Countries run balance of payments deficits when their tradable goods are expensive on world markets because their producers are not sufficiently cost effective. These deficits cannot continue unless other countries are willing to help finance these deficits indefinitely by lending money to deficit-running countries. This is unlikely, unless either the deficits are small or a country has an excellent record on debt servicing. Otherwise,countries with balance of payments deficits must reduce their deficits. One option is to devalue their currency if they control its value. Devaluation makes exports cheaper to other countries and imports more expensive to domestic consumers and companies. These effects both tend to cut the trade deficit. Another way to improve international competitiveness is to have sufficient reductions in wages and prices that make the cost of goods more competitive internationally. Still another way is to lower production costs through improved efficiency.
I mention these types of adjustment as a background for discussing whether Greece should exit from the euro. There is no good solution for Greece, only least bad ones, given Greece’s extensive foreign debt, and lack of competitiveness of its goods in the EU and elsewhere in the world at the present international value of the euro. I have concluded that the better of the two basic dismal alternatives is for Greece to leave the euro zone, and return to the drachma. IMF estimates suggest that Greece needs a devaluation of at least 15-20% against the euro zone average, and much more against Germany just to balance its current account. A greater devaluation would be needed to stabilize its international debt. These are not firm estimates since needed currency adjustments are notoriously difficult to calculate, but there is no doubt that imports will become significantly more expensive to the Greek population.
Before the euro was launched I was skeptical that it could succeed (see my “Forget Monetary Union-Let Europe’s Currencies Compete”, November 12, 1995, reprinted in The Economics of Life). I said, among other things, “Competition among currencies helps discipline irresponsible governments by reducing their incentives to …finance budget deficits arising from dubious expenditures, such as inefficient state enterprises… and in order to penalize and discourage irresponsible government-based monetary and fiscal policies.” Not a bad description of what ails Greece! A single currency also makes it difficult for countries to restore competitiveness to their export sector, when they are subject to negative shocks that require their wages and prices to fall relative to those of other countries.
For the first 8-10 years of the euros’ existence, it appeared as if my concerns were misplaced since the euro performed very well. Many economists even claimed that it would eventually replace the dollar as the major international currency. The crisis of the past few years has crushed that optimism, and many now agree that it was not wise for Greece, and probably Italy, Spain, and Portugal as well, to have become part of the euro zone. Still, Greece is part of this zone. So the question now is whether Greece should abandon the euro, or make the fiscal and other adjustments demanded by other members, mainly Germany, in return for possibly continuing financial help?
If Greece stays in the euro zone, it will go through many additional years of painful adjustment that will mean indefinitely high unemployment and slow, if any, growth in the Greek economy. Over these years Greece’s standard of living- even with the cushion of aid it receives from Germany and the IMF- will continue to fall relative to that of Germany and other countries in the euro zone since its real income will fall further behind incomes in these countries.
If Greece leaves, the initial adjustment would be drastic. Greece would have to default on pretty much all its international debt denominated in euros, including loans from the ECB, since the value of the drachma relative to the euro would be too low to enable Greece to repay the debt. Greece would be unlikely to receive further aid from euro zone countries, and certainly Greece will not have access to the international capital market for some years to come. There would be a run on Greek banks as depositors try to get euros and lose confidence in the viability of these banks. Already, many depositors have withdrawn their deposits, as they fear Greece’s exit and a devalued drachma. Greece might be thrown out of the EU itself, which would carry great costs if it happened (I do not think it will).
The adjustment to the drachma would take a minimum of 18 months and possibly longer, and during this period the real income and prestige of Greeks would slide a lot. But countries like South Korea and Indonesia came back strong after their defaults and currency depreciations due to the Asian crises of the late 1990s.
I said earlier that Greece has no good choices, and exit from the euro would carry large costs. Nevertheless, I believe Greece in the long run would be better off through having the additional flexibility from controlling its own currency. My major concern is that this flexibility will not be used properly because the added flexibility through devaluations might take away the urgency of reforms in its government sector and labor markets. Greece really needs these reforms to become a more effective economy in the longer run.
I agree with Becker that it would make sense for Greece (from the standpoint of Greek self-interest) to replace the euro with its own currency, but my reason is slightly different; it is that it is the politically more practicable solution to Greece’s economic woes. I also suggest a caveat based on the costs to Greece of transitioning from the euro to a homegrown currency: Greece would be better off in the long run with its own currency, but it may not be able to avoid or tolerate the short-run costs.
From a narrowly economic standpoint, disregarding politics, abandoning the euro would have consequences for the Greek economy comparable to the consequences of adopting a further set of “austerity” measures, as urged by the Germans. Such measures might include laying off a large number of public sector workers, cutting public pensions, curtailing the powers of unions, cracking down on tax evasion and corruption more generally, and eliminating restrictions on competition, such as licensing requirements for new businesses and for professionals such as lawyers and accountants. The problem with enacting such austerity measures is that they are politically infeasible in the circumstances in which Greece finds itself. This is partly due to Greeks’ hatred of Germans (rooted in the brutal German conquest and occupation of Greece during World War II, and also in the disdain for Greeks that Germans feel and make little effort to disguise), but more to distrust by the Greek people of the Greek government and to the understandable resistance of the beneficiaries of Greece’s economically unsound policies (public sector workers, public pensioners, professionals protected from competition, and so forth) to give up any of their benefits.
