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So two misunderstandings. One is that you have to balance the budget to reduce the debt load. Yglesias tackles that here.

With great fear of being taken out of context by Ron Paul supporters I should make clear that the debt only has to grow more slowly than the Nominal GDP, not Real GDP for the debt burden to fall.

So if our total debt is $10 Trillion and our economy is growing at 5% nominally, then any deficit less that $500 Billion will tend to shrink the debt burden. Any deficit greater than $500 Billion will tend to increase it. This is why we haven’t had many surpluses in US history but the the debt burden is usually falling.

FRED Graph

The reason its nominal GDP that counts is because interest payments are figured in as part of the deficit. Suppose we have lots of inflation. That will tend to make interest payments on the debt rise. You could think of this as the debt growing to match inflation.

However, the US Budget accounts for interest payments on the debt. So when you are comparing the deficit to the growth rate of the economy, you have already accounted for the debt growth due to inflation.

The second thing you can see from that graph is that the debt burden has been much higher in the past.

In 2009 we just broke through the Reagan-Bush peak and haven’t come close to the WWII peak. Moreover, this is dominated by the recession. The recession contributes in four ways

  1. A smaller economy means less revenue and hence a higher deficit. This amplified by our progressive tax structure
  2. A smaller economy means lower GDP, and so the debt burden is divided by a smaller number
  3. Tax cuts, spurred on by recession have brought down revenue still further
  4. Spending, automatic and planned has increased in response to the recession

As the economy improves the northward spike will abate.

In the out years we can talk about deficits that are set to accumulate. However, this represents health care costs that the government has promised to pay for but not promised to tax for. In theory either of those promises could be changed.

More importantly, however, health care takes resources away from the rest of the economy whether the government pays for it or not. Obsessing over future budget deficits because of Medicare and Medicaid but ignoring future stagnant or even falling take home pay because of private health care is silly.

We could just end any and all public financing for health care tomorrow and the budget deficit and future deficits would vanish. Woo-hoo! However, the problem of expensive health care would still be with us.

Jim Hamilton has a nice breakdown on all the positive signs for US growth. I even have a new presentation I am giving titled “Don’t Be Lulled into Fall Sense of Despair” that basically argues that if things go as planned the US economy will be growing steadily and so will profits and tax revenues.

All that having been said my worry is that this will cause the Fed to back off of its aggressive stimulus policy. The Fed should stay the course with QE2 and consider QE3.

As I have mentioned before, we are conditioned to think of 3 – 4% growth as strong. However, that is in a world where there are few slack resources. This is not our world. Our world has plenty of idle resources.

6% growth is not unrealistic. I urge the Fed to push towards that goal. High profits and growing government revenues are great but we need to put people back to work.

The Mankiw Rule for example doesn’t call for raising the funds rate above zero until the (unemployment rate – core inflation) rate drops below 6. Right now we are still above 7.5

FRED Graph

Indeed here is what the Mankiw Rule says the Fed Funds rate should be

FRED Graph

We are still deep into negative territory meaning that we need additional monetary stimulus above and beyond a zero interest rate.

As a side note, I would love to claim that QE2 is behind this increased growth but that is premature. The timing is right on, but we need more evidence before we can claim intellectual victory.

Kevin Drum pushes back

The healthcare front is harder to judge. I agree with Tyler that we waste a lot of money on healthcare, but at the same time, I think a lot of people seriously underrate the value of modern improvements in healthcare. It’s not just vaccines, antibiotics, sterilization and anesthesia. Hip replacements really, truly improve your life quality, far more than a better car does. Ditto for antidepressants, blood pressure meds, cancer treatments, arthritis medication, and much more. The fact that we waste lots of money on useless end-of-life treatments doesn’t make this other stuff any less real.

Matt Yglesias cosigns

I think that’s spot on. The consumer surplus involved in successful medical treatments is gigantic. Indeed, I would say that’s probably a good start at an explanation for whythere’s so much waste. But from a policy point of view this is why I often find myself moored between the impulse to “control costs” and the impulse to “expand access.” What I really want to do is promote good health and there are an awful lot of things we could do to do that at very low cost.

Points well taken and I’ll both backpedal a bit and clarify a bit.

First, yes there are big quality of life improvements that don’t show up in our life expectancy data. Treating pain and emotional distress, of many different forms, is at least as important as extending life and our system has made great strides in doing that.

I want to completely concede that the treatment of pain has improved drastically and that has made a world of difference.

Second, I want to clarify about major breakthroughs. People talk about statins, beta-blockers, chemotherapy, radiation therapy, etc in the treatment of our two major killers, cardiovascular disease and cancer. However, the actual dent these things make in like expectancy is small.

Take statins, which are one of the major weapons in the fight against heart disease. Even the published results in JAMA suggest that the number of people who have to be on statins to prevent a single person from having a single coronary event is between 44 and 258.

However, real world results almost always are worse than trials, not all coronary events are fatal, and the prevention of a coronary event only extends life expectancy if the patient doesn’t die of something else in the mean time. Which makes our frontline weapon not that effective in actually extending life.

Contrast this to penicillin in the treatment of Scarlet Fever. The number to treat is basically one. See a case of Scarlet Fever, administer penicillin. Nearly a fifth of all the people who contract the disease would die from it with no treatment. With treatment almost no one does. The extension in life can be many decades if the disease in contracted in the teens or twenties.

Statins don’t do this. Beta-blockers don’t do this. Chemotherapy in the treatment of cancer doesn’t do this. And, keep in mind these are treatments. Much of our health care dollars are spent on diagnostics. For diagnostics to have any life extending value at all you have to find something, which usually you don’t.

Diagnostics are particularly vulnerable to my critique. People feel reassured when the doctor walks in and says “the MRI was clear.” However, the docs could rephrase this as “I just spent $2000 of your money and its going to make no difference in your health outcome whatsoever, yeah!”

I think I have complained about decision trees before, but people confuse changes in their information set with changes in the state of nature. That a diagnostic procedure comes back negative doesn’t make you healthy, it just reduces your uncertainty about a predetermined fact.

Whatever was true before is true now. We just have more information. Was that information worth $2000? That depends crucially on what we do with it. However, if what we do with it is usually nothing and sometimes to initiate a treatment which will only have an effect in 1 out of 50 cases, then we really have question what we are doing here.

One of the obvious areas where Tyler’s thesis will run into controversy is in Medicine. Medicine is the most obvious place to look for innovation outside of the information sector.

Its also where a big chunk of the middle America’s paycheck has gone. Its not much of a stretch to say that if you think medicine has done a lot of good then you think the last 30 years have been good for the average American. If not then not.

Here I tend to side with Tyler. I don’t think most medicine has done that much good and I am not optimistic about the usefulness of most future medical spending.

This is not to say I don’t think there will be important breakthroughs. I think there will and the next fifty years will be exciting on that front. Its just that along the way we will dump a bunch of GDP down the drain, paying for medicine that is not so good.

The question is why are we doing this?

I have struggled with this. Is it because medical breakthroughs are reaching diminishing marginal returns. That doesn’t seem right because quite frankly there weren’t that many breakthroughs in the past.

We have vaccines, antibiotics, sterilization and anesthesia. That’s about it for really big time breakthroughs.

The view I subscribe to currently is that most people don’t care that much about increasing their life expectancy, they care about being cared for and being cared about. They care about reassurance and they care about feeling like they are not alone.

We can see that people don’t care that much about maximizing their life expectancy because they place an enormous premium on their doctor’s bedside manner and a much smaller premium on his error rate. We can see that when objectively bad doctors who are nice rarely get sued for malpractice, while much better doctors ,who are assholes get sued all the time.

We can see that when we offer potential surgical patients stats on the number of fatalities at prospective hospitals and they refuse them.  We can see that when message boards about doctors are filled with comments like “He really understood me.” “She took the time to stop and listen. “ “I knew they cared about whether I got better” “I was more than just a number.”

These are not comments about the skill of the medical provider but about the caring of the medical provider.

Now, when I present this stuff to my students they often say: but a doctor who cares will do a better job and so you are more likely to live longer.

Lets ignore the fact that if this were true it should be captured in the doctors’ stats. Suppose that it is true. Then why in the world are we investing all of this time an energy selecting really smart students and then putting them through years and years of training if the main thing that matters is how much the doc cares?

Dealing with this is a real puzzle. Though I am a free market person, I see the price system’s big advantage is that it conveys information. In medicine virtually no information is conveyed through price. People at all levels are confused about what they really want or what we should do.

For example, when I speak with doctors the issue of non-compliance often comes up. This is typically to explain why treatments that look good in clinical trials don’t work out as well in real life.

Non-compliance is the issue of getting patents to go along with some aspect of the treatment they don’t want to go along with. I argue that if the treatment only works if the patient does something that he or she isn’t going to do, then the treatment doesn’t work. Doesn’t matter what JAMA says. To the docs I say, you go to war with the patients you have, not the patients you wish you had.

To society at large, however, I say, we have to rethink what we are doing here. Ultimately, we want to make sure that we are spending money to make someone better off. If the doctor is complaining, the patient is complaining, and either the insurer or the government is getting a huge bill, then exactly who are we serving here?

A couple days ago, Reihan Salam put forth the question of why the United States is so great. Which means how has the US economy performed so well over the last century? Karl answers with what he deemed a “conventional answer”, and FreeExchange grapples with the question, concluding a mix of market size and the influx of talent to America (read: immigration).

I agree that market size has a lot to do with the wealth that the US generates. The most important thing to note is that the US is a free trade area. Capital and labor are free to migrate easily and efficiently across the borders of states in the US. This advantage, the comparative advantage of trade, has allowed the US to innovate in ways that having trade barriers would not allow. The most striking example comes from (I believe) David Friedman, when he noted that there are two ways to make automobiles; you can erect a factory and build them with steel, or you can plant a field and build them with agriculture…or, presumably, you could erect a tower, and build them with finance. The easy with which this division of labor can manifest itself within the United States is definitely a key to the prosperity we enjoy. Although I believe that the advantage of market size has run its course, it has still been very important.

I want to touch on an element that fell out of favor among researchers in the 60’s, but has since seen a tepid renaissance. That is, culture matters.

Conveniently, that is the title of a book that was put out after a Harvard international studies conference headed by Lawrence Harrison and Samuel Huntington. To begin, I’d like to turn to Robert Putnam, from his book, Making Democracy Work, in which Putnam describes his visit to the government offices of the poor Puglia region of Italy:

In the dingy anteroom loll several indolent functionaries, though they are likely to be present on an hour or two each day and be unresponsive even then. The persistent visitor might discover that the offices beyond stand only ghostly rows of empty desks. One mayor, frustrated at his inability to get action from the region’s bureaucrats exploded to us, “They don’t answer the mail, they don’t even answer the telephone!”

Putnam then contrasts that experience with the experience of the government offices in the rich Emilia-Romangna region in the north:

Visiting the glass-walled regional headquarters is like entering a modern, high-tech firm. A brisk, courteous receptionist directs the visitors to the appropriate office, where as likely as not, the relevant official will call up a computerized database on regional problems and policies…A legislative pioneer in many fields, the Emilian government has progressed from words to deeds, its effectiveness measured by dozens of daycare centers and industrial parks, repertory theaters adn vocational training sites scattered throughout the region.

These two regions stand but 400 miles away from eachother, but they may well be worlds apart. The curious question is, why? They are both populated by Italian people who share the history of Italy. Putnam concludes that the source of this disparity is low trust leading to an inability to achieve large-scale cooperation. He argues that the differing histories is the source, tracing all the way back to medieval times. While the south was traditionally monarchist, hierarchical, closed, and dominated by the church; the north was more egalitarian, communal, and open to trade. Later, the north was influenced by the ideas of the enlightenment.

The idea is that while the south was discouraging networks from forming, as they presented challenges to the hierarchy (and especially the church), the north embraced the formation of social networks, which allowed it to form valuable human (and social) capital.

In their book, Harrison and Huntington present data regarding trust and economic performance (measured in PPP per capita GNP). Not surprisingly, there is a strong correlation between the percentage of people who “trust people in general”, and GNP per capita (sorry I don’t have a link, but if I find suitable data, I’ll reconstruct). The question is, why? Argentinean scholar Mariano Grondona has proposed typological rules. These rules fall into three broad categories.

  • The first category are norms related to individual behavior. These include norms that support a strong work ethic, individual accountability, and a belief that you are the protagonist of your own life and not at the whim of mystical powers or “powerful leaders”.
  • The second category are norms related to cooperative behavior. Foremost is a belief that life is a non-zero-sum game and that there are payoffs to cooperating in a larger group. Societies that believe in a fixed pie of wealth have a difficult time creating social capital, and are often characterized by looting and cheating.
  • The third category are norms related to innovation. Cultures that look to rational scientific explanations of the world tend to be more innovative. It is also very important that a culture be tolerant of heresy and experimentation. Orthodoxy stifles innovation. It is also important that a culture welcome competition and celebrate achievement. Overly egalitarian societies reduce the incentives for risk-taking.

Not surprisingly, those cultural traits are also the key to well-functioning organizations, including businesses, charities, and governments. A final norm, and one that is possibly the most important, is how people view time.[1] As Eric Bienhocker states:

Cultures that live for today (or, conversely, are mired in the past) have problems across the board, ranging from low work ethic, to inability to engage in complex coordination and low levels of investment in innovation. Why work hard, and invest in cooperation and innovation if tomorrow doesn’t matter? In contrast, cultures that have an ethic of investing for tomorrow tend to value work, have high intergeneration savings rates, demonstrate a willingness to sacrifice short-term pleasures for long-term gain, and enjoy high levels of cooperation.

Trust also affects the intangible wealth of nations. Bryan Caplan is fond of touting the fact that poor immigrants are extremely productive, as long as they work in America. The amount of physical capital (A, k, L in Cobb-Douglas) in the US certainly tells part of the story, but as the World Bank has pointed out, it can’t come anywhere near telling the whole story. In fact, our institutions contribute 80% to the US’ capital stock. Contrast that with the poorest nation on earth, the Democratic Republic of Congo, whose intangible capital actually depresses the total wealth of the country.

William Easterly has pointed out that in the last half-century, the developed world has provided more than $1 trillion in economic assistance to the developing world. Yet poverty in places like Africa and South America still persists. Africa even regressed[2] (until recently). The lesson? It is important not to ignore the cultural basis of economic growth.


[1]The Origin of Wealth, Eric Bienhocker. I’d like to thank Bienhocker as well, for providing a guide to much of my analysis of culture.
[2]Just wanted to let you know that that is one of my very favorite TED speeches. It is incredibly inspiring.

Millenocket, ME. has the right idea. Matthew Yglesias has apparently been to Millenocket, and finds what they are doing funny. I’ve never been there, but as the article points out, it’s a pretty dead town, with horrible weather…so it seems out of place:

Never mind that Millinocket is an hour’s drive from the nearest mall or movie theater, or that it gets an average 93 inches of snow a year. Kenneth Smith, the schools superintendent, is so certain that Chinese students will eventually arrive by the dozen — paying $27,000 a year in tuition, room and board — that he is scouting vacant properties to convert to dormitories.

There are three ways in which I’d like to analyze this development; from an economic standpoint, a human welfare standpoint, and a social standpoint. I will argue that all three a net benefits to the US and the world, and we should make a long-term policy commitment to this type development around the country (and, indeed, other countries should imitate it).

The economics of importing capital through education are fairly straightforward. The long run growth of an economy, given money neutrality, is a function of an economy’s real capital stock. Ceterus paribus, increasing the efficiency of capital increases the ability of an economy to grow in the long run. If the $27,000 spent on educating a Chinese child is more productive than any other investment, which means the real returns to a US education are higher than any other investment available to them (something that is almost surely the case), then this results in an increase in the marginal efficiency of capital. Whether these Chinese immigrants remain in the US, or return to China, the effect on world growth will for the better. Literally everyone will be better off due to the rising of the world Wicksellian equilibrium interest rate as China and other countries become more productive (and thus, richer).

The US is arguably much more efficient at education than the Chinese, so why not export education?

From a human welfare standpoint, consider this analysis from the World Bank:

This volume asks a key question: Where is the Wealth of Nations? Answering this question yields important insights into the prospects for sustainable development in countries around the world. The estimates of total wealth–including produced, natural, and human and institutional capital–suggest that human capital and the value of institutions (as measured by rule of law) constitute the largest share of wealth in virtually all countries.

[...]

Growth is essential if developing countries are to meet the Millennium Development Goals by 2015. Growth, however, will be illusory if it is based on mining soils and depleting fisheries and forests. This report provides the indicators needed to manage the total portfolio of assets upon which development depends. Armed with this information, decision makers can direct the development process toward sustainable outcomes.

This analysis looks at the levels of “intangible wealth” that is embedded within human and institutional capital. The US is found to have $418,009 in intangible wealth per capita (comprising 80% of our real capital stock). That means, simply by stepping within the borders of the United States, human productivity is enhanced by this massive stock of wealth embedded in our people and our societal institutions. By contrast, China has just $4,208 per capita (comprising 55% of the total wealth stock).

Now, despite the obvious material living standards present in the United States, access to intangible capital totaling more than 99 times the amount available in China, comprises a vast gain in human welfare for each and every person who comes to the United States to live and be educated.

Finally, from a societal standpoint, having more immigrant workers increases the real wage rate for most people in the US. Not only that, but it because of the increase in marginal productivity of the Chinese worker (assuming that a non-trivial sum of people will return to China), this will increase the wages of Chinese workers — which, in turn, will increase the demand from China for US-produced goods and services. A greater supply of future labor is very important to the future of the wealth creation (and thus, the welfare state), as is evident by Japan’s aging population.

So, let’s overcome this roadblock…

There is one hitch. Under State Department rules, foreign students can attend public high school in the United States for only a year, a system that Dr. Smith considers unfair, given that they can attend private high schools for four years.

…and make a real Pareto improvement in the lives of people around the world. Most of all, the lives of these prospective Chinese immigrants.

To end, a quote from Terry Given, an English teacher:

“I don’t want to sound flip,” Ms. Given said, “but why not? We won’t know until we get the opportunity to know them and give them the opportunity to know us. There’s something to be said for putting ourselves out there to see if we can be the prize that’s claimed.”

Amen.

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