How to Reform Social Security, Part II

The last time I wrote for an academic audience about Social Security reform was this paper, which I presented in Sweden two years ago at a conference sponsored by the Foundation for International Studies on Social Security. In that paper, I argued that the most sensible way to restore solvency was by raising the age at which the system pays out full benefits, also called the normal retirement age, or NRA. (The discussion below is similar to the section on "Moving Forward," which starts on page 9 of that paper.)

Arnold Kling recently wrote about the need to reform Social Security on his blog and at TechCentralStation and concluded that, "The retirement age is the most logical and effective policy lever." I think he is exactly right, primarily because it squarely addresses one of the two main reasons why the system is projected to run into cash flow problems in the near future.

The dramatic increase in Social Security's cost rate over the next several decades is mainly due to the increase in the number of beneficiaries relative to covered workers. In 2004, there are 30 beneficiaries per 100 workers. By 2080, there will be 54, an increase of about 80 percent (as shown in this table). Over the same period, the program's cost rate--the ratio of benefits paid to taxable payroll--will increase from 11.07 to 19.39 percent, an increase of about 75 percent (as shown in this table). That the increases are so close shows that the projected deterioration in Social Security's finances is almost entirely the product of demographic shifts.

There are two reasons why there will be about 80 percent more beneficiaries relative to workers in the future: lower fertility rates and lower mortality rates (see this table for the history and this one for the projections). There is probably no easy way to link a reform of the system to changes in fertility rates, but it seems straightforward to base reform on changes in mortality rates.

Failing to index the retirement age to life expectancy implies an increasing portion of adulthood spent collecting benefits. Policy makers could craft a sensible justification for raising these ages. Consider how much easier it is to explain why retirement ages have to increase than it is to make sense of, say, an effective switch from wage indexing to price indexing in the calculation of the benefits (the centerpiece of Commission Model 2). Other reforms could be introduced to compensate for the impact of lower fertility rates on the system's finances, and I would not be against the ones that work by reducing future benefits rather than raising future payroll taxes. I would prefer to just stick with one policy lever to keep things simple.

A rough calculation suggests that the normal retirement age would have to increase to 73 by 2080 in order to restore solvency using only this policy lever. Though it seems to be a large change, it can be phased-in at a rate of about a year of age per decade (if we start now). When fully phased in, a worker who wished to retire at the currently legislated normal retirement age of 67 would face actuarial reductions of about 40 percent of benefits (e.g., the current early retirement reduction factor of 6 2/3 percent per year for 6 years). It would be perfectly reasonable to help people retire earlier than the NRA by facilitating a system of personal accounts, and, as I noted earlier, if any new money is coming into the system, it should be done through personal accounts.

Raising the NRA by this much would create a few complications, which could be easily addressed. Here is a list of the ones I think are most important:

1. The Early Eligibility Age. Workers can first claim benefits at the early eligiblity age (EEA), which is currently 62 and not scheduled to increase. Benefits are reduced at an actuarially fair rate for each year that benefits are taken before the NRA. When the NRA is 67, the total reduction for those 5 years will be 30 percent of benefits. If the NRA goes up, then the EEA should also go up. Otherwise, some people who live for a long time after claiming benefits at age 62 would be at risk for poverty later on in old age.

2. Pressures on the Disability Insurance Program. Workers who become disabled before their normal retirement age are eligible for disability benefits. These benefits are more generous than benefits taken early in the absence of disability. With higher ages for full and early benefits, there is more of an opportunity (and possibly a greater incentive) for workers to claim disability. This will increase program costs and can be addressed by having the normal retirement age increase a bit faster than a year per decade, if necessary.

3. The Bigger Hit to Low-Earners. People with higher incomes over their lifetime tend to live longer. Raising the Normal Retirement Age therefore disadvantages lower income workers more than higher income workers. This impact can be offset by changes in the benefit formula to give higher replacement rates for lower earnings, paid for by lower replacement rates at higher earnings levels.

With the retirement ages linked to projected improvements in life expectancy, personal accounts can serve two purposes. First, their accumulations can facilitate retirement at ages earlier than the legislated early and normal retirement ages. There is nothing wrong with people retiring when they choose--they just should not do so at the public's expense or at the risk of their own poverty later in old age. Second, when confronted with the magnitude of the increase in the NRA required to restore solvency, policy makers may decide that they prefer to bring new revenues into the system rather than rely solely on higher retirement ages. Investing those revenues in personal accounts rather than the Trust Fund helps to ensure that the additional revenues are actually saved for retirement rather than becoming a source of funds for the government to finance the rest of its expenditures.

The reason I like using higher retirement ages to restore solvency is that it simply brings our definition of "Old-Age" in Old-Age, Survivors, and Disability Insurance in line with contemporary (and evolving) notions of life expectancy. It gets Social Security to live within its means and allows the system to continue alleviating poverty among the elderly.

How to Reform Social Security, Part I

I have devoted a few posts to taking the Democratic leadership in both the Congress and the Presidential campaign to task for failing to play a constructive role in the debate on Social Security reform. In less strident language, I have also noted my disappointment that President Bush has not put more emphasis on this issue by, for example, submitting one of the plans devised by his Commission as a starting point for bipartisan legislative debate. So what do I think is the right way to reform Social Security?

Here are my objectives, in declining order of importance:

1. Restore Solvency. The pressing problem today is that the benefits promised under current law are projected to exceed the revenues collected. The present value of that excess is $10.4 trillion. We need to fill that hole.

2. Relieve Poverty. The purpose of Social Security is to provide insurance against poverty in old age. Social Security collectively refers to the Federal Old-Age, Survivors, and Disability Insurance programs. Any reform of the system should pay careful attention to these risks of elderly poverty.

3. Keep the Program Small. I do not believe that government programs should be any larger than they have to be in order to achieve their objectives. I consider myself to be a proponent of limited (though purposeful) government. If we can meet the objectives of having the program financially sound and keeping the elderly out of poverty with a small program or with a large program, then I choose the small one.

These three objectives don't make any mention of personal accounts. That's because they don't necessarily require the program to get any bigger, measured by the size of the taxes that are necessary to support it. (Solvency could be restored through progressive benefit cuts entirely.) However, most people who have proposed a specific reform have added new revenues. Once new revenues are being added to the system, then it becomes important to figure out where they should go--the Trust Fund or personal accounts.

Confronted with that choice, I opt for personal accounts. For me, an immediate and permanent contribution of 3.5 percent of taxable payroll into personal accounts for all workers, in addition to the 12.4 percent payroll tax that they and their employers already pay, is preferable to the current system. The contributions are 3.5 percent because that is the amount that the Social Security actuaries say is required to restore solvency even if invested entirely in Treasury bonds. But such a reform, though preferred to the current scenario, is also far from ideal. I'll outline a better system in the next post.

What Social Security Reform Should Democrats Propose?

In my last post on Social Security, I criticized Congressional Democratically leadership, specifically Congressmen Rangel and Matsui, for failing to play a more constructive role in the debate about how to restore long-term solvency to Social Security. What if you are a Democrat (or not) who recognizes that there is a $10.4 trillion hole in the program's finances, but you don't want to rely on equity investments in the Social Security trust fund or personal accounts to restore the program to solvency.

Fortunately for you, two very smart economists have done the heavy lifting for you. Peter Diamond of MIT and Peter Orszag of the Brookings Institution have written a book laying out the rationale for a reform of Social Security based on modifications to its existing structure that don't include personal accounts or trust fund investments in equities. You can buy the book, Saving Social Security: A Balanced Approach, read a detailed summary, or view some slides from a presentation at the American Enterprise Institute last January. The plan is one of those that has been scored by the Office of the Chief Actuary at the Social Security Administration.

I have my reservations about this plan--specifically that it is less "balanced" between increasing revenues and decreasing expenditures than the authors suggest. (See the commentary by Eric Engen and Maya MacGuineas from the AEI presentation for some graphical illustrations.) But their plan does meet the key test of plugging the whole $10.4 trillion shortfall, while carefully explaining how and why it would change the program to accomplish this. That makes it a reasonable contribution to a new bipartisan attempt at reform.

This plan was made public in December 2003. I think it is particularly telling that none of the Democrats who claim to be vanguards of Social Security as it has traditionally been implemented have shown the leadership ability to propose this plan as a bill, let alone build the support to move it through Congress. A bipartisan, legislative discussion of the merits of Commission Model 2 (or some alternative with personal accounts) compared to the Diamond-Orszag plan would be quite a sight to see. I might even call it statesmanship.