The beauty of replacing the euro with a Greek currency is that this single, politically feasible—if not downright popular—legislative measure is likely to bring about indirectly economic results similar to those that explicit austerity measures would be likely to bring about. Euros held by Greeks, including Greek banks, would be exchanged for the new currency (the drachma—the name of the Greek currency before Greece substituted the euro), which because of Greece’s parlous economic state, and the benefits of devaluation, would be worth substantially less than the euro. One result would be that Greek exports would be substantially cheaper, and this would increase demand for them, which would stimulate an increase in their supply, leading to increased employment in the export sector of the Greek economy. The prices of imports would be higher, and this in turn would encourage substitution of domestically produced goods for imported goods; domestic production would thus increase to serve domestic as well as foreign markets, further increasing employment.
Such mechanisms make devaluation an almost surefire way of bringing an economy out of a depression by lifting emplooyment. Successful recent devaluers include Russia, South Korea, Indonesia, and Argentina. In addition, increased demand for workers in productive industries would lead to higher wages, which would draw workers from the bloated public sector, thus reducing the size of that sector (one of the goals of austerity measures). Increased demand for Greek products would also place pressure on government to relax restrictions on competition (another goal). There would also be pressure for a more rational system of taxation and public benefits. A thriving private sector, in short, would exert pressure for greater economic efficiency, just as the austerity measures that are political poison would do.
Still another consequence of abandoning the euro and of the ensuing devaluation would be a reduction in Greece’s huge public debt. Much of that debt has been financed by the European Central Bank, and one of the main aims of the austerity measures it to avoid Greece’s defaulting on that debt. With the change in currencies and ensuing devaluation, creditors would be paid in drachmas worth much less than the euros in which the debt to those creditors was denominated. The pressure for politically destabilizing short-run austerity measures would be relaxed; instead those austerity measures would unfold gradually as a consequence of an increasingly productive and prosperous private sector, a trend that would reduce the demand for government services along with incentives for tax evasion and corruption.
Default would of course reduce the ability of the Greek government to borrow at tolerable interest rates, but that would exert a further indirect pressure for efficiency and for a reduction in the bloated (and therefore expensive) public sector.
The main objections to Greece’s abandoning the euro are twofold:
First, because of the possible domino effect of that abandonment, and of the ensuing default, on other financially precarious euro nations such as Spain and Italy, Greece may be able, by threatening to leave the euro rather than actually leaving it, to obtain further substantial financial aid from the European Union, though this seems unlikely and would in any event be only a short-term solution to Greece’s economic problems. Yet the threat route seems to be the one the Greek government is on at the moment.
Second and more ominous, the transitional costs involved in switching currencies could be immense, creating its own political risks. Most of the benefits of devaluation, namely the benefits in increased exports and in substitution of domestic for imported goods, and resulting pressure for overall increases in efficiency, will not be felt immediately. But the transitional costs will be.
Suppose Greece were to announce that in three months it would be freezing transfers of capital to other countries and requiring that all euros in Greece be exchanged for drachmas at a specified rate of exchange. The reason for the three-month waiting period would be that it takes time to create (in this case, re-create) a currency, print the new currency, and price all goods and services in the new currency. (In 2003 it took the United States three months to create a new Iraqi currency.) But given such advance notice, Greek individuals and companies would forthwith transfer to other countries all the euros they could spare from immediate consumption or other expenditures, thus draining enormous wealth from the country before the switchover data prevented further capital flight. What the Greek government needs somehow to do is prepare for the changeover in currencies in secret, so that euro holders are unable to transfer their euros abroad. It is not clear that this is feasible. Devaluing an existing currency is much simpler than changing currencies, especially changing out of a foreign currency, such as the euro. Greece cannot devalue the euro.
And even if the currency changeover proceeded smoothly, the immediate effect on the prices of imported goods (immediately much higher), and on savings (immediately worth much less—the obverse of the effect of devaluation in reducing debt), would be economically destabilizing, with potentially serious political as well as economic consequences in an already depressed economy.
If the transitional costs can be reduced to a tolerable level, however, abandoning the euro seems the best bet for a Greek economic recovery. But it’s a big “if,” and the alternatives are not appealing.
President Obama’s declaration of support for homosexual marriage has focused public attention on the question whether such marriage should be permitted, although so far the response has been rather tepid. It no longer seems a hot issue, though it may heat up in the furnace of a presidential election campaign.
In 1967 the Supreme Court, in a case called Loving v. Virginia, held that the prohibition found in the laws of a number of southern states against interracial marriage was unconstitutional. The decision was the culmination of a long series of judicial, legislative, regulatory, and corporate measures that collectively had eliminated most public, and as well a degree of private, discrimination against blacks. It would have been odd for prohibitions of interracial marriage to have survived the antidiscrimination movement. The evolution of homosexual rights has been similar. In the 1950s, when I was growing up, homosexuals had, as homosexuals, no rights; homosexual sex was illegal (though rarely prosecuted), homosexuals were banned from the armed forces and many other types of government work (though again enforcement was sporadic), and there were no laws prohibiting private employment discrimination against homosexuals. Because homosexuality is much more concealable than race, homosexuals did not experience the same economic and educational discrimination, and public humiliations, that blacks experienced. But to avoid discrimination and ostracism they had to conceal their homosexuality and so could not openly engage in homosexual relationships or disclose their homosexuality to the heterosexuals with whom they associated. Homosexual marriage was out of the question, even though interracial marriage was by the 1950s legal in most states.
Although I knew in the 1950s that there were homosexuals, if asked I would have truthfully said that as far as I knew I had never met one, or expected ever to meet one, any more than I had ever met or expected to meet an Eskimo.
