To me, the most interesting part of economics is talking about policies and their outcomes. I can talk theory all day but students only relate to it when you can use good examples and show that these boring policy decisions have real impacts. I talk about the fact that there is no market for kidneys and most students probably think I’m crazy, that if we had a private market for kidneys they might wake up in a bathtub full of ice with a 12-inch gas in their side. Then I tell them that 4,000 people in the U.S. die every year because they can’t get a kidney transplant. More people than died in 9/11, and it happens every single year. Then they start to actually think about the pros and cons of different policies. In the past, I would talk about different government polices (price controls, taxes, etc.) and try to go through it as systematically as possible, but I never had a formula that I followed. This semester I was finally able to crystallize everything together.

In this process, there are 4 main steps to thinking through the economic impacts of any government or market-based policy. You can get more detailed than this, of course, but I think this does the job just fine.

1. What is the goal of the policy? What specifically is it trying to accomplish?
2. What are the effects on the market in question, and what secondary effects might we expect in other markets?
3. Who benefits and who loses as a result of the policy?
4. Is the policy successful in accomplishing its stated goals? If not, how can we alter the policy to improve the outcome and how does this affect questions #2 and 3? (Note to Washington: this does not mean always throwing more money at the program.)

The goal in my introductory economics classes is to teach positive economics: what are the facts? Normative judgments about a policy can be made at any of these four levels.

For example, the goal of taxes is either to raise revenues or to discourage behavior. If demand is elastic, you’ll change people’s behavior when you raise prices. If demand is inelastic, you won’t discourage much behavior but you’ve got a great revenue source. Sen. Daniel Patrick Moynihan’s proposed 10,000% tax on hollow-point bullets was not designed to raise money, but cigarette taxes are – if they really wanted people to quit smoking, they could make the tax bigger and really get people to quit.

For example, let’s examine the health care reform debate in this context.

1. What is the goal? It was supposed to be to provide universal health care for everyone and reduce costs.
2. The CBO and other entities have determined that the Senate bill would increase overall costs (the deficit goes down because taxes go up by more than spending), shift some people from private plans to public plans, and leave many millions of people still without health care.
3. Depending on the bill, either the rich pay more taxes or people with good health care packages pay more. Some people will see their doctor stop carrying their insurance provider and may have to switch doctors. The effects are myriad and complicated.
4. It doesn’t seem to accomplish either the goal of reducing costs or covering everyone. Somehow the Democrats switched the first goal to “reducing the deficit” instead of reducing costs, but that wasn’t the stated goal initially.

Now, you can debate the health care reform bill on any of these four levels and come to a normative judgment that you don’t like teh bill.

1. You may think that there isn’t a fundamental problem in health care. True, some people don’t have it, but many of those that don’t actually quality for government programs but are just not signed up, and others could afford it but would rather spend their money on other things.
2. You may think that the effects on the market do not justify taking this action. As some have said: why change the health care system for the 90% of Americans who have it just to give it to the other 10%. Isn’t there a better way?
3. You may already have a great health care plan and expect to lose. Unions have sometimes given up pay increases to get nicer health care packages and now they might lose those plans.
4. You may feel that there actually is a problem with health care but that this bill just doesn’t fix the problem. Some on the left don’t like it because it doesn’t cover everybody, while some on the right think the fact that it doesn’t lower costs means we should start over.

So I’ve been using this 4-step approach in my principles classes this semester and I think it’s a great way to think about an issue. It helps to figure out exactly what you believe and specify you disagree with people.

Let’s take the stimulus bill. Last week it turned 1 year old and the Obama administration touted it as one of the most effective government programs ever, while some Republicans say it hasn’t created a single job. Both of those are major hyperboles, so let’s look at the stimulus using this 4-step approach.

1. What was the goal of the stimulus? To prevent a depression and to keep unemployment from rising above 8%. Now, I have to clarify the difference between a prediction and a goal. The goal was to stimulate the economy, while the prediction of how effective it would be (keeping unemployment below 8% instead of the dreaded 9% predicted without the stimulus) depends not just on the policy itself, but also onthe changing economy it was put into. It was predicted to “create or save” 3.5-4 million jobs, most of those in the private sector.
2. What effects on the market would this have? The goal was to boost aggregate demand for output and keep output high. Our economy has started to recover, with 6% GDP growth in the last quarter. Is this because of the stimulus or because every economy at some time recovers anyway? Those who passed the bill will take credit for an increase in GDP whenever it occurs. Joe Biden said the effects would be seen immediately. Then the administration backtracked: it was supposed to happen in summer, then fall, and now when it finally happens in winter they clame success. When they don’t get what they predicted when they predicted it, they push back the prediction – but they’ll never say the program didn’t work, just that it didn’t work as fast as they had hoped. It’s like Paul Krugram predicting a recession almost every year during the Bush administration. He finally got his recession in the last year and claimed he had been right all along. But what about every year his prediction was wrong? If he’s going to take credit for being right one year, he has to take blame for being wrong 5 other years. But I digress – the goal was to keep unemployment below 8% and that clearly didn’t happen. 9% was supposed to be a depression and this stimulus was supposed to save us from that. Now we’re at 9.7% so that must be even worse than a depression, right? No, apparently the stimulus saved us from a depression. (I’m just as confused as you are about how 9% is a depression if we do nothing, but when it hits 9.7% after we act we’re supposed to give them credit for saving us from a depression.)
3. Who benefits and who loses? If your job was saved, you benefit. Much of the benefit has been to state employees, a group to which I admittedly belong. Some businesses have been helped by the green initiatives. Most people got a tax cut – granted, it was only $30/month so you might not have really noticed it, especially when the increase in gas prices since last year has eaten up that entire $30. (Gas prices have increased by $.60 since the stimulus was passed; if you drive at least 10 miles a week, your stimulus rebate is going to gas.) Our children lose because we’re borrowing most of this money and will have to pay it back. Previous generations have been able to pass debt onto their kids and they’d pass it onto their kids, but now the debt/GDP ratio is starting to fall into very dangerous territory. Future generations, perhaps even this current generation, won’t have that option and will have to make cuts.
4. Did the program accomplish its goals? If the goal was to reduce the severity of the recession, I think it’s done that. I think the people who say the stimulus hasn’t created a single job because we’ve lost 4 million jobs are either stupid or deceitful. We would have lost more jobs without the stimulus.

So when a Republican goes on a Sunday talk show saying he opposed the stimulus but was found at a ribbon-cutting ceremony for a project funded by stimulus money, he’s in a bit of a pickle. They ask him if things would have been better without the stimulus. He wavers and stammers and can’t answer the question. But there’s an easy answer to that question: tell the truth. No, things would not have been better without the stimulus.

But as an economist and not a politician, I don’t think that’s the relevant question. The question is: was the specific stimulus policy passed the best thing to do? I don’t think it was. The Republicans had a plan too. According to the econometric model used by Dr. Christina Romer, the Chair of the President’s Council of Economic Advisors, it would have created even more jobs at almost half the cost.

Yesterday, Governor Ed Rendell (D-PA) was on This Week touting the stimulus bill. To rebut all those people who say the stimulus hasn’t created a single job, he cited his own state’s statistics. He said that $3 billion of his state’s budget was coming from the stimulus, and if he didn’t get that money he would have to lay off 37,000 people. So yes, the stimulus saved some jobs. Without that money, either those people lose their jobs or taxes go up and other people lose jobs because consumers don’t have as much disposable income.

But when I heard that, I got my calculator. Each job Gov. Rendell is saving costs an average of $81,000 – twice the average private-sector job. The average private-sector job pays $40K while the average government job pays $71K.

Much of the angst and protest by Tea Party members is about the size of government. They feel it is too bloated and too big, intruding on our lives too much, especially if the health care bill passes. They look at the difference between the cost of government jobs and private jobs as a sign of bloated government. If you favor bigger government, do you really favor spending twice what you would in a private sector job? I’m all for saving jobs; I’m just for doing it as efficiently as possible.

Did the stimulus work? Is the economy better off in the short run than it was before? Yeah, it is. It didn’t keep unemployment below 9%, and it hasn’t created even half of the private-sector jobs that it was supposed to. For it to reach its private-sector employment job, virtually every job created from this point forward must be a private-sector job, and that’s simply not going to happen. Whether that’s because the bill was flawed, the economy was worse than expected, or people reacted to the stimulus by changing their behavior (saving more, for example, in anticipation of future tax increases to pay for all this additional debt), is a question that keep econometricians busy for the next few decades.

