies, new ways of doing business. It isn’t all pleasant. Lots of incumbents lose out. Rising productivity is the core of a “growth” agenda as economists understand the word. 

You see in the graph that something terrible happened in the 1970s. Productivity, which was behind the large postwar boom, slowed down to a glacial 1% per year. 1982 marked a break in that as well. Productivity  started growing 1.69% per year, producing the boom of the late 1980s and 1990s, and incidentally producing large Federal surpluses.

OK, but the far right of the graph doesn’t look so good does it. Here it is, blown up, with a 2003-today trend marked in as well.

This is an economists’ horror movie. Yes, productivity did rebound. But it seems to be growing slowly as well.

The trends are an economists’ horror movie. Real GDP seems not to be recovering at all – no period of swift growth to go back to a trend. We seem stuck at 2.4% growth forever. The CBO is giving up on us too. Employment will not recover as a fraction of population until the economy recovers. We seem stuck at low employment forever. And now we seem headed to a 1970s productivity slowdown as well.

I don’t view this as contentious, outside of Presidential politics. Paul Krugman thinks the economy is pretty awful too.

What to do? If only it were so simple as to have the Fed print up another two trillion dollars, or have the Treasury borrow another $5 trillion and blow it on stimulus boondoggles. We’re stuck in sclerotic growth, and to everyone but a few die-hard extremists, that means growth-oriented policies are the only way out. 


Disclaimer. Yes, I know there are better ways to measure all this, especially productivity. This is an attempt to paint the basic picture using the simplest numbers. The message is, look at the levels and look at the trends. If you do that with better data, you will have gotten the message.

Data are from the St. Louis Fed’s wonderful Fred database, series GDPC96, GDPPOT,  EMRATIO.

Sand in the gears

Today’s Wall Street Journal has a beautifully informative editorial, “Employment, Italian Style.” Snippets:

Once you hire employee 11, you must submit an annual self-assessment to the national authorities outlining every possible health and safety hazard to which your employees might be subject. These include stress that is work-related or caused by age, gender and racial differences. You must also note all precautionary and individual measures to prevent risks, procedures to carry them out, the names of employees in charge of safety, as well as the physician whose presence is required for the assessment.


Once you hire your 16th employee, national unions can set up shop. As your company grows, so does the number of required employee representatives, each of whom is entitled to eight hours of paid leave monthly to fulfill union or works-council duties. Management must consult these worker reps on everything from gender equality to the introduction of new technology

Hire No. 16 also means that your next recruit must qualify as disabled. By the time your firm hires its 51st worker, 7% of the payroll must be handicapped in some way,…

Once you hire your 101st employee, you must submit a report every two years on the gender dynamics within the company. This must include a tabulation of the men and women employed in each production unit, their functions and level within the company, details of compensation and benefits, and dates and reasons for recruitments, promotions and transfers, as well as the estimated revenue impact….

This kind of thing is hard to track down. You can’t easily find a prepackaged “list of regulatory sand in the gears lowering productivity and employment in Italy,” the way we can find (statutory) tax rates, spending numbers, interest rates, and so on.  So like the drunk in the old joke, looking for his car keys under the light even though he knows he dropped them a block a way, much economic discussion focuses on those headline issues (“Stimulus!” “Austerity!” “Bailout!” “Leave the Euro!” “Raise/lower taxes!”) and ignores all the sand in the gears.

The journal writes, 

All of these protections and assurances, along with the bureaucracies that oversee them, subtract 47.6% from the average Italian wage, according to the OECD.

I wish the WSJ had footnotes or links, even in its online edition, to make it easier to track down  numbers of this sort. A quick tour through the OECD website provides some horrifying numbers on
 Labor tax wedges of 40-50%, to which we must add “non-tax compulsory payments (NTCPs)” which “represent a strong increase over and above the overall tax burden. E.g., in 2011, the compulsory payment wedge for the average single worker was 50.4% compared with the corresponding tax wedge of 47.6%” And remember, once they give you a euro, you still pay another 21% VAT before you can eat that plate of delicious pasta.  But the WSJ paragraph suggests 47.6% is the effective wedge of regulation on top of explicit taxation. (If readers know where it came from, add a comment.)