They Spill More than We Make

On the occasion of SiteMeter telling me that Vox Baby has received its 10,000th hit, I thought I would share the following story.

In the spring of 1993, while visiting San Francisco, I joined a group of friends in a trip up to Napa Valley. I think it was the first trip to wine country for each of us, and so we started by just stopping at one of the first wineries on our route. It was a great little place, called De Moor Winery, and the couple who owned it spent a lot of time teaching us about the different types of wine they made and offering us some of it to taste. I remember really liking a dessert wine and buying some for later. As we were about to leave and head out to some other wineries, a friend of mine asked, "So, how do you compare to Mondavi [the enormous winery just up the highway]?" Without missing a beat, the owner replied, "They spill more than we make."

After about four weeks of blogging, I can say that my respect for the masters of the craft has grown considerably. More people will probably visit the most popular blogs by accident in a day than will visit Vox Baby on purpose in a month, but I have enjoyed the opportunity to contribute to the new medium in whatever capacity I can. I thank everyone who has visited, read, linked, or commented over the last month. I look forward to many more posts and discussions.

Social Security and the Legislature

In my last post, I tried to clarify some of the misstatements the Kerry campaign has made about the President's Social Security policies. I noted that I think this issue (and the analogous problems in the Medicare system) should be receiving more attention in the campaign.

More importantly, programs that redistribute hundreds of billions of dollars per year should be addressed as part of the high-frequency activities of both the legislative and executive branches of government. We shouldn't think about reform only in the crucible of a partisan election campaign. The President convened a commission, thanked it for its report, but has done little in public to move the issue forward since then.

What has Congress done? The good news is that there are several Senators and Representatives who have put forward reform plans that are well specified enough for the Office of the Chief Actuary at the Social Security Administration to analyze and formally report on them. A list of these plans, with links to the reports, is available here. The list includes plans by people in and out of elected office. There are plans that include large personal accounts, small personal accounts, and no personal accounts. The idea that we would be starting from scratch in discussing reform is misguided. There already exist several plans that would be reasonable places to begin a new round of bipartisan discussion.

Some legislators have taken a leadership role on this issue. If it were up to me, and I had to pick one of these plans to start the discussion, I would pick Senator Lindsey Graham's plan, given its focus on solvency and its inclusion of personal accounts, but I am by no means endorsing that plan to the exclusion of others. There are also plans from Representative E. Clay Shaw Jr. and Representative Paul Ryan, who are Chairman and Member (respectively) of the Social Security Subcommittee of the Ways & Means Committee. Again, these plans are not perfect, but they do represent more of a contribution to the debate than the ambiguous statements of politicians who won't develop a specific plan.

Unfortunately, this latter group includes the senior Democrats on the Ways & Means Committee, and this, along with Senator Kerry's refusal to make any specific statement about restoring solvency while criticizing the Commission's plans, undermines the Democrats' credibility on this issue. Consider the following two examples.

Congressman Robert T. Matsui is the ranking Democrat on the House Ways & Means Subcommittee on Social Security. His website's page on Social Security also lists him as the Convening Co-Chair of the Social Security Leadership Task Force for the House Democratic Caucus and the "leading opponent" of Social Security privatization. The website says nothing about how he would plug the $10.4 trillion hole in Social Security's long-term finances. With respect to finances, it says only, "As a result, Matsui believes that today’s choices should be targeted and incremental improvements to the system that will also help increase very long-term solvency." Even these "incremental" improvements are not enumerated.

Congressman Charles B. Rangel is the ranking Democrat on the House Ways & Means Committee. Social Security does not figure prominently on his website, but there are links to the Democrats' Ways & Means Committee website. That website has mostly political statements about current news and legislation, including my own favorite, a selective misrepresentation of the Economic Report that rivals the Kerry campaign's. It does eventually have a section on the challenges facing Social Security. In the answer to the question, "How big is the problem?" the website states:

The long-range actuarial deficit is 1.92 percent of wages that are subject to Social Security taxes. That is, raising Social Security’s revenues, or cutting its benefits, by an amount equal to 1.92 percent of wages would close the gap.

Very poor form. The 1.92 percent long-term actuarial deficit is measured only over the first 75 years of the projection period. (This was the figure from the 2003 Trustees Report, the latest one available when this webpage was last updated in June 2003.) The analogous figure is 1.89 percent in the 2004 Trustees Report. If all that occurred was a revenue increase of 1.89 percent of taxable wages for the next 75 years, then after the end of this 75-year period, the system would face annual deficits of 6 percentage points of payroll with a Trust Fund equal to one year's worth of benefits, or about 20 percent of taxable payroll that year. (See the last number in this table to verify the 6 percent annual deficits.)

The problems with using this 75-year actuarial deficit, along with other abbreviated metrics for the system's finances like the date of trust fund exhaustion, are clearly explained in Chapter 6 of the Economic Report of the President (pages 137-139, in a section appropriately named, "Misunderstanding the Financial Crisis"). The first page of the Economic Report of the President has the words "Transmitted to the Congress." I wonder.

Whether in the campaign or in their decades-long tenures in the legislature, the Democratic leadership appears to be capable of nothing but criticizing other people's positive contributions to the debate on Social Security reform. And every year that this issue goes unaddressed shifts more of the burden of resolving it onto future generations.

Senator Kerry's Statements about Social Security

This post follows on the reference in an earlier one to what FactCheck.Org reported about the Kerry campaign's criticism of the President's plans for Social Security. My goal here is to clear up the misstatements that Senator Kerry has made about executive and legislative branch analyses of the Commission to Strengthen Social Security's report from 2001.

While in Washington at the CEA, I had the opportunity to be the primary author on a chapter in the Economic Report of the President (ERP) about Social Security. You can download the whole document and read Chapter 6, or you can use that website search it for the relevant passages that I'll quote below.

On the campaign as of late (see Senator Kerry's speech in Wilkes-Barre on Tuesday and a press release and its background material from the same day), there are several examples of what I will politely refer to as "poor form." I'll take most of these quotes from the press release, just to keep things simple, but in an order that makes sense for the purpose of the post.

As the press release starts enumerating "facts," it states:

George Bush’s Plan Costs $2 Trillion – According to His Own Advisers

The plan in question is a version of Model 2 presented by the President's Commission to Strengthen Social Security. You can find the Commission's final report here. You can find the Social Security Office of the Chief Actuary's scoring of the plan here. It is not a plan that the President has endorsed. Calling it "George Bush's plan" is inaccurate. Why is there any confusion? On page 142 of the ERP, in the third paragraph of a section on "Can We Afford to Reform Entitlements?" the report states:

As an illustration, consider the recent President’s Commission’s Model 2, under the assumption that all eligible workers will voluntarily choose to establish a personal retirement account (thereby maximizing the transition costs to be discussed below).

The press release misrepresents an illustration as an endorsement. Were we really supposed to write about the economics of reforming Social Security through personal accounts without providing an example of such a plan? The press release gives something of a clue in an earlier sentence:

George Bush’s economic advisers analyzed one and only one Social Security plan: Plan 2 put forward by his Social Security. [sic--where's the proofreader for this campaign?]

That would be a tough one for them to verify. I know that they didn't call me to ask me how many plans I analyzed. To clear up any of their confusion, I can attest personally that I analyzed numerous Social Security plans during my time at CEA. We only used one for the purpose of illustration. There must be some rule somewhere that stipulates that if we use one plan for an illustration, then we have to use many plans for illustration, even if doing so would not help answer the question, "Can We Afford to Reform Entitlements?" and would needlessly add length to the 240+ pages of text already in the ERP chapters. I will be curious to read an Economic Report from a hypothetical Kerry administration. Will they opt for no illustrations or needless illustrations?

It is also misleading to label this as "Plan 2 put forward by his Social Security" Commission. As the ERP clearly states, we have assumed 100 percent participation in the accounts for the purpose of illustration, so that no one would be able to say that we had understated the changes in deficit or debt that could result. Taking up the accounts is voluntary, so an assumption about take-up has to be made. Here's what the actuaries said (quoting from the actuarial memorandum):

For Model 2, participation would be expected to be higher. If the benefit offset yield rate is computed as 2 percent above the realized or expected inflation rate, actual net yields on personal accounts would generally, but not always, exceed the benefit offset yield rate. Due to this uncertainty, the 67-percent participation assumption is likely to be the most appropriate of the three assumptions in this case.