Beginning in the 1960s and accelerating dramatically in the 1990s and 2000s, legal changes and changes in public attitudes resulted in the dismantling of most public and private discriminatory measures against homosexuals. Why the powerful antipathy toward homosexuality gave ground so rapidly and, it seemed, effortlessly, in the sense that resistance seemed to melt away rather than having to be overcome by militant action, is something of a puzzle. Greatly increased tolerance of nonmarital sex, and of cohabitation as a substitute for marriage, reduced the traditional abhorrence of homosexual sex, which was (and to a large extent still is, since only a handful of states recognize homosexual marriage) nonmarital; and with the decline of prudery, deviant sexual practices created less revulsion in the straight population. A number of foreign countries and U.S. states recognized homosexual marriage or close-substitute civil unions.
Another factor in increased tolerance is that as homosexuals began feeling less pressure to conceal their homosexuality, and so began to mingle openly with heterosexuals, the latter discovered that homosexuals are for the most part indistinguishable from heterosexuals, and this created sympathy for homosexuals’ desire to be treated equally with heterosexuals both generally and in regard to marriage. Moreover, the older view of homosexuality (especially male homosexuality) as a choice—the “selfish” choice because male homosexuals have on average more sexual partners (because men are on average more promiscuous than women) and didn’t have to worry about pregnancy (one reason men are more promiscuous than women)—gradually gave way to realization on the part of most people that homosexual preference is innate, rather than chosen or the result of seduction or recruitment. There is no gene for homosexuality (as shown by the fact that if one identical twin is homosexual, more often that not the other one is heterosexual), but it is highly likely that a combination of genetic factors (studies of identical twins reveal that if one identical twin is homosexual, the likelihood that the other will be is greater than the incidence of homosexuality in the population as a whole) and prental and other biological factors cause homosexuality. See the excellent discussion in “Biology and Sexual Orientation,” http://en.wikipedia.org/wiki/Biology_and_sexual_orientation.
That there is a genetic component in homosexuality may seem paradoxical, since homosexuals produce on average fewer offspring than heterosexuals, which might lead one to expect that over time homosexuality would diminish and eventually disappear—which of course has not happened. But in the harsh ancestral environment in which human beings evolved, there was a tradeoff between number and survival of offspring. A family with many children would not be able to feed and protect them; none might survive childhood. Both menopause and homosexuality are ways of increasing the ratio of adult caregivers to children, since homosexuals can provide care to their nephews and nieces and menopausal women to their grandchildren, without either group having obligations to their own children. The result can be a net increase in inclusive fitness (number of descendants); there are fewer offspring but more survive to an age at which they produce offspring.
This is just a theory; it has not been confirmed by evidence. An alternative theory, for which there is some evidence, is that male homosexuality has survived because the female relatives of male homosexuals are more fertile than women who have no male homosexual relatives. This is an alternative genetic explanation for homosexuality.
Whatever the precise causality, there seems very little doubt that homosexuality is innate. It appears to be universal, despite public and private efforts (the latter by parents) to prevent it. Homosexuals invariably report having discovered their homosexual orientation at an early age. And psychologists’ efforts to “cure” it have virtually never succeeded, despite the disadvantages even in a tolerant society of being homosexual.
If homosexuality is innate, it becomes difficult to see why it should be thought to require regulation. And for the additional reason that the homosexual population is very small. Kinsey’s estimate that 10 percent of the population is homosexual has long been discredited; it appears that no more than 2 to 4 percent is. This small population is on the whole law-abiding and productively employed, and having a below-normal fertility rate does not impose the same costs on the education and welfare systems as the heterosexual population does. It is thus not surprising that in response to the President’s announcement of his support for homosexual marriage, Republican leaders cautioned their followers not to be distracted by this issue from the problems of the U.S. economy. This was tacit acknowledgment that homosexual marriage, and homosexual rights in general, have no economic significance.
It seems that the only remaining basis for opposition to homosexual marriage, or to legal equality between homosexuals and heterosexuals in general, is religious. Many devout Christians, Jews, and Muslims are strongly opposed to homosexual marriage, and to homosexuality more generally. Why they are is unclear. If as appears homosexuality is innate, and therefore natural (and indeed there is homosexuality among animals), and if homosexuals are not an antisocial segment of the population, why should they be thought to be offending against God’s will? Stated differently, why has sex come to play such a large role in the Abrahamic religions? I do not know the answer. But whatever the answer, the United States is not a theocracy and should hesitate to enact laws that serve religious rather than pragmatic secular aims, such as material welfare and national security.
Posner shows how attitudes toward homosexuals have changed dramatically during the past half century. This change did not take place in a vacuum because most sexual and family attitudes underwent revolutionary changes during the same time period. Divorced women were outcasts at that earlier time, whereas now divorced women as well as men are considered part of the normal marital landscape. To be an unmarried mother was then considered shameful, whereas although unmarried motherhood is not yet accepted as normal, unmarried mothers are not ostracized. The pill and other improved contraceptives ushered in a sexual revolution that enormously increased sexual activities of unmarried teenagers and adults.
In today’s sexual environment, homosexuality no longer seems exotic or radically unnatural. For this reason, while American anti-discrimination law protects homosexuals from discrimination, acceptance of homosexuals in the workplace and elsewhere would have greatly increased even without legal protection against discrimination. I am not familiar with any studies that assess the causes of the decline in discrimination against homosexuals, but they would show, I believe, that changes in attitudes were more important than legislation.
