Tuesday, December 28, 2010

State rights vs. federal rights



Published in Standard-Examiner, Ogden, Utah, December 24, 2010

Rep. Rob Bishop of Utah has introduced a constitutional amendment in the House. It states that, "Any provision of law or regulation of the United States may be repealed by the several states, and such repeal shall be effective when the legislatures of two-thirds of the several states approve resolutions for its purpose that particularly describe the same provision or provisions of law or regulation to be repealed." The 10th Amendment states, "The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people."

Now it appears that rather than pushing Rep. Bishop's bill, GOP leadership has agreed to require constitutional backing attached to every bill starting in January. Let me first point out some problems in Rep. Bishop's proposed amendment before commenting on the new proposal.

It seems that Rep. Bishop wants the states to pick and choose "provision or provisions" or particular regulations in the legislation that states find onerous. However, picking and choosing will require value judgment by legislators. Why does Rep. Bishop think that states' legislators are better able to make a value judgment about a piece of legislation than the duly elected federal legislators? I am sure the value system of Utah's legislators may not agree with the values of many others in the state on education, immigration, health care, environment quality, equal rights for gays and host of other issues.

My point is that value judgment is in the eyes of the beholder and one's values may dramatically differ from the values of others. If Rep. Bishop does not trust the values of the representative government of all the people in the United States, what is so special about the values of only two-thirds of the states? Isn't the voice of people of one-third of the states germane on matters affecting them? If picking and choosing provisions in a legislation means that it should pass a cost-benefit test, that is also very problematic to resolve due to twisting of statistics by interest groups to promote their agenda. Every state may have to set up independent commissions to make recommendations to the state legislatures about the provisions in a particular legislation, adding another level of costly bureaucracy. That is also questionable, given the politics involved in the appointment of members to commissions.

Let us look at the last part of the sentence in the 10th Amendment. It says, "powers... are reserved to States, or to the people." It gives rights to states' as well as rights to the people. In a representative government, people of the United States elect their representatives to the House and Senate. Why is the people's voice through its federal representatives less important than the voice of two-thirds of the state legislatures?
It appears that this push for repeal was triggered by the health care legislation, especially the requirement that everyone buys health insurance or pays a penalty of 2.5 percent of income, exempting poor, elderly and some others. Article 1, Section 8, of the Constitution assigns the Congress the "...Power To lay and collect Taxes, Duties, Imposts and Excises, to pay Debts and provide for the common Defense and general Welfare of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States;" I emphasize words "Imposts" and "general Welfare."

Health care legislation is for the general welfare of the people and the Congress has the right to impose a levy to promote it. The only question is if it is going to be uniform. Perhaps Rep. Bishop should make sure that everyone in the U.S. is treated equally with this levy.

Some may consider health care decisions as a personal matter but they do not consider the spillover effects of one's health on the society at large. When one shows up in an emergency clinic without insurance, it increases the cost of insurance for others. We all suffer if any one has HINI or AIDS. We do not have personal freedom to impose costs of our actions on others. Also, a healthy society is a productive society and hence we all have a stake in the health care of other people.

Rep. Bishop's opinion piece in this paper on Dec. 18 invokes the founders' intent to justify his position while ignoring the fact that the founders' intent is codified in the Constitution. He does not even trust the independent Supreme Court's decisions.

The recent agreement among GOP leaders to justify constitutionality of every bill is also a fruitless effort. The Constitution lays down very general principles, for example, broad powers granted to the Congress in Article I, Section 8. Moreover we all have the opportunity to use the independent judicial system to arbitrate. Democracy is not a luxury because it takes patience, compromise, reconciliation and time to make it work.

Mathur is former chairman of the economics department and professor emeritus of economics at Cleveland State University, Cleveland, Ohio. He resides in Ogden. He also offers new blog posts for the Standard-Examiner at http://blogs.standard.net/economics-etc/.

Tuesday, December 14, 2010

The unemployment problem


Vijay K. Mathur 
Published in Standard-Examiner, Ogden, Utah, December 9, 2010

Americans are frustrated about the unemployment picture and, in spite of the efforts made by the administration to stimulate the economy, unemployment is stubbornly parked between 9 and 10 percent. It is higher than the unemployment rate, which prevails when the economy's growth rate is at full employment without significant inflation rate. Now you may ask why there is unemployment when there is full employment? Let me explain.

