Senator Hatch, balanced budget amendment is misguided

Vijay K. Mathur

Published in Standard-Examiner, January 30, 2011, Ogden, Utah

 Sens. Orrin Hatch, R-Utah, and John Cornyn, R-Texas, are attempting to push once again the balanced budget amendment; Senator Hatch thinks that this time most people are frightened by the deficit and the debt.

He did not succeed previously, but this time most in Congress will join their hands in harmony to tackle this supposed threat to national economic security. However, the senators do not realize that their amendment will increase economic and political insecurity. It seems that Sens. Hatch and Cornyn are not familiar with the way fiscal policy works and the real affects of public debt.

In his column in this paper on Jan. 27, "Balance the budget," Senator Hatch states that Washington spending is leading the nation into bankruptcy. However CBO's estimates on President Obama's budget show that the actual deficit was 9.9 percent of the GDP in 2009. It is projected to be 10.3 percent in 2010, and is expected to decrease continuously through 2020, when it would be only 5.6 percent of the GDP. This data does not show that we are on the path to bankruptcy.

Senator Hatch claims that Congress cannot be trusted to remain on the path of fiscal balance. However, he forgets that budget deficits have been with us since the 18th century. They have been generally on an increasing path since 1932. The deficit during 2002-2009 (including recession years) has been increasing at the average rate of 36 percent per year. Most of this period consists of President George W. Bush's years, when Senator Hatch voted for the discretionary war on Iraq and the Bush tax cut. He could have made a serious attempt to balance the budget and propose a war tax to pay for the war during this time period when the average economic growth was 5.9 percent per year.

After WW II, the federal debt (excluding debt held in federal government accounts) reached its lowest points at 23 percent of the GDP in 1974 from the high of 108.6 percent of GDP in 1946. After a slight increase in late '70s, there has been generally an upward movement in public debt as a percentage of GDP since 1982, irrespective of the political party in power. Senator Hatch is frightened by the increase in debt, not realizing that the economy has gone through a very severe recession, one not seen since the Great Depression. The CBO's debt forecast of 90 percent of GDP by 2020 should be viewed in proper perspective. Like us, most developed nations faced severe recessions during 2007-2009.

Therefore, for example, Euro area debt was 92 percent of GDP in 2010 and is not expected to be less in 2011; our debt will be 63 percent in 2011. We are fortunate that our economy is bouncing back with positive growth, partly because of the fiscal stimulus and assistance to the financial market, and it shows in the CBO's deficit forecast.

Senator Hatch exaggerates the burden on future generations. Most of the public debt is held domestically, and therefore to that extent domestic bondholders are asset rich. There is a transfer of income from non-holders of government bonds to holders. It does not affect the income of the country. Even if our children and grandchildren inherit debt, they will be asset rich. To the extent foreigners own our debt, there is a leakage of interest income from the U.S. But if foreigners get rich they will spend it somewhere, including imports from the U.S. To take advantage of high-income foreigners' demand, we have to become more competitive in the world market. It also requires that we save more and consume less, so that we have enough supply to meet foreigners' demand for our products. There is no convincing evidence that public debt reduces national saving or reduces our competiveness.

The real problem arises when the increase in public debt is beyond our capacity to service it and deprives us in meeting our other public demands for security and other services. Estimates show that interest payments in 2010 would be 2.9 percent of GDP, which would decline with increasing growth rate. Also, in the current environment of low interest rates, we have not seen any crowding out of private investment.

The effort on the part of private and public sectors should be to direct spending which helps develop new technologies, infrastructure, human capital and futuristic products so that we could compete in the world market.  Future generations will thank us for the real assets they will inherit, and at the same time we would generate robust growth and revenues in the current period. We need a sensible and stable tax structure and spending priorities, which encourage productive entrepreneurship.

Politicians should not think of the federal budget like state and local budgets. The federal budget is one of the most effective tools of fiscal policy. The amendment would deprive the federal government the use of that tool to manage the economy. Unless Congress can outlaw business cycles, the balanced budget amendment should be permanently buried.