I am not suggesting that discrimination against homosexuals is gone. The recent resignation of an important member of Governor Romney’s staff was apparently forced by the public disclosure that he was a homosexual. Still, such discrimination has greatly declined, and in an increasing number of activities homosexuals no longer have to hide their sexual orientation, and often openly bring their sexual partners to different public events.
In more and more states, although still a minority of states, homosexuals can now form civil unions that give them most of the rights possessed by heterosexual marriages. Moreover, a growing number of companies give surviving members of homosexual unions the same benefits as they give survivors of heterosexual unions. One natural and desirable change would be to give homosexual civil unions the full set of rights that married couples have. Indeed, one may want to go as far as several Scandinavian countries, and give the same rights that married couples have to couples who have lived together for a number of years, even if they never codified their relationships into marriages or civil unions.
Gay couples would of course welcome such changes, but many of them would object that these changes would not go far enough because they want to call their unions “marriages”. As Posner indicates, many religious Christians, Jews. and Moslems, and some other heterosexuals as well, strongly object to calling homosexual unions “marriages”, although many of these objectors would be willing to give homosexual civil unions most of the rights that married couples have. Yet it is strange that homosexuals can more readily adopt children, or provide the sperm for children that they raise, than they can call themselves “married”.
I have argued several times previously that all “marriages” should be basically contractual arrangements between couples, whether heterosexual or homosexual. These couple-specific contracts would specify the duties of each member, including the conditions needed to terminate their arrangement, so that couples rather than laws and judges would determine the conditions under which they stay together or breakup. These contracts would be tailored to the special needs of each couple, and could even be made compulsory in order to take away any information revealed when a person asks his or her mate for a contract (see my discussion of gay marriage on 8/10/2008).
If such contracted civil unions became the norm, homosexual unions would not be any different than heterosexual unions. If civil unions obtained all the rights of marriage unions, then the issue of gay “marriage” would turn only on language, although it is emotionally charged language on both sides of the debate.
As part of my classical liberal views I believe that gays who form unions and want to call these unions “marriages” should clearly have the right to do so, even though many others object to that description of their unions. However, since law is settling the gay marriage issue, the next best solution is to have these laws determined at the state rather than federal level. When laws are at the state level, homosexuals who want to call their unions marriages can move to states that allow that designation, or they should be able to gain residency in states that allow that description, and afterwards return to their states of more permanent residency.
But as Posner reminded me, this type of temporary move to another state runs into the 1996 Defense of Marriage Act, which says that no state is required to recognize a marriage made in another state if it is not between a man and a woman. The Obama administration indicates that it will not enforce the Act, but it is not clear how they can force states to recognize marriages between gays if they do not want to.
Even if homosexual marriages arranged in other states had to be recognized by all states, this kind of evasion of state laws that do not allow homosexual marriages is not ideal. It is similar to the way couples could divorce prior to the 1970s when they lived in states where divorces were banned or difficult to acquire. Many individuals wanting a divorce went for several weeks to gain residency in states like Nevada that allowed divorce. After gaining their divorces, they then returned home as divorced persons.
To repeat, the ideal solution would make all “marriages” contractual civil unions that would specify the rights of both parties. Every couple, including gay couples, would then be allowed to call their arrangement a marriage if they so desired. Unfortunately, such a radical change in the approach to “marriage” is unlikely to occur in the foreseeable future.
The jobs report from The Bureau of Labor Statistics this past Friday is not good reading. The economy added about 115,000 workers, the slowest increase in 6 months. To make matters worse, over 40% of the unemployed have remained out of work for at least six months. The unemployment rate did drop a notch, but this was because many discouraged workers left the labor force. In fact, the recovery is the slowest in the post World War II period. No single factor explains this slowness, but a combination of several explains most of the slow recovery.
Recoveries after major financial crises are notoriously slow. This is well documented in the book This Time is Different: Eight Centuries of Financial Folly, by Carmen Reinhart and Kenneth Rogoff. The authors study many financial crises, and the recoveries from these crises. Recoveries are slow partly because the dire nature of a financial situation is not recognized quickly, and policies that try to end a crisis are usually implemented slowly.
While slow recoveries from major financial crises are common, employment would have increased considerably more rapidly, and unemployment would have fallen much faster, were it not for several factors special to this recovery. Scott Baker, Nicholas Bloom and Steven Davis have studied changes in economic policy uncertainty since 1985, and have constructed an index of the degree of economic policy uncertainty during the past 26 years (see their “Measuring Economic Policy Uncertainty”, October 2011). The index spikes sharply after major events, such as Black Monday’s stock market fall in 1987, the 9/11 attack, and the beginning of the 2nd Gulf War. Economic policy uncertainty according to their index also rose to extremely high levels during the past several years, especially during the 2010 midterm election, the debate over the stimulus package in 2009, the Lehman bankruptcy and TARP legislation in 2008-9, and the Eurozone crisis and the US debt ceiling disputes in 2011.
These shocks to the degree of uncertainty about the economy and economic policy significantly affected hiring and investments by American businesses. The authors estimate sizable negative effects on employment for up to two years after an increase in the degree of economic policy uncertainty equal to the actual change between 2006 and 2011. Greater uncertainty encourages firms to delay investments in business capital and in new hires. Households faced with a more uncertain economic environment postpone purchasing consumer durables, not only housing but also cars and appliances. Companies and households delay these investments partly because they want to wait to see how the uncertainty is resolved before undertaking potential risky investments. They also wait because greater economic uncertainty raises the cost of capital.