Bankers have taken a beating in the last year or so, being blamed for the “Great Recession” and for receiving bonuses for work despite the fact that their companies received bailouts. A friend of mine even received a Christmas letter from a family friend who literally spent paragraphs defending herself and the banking industry — and then went on to talk about how they just bought their second home, an enormous beach house. I think that’s what they mean by the word “tone-deaf.”

President Obama said a while back that he didn’t take this job to bail out “fatcat bankers,” and seems to have had no problem assigning blame to them. But now it seems he’s reversed himself a bit. A Bloomberg article reporting that some CEOs of large banks took home over $10 million in bonuses includes this:

The president, speaking in an interview, said in response to a question that while $17 million is “an extraordinary amount of money” for Main Street, “there are some baseball players who are making more than that and don’t get to the World Series either, so I’m shocked by that as well.”

“I know both those guys; they are very savvy businessmen,” Obama said in the interview yesterday in the Oval Office with Bloomberg BusinessWeek, which will appear on newsstands Friday. “I, like most of the American people, don’t begrudge people success or wealth. That is part of the free- market system.”

I’m shocked that Obama is shocked that some athletes are paid well but don’t perform up to his expectations. (Does he really want to talk about people not meeting up to the expectations people have of them? Really?) Is he shocked when some athletes who are paid relatively little have a great year? His shock shows a complete lack of knowledge of contracts, which perhaps should be expected given the penchant he has for ignoring them and his faux outrage over the AIG bonuses. These bonuses were specifically allowed in the stimulus bill, and have come about over time largely because of the different way that regular compensation and bonus compensation have been treated by income tax laws. So people on Wall Street take lower pay and expect higher bonuses, whether they performed well or not. In fact, they shouldn’t even be called “bonuses” because that’s not really what they are. They are a different form of compensation designed to reduce tax exposure. Most of us don’t understand the complexity of it so when people get ”bonuses” even when their businesses did poorly, it seems shady. But that’s not what it is at all.

For example, let’s compare the salary structures of NBA and NFL players. NBA players have guaranteed contracts, so if a player blows out a knee and can’t play again, the team is on the hook for the entire contrat. NFL players don’t — and the NFL Players Association is trying to get that changed. But until it gets changed, how do NFL players hedge that risk? They get large signing bonuses. True, some of these players won’t be good in a year or two. Obama would look at that situation and either say that the team’s owner was stupid for giving that player the money, or that the player was greedy and didn’t deserve the money. The fact that all of them get these signing bonuses would slip right past him. The fact that they’re not really bonuses at all — just a different way of structuring compensation – would be lost on him.

Apparently, President Obama thinks that only if you make it to the World Series should you earn a lot of money. That only if effort and luck all coincide to translate into the ultimate pinnacle of success should you be paid a lot of money. His shock displays not only a lack of understanding of contracts and their limitations, but also a complete lack of knowledge about uncertainty. If contracts were rewritten for all athletes so that players were only paid large salaries if their teams were successful, what would happen? They’d get bigger signing bonuses instead that were guaranteed, and the amount of pay they received would be largely unaffected. Players on a team cannot determine the fate of the entire team unless it’s in a sport that only has 5 people playing (the NBA) and you’re so dominant that you can carry your entire team, like Magic, Larry, Michael and Kobe have shown they can do. Players understand this. Owners understand this. They would make some alternate arrangement to get around it. But the smartest president we’ve ever had either can’t understand it or can’t appreciate it.

I find it hard to believe that this is the same man who loves unions so much and admitted to running all his important decisions by Andy Stern of SEIU (who for a while was the most frequent visitor to the White House until that information was made public). The effect of a union is that your salary is largely pre-determined and does not depend whatsoever on how well you actually perform. My salary at SCSU for the rest of my life is determined entirely by the union’s negotiations, whether I’m the best teacher here or one of the worst. When MnSCU decided a few years ago that it wanted to hand out a dozen or so Professor of the Year awards (along with $5,000 prizes), to reward hard-working professors who put extra effort into helping their students, what was the reaction? The SCSU Faculty Association Senate voted it down almost unanimously because they didn’t like the idea that having some people singled out for their exceptional performance would imply that these professors are actually better than others. Parish the thought!

The only thing certain in this life is uncertainty. President Obama needs to understand this and accept it, not try to fight it. Fighting it leads to micromanagement, where his Pay Czar will have to determine whether a $17 million bonus was “properly earned” because of a CEO’s ”savvy” business decisions, or whether it was “corporate greed.” And where his Secretary of Health and Human Services will send letters to health insurance companies who raise rates because their healthiest customers drop their policies due to the recession, raising the average cost of the remaining customers. These companies will have to justify every action they make so that some government official can determine whether this is a “justifiable” business practice or just an unhealthy quest for that ultimate evil: profit. So instead of markets and stockholders deciding issues of prices and pay, all of this will be determined by one person or one small government committee, who will no doubt reward those who contribute to them and punish those who disagree with them. They’ll give contracts worth millions of dollars to their spouses and friends, all the while telling us that they’re making better decisions than we could make for ourselves.

I guess it should come as no surprise that the most “intellectual” president we have ever had, with a cabinet with the least amount of actual business experience, would think that he can know everything perfectly and determine how businesses should make decisions better than they can. I wish he were a little less confident in his ability to make decisions and left more of those decisions to the little people who have been making them for centuries. If President Obama wants to tie people’s salaries and bonuses to their performance, I say we start by tying the pay of the president and Congress to their approval ratings. For every point under 50%, you lose 2% of your pay. 0% approval = no pay. It would certainly help reduce our budget deficit.

As the cliche saying goes: there are lies, damn lies, and statistics. But the creation of the statistic for a job that is “saved or created” has got to be one of the worst statistical nightmares in history and it is completely meaningless, as it is entirely unprovable. Nevermind the accounting gaffes, the jobs created in zip codes and Congressional districts that don’t exist, and the accounts of dozens of jobs being saved for a few thousand dollars (would you take credit for saving a job that paid a person a few hundred dollars a year?). And nevermind that when the White House says “jobs” they really should be saying “job-years.” (Giving someone a job for one year is much different from creating a job that continues on in perpetuity.) The problem is that the statistic relies on both job creation by the spending itself, as well as jobs created by the “spending multiplier” — jobs created when the people whose job was ’saved or created” spend their money at their local stores, thereby “saving or creating” other jobs. In theory, you can do that. But in practice it’s near impossible, especially when those multipliers have clearly changed in our economy. People get concerned about the future and those people whose jobs were “saved or created” aren’t spending as much, so they’re not multiplying as much. And how do you account for the jobs that were lost because people stopped spending their money because of the expected increase in the budget deficit, or because of the fall in the dollar? If you’re going to go through a counter-factual scenario and do it in an honest way, you have to look at how everything changes, not just the things that go in your favor.

Some accounts put the cost of each of these jobs “saved or created” at over a half million dollars. The problem with that is that it treats all money as going to jobs, when some of it is being spent on infrastructure and capital equipment, which will provide benefits long after the stimulus is over.

Bottom line: it’s impossible to know how many jobs were saved or created. And touting a number, any number, when we’ve lost 7 million jobs in the recession just doesn’t hit home with people. That’s like me getting pulled over for going 30 mph over the speed limit in a school zone with kids everywhere and telling the cop, “At least I wasn’t going 40 mph over the limit! And I’m not even drinking either!” While it might be true, it probably won’t go far in convincing the cop to let me off.

Maybe I’m just being too skeptical. Maybe it really is easy to determine exactly how many jobs were “saved or created.” Or maybe not. This story from the Politico highlights the fact that three different Obama administration officials, on the same day, gave three different numbers for the number of jobs “saved or created” as a result of the stimulus bill:

Valerie Jarrett had the most conservative count, saying “the Recovery Act saved thousands and thousands of jobs,” while David Axelrod gave the bill the most credit, saying it has “created more than – or saved more than 2 million jobs.” Press Secretary Robert Gibbs came in between them, saying the plan had “saved or created 1.5 million jobs.”

(Good catch by Axelrod.) Any number they pick can never be proven and is based on a wealth of assumptions, but even still you’d think the least they could do is get together and come up with one number. Then maybe we’d believe them.

Today in his speech about the middle class, Obama claimed that the stimulus had ”saved or created” 2 million jobs, so that’s the number he’s going with. (Wise up, Gibbs!) Then he added that “economists agree,” even “conservative economists.” I find it fascinating that his own administration can’t agree on a number, but he is going to claim that economists of all stripes agree with the one specific number he gave today. Hogwash.

