Monday, August 22, 2016

Micro vs. Macro

The cause of sclerotic growth is the major economic policy question of our time. The three big explanations are 1) We ran out of ideas (Gordon); 2) Deficient "demand," remediable by more fiscal stimulus (Summers, say) 3); Death by a thousand cuts of cronyist regulation and legal economic interference.

On the latter, we mostly have stories and some estimates for individual markets, not easy-to-use  government-provided statistics. But there are lots of stories.

Here is one day's Wall Street Journal reading while waiting for a plane last Saturday:

1) Holman Jenkins,
... unbridled rent seeking.  That’s the term economists use for exercising government power to create private gains for political purposes. 
Channelling Jefferson,
Mr. Obama’s bank policy dramatically consolidated the banking industry, which the government routinely sues for billions of dollars, with the proceeds partly distributed to Democratic activist groups. 
His consumer-finance agency manufactured fake evidence of racism against wholesale auto lenders in order to facilitate a billion-dollar shakedown.
 His airline policy, urged by labor unions, led to a major-carrier oligopoly, with rising fares and profits. 
His FDA is seeking to extinguish small e-cigarette makers for the benefit of Big Tobacco and Big Pharma (whose smoking-cessation franchise is threatened by cheap and relatively safe electronic cigarettes). 
His National Labor Relations Board, by undermining the power of independent franchisees, is working to cartelize the fast-food industry for the benefit of organized labor.
Summing up,
We could go on. Mr. Obama’s own Council of Economic Advisers complains about the increasing cartelization of the U.S. economy—as if this were not a natural output of regulation. In a much-noted Harvard Business Review piece this spring, James Bessen, an economist, lawyer and software entrepreneur, cites increased “political rent seeking” to explain the puzzle of rising corporate profits in the absence of job creation and economic growth.
The truth is, government playing neutral arbiter over the private economy doesn’t produce rents. A stable and predictable regulatory system produces only mingy or non-existent rents.
2) Uber class action buffet
Federal judge Edward Chen on Thursday rejected a $100 million settlement in a class action alleging that Uber misclassified drivers as independent contractors. That’s a big pot of cash, but the judge says the ride-hailing company can be raided for billions more....Judge Chen complained, however, that the settlement required class members to drop all employment-related claims (e.g., minimum wage, rest and meal breaks and workers’ compensation) ...he settlement would have pre-empted at least 15 lawsuits for employment-related claims as well as cases “before various administrative bodies such as the NLRB.”...the settlement would have scotched lawsuits brought under California’s Private Attorneys General Act—known among businesses as the “bounty hunter law”—that lets private attorneys litigate labor, safety and health code violations on behalf of the state. California pays the lawyers’ fees and keeps 75% of the bounty. The state’s Labor & Workforce Development Agency carped that the statutory penalties against Uber could exceed $1 billion.  
Uber brings flexible employment to thousands, and dramatically better and cheaper rides to consumers and businesses. Whatever you think of contractors vs. employees, nothing in this improves productivity and economic growth, or encourages the needed massive investment towards self-driving ubers.

3) You don't need a dentist to fill a cavity Whether (cheaper, less licensed) dental therapists will be allowed to provide basic services especially in poor areas where there are no dentists.

4) How Obama’s FDA Keeps Generic Drugs Off the Market
 One of the biggest factors fueling the angst over drug prices in the U.S. is that some older medicines that should be sold cheaply as generics are still priced very high, often owing to a dwindling number of generic competitors recent years the Food and Drug Administration has imposed on generic firms many of the same costly requirements that the agency applies to branded-drug makers.  
In 2003...we estimated that it cost less than $1 million for a firm to file a generic-drug application. ...Today, filing a generic application requires an average of about $5 million and can cost as much as $15 million.... 
For generics filed in 2009, the median review time exceeds three years. Yet generics launched in 2015 took about four years for the FDA to approve, since less than 2% of applications were approved on their first submission.    
A new FDA draft regulation...would force the generics to clutter their drug labels with defensive advisories to avoid “failure to warn” lawsuits. Legal fees stemming from the regulation would add over $5 billion to annual health-care costs, rising to $8.6 billion by 2024, ...
And this is just one morning's reading of one paper's opinion section while sipping coffee at the airport. Even the New York Times is waking up to the apres-Obama regulatory deluge.

As these stories make clear, the problem is not benevolent but ham-handed interventionism. The problem, much tougher, is best described as "cronyism." A veneer of public purpose stifles markets, to drive profits to connected parties in return for political support.

Can we really screw up every single market but make it all up with "demand?" The "ideas" and "stimulus" approaches presume everything else in the economy is working just fine. Is investment really slow only because there are, fundamentally, just no good ideas to invest in any more?

The deeper economic issue is whether "macro" and "growth" outcomes really can be separated from "micro" distortions in each market.


  1. I love the Holman Jenkins WSJ piece that you quoted from. He’s my favorite regular WSJ columnist. Question: I didn’t know what he was referring to with this statement: "His airline policy, urged by labor unions, led to a major-carrier oligopoly, with rising fares and profits.” What’s his airline policy? Obviously, he doesn’t want to allow foreign competitors in domestic markets, but this has been a long-standing policy and so it’s hard to see how this leads to rising fares, as opposed to high fares.

