Category: Policy

We Need a Good Recession

“I believe if the credit markets are not functioning, that jobs will be lost, that our credit rate will rise, more houses will be foreclosed upon, GDP will contract, that the economy will just not be able to recover in a normal, healthy way.” – Ben Bernanke, Fed Chairman, Sept. 23rd, 2008

“that our American economy’s arteries, our financial system, is clogged and if we don’t act the patient will surely suffer a heart attack — maybe next week, maybe in six months, but it will happen.” – Hank Paulson, Secretary of the Treasury, Sept. 23rd, 2008

Even before testimony concluded yesterday on Capitol Hill, reports with headlines like “Bernanke: Recession Certain in Absence of Bailout” and “Bush Administration Tells Congress to Act Quickly or Risk Recession” hit the wire services. Both Ben Bernanke and Hank Paulson stated clearly that a recession would occur if the proposed $700 Billion dollar bailout plan were not enacted. Similar threats of recession were used earlier this year when President Bush and Congress enacted a tax rebate stimulus program.

Let me ask a simple question: why is everyone so afraid of a recession? Recessions and boom times are both natural parts of the business cycle in market economies, and the United States experienced twenty recessions (including the Great Depression) in the 20th century alone. Economic downturns, with the associated bankruptcies and layoffs, help trim inefficient investments made at the peak of economic cycles, thus paving the way for the next round of economic growth.

The alternative to business cycles can be found in state-controlled economies, where inability to reallocate capital to new enterprises slows overall economic growth dramatically. Governments presiding over market economies also attempt to tamper with business cycles, and while intervention may soften the landing in a recession, it may also delay the recovery. Japan’s “lost decade” of the 90’s, where poor economic growth was the norm, resulted after Japan’s incredible economic boom of the 80’s. The extraordinary length of Japan’s recovery stemmed partly from the Japanese government’s inability to allow corporate and bank bankruptcies progress at the rate needed to clear out bad loans and start a new economic cycle.

The US would do well to heed Japan’s allegory. Ideally, any intervention in the financial markets should enable orderly collapse and restructuring of businesses overridden with bad debt. No one gains in a financial panic, but an unwinding of the excesses of the US housing bubble is inevitable. Creative Destruction is at the heart of the business cycle, it’s at the heart of the American economy, and it will be necessary in this cycle as well. Let’s not make it take longer than necessary.

Posted on by praveenghanta 4

Mortgages and Health Insurance: The Biggest Subsidies of Them All

Economists decry government subsidies, because they distort the market and cause inefficiencies, thus wasting taxpayers’ money and decreasing overall economic growth. Taxpayers and advocacy groups rightly decry government subsidies to corporations as pork-barrel spending.

Where then is the indignation regarding the two biggest subsidy programs of them all?

I’m talking about the home mortgage interest deduction and the employer health insurance deduction. The home mortgage interest deduction subsidizes homeowners at the rate of $100 billion per year, while employer health insurance is similarly subsidized at $250 billion per year. These subsidies carve a large hole in government revenue, which could otherwise be used to reduce the deficit or reduce taxes for everyone.

Both subsidies also have a more insidious effect – they raise prices for both homes and medical care, thereby making it harder for those with low incomes to afford either one. The mortgage deduction lowers the effective cost of a house for all buyers, thus increasing demand and raising prices. The net effect of the subsidy is to cause Americans to live in bigger houses than they otherwise would, without raising rates of home ownership significantly. Similarly, the employee health care deduction raises the cost of health care for everyone, and causes Americans to spend more on health care than they otherwise would.

Neither deduction is designed to help those with the greatest difficulty in getting a home or health insurance. Lower income families can’t afford the down payment required to avail themselves of the mortgage tax break, and most low-paying jobs don’t provide health care as a benefit.

These subsidies are popular because they target middle and upper-income America, but that doesn’t make them any more effective than much-maligned corporate subsidies. $350 Billion is a lot of money, and should either be given back to ALL American taxpayers, or spent paying for the deficit, recent wars, or other priorities.