[On a side note, less than three months ago, at the end of December, the administration was saying that the stimulus bill had saved or created 1 million jobs. So for the last three months, when unemployment has been the highest in this recession, at 10%, and when we lost jobs every month but November, we've "saved or created" 1 million jobs -- as many as were "saved or created" in the previous 8 months. Do you believe that? Didn't think so.]

To me, the saddest part in all of this is that the “2 million” jobs “saved or created” is used as a defense that the stimulus worked. Tell that to the 7 million people who have lost jobs. The administration used to agree that “less bad” is not success:

“The first quarter of this year, we were losing jobs at an average of 700,000 jobs per month, month after month,” he said. “In the quarter that ended this week, the loss was 250,000 jobs per month, two-thirds less.”

Still, he said, “those facts and those realities aren’t good enough for President Obama, and they aren’t good enough for me.”

“We don’t think that ‘less bad’ is good,” Biden said. “‘Less bad’ is not our measure of success. One job lost is one job too many, and it’s still too much pain.”

If less bad is not your measure of success, why is it the first thing that comes out of the mouth of anyone from your administration whenever they are asked about the economy?

Using numbers from hypothetical situations is difficult, heavily dependent on assumptions that may never be proven, but the context in which you use these numbers is everything. Consider the following two scenarios:

a) You run a hospital that has had 1,000 staph infections in the previous year, so you institute a new protocol for hand-washing and this year you only have 200 staph infections. It’s pretty clear that the program is a success. And yes, even 1 staph infection is one too many, but you’ve made improvement and you can make a decent claim that your program made things better.

b) You run a hospital that had 1,000 staph infections the previous year, so you institute a new protocol and at the end of the year had 2,500 staph infections. Suppose you came out and said, “Yeah, staph infections were up this year, but we were hit by an epidemic and it would have been much worse without the measures we took. Without our protocol we would have had 4,000 staph infections.” Would people believe you? What if other reputable doctors were saying that the protocal wouldn’t have any impact (as some economists have said about the stimulus bill) and point to the increase in staph infections as proof that the protocol didn’t work?

Both of these examples rely on counterfactuals that can never be proven. But if you’re taking credit for something that cannot be proven at a time when the thing about which you are claiming success  is going in the opposite direction, you’re probably going to have a hard time convincing people.

Footnote: This piece talks about how the task is so impossible that the administration is now not releasing employment updates because they can’t crunch the numbers. Even OMB director Peter Orszag has stopped using the phrase “saved or created” in favor of the more provable “funded by stimulus dollars” term. It’s going to make the number of jobs smaller, but at least this one is verifiable (assuming of course they can fix all the problems they have collecting the data).

A colleague of mine has a different quote in his e-mail signature every few months. His current one is from Thomas Sowell:

The first lesson of economics is scarcity: There is never enough of anything to satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics.

I couldn’t help but think of that quote when I watched yesterday’s episode of 60 Minutes. California Governor Arnold Schwarzenegger was talking about the state’s water shortages. Partially because of drought and partially because of environmental restrictions because of the Delta Smelt, California’s farmers are having to leave large swaths of their land barren. Almond trees that took 20 years to grow are being mulched because there simply is not enough water to go around.

Schwarzenegger seems to think that the way to fix the problem is to borrow $11 billion  to renovate dams (to increase water storage capacity) and many more billions to build a new canal to route water around the delta, saving the Delta Smelt. Nevermind that the new canal would be a larger project than the Panama Canal. In Schwarzenegger’s words: “I love cranes.” I can just picture the governor now playing with Tonka trucks in his sandbox. 60 Minutes correspondent Leslie Stahl asked the governor about the trade-offs that need to be made here between water for drinking and water for farming.

Leslie Stahl: There are people who say the southern part of the state is thirsty. They say that some of these farms should just go out of business, that they take too much water and people need that water.

Gov. Schwarzenegger: Yes, you know, of course, I, I, I totally understand that. But I look at the whole picture again. I tell you, I want it all! I love our farms!

Leslie Stahl: Yes, but is that realistic?

Gov. Schwarzenegger: Yes, it is realistic. Anything is realistic! It doesn’t mean that because it’s a desert that we cannot go and bring water in here and start growing things. All we have to do is deliver water and then we can grow anything we want!

Leslie Stahl: So much for the idea that the state is entering an age of scarcity.

The tone in Stahl’s voice as she delivers that last line is dripping with sarcasm. Good for her pointing out the obvious.

I guess it’s perfectly reasonable for a man whose career was made starring in movies with computerized special effects can think that anything is possible. As Avatar has now shown, anything is possible in movies these days. I mean, if  they can make us believe that the bus in Speed could actually jump a 100-foot gap in a freeway (Mythbusters test: not even close) and convince us that Maggie Gyllenhaal is anywhere close to attractive enough to substitute for Katie Holmes in The Dark Knight without us noticing, then what can’t those guys at Industrial Light and Magic do? Maybe Schwarzenegger has been around Hollywood so much that he can’t distinguish reality from CG fantasy.

I would like to think that Schwarzenegger’s proximity to Hollywood is the cause of his behavior. But, sadly, almost all politicians do this very thing. Pointing out that we cannot do everything for everyone without borrowing from someone else or sacrificing something is considered anti-American, unpatriotic nay-saying. We’re the greatest country in the world and we can do everything! USA! USA!

Since we can’t handle the truth, politicians don’t tell it to us straight. Because we don’t want to make sacrifices, the government gives us their only solution: spending more money. Nevermind where that money comes from or the long-term costs of borrowing money or the effect on jobs from raising taxes. Why, I’m sure we’ll just get the rich people to pay for it anyway. God forbid we try letting the market work, allowing the tighter supplies of food and water to cause consumers to conserve resources more so that there is more water to go around to its most valued use. Just give the government more money and they’ll fix all your problems.

Listening to Schwarzenegger talk and the enthusiasm with which he wants to borrow and spend so much money, you would never know the state is almost $50 billion in debt with a $21 billion annual budget deficit and the worst credit rating of any state in the nation. And you would also never know he has a degree in Business and International Economics from the University of Wisconsin–Superior.

It looks like Sowell was right.

P.S. Whether Schwarzenegger realizes it or not, there is always a sacrifice. The cost of the previous over-spending is the MC Hammer-like credit rating the state now has and the higher interest payments that result from it; as well as the lost tax revenues from people who have fled the state because it has the highest sales and income tax rates of any state in the nation. You can’t avoid the first rule of economics no matter how hard you try.

P.P.S. (For Benjamin’s comment): One’s cute, the other…not so much.

I was reading this article today on CNN.com about today’s meeting between President Obama and the CEOs of a dozen major banks. His displeasure with the banking community was shown in yesterday’s interview on 60 Minutes, when he said that he did not come to Washington to help out “fatcat” bankers. I’m sure that’s just the kind of thing these guys want to hear before their meeting. (Note to Obama: if you are going to ask someone for a favor on Monday, try not to publicly insult them on Sunday.)

The article brings up several great points. The federal government bailed out many of these banks through the TARP program when they suddenly found themselves with housing assets that weren’t worth nearly as much as they thought they were worth a year before. So to remain solvent, they borrowed the cash from the government. The government did not put many strings on what the banks could do with the money — and some of them responded by buying up other banks. The federal government even forced its way into a few banks, telling their CEOs that if they did not take some of the money they would be audited.

[If you wonder why I'm skeptical of federal government power, this is a prime example. What lessons do we learn from TARP? If you give people money without conditions, they'll take it and do things they think are most appropriate. If you put conditions on the money, they may not want to take it. Only the federal government thinks that their goal should be to design a way to force banks to take money with conditions on it so that they then have control over them and can make private companies do the government's bidding. Hmm...I wonder if that will happen with health care.]

I remember when President Bush and Congress were trying to justify passing TARP. They knew that a Wall Street bailout would be unpopular, so they told us that the world would basically collapse if we did not pass it, and they also told us to look on the bright side: if this works like other bailouts (Chrysler, for example), we’ll get all the money back with interest and John Q. Taxpayer could even make some money on the deal. Cha-ching! I mean, how can you not pass such an obvious money-maker for the people, right?