Plan 2 put forward by the Commission would more accurately use the 2/3 participation rate. The Kerry campaign can have its $2 trillion in nominal costs over 10 years, but it also has to then agree that everyone would opt for personal accounts. Not a very good assumption for them to maintain while saying personal accounts are a bad idea. Which would they like?

Back to the press release. This next quote is particularly frustrating:

The Economic Report of the President 2004 says that “personal retirement accounts widen the deficit by design.”

How about an ellipsis folks, or better yet, the whole sentence? On page 144, the ERP states:

Personal retirement accounts widen the deficit by design—they refund payroll tax revenues to workers in the near term while lowering benefit payments from the pay-as-you-go system in later years.

The background file on the Kerry website has the whole paragraph with some red underlining of the part of the sentence that is quoted. Are we to understand that the Kerry campaign thinks that the second part of the sentence is irrelevant? It is most of the reason why anyone would add personal accounts to the system (the remainder being the opportunity to invest their contributions in financial assets other than Treasury bonds).

The press release then states (continuing its reference to the ERP):

Chart 6-4 shows the “change in the deficit” as a share of nominal GDP, these numbers correspond to $2 trillion in nominal dollars. The precise numbers are available in a Memorandum from the Social Security actuaries, they show that the current dollar cost is $2.004 trillion from 2005-14. [sic--can we get somebody over to the Kerry campaign who can edit a run-on sentence?]

Well, yes, that is one thing that is shown in (the data underlying) Chart 6-4, but that's not the most important thing that Chart 6-4 shows. To get an idea of what that might be, just read the caption to the chart:

Relative to GDP, reform initially increases then reduces the deficit and debt.

I think that this is one of those things that a campaign staffer might miss by only underlining the first parts of sentences. The chart shows that all of the debt that would be accumulated during a transition is repaid, with interest, out of reduced program expenditures later on. This is what it means when the dashed curve crosses the horizontal axis and goes into negative territory. Looking at only the first 10 years of a reform that would affect cash flows for many decades is obviously not the right way to discuss policy. (In other areas, the Bush administration has made this mistake as well.)

The press release then quotes three newspaper stories that make similar errors. It finishes with some excerpts of a CBO report. The first one is:

CBO estimates that Bush’s plan will force benefit cuts (even when you include the value of the individual accounts) that grow to up to 45 percent. According to CBO, the President’s plan “would reduce expected retirement benefits relative to scheduled benefits, even when the benefits paid from IAs [individual accounts] under CSSS Plan 2 are included… For example, benefits for the 1980s birth cohort would be 30 percent lower, and benefits for the 2000s cohort would be 45 percent lower.”

Note first that the CBO doesn't refer to this as "Bush's plan." More importantly, I suppose that the ellipsis in this paragraph includes the following footnote from the CBO's report:

13 Since the medians are presented here as point estimates, IA payouts are computed assuming risk adjusted returns equal to the Treasury bond rate.

The CBO shares some of the blame for this one. CBO inappropriately uses the phrase "expected retirement benefits" in the text but then clarifies that it is using the Treasury bond rate to accumulate the accounts. The appropriate terminology for CBO would be to say that it is assuming that the portfolios were invested entirely in Treasury bonds. This is the most conservative investment approach, since it chooses to take on zero equity risk. As long as the equity premium is positive, this assumption serves to overstate the reductions in expected benefits that would occur. (As implied in the footnote, we would really want to see the whole distribution of possible benefit levels, not just point estimates.)

This is a very odd assumption to make as a baseline. As far as I know, there is no presumption among people who propose adding personal accounts to Social Security that people who opt for them would then choose to invest them in such a way that eliminated one of the key advantages of having a personal account--the opportunity to obtain higher expected returns in exchange for taking on some financial risk.

Another issue with this quote is that the CBO is making a comparison to "scheduled" benefits, but we know that there are not enough projected revenues to pay scheduled benefits. Comparing an infeasible current law baseline to a reform that is feasible is obviously not a sensible thing to do. The last part of the press release seems to be designed to address that:

Even compared to a scenario with benefit cuts to extend solvency, Bush’s plan would still cut benefits. CBO analyzed a hypothetical scenario with benefits to ensure Social Security is solvent. Specifically, CBO assumes that benefits are paid by payroll taxes after Social Security’s projected insolvency in 2052. Bush’s plan has lower benefits than even this scenario.

But, of course, the 45 percent number is the one that will be quoted--for example, in the speech:

According to the nonpartisan Congressional Budget Office, the Bush privatization plan would cut Social Security benefits. It will cut them by 23 to 45 percent.

Having the last paragraph in the press release does not undo the critique that the Kerry campaign has made an inappropriate comparison in the speech. Note as well that the speech does not clarify that the reductions in benefits are explicitly not going to affect anyone in or very near retirement today.

The press release also does not refer to the benefit simulations that were done in the actuarial memorandum it cited earlier. The Social Security actuaries are also nonpartisan--this isn't an issue of credibility. The simulations that appear to be least favorable to personal accounts are presented in this table. This table includes projections for workers with low, medium, high, and maximum earnings, for different assumptions about the portfolio investment, and for different years of eligibility.

Focusing again on the worst case scenario for the personal accounts (the 2075 retiree), the table shows two useful things. First, even with a portfolio entirely in Treasury bonds, a low-earning retiree would obtain more than 100 percent of the benefits payable (the concept being used in the last paragraph of the press release). This is due to the redistributive elements of Model 2 that were included for this purpose. This is not true of the other earnings levels--an important refinement of the point made in the CBO report.

Second, with a portfolio invested half in equity and half in a mixture of corporate and Treasury bonds, workers with low, medium, and high earnings are expected to get over 100 percent of payable benefits, though not as much in benefits as is scheduled under current law. And again, this is an expected benefit level, so it includes some financial risk, and whether you believe this is good policy will depend in part on whether you believe first that the expected return assumptions are valid and second that it is appropriate to let workers decide for themselves if the return justifies the risk. The Kerry campaign has ignored an important section of the actuarial memorandum that it cites in other places.

That's my reading of the Kerry campaign's criticism of the President's Social Security policy. Every quote in that press release is selectively excerpted to confuse the reader about the key issues with the Commission's plan, the President's association with it, the ERP's discussion of it, and CBO's analysis of it. There is also nothing in the Kerry speech that provides anything more than boilerplate about what the Senator would do to reform the system. (Start reading after the criticisms of the President--not all of which are inaccurate--with the statement, "John Edwards and I have a real plan to cut the budget deficit in half and protect Social Security." Tell me if you see a plan.) There is also absolutely no recognition of the magnitude of the hole in Social Security's finances.

I'll state the following for the record (with this whole post as the context): I am disappointed that this issue hasn't moved more quickly under President Bush and will take some responsibility for not doing more to help it along while working in Washington. I believe that the President should submit some plan to Congress that restores the system to solvency--whether the Commission's Model 2, another plan that has been scored by the actuaries, or something better--to restart the bipartisan reform process. It would be reasonable to hold him to account for the failure to do that, but only someone who actually had a plan could credibly do that.

In an upcoming post, I'll discuss what I think might be better and what Democrats who do not favor personal accounts should be saying about how they would reform Social Security.

Why Is Social Security a Campaign Issue?

Last week was not a good one for Social Security as a campaign issue. On Tuesday, Senator Kerry's campaign speech in Wilkes-Barre (and related materials) suggested a profound disregard for the issue. President Bush said very little there on Friday about the need for reform and his principles for accomplishing it. In the briefest possible statement, here is why Social Security should be a campaign issue.

At present, the Social Security actuaries project an unfunded obligation of $10.4 trillion in the Old-Age, Survivors, and Disability Insurance (OASDI) program. This number comes directly from the 2004 Trustees Report released in March. (See Section IV.B.5 and Tables IV.B.7 and IV.B.8 in particular.) This is the present value of the projected payments less the present value of projected revenues for the system over the infinite horizon. It is the most comprehensive way to measure the hole in the system's finances.