    1. I'm not sure what he has in mind either. But I haven't been following airline regulation. It's all too much, too fast...

    2. In this case, I think that Jenkins is really arguing that the administration is passively encouraging oligopoly by not objecting to airline consolidation because the major airline unions have become supporters of the mergers. The basic idea is that as long as the union members suffer minimal loss of benefits or service credit in a merger then they should be net beneficiaries as the oligopoly results in much more stable markets with more stable profits for the companies and more stable employment conditions for the employees.

      The history of the industry since deregulation has been very much boom/bust driven by excess capital spending in economic booms as competitors try to grab share. In the down cycle, airlines have retrenched (often thru bankruptcy) which has led to downward renegotiation of union deals, usually through furlows and reduced service credit for remaining employees.

      As a successful investor in airlines in this cycle, its clear to me that they have behaved in much more carefully in adding capacity, which has maintained pricing power much longer than prior cycles. But I am not convinced that they have acted as true oligopolists, but the absence of government interference in mergers is notable compared to other industries or to the history of airline regulatory concerns about concentration in individual markets.

    3. The policy under the guise of safety is how you count a "full shift" for a pilot and crew. Previously it was sealed door to sealed door, now it's show up to work. The major effect is increasing how much single delays can impact the entire system because it's very easy for a crew now to go over their allotted time if they're stuck in the captains lounge. This has a minor impact on major airlines who have more route flexibility but leads to a ton of cancellations on the jet blues and virgin's of the world that don't have the same flexibility. I'm sure EVERYONE noticed how much the same weather issues are creating far more cancellations and delays. ALL FAA!


    5. In the big scheme of things, though, pilot rest does not sound like a big cronyist anti competitive regulation. It's going to raise costs for everyone a bit, and airlines have to keep a few extra pilots around. Truckers also have to sleep. And of all the regulations raising costs and reducing innovation in aviation it also seems pretty small.

  2. Nice post. Related to the efficacy (or lack thereof) of fiscal stimulus, I would also point to the numerous stories of inefficiency in federally-funded infrastructure projects. Some of these problems are certainly attributable to costly regulations (historical preservation, permitting, etc.) while others rise from more general issues of accountability.

  3. Today's WSJ. Stanley Fischer, concerned about long-term productivity, said more public investment in infrastructure and education along with regulatory Changes could boost flagging growth! Really? We've had eight years of shovel ready jobs and student loans approaching a trillion dollars. He didn't mention economic policies akin to blood letting and leeches to cure an ailing patient! Maybe the Fed should get out of the way as well.

    1. So now central bankers have become fiscal policy experts? Perhaps he should resign his post as Vice Chair of the Fed and run for Congress.

    2. Of course Frank! They are all experts with one flaw, the inability to understand, if it's not broken, fix it until it is!

  4. "The truth is, government playing neutral arbiter over the private economy doesn’t produce rents. A stable and predictable regulatory system produces only mingy or non-existent rents" -- ummm no? Regulations raise barriers to entry which favors large firms who can afford lawyers and lobbyists over small businesses and entrepreneurs who have neither the legal expertise nor the resources. And what is this fantasy about neutral arbitration, as if transgender bathroom law and critical sexual assault theory are branches of engineering? Just ask an expert EPA engineer to form a coherent rebuttal to Epstein's case for regulatory takings law and watch them squirm and it will be perfectly clear that THEY'RE RENT SEEKERS TOO! if I know it's just an example of a story about rent seeking but still... Also in response to the second author, the NLRB is technically an independent agency and not in the executive branch.

  5. Thanks for the post. One question: do you think these policies hamper the level of economic growth, or its growth rate? I appreciate one can't readily distinguish the two in finite time, but conceptually it's more likely to be the former, right?
    It seems that Summers' thesis is really about the former too, with Gordon talking about something which hits the growth rate directly.

    While I agree that there's may be a lot of regulation that could be removed and be good, it's worth noting that here in the UK the Conservative government has tried to remove regulation and the UK's GDP growth performance has been somewhat similar to the US's (with a worse productivity growth rate). I appreciate there's lots of other differences which might offset this, but this at least suggests that the weakness of the recovery is not due to abnormally high amounts of regulation (relative to the long run average)?

    1. I've learned from Chad Jones' work that there really is no distinction between "level" and "growth rate" effects. The promise of the first generation of new growth theory, that there are policies that skip a derivative and make everything else insignificant, didn't bear out. Everything is level -- albeit very big levels, with very long adjustment paths. I'll post at some point in detail.