Heightened uncertainty is inevitable during recessions, especially serious ones. However, some of the uncertainty during this financial crisis was avoidable if Congress and the president had not passed an ineffective stimulus package over a divided Congress, if they had resolved the budget deficit and debt ceiling issues (especially by trying to get entitlements under control), if agreement on tax policy toward broader and flatter taxes had been achieved, and if clearer policies were adopted about which companies would be allowed to go bankrupt and which would be bailed out.
Another force slowing down the recovery in employment was the result of more generous means-tested policies introduced during the recession. My colleague Casey Mulligan discusses these policies and their employment effects in “Do Welfare Policies Matter for Labor Market Aggregates?” (January 2012). He shows that they raised unemployment and reduced employment because they gave perverse incentives on the supply side of the labor market. Many others have also argued that the extension of unemployment compensation to 99 weeks clearly encouraged some of the unemployed to remain unemployed much longer than they would have if unemployment compensation ceased after a year.
Mulligan measures in addition the impact on employment and unemployment of several other policies adopted during the recession. For example, the food stamp program SNAP) was made more generous and more easily available, which enabled additional families to qualify for food stamps by reducing their earnings through remaining unemployed, withdrawing from the labor force, or working part time rather than full time. Policies were introduced to reduce mortgage debt of lower income families. Mulligan’s calculations suggest that the aggregate effect of all these policy changes on both US employment and unemployment was large because they reduced the supply of men and women who wanted to work, or to work full time.
The literature on financial crises shows that the employment recovery from this recession would likely have been rather slow even with clear and productive government responses. Unfortunately, such responses were not forthcoming. Instead, many of the policies discussed or implemented discouraged both hiring by companies and job seeking by members of the potential labor force through raising the uncertainty about where the American economy was headed. They also reduced employment by creating greater incentives to remain unemployed, or to stay out of the labor force.
In 2007 and 2008, the U.S. unemployment rate was only 4.6 percent, though it started to rise after the financial crisis hit in September 2008, reaching 10.1 percent in October 2009. Since then it has fallen to 8.1 percent. The unemployment figure is not terribly illuminating, as it defines the unemployed as persons who are looking for a job, thus excluding those who have stopped looking because they don’t think they’ll find one; in the latest quarter, the unemployment rate fell (from 8.2 percent in the previous quarter) only because of the large number of persons who dropped out of the labor force, thus reducing the denominator in the fraction of unemployed. The 8.1 percent figure also excludes the underemployed. A further concern is that more than 40 percent of the unemployed have not been working for more than six months, and it hard to land a job after having been out of the workforce so long; work skills and attitudes tend to atrophy, making employers reluctant to hire the long-term unemployed.
The current depression (calling it a mere “recession” that ended in June 2009 when GDP stopped falling strikes me as ridiculous) began almost four years ago. That employment has not recovered is not surprising. When the financial crisis struck in September 2008 the personal savings rate of Americans was only 1 percent, the reason being that the housing bubble had inflated the apparent savings of homeowners by increasing their home equity relative to their debt. The rapid plunge in the market value of people’s personal savings caused them to reduce their consumption spending in an effort to rebuild their savings. At the same time, the uncertainty of the economic environment and the weakness of bank balance sheets caused banks to restrict lending (other than to the federal government and a handful of other reliable borrowers), so credit for consumer purchases became harder to get, and this further reduced consumption spending. The Federal Reserve flooded the banks with money, but the banks hoarded the money. With credit scarce and consumer spending down, companies reduced production and so laid off workers, which further reduced consumer spending, both directly by reducing incomes and indirectly by increasing uncertainty about the economic future.
When the downward spiral stopped, and consumer spending revived, companies were reluctant to hire back the laid-off workers because of continued uncertainty about economic conditions arising in part from the deepending economic crisis in Europe and slowing economic growth in countries like China, India, and Brazil.
I do think the government could have broken the downward spiral earlier, and had it done so unemployment would be somewhat lower today, though I doubt it would be dramatically lower. The $800 billion stimulus (Keynesian deficit spending as a depression remedy) should have been larger, should have been introduced earlier (in the fall of 2008 rather than in February 2009), should have been designed differently, with a focus on financing projects requiring labor rather than on transfer payments (since much of the transferred money could be expected to be saved rather than spent—and in a depression one wants spending not saving), and should have been executed with a greater sense of urgency, as in 1933, when literally millions of the unemployed were put to work within months and the economy began a rapid recovery, though the recovery stalled in 1937 when the government increased taxes and reduced the money supply.
In addition to restoring jobs during a depression, government can preserve jobs, as it did with the financial aid to the Detroit automakers, which saved hundreds of thousands of jobs at a particularly critical time (the first half of 2009). It now appears that the government should also have given financial aid to the states (which cannot create money to pay their obligations and thus can engage in deficit spending only with the consent of their creditors) to enable them to avoid having to lay off public workers, such as teachers, police, and firefighters—the states have laid off almost 600,000 of their employees during this depression.
I don’t think there’s much else the government could have done to arrest the depression. Attempts at fundamental economic reform should not be made during a depression, because they create uncertainty, which increases the incentive of businesses and consumers alike to hoard rather than spend; hence the Administration’s health-care reform was mistimed. The extension of unemployment benefits, along with more generous means-tested benefits programs like stamps, may also have been a mistake, by reducing economic pressures on the unemployed to find work. On the other hand, these transfer payments, although an inefficient method of promoting employment (because as I said transfer payments may to a significant extent be saved rather than spent), do increase incomes; and some—probably most—of the increased income is spent, in turn increasing demand for goods and services and so production and employment. Obviously, however, indefinite extension of unemployment benefits cannot be the solution to the unemployment problem.