As it turns out, that seems to be exactly what’s happening. The banks have already paid back $71b of the $205b that was loaned out, plus another $7b in dividends. That’s supposed to be good news, right? Now taxpayers aren’t on the hook for these toxic assets any more. But it doesn’t seem like that’s what the people in charge of our financial institutions want. Obama and Geithner are not happy about this. They don’t want the banks to pay the money back because, once they do, the government no longer has any control over them. Although that may change if Congress passes the House’s Banking Reform Act — then they can decide that any private insitutition they deem too dangerous to fail can be taken over by the government. Yay for government! But until it passes (and it will, since any bill increasing Congressional power seems to pass pretty easily), Obama has very little power today to force these bankers to do anything. He wants them to start making more loans to small businesses, but the banks don’t want to loan the money. We know credit is tight these days, but has anybody stopped to ask why banks are not making these loans? After all, if loans were profitable, banks would make them and earn profits on them. So why aren’t banks making small business loans? Because these loans right now are not a great risk for the banks. (Remember when banks were the bad guys for taking on too much risk? It seems so long ago…) Back in February, the Small Business Administration’s (SBA) default rate on its loans soared to 12%. If it were your money on the line, would you make a loan if there were a 12% chance that you would lose the principle and get absolutely nothing in return? Didn’t think so. The last time we tried to get banks to make loans to people who had a high risk of default, it was called the Community Reinvestment Act and it helped lead to the subprime mortgage crisis that caused the current recession (or is it former recession? I’m not sure – if you ask Christina Romer and Larry Summers, whose offices are adjacent to each other in the West Wing, they’ll give you two completely different answers.)

(Update: This article explains that a study of business bankruptcies found that 50% of them were current with their lenders when they suddenly declared bankruptcy — the lenders never saw it coming. Yet another reason why lenders might be reluctant to loan to small businesses in today’s economic climate.)

As proof that the banks are not lending enough, you can look at statistics showing that the amount of lending has fallen. But we also know that individuals have become more conservative with their finances and do not want to borrow as much. The current saving rate is the highest it’s been in decades — a great sign that people are finally being financially responsible after so much excessive consumption. Obama says credit supply has fallen; bankers say credit demand has fallen. And as all my students in principles of microeconomics should know: if all you know is that the quantity of a good is down, you cannot determine whether demand or supply fell (or both) without knowing what happened to the price. Unfortunately, price data is difficult to come by. I spent a good deal of time searching for small business loan interest rates this morning and could find no historical data — let me know if you find any. For now, let’s just say that both are possible explanations. But even if supply has fallen, there is a perfectly rational explanation for it: small business loans in today’s climate are extremely risky.

Sure, it’s easy to put the blame on the “fatcat” bankers — everyone in Washington loves to do that. Politicians would have you believe that large salaries and bonuses for CEOs and bankers is the source of all problems, but they’re insignificant in the relation to the entire economy. All a bunch of sound and fury signifying nothing. But let’s deal with the facts. If I discovered that a company I owned stock in were loaning money out and getting none of it back 12% of the time, I would sell my stock in that company.

If you want banks to make more loans to small businesses, you need to bring some certainty back into the economy. Small businesses don’t know what will happen with cap and trade regulation and they don’t know how much a worker will cost them if health care reform passes — so they’re sitting on their hands while unemployment passes 10%. There are plenty of good workers out there to be hired, and firms would love to hire them, but without knowing the long-term cost of those workers, it’s not worth the risk. If you want the unemployment rate to fall, reduce small business income taxes and capital gains taxes, make it clear how much health care will cost or abandon the effort, and reduce business regulations. Then you’ll see small businesses succeed and banks extending more credit.

Or you can just blame the bankers.

This Week with George Stephanopolous was really good this morning. He had on two senators and two representatives, one from each party, to discuss the Senate and House health care reforms. Senator Tom Coburn (R-OK), a practicing doctor himself, seems to make the most sense to me and he had a lot of great arguments about why this bill is not good for patients. The debate started out as the typical back and forth with Democrats saying their bills are awesome and will save health care and Republicans saying they won’t work and will just cost us a trillion dollars, neither party actually citing statistics or facts.

Then something strange happened — the facts came out. Initially, George did a horrible job as a moderator. Facts were brought up that wiped out a Democrat’s argument, the Democrat chalked it up to simply a difference of opinion, and George just left it at that. Hopefully people are smart enough to see through this kind of dishonest debate.

Here’s a great two-fer example of this. When confronted with the fact that the Congressional Budget Office (CBO) said that both bills of the bills would actually increase health insurance premiums, despite the insistence of Democrats that the whole purpose of health care reform is to decrease costs for households, Rep. Debbie Wasserman-Schultz (D-FL) said this: “Well, there are differences of opinion as to whether or not the Congressional budget analysis is correct on the increase in premiums, but the important thing here is that I hope we can all agree that we have to get rid of the profit-driven, insurance company-drive health insurance system that we have, where it’s insurance company bureaucrats, Senator Coburn, that are getting in between patients and their doctors. To suggest that this bill will put government in between patients and their doctors is really disingenuous.”

Did you catch that? Nevermind the facts. Who cares what the CBO says? It’s just an opinion anyway. Now let’s change the issue to those evil insurance companies.

When the CBO scores a Democrat bill in their favor, they tout the CBO as the “gold standard” which must be respected and believed as the gospel truth. But when the CBO says something the Democrats don’t like, they say “well, there are differences of opinion on that.” I call shenanigans.

In response to her, Sen. Coburn goes on to cite the fact  that the percentage of claims denied by government-run Medicare (6.5%) is almost twice the national insurance company average of 3.5%. In response to the Republican concern that government will ration care, the typical Democrat argument is basically that rationing is going to exist under any health care system (100% true, by the way), but rationing already exists and it’s done by those evil insurance companies. Yet Coburn cites the fact that government rations more than insurance companies. I think that’s a pretty important fact to consider. (Note: see the comments on this post for more on the other side of this issue.)

Another great example happened when Rep. Marsha Blackburn (R-TN) actually read from the bill itself. She started by discussing the controversial announcement this week by the Preventive Services Task Force saying that women should not get mammograms until age 50, replacing the current guidelines which say they should start at age 40; and instead of getting them every year, they should get them every two years. Republicans have been skeptical of this, arguing that this is exactly the kind of government rationing they have been worried about.. They argue that not just a coincidence that as the Democrats are looking to expand the government’s role in health care, the federal government is releasing guidelines telling women to not get as much preventive care. The American Cancer Society rejected these new guidelines.

(Note: The PSTF also said that self-examination does more harm than good, as it gets women thinking they might have cancer when they don’t and then we waste money looking for it. You hear that, women? After decades of saying that you should check yourself for lumps because early detection is the key to beating breast cancer, now the government is saying to stop looking for cancer — because, you know, if you find it, you’ll need to be treated for it. And we wouldn’t want that to happen when the government is going to have to pay for it. Democrats always say we have a horrible health care system, but the one thing that they cannot dispute is that our rate of cancer detection and survival is higher than every other country in the world. If we go down this route towards government-run health care, expect those rates to fall in line with the rest of the world; i.e. more people will die from cancer just at the point where cancer rates in the U.S. are falling because we are so successful at beating it. But the government will save money, so yay for that! As Dr. Bernadine Healy, former Director of the National Institutes of Health, said about the new guidelines: “This will increase the number of women dying of breast cancer. Women in their forties have a very aggressive kind of breast cancer. They tend to progress fast. And to not screen women in that age group is astounding to me and it goes against the bulk of individuals who are actually caring for patients. You may save some money, but you’re not going to save lives.”)

OK, back to the show. Blackburn read verbatim from the bill. Citing titles, sections and pages, she explained how the bill renames the Preventive Services Task Force to the Clinical Preventive Services Task Force. Then she explained how the bill assigns the CPSTF the task of rating all preventive services with a grade of A, B, C, D, or I. At this point, Stephanopolous seemed shocked (shocked!) that the representative had actually read the bill, even perhaps a little annoyed by it. But Blackburn pressed on, explaining that the bill says that only services rated A or B actually must be paid for by health insurance. And the preventive cancer treatments between ages 40 and 50, which the PSTF just announced are unnecessary, were given a rating of C. So the fact is that if women want to continue to get screenings at age 40, they will not be paid for by insurance or the government. You can still argue that we might find more breast cancer in one respect: women over 50 without health insurance will now get free mammograms under their health insurance or government option. But you can’t deny the fact that women 40-50 will either get fewer mammograms or have to pay for them out of pocket. Or can you?

Wasserman-Schultz, who suffered from breast cancer herself just a while back, then accused Republians of playing politics with breast cancer. She flat out denied what Blackburn had just said. Her response to the assertion that the CPSTF’s guidelines would essentially become law: ”No, they would not be.”