At any given time there is always unemployment because the labor market is constantly in flux. There are three main types of unemployment in addition to seasonal. The first is frictional unemployment. During any month, thousands of people are changing their jobs, waiting to start a new job, waiting to be recalled after being laid off from the job, and entering and reentering the labor force to look for jobs. This unemployment is for a short duration (usually 1 to 26 weeks); 54.2 percent of the people were unemployed for one to 26 weeks in the second quarter of 2010. It has decreased from 82.8 percent in the second quarter of 2007. This is partly due to the fact that those who are employed are not leaving their jobs, causing a drop in turnover rate, and those who are unemployed are unemployed for longer durations (27 weeks and more).

Frictional unemployment arises when the labor market is in the process of matching workers with available jobs. This matching process takes time until workers with different talents, experiences, aspirations, and at different locations, find jobs which match goals of businesses at different locations looking for workers with certain skills, experiences. If people with skills in demand are frequently in and out of the labor market and if duration in searching for jobs increases due to wage expectations, lack of information, uncertainty, and locational immobility, frictional unemployment will rise. For example, an IMF study estimates that negative equity problem in the housing market, which has led to decreased mobility, has added 0.5 percent to 1.5 percent to the unemployment rate.

The second type of unemployment is structural unemployment, which arises when people are chronically unemployed. Their skills do not match what businesses demand due to changes in industrial composition or they are unskilled, hence they are employed for very short periods of time. Full employment implies that the only unemployment left is frictional and structural; economists call it a full employment unemployment rate or natural rate of unemployment (NARU).

Following the consensus among economists on NARU of 5.5 percent before this recession, the current unemployment rate of 9.8 percent in November 2010 is 4.3 percent above NARU. This 4.3 percent unemployment rate is cyclical unemployment, which arises due to lack of aggregate demand in the economy for goods and services. This is the third type of unemployment rate. Growth rate of GDP currently is below the full employment growth rate because of the excess unemployment rate above NARU. But, we have come a long way since the decline in growth rate at around minus 6.8 percent. That was at the lowest point of the recession in January 2009.

The good news in October 2010 was that from September 2009 to September 2010, the job openings' rate was constant; the hiring rate increased, the job separations' rate decreased and all components of GDP grew in the third quarter. However, the unemployment rate is stuck at a higher level. Most likely, NARU has increased as well because of changes in both frictional and structural unemployment. Bureau of Labor Statistics (BLS) data show that from the second quarter of 2007 to the second quarter of 2010, one- 26 weeks of unemployment as a share of total unemployment decreased by 28.6 percent. The share of 52 weeks or more increased by 21.4 percent. These were record-high increases since 1967.

The current high unemployment rate is not due to the entry of more people into the labor force, because labor force participation rate has been stuck at 64 percent to 65 percent since last January.

To bring down the unemployment rate, policies must be aimed at reducing cyclical, frictional and structural unemployment. Reducing cyclical unemployment requires increasing aggregate demand (consumption, private investment, government expenditure, and net-exports). Reducing frictional unemployment will require stimulating demand, removing uncertainties in regulations and fiscal policy, detailing better information flow in labor markets and fixing the mortgage mess. Training and technical education programs must be implemented on a large scale for people who are structurally unemployed.

Let us hope that Congress does its part in implementing a far-sighted expansionary though sustainable fiscal policy, which complements the Fed's monetary policy to stimulate aggregate demand. Congress also has to work on the long-term goals of energy independence, reducing carbon imprint, building human capital stock, sensible immigration and free trade policy, which does not encourage outsourcing.

Mathur is former chair of the economics department and professor emeritus of economics at Cleveland State University, Cleveland, Ohio. He resides in Ogden. He also offers blog posts for the Standard-Examiner at http://blogs.standard.net/economics-etc/.

