Over two years ago I posted a link to an article by Mark Thoma, about the three types of unemployment. It is more than discouraging that unemployment is still in the policy news 29 months later. Today’s article is in The New Yorker, written by financial columnist James Surowiecki:
We are stuck with an unemployment rate three points higher than the postwar average, and the percentage of working adult Americans is as low as it’s been in almost thirty years. What’s most troubling is that so much of this unemployment is long-term. Forty per cent of the unemployed have been without a job for six months or more—a much higher rate than in any recession since the Second World War—and the average length of unemployment is about forty weeks, a number that has changed very little since 2010. The economic recovery has now lasted nearly three years, but for millions of Americans it hasn’t yet begun.
One important takeaway from the article is that some long term unemployment is becoming chronic – moving from cyclical to structural unemployment.
For my students, let’s review the three types of unemployment.
Frictional unemployment (typically about 1 percentage point in the unemployment rate) is due to new people entering the labor market and some workers switching jobs. The short term gaps in their employment is largely unavoidable, although with web-based job boards this component of unemployment may be decreasing a bit.
Structural unemployment (somewhere around 3-4 percentage points) is a mismatch between the jobs available and the skills or geographic location of the workers. As our economy evolves and develops some people lack the training or skills to participate in new jobs. Or new jobs are located in new parts of the country, leaving some workers stranded, unless they migrate. Structural unemployment can also come from significant shifts in technology. If an industry adopts more automated assembly processes, workers who used to do manual assembly are less needed. We could help this with job retraining and relocation, but government efforts on this score are infrequent and insubstantial.
Cyclical unemployment is the loss of jobs due to short term changes in the economy. If we enter a recession, and demand slows down, producers will lay off workers. This form of job loss is presumably short term and will recover once demand in the economy recovers.
Surowiecki reports that some economists are worried that the unusually long periods of unemployment may be shifting some unemployment from cyclical to structural. Those who have not had a job for a long time may find their job skills diminishing and their job confidence declining. While once these displaced workers could bounce back as the economy recovers, now they are not as competitive when new jobs appear. Their part of unemployment becomes more permanent.
A country’s economy depends, in large part, on the scarce resource of skilled labor. When we can use that labor to create economic value, our national income grows, along with the income of those workers’ families. When we allow those skilled workers to wither on the vine, we reduce that scarce resource. All of the recent political posturing on jobs solutions has done little to address this evaporation of our country’s important resources.
Our Macroeconomics classes are studying alternative ways to improve the economy of Sudan and South Sudan. They are allocating scarce foreign assistance funds among a number of different investment options. Certainly the two countries are very poor, yet they have (or had when they were a single country) substantial oil reserves. In addition to pouring in western dollars, what other steps could these countries make to improve their prospects?
Daren Acemoglu and James Robinson, in their book,Why Nations Fail, start their journey by describing the Texas border town of Nogales. The US/Mexico border runs through the t0wn, but otherwise the inhabitants are very similar. Yet, income and general living standards are much lower on the south side of town.
Early in their book the authors talk about economies that are extractive versus those that are inclusive. Extractive economies, by their definition, often start with colonial exploitation, where a conquering country subjugates the original peoples, and work to extract economic wealth from the resources in the country. Extractive economies can also be home grown, where an elite segment of the population works to extract wealth for their own benefit, and keep the rest of the populace unsupported.
Inclusive economies offer economic opportunity to their citizens, support the rule of law, protect private property rights, and present a stable government that will not try to appropriate private assets. The key to this model is a sense of opportunity on the part of the average citizen, which leads to greater risk-taking, innovation, and progress.
Back to Nogales… In an interesting historical analysis, Acemoglu and Robinson argue that European conquerors found both resources and a population in southern latitudes that were primed for extractive exploitation. Settlers in North America found a more forbidding welcome – both from weather and the original peoples. While early attempts at colonization in North America tried the extractive model, those attempts largely failed. Subsequent colonization had to adopt inclusive strategies. Fast forward 400 years and North America (primarily the United States) has an economic structure that rewards individual effort and investment. Further south, the economies developed from extractive colonial origins and the structures and wealth distribution today still inhibit growth.