Note that this is the unfunded part of the obligations--it is over and above all of the payroll taxes (12.4 percent of taxable payroll) and income taxes on benefits that go to support the program under current law. If this gap were to be closed through payroll taxes, it would require them to be raised by 3.5 percentage points, immediately and permanently, with the additional surpluses over the next few decades saved (in Treasury bonds) to finance annual deficits that are projected to grow to about 6 percentage points of payroll over the next 75 years.

This $10.4 trillion unfunded obligation is sometimes referred to as implicit debt, to distinguish it from the federal government's explicit debt issued in the form of Treasury bills, notes, and bonds held by the public. At present, implicit debt from Social Security and Medicare is several times larger than the government's explicit debt. Is having so much implicit debt a problem? I think so, and the reason is that, just like explicit debt, we accrue interest on implicit debt.

As an example, suppose that I made a promise to pay you $100 (in today's dollars) in 20 years. At a real interest rate of 3 percent per year (the long-term rate assumed in the Trustees Report), that obligation has a present value of 100/(1.03^20), or $55.37. I have implicit debt of $55.37 today. What happens if I don't do anything to reduce that obligation this year? Next year, with only 19 years left, the obligation will have a present value of 100/(1.03^19), or $57.03. As you would expect, the present value of the implicit debt grows at the interest rate each year, just like the value of explicit debt would if we issued more debt to cover the interest payments due each year.

So if we have an implicit debt of $10.4 trillion, and the real interest rate is 3 percent, then next year, the implicit debt will grow by 0.03*10.4 trillion = $312 billion, up to $10.7 trillion, if the assumptions underlying the projection stay the same. Why does this matter? Primarily, it matters because both the President and Senator Kerry have repeatedly stated (see the two speeches in Pennsylvania linked above) that they will not cut benefits for those at or near retirement age. (The Senator's statement may be even more encompassing, including benefits at any time in the future. I cannot tell for sure from his public statements.) This, in turn, means that each year that elapses without reform causes the burden of financing the unfunded obligations to be shifted away from one more birth cohort that crosses the threshold of being "at or near retirement." The more we wait, the larger the burden on future generations, and the higher that 3.5 percentage point surtax would have to climb.

If I were running the show, both Social Security and Medicare (which has even larger unfunded obligations) would be reformed so that under current law and reasonable economic and demographic assumptions, they are projected to have zero unfunded obligations. This means changing current law to reduce future benefits, raise future taxes, or both. It means revisiting the issue periodically to ensure that unfunded obligations never stray too far from zero due to changes in projection assumptions or the program's experience.

In some upcoming posts, I'll outline the way I would do it, as well as offer some critiques of what the candidates and their parties have (and have not) said about the issue.

Triumph Takes on Spin Alley

For those of you who cannot stand all the spinning that goes on in the political world, this commentary may be the funniest thing you see in a long time.

UPDATE: If the link above does not work directly, go here. The clip's title is called Triumph: Poop Valhalla. There are some other funny ones on the list as well.

In Praise of FactCheck.Org

It is often said that "truth is the first casualty of war." Political parties today look quite a bit like warring factions and very little like a constructive part of informed debate and policy making today. I think we would all prefer that elections be a celebration of democratic principles, regardless of who wins, rather than the melees they currently resemble. But most of us sit by and do very little to clean up this mess.

If you are Internet savvy enough to have found this blog (and I thank you for doing so), then you are almost certain to have come across FactCheck.Org. I have to admire any organization willing to insert itself into this process and try to separate fact from fiction. Here's the most recent (from October 21) post:

$8 Million Worth Of Distortions
Two Bush ads full of misleading and false statements ran more than 9,000 times in 45 cities last week.

You can watch the two ads. You get a summary. You get an analysis, in which FactCheck.Org assesses each assertion made in the ads. You even get sources and related articles. FactCheck.Org is trying to walk a very difficult path: it tries to be politically neutral when it can and politically balanced when it cannot be neutral. In the spirit of a good Internet entity, it updates its work if new information comes to light. Some of its posts are actually correcting facts, sometimes it goes a little further to "complete the picture." I thought it got this one on Social Security right (and I'll blog more on Social Security later):

Kerry Falsely Claims Bush Plans To Cut Social Security Benefits
It's not Bush's plan, and it wouldn't cut benefits.

So kudos to FactCheck.Org for holding politicians a bit more accountable in an open and non-partisan way. Now who wants to do the same thing for newspapers?

In Praise of Vote Clamantis in Deserto

One of the joys of being a professor, and even more a director of a public policy center, is that students will often surprise and amaze. Here's a project that one Dartmouth student undertook to help make sure that college students are registered to vote, whether in New Hampshire or in their home states.

Vote Clamantis at Dartmouth

Dartmouth's motto, "Vox Clamantis in Deserto" translates to, "A Voice Calls Out in the Wilderness". Vote Clamantis is the voice of the student vote. Dartmouth students, like many young people already know the most important things any citizen needs to know: the issues that matter to them and to their communities. They attend a college that fosters their sense of awareness of issues both local and far-reaching. Yet even in an active community like Dartmouth too often thought is not turned into action.

Vote Clamantis in Deserto is a continuous nonpartisan voter registration drive to register every eligible Dartmouth voter for Election Day on November 2nd, 2004 and to obtain him or her an absentee ballot, if necessary, for his or her state.

Read more about the project in an op-ed in The Dartmouth by Kaelin Goulet, the project's founder. If you are a Dartmouth student and you haven't registered to vote, this site will guide you through the process. If you are not a Dartmouth student, but still need to register, be sure to check out the links at the site, which may also be of assistance.

A Blogging Panel

Last evening at Moravian College in Bethlehem, Pennsylvania, three of the most renowned bloggers appeared on the same stage to discuss the emerging medium: Ana Marie Cox of Wonkette, John Hinderaker of Powerline, and Markos Moulitsas Zuniga of dailykos.

When I was working in Washington earlier this year, I thought Wonkette was required reading. Her commentary on the DC political scene is hilarious. She was a good tonic for a day of taking everything extremely seriously. I’ve mentioned before that I read Powerline regularly. I don’t read Kos at the moment, largely because I prefer Brad DeLong’s website for my daily dose of “here’s a smart guy left of center who disagrees with me on a lot of things.” Throw in Andrew Sullivan and (now) Marginal Revolution, and you’ve got my regulars.

One of Hinderaker’s blogging partners has a post on the event, in which he relates some of the Q&A. I thought this one was particularly interesting:

Q. Does blogging really matter; not that many people read them?

A. Readership is greater than you think. Moreover, the readers we get are important for our purposes -- opinion shapers (Rocket); journalists (Wonkette); fellow activists (Kos).

The post also has a link to an account of the event in a local paper. Let’s hope this is one of the first of many more instances where leaders of the new medium come together to provide their thoughts about how and why they use it.

Price Gouging

Catching up on my blog reading over the weekend, I noticed a few interesting posts on Marginal Revolution about price gouging in flu vaccines (see the followup as well). Alex Tabarrok summarizes the problem quite well, and points out a key problem with trying to limit vaccine prices during a shortage:

If the firms can't price high during a shortage then there is no incentive to plan for a shortage.

But doesn't this mean that if prices are allowed to rise to clear the market, then you get a bunch of rich but healthy people getting vaccinated while some poor but vulnerable people go without? Not necessarily. The Boston Globe (sorry, no direct link--the Globe charges for its articles) reported on Friday on the approach being taken by the city of Boston:

CITY SEEKS TO BUY EXCESS FLU VACCINE
Published on October 15, 2004

To provide flu vaccine to those who need it most, the city of Boston announced yesterday a voluntary buyback program, encouraging employers who buy too much of the serum to sell it to the city for distribution to high-risk populations. The Boston Public Health Commission will purchase the excess vaccine and make it available for vulnerable persons including pregnant women, children, the elderly, and people with chronic medical conditions, officials said.

I think that this is the right approach. In fact, the city shouldn't just limit its purchases to "excess" vaccines. The city should figure out the marginal benefit of having another high-risk person vaccinated and purchase vaccines up to the point where the marginal cost of the vaccine just offsets that benefit. This approach provides the right incentives for the vaccine's producers and distributors to deliver more of the product--in future years if not this one--and it allows the city to allocate the vaccines as it sees fit.