At this point I give Stephanopolous some credit. He actually put the language of the bill right up on the screen so we could all see that what Blackburn had said was 100% true. Wasserman-Schultz’s answer: “This task force’s recommendations are simply recommendations. They aren’t controlling, they aren’t going to be binding.” Again, shenanigans. Sure, nobody is saying that a 40-year old woman can’t get a mammogram, but she’s going to have to pay for it herself because no insurance company, especially the government option, will pay for it. I don’t know how this woman can lie to the American public with a straight face, but she did. And to his credit, Stephanopolous called her out on it.

Health care reform (a.k.a. health insurance reform, because it sounds less controversial) is a difficult thing to do, no question about it. There are going to have to be some sacrifices made no matter what we do – if you want to cut costs, you have to improve efficiency or reduce services; it’s that simple. When politicians, of either side of the aisle, exaggerate claims, dismiss facts, or flat-out lie about what is in the bill, they need to be called out. I’m glad that George Stephanopolous finally did that today, and I hope he’ll continue to do it in the future.

The Senate bill was released today and I have a few thoughts about how politicians on both sides are being dishonest about the bill.

Let’s start with the Republicans. The CBO’s estimate of the effects of the bill are that the cost for the government option health insurance plan will likely be higher than private plans. On Fox News, Carl Cameron reported that this confirmed what Republicans have been saying for months — that government-run health care will be more expensive. Really? That’s not how I remember it at all. I remember Lindsay Graham (R-SC) saying that the government option would be cheaper than private plans. And because it is cheaper, companies will ditch their private health insurance plans. Private health insurance companies won’t be able to compete and they’ll be driven from the market. the government option was supposed to destroy private health insurance. Now we discover that it won’t, and that’s somehow bad too? Republicans are trying to take both sides of this issue. If the government option is less expensive, it will ruin private industry. If it’s more expensive, it’s a sign that the government is inefficient and can’t do anything right. You can’t have it both ways, guys.

Speaking of having it both ways, let’s move on to the Democrats. In trying to keep this bill deficit-neutral, they are forced to raise about a half trillion dollars in taxes. $28 billion of this is taxes is expected to come from employers that do not provide government-approved health insurance plans for their employees, so they get fined. So what happens if these companies shape up and put their employees on the government option? The government now has to pay for the health care of these individuals, and the government does not collect the tax revenue. Seems to me the Democrats are counting on money that, if their bill is successful, they won’t get. It’s just like the SCHIP bill passed a few years ago. In order to help pay for an expansion in the State Childrens Health Insurance Program, the Democrats in Congress increased cigarette taxes. If people stop smoking (as we want them to do), the government doesn’t get its money and the kids don’t get health care. As I tell my students, next time you’re smoking, just tell yourself, “I’m doing it for the kids.”

The Democrats say the bill costs $848 billion and will reduce the deficit by $130 billion. That means they’re increasing revenues by 848+130 = $978 billion. Some of this is assuming new efficiencies in Medicare that the CBO says are questionable. And the rest of it is on taxes. The goal wasn’t to reduce the deficit by increasing taxes (especially in a recession) — it was to provide affordable health care for all. If you only need $848 billion, why not increase taxes enough so that you get $848 billion in revenue. If you ask me, this extra $130 billion is because they know those Medicare cuts won’t happen.

And last but not least is the difference in timeline between costs and revenues. The Democrats start collecting taxes next year, so the $978 billion in revenues comes over 10 years. But the benefits people get in the health care bill don’t start for 5 years. So they’re actually saying that we’ll collect money for 10 years and only pay it out for 5, and somehow this is a deficit reduction. That’s like me saying that I’m only going to pay half of my bills this year and then, at the end of the year being proud of all of the cash that I have in my checking account. It’s ridiculous. And the CBO says that in the second 10-year period of the bill (2019-2029), health care costs will TRIPLE.

And politians wonder why we’re sick of their games and want to throw them out of office. They can’t be honest about the numbers. They play a shell game with our money. And they talk out of both sides of their mouths. My suggestion for 2010: vote out every single incumbent. Maybe they’ll get the message.

I’m usually one to have a strong opinion on something one way or another, once I figure out what the facts are. But after reading a story today about a proposed new law, I’m not sure whether I like it or not. I think I could be in favor of it but, well, I need more facts. Selling me on public policy changes based purely on theory is not easy to do.

The proposed law would require that when an employer tells a sick employee to stay home, they pay the employee for up to 5 days of sick leave. Currently there is no law forcing employers to offer any paid sick leave. But with H1N1 waking people up to the possibility of a pandemic, lawmakers are starting to reconsider this. The Center for Disease Control (CDC) has been advising employers to encourage their sick employees to stay home. My school did the same thing for faculty, staff and student. But faculty have paid sick leave and, worst case scenario, students get the day off. We don’t usually hear complaints from them about that.

For millions of people, especially hourly workers, staying home for the good of the firm means less money in their pockets, a difficult decision for people to make, especially in a soft economy. They don’t want to infect their co-workers, but they can hardly afford to stay home. The CDC is spinning this as a good thing for employers: if your sick employee stays home, she won’t infect her co-workers and the amount of sick time taken overall will decrease. Paying for sick leave encourages her to make a decision that is in the best interest of the firm. Overall productivity will stay high and the few days of paid sick leave the firm has to pay is small relative to the potential loss in profits from a firm-wide outbreak.

(A quick market-based analysis: if the CDC is correct, profit-maximizing firms would have been voluntarily doing this all along — especially evil corporations who only care about profits. If the CDC is correct, you don’t need to force firms to pay for sick leave. So if they’re not choosing to do this, they must have concluded that they would rather have less-than-full productivity out of a more sick work force than have some people stay home sick and have to pay them for it.)

One problem I have with the article: no mention of any statistics. The CDC seems to just assume that when an employee goes to work sick, she will infect other people and they will infect others. While that’s certainly possible in theory, there is also the other side of the argument: many employees work while sick and maintain their productivity and don’t infect anyone. It depends on individual behavior, how communicable the disease is, and how long it lasts. I’m not sure how you would gather statistics on this to do a cost-benefit analysis here, but it seems that nothing like this has been attempted. But Congress can’t afford to worry about that — they’ll pass a law anyway.

Next thing you know, we’ll be passing mandated flu shots. Actually, that would no doubt be stricken down as unconstitutional. (Actually, I’m not sure that word means anything any more.) Instead, the government will just impose fines or taxes on firms that do not offer free flu shots to their employees. And they’ll tell firms: it’s for your own good. And it might be. It very well may end up costing less for the firm to pay for all its employees’ flu shots than endure a loss of productivity as people take sick leave. But without any data or analysis behind it, I’m skeptical.

I’ve talked about the gender pay gap before here. To summarize it as I see it, here is a quick rundown of the facts. For the same job with the same experience and qualifications, men make perhaps 5-10% more than women — that is clearly unfair. Yet the average woman working full time earns only 78% of what the average man earns working full time. How do we explain these two results? It boils down to either inequality of opportunity (men are keeping women out of high-paying professions) or a difference in choices — women choose different jobs, either because of personal choice or societal pressures. It’s hard to prove any of those causes — and it is probably a little of each of these — and it’s unclear what the solution is exactly.

This morning on Meet the Press, there was a roundtable discussion on the state of women in America. I was struck by a comment at the very end by Maria Shriver. In the context of a discussion about Hillary Clinton’s role in last year’s presidential primary, she was asked by the moderator why there are not as many women as men in politics. Her response was that women do not want their lives exposed the way politicians’ lives are these days. She finished up saying, ”It’s not that women aren’t competent, but women view success differently than men. They view power differently than men. And they often want very different lives than men.”

I am glad that Maria Shriver, a self-described feminist, can be honest enough to admit that women want different things out of life than men. I think anyone with half a brain can realize that. Yet some women’s rights groups, like the Women’s Center at my university, would lead you to believe that somehow this should not translate into different occupational decisions or different salaries.  The WC has send out information in the past saying that women working full time should earn 100% of men working full time, regardless of the occupations they choose. To them, anything less is discrimination.

Studies have shown that men take jobs that require them to travel more; they work outdoors more often in harsh temperatures; and they work riskier jobs (94% of all workplace fatalities are men).  To borrow from President Obama’s favorite phrase: “Let me be clear:” I think women should be paid the same amount of money for the same work with the same qualifications, plain and simple. One study of people at age 30 grouped people by major and, without even correcting for job or industry, found that women who majored in economics earned 99% of what men who majored in economics earned. I think that’s a pretty good statement for the economics profession.