I have more to read in the book. I look forward to the journey.
This is first in a series of notes – both to myself and to my teaching assistant, Katherine. She’s looking forward to graduate school in a year or two, and sought out the experience of being a TA in preparation for teaching she might do in the future. This gives me a good excuse to record my aspirations and experiments in pedagogy. I’ll stick primarily with teaching experiences in Principles of Economics courses.
First day of class…full room, anxious, wary students, some hoping to get into class even though it is officially full. I like how life sort of resets every new term (though not as much for Spring Term here after less than a week of Spring Break) but it is also a half step back in terms of rapport with my students. Just a couple of weeks ago, at the end of the term, my students and I had settled into a comfortable rhythm. They knew me and I knew them. When I walk into the classroom on the first day of class I yearn for that comfortable place. Instead the students don’t know me and I haven’t figured them out. Not so comfortable.
In our university, Principles of Micro/Macro qualify for general education requirements. They are also pre-requisites for business majors, and of course they are required for Econ majors and minors. With some exceptions it is fair to say that many students don’t really want to be in my class. It’s a hurdle they have to jump in order to get on with the rest of their academic lives. So my goal is to convert them, in a way. I’m hoping they’ll walk out of class after a week or two, and think to themselves, “This is kind of interesting. I never knew how that stuff worked.” Then, if things go well, they might confess to talking to their family or their friends about economic issues. In a perfect world they’ll bring me an article they read in The New York Times, and want to talk about it.
Still the first week is tough. Trust and rapport haven’t been established. It is tempting, and I suspect the default behavior for many of us teachers, to slog through the syllabus – reciting rules, explaining expectations, justifying textbook choices, and the like. One thing I gave up several years ago is printing and distributing the multi-page syllabus. It is a lot of paper, and probably won’t be read – ever. Instead I post it on our course web site, emphasize it’s importance, and then it isn’t read there – but at least some trees are still standing as a result.
Syllabus discussions are very top down. I’m setting rules as the authority figure. I need to do that, but it is a terrible way to start a learning relationship. So, I’ve taken to jumping in very early with some subject-specific exercise. In Macroeconomics I give the students an opinion poll – on which economic issues they are most concerned about. We tally the results to see where the interest lies, and then for each issue I give a mini-introduction to the topic and raise some questions. In Micro we hold a double oral auction for some silly item, where the students are walking around, bartering, and establishing a market. Inevitably I have to return to top-down, orientation stuff, but my hope is that they students will leave that first day thinking, ”huh, maybe this won’t be so bad after all.” Stuff of dreams…
I have no excuse – no teenage daughter or son around the house to lure me into Suzanne Collins’ trilogy that starts with The Hunger Games. I read all three just for the fun of it. And now there is an interesting tie-in between the book/movie and economics; specifically how some countries prosper and others don’t.
At first glance, the economic landscape depicted in Suzanne Collins’ best-selling Hunger Games trilogy doesn’t make much sense. Despite its post-apocalyptic condition, the fictional nation of Panem is quite technologically advanced. It has high-speed trains, hovercrafts, extraordinary genetic engineering capabilities, and the ability to create extremely advanced weapons. And yet Panem is also a society of tremendous economic inequality, with clear examples of absolute economic deprivation and even famine.
Most importantly, Yglesias refers to a much-quoted book, Why Nations Fail, by Daron Acemoglu and James Robinson. These authors have some plain sense observations about how and why nations grow and prosper. We’ll look at those observations in more depth later.
Meanwhile, the Slate article is a good start, and an interesting connection to this weekend’s blockbuster movie.
University of California (Berkeley) economist Brad DeLong took my late-in-life education on economic issues to a new level. I’ve plenty more to learn, of course, but I enjoyed his discussion.