A depressing possibility is that the depression has accelerated what may be a long-term trend to reduced employment in many industries. Until quite recently, the depression had fostered significant productivity gains, as employers tried to get more work out of fewer workers, as by speeding automation and adopting more efficient personnel management policies. By “accelerating” I mean adopting these measures earlier than they would have done without the spur of falling demand. So the depression may have brought forward inevitable changes in production that will result in reduced employment and earnings. Eventually the displaced workers will find jobs in industries not experiencing the same productivity advances, but the transitional period of high unemployment may be protracted.
The fact that the unemployment rate was less than 5 percent before the depression may refute the suggestion of a long-term decline in employment. But remember that the unemployment rate can be misleading. If we look instead at the percentage of the working-age population that is employed, it has declined from its peak of 67.1 percent in 2000 to 63.6 percent this year—and the decline began before the onset of the depression.
A promising field of economics called organization economics studies the organization of activity within complex entities such as for-profit corporations, government agencies, and not-for-profit private corporations. Colleges and universities (which I’ll discuss interchangeably, calling both types of institution of higher education “university” because universities are generally larger and more influential) straddle these divides—there are public universities, private not-for-profit universities, and private for-profit universities. I’ll focus on the second—private not-for-profit universities. Public universities don’t seem much different from private not-for-profit ones, in part because in recent years many public universities have made sustained and successful efforts at raising money from alumni and foundations, lessening their dependence on state funding and as a result achieving considerable, in some cases virtually complete, autonomy. As for the for-profit universities, they presumably can be modeled as typical for-profit service corporations. That leaves the not-for-profit university, which plays a much larger role in American higher education than in higher education in other countries. Most of the wealthiest and most prestigious American universities are private.
The differences between for-profit and not-for-profit institutions are not profound; we observe this in their coexistence in a number of fields, such as health care and education. The major difference is that for-profit institutions are financed in part by equity investment, in which the investors are compensated by ownership of any residual of revenue over cost—i.e., profit—while not-for-profit institutions are forbidden to distribute the residual to investors. They borrow, just like for-profit institutions, but the remainder of their capital consists of donations rather than of equity investment; the university’s endowment correspondents to the equity in a for-profit corporation. The residual goes in part to university administrators in the form of enhanced salary or bonuses and in part (usually in larger part) to expanding or improving the institution.
Not-for-profits are more risk-averse than for-profits because their administrators cannot capture as much of the upside of risky investing as equity investors, and corporate executives, whose compensation is usually tied in one way or another to the corporation’s profitability, can. But competition forces even not-for-profits to take some risks, as we learned when the financial crisis that began in 2008 revealed the degree to which university endowments had been invested in high-rolling hedge and private equity funds. Competition for students and faculty forces university administrators to seek to maximize revenue and minimize cost. Competition is a pervasive socioeconomic phenomenon; it is not limited to businesses.
The competitive pressures on universities can and often do result in a misalignment between private and social goals. From the standpoint of society as a whole, the goals of higher education are to enlarge general (as distinct from firm-specific) human capital by imparting valuable intellectual skills to young people of intelligence and ambition, and to produce research that generates mainly external benefits and so is underproduced by for-profit entities. And to a large extent, certainly, the universities work toward those goals, and with considerable success. But from the personal standpoint of a private university’s trustees and administrators, another goal is to maximize revenue (net of cost) and hence tuition income, donations, research grants, and income from consulting and patents—the grant money and income from consulting and especially patents being shared between faculty and university. The consequences of these endeavors include a high level of expenditures on student amenities (to attract rich kids), on intercollegiate sports (to stimulate alumni donations), and on faculty “stars” who can attract research grants and impress parents and alumni. Other consequences include light teaching loads for faculty stars as a form of untaxed compensation, student pandering (beyond provision of amenities) and so grade inflation, reduction in required courses, and proliferation of extracurricular activities—all being aspects of treating students as “consumers” to be pampered in partial compensation for high tuition and student debt and to encourage future donations. Still other consequences of endeavors to maximize revenue include recruitment of student athletes who may have no intellectual interests or promise, “legacy” admissions (discrimination in favor of student applicants who are children of alumni, especially wealthy alumni), and encouraging applied research (because it is patentable, as basic research is not). False advertising of job opportunities for graduates of graduate schools and professional schools (such as law) is also a not uncommon university marketing tool.
From an overall social standpoint, therefore, there is a great deal of waste in the American university sector (as there is in most institutions), but it is not obvious to me what if anything should be done about it. I note, however, that there is a good deal of government subsidization of private universities, in the form of research grants but, more important, of below-market student loans. Government grants for basic research are defensible because, by definition, basic research generates only external benefits. Subsidizing tuition by means of below-market student loans makes less sense. If the loans, not being subsidized, were more costly, tuition would be lower; and promising students would still receive scholarships and low-cost loans, financed by the universities themselves, because universities want to have good students (along with student athletes, legacies, and “diversity” admits), to build reputation and attract good faculty. Many students who receive subsidized loans to enable them to go to college, but would not be subsidized by a university, would be better off not going to college. College is not for everyone.