Posted on by praveenghanta 6

Obama & McCain: Here’s a real way to reduce gas prices!

Oil prices have continued their steady march, breaking through $135/barrel (which implies gas around 4.25) and climbing. As noted previously, the fundamentals driving oil prices higher are steady growth in global demand for oil combined with flat supply – an Econ 101 recipe for higher prices. What’s a presidential candidate to do about the situation? John McCain and Hillary Clinton both expressed strong support for a repeal in summer gas taxes; Barack Obama chose not to hop on the bandwagon, but offered no immediate alternative. So what can we do in the short term in this regard?

First, eliminate the use of heating oil in American homes. Heating oil and diesel fuel are essentially the same product, so heating oil demand directly impacts the price of diesel and gasoline. Replacing oil heating with gas heating would replace demand for imported oil with demand for natural gas that is produced primarily in the US and Canada.

Eight million homes in the US still use heating oil, and it accounts for roughly 2% of all oil demand in the US. Since oil prices are decided at the margin, a 1% drop in demand could significantly impact price. A $4000 tax credit would convince most heating oil users to switch immediately, and would send a strong signal to gas utilities to expand their service areas. If four million homes switched to gas overnight, this would cost taxpayers $16 Billion in one-time tax credits, about the same as two summers of the McCain/Clinton tax holiday plan. But the additional natural gas demand would be manageable, and the market signal of reduced oil demand would have swift impact.

Second, buy out old gas guzzlers and crush them. Since new vehicles are much more efficient on average, buying old junkers that get less than 20mpg would be an efficient way to reduce oil demand, while potentially helping poorer consumers to find new transportation. For example, offering $2000 per inefficient old car would enable many drivers to retire their old vehicles and move to new, efficient vehicles by using the money as a down payment. 10 million cars could be retired by spending $20 billion, and if each 15mpg vehicle were replaced with a 25mpg vehicle, 210,000 barrels per day of consumption could be eliminated.

Replacing oil heat and getting rid of old gas guzzlers may sound wonkish, but together these ideas could reduce US oil consumption nearly 5%. Unlike many plans under discussions, these steps are feasible and can be implemented today. Of course, these are only steps in a larger energy plan – but it’s better than many of the steps that politicians are currently advocating!

Calculations:

8 million homes * 730 gallons per year / 42 gallons per barrel / 365 days = 381,000 barrels per day

Converting 200,000 bpd of heating to natural gas requires 7 BCF (billion cubic feet) per week of natural gas. Since this consumption is wintertime only, it’s probably closer to 20 bcf per week, which is large, but not unsustainable, given that the US draws roughly 100 BCF per week from storage during the winter.
For cars, if each old 15mpg car is driven 12,000 miles per year, it consumes 800 gallons per year, compared to 480 gallons for the same distance in a 25mpg car. This equates to a savings of 3.2 billion gallons per year, which is equivalent to 210,000 barrels/day.

Posted on by praveenghanta 5

Paper or Plastic? A true cost analysis

Plastic grocery bags have been banned or taxed to discourage their use in other countries, and recently San Francisco approved similar measures. While reusable bags are touted as an obvious alternative to disposable bags, paper bags are also seeing a resurgence, and are the standard bags at upscale grocers like Trader Joe’s. Paper bags are often assumed to be more environmentally friendly, which begs the question: what is the true cost of both bag varieties?

Numerous reports have been published on this topic, with the Washington Post and Environmental Literacy Council providing particularly good comparisons. On most counts, plastic bags come out ahead, even after comparing the true cost of two plastic bags against one paper bag (to make up for differences in bag size). Plastic bags require 50% less energy to produce and cause significantly less pollution during manufacturing. Paper bags are recycled more often, but over 85% of paper and 97% of plastic bags end up in landfills, where neither biodegrades, and where plastic bags take 90% less space. Plastic bags are criticized for endangering certain marine animals, and because they often end up as litter since are easily blown about.