In such a setup, the conclusion of Mankiw and Weinzerl that monetary policy has the exclusive role to play is straightforward: One stabilization policy tool–monetary policy–is non-distortionary. The other stabilization policy tool–fiscal policy–is distortionary. If monetary policy can do the job, there is then no need for fiscal policy. And if you do resort to fiscal policy, use the fiscal policy that is most effective at getting people to spend money on the things they were at the tipping point of buying anyway–use the investment tax credit rather than direct government purchases or tax cuts which might well not be spent. End of argument.
Well, actually it wasn’t the end of his argument. He goes on to assert that well-designed fiscal policy is as important and powerful as monetary policy during unusual times like we are experiencing right now.
Prof. DeLong’s discussion is a bit tough going for Principles students. Let me see if I can translate.
In normal times, when short term interest rates are noticeably above zero, monetary policy is often the best tool for government to use to correct the economy. In class we talk about correcting for either a recessionary gap or an inflationary gap. DeLong agrees with Mankiw and Weinzerl that monetary policy is sufficient and does less to distort the marketplace. What does he mean by distortion? In a perfect economic world individuals make decisions on whether to save or spend and if they spend, on what kind of things. When government decides to spend additional money (i.e. uses fiscal policy) then that means it must raise taxes to pay for that spending. Those taxes change, or distort the decisions that rational individuals would make. This moves us away from our theoretically perfect model of allocating resources.
Potential vs. Actual (Real) GDP
As a side note, much government spending is valued by the public and helps correct problems in the market or helps society meet other goals – such as caring for the disadvantaged. So spending and taxes aren’t necessarily bad for those kinds of goals, but spending to stimulate an economy does potentially distort how we would use our funds. In my classes I also point out that fiscal policy is usually a pretty blunt instrument, wielded by not very expert politicians. There are all sorts of time delays, political compromises, and imperfect implementation. So, monetary policy is often the best way to solve short term, mild-to-moderate problems in the economy.
Back to DeLong. He agrees with Mankiw and Weinzerl, but goes on to argue that monetary policy has a hard time working during a liquidity trap – when short term interest rates, and the interest rate target set by the Federal Reserve are so close to zero that pumping more money into the economy just gives it bloat, rather than relief. In these tough times, monetary policy can possibly work if the Fed promises to keep interest rates lower and inflation higher in the future. However, DeLong points out that future Fed committees are not bound by the promises of today’s leaders. If investors think there will be a change of heart, and interest rates will rise in order to force inflation lower, then those investors will delay their spending plans.
On the other hand DeLong argues that an aggressive fiscal policy – i.e. more spending now, backed by printing more money, can have a strong impact, and the government will be less likely to back down from its policies in the future.
DeLong also argues that monetary policy can introduce distortion – by changing the relative amount we invest in projects with short term benefits versus those with long term benefits.
Here’s the last summation:
It is important to get the overall level of production right–to match total spending to potential output. It is also presumably important to direct spending toward high-value commodities. It is important to get the balance between private and public purchases right. And it is important to get the balance between short-duration and long-duration assets right.
Thus fiscal and monetary policy are likely to both have proper stabilization policy roles to play.
Fresh data suggest China is moderating its appetite for investing in U.S. securities, a trend that could mean lower flows of cheap capital from Beijing and a possible rise in borrowing costs across the American economy. An analysis of U.S. Treasury data suggests China, with $3.2 trillion in foreign-exchange reserves, has begun to rapidly diversify its currencies portfolio. “It clearly indicates China’s intention not to put all its eggs in one basket,” said Lu Feng, director of Peking University’s China Macroeconomic Research Center. China still remains a strong buyer of U.S. debt. China’s holdings of U.S. securities rose 7% to $1.73 trillion as of June 30, an increase of $115 billion from 12 months earlier, Treasury data show.
This is a good time, then, to review how our balance of payments work here in the U.S. and to explore China’s role in our economy.