The whole process shifts the costs to the public, but this is, at least to some degree, as it should be. It is the public's objective of ensuring that the most vulnerable populations are vaccinated with highest priority. (Though see Alex's discussion of those likely to spread the disease as potentially higher priorities for limited vaccines.) People can reduce the price that the city has to pay by voluntarily staying out of the market if they choose. The story in the Globe reminded me of the Nature Conservancy's land acquisition program--it would be nice to be able to steward key lands without owning them, but when necessary, they just buy the land so they can manage it as they see fit.

Of course, that wasn't the only story in the Globe about price gouging this weekend. There were also reports of the following:

FANS HIT WITH HIGH PARKING FEES
Published on October 16, 2004
Author(s): Heather Allen, GLOBE CORRESPONDENT

Being down two games to the Yankees in the American League Championship Series is bad, but paying $100 for parking in hope of witnessing a comeback is insufferable.

City officials say some parking lot owners near Fenway are trying to gouge game-goers with prices triple what they charge during the regular season or even higher.

Same deal. If you want parking to be available around Fenway during the playoffs, let the people who own land near the stadium charge what they want. At most, the Mayor's office--which was contemplating price regulations--should require lots to post their prices visibly so that people can make an informed choice without contributing to traffic jams.

Of course, any Sox fan who attended Saturday's game deserves a refund of more than just the parking fees.

And Following Up on the BLS E-mail

So now let's tabulate this group of "people who want a job now" but are not in the labor force. Using the links from the previous post, we can generate the following comparison of June 2003 and September 2004 (with the first 6 rows in thousands, and pardoning me for the poor formatting):

6/2003 9/2004
Labor Force 146,917 147,483
Employed 137,673 139,480
Unemployed 9,245 8,003
Not in Labor Force 74,097 76,458
Want a Job 4,687 4,850

Unemployment Rate 6.29% 5.43%
LF/(LF+NILF) 66.47% 65.86%
Emp/(LF+NILF) 62.29% 62.28%
Want/NILF 6.33% 6.34%
(Unemp+Want)/(LF+Want) 9.19% 8.44%

The first five rows are the raw data in thousands. The next five rows are the key ratios. The unemployment rate, labor force participation rate, and employment-population ratio are as discussed in the original post. The last two lines make use of the new category suggested by the BLS e-mail in the previous post. The share of those "Not in the Labor Force" who "Want a Job" is at about 6.33 percent in the two months. If we were to add this group to the labor force as unemployed, and then recompute the unemployment rate, we would see (in the last row) that it fell by 0.75 percentage points, from 9.19 to 8.44 percent of this augmented labor force.

With this measure, as with the other augmented measures of unemployment discussed in the original post, there is no empirical support for a proposition that the reduction in the unemployment rate (since its peak) is due to in any substantial way to a greater fraction of the potential labor force being involuntarily out of job.

BLS to the Rescue

Ask and you shall receive. The Division of Labor Force Statistics at the Bureau of Labor Statistics kindly responded to my e-mail, and they set me straight on whether Ryan, who commented on the original post, would be classified as discouraged or just not in the labor force. Recall that Ryan described himself in this way:

I was let go and looked for work for 6 months before deciding that what I really needed to do to get a decent paying and more stable career path was to go back to school. If I had been able to find a job, I'd be working.

Here's the text of the very helpful e-mail (with my emphasis added on the parts that are directly relevant to the discussion thread):

Good afternoon,

Your question was forwarded to me. This is a good question. I have attached a document below that will provide more information on the concepts and definitions used in the Current Population Survey or CPS. The CPS is the main source of information on the labor force in the United States and is a monthly sample survey of about 60,000 households.

Questions posed to respondents in the CPS refer to their activity during the Sunday to Saturday that includes the 12th day of each month.

To be classified as unemployed, a person would have not had any employment during the survey reference week, had to be available for work (except for temporary illness), and had made specific efforts to find employment sometime during the 4-week period ending with the reference week. (Individuals who were waiting to be recalled to a job from which they had been laid off are not required to have been looking for work to be classified as employed.)

People who are defined as discouraged workers are individuals who are not in the labor force (i.e. they are not employed or unemployed), but want and are available for a job and had looked for work at some point in the prior 12 months; however, they are not currently looking for work because they believe there are no jobs available or are none for which they would qualify.

Discouraged workers are a subset of the "marginally attached" and these individuals meet the same conditions with regard to their ability to take a job and job search in the prior 12 months, but the reasons they provided for not looking include, for example, transportation problems, child care problems, or ill health/disability.

To specifically answer your question: this person would be considered to be not in the labor force. Additional information would have to be obtained to determine whether this person meets the criteria mentioned above.

Again, I have attached a document below that provides more information on the concepts and definitions used in the CPS. http://www.bls.gov/opub/hom/homch1_c.htm

This person most likely would fall under the broader group of people who say that they "want a job now" and we do publish this estimate monthly. These individuals are considered to be not in the labor force, but are not considered to be marginally attached because they did not meet the criteria for job search in the prior year and/or were not available to take a job during the survey reference week.

BLS does publish this series monthly and here is the code for this series. (This is the code for the seasonally adjusted monthly data.)

LNS15026639

Simply paste this code into the box on this site, choose "All Years" and then click on "Retrieve data". http://data.bls.gov/cgi-bin/srgate

I hope this information is helpful and please let me know if you have any additional questions.

Wrapping it up on Krugman

I have been getting more feedback and criticism in the comments on my last Krugman post. Some of it is on target, and some of it is not. I'm right about Krugman, but I'm wrong about Ryan. I'll deal with the Krugman part here and the Ryan part in the next post.

On the Krugman part, I think I addressed what the commenter is saying in the three paragraphs of the post beginning with "However, the employment-population ratio can fall ..." I'll try again, with as little ancillary discussion as I can. The commenter writes (with my emphasis in bold added):

You use one piece of anecdotal information to try and refute Krugman, but you misconstrue what he said. He did NOT say that every person who dropped out of the labor force did so because they stopped looking for work. What he said was the drop in the unemployment statistics was only due to a set of people dropping out of the statistics. This can be true even if your wife dropped out of the labor force as you described. The person who took her job may not have been unemployed. That person may have been reentering the labor force so even though the job did not "disappear" no net employment gain happened.

It is true that he did not say exactly that (but nor does my argument require that he said exactly that). The issue, in the commenter's language, is the particular set of people who are dropping out of the statistics. Let's take another look at what Krugman said:

... unemployment declined only because some of those without jobs stopped actively looking for work, and therefore dropped out of the unemployment statistics.

As I said, Krugman's use of the word "only" requires that there were no other causes for the reduction the unemployment rate other than the one he cites, "some of those without jobs stopped actively looking for work." The statement is falsified by any instance in which a person voluntarily (and not as a response to some diminution in his or her labor market opportunities) chooses to retire, raise a family, volunteer, or go back to school, provided that s/he is replaced on the job by an unemployed person who was actively looking for work. Like an unemployed person stopping an active search, a voluntary exit that allows an unemployed person to become employed causes the unemployment rate to decline, the labor force participation rate to fall, and the employment-population ratio to stay the same.

Krugman's use of the word "only" requires that there be no such instances. I think I am on much firmer ground asserting that there is at least one such person than Krugman is in asserting that there are no such people in a labor force of over 140 million people. Nothing else in any of the previous posts is necessary to demonstrate his error.

Thanks again for the comments.

An Update on Presidential Debates and Vocabulary

A few days ago, I posted on the Princeton Review's grading of Presidential debates based on the vocabulary level that one would need to understand them. An article in this morning's edition of The Dartmouth points me to the Princeton Review's grading of the first Presidential debate in 2004. Read some commentary about it here. The results? More of the same: Bush around a 6th grade level and Kerry around a 7th grade level.

Reviewing the Comments on Unemployment

We have had a few more comments on the Krugman posts below. They are interesting questions and merit more discussion. A comment on the original post early this morning asked:

Are you sure you understand the precise definitions used in the household survey because you seem confused in the comment above?

My original post listed the definitions of discouraged and marginally attached workers that form the basis of the U-4 and U-5 measures of the unemployment rate. I wouldn't say that I was confused about the definitions, since I included them in the original post. The issue is whether Ryan's (an earlier commenter) situation would be classified by the CPS as being discouraged. I thought that it would. Here is how Ryan described his situation:

I was let go and looked for work for 6 months before deciding that what I really needed to do to get a decent paying and more stabile career path was to go back to school. If I had been able to find a job, I'd be working.