  6. John, in the interview you linked to earlier, you said you're a fan of the new Keynesian model, which I think you stated is really a consumption function based on the permanent income hypothesis. Permanent income is of course just the present discounted value of future flows, and is then a stock. The stock of wealth comes in different forms. Capital is human, intangibles, tangibles, and financial, and these generate -- interdependent -- flows of income. So both macro and micro theory need to understand the formation and valuation of capital so that current demand management and growth theory can be merged. But, listening to a fun discussion between Eugene Fama and Richard Thaler on the efficient market hypothesis (check youtube), it's clear that one thing they agreed on is that we don't have and can't really get a theory of what appropriate capital values are or should be. Yes, the market is the most efficient mechanism for incorporating relevant information, but there is no model (not CAPM, not the empirical asset pricing model, not anything else) that can establish the "correct" price of capital assets. That includes not just stocks and bonds, but real estate and human capital (i.e., labor earnings) as well. But the point seems to be that the "new" Keynesian model would indicate that we need to look at all market mechanisms that set the prices of labor, financial instruments, real estate, physical capital, and the intangible knowledge capital in modern corporations. In other words, heed the efficient market theory, and make sure that the markets for all capital assets, including human capital, are able to function as freely as possible. That's how you get growth, i.e., higher levels of capital which yield higher rates of return and higher future income streams. If that's the new Keynesian model, there's much more to economic policy than Summners' simple fiscal demand management ideas, and sounds more like the kind of policies generally advocated by the Wall Street Journal -- and old school Chicago.

  7. All good.

    Now, let's go after property zoning, the criminalization of push-cart or truck-vending, and the evidently permanent federal corn-ethanol fuel program.

    And can we stop licensing lawyers?

    And stop paying interest on excess reserves to banks?

    I would also like to end a 100% taxpayer-funded federal medical and welfare program for former federal employees who retire after 20 years of service. The VA.

    Sadly, my echo chamber had no walls.

  8. Real-GDP is a metric that is basically a hybrid of what governments care about (growth) and what people care about (personal productivity (or spending power) improvement). It's not worth even thinking about the problem without disentangling the two separate issues here.

  9. Progressive Neo-liberalAugust 24, 2016 at 1:09 PM

    Professor Cochrane,
    This post fills me with despair because I don't hear anyone from the GOP advocating for any of the ideas that you put forth. It would be one thing if we had two parties who were trying to solve problems and competing for the best way to do so, but instead it's arguably different constituencies fighting over rents. It feels like true pro-growth policies are entirely missing from the political discourse. Can you point any politician out to me (on the right especially) who wants to reform zoning, occupational licensing, drug discovery / FDA, etc? The only people I've seen arguing for these things have been mostly Democrats (for example, this from the White House on occupational licensing: ).

  10. Do you really not know that the primary owner of e-cigs is " big tobacco"?

  11. If you are looking for explanations for the Great Stagnation, consider this possibility: the optimal equilibrium in the market for coercion is stagnation. The other 'equilibriums' involve a lot of physical conflict?

  12. Can we answer D) All of the above? Last I checked things can be caused by a multitude of factors, often without 1 being dominant. It's easier and more digestible to say "Stagnation is caused by X" than "Stagnation is caused by an unknown mix of X, Y and Z".

  13. John,

    "The cause of sclerotic growth is the major economic policy question of our time. The three big explanations are 1) We ran out of ideas (Gordon); 2) Deficient demand, remediable by more fiscal stimulus (Summers, say) 3); Death by a thousand cuts of cronyist regulation and legal economic interference."

    How about 4) We mistakenly thought that by giving stuff away (unemployment benefits, bank bailouts, credit, tax breaks, etc.) that this would resuscitate growth in trade.

    Perhaps charity is not the best way to spur growth (economic, emotional, or otherwise)? How many well adjusted adults have come along that have had everything handed to them on a silver platter?

  14. 1) At a time of the highest rate of expansion of scientific knowledge in the history of humanity, the concept of a "shortage of ideas seems insane". We have a shortage of imagination by certain economist.

    2) There is always demand for doing something better and more efficiently than it is being done at present.

    3) Any set of regulations/standards etc. creates arbitrary limits that prevent innovation from being implemented. Of course these limits are set by those organizations that benefit from the regulations/standards.

    Each human can only see part of the picture. My little view, with documented facts that regulations are the problem is as follows.

    I do see a 5 billion dollars per year opportunity in So. California for offshore aquaculture that is being directly blocked by US and California bureaucrats. In California, we don't have NE Pacific storms or Huricanes, allowing offshore operations year around plus we have deep water with lots of flow and 35 million people who want fresh seafood. In the rest of the world, aquaculture (especially offshore) is expanding at double digit rates, but in the US it is shrinking under a regulatory strangulation.

    In California, with a 35 million people market for seafood, the industry is evolving in Mexico. My consulting work in this area is now in Mexico where the regulators are not as power hungry and insane.

    In California, the regulatory system has been working on a desalinization proposal (making fresh water from saltwater) for 12 years concerned with 80 million fish larva "entrained in the intake seawater" per year being killed by the facility. Having bought, traded and sold fish fish larva for < $1000/million, having the regulators propose a billion dollar "solution" to this "entrainment" problem is representative of "institutional insanity". Meanwhile, many dozens of members of the "educated elite" (almost all have a MS degree or higher) have earned a high income discussing, studying, lobbying, debating, getting retirement, etc. while "Joe Median" employee who would build, operate and maintain the desalinization facility, providing water to So. California go without jobs.


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