Balance of Payments
With some detailed records and some good guessing our government estimates how much money is flowing in and out of the country each quarter. You can read these reports, from the Bureau of Economic Analysis here. The most widely publicized of these is the trade deficit which measures the inflow of funds (when we sell/export goods and services to overseas customers) versus the outflow of funds (when we pay to import goods and services.) Most everyone knows that the U.S. chronically runs a trade deficit. A somewhat broader definition is the current account balance, which includes the trade deficit but also adds in unilateral transfers (think of grants and foreign aid) and interest income on investments. The current account balance (inflows minus outflows) is also negative.
If we keep running these deficits, shouldn’t we be running out of money? That’s a good question but fortunately there is another flow of funds into the U.S. that largely offsets our current account deficit. These are capital funds (think of loans or purchases of real assets) that outside investors, including foreign countries make. When an investor in Switzerland, or an insurance company in Singapore, or the government of China buys a U.S. treasury bond, that represents a flow of funds into the United States. These bond purchases also put some upward pressure on the value of the U.S. dollar, since those purchases require dollars to be completed.
To put it simply and approximately, our appetite for imported goods and services is paid for by foreign investments in our country. In theory this can continue on for a long time.
China’s Actions
Instead of a trade deficit, China has a trade surplus – exporting more goods and services than it imports. Though this surplus has been shrinking in recent years, the accumulated surpluses generated added to the stock of funds held by China. It is prudent for China to hold those excess funds in different currencies – kind of like a stock portfolio. It has also been prudent for China to invest their funds in US bonds, which are still considered the safest investments in the global economy.
China also purchases assets denominated in dollars in order to influence the relative exchange value of their currency, the yuan (AKA renminbi) against the dollar. They have manipulated the value of their currency in order to keep the value of the yuan relatively low against the dollar. This preserves the low cost competitiveness of Chinese goods in the American market. When China buys dollar assets, like US bonds, that puts upward pressure on the dollar and downward pressure on the yuan. They have been criticized for this currency manipulation, which is relatively rare in a global climate of floating exchange rates.
When Things Begin to Change
This takes us back to the WSJ article. Though China’s holdings of US bonds continue to grow, some analysts see a new trend that will diversify China’s holdings away from the dollar. What might that mean for us?
If China and other foreign investors slowly begin to shift their investments away from the U.S. and towards other attractive economies, the capital inflow that pays for our trade deficit shrinks. The value of the U.S. dollar on currency exchanges might slide more than it is doing now. The impact of a weaker U.S. dollar is that our exports seem cheaper to foreign buyers and they will go up, while foreign goods will appear more expensive to American buyers and imports will go down. Those two forces will shrink our trade deficit. In addition, if capital flows into the U.S. slow down we will see upward pressure on interest rates – particularly on long term loans such as mortgages.
In many ways a slow, purposeful shift in capital funds might be healthy in the long run for the U.S. They can reduce the trade deficit and restore a sort of balance to our position in the global economy. If that shift happens suddenly, however, it would wreak havoc with our economy and almost certainly drive us into a deep recession.
Could China trigger a huge shift in capital flows? In theory. yes. A pragmatic policy on their part would argue against that kind of radical action. They, after all, have a lot of their “savings” in U.S. bonds and it is not in their interest to drive down the value of those bonds. And radical action would cause swift changes in the value of their own currency against the dollar, which in turn would decimate their sales of goods to the U.S. Still, a politically motivated action, similar to declaring war, could prompt them to harm the U.S. economy, even at a significant cost to their own domestic economy. I don’t pretend to have a good crystal ball in this arena, but it is tough to imagine the current leadership would take those radical actions.
Princeton economist, Uwe Reinhardt, contributes regularly to The New York TimesEconomix Blog. Recently he wrote, in
“Health Care Payers Push Back Against Costs“ that high U.S. healthcare costs are driven by several factors:
American’s over-use of high-cost/high-tech services owing to some American’s being over-insured.
High administrative costs (mostly in the health insurance area)
Higher prices paid by Americans for healthcare services and products
On this latter point – higher prices – he points to an imbalance of power between the buyers (and payers) vs. the suppliers of healthcare.