The original commenter commented again on yesterday's post and stated:

If I give up looking for work to go back to school because the labor market sucks then I am not counted as discouraged, marginally attached, or part-time due to economic reasons and yet I have most assuredly "stopped actively looking for work and therefore dropped out of the unemployment statistics."

As I noted, that's far from clear to me. Someone who goes back to school is out of the labor force. My conjecture, however, is that this does not mean that he is not also discouraged or marginally attached if he did so, as in Ryan's case, only because he couldn't find a job. If he is discouraged, then he adds to both the numerator (unemployed plus discouraged) and the denominator (labor force plus discouraged) of U-4. His situation would raise that measure of the unemployment rate, and the fact that this measure of the unemployment rate has fallen by the same amount as the standard measure (counting discouraged workers as out of the labor force) would invalidate Krugman's point. Since this is a question of interpretation, I e-mailed cpsinfo@bls.gov and asked for guidance. I'll post with any answer that I receive.

Both new comments have mentioned the employment-population ratio, with the original commenter kindly sending me the link to this post from January 6, 2004, at Brad DeLong's website. I acknowledged in my original post that Krugman was correct in stating that the employment-population ratio was unchanged since June 2003, and Brad's post graphs this ratio since 1950 and notes how much it has fallen from its historical high since the start of the recession.

However, the employment-population ratio can fall not only because some people may become discouraged but because some people voluntarily choose to leave the labor force of their own accord. This is why the fact that it has not increased is not enough to support Krugman's point. My wife was working full time in 2000, working part time for non-economic reasons in early 2003, and is now voluntarily out of the labor force. Someone else is doing the job she used to do, and that ultimately allowed another person to become employed in her place (i.e., someone was hired to replace her, then someone was hired to fill her replacement's old job, etc., until someone who was unemployed or not in the labor force became employed.)

There remains no piece of evidence to support Krugman's statement that "...unemployment declined only because some of those without jobs stopped actively looking for work, and therefore dropped out of the unemployment statistics." He cannot use the word "only"--that language is falsified by the presence of even a single person with my wife's job history whose departure made room for a new person to become employed. He says "stopped actively looking for work." The BLS allows for alternative definitions of the unemployment rate that accommodate the presence of people who are not "actively" looking for work and are thus not in U-3 but are in U-4, U-5, or U-6. That all of these measures have declined since U-3 peaked in June 2003 casts doubt on his statement more generally.

As I have laid it out here, Krugman's argument (cutting him a break and substituting "primarily" for "only") can only be right if there is evidence to show that 1) there are people who have dropped out of the labor force involuntarily in such a way that they would not be counted as discouraged, marginally attached, or working part-time for economic reasons, and that 2) the number of these workers substantially exceeds the number of people who left voluntarily for reasons unrelated to the job market.

There is no empirical evidence for either piece. Brad provides a good discussion, raising some possibilities, and asks the question, "Why? What's happened to change the relationship between changes in employment and changes in the labor force? And what does it mean?" He concludes with, "It is a mystery to me." Paul Krugman, in a highly partisan op-ed, asserts a particular answer that is in direct conflict with measures of unemployment that are designed to address the question.

A fact-checking procedure at the New York Times would have required him to cite evidence for his assertions before putting them in print. He would have had to prove his point, rather than (at best) making a harsh sounding statement with enough ambiguity so that, ex post, one could find a particular interpretation and some circumstances under which it may be true. This sort of fact-checking is one of the reasons why publications from, say, The Brookings Institution, are so highly regarded. In articles or book chapters that I have written for them, they put their authors through that test, and that makes the publications better.

That the New York Times does not see fit to do so is one of the reasons why the mainstream media is losing credibility, and alternative media like blogs--where people like me and people who obviously start with different perspectives from mine can figure things out together and check their arguments--are growing in importance.

Thanks again for your comments.

Three Economists, Krugman, and a Comment

A comment on my last post suggests that a search of Brad DeLong's archives is relevant to a discussion of alternative measures of the unemployment rate. The comment may be referring to this post. Brad discusses the measure of the unemployment rate that includes discouraged workers (U-4) in a response to a part of CEA Chairman Greg Mankiw's editorial in the New York Times on August 22, 2004.

In the New York Times editorial (as quoted in Brad's post), Greg writes:

The [u]nemployment [rate] has fallen, [pessimists] say, only because the economy is so bad that people have become discouraged and given up looking for work. But that also does not square with the facts. The Bureau of Labor Statistics has a little-publicized alternative measure of unemployment, called the U-4, which includes those discouraged workers. And what does it show?... [I]t peaked in June 2003 at 6.6 percent and has since fallen to 5.9 percent....

In his post, Brad writes:

Here we need to do a little data analysis. The seasonally-adjusted U-4 unemployment rate started 2001 at 4.4%, rose to 6.0% by the end of 2001, continued a slow rise to 6.6% by June of 2003, fell back to 6.0% by the end of 2003, and since then has stuck at 5.9%-6.0%.

And in my post, I presented all 4 of the measures of the unemployment rate as of this month's employment report for September. U-4 is now down to 5.7 percent. The other three are down by comparable amounts in percentage points.

Neither Greg nor Brad nor I disagree with the simple fact that the unemployment rate adjusted to include discouraged workers has fallen from its peak last June. That dubious honor belongs to Paul Krugman, who wrote:

Mr. Bush will boast about the decline in the unemployment rate from its June 2003 peak. But the employed fraction of the population didn't rise at all; unemployment declined only because some of those without jobs stopped actively looking for work, and therefore dropped out of the unemployment statistics. [emphasis added]

It is not clear to me whether the commenter understands this distinction, but I hope it is clear now. Krugman's statement is false. The presence of nearby statements that happen to be true does nothing to make this particular one true. Krugman should know better, and the New York Times should have a mechanism in place to ensure the integrity of what appears on its editorial page.

Brad's post goes on to discuss the disconnect between the reading of the labor market one would get from looking at the unemployment rate and the reading one would get from looking at the growth of payroll jobs. This is a puzzle that economists, by our own admission (mine and Brad's, at least), have not yet figured out.

Paul Krugman, Meet Irony

A colleague of mine pointed me to Paul Krugman's column in yesterday's New York Times, "Checking the Facts, In Advance" (archived here). Krugman begins his column with the statement:

It's not hard to predict what President Bush, who sounds increasingly desperate, will say tomorrow. Here are eight lies or distortions you'll hear, and the truth about each:

I don't have time to go through each of his points individually, but I will simply point out the key error in his second point on unemployment. He writes:

Mr. Bush will boast about the decline in the unemployment rate from its June 2003 peak. But the employed fraction of the population didn't rise at all; unemployment declined only because some of those without jobs stopped actively looking for work, and therefore dropped out of the unemployment statistics. The labor force participation rate - the fraction of the population either working or actively looking for work - has fallen sharply under Mr. Bush; if it had stayed at its January 2001 level, the official unemployment rate would be 7.4 percent.

First, let's identify the part that Krugman gets right. The employment-population ratio is unchanged between June 2003 and September 2004: 62.3 percent of the population over age 16 is employed. The labor force participation rate has fallen over that period of time from 66.5 percent to 65.9 percent, and the unemployment rate has fallen from 6.3 to 5.4 percent of the labor force.

Next, consider the part that Krugman gets wrong. The BLS keeps track of information on several different types of unemployment rate, precisely to make sure that changes in the unemployment rate are not driven by changes in discouraged workers. The BLS uses the following concepts:

1. Marginally attached workers are persons who currently are neither working nor looking for work but indicate that they want and are available for a job and have looked for work sometime in the recent past.
2. Discouraged workers, a subset of the marginally attached, have given a job-market related reason for not currently looking for a job.
3. Persons employed part time for economic reasons are those who want and are available for full-time work but have had to settle for a part-time schedule.

How have the unemployment rates including these groups as unemployed members of the labor force changed? According to the data at the BLS:

Unemployment Rate: Fell from 6.3 to 5.4 percent between 6/2003 and 9/2004

UR, Incl. discouraged workers: Fell from 6.6 to 5.7 percent

UR, Incl. discouraged and marginally attached workers: Fell from 7.2 to 6.4 percent

UR, Incl. marginally attached workers and those employed part-time for economic reasons: Fell from 10.3 to 9.4 percent

In no case is Krugman's statement, "unemployment declined only because some of those without jobs stopped actively looking for work, and therefore dropped out of the unemployment statistics" supported by the data. When those workers are included, we still get about a 0.9 percentage point drop in the unemployment rate, however it is measured.