Yet I don’t think that, for the economy as a whole, women’s average salaries should equal men’s average salaries — at least not if women are working more convenient hours, in less risky and less stressful jobs. The difference lies in whether you are comparing the same job or a different job — and if you work a different job you should not expect the same pay. For example, the research requirements for tenure at SCSU are much lower than those at Harvard and, not coincidentally, SCSU pays a much lower salary than Harvard. It would be ridiculous for me to complain that I do not get paid as much as a Harvard professor when their lives are much more stressful because their tenure requirements are more strict. I made a decision based on what I wanted out of life and I live with the consequence that others in my profession get paid more than I do for working what is clearly a more difficult and stressful job.

Some women’s rights groups want women to have equal incomes despite having different goals, making different decisions and working in different jobs — “wanting different lives,” according to Shriver. That is asking for special treatment, not equal treatment.

I’m a libertarian and my general stance is that we should try free market solutions first and then, if those don’t work, look to the government. The  main problem I have with government is that when they change the rules of the game, they change the way people behave and that creates new problems — which invariably call for more government intervention (spend more on education because we’re not getting good outcomes!) instead of less. For example, taxing high incomes but not bonuses caused Wall Street to change their whole pay structure so that now executives get huge bonuses. The government didn’t like that, so they tried forcing companies to offer stock instead of cash, so that executives have a stake in company performance. But that just increases the reward for cooking the books to make the stock overvalued. So now they have to have new accounting rules and other ways of trying to fix that problem, using “clawback” features and trying to base bonus pay on long-term stock performance instead of short-term performance. That will invariably cause another problem they’ll try to fix. It’s not that the goverment TRIES to screw things up — it’s just that they end up doing that because they fail to account for how people will respond to changes in laws that change their incentives.

Now this from the bill in the Senate Finance Committee makes me reconsider the notion that nobody in Washington understands incentives:

Under current regulation, incentives based on health factors can be no larger than 20 percent of the premium paid by employer and employee combined. The legislation passed by the Health and Finance committees would increase the limit to 30 percent, and it would give government officials the power to raise it to 50 percent.

and

Douglas J. Short, BeniComp’s chief executive, said the incentives he uses focus on outcomes, not conditions.

“I can’t give you an incentive based on being a diabetic or not being a diabetic, but whether you’re managing your blood glucose level — I can give you an incentive based on that,” Short said.

I understand the concern that people wil pre-existing conditions have, but I also understand the perspective of health insurance companies. If insurance is supposed to be for things beyond your control (like flood insurance, for example, which is completely beyond my control as a homeowner), then insurance companies base rates on observable characteristics and statistics. If I live in a flood plain, they charge me higher rates — not because of anything I did but because the risk is higher.

And in some cases, that’s what health insurance is. I could get cancer, fall down and crack my skull open or any number of things. And the premiums I have paid will cover the cost of the treatment — I use health insurance to smooth my payments for medical care over my entire life rather than have massive expenditures every once in a while. But when I have a pre-existing condition, the risks and expected costs are higher. Granted, there may be nothing I can do about it, but forcing health insurance companies to take people with pre-existing conditions at the same rates as everyone else is forcing health insurance companies to pay for something that will make them lose money overall on that person. How is that fair to them?

Back to the story, and my main conclusion: I love this. We’ve become a society of people that mostly eat too much and exercise too little because, well, we can. I like the compromise the Finance bill makes: force insurance companies to take everyone but allow them to charge higher rates to people whose behaviors are resulting in higher costs. If you are overweight and eat fast food 5 times a week, and put yourself at higher risk for heart disease, why should your insurance company bear that risk? They shouldn’t — you should. Many companies have tried incentivizing good behaviors, like paying for part of a subscriber’s gym membership fees if the person exercises at least twice a week. That’s all well and good. But in addition to carrots, sometimes you need sticks.

As a libertarian, I believe you have the right to do whatever you want with your body and your property, as long as nobody else has to bear the costs of your actions. If we legislate a health insurance system where insurance companies are forced to take you regardless of your condition, there should still be a way of making you pay for the poor health choices you make from that point on. The Finance bill seems to recognize this.

In my Managerial Economics class today, we were wrapping up the section on perfect competition. Economic models are often assailed because their assumptions are not always realistic. In perfect competition, we assume every firm is identical — an assumption that is clearly not true in many competitive markets. Farms come in a wide variety of sizes. The assumption of equal size is not a crucial one; it just makes the analysis easier. But more important than the accuracy of the assumptions of a model is the accuracy of its testable implications — does the market behave in ways the model predicts it should? For example, one common attack on Keynesian models is that their aggregate supply assumptions typically assume that when output is high it is because real wages are low and that is why firms are using a lot of workers – however, we usually see high real wages during economic booms. Two  major implications of the model of perfect competition are that prices should be a) relatively stable, and b) rising slower than those in less competitive markets.

Prices must be relatively stable because, if price were trending upward over time persistently, it would indicate positive economic profits in the market and this would invite entry, which would increase supply and bring prices down. Sure, there will be small fluctuations, but they should not be large or prolonged.

Prices should be rising slower than average (slower than the rate of inflation) because of the extreme importance that perfect competition places on cost-cutting. If you want to increase profits, advertising won’t do it — you’re already selling as much output as you can and advertising is pointless when your product is the same as every other firm’s. But every dollar you cut in costs is a dollar of profits. And the large size of competitive markets makes it likely that others will develop innovative technologies that they can sell to all the firms in the market. This is one of the reasons why the relative price of food in this country has fallen so dramatically in the last 150 years — produce a new farm implement, fertilizer, or tool and you have millions of customers, all buying your product so they can have a cost advantage over their competitors (except they all buy it, so the price drops and they still have zero economic profit).

I decided to try to test the implications of the theory to see if this holds. While agriculture is often characterized by perfect competition, most people association agriculture with fruits and vegetables. That adds more complications, as farmers plant crops based on expectations of future prices when the crop is harvested; and plants are subject to changes in weather like droughts and freezing. But agriculture also includes beef, poultry, and eggs. These are not as susceptible to changes in supply due to weather, and it only takes about a month to raise a chicken to 3.5-lb broiler size — a relatively quick time to respond to changes in market conditions.

So I compared the average monthly prices of a few different goods. For competitive markets, I used turkey (a very competitive market, with an HHI of about 50) and chicken. For comparison, I also looked at gasoline (a mildly concentrated market as classified by the Department of Justice, with an HHI of about 1600). The numbers on the horizontal axis indicate months, 180 in total (Jan 1990-Dec 2004). The numbers on the vertical axis are both nominal prices — gas is per gallon, turkey is per pound (I think — it says nominal prices to consumers for frozen birds, but the data does not specify the units) and chicken is a retail price index.

Average monthly prices, January 1990-December 2004

Note that turkey prices rise at less than 1% per year, much lower than the rate of inflation. Chicken starts out at a higher price (it’s an index, not an actual price) and rises at around 2.4% per year. Gas prices rise at around 7% per year, twice the rate of inflation. Notice also that while gas prices have swings of 10-20% per month on a pretty regular basis, chicken and turkey prices have much smaller monthly fluctuations. Chicken prices are incredibly stable. In only two of 180 months is the change in prices greater than 3.5% and the highest change is 7%.  (in absolute value, so we include both increases and decreases) is only 1% per month. In contrast, the largest monthly change in gas prices is a 19% increase, and 40% of the monthly changes exceed 3.5%. The turkey market would be as stable as the chicken market except for those big drops about the same time every year in, you guessed it, November.

If explore the turkey data, you will find that in all 15 years, the month with the lowest average price is November, the month when demand is unquestionably the highest: consumption in November is now about 50% higher than the monthly average. (50 years ago it was 200% higher and 20 years ago it was 100% higher; the dropping increase in November consumption, relative to other months, is due to increased consumption of turkey in these other months, a trend that started in around 1990.) I think the likely explanation is that supermarket competition for such a huge consumer base causes firms to reduce prices, hoping to entice customers to do the rest of their Thanksgiving shopping in their store. It’s useful to have the basic model to help our understanding of markets, but also to acknowledge unique features of each market that can’t be simplified or assumed away, like the fact that turkey sales are heavily holiday-dependent, but chicken sales are not.

These are only three examples, but you can find a lot more markets and I’m pretty certain you would find a similar result: competitive markets are more stable and predictable, and offer consumers lower prices. It’s nice when we can point to observable outcomes in markets and justify our models. They might not be perfect, but sometimes they’re a pretty decent approximation of reality.