[...]higher prices are the product of a deliberate strategy, hashed out in our political bazaars between the supply side of health care and state and federal legislators, always to keep the payment side of our health system fragmented and relatively weak vis à vis the supply side of health care.
He also notes how difficult it is for patients to do price comparisons – “price opacity” he calls it. He saves his strongest reaction to the system of price discrimination found in healthcare today. Providers charge (and are paid) differently depending on who pays the bill. Insurance companies demand substantial discounts from hospitals, and Medicare reimbursements are significantly lower than provider costs.
Reinhardt warns providers to prepare for an era of increasing price information and comparisons, along with other purchasing initiatives.
To add my own commentary: Our public discourse on complex problems often veers towards finding the villain – the “bad guy.” Once identified that villain gets all of our attention and if the political stars are aligned government legislation and regulation results. If healthcare costs are an inflated balloon, then pushing in on one portion will only cause the balloon to bulge out elsewhere. It would be a mistake to assume that our healthcare challenge would be fixed by just getting providers to reduce their prices.
More open price comparisons and a more straightforward pricing mechanism are two important elements in successful healthcare reform. With only some exceptions, providers (physicians, hospitals, drug companies, tech companies) are not looking for ways to extract more money from patients. They are taking steps to survive in a broken marketplace. Changing public attitudes about appropriate care, changing insurance to give patients more exposure to their decisions and choices, giving providers incentives to prescribe cost effective care, opening scope of practice laws to let well-trained but less expensive professionals provide some care, and maintaining vigilance over abuse of the patent and malpractice systems are all important steps to take.
In honor of the first week in our Healthcare Economics class, and the beginning of a 6 week session on healthcare via OLLI, here is an interesting report from The New York Times.
National health spending rose a slight 3.9 percent in 2010, as Americans delayed hospital care, doctor’s visits and prescription drug purchases for the second year in a row, the Obama administration reported Monday.
The recession, which lasted from December 2007 to June 2009, reined in the growth of health spending as many people lost jobs, income and health insurance, the government said in a report, published in the journal Health Affairs.
from The New York Times
There are a couple of takeaways from this news.
First, the reduction in spending on healthcare could mean a welcome, albeit temporary relief to those governments and organizations that pay for healthcare….BUT…no real relief for state and local agencies which provide/finance healthcare for poor people. Recessions, of course, result in greater numbers of people qualifying for government-supported care.
The other point is a reminder that some portion of healthcare services are discretionary. When healthcare spending was growing by 10 percent or more each year in the 1980s, that growth probably wasn’t driven by an increase in the need for services. Likewise the slower growth over the last several years is probably not due to the population getting healthier and needing fewer services. Instead, people moderated their demand for healthcare. They put off diagnostic tests, or did not follow through on treatments or prescriptions. Going in the other direction, hospitals routinely see increases in elective surgeries near the end of a calendar year, as people have already met insurance deductibles, and decide to seek care before those deductibles are reset in the new year.
Is this good news? Not necessarily. To the extent the people put off truly necessary tests and treatments, those delays may cost us more in the long run. To some extent, though, tough economic times force us to be more cautious about discretionary spending, and there may be very little impact on long run health status. There is the old saying that if you get a cold, it will take 7 days to go away, but if you see a doctor you’ll be cured in a week! One important element of effective healthcare reform is to introduce that sense of caution in our population. It is a delicate balance – not wanting to interfere with early testing and early, cost-effective treatment, but also discouraging care that has less impact on long term health.
Prices for medical care services and supplies also stayed roughly on par with general inflation during this last year, which is a change from the decades of the 1980s and 1990s where the medical care component of the consumer price index routinely outstripped regular price increases.
I wouldn’t have to polish my crystal ball very much to predict that spending increases for healthcare will pick up speed as the economy recovers. This remains the single most important issue in our nation’s federal deficit struggles.
Was it Popeye’s friend, Wimpy, who kept asking for a hamburger on credit? Today’s credit markets are anything but robust, with reduced demand and supply for borrowed funds. Always eager to find obscure terms for modern dilemmas, economists refer to this condition as a liquidity trap. With a little prodding from Facebook friend and neighbor, Patrick, we’ll give the concept a once over.
Jumping to the conclusion (and resisting the academic approach of a slow, careful warm-up) there is bad news and good news about liquidity traps. The bad news is that they make it difficult for the Federal Reserve to execute monetary policy. Creating 100s of billions of dollars has a muted impact on our economic recovery. The good news is that the liquidity trap dampens the significant inflation we might expect with the creation of all that money.
OK, back to the beginning. During times of slow or no growth and high unemployment the Federal Reserve can create/inject money, largely by increasing reserves that banks have in their accounts with the Fed. They can do this by buying U.S. treasury bonds on the open market, or even by buying troubled/toxic assets from banks. This increase in the supply of money allows interest rates to fall, which in term spurs demand for more consumption and investment. This is classic monetary policy. With mild downturns this is often enough to increase growth and kick start the economy. For the most recent 2007-2009 recession the Fed took these actions, a number of times in a number of ways, and those actions were not sufficient. Now the target short term interest rate – the Fed Funds rate – is essentially at zero. The Fed can’t lower the interest rates any further. Here’s a graph of the Fed Funds rate since 1980. The big peak at the beginning of the graph was the result of aggressive Fed action to contain inflation. Now, though, the rate has sunk to the very floor.
Fed Funds Rate - St. Louis FRED database
One thing that is happening is that while reserves are building up in our financial system, the banks are holding on to them rather than increasing their lending. Some argue that the banks are using the added funds to improve their balance sheets, which were hurt by the dramatic loss in value of securitized mortgages and other derivative assets, and to build up enough cash to pay executive bonuses. The banks argue that demand for credit by qualified borrowers is low. I don’t put much credence in the latter explanation. One apt analogy for this situation is that the Fed is trying to push on the end of a string, in order to get the economy going.
There is another layer to the liquidity trap concept, and that has to do with the buying public’s (people and business) expectation for inflation. The theory goes that if buyers expect inflation in the future, they will increase buying now. They expect the value of their cash or savings to go down during inflationary times, so they seek to use it now, while its value is still high. This works with traditional monetary policy where an injection of money would be expected to increase inflationary pressures.
On the other hand if purchasers believe that inflation will be controlled, then there is less pressure to buy now. That’s what is happening now. Despite what some politicians suggest, inflation is not right around the corner, and buyers are in no hurry to convert their cash into goods. We see evidence of this with the continuing low interest rates on U.S. bonds. Expectations of high inflation would push those interest rates up. Low inflation expectations, even in the face of increasing money supply is another symptom of a liquidity trap.
This scenario played out, to grim effect, in Japan in the 1990s, as their central bank poured money into the banking system and no one responded. Their “lost decade” was one of almost zero growth.
This paper by a New York Federal Reserve staff economist explains things in more detail, complete with impenetrable equations.
My first childhood visit to Washington, DC included a visit to the Bureau of Printing and Engraving. There you can watch paper currency running off the printing presses, being inspected, sliced, and bundled. In the gift shop you can buy bags of shredded, rejected currency, or a sign that says, “The Buck Starts Here.”
Well, in addition to the Bureau, your local community banks also create money. They do it through the system of fractional reserve banking. I just recorded a video clip, available through my PlainSenseEconomics channel on YouTube. It’s for my Macro econ students. And you can watch it, too.
If you are a student (or just interested...) and are looking for descriptions of basic economic concepts, see the categories on the left. Choosing "Macro Concepts" or "Micro Concepts" will display a list of descriptive posts. The "Issues" posts are more timely and are applications of some of the concepts described here.
Author – Doug Gentry
I teach principles of economics courses and a course in the economics of healthcare at Southern Oregon University.
I teach principles of economics courses and a course in the economics of healthcare at Southern Oregon University.