Also left out is the effect of this kind of hyper-regulation on corruption. You can imagine when the inspector comes in to see if all the paperwork is up to date how the conversation evolves. (Ask Luigi Zingales)

Cleaning up this mess is what we mean by “structural reform.” How to achieve it politically seems like a nightmare to me.  Fighting each of ten thousand regulations one by one seems hopeless. Each one sounds good, each one taken alone seems minor, each one has an entrenched interest backing it and an army of bureaucrats whose jobs depend on its enforcement. And the economy dies the death of a thousand cuts. Can you really abolish it all in one fell swoop or grand bargain?

Certainly not if you don’t try. 

The WSJ headline was

Prime Minister Mario Monti has issued a new “growth decree” to revive Italy’s moribund economy. Among other initiatives, the 185-page plan proposes discount loans for corporate R&D, tax credits for businesses that hire employees with advanced degrees,.. 

Not to belabor the obvious, but this is incredibly depressing. More special programs are not what Italy needs. I hope there are better ideas in the rest of the 185 pages.

Rajan on the world's troubles

My colleague Raghu Rajan wrote a very thoughtful essay in Foreign Affairs. Though titled “The True Lessons of the Recession” it’s really more a grand view of the last 50 years and prospects for growth ahead. The subtitle “The West Can’t Borrow and Spend Its Way to Recovery” is worth repeating.

Raghu reminds us that growth, in the end, comes from productivity. Keynesians have stolen the term to mean a few years of caffeinated stimulus, but to everyone else, growth means better living standards for decades. And the lesson of modern growth theory is that such growth comes only from greater from productivity – people able to produce more valuable goods and services per hour that they work.

Raghu reminds us that growth is not a given. There is no stone tablet saying GDP per capita will rise 2% per year forever. Every drop of growth is hard-won. It comes from people investing in ideas, in the human capital that produces ideas, in better skills, and able to start businesses, displace ossified incumbents, make new and better products and services.

He offers a thoughtful capsule view of the last 50 years; the strong postwar growth, how it petered out, and how the US responded with deregulation. Now it’s petering out again, and the question for us is whether we will be able to remove the sand in the gears. 

Raghu reminds us what economists know but seems forgotten in policy circles: The global rise in inequality over the last 30 years comes from the rising returns to skill, not from lower taxes, “greed” or malfaisance. The rich didn’t get richer; new people came in and got rich. As he put it, starting in the 1980s, 

It was no longer as important to belong to the right country club to reach the top; what mattered was having a good education and the right skills.

Raghu goes on to a long list of disastrous policies our government has followed which are greatly to blame for the current mess.  

While I agree these policies are disastrous, I’m less convinced of Raghu’s political narrative: that our government subsidized houses and credit as a benevolent but ham-handed attempt to address rising inequality.  There is more to an overarching theory of the political determinants of US economic policy than this. 

In part, I think Raghu’s own analysis proves the point,

Outside the United States, other governments responded differently to slowing growth in the 1990s. Some countries focused on making themselves more competitive.

OK, so if other governments such as Germany chose different policies, then our particularly damaging policies were not simply an inevitable reaction to the skill premium.

I part company even more as Raghu describes what to do about it. Raghu’s analysis emphasizes  America’s disastrous inability to provide its middle-class citizens with decent education. You would think a stunning denunciation of teacher’s unions and associated public-school bureaucracy would follow, but it doesn’t.

Raghu offers instead:     

The United States must improve the capabilities of its work force, preserve an environment for innovation, and regulate finance better so as to prevent excess.

This kind of sentence drives me a bit batty. Who is the subject of this sentence, really? You smell a new set of programs, but to be put in place by the same government that Raghu so skewers for the last 20 years?

Admittedly, Raghu adds, 

None of this will be easy,… Government programs aimed at skill building have a checkered history. Even government attempts to help students finance their educations have not always worked; some predatory private colleges have lured students with access to government financing into expensive degrees that have little value in the job market. 