The over 4,000 American private and public colleges and universities compete fiercely for students, faculty, and grants, and constitute the most competitive system of higher education in the world that provides both high quality and low quality programs. American universities are a magnet for postgraduate, and increasingly also for undergraduate, students from other countries. These two facts suggest that American universities (like Posner I use the word university to stand also for colleges) are doing a very good job of catering to the interests of students the world over. More generally, American universities are pretty successful in producing higher education that contributes effectively to social welfare, given the public policies that impinge on their behavior.
American public, private non-profit, and increasingly for-profit institutions of higher education compete hard for students and faculty. As a result, they offer a variety of courses, programs, and qualities of colleges and universities that range from a bare minimum program at many public community colleges to elite education at universities like Harvard, Stanford, and Chicago. These programs cater to students of varying qualities and with different interests. Students vote with their feet by choosing some institutions and programs over others, and by traveling long distances from other countries to attend American universities. This “voting” has made American universities responsive to the interests of students, which on the whole is a very good thing since these interests reflect changing job prospects and other changes in society.
In addition, American universities conduct much of the basic research conducted in the US, with support from the federal government and private gifts. That many young and older scientists and scholars from abroad compete to spend significant time at American universities is a good indication of the leading edge quality of this research. Perhaps they do not do “enough” basic research, but they do much more than universities elsewhere, and they would do even more if the federal government increased its support of university research.
American universities have been criticized because many of them engage in high-level competitive sports that involve heavy recruitment of student athletes. Since students and alumni like rooting for their school’s teams, these are perfectly appropriate activities for universities, aside from a couple of major problems. One is the exemption that the Supreme Court has granted to the obvious cartel-like behavior of the NCAA that uses its power to severely restrict compensation to student athletes, especially those in football and basketball. Universities should be forced to pay competitive prices for these athletes, not the much lower cartelized prices that the NCAA enforces. A much higher cost of star football and basketball players would induce some universities to tone down their emphasis on these sports, but many universities would still compete in these and other sports.
I agree with Posner that the federally financed student loan program needs significant modifications. More market-based interest rates on these loans are desirable, but in addition students under various circumstances should be allowed to borrow more than the current maximum limits on these loans. Especially students who attend expensive private universities may want to borrow more than they can at present, but most of them also receive high enough earnings later on to finance the interest repayment burden on these loans. It is no harder for most families to carry $100, 000 or more in student loans than it is for them to repay mortgage loans of comparable size.
However, students who are fettered with loans that they cannot repay should be able to discharge all or part of their loans through personal bankruptcy. To be sure, unlike mortgages, student loans do not have collateral that can be taken over by lenders in case of defaults on the loans. This is not so different than home ownership in the many states that do not allow the individuals declaring personal bankruptcy to be sued, although lenders can foreclose their homes. Despite the absence of collateral, workers who cannot repay their student loans should have the option of reducing the burden through discharging some of the loans through personal bankruptcy, the way other debt can be dischargeable through bankruptcy. To limit the abuse of this privilege, universities (including the for-profits) that make many student loans that end up being in arrears or discharged through bankruptcy should have their ability to make further loans severely constrained. This is already done to some extent, but tightening these constraints would force schools to be more careful in who they qualify for loans and the amounts they qualify for.
Having taught for almost all my adult life at American universities I am well aware of their many limitations. These include faculty who cater to students by easy grading and telling jokes, faculty who engage in vicious battles over trivial issues, faculty and administrators who are afraid to take stands against political correctness and the latest education fads, alumni and other donors who are cultivated for large gifts that really do not help a university’s mission, and so forth. Nevertheless, on the whole, American universities do an excellent job of providing up to date and diversified education for students of varying abilities and interests. Many of their “failures” are the result of bad incentives provided by federal and state support and regulation of university programs. Students the world over have voted for decades with their feet in favor of American universities against what is available in other countries.
Manufacturing employment as a fraction of total employment has been declining for the past half century in the United States and the great majority of other developed countries. A 1968 book about developments in the American economy by Victor Fuchs was already entitled The Service Economy. Although the absolute number of jobs in American manufacturing was rather constant at about 17 million from 1969 to 2002, manufacturing’s share of jobs continued to decline from about 28% in 1962 to only 9% in 2011.
Concern about manufacturing jobs has become magnified as a result of the sharp drop in the absolute number of jobs since 2002. Much of this decline occurred prior to the start of the Great Recession in 2008, but many more manufacturing jobs disappeared rapidly during the recession. Employment in manufacturing has already picked up some from its trough as the American economy experiences modest economic growth, and this employment will pick up more when growth accelerates.
Still, if past trends continue, the share of American jobs in manufacturing will probably be lower in the future than it was even as late as 2007. New and exciting technologies, like 3D printing, may bring back some manufacturing output to the United States since labor costs will be a lower fraction of the total cost of manufactured products based on these new technologies. However, these technologies are unlikely to offer many jobs since they are generally labor-saving, not labor-using, but the jobs will require skilled and better paid workers.
Commentators have always lamented a sizable fall in jobs in any large sector of an economy. A prominent example is the huge decline in farm employment during the twentieth century in all developed countries. In 1900, about 40% of American jobs were in agriculture. This fraction continued to drop during that century, despite a host of special subsidies and tax breaks to the farm sector. Only 2.5% of the American labor force has worked on farms during the past couple of decades. The enormous advances in farm productivity are a major reason behind the disappearance of farm jobs. With about 2% of the labor force currently on farm, the US manages not only to provide the vast majority of food consumed by 300 million Americans, but American farmers have enough production left over to export large quantities to the rest of the world.