What, then, is the explanation for how the labor force participation rate dropped, if it is not due to people becoming dissatisfied with the labor market? Consider more people voluntarily taking time out of the labor force--whether to retire, raise a family, or go back to school--as just three possibilities.

Sadly, if you are going to read Krugman, then you probably also have to read Luskin, and you should double-check for yourself any facts asserted by either one.

More importantly, I think it is incredibly poor form for the "paper of record," or any newspaper at all, to not insist that all of its columnists have their writing fact-checked. Every statistic I have just listed is available at the BLS website that reports on the household survey of employment, which is the source of all data about the unemployment rate. The alternative measures of unemployment are in Table A-12 each month. (Follow this link, click the boxes for "Seasonally Adjusted" on items U-3 through U-6, and see for yourself.)

Partisan Rancor, Then and Now

In a recent post, I suggested that much of the blame for the quality of the political campaigns resides with the major parties. The view that political parties have become more partisan and that campaigns have increasingly sunk to the least common denominator seems to be widespread. I have called this the politics of distraction, and by shifting the public's attention from the essential to the superficial, it does the nation a great disservice. The mainstream media are also complicit in this shift. We sense that it wasn't always like this--my preference for the discourse in the Nixon-Kennedy debate compared to the Bush-Kerry debate is evidence that I think there was a better time in the recent past.

But even the last half century is too short a time period to think about partisanship in politics. I recently finished Founding Brothers: The Revolutionary Generation, by Joseph J. Ellis. The book focuses on the decade of the 1790s when the Republicans and Federalists feuded over the legacy of the American Revolution--whether its objective was to be independent of any central government or simply the British central government. The battle to succeed Washington--who was the only one able to transcend this partisanship--was hotly and venomously contested. Jefferson's scheming in particular contradicts any suggestion that the partisanship of modern times is unprecedented. Better historians than I can fill in the history of partisanship that has been with us since then.

So why does everyone seem to believe that partisanship is getting worse? My preferred explanation is that many people who are alive today came of age during a very unusual period of history in which partisanship was dormant. Not non-existent, but certainly not front and center like it had been before and is now. Consider the arc that began with Roosevelt's landslide re-election in 1936, intensified during World War II, crested during the early years of the Cold War and the space race, began to decline with the assassination of JFK, and ended tragically with Vietnam and Watergate.

During this span, strong presidents kept the nation unified against the external threat of the Soviet Union. Broadcast journalism was just coming of age and served first to unify the country around a common set of middle class values. Legislators worked across the aisle to pass significant legislation in foreign as well as domestic policy. But violence at home and abroad and criminal activity in the Nixon Whitehouse tore the unity apart. In the absence of a stable ruling coalition, the exceptional period was over. Partisanship was free to return, and with more modern technology for organizing and communicating along party lines, it has grown more virulent over time.

I'll offer some more hopeful possibilities for how the situation might be improved in a later post.

In Praise of Finn Kydland and Edward Prescott

The Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel 2004 was awarded to Finn Kydland and Edward Prescott "for their contributions to dynamic macroeconomics: the time consistency of economic policy and the driving forces behind business cycles." Congratulations to both of them on the well deserved recognition.

The two parts of their work are significant to the way economics is taught and new research developments are made. I have never done academic work on business cycles, but their insights on time consistency are directly relevant to public finance where I have done research. Marginal Revolution has a brief discussion of this aspect of their work, linking it to a discussion of why it is difficult to maintain an equilibrium in a market like prescription drugs that I addressed a few days ago.

The logic (like much in economics) is obvious once you see it. Think about a project that requires a firm to make an investment in order to generate profits in some future period. A government has every reason to claim that it will not tax those future profits, so that the firm will undertake the project. However, once the capital is in place and production is underway, the government can now tax the firm's profits heavily, since the firm has little choice now but to use the capital in production, despite the high taxes.

If the government has a reputation for behaving opportunistically, then firms will not undertake the investment. This insight applies equally well to monetary policy. A central bank that allows inflation to rise opportunistically (to lower real wages and thereby boost employment in the short term) will not be able to convince firms and workers to sign long-term contracts that require price stability. In the long term, economic activity will be lower as banks will be less willing to lend, firms will be less willing to invest, and workers will be less willing to work.

Kydland and Prescott's work shows why policy makers should behave in a consistent manner whenever possible, even though they will have to pass up opportunities to confiscate revenue or manipulate economic outcomes in the short term.

Presidential Debates, Then and Now

C-Span aired the first debate between Kennedy and Nixon this evening. I was struck by the difference between the quality of the discussion of the issues then and now (though I have only watched excerpts of last evening's debate). I was reminded of a short piece written by Diane Ravitch in January 2001 for the Hoover Institution, "Dumbing Down the Public: Why It Matters." She cites a study by the Princeton Review pertaining to the vocabulary used by candidates in debates:

The Princeton Review, best known for its test preparation services, analyzed the vocabulary used by the presidential candidates in the campaign debates of 2000 and compared it to the vocabulary levels used in earlier campaign debates.

The Princeton Review obtained transcripts of the Gore-Bush debates, the Clinton-Bush-Perot debate of 1992, the Kennedy-Nixon debate of 1960, and the Lincoln-Douglas debate of 1858. It analyzed these transcripts using a standard vocabulary test that indicates the minimum educational level needed for a reader to understand a document. This test is ordinarily used to evaluate textbooks and other educational materials.

The results? In the debates of 2000, George W. Bush spoke at a sixth-grade level (6.7); Al Gore spoke at a high seventh-grade level (7.9). In 1992, challenger Bill Clinton scored in the seventh grade (7.6), President George Bush in the sixth grade (6.8), and Ross Perot at a sixth-grade level (6.3).

Our contemporary politicians, who found it necessary to speak to us as sixth and seventh graders, compared unfavorably with Kennedy and Nixon, both of whom spoke in a vocabulary appropriate for tenth graders. And they, in turn, looked sophomoric when compared to Abraham Lincoln and Stephen Douglas, whose scores, respectively, were 11.2 and 12.0.

(Kerry's reference to "Orwellian" language aside, I suspect that this year's debates will resemble other modern debates.) Ravitch then poses the question, "Is it the candidates who have dumbed down their appeals or are they simply acknowledging that the public has a limited vocabulary?" Ravitch argues for the latter, and her thesis is that this limited quality of Presidential debates (and, I would add, the campaigns more generally) is one of the prices our society pays for the poor job we do in educating our students.

She may be right, but I don't think it is an either-or proposition. There are other reasons why Presidential campaigns have increasingly resembled little more than photo-ops, soundbites, and negative attacks. Modern campaigns are reflections of modern political parties, and it is reasonable to hold the two major parties to account for how the campaigns are conducted. I'll post more about that soon.

Re-importation, follow up

There were lots of interesting comments on the original post about prescription drug re-importation. One commenter noted that the patent argument may be a red herring. Here is why I think that the issue ultimately becomes one of honoring patents.

The drug companies are willing to sell in foreign countries closer to their marginal cost--and yet still continue in the market year after year--because the United States already allows them enough patent protection to cover their fixed costs by selling domestically. The foreign countries are "free riding" on the American consumer's willingness to do this.

To continue the idea, suppose that re-importation were allowed from Canada. The drug companies would act to curb their exports to Canada to protect their patent. The Canadian government would now face shortages of the drug and, I am guessing a bit here, would abridge the patent by producing the drug itself. That threat is what strengthens the foreign government's hand in the negotiations.

Unlimited re-importation is not a stable outcome in a dynamic sense. It is true that limited re-importation would initially lower some prices for some consumers in the United States and raise it for some consumers in other countries. But it would do so in a haphazard and circuitous way. Smaller price differentials would still exist, and not everyone would be able to buy re-imported drugs at the cheaper price. Shortening the patent period--and getting the foreign countries to honor that patent period--achieves the same type of result for price changes but does so in a more sensible way. That's why it is a policy that we should be pursuing, in cooperation with our trading partners.

In Praise of Southwest Airlines

There's nothing like a trip on United to make me miss Southwest.

I confess. I am one of those people who really likes to fly on Southwest. I am in awe of the business model and the straightforward execution. They do exactly one thing: fly full planes on profitable routes. They do it with good cheer under challenging circumstances. Everything else is secondary to that objective. I know that I may be in a minority here, so I'll focus on three things that Southwest lacks and explain why their absence doesn't bother me. Then I will mention some things that Southwest does uniquely well.