Another good measure of cost is the price of the two items, since neither is heavily subsidized, and since the price that stores pay for bags represents the direct cost involved in production. Plastic bags cost 50% less than paper bags in the US (2 cents for two plastic bags versus 3-4 cents for one paper bag). Advantage plastic.

On most counts plastic is the clear winner for the consumer, the environment, and businesses. In fact, after weighing the costs and benefits, the Natural Resources Defense Council recommends plastic bags to everyone unable to use a reusable bag, and recommends paper bags only for those living on the coasts (to protect marine wildlife). Perhaps, as with ethanol, paper bags have just become another easy way for politicians to score points for being green, rather than taking more beneficial (and difficult) steps to protect the environment.

Posted on by praveenghanta 6

US Healthcare – Where does all the money go?

The Census Bureau recently released the results of its 2006 Services Industry Survey, which shed light in particular on where US healthcare dollars are spent:

Census Bureau Press Release: “Doctors and Dentists Account for 27 Percent of $1.6 Trillion in Health Care Revenue”

Full tabular data on US healthcare spending in 2006

The second link provides some detail on where US health care spending goes. It’s worthwhile to note that $117 Billion in Social Assistance is included, with line items like children’s daycare, community housing assistance, and other rolled into the overall Health Care and Social Assistance category. Without Social Assistance, health care spending is actually 1.45 trillion, or 11% of US GDP.
Read the full entry (500 words) …

Posted on by praveenghanta 3

The Myth of Energy Independence

“We’ll grow our own energy right here in America, and stop sending our money to the Middle East!” This refrain has become very common in the US energy debate going on today. Coal producers are lobbying for increases or extensions to programs that subsidize the cost of turning coal into diesel fuel, and corn growers have successfully lobbied for a 51 cent-per-gallon subsidy on gasoline-ethanol blends (sometimes containing as little as 1% ethanol). Meanwhile, politicians proclaim that our dependence on foreign oil is a threat to national security.

Is the answer to America’s energy needs really to grow or drill it all at home? And would doing so help moderate the rapid rise in gasoline prices, and in energy costs as a whole? These questions deserve further review.
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Posted on by praveenghanta 2

Top Five Worst Subsidies

Anyone versed in basic economics knows that government subsidies are almost always a bad idea. To be sure, government support can be crucial in furthering basic research and other beneficial activities that for-profit corporations avoid. But it’s a sad reflection of America’s budget process that we continue to subsidize activities that are well established and often highly profitable. In other cases, we taxpayers distort costs through our subsidies, thus encouraging over-consumption of a subsidized good relative to an unsubsidized one.

While many articles on this blog have been devoted to the topic, I couldn’t resist – so here’s my top-five list of most-reviled government subsidies:
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Fatten us all with Farm Subsidies

This New York Times Magazine article does an excellent job of exposing how farm subsidies have contributed to obesity amongst Americans, and particularly amongst America’s poor.

In a nutshell, by subsidizing the overproduction of corn, soybean, and wheat, the American government drives the cost of these staples down, which in turn encourages overconsumption. All the extra caloric energy produced by America’s subsidized farmers gets translated into Twinkies, candy, potato chips, and myriad other junk – junk that interestingly offers far more calories per dollar than more healthy foods. The junk food fits perfectly into a low-income budget, which helps explain the paradoxical poverty-obesity correlation in the US.
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Tax Pollution, Not Work

How could it possibly be a bad idea? Environmental pollution is the largest single economic externality faced by modern market economies like the United States. Households and companies alike do not suffer direct costs for their pollution, and therefore have no incentive to curtail it. Meanwhile we all suffer its negative effects, which include increased rates of asthma and respiratory illness, and also include rising temperatures worldwide.
Read the full entry (365 words) …

Posted on by praveenghanta 2