(I wanted to include the image below in my comment, but I can’t, so I’m doing it here.)

(This is really two posts: one on health care and one on taxes and spending, but they are tied together by the theme of ideological consistency — or a lack thereof.)

Health Care

On his show Real Time yesterday, Bill Maher said this: “A sixth of our economy is based on people getting sicker.” He also said, “People are sick and we make money off sick people.”

That struck me as an extremely pessimistic, upside-down view of health care. In Bill Maher’s world, money spent on health care is based on people getting sicker. In his world, it’s a giant corporate conspiracy, whereby Big Agriculture produces horrible food products that we stupid Americans ingest, some other cabal of corporations figure out a way to get us to stop exercising and become couch potatoes (not sure who does that – but I’m sure Sony, Microsoft and Nintendo are all involved), then Big Pharma comes in and gives us pills to fix everything. Everybody makes money in the process, while Americans just get sicker. In this pessimistic world view, it’s obvious that we would want to reduce health care spending. I have a more optimistic view of our health care system, where drug companies find cures for diseases that allow us to live longer, more productive, more enjoyable lives. Yes, providing statins that can reduce cholesterol levels might reduce a person’s incentive to exercise — but providing unemployment insurance reduces a person’s incentive to find a job and we have no problem with that. It seems that if Bill Maher had his way, we wouldn’t spend any money on health care and people would just have to eat better and make smarter health decisions. Fine, Bill — just don’t get sick. And be sure not to age, okay? (more on this later)

Taxes and Spending

On that same show, Bill Maher brought up a speech made earlier this week by Sarah Palin. In it, she said that if we want to create jobs, we have to reduce income taxes, reduce payroll taxes, reduce capital gains taxes, and eliminate the estate tax (the death tax if you’re a Republican). It’s the classic supply-side argument that has been shown to increase labor supply when it has been done before. The debate is usually about whether doing this will also increase tax revenues, and that depends on which side of the Laffer curve we are on. Paul Krugman had a different  take on this proposition, ignoring the tax revenue question and basically saying it would result in less employment: “What she’s saying basically is we need to do more of what George W. Bush did.” He goes on to say this is like a witch doctor making a sick patient bleed more to cure him, wonders why we would want to continue the policies that led to the worse employment-creating presidency since Herbert Hoover (patience, Paul –just wait until Obama’s done with the economy) and argues that instead the solution to our current unemployment situation is an increase in taxes. Many macroeconomists, including Richard Posner and Krugman himself, have gained a newfound respect for Keynesian economic theories as a result of our current economic situation. But even Keynes himself would have a really hard time rationalizing how higher taxes would increase output in the short run, but somehow Krugman thinks it can happen. The problem I have is that I’m not sure how that squares with what he’s written already about this financial crisis. For example, in this article, he argues that cutting spending during a crisis is an absolutely crazy, horrible thing to do — yet somehow raising taxes is the right thing to do, Paul?

I also find it laughable that people like Krugman will point to the Bush economy and say “he did X, and it didn’t work out well, so it would be insane to do even more X,” as if X were the only thing that happened in 8 years. Nevermind 9/11, wars, increased globalization, and a variety of other factors — it’s all because of tax cuts. Yet even if this were true, this is a new philosophy for politicians (admittedly, Krugman is not a politician, but when your weekly column consists entirely of bashing Republicans, you’re flirting with the label). Usually, their strategy is: spend money on X, and if that doesn’t fix the problem, spend even more money on X. Democrats have been fighting the “war on poverty” for decades and aren’t getting anywhere. Republicans have been fighting the “war on drugs” for just as long and with just as much success. We keep increasing spending and government control over education, and our country’s educational performance continues to get worse and worse, yet the solution proposed by Democrats  is to spend even more. (This includes Michael Moore this week on the Howard Stern show — no transcript available unfortunately, but I was listening to the show and heard him say that the problem is we don’t spend enough money on education.)

If spending increases are good, then tax increases should be bad. If “doubling down” on wars or tax cuts is bad, then doing so on education should also be bad. There seem to be no principles left in either party — it’s just bashing the other side and trying to get votes. How about a little ideological consistency?

Back to Health Care

Here’s where, as much as it may pain me to do so, I am going to give Bill Maher some credit. On his show last week, he slammed Obama for not asking Americans to sacrifice anything. He said that those who chastised George Bush for not asking Americans to sacrifice after 9/11 (remember that he basically said that if we don’t keep shopping, the terrorists win), should also be chastising Obama for not asking Americans to make any accomodations on health care. If this is in fact a crisis, as we keep hearing from the President, then he can’t come out and say “we’ll pass health care and you can keep your doctor and keep your insurance and we’ll cover everyone and it won’t increase the deficit and everything will be perfect, I promise.” (Not an actual quote, just my paraphrasing.) Maher argued that Obama needs to come out and tell us that we can’t keep doing what we’re doing, and that we will have to sacrifice. We need to eat healthier, we need to exercise more, we need to stop smoking — those 3 things account for a significant part of our health care spending and are 100% preventable.

I don’t agree with Bill Maher on much, but I’m completely behind him on his proposition. The only problem is that if we were to do all of that, health care spending in our economy would likely increase, not decrease. Studies have clearly shown that the longer people live, the more expensive each year of routine health care becomes. We’ll spend a lot more money on expensive procedures like hip replacements, knee replacements, bypasses, etc. for people who used to die of a heart attack at age 50 but now have statins, read nutritional information on their food, and exercise regularly. The number of hip replacement surgeries is expected to double from 2002 to 2015, and only 5-10% of them are performed on people under age 50 (stats). Seventy percent of knee replacement surgeries are on people over the age of 65, although as the technique become better, we’re starting to see more of them performed on younger people (stats). Hip replacements cost $39,000 on average and knee replacements cost $35,000. Expect the cost of health care to continue to increase as we live longer lives. These cost increases are obviously not due to people being sicker. They’re due to an aging of the population and improvements in technology and surgical techniques that allow more people to qualify for the surgery than before.

Governor Pawlenty made waves about a year ago when he proposed that he wanted MnSCU to have 25% of its credits generated through online courses. The current amount is 9%, so he wants to almost triple online enrollment in 7 years, quite a hefty feat. Yet there are no real guidelines passed down from MnSCU or SCSU about what an online course must contain. There are some outside standards (the one I am going to be using is by Quality Matters), but nothing from the administration. As educators, we like flexibility and academic freedom, so I appreciate nobody telling me exactly how an online course is supposed to look. However, a mandate for increased production of something without any standard on quality will likely lead to a reduction in quality, and some of us in academia are concerned about that.

I’m in the middle of a redesign of the online principles courses in the Economics department to take advantage of new technology and a new and growing understanding of what it takes to create a good online course. There are many issues to consider and I’d bore you if I went into them here. Let’s just say that I have a very good vision for what I want the online courses to look like and am trying to make sure I can get the technology to do it in a way that is easy for students to follow. But as professors, sometimes we find that our vision of a course conflicts with what students want in a course. In that kind of a disagreement, the professor usually wins, but sometimes the class as a whole loses as a result. Our job is not an easy one: to balance our professional expectations for what goes into a course with an understanding of what our students will and will not do; to push students to do work we know will be beneficial for them, making them live up to our expectations, without pushing too hard and risking a revolt.

For example, I would love it if all my students read their textbooks before class. It would allow me to spend more time on applications and extensions of the concepts and less time going through the basics. A few years ago, I started using pre-lecture quizzes to force students to read the book before lecture. The questions weren’t too difficult, but you had to read the chapter if you wanted to pass. I eventually came to find that students just skimmed the book  or searched through the book to find the answer to the question without really paying attention to what they were reading. The pre-lecture quiz performance was never good. Students did the quiz but didn’t learn much, so I had to go over the basics anyway. My students told me, through their behavior, that they’re simply not going to read their textbook before lecture, since they felt I did a good job communicating the concept in lecture and they didn’t need to read the book. The pre-lecture quiz idea was great in theory but just didn’t work well in practice. (I got the message, loud and clear, and have dropped the idea from my courses.)

The purpose of this post is to solicit feedback from students about online courses. For those of you who have taken online courses: what made it a good or bad course? Why did you choose the online course instead of a lecture-based course: convenience or a perceived lower level of difficulty? Was it easier or harder than a lecture-based course? Was it just as educational as a traditional lecture course would have been? If you had a bad experience, what could your professor have done differently to have made it better for you?