Big productivity gains in manufacturing are also a major cause behind the decrease in manufacturing employment in the US. Higher productivity lowered prices of manufactured goods relative to prices of services. Yet employment in manufacturing fell because the lower manufacturing prices did not stimulate a large enough increase in the demand for manufactured goods to offset the productivity increases of the manufacturing workforce.
A second obvious force reducing jobs in American manufacturing has been the growth in China’s economy and its exports of a large variety of cheap manufactured goods (which are a great boon to American and other consumers). Since China did not become a major player in world markets until after 1990, exports from China cannot explain the downward trend in manufacturing employment prior to that year, but Chinese exports were important in the declining trends in manufacturing during the past 20 years. Finally, the recession cut jobs in all sectors of the American economy, but especially in factories and construction.
President Obama, in his State of the Union address, advocated special tax breaks and support for the manufacturing sector. I do not see any more convincing case for subsidies to manufacturing than there was for the special treatment of agriculture during the long decline in farm employment. Most of the arguments made in support of privileges for manufacturing could be made for services and other sectors of the economy. For example, although certain manufacturing industries have had high rates of productivity advance, so too has mining, such as through the development of fracking techniques. The most important technological advance of the past several decades has been the computer and the Internet, for these gave birth to email, word processing, apps, online sales, and social networks like Facebook and Twitter.
Instead of singling out manufacturing for special privileges, the government should get behind certain general policies. High on the list would be raising the rate of growth of the American economy, for this will tend to create jobs in most sectors of the economy. More government support may be justified for basic research in science and other areas that would also benefit all sectors, not just manufacturing. Local and state governments, along perhaps with the federal governments, could try to reduce the dismally high dropout rates from American high schools. Dropouts have trouble finding good jobs even in the best of times, and they suffer the most during recessions.
Many other steps can be taken to help the American economy, especially by limiting the growth of entitlements and the federal budget. None of the steps to improve the economy involve favoring manufacturing employment and the manufacturing sector. The call by many for special treatment of manufacturing jobs is basically misguided.
The only secure ground for the government’s subsidizing a producer is that the goods or services that he sells are likely to confer external benefits, which is to say benefits that, because they are not paid for by the buyers, do not contribute to covering the producer’s costs. The total social benefits, private as well as public, that his production creates may exceed his costs, but he will not produce if the private benefits (the payment he receives from customers) do not cover those costs.
Some manufactured products, vaccines for example, confer external benefits: when most of the population is vaccinated against some disease, the risk to the rest of the population may be so slight that they stop buying the vaccine: they are benefiting from it but not paying for it. Another example is intellectual property that, in the absence of patent or copyright protection, could easily be copied: the original producer of the intellectual property would be conferring benefits on the copiers for which he would not be paid.
External benefits are actually rather pervasive in manufacturing as in other sectors of the economy. For example, consumers who value a product much more than its market value derive an external benefit, because (by definition) the manufacturer does not capture this “consumer surplus [value].” But there is no reason to think that manufacturing confers greater external benefits than other sectors.
There is a general anxiety about becoming dependent on foreign nations for products that are vital to our nation. That is a legitimate concern when one is talking about products that are essential for national security or economic welfare, such as military aircraft; and obviously our military production is heavily and justifiably paid for largely by the government, although some is paid for by foreign buyers. The foreign “products” that might be thought essential to our security and welfare are not manufactured goods at all, but commodities such as oil and rare earth metals. The United States is still the world’s largest manufacturing country, accounting for a fifth of total world industrial output.
Becker points to the analogy of agriculture. Employment in agriculture has plummeted, leading to anxieties spurred by agricultural companies about the decline of the “family farm” and the loss of the imagined virtues of the independent farmer, to combat which agriculture continues to be heavily subsidized. The subsidies are widely recognized to be a pure social waste, and the same would be true of subsidizing manufacturing. Like manufacturing, American agriculture is thriving with its historically small labor force.
The decline in agricultural employment is a product of technological advance, and likewise the decline in manufacturing employment. Subsidizing manufacturing will no more increase employment in manufacturing than subsidizing agriculture has prevented the precipitous decline of agricultural employment, for a manufacturing subsidy will be used to speed the automation of manufacturing tasks and so accelerate the decline of manufacturing employment--unless the subsidy is conditioned on increased employment, which would would mean diverting workers from more to less productive work. We would not be better off if 40 percent of the labor force were in farming rather than 2.5 percent, or if 28 percent of the labor force were in manufacturing rather than 9 percent.
Some concern has been expressed that we need to boost manufacturing in order to reduce our trade imbalance, because many manufactured goods are exported. But a recent article in the New York Times (April 10) points out that the United States is the world’s largest exporter of services—and would be larger still if we took steps, such as loosening visa restrictions that impede international provisions of services and making the same efforts to pry open foreign markets to American services as we do to pry open foreign markets to American goods.
The politicians know all these things. The push to promote manufacturing is political in origin and may (one hopes will) be abandoned after the election. Its political appeal is related partly to the fact that unions still have a foothold in manufacturing, and partly to the fact that America’s prowess in manufacturing (think of the vast output of munitions in World War II) is associated in the public mind with the epoch of greatest American world power.
I have no objection to efforts to negotiate with foreign countries trade agreements that facilitate U.S. exports (they also of course facilitate imports—and that’s fine too). Such efforts are the centerpiece of the Administration’s program of stimulating employment in manufacturing. But the efforts should be extended to services. I can think of no rational basis for putting manufacturing ahead of services.