OK, but he’s still apologizing for not layering new programs on top of the old failed programs. And with this little caveat the start-new-programs instinct takes over full-force,

That is not to say that Washington should be passive. Although educational reform and universal health care are long overdue, …

Wait a minute, Raghu! You just diagnosed the disasters of America’s public education system, and how desire to subsidize the middle class led to policy disasters. You want the same genius system to run health care too?

[Washington] can do more on other fronts. More information on job prospects in various career tracks, along with better counseling about educational and training programs, can help people make better decisions before they enroll in expensive but useless programs. 

Again, that indefinite tense. Who is going to provide this “more information?” and “counseling?” What about that “checkered history” of such efforts in the past?   

…subsidies for firms to hire first-time young workers may get youth into the labor force and help them understand what it takes to hold a job. 

Rajan offers brillant analysis of the global skill premium, and we’re back to tinkering with the tax code to overcome the disincentives offered by the minimum wage?

As finance professors, both Raghu and I pay extra attention to financial regulation.

Finally, even though the country should never forget that financial excess tipped the world over into crisis, politicians must not lobotomize banking through regulation to make it boring again. 

Amen, brother Rajan. But continuing,

At the same time, legislation such as the Dodd-Frank act, which overhauled financial regulation, although much derided for the burdens it imposes, needs to be given the chance to do its job of channeling the private sector’s energies away from excess risk taking. As the experience with these new regulations builds, they can be altered if they are too onerous.

What? The Dodd-Frank act is a monster compared to Fannie and Freddie, which Raghu just skwered. He surely would not write

At the same time, agencies such as Fannie and Freddie, although much derided for the subsidies and distortions they impose, need to be given the chance to do their job of channeling funds to housing, small business and student loans. As the experience with these agencies builds, they can be altered if their side-effects are too onerous.

 He does write

Americans should remain alert to the reality that regulations are shaped by incumbents to benefit themselves. They should also remember the role political mandates and Federal Reserve policies played in the crisis and watch out for a repeat.

Yes. Exactly why hoping that a complex monster like Dodd-Frank can work is sure to lead to more trouble.  Dodd Frank is designed and destined to lobotomize, monopolize and politicize the financial system. 

In sum, I think Raghu’s soft tinker-at-the-edges solutions just don’t match the eloquence of his diagnosis. We have a disastrous public education system that is leaving the middle class and poor behind, and a shattered middle-class family structure that renders education even more difficult. Accept his diagnosis that our political system drove us to financial disaster by patching up the resulting inequality.  Is not the answer much more far reaching, and much more of the stop-banging-our-head-against the wall variety?

One sentence on “educational reform” isn’t enough, let’s talk about the deep reforms that need to be taken, now. How can he  hope that the same political system will act more wisely, though it has much greater arbitrary power with the health law and Dodd-Frank?  Take his reading of the 1980s deregulation and how it solved the stagnation of the 1970s and gave us a new round of growth. Is the answer not the same sort, get out of the way rather than a spate of new Federal “competitiveness” programs?

Raghu regains his eloquence on the idea that a touch more stimulus is all we need, that growth is just a short-run “demand” problems not deep “supply” problems. 

Countries that don’t have the option of running higher deficits, such as Greece, Italy, and Spain, should shrink the size of their governments and improve their tax collection. They must allow freer entry into such professions as accounting, law, and pharmaceuticals, while exposing sectors such as transportation to more competition, and they should reduce employment protections…

Yes, but why does the same advice not hold for the US as well? Certainly not because we have the option (for a while) of running higher deficits.

But he really comes in to focus with this gorgeous paragraph: 

The industrial countries have a choice. They can act as if all is well except that their consumers are in a funk and so what John Maynard Keynes called “animal spirits” must be revived through stimulus measures. Or they can treat the crisis as a wake-up call and move to fix all that has been papered over in the last few decades and thus put themselves in a better position to take advantage of coming opportunities. For better or worse, the narrative that persuades these countries’ governments and publics will determine their futures— and that of the global economy

Yes!

Anyway, go read the original – provocative, thoughtful, and refreshingly well-written.