Thursday, December 2, 2010

Government’s role in a free market economy


Vijay K. Mathur

Published in Standard-Examiner, Ogden, Utah, November, 21, 2010

 Among many people, politicians and media pundits, there seems to be confusion about the operation of free markets.  Sometimes the word capitalism is used to propagate the notion of free markets.  However the word capitalism came into use almost one hundred years after the publication of The Wealth of Nations in 1776 by Adam Smith, the most ardent supporter of free markets.  Capitalism should not be confused with the system of free markets.   Like markets capitalism is evolutionary, however it encompasses not only economic organization but also political and social organization.

According to Adam Smith, self-interest (not selfishness), property rights and division of labor are three important interrelated pillars of economic growth.   Property rights, if clearly defined and enforced, ensure that people are free to transact their goods and services at positive prices.  Self-interest of sellers to make profits and of buyers to obtain products they prefer at the lowest prices brings sellers and buyers together in a market transaction.   Self-interest in competitive markets maximizes economic welfare of the society.  If free and competitive markets work, they efficiently allocate products among consumers according to their preferences, allocate inputs among producers, and enable producers to obtain the maximum output with given amounts of inputs.   Division of labor facilitates scale economies to bring down costs. 

However, there are circumstances when markets do not perform their function efficiently.  Economists refer those states of the markets as market failure, a point missed by many who blindly promote virtues of free markets. 

Market failure occurs due to many reasons.  Let me discuss five of those reasons.  First is monopoly power, where one or few producers and/or sellers gain control of the market.  Monopolists restrict output and charge prices higher than the competitive market prices.  That is the reason we have antitrust laws.  The first major statute was The Sherman Act of 1890, enacted in response to the widespread growth of combinations or trusts in 1880’s.  Since the Sherman Act, other statutes have been enacted to deal with other anticompetitive behavior of businesses.  Proper functioning of free competitive markets requires either to break-up monopolies, cease and desist monopolistic practices or regulate them.  For example, in 1911 the Supreme Court broke up the Standard Oil Company into 33 geographically separate companies. Monopolies of electric and gas utilities are regulated to promote public interest.

The second reason for market failure is when producers do not fully bear total costs of products or are unable to capture all benefits of producing products. For example, oil and gas producers in Utah do not bear the full cost of health hazards their pollution imposes on population in the Uintah basin as well as in the Salt Lake valley.  Many of the benefits of basic R&D and education pass on to others who do not pay the total price for inventions and knowledge production.  Another example is when uninsured people seek health care in emergency clinics, thus causing higher premium costs to insured people.  All such cases require government regulation or taxes or subsidies to improve efficiency of markets. A British economist A.C. Pigou, presented the earliest and most cogent discussion on market failure in 1920 in his book, The Economics of Welfare.

Thirdly, market fails when there is a common property resource.  Common property is nobody’s property, hence the property is misused.  For example, Great Lakes, Amazon rain forest, Yellowstone National Park, national parks in Utah, Great Salt Lake are common property resources.  Such resources cannot be privatized; the government has to intervene to preserve common property.  The fourth reason is lack of information, misinformation or asymmetry of information.  For example, the recent mortgage crisis was partly the result of asymmetry of information and/or misinformation to the participants, especially the borrowers.  Health insurance also faces the problem of asymmetry of information. Therefore there is a need for regulations in such markets.

Finally, risk and/or uncertainty may be an impediment for free markets to provide products, which may be welfare maximizing for the society in the future.  For example, production of renewable energy and construction of transmission lines are very risky ventures at early stages of development, hence this sector will require government assistance to grow, just like Railroads and system of Canals did in the 19th century.

There are a host of other areas where free markets will not work efficiently and promote public welfare as envisioned by Adam Smith without some government intervention:  for example, areas of product safety, workplace safety, airwaves allocation, oil and gas exploration. Therefore government intervention is essential for the working of free and competitive markets.  I do recognize that government intervention in markets should be measured for efficient operation of markets.  But indiscriminately diluting regulations, taxes, subsidies and user fees, which are essential parts of a vibrant free market competitive economy, may result in undesirable consequences which no one would value.

Mathur is former chair of the economics department and professor emeritus of economics at Cleveland State University, Cleveland, Ohio.  He resides in Ogden.  He also posts original blogs for the Standard-Examiner at http://blogs.standard.net/economics-etc/.

Tax cut stalemate in Congress adversely affects the economy


Vijay K. Mathur

Published in Standard-Examiner, October 10, 2010, Ogden, UT

The current debate between the GOP, Democrats and Tea Party enthusiasts on the continuation of Bush tax cuts has created a stalemate in Congress.

Congressional Democrats and the Obama administration would extend most of the Bush tax cuts for individuals with incomes less than $200,000 and families with incomes less than $250,000 a year starting in 2011 (close to 98 percent of income earners) and end tax cuts for those with higher incomes (comprising nearly 2 percent of high-income earners).

Republicans and some blue-dog Democrats, who are fearful of losing upcoming elections, are pushing for extending Bush tax cuts for all income earners, including the top 2 percent. This stalemate adversely affects most Americans and the economy.

Note, since the Bush tax cuts are still in place, all the expansionary effects of the tax cuts are already being incorporated in the current state of the economy. Hence continuation of tax cuts is not likely to provide any more stimulation than it already has, except in some cases.
The unemployed may be enticed to enter the labor market due to the increase in after-tax real wage rate, and others in low to middle income groups may increase their work effort and firm up their consumption plans in response to the certainty of low taxes. The GOP proposal to include top 2 percent of income earners in the tax cut plan is couched in the supply side doctrine, which became popular in Reagan administration.

It professes that lower taxes will encourage work effort, saving, investment, and perhaps productivity. The historical evidence on supply side effects is thin at best. The Tax Policy Center estimates show that under Obama's proposal marginal tax rates will be 0 percent to 15 percent for 85.4 percent of the tax units (tax filers comprising singles, married filing separately or jointly and head of households), 25 percent to 28 percent for 8 percent of the tax units, and the highest rate of 39 percent for 0.1 percent of the tax units; 6.5 percent will be non-filers.

Given a very small fraction of tax filers in the top tax bracket, one should not expect significant supply side effects in response to their tax cuts. It is the uncertainty of tax rates at the current time which matters more to very high income tax payers than the reversion of marginal tax rates to Clinton era levels.  It seems that the GOP and their sympathizers have an exaggerated view of the tax burden of Americans, especially high-income earners.

Many conservative economists support tax cuts for very high-income groups as well. Some cite a June 2010 study by Christina Romer, former chair of CEA (Council of Economic Advisors) in the Obama administration, and David Romer to support their argument. The Romer and Romer (RR) study does find a significant and large expansionary effect of legislated tax decreases, as measured by changes in tax revenue, on output growth. Its maximum effect occurs after 10 quarters (Bush tax cut was enacted in 2001). However RR do not examine effects of changes in marginal tax rates or in different taxes or reducing tax rates of high-income earners on output growth. In addition, the RR study does not claim to prescribe the mechanism through which taxes affect growth, i.e., supply side effect or demand side effect.  Finally, RR admit that their estimates, though significant, are not precise.

The supply-side argument cannot be supported by the RR study. However, evidence on the expansionary effects of lower taxes on the demand side is more convincing, hence lower taxes for 98 percent of income earners makes more economic sense.  Since real wages of many in low to middle-income groups have declined, continuance of lower taxes will tend to increase consumption by removing uncertainty of taxes, thus providing them incentive to increase their work effort, plan for consumption and saving in response to higher after-tax wages.

Laura Tyson, former chair of CEA under the Clinton administration, suggests that part of the revenue gained due to the expiration of the Bush tax cuts for high-income earners could be used to spend on investment programs to increase employment, and part could be used to reduce the deficit; it is a better idea at this time in the recovery process.

One of the most important components of any tax policy is that it should minimize uncertainty. Postponing extension of the tax cuts now for 98 percent of Americans creates uncertainty and will make people hedge on their economic actions beneficial to the economy. However it would be advisable if the Obama administration does look into the modification of taxes -- personal income, payroll, capital gains, corporate and estate -- in the near future. I would be more inclined to reduce corporate tax, increasing income limit of payroll tax, and closing the loopholes in defining capital gains, if the decision is made to reduce capital gains tax in the future.

It is hoped that the decision on tax cuts will be based on evidence and not on ideology.  At the present time, Congress should pass the Obama tax proposal to remove tax uncertainty, put the economy on the path of growth and full employment with minimal inflation, and set the trajectory for deficit reduction.

Mathur is former chair of the economic department and professor emeritus of economics at Cleveland State University, Cleveland, Ohio. He resides in Ogden. He also posts original blogs for the Standard-Examiner at http://blogs.standard.net/economics-etc/.

Monday, September 27, 2010

Revaluing Chinese yuan won't solve trade deficit and indebtedness

Vijay K. Mathur

Published in Standard-Examiner, September 23, 2010, Ogden, UT

We are hearing the call for protectionist policies from the political right and left in response to the manipulation of yuan (also called renminbi) by China. An academic study by Thomas Oatley in Business and Politics, 2010, argues that trade politics and exchange rate politics are interrelated. He finds that as the exchange rate, adjusted for price, appreciates beyond some optimum level, a large share of businesses competing with imports support protectionist policies. Undervaluation of the currency by China makes U.S. exports more expensive than Chinese imports. This situation is partly due to our rising trade deficit with China, which increased 171 percent from 2000 to 2009.

As our trade deficit with China worsens and our debt to China increases, concern about currency manipulation becomes more worrisome because it weighs down the economic recovery process.
Trade deficit and international debt of the US are related. International accounting teaches us that when exports are less than imports, causing a trade deficit, China will acquire more U.S. assets than Chinese assets held by U.S. (net debt to China). Hence more trade deficit implies more net debt to China. 

What can be done to reduce our debt to China? Decrease our imports and increase our exports. It will also help if we start consuming less and saving more. Reduced consumption reduces imports, allows a greater supply of our goods and services available for export, thus improving trade deficit. More saving will also provide more domestic capital for our investment projects and reduce Chinese ownership of public debt. In addition, when Chinese buy large amounts of our private or public bonds, prices of bonds increase and interest rates decrease, adversely affecting our retirees who are dependent on earnings from bonds.

Are Chinese manipulating their currency to keep the price of the yuan low against the dollar? The Wall Street Journal reported on Sept. 1 that in "mid-June, China rolled out a new currency policy that freed the yuan from its two-year defacto peg to the U.S. dollar." But in spite of this policy change, yuan has not appreciated much against the dollar. In fact the exchange rate of yuan with dollar has been fairly constant since 2008. However, it must be noted that even if yuan becomes expensive relative to dollar, our trade deficit may still not appreciably decrease. It all depends upon the sensitivity of our consumption to import-price increases, demand of our exports to price decreases in China and the response of our businesses to increase the supply of products demanded by Chinese consumers. Moreover if Chinese do appreciate their currency, they may switch to the exports of more high-end products which bring the same or more export revenue to China.

Some economists argue that over time Chinese labor will demand higher wages, thus increasing cost of production and consequently prices. This will favor our exports against imports from China. This expectation is based on the fact that China's workforce is aging and hence reduced labor supply will put upward pressure on wages, assuming that China continues to grow robustly in the future. That will help narrow the trade deficit in the long run, even without the appreciation of the yuan against the dollar. 

The empirical evidence of wage increase on prices and its affect on exports of a country is thin at best. If wages increase relative to the price of capital, China may respond by substituting capital for labor. This will reduce their cost and put downward pressure on wages and prices. China may also respond by producing high value-added products which directly compete with the U.S,; some evidence seems to suggest that China is already moving in that direction.

These actions may offset the effect of yuan appreciation. Yuan appreciation is not a panacea for fixing the trade deficit and indebtedness to China. Besides putting pressure on China to make the yuan flexible against the dollar, we also have to invest more in developing high level skills and accumulate human capital. We must innovate more, develop new technologies, produce more competitive products for the international markets using our own technologies and innovations, reduce outsourcing, and save more to generate more internal capital for investment in future technologies.

Former CEO and Chairmen of Intel, Andy Grove, remarks in his essay in Bloomberg Business that "the underlying problem isn't simply lower Asian cost. It's our own misplaced faith in the power of startups to create U.S. jobs. ... Equally important is what comes after that mythical moment of creation in the garage, as technology goes from prototype to mass production."

Mathur is former chair of the economics department and professor emeritus of economics at Cleveland Sate University, Cleveland, Ohio. He resides in Ogden. His articles also appear in vijaykmathur.blogspot.com.