At least one German policymaker is talking sense: its Joschka Fischer (surprise!)

In college, one of mine (and Mattis’) favorite politicians was Joschka Fischer, a leader in the German Green Party and former Foreign Minister and Vice Chancellor. It is encouraging to see him publishing at Project Syndicate, and I certainly hope more German policymakers see problems in Europe the same way he does. If they don’t, Germany may be in trouble, because an export-led growth model is, by definition and by experience, not built to last. German domestic demand certainly looks fairly weak. We will have to see what happens, but after the continuing low inflation/negative yields and continued downward revisions to economic growth, something had to give, and hopefully that something will be Greece and Yanis Varoufakis.

Anyway, the reason I got thinking about this post, Joschka Fischer:

Not long ago, German politicians and journalists confidently declared that the euro crisis was over; Germany and the European Union, they believed, had weathered the storm. Today, we know that this was just another mistake in an ongoing crisis that has been full of them. The latest error, as with most of the earlier ones, stemmed from wishful thinking – and, once again, it is Greece that has broken the reverie.
Even before the leftist Syriza party’s overwhelming victory in Greece’s recent general election, it was obvious that, far from being over, the crisis was threatening to worsen. Austerity – the policy of saving your way out of a demand shortfall – simply does not work. In a shrinking economy, a country’s debt-to-GDP ratio rises rather than falls, and Europe’s recession-ridden crisis countries have now saved themselves into a depression, resulting in mass unemployment, alarming levels of poverty, and scant hope.

Warnings of a severe political backlash went unheeded. Shadowed by Germany’s deep-seated inflation taboo, Chancellor Angela Merkel’s government stubbornly insisted that the pain of austerity was essential to economic recovery; the EU had little choice but to go along. Now, with Greece’s voters having driven out their country’s exhausted and corrupt elite in favor of a party that has vowed to end austerity, the backlash has arrived. Continue reading

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Wages may rise, but not as much as we think they should

Prof. Mark Thoma has another extremely accessible article arguing that achieving “full employment” alone is not nearly enough to solve the problem of stagnating wages.

I’m planning on posting some more interesting research on new trends in labor economics, but I’ve been hesitant because I’m not sure what I want to say. I am developing my own thoughts about what is happening in the U.S. labor market, but I’m not quite ready to share them.

Anyway, I want to share a lot of Prof. Thoma’s article. I really liked the quote from St. Thomas Aquinas.

The most recent employment report brought mixed news. The unemployment rate continues its slow but steady downward path and now stands at 5.6 percent, but wages remain flat. In response, most analysts made two points. First, the lack of wage growth indicates that we are not yet close enough to full employment to generate upward pressure on wages, so policymakers should be patient in reversing attempts to stimulate the economy. Second, once we do get closer to full employment the picture for wages will change and the long awaited acceleration in labor compensation will finally materialize.

I fear this trust that market forces will eventually raise wages will lead to disappointment. Inequality has been increasing for over three decades, and during that time we have been at or near full employment many times. Yet, wages over this time period have been flat. As noted by the Economic Policy Institute, “Since 1979, the vast majority of American workers have seen their hourly wages stagnate or decline—even though decades of consistent gains in economy-wide productivity have provided ample room for wage growth.” The idea that market forces alone will increase wages sufficiently to offset increasing inequality is not supported by the evidence from these years. There’s more to the story than market forces.

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Prof Duy on the FOMC statement this week: Many hard questions

I’ve been reading Prof. Tim Duy for a few years now and love his work. Just based on my casual reading, I have found myself slightly surprised by how optimistic he is about the U.S. economy. His recent writings have made me more optimistic. I still find myself significantly less confident about the outlook for the U.S. and world economy looking at the socio-political economic atmosphere (downside risks in Europe, Russia, parts of Latin America, China, Japan). This is not to mention some strange or uncomfortable things in the U.S. recovery: weakness in housing; continued wage stagnation; low inflation; and high lending on student loans and credit cards (is this good? I doubt it), as a few examples that I think about. One of the things that I have learned, and am working to internalize for my conceptual understanding of the economy, is the resilience and underlying strength that, even with the downside risks and pressures over the past 2-3 years, the U.S. economy continues to grow.

Anyway this post shares Prof. Duy’s newest questions for Janet Yellen that I found interesting/challenging. Bottom line first:

Bottom Line: Odds are high that the Fed alters the statement to increase their policy flexibility next year. But even if they drop “considerable time,” Yellen will emphasize via the press conference that this change does not mean a rate hike is imminent. She will emphasize that the timing and pace of rate hikes remains firmly data dependent. The current oil-related disruptions in financial markets loom like a dark cloud over a both the FOMC meeting and the generally improving US outlook.

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Today’s disappointing economic policy: EU’s Juncker Plan

There is a new proposal to save the EU economy, and it is pretty complicated. Luckily, Frances Coppola has done the research and written a clear and informative account. I’ll put some excerpts below, but the short version is that the EU is trying to get the private sector to invest EUR 315 billion by taking on the risk of the first EUR 21 billion–that 21 bil is money that either doesn’t currently exist or is already committed to EU initiatives.

The new President of the European Commission has recently unveiled his second attempt at increasing European investment without raising public debt levels. His first attempt, which envisaged leveraging the ESM, was shot down by the Germans. This version leverages both the EIB and the EU’s own budget. By committing 16bn EUR from the EU’s budget and 5bn from the EIB, Juncker reckons that upwards of 315bn of new investment could flow into EU-wide projects, increasing jobs and improving infrastructure. It sounds wonderful, doesn’t it?

I’ve drawn this up as a leveraged structure:

Note that the actual investment would be Mezzanine + Senior Debt, i.e. EIB subordinated lending plus private sector investment. The Equity portion is described in the factsheet as “protection”. There is no actual money involved. It consists of public guarantees, not real money. In effect, the EU and EIB combined are providing insurance to private sector investors – accepting “first losses” of up to 21bn Euros. The EU’s portion would guarantee the first 16bn Euros of longer-term infrastructure investment: the EIB would guarantee the first 5bn of capital investment in SMEs.

In fact, let us be completely clear. NONE of this money exists. Not a single Euro of it. This is a synthetic structure based entirely upon insurance, not actual funds.

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How will the West Coast survive? (water scarcity and economics)

Tim Taylor, THE Conversable Economist, reviewed the economic of water in the western U.S. I thought it provided a somewhat discouraging, yet extremely interesting look at a field of economics (and an important issue) that is hugely important. He cites to the these three Brookings papers that provide a more extensive look at these issues. Because of time constraints, I just wanted to share Prof. Taylor’s thoughts and maybe add a few of my own:

Fresh water doesn’t get used up in a global sense: that is, the quantity of fresh water on planet Earth doesn’t change. But the way in which the world’s fresh water is naturally distributed–by evaporation, precipitation, groundwater, lakes, and rivers and streams–doesn’t always match where people want that water to be. The man-made systems of water distribution like dams, reservoirs, pipelines, and irrigation systems can alter the natural distribution of water to some extent. But the American West is experiencing a combination of drought that reduces the natural supply of water and rising population that wants more water. Even with drought, population pressures, and environmental demands for fresh water, there is actually plenty of water in the American Southwest–at least, if the incentives are put in place for some changes to be implement by urban households, farmers, water providers, and legislators. …

Here’s a figure from Culp, Glennon, and Libecap showing the U.S. drought situation, concentrated in the southwestern United States:
These southwestern states have also experienced dramatic population growth in recent decade. Of the regions of the United States, these are the states with the highest population growth and the lowest annual rainfall even in average times. Here’s a figure from Kearney, Harris, Hershbein, Jácome, and Nantz:

Here’s my master plan for how to address the water shortfall, drawing on discussions in the various papers.

1) Reduce the incentives for outdoor watering by urban households in dry states. 
If  you had to guess, would you think that urban households in dry states of the American southwest use more or less water than other states? In general, these households tend to be heavier users of water. Here’s a figure from Kearney et al., who report (citations omitted):

Outdoor watering is the main factor driving the higher use of domestic water per capita in drier states in the West. Whereas residents in wetter states in the East can often rely on rainwater for their landscaping, the inhabitants of Western states must rely on sprinklers. As an example, Utah’s high rate of domestic water use per capita is driven by the fact that its lawns and gardens require more watering due to the state’s dry climate. Similarly, half of California’s residential water is used solely for outdoor purposes; coastal regions in that state use less water per capita than inland regions, largely because of less landscape watering . . .

There are a variety of ways to reduce outdoor use of water: specific rules like banning outside watering, or limiting it to certain times of day (to reduce evaporation); the use of drip irrigation and other water-saving technologies; and so on. For economists, an obvious complement to these sorts of steps is to charge people for water in a way where the first “block” of water that is used has a relatively low price, but then additional “blocks” have higher and higher prices.
2) Upgrade the water delivery infrastructure. 
One hears a lot of talk about the case for additional infrastructure spending, but much of the focus seems to be on fixing roads and bridges. I’d like to hear some additional emphasis on how to fix up the water infrastructure system. As Ajami, Thompson, and Victor note:

“Water infrastructure, by some measures the oldest and most fragile part of the country’s built environment, has decayed. … Water infrastructure—including dams, reservoirs, aqueducts, and urban distribution pipes—is aging: almost 40 percent of the pipes used in the nation’s water distribution systems are forty years old or older, and some key infrastructure is a century old. On average, about 16 percent of the nation’s piped water is lost due to leaks and system inefficiencies, wasting about 7 billion gallons of clean and treated water every day …. Metering inaccuracies and unauthorized consumption also leads to revenue loss. Overall, about 30 percent of the water in the United States falls under the category of nonrevenue water, meaning water that has been extracted, treated, and distributed, but that has never generated any revenue because it has been lost to leaks, metering inaccuracies, or the like … “

This point only compounds how believable it is that real interest rates are negative (investors are paying the government to hold onto their money), and politicians are still trying to reduce government spending. The consensus in favor of raising government spending to a sane path is growing,  and spending on infrastructure will be a huge part of it (a lot of the spending we will need to do anyway, so why not do it now when it’s cheap).
3) Let farmers sell some of their water to urban areas. 
For historical reasons, a very large proportion of the water in many western states, but especially California, goes to agricultural uses. Some of these uses combine relatively high market value and relatively low use of water, like many fruits (including wine grapes), vegetables, and nuts. But the use of water for other crops is more troublesome.  Culp, Glennon, and Libecap go into these issues in some detail. As one vivid example, they write: “In 2013, Southern California farmers used more than 100 billion gallons of Colorado River water to grow alfalfa (a very water-intensive crop) that was shipped abroad to support rapidly growing dairy industries, even as the rest of the state struggled through the worst drought in recorded history …”
There are a substantial number of legal barriers to the idea of farmers trading some water to urban areas, but the possibilities are quite striking. Here’s a figure showing that 80% of California’s water use goes to agriculture, with a substantial share of that going to lower-value field crops like alfalfa, rice,  and cotton. In agricultural areas, as in urban ones, there is often considerable scope for conserving water in various ways,  like targeting the use of irrigation more carefully, making sure that irrigation ditches don’t leak while carrying water, and the like.

One approach they describe, implemented starting in 2002 in Santa Fe, New Mexico, required that any new urban construction had to find a way to offset water that would be used in that construction.

As an example, developers could obtain a permit to build if they retrofitted existing homes with low-flow toilets. Residents of these homes welcomed the chance to get free toilets, and Santa Fe plumbers jumped at the opportunity for new business. Within a couple of years plumbers had swapped out most of the city’s old toilets with new high-efficiency ones. Water that residents would have flushed away now supplies new homes.  … In short order, a market emerged as developers began to buy water rights from farmers. Developers deposited the water rights in a city-operated water bank; when the development became shovel-ready, the developer withdrew the water rights for the project. If the project stalled, the developer could sell the rights to another developer whose project was farther along. Santa Fe also enacted an aggressive water conservation program and adopted water rates that rise on a per unit basis as households consume additional blocks of water. Thanks to the innovative water-marketing measures, the conservation program, and tiered water rates, water use per person in Santa Fe has dropped 42 percent since 1995 …

4) Set up groundwater banks. 
Historically, most western states have allowed any property owner to drill a well and use groundwater without limit. But the groundwater reserves are slow to recharge, and with the drought and population pressures, they are under severe stress. Culp, Glennon, and Libecap explain (citations omitted):

Groundwater has been the saving grace for many parts of the water-starved West. Following the advent of high-lift turbine pump technology in the 1930s, many regions had access to vast reserves of water in underground aquifers that they have tapped to supply water when surface water supplies were inadequate. A recent study looked at data on freshwater reserves above ground and below ground across the Southwest from 2004 to 2013. It found that freshwater reserves had declined by 53 million acre-feet during this time—a volume equivalent to nearly twice the capacity of Lake Mead! The study also found that 75 percent of the decline came from groundwater sources, rather than from the better-publicized declines in surface reservoirs, such as Lake Mead and Lake Powell. Much of this decline occurred because some Western states, including California, have historically failed to regulate, or do not adequately regulate, groundwater withdrawals. As a result, groundwater aquifers are effectively being mined to provide water for day-to-day use. In response to the ongoing drought, California farmers continue to drill new wells at an alarming rate, lowering water tables to unprecedented depths …In the San Joaquin Valley of California, excessive groundwater pumping caused the water table to plummet and the surface of the earth to subside more than twenty-five feet between 1925 and 1977 …”

Arizona has already been taking steps toward groundwater protection, both by limiting what can be taken out and by providing incentives to save water in the form of recharging groundwater (which avoids the problem of evaporation).

Although not yet developed into a formal exchange, Arizona has been at the cutting edge in developing groundwater recharge and recovery projects and a supporting statutory framework to help enhance the reliability of water supplies. Arizona allows municipal users, industrial users, and various private parties to store water in exchange for credits that they can transfer to other users. Because water stored underground in aquifers is not subject to evaporation, groundwater that is deliberately created through recharge activity can be stored and recovered later. This recharge and recovery approach is facilitated by Arizona laws that restrict the use of groundwater in several of the state’s most important groundwater basins; these restrictions prevent open access to the resource. Restrictions on open access, combined with statutory and regulatory provisions that allow for the creation and recovery of credits, created the essential conditions for trade in stored groundwater. As a result, numerous transactions have occurred between various municipal interests, water providers, and private parties.

California passed legislation last month to regulate groundwater pumping for the first time.
It is insane if more states have not implemented policies like this. We have bodies of experience with similar environmental resources (although each is different), but it might in fact be easier to create a market for water. If I recall correctly the US has worked on similar mechanisms (as far as creating market-type mechanisms for environmental goods or bads) for NOx, SOx and particulates, carbon, wetlands, and brownfield sites, not to mention threatened and endangered species. With water, we can actually touch it and move it (without it necessarily moving of its own volition). It will be difficult, but important to get the incentives right, and I as I hoped to point out, we have experience and bodies of research that should help.
5) More research and development on water-saving technologies. 
As Ajami, Thompson, and Victor discuss at some length, there is relatively little innovative activity in water conservation and purification, as opposed to, say, energy conservation and new sources of energy. They argue that part of the reason is that energy-providing companies compete against each other, while most water companies are sleepy publicly-run local monopolies. Potential entrepreneurs have the ability to look at a lot of ways of producing and using energy, confident that if they come up with something useful, their invention will find a ready market. But entrepreneurs looking at various methods of water conservation will often find that their ideas apply only locally, or are hard to patent, or are hard to sell to water companies and users. Here’s their figure comparing spending for energy and water innovation at a global and U.S. level.
Drought is a natural problem. But the factors that determine how water is available get used represent an economic problem of the incentives and constraints that determine the allocation of a scarce resource.  In the American West, the institutional problems of water allocation seem to me even more severe than the natural problem of drought.
This one was shocking to me. The relatively small amount of money going into investment, research and innovation and water-saving technology. My takeaway is twofold: 1. the government (state and/or federal) needs to build better markets and incentives around water “production” and consumption; 2. the research and investment here could be driven by the private sector if the incentives are right, but more likely it is a ripe example of a public good (so the government should up its investments in water-related development). [I also would think there are implications for the huge population growth in the West, but, who knows, maybe the water scarcity problem won’t end up affecting the desire of people to continue going (and staying) out there]

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A Captivating Environmental Lawsuit

A few weeks ago, I was perusing the NYTimes online, and, as a casual environmental law enthusiast, I was baited into clicking on an article that turned out to be one of the most well-written newspaper articles I’ve read in months (maybe years).

The title is “The Most Ambitious Environmental Lawsuit Ever” by Nathaniel Rich.

I got hooked and went along for an enlightening, engaging, (and ultimately somewhat depressing) ride (HINT: the lawsuit may not survive, in large part because of taken politicians and regulators… and oil politics).

In Louisiana, the most common way to visualize the state’s existential crisis is through the metaphor of football fields. The formulation, repeated in nearly every local newspaper article about the subject, goes like this: Each hour, Louisiana loses about a football field’s worth of land. Each day, the state loses nearly the accumulated acreage of every football stadium in the N.F.L. Were this rate of land loss applied to New York, Central Park would disappear in a month. Manhattan would vanish within a year and a half. The last of Brooklyn would dissolve four years later. New Yorkers would notice this kind of land loss. The world would notice this kind of land loss. But the hemorrhaging of Louisiana’s coastal wetlands has gone largely unremarked upon beyond state borders. This is surprising, because the wetlands, apart from their unique ecological significance and astounding beauty, buffer the impact of hurricanes that threaten not just New Orleans but also the port of South Louisiana, the nation’s largest; just under 10 percent of the country’s oil reserves; a quarter of its natural-gas supply; a fifth of its oil-refining capacity; and the gateway to its internal waterway system. The attenuation of Louisiana, like any environmental disaster carried beyond a certain point, is a national-security threat. …

The land loss is swiftly reversing the process by which the state was built. As the Mississippi shifted its course over the millenniums, spraying like a loose garden hose, it deposited sand and silt in a wide arc. This sediment first settled into marsh and later thickened into solid land. But what took 7,000 years to create has been nearly destroyed in the last 85. Dams built on the tributaries of the Mississippi, as far north as Montana, have reduced the sediment load by half. Levees penned the river in place, preventing the floods that are necessary to disperse sediment across the delta. The dredging of two major shipping routes, the Mississippi River Gulf Outlet and the Gulf Intracoastal Waterway, invited saltwater into the wetlands’ atrophied heart.

Beneath the surface, the oil and gas industry has carved more than 50,000 wells since the 1920s, creating pockets of air in the marsh that accelerate the land’s subsidence. The industry has also incised 10,000 linear miles of pipelines, which connect the wells to processing facilities; and canals, which allow ships to enter the marsh from the sea. Over time, as seawater eats away at the roots of the adjacent marsh, the canals expand. By its own estimate, the oil and gas industry concedes that it has caused 36 percent of all wetlands loss in southeastern Louisiana. (The Interior Department has placed the industry’s liability as low as 15 percent and as high as 59 percent.) A better analogy than disappearing football fields has been proposed by the historian John M. Barry, who has lived in the French Quarter on and off since 1972. Barry likens the marsh to a block of ice. The reduction of sediment in the Mississippi, the construction of levees and the oil and gas wells “created a situation akin to taking the block of ice out of the freezer, so it begins to melt.” Dredging canals and pipelines “is akin to stabbing that block of ice with an ice pick.”

The oil and gas industry has extracted about $470 billion in natural resources from the state in the last two decades, with the tacit blessing of the federal and state governments and without significant opposition from environmental groups. Oil and gas is, after all, Louisiana’s leading industry, responsible for around a billion dollars in annual tax revenue. Last year, industry executives had reason to be surprised, then, when they were asked to pay damages. The request came in the form of the most ambitious, wide-ranging environmental lawsuit in the history of the United States. And it was served by the most unlikely of antagonists, a former college-football coach, competitive weight lifter and author of dense, intellectually robust 500-page books of American history: John M. Barry.

The last paragraph gets me. Anyway, there are some shocking post-Katrina stories, but the gist is that Barry joined a regional levee board and decided to bring a lawsuit against oil companies. While the