First, Southwest doesn't pre-assign seats. Seating is open, and the seat you get depends on how close to the front of the line you are. People who would obviously not fare well under these rules, like families with young children and those with medical conditions, get to board first. In my experience, I have found that as long as I am in the second (of three) boarding groups, I can get a window or an aisle seat. This is as we would expect, since two thirds of the seats are window or aisle seats. Yes, I admit that the anxiety sometimes gets to me, but consider the payoff. In exchange for imposting a little anxiety on me--a basically organized and prompt person--this policy makes Southwest an unappealing choice for people who like to show up late. You have heard the quip, "If you never miss a flight, then you are spending too much time in airports." Guess what. Catering to those people makes it very difficult to operate an airline efficiently. Better that they fly someone else.

Second, there is no first class and there are no upgrades. Wonderful. Keeping track of all that stuff is way too complicated for most airlines. Today, when I checked in at the United kiosk, it asked me if I wanted to upgrade or get a seat with more legroom. So every person, regardless of whether they would be interested, has to answer these questions. What a waste of time and a needless distraction that could confuse some people. Better to focus on filling up a plane full of identical seats.

Third, there is no food service. This complaint reminds me of another quip, "The food is terrible and the portions are small." No airline has ever gotten food service in coach satisfactory. Airports are filled with food courts and shops. Better to let each person bring on board whatever s/he wants to eat and leave the cost out of the ticket price. Food service also imposes a logistical burden. Better to let the plane leave 5 minutes earlier than to have to make sure that the right type and quantity of food was delivered. Less time on the ground means more flights and more reliable scheduling.

And then there are the things that Southwest does right. The frequent flyer program is completely sane. Travelers earn a point for going to a destination. Collect 16 points in a year, and then you get a free ticket that you can use on any flight on any date that isn't blacked out during the next year. There is no wondering about whether the airline will make available enough seats on a particular flight. There is no need to keep track of miles or to think about alternative ways to spend them.

Southwest also only flies B737's. No need to worry about whether the crew is trained to operate this type of aircraft or the other. No need to be careful of substituting equipment at the last moment for fear of wrecking the pre-assigned seats. Southwest also avoids the largest and busiest airports in most metropolitan areas in favor of satellite airports--Manchester and Providence instead of Boston, Oakland and San Jose instead of San Francisco, Fort Lauderdale instead of Miami, Islip instead of New York City, and Midway instead of O'Hare. Major airports have major delays. An airline cannot make money with the planes on the tarmac.

Southwest also will only fly to a city if it can have 10 or more flights per day. This means that it can do maintenance and refueling at the outlying airports rather than the hub. This allows for much smoother execution, since there is more competition for resources and risk of a bottleneck at a hub.

I have been following the airline industry as a hobby for quite a while. Southwest is seldom if ever acknowledged as the best airline. Airlines are typically ranked based on passenger miles or revenues. What's the point of obtaining a dollar of revenue if it cost two dollars to get it? What's the point of flying a passenger mile if you lose money on it? Southwest is not the leader in these categories. But it is the leader where it counts. Check out the market caps of all publicly traded airlines on this page. No other domestic airline even comes close.

I think I get so agitated about this issue because there are always airlines in Chapter 11 lobbying the federal government for a bailout. I have a lot of respect for people who work at airlines. What they do is not easy, and most of them do it sincerely. But there is no compelling reason why taxpayers should have to repeatedly subsidize unsound business practices.

Marginal Revolution, and Templates

Two more thank-you's are due to people in the wider community. The first is to Marginal Revolution, for posting about Vox Baby's appearance.

The second is to several readers who pointed out that my template switch caused people using some browsers (typically on Macs) to have trouble reading the page. I switched templates because my PC was showing poor formatting on the original template, and I looked around until I found one that showed proper formatting. Based on the feedback, I switched to a new one that also looks okay on my PC and that seems more robust against the troubles folks were having on Macs, because the background is lighter. I hope this works. I have asked the tech folks at blogger.com for guidance. Please let me know if there are further issues.

Prescription Drug Re-importation

Yesterday, Professor Brad DeLong linked to his op-ed in the L.A. Times today about prescription drug re-importation from Canada or Europe. We spent quite a while thinking about this issue at CEA, and so it seems like a good topic on which to post. Some of this thinking, but certainly not all, made it into the Economic Report of the President 2004 (see Chapter 10 and Box 10-1, in particular).

Prescription drug prices are lower in other countries, primarily because these countries impose price caps that are lower than the market (patent protected) prices that the drug companies can charge in the United States. The American public--whether individually, through health insurance plans, or through state governments--is searching for ways to buy the drugs at the cheaper prices in other countries like Canada. The impetus for Brad's op-ed is that the Administration is currently claiming that it would be unsafe to allow prescription drugs to be re-imported.

Brad correctly points out that the Administration's arguments about safety concerns are untenable--the FDA monitors the importation of many items that, if manufactured improperly, would pose a health risk. There is no reason why it could not effectively monitor the safety of prescription drugs--particularly re-imported prescription drugs. The costs for monitoring would be paid by the consumers of the re-imported items.

Prescription drugs are an example of a product with high fixed costs of producing the first unit, given the R&D and testing they require, but much lower or near-zero marginal costs of producing the second and all subsequent units. Static efficiency at a point in time requires that the price of each incremental unit equal the marginal cost of that unit--the low number. But dynamic efficiency over time requires that the manufacturer be able to charge enough to recover the fixed costs--a higher number.

The typical way this tension between static and dynamic efficiency is resolved is through a patent with a fixed expiration date. The patent allows the producer a period of time to charge a monopoly price above the marginal cost of production. When the patent expires, the competing producers can enter the market at lower prices that more closely approximate the marginal cost of production. The optimal patent length gives the producer just enough time to recoup the fixed costs of R&D and testing (on all products, not just those that make it to market).

It should be clear that it is not the presence of Canada and Europe that is forcing our drug prices to be high. If Canada and Europe did not exist, our drug prices would not be any lower. Instead, the price disparities across countries are ultimately due to a refusal of foreign countries to honor the patent in the same way that the United States does. If they did, then it would be possible to shorten the patent period that applies in the United States, thereby lowering the average price of prescription drugs that U.S. consumers face at any point in time, without lessening the drug companies' profits (which are their incentive to develop the drugs in the first place).

The top priority for U.S. policy makers on this issue should therefore be to start these negotiations in earnest. It may very well be that other countries have less of a demand for innovative drug therapies. In that case, as part of the outcome of this negotiation, we would expect that, beyond the reduction in the number of years of patent protection allowed by a more equitable sharing of the burden of the fixed costs, the number of years of patent protection would be even further reduced. We would have fewer innovative therapies and now lower drug company profits, but the equilibrium would better reflect the desires of everyone participating (now equally) in the market.

Happy Anniversary, Free Speech Movement

This week, the University of California at Berkeley celebrates the 40th anniversary of the Free Speech Movement. A listing of events on that campus can be found here.

The L.A. Times ran a story on Friday, "Free to Be Silent at UC Berkeley," wondering where all the student activism had gone on campus. This quote, found under the heading, 'Nothing but a Cafe?' was particularly annoying:

Faculty and students say that increasingly selective admissions standards, higher costs, onerous academic workloads and a largely apolitical Asian student population are some of the reasons behind the change in campus politics.

Call me crazy, but one would think that on the 40th anniversary of an event that so starkly showed how one generation can lose touch with another, the L.A. Times would have devoted more space to highlighting the role of alternative media in promoting free speech. The article comes close, with this passage:

But Kalin McKenna, 21, a combined history and premed major from Lake Forest, said busy students had found a new way to agitate.

"There's more online activism now," said McKenna, national outreach coordinator for Mobilizing America's Youth. " A lot of people know they can get the information they need from a computer. Rather than attend a forum for an hour, they read a synopsis of the forum on the Internet that takes 30 minutes."

Not to worry. There is a web feature on the Berkeley website highlighting the role of bloggers on the Berkeley campus. It makes for good reading. The Free Speech Movement hasn't died--it evolved and lives on.

Closer to home, Dartmouth also has plenty of interesting blogs, including Rockyblog, hosted by the Rockefeller Center.

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