Please share your thoughts so that I can understand why students take online courses and what makes them successful from a student perspective. Our goal is to make our department’s online courses as educational and informative as a traditional lecture course — I’m just trying to figure out what that means for students.

By now, we all know that President Obama said he would not pass a health care reform bill health insurance reform bill if it adds to the deficit. And one significant problem is that the Congressional Budget Office (CBO) has scored the reform that has made its way furthest in the political process (H.R. 3200) and said it would add $1 trillion over the next 10 years. That has left some House Democrats angry, saying that the CBO has not accurately accounted for the savings that will come from increased preventative care.

Unfortunately for them, the facts don’t support their claim. CBO Director Doug Elmendorf cited a study from the New England Journal of Medicine saying that in 80% of preventative care programs, the costs of treatment actually increase. A new article in the journal Circulation says that increased diagnosis and treatment of diabetes actually costs more than the alternative.

How can prevention of disease be more expensive than treatment? Two reasons. First, you have to test a whole lot of people before any of them show symptoms and many of them would not get the disease anyway, so that costs money. Second, because unfortunately it is cheaper to let someone go undiagnosed with diabetes and die prematurely than to spot it early and pay to treat them every year they live, especially when that treatment will make them live longer. As Stuart Varney essentially put it this morning: it’s cheaper to have someone drink a fifth of Jack Daniels and smoke a carton of cigarettes every day and die at 50 than it is to have them live long lives and have to spend money on them for 90 years. If you want to save on health care costs, encourage unhealthy behaviors and people die sooner, as health care costs rise significantly the older a person becomes.

That sounds absolutely horrible, right? Well that’s what happens when all you focus on is costs. When conservatives get up in arms over health care costs in this manner, they’re falling victim to the same distorted logic that liberals use when they say that our health care costs too much. Not all health care costs are bad — when we save lives with new pharmaceuticals and surgery techniques, and prevent disease with new methods of testing and diagnosis, that costs money. But aren’t those things good?

(Aside: We have a lower life expectancy in the U.S. than in many countries, but much of that is due to violent crime and automobile accidents, not health care — adjusting for that, we perform much better, and it’s likely due to our advances in medicine. If memory serves correctly, about 80% of Nobel prizes in medicine in the last 30 years have been given to Americans.)

When we make people live longer, that costs more money too. This is worsened by our Social Security system: since the program was created, life expectancy has increased by more than 10 years, yet we have only pushed back the age at which you can receive full benefits by 2 years. Old people keep living longer and they retire at the same age, so that increases the burden on everyone else. But despite this increase in costs, my questions remain: is the cost of health care the only thing that matters? What about the benefits?!

I remember a study I read about a few years ago which stated that the increase in life expectancy that has occurred in the last century has increased the overall benefits of the average person by over a million dollars. You live longer and have more health care costs, sure — but you have more time with your family, your quality of life increases, and we’re all better off as a result. Democrats say “we spend too much on health care” despite the fact that this spending ends up making us better off. (Here’s a study saying this very thing about the US, and another one saying the same thing for Japan.) And now Republicans are saying that spending more money on prevention is bad just because it costs more, ignoring the potentially beneficial effects on quality of life.

I think  Charles Krauthammer puts this in its proper context: prevention is not the magic bullet that some Democrats think it is, and it has its own costs – but it still can be a good thing, and worth paying if it means people live longer, healthier lives. A little more emphasis on the benefits of health care, not just the costs, would be a refreshing change — from both sides of the political spectrum.

P.S. I think there is an analogy here to the global warming climate change debate: some would argue that we should focus on prevention regardless of the cost, and impose taxes on carbon and other costly regulations, while others say we should focus on treatment — work to adapt to future climate change if and when it happens with economies that are stronger and better able to withstand fluctuations in climate.

This is a busy semester for me but if I don’t take some personal time I’ll go crazy, and nobody wants that. I’m spending the day reading a book my mother recommended to me: Buyology: truth and lies about why we buy, by Martin Lindstrom, one of Time magazine’s 100 most influential people.

Lindstrom works in product branding and oversaw a huge research study using fMRI and SST analysis to look at how the brain works when we think about and buy products. I’m only two chapters in but it’s I think this book is revolutionary (and a bit scary) and I can see why he made Time’s list.

A few posts ago, I discussed the importance of assumption of rational self-interest that we usually make in economic models. A commenter pointed out that people don’t always behave rationally, and I countered by saying that while that might be true, unless you have a better model to explain how exactly they do behave, you don’t really get anywhere. Lindstrom’s efforts are a step in that direction, to account for how our brains behave and incorporate that behavior that into our models.

Let me quickly mention something I often talk about in introductory economcis classes as a way of broaching the topic of experimental economics. In economics, we have a game called the take-it-or-leave-it or ultimatum game. Two people play the game together once: they don’t know who they’re playing against and will never play with that person again. The game’s administrator tells Player 1 that he has 10 $1 bills to split between himself and Player 2. Player 1 has to propose a way of splitting the money between himself and Player 2. If Player 2 approves of the proposed split, the two players split the money accordingly. But if she rejects the split, they both get nothing.

In experiments, we often see people propose 50/50 splits and they’re almost always accepted. Sometimes Player 1 will keep $6 and offer $4, giving himself a little more because he has to make the split. But economists would probably argue that both of those splits are irrational. The way the game should be played is for Player 1 to keep $9 and offer Player 2 $1. Realizing that $1 is better than nothing, Player 2 accepts the split (perhaps bitterly) and walks away with a buck. But in fact, when that $9/$1 split is proposed, it is often rejected, as are other unfair splits ($8/$2 or $7/$3). This article explains that the ventromedial prefrontal cortex (VMPC) has a role to play in emotional decisions, and people with damage to their VMPC have been shown to be more likely to reject what they perceive to be an unfair split. (Note: even dogs have been shown to have some innate understanding of “fairness” — research has shown that when two dogs are both rewarded for performing a trick, and then dog A stops being rewarded for performing the trick, dog B ends up not performing either, out of solidarity.) Other research has shown that when people reject the unfair split, an area of the brain that is associated with feelings of pride lights up with activity. It seems some people feel their pride is worth more than $1, so they reject the split and feel better about themselves for having done so. You might still be able to say that the behavior is rational — they simply value their pride more than $1, so economists have to try to figure out how much a person’s pride is worth to them. However you want to view it, we clearly have to somehow account for how our brains work when we behave in ways that traditional assumptions cannot explain.

Buyology seeks to do some of this, explaining why we do the things we do. We all want to think that we’re rational, but the truth is that we are not always rational. Humans are animals ruled by both reason and emotion, and sometimes the emotion wins out: Lindstrom cites the case of a Coke/Pepsi taste test, where the part of our brain that deals with rationality tells us the Pepsi tastes better, but the emotional part of our brain remembers growing up with Coke and we end up saying we like Coke better. (How do they know this? They perform one taste test first and don’t tell the participants what they’re tasting, then they do another and tell them they’re going to taste Coke, and when they tell people that, they can see that emotional part of the brain light up.) The book also explains why warnings on cigarettes don’t work. When asked, smokers will invariably say that the warnings are effective and cause them to smoke less. But the brain doesn’t lie, and when smokers see warning labels while in a fMRI machine, the area of the brain called the nucleus accumbens (otherwise known as the “craving spot”) lights up. When stimulated, this region of the brain requries higher and higher doses to be satisfied. Lindstrom summarizes these results by saying: “In short, the fMRI results showed that cigarette warning labels not only failed to deter smoking, but by activating the nucleus accumbens, it appeared they actually encouraged smokers to light up. We couldn’t help but conclude that those same cigarette warning labels intended to curb smoking, reduce cancer, and save lives had instead become a killer marketing tool for the tobacco industry.” (p. 15)

Some people are understandably worried about this kind of research: by finding out what makes consumers tick, won’t marketing companies be able to sell us whatever they want, just by pressing the right brain buttons? Won’t political operatives use this to produce the most effective political ads? (Answer: yes, and they already do.) Lindstrom understands that criticism but basically argues that only when consumers know how they their brains work can they account for that and behave accordingly. Knowing that my emotional side wants Coke but my brain wants Pepsi gives me information that I can use to determine which one I really want to rule my decision. I regain control over my decisions, choosing my behavior instead of letting the marketing companies do it for me.

This is one step in the right direction for economists, and hopefully we can replace our simple assumption of rational self-interest with a theory of behavior that is more realistic and at the same time something we can model accurately.