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

The unemployment problem

Published in Standard-Examiner, Ogden, Utah, December 9, 2010

Vijay K. Mathur

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/.

The 'free rider' problem

Vijay K. Mathur

Published in Standard-Examiner, Ogden, Utah, January 15, 2011

A free rider is a person who enjoys the benefits of goods without contributing to the full cost or partial cost of providing them. This problem usually arises when there are spillover benefits or costs in the provision of goods.

The free rider problem is usually more acute in the case of public goods. Public goods are those where we cannot exclude others from their consumption, unless incurring substantial cost if the goods are provided at all, and the consumption by anyone does not reduce the amount available to others. Examples of pure public goods are national defense and environmental quality. The spillover effects of public goods deem it necessary to provide these goods collectively either through taxes and/or subsidies.  However, there are other areas where the free rider problem may arise due to significant spillover effects.

 Suppose in a neighborhood, a homeowner improves his house and pays for the improvements. This action by a homeowner also improves the value of houses of his neighbors. Neighbors enjoy this benefit even though they do not pay for it. Similarly, if a neighbor does not maintain his house, it will bring down the value of other neighbors' homes. This is a cost to the neighbors. In fact, the self-interest of the next-door neighbors dictates that they should also not maintain their homes. This type of behavior is responsible for the deterioration of housing in many inner cities around the country. That is the reason we have zoning laws, a collective action to make people maintain their properties.

If zoning laws are not enforced promptly and efficiently in neighborhoods, all households bear the consequences of diminishing housing values. Salt Lake City's recent decision to enforce sidewalk snow removal regulations for homeowners is meant to mitigate this problem.

A variant of the free rider problem may also arise in condo developments and/or gated communities where homeowners' associations impose flat maintenance fees on all units irrespective of their sizes and acreages. If there is a flat maintenance fee assigned to each homeowner, owners with bigger houses and acreages free ride on others with smaller units and land area. An appropriate policy will be to assign fees based upon the square feet of the unit and acreage outside the unit requiring maintenance.

The free rider problem also exists in public school systems. Low-income people, who have more than the average number of children in public schools and live in smaller homes with lower property taxes, free ride on others who have fewer children in public schools, have higher income and live in bigger homes with higher property taxes. The counter argument in public education is that higher income people with smaller families benefit from the education of others in terms of knowledge base and reductions in other harmful activities like crime when the population is more educated. Hence, they enjoy the flow of benefits from others' education. But the same argument can be made by high-income earners and the effect of their children's education on others, including low-income earners.

A stronger argument for public education at all levels is that it increases the knowledge base of the community, the state and the nation. Knowledge has significant spillover effects, where the more educated the general population, the more knowledge accumulation. It is like a public good. Accumulation of knowledge capital, especially in the modern economy, is crucial for economic development and the prosperity of a nation.

Pharmaceutical companies free ride on basic research and development at universities, but that has not stopped the public from supporting institutions of higher education. Drug companies, as well as other companies, are recognizing the benefits they derive from basic R&D at universities and hence are increasingly supporting those R&D programs. This free riding is beneficial to the society in the case of drugs' development. Drug companies face very large investments and risks in clinical trials. A very small fraction of efforts result in successes, but success brings substantial rewards to drug companies as well as to the society.

The free rider problem in the health insurance market is very pervasive. The so-called mandate in the health care law, that all must buy insurance or pay additional tax, implies that those who reap the benefits of health care by showing up in emergency clinics of hospitals must pay at least some amount for those benefits. Uninsured people are passing costs of their benefits by increasing others' insurance premiums.

There are many other areas where the free rider problem may arise, but it is important to note that the spillover benefits have to be significant enough to outweigh the costs of fixing such problems. We definitely do not want to impose a tax on people who benefit from neighbor's gardens, because costs will outweigh benefits.

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 blogs for the Standard at http://blogs.standard.net/economics-etc/.