Baldwin Wallace University Economics Blog ... thinking out loud ...: September 2011

Sunday, September 25, 2011

...Dwight's plea

By kay.e.strong

It was Dwight D. Eisenhower, a five-star general, who first drew attention to the potential for misplaced power to threaten America’s peaceful methods and goals. As President, he alluded to the emergence of “an immense military establishment and a large arms industry.” Pleading that the nation take nothing for granted, in his farewell address to the nation he asserted, “Only an alert and knowledgeable citizenry can compel the proper meshing of the huge industrial and military machinery of defense with our peaceful methods and goals, so that security and liberty may prosper together." [Farewell Address, January 17, 1961]

If only “an alert and knowledgeable citizenry can compel proper meshing,” what do we—the citizenry know? Do we know that some fifty years ago this phenomenon was indelicately described as the military-industrial-congressional complex? That this complex refers to a self-reinforcing network of relationships: (a) Pentagon leaders in need of approval for hefty defense spending budgets exercise oversight on contract disbursements, (b) the industrial armament sector in need of lucrative government contracts and flush with profits and legions of lobbyists, and (c) legislators in need of reelection contributions exercise voting power over beneficial legislation.

Do we know that the Department of War, oops, that name changed euphemistically from War to Defense in 1947, corners the single largest share of annual discretionary fund in federal budget? That the defense budget, according to the National Priorities Project (NNP), “has largely escaped budget cuts in recent fiscal years, experiencing real growth while other agencies and programs have sustained critical cuts.” And as such the Pentagon’s annual budget has grown by 43% from $290.5 billion to $526.1 billion (in constant FY 2012 dollars) since 2001. “Security,” the newest euphemism replacing defense, has consumed $7.6 trillion since 9/11. According to one estimate the DoD announces contracts valued at $5 million or more each business day.

Due to the size of its budget, the Department of Defense is responsible for an estimated 39% of net interest paid on the national debt in 2011. This has varied historically from a high of 70% of interest in 1946 to a low of 10% in 1940. The federal government has spent an estimated $2.7 trillion on interest paid to finance national defense. Both increased federal borrowing and increased Department of Defense spending are associated with periods of war. [NPP: http://costofwar.com/en/publications/2011/ten-years-after-911/department-defense-budget/ ]

Do we know that while the authorized DoD budget pays DoD employees and soldiers, buys weapons and supports training and war-fighting (NNP), other monies attached to DoD are off-budget appropriations, i.e. not included in the federal budget proper. These “off-budget” monies finance emergencies and fund wars. Ten years of war in the Middle East has come at a staggering price tag: $1.26 trillion through 30 Sep 2011. Current estimates place the cost of war at some ten billion dollars a month. If you prefer running tallies, then visit the Cost of War Counters <http://costofwar.com/en/ >--updated every millisecond.

Given the cold hard facts, I’m hard pressed to conclude that the biggest threat to American security and liberty lies outside our borders. The distress of a federal budget long hijacked by the military-industrial-congressional complex is being felt in every corner of America…crumbling infrastructure, growing impoverishment, stalled economic growth and the lost futures of our youth. Just how much more economic “hollowing" can the nation sustain before it enters a unrecoverable free-fall?

“Only an alert and knowledgeable citizenry can compel the proper meshing of the huge industrial and military machinery of defense with our peaceful methods and goals, so that security and liberty may prosper together."-- Dwight D. Eisenhower’s Farewell Address to the Nation, 1961

Kay Strong, Ph.D., Southern Illinois University, M.T., University of Houston, M.A., Ohio University; Associate Professor at Baldwin-Wallace College; Areas of expertise: international economics, contemporary social-economic issues, complexity and futures-based perspectives in economics. E-mail: kstrong@bw.edu

Friday, September 23, 2011

Jobs vs. Government

By Lewis Sage

Point one: Anyone who’s paying any attention at all recognizes that our budget battles stem in part from a real philosophical disagreement as to the proper size of government. (See Framing the Budget Debate, 9/18/11.) Some take the position that government is too big; others demur. It seems out of fashion to speculate that the public sector might be too small for our own good.
Point two: Even the most cynical among us would agree that we all want employment to recover… sooner or later. And it’s absolutely clear to all that the private sector must grow dramatically to end the current malaise. The trick – and what the fight might seem to be about – is how to ignite that growth. Public employment is at the center, both because it measures the size of government and because it can either to spark or to squelch recovery.

So where have policy initiatives – or the lack of them – taken us recently? What choices have we made, at least implicitly? For evidence, let’s look at the past twelve months. (Data are from http://www.bls.gov/web/empsit/cpseea07.pdf.)
Between August 2010 and August 2011, seasonally adjusted employment in the US increased by a net 357,000. Digging a bit deeper, we find that, in the private sector, changes in agriculture (+) and self-employment (-) washed each other out, while the rest of the private sector added about 560,000 jobs, an increase of a little more than 0.5%. Not much, certainly not enough to drive down the rate of unemployment, but a move in the right direction. Public sector employment, on the other hand, fell by 278,000 jobs in the same interval, cancelling roughly half the effect of private-sector growth as states scrambled to cut spending and balance their bleeding budgets without adequate federal support.

That’s no way to reduce unemployment and spur recovery. It looks much more like a way to shrink government and delay economic growth.

Dr. Lewis C. Sage likes intersections. Since 1991, he has taught Law and Economics, Mathematical Economics, and the Economics of Healthcare. A former Fulbright Fellow (Bulgaria 1995-6), he teaches an interdisciplinary Honors seminar, Enduring Questions, and is studying strategy in the NFL draft with faculty and students in Sports Management and Psychology. E-mail: lsage@bw.edu

Sunday, September 18, 2011

…Buffet gets WAIT-T!

By kay.e.strong

Warren Buffet, the second wealthiest American, has been a long time proponent of tax reform. Not because it over-taxes the super-wealthy but quite the opposite. Buffet complains that “a billionaire-friendly” Congress has created a federal tax code that favors ultra-rich investors by taxing investment gains at a lower rate than wage earnings. Eighty percent of government revenues comes from personal income and payroll taxes—taxes borne most heavily by a shrinking middle class. In his NYT article Stop Coddling the Super-Rich (14 Aug), Buffet writes “It’s time for our government to get serious about shared sacrifice.” Thank you, Mr. Buffet! What a refreshing acknowledgement that we’re all in this together!

The diehards among us will mount the argument that in America each individual is wholly responsible for his/her own financial fate. In fact, indolence—or a similar synonym is an oft-cited explanatory variable for the existence of personal poverty. However, one-dimensional explanations are a poor basis for understanding complex phenomenon. Take, for example, the Pareto 80-20 rule as a first approximation explaining the wealth distribution emerging naturally from activity in a complex economic system. According to the 80-20 rule, a skewed distribution whereby 80% of the wealth is owned by 20% of the people is an emergent property arising naturally at the macro-level as a result of collective micro-behavior in a vibrant economy.

Why? First, recognize that each individual follows a unique path through the game of life with a starting point on the board established by a mixed bag of genetics, parental social-economic status, geographic location and such. Second, small differences—whether good or bad—in our initial starting conditions affect the final outcome of the game. These initial differences get magnified over time and our paths diverge sending some twenty percent of us along the path to wealth and riches and the other eighty percent along the other path. Again, this outcome is an emergent property of a health complex economic system. So what does the data tell us—are we co-creating a healthy, vibrant economy?

First, a caveat: income and wealth are not synonymous. Income is a flow variable representing earnings, while wealth is a stock variable representing the conversions of unspent income into assets such as homes, stock portfolios and savings. The Census Bureau in the 2010 Poverty, Income and Health Insurance reports that the top 20% of all US households own fifty (not 80) percent of all income with the top 5 percent in possession of a twenty-one percent cut of that. The remaining 80% of American households share the other half. The Federal Reserve reports that 80% of stock belongs to the richest 10 (not 20) percent of Americans. Economist E. N. Wolff at New York University has aggregated data on financial wealth in the US. He calculates that the top 10% (not 20) of households hold more than 80% of total income-producing assets (business equity, financial securities, trusts, stocks/mutual funds and non-home real estate) in the US. Taken together we now understand how the richest 20% of US consumers account for 40 (not 80) of the seventy percent of all spending attributed to consumers.

According to the data, income shares per se are not as highly skewed as the Pareto rule predicts, however, the concentration of wealth is more highly skewed than expected. So, what’s happening? Is this proof of Warren Buffet’s argument? Have the rule of the game been bent in favor of the few? Has changing the “official” rules of Monopoly in the middle of the game ever favored the rule changer?

I will be eager to hear the sentiment of Congress after the President proposes a special tax on taxpaying millionaires—0.3% of all taxpaying Americans. Will the mindset of Congressmen remain stuck in the mythical world of Horatio Alger or will they take a first step into a “complex” new world economy?

Framing the Budget Debate

By Lewis Sage

The federal budget is mind-numbingly complex; I get that. I’ve written about some of that complexity – as has Dr. Strong – a lot over the past couple of months. [No Magic Wand (7/14), Spending Cuts and Tax Increases (7/18), Rationality and Freedom (8/8).] But how someone answers just two fundamental questions may tame the complexity, prune the logical tangle, and frame the debate over short- and long-term fiscal policy.

Question One: Does fiscal policy work? Do spending increases and tax cuts boost private sector spending and ignite the output multiplier? If your answer is, “No,” then you see no role for public policy in the economic recovery and you can proceed directly to Question Two. If, on the other hand, you believe that fiscal stimulus works in the short run, then, logically, you must also believe that its inverse works as well: less spending and more taxes run the multiplier in reverse. Bottom line: if fiscal policy works, then even a budget-neutral reduction of federal spending would create a second dip in the economy, while some form of fiscal stimulus would prevent that dip and, if large enough, reduce unemployment.

Question Two: Is the federal government too big? This is an essentially philosophical issue on which reasonable folks can disagree, reasonably. If you think it is too big, then it’s a problem that’s been around for at least the past thirty years [More on Spending Cuts and Tax Increases (7/24)]. At the beginning of the Reagan administration, total federal spending was 21.2% of GDP; it’s been as much as 22.4% (1985) and as little as 18% (2000), but it was back to 20.8% at the start of the Obama administration. If you believe that federal spending is too big a fraction of our economy, note that the last time it was less than 18% was in the middle of the Johnson administration (1966) and that to get below 15%, we have to run the clock back to Truman (1951).

So, assuming that 1) we would prefer low unemployment to high unemployment; and that 2) huge federal budget deficits can’t persist indefinitely, here’s how the answers to our questions parse the political rhetoric.

	Fiscal policy works	Doesn’t work
Government is too big	Cut taxes immediately; cut spending later	Cut taxes immediately; cut spending more
Not too big	Fiscal stimulus immediately; fiscal contraction later	Raise taxes immediately; leave spending at 20% of GDP

If fiscal policy doesn’t work, the only issue is the size of government: balance the budget by shrinking spending more than taxation if government is too big for your tastes or close the gap with increased taxes if the scale of government is ok.

If fiscal policy does work, then the belief that government is too big guides us to stimulative tax cuts now and to large, budget balancing, spending cuts when the economy has recovered. If a federal share around 20% is acceptable, then temporary tax cuts and spending increases are indicated and, post-recovery, permanent tax increases will be required to close the gap.

If you can’t find your favorite politician’s position on the menu, it’s worth asking why not.

Sunday, September 11, 2011

...rethink "our recovery"

By kay.e.strong

Why are we so confused about the motivating force for jobs creation?

In an earlier blog, …connecting the dots, I provided a mini lesson on the simple circular flow of economic activity. In this model we have households and businesses and resource markets and product markets. Households are linked to resources markets because households own all the resources, that is, land, labor, capital and entrepreneurship. The resource market is linked to businesses because businesses purchase resources and convert them into finished products. Businesses as the pass-through are linked to the product market. The product market is linked to households because households use the income they earn from the sale of resource to make purchases in the product market.

In a diagram, households are linked to both the resources market and the product market. Businesses are linked to both the resource market and the product market. Tangible stuff like resources and products move opposite their payments.

At this point in class, I love to raise a kinda’ economics chicken and egg question with my students: Where does it all begin?

After tossing ideas around for a while, I take a poll. If a majority has not begun to coalesce on the side of households, I let the debate continue. Ultimately, students come to the correct conclusion that it does not matter what resources exist or what products one could create IF no one wants to buy it!

In a consumer-driven economy households jump start the reciprocating cycle with businesses by demanding products---NOT the other way around! Sadly, even the President failed to get it right when he declared that “Ultimately, our recovery will be driven not by Washington, but by our businesses and our workers.”

Why do households get so little press? In August when the Conference Board reported a 14.7% drop in the consumer confidence index, was anyone listening? If it had been the stock market that dropped 14.7% over a one month period, a national emergency would have been declared. Congress would have rushed in with a huge financial relief package.

Did you know that the Expectations Index fell 23 points in August? What is it, you ask? A sub-index that assesses whether consumers feel business conditions are “good, bad or normal” and whether employment and income is expected to “increase, decrease or stay the same.” Listen, please, households are speaking!

The “lethargic” state of the economy is—as systems theory describes it—an emergent property that gives evidence at the macro-level of the dissatisfaction felt at the micro-level. Any plan to jump start the economy that ignores the “current state of households” is doomed from the get-go.

In truth, our recovery will be driven by income-earning households acting as consumers creating demand for products produced by businesses. Contrary to the President’s assertion,Washington can drive the recovery by creating an environment conducive to shoring up the bleak state of households! A TARP for households, anyone?

Friday, September 9, 2011

The Government Is Us

By Lewis Sage

In the past week or so, we’ve been treated to a lot of public analysis of the President’s jobs plan – what might be in it, what should be in it, when it might be presented, what the timing of its presentation might mean, why the words “infrastructure” and “stimulus” were absent from the speech, what this all portends, etc. ad nauseam. In the end, the plan is a fairly predictable 60-40 mix of short-term temporary tax cuts and expenditure increases coupled with a combination of long-run tax increases and spending cuts. It’s a recipe for stimulus now, when we need it, and fiscal restraint later, when we can afford it.

But that’s not what I want to get at today. Instead, I want to examine two simple statements about job creation that I heard this week, the first from one of my Economics Principles students, the second from a caller on a radio talk show. Student first.

Toward the end of a brisk discussion sparked by the NYT Op-Ed essays How to Bring the Jobs Back (09/07/11), the talk turned to various tax incentives for employers to hire more employees. At that moment, a student with some real world entrepreneurial experience, speaking from the employer’s perspective, said, “I don’t care if I get a 70% tax cut; I’m not hiring until I see my demand go up,” or words to that exact effect. But product demand only increases when we spend more. And most of us only spend more when our incomes rise and we are reasonably confident that they won’t recede like the falling tide. And our incomes come from our jobs… and we’re back to that pithy statement, “I’m not hiring until I see my demand go up.” That’s the real point, isn’t it? We can’t make it better until we make it better.

The government does not exist to do things for us. The government is an instrument through which we can do for ourselves. That’s not just a semantic difference. We can use the fiscal authority of government as part of the repair process, but so long as we see ourselves as supplicants rather than responsible participants, we will continue to blame the President, Congress, the state legislature, the town council, … and the recovery will be doomed to limp along.

The radio listener, no doubt responding to current talk of further “quantitative easing” by the Federal Reserve, suggested that, rather than buying bonds, the Fed should consider spending on jobs. Maybe I misheard: I was on the turnpike and my hearing isn’t as good as all that. For the sake of argument, let’s say I got it right. The caller seemed to want to divert money from the (undeserving?) financial sector to task of putting Americans back to work. Ignoring any pedantic discussion of what the Federal Reserve is legally allowed to do, there’s a serious problem here.

The Federal Reserve is, ultimately, our central bank. When it undertakes quantitative easing, it’s increasing our money supply, driving the interest rate down, and lowering our federal government’s cost of borrowing. That allows us (as the government) to spend more on jobs and less on interest payments. Recovery is not a competitive sport. It's a cooperative effort.

Friday, September 2, 2011

Is It Better to Pick Second in the NFL Draft?

By Lewis Sage

Speaking of the relative value of a player selected later in the NFL draft, there’s good evidence that the chance to select first in the opening round is substantially over-valued.

The rule of thumb, developed by Jimmy Johnson and used by ESPN, attributes a value of 3000 (30% of the value of the entire value of the seven-round draft) to the first overall selection and 2600 to the second, meaning that the first pick is worth about 15% more than the second. Chase Stuart’s (2008) alternative assigns values of 73 and 64, rating the top pick slightly more than 14% ahead of the second. Judging from past performance, however, this sort of difference seems unwarranted.

I’ve looked at the lifetime productivity of these picks in the draft years 1950-1996, the last year being early enough to exclude careers that had not ended by 2010. Over that time, a total of 26 quarterbacks were drafted in the first two slots, 16 first and 10 second. The analogous numbers for running backs were 14 and 6. In the same years, 11 defensive linemen were chosen first overall and 8 second.

Among the quarterbacks chosen first overall, the average career length was 11.3 seasons with a standard deviation of 5.6 seasons; among those chosen second, the corresponding statistics were 12.8 and 3.7. Those drafted first averaged 2.1 Pro Bowls; those picked second averaged 2.3, with a smaller standard deviation. On the surface, this suggests that the latter group is slightly better – or at least no worse – than the former. Results were comparable for running backs and defensive linemen: second-selected running backs had longer careers and averaged slightly more Pro Bowl appearances than first-chosen; the two groups of linebackers were statistically indistinguishable. My first impression, based on 41 firsts and 24 seconds, is that the overall first and second choices should be valued equally.

http://www.pro-football-reference.com/blog/?p=527, accessed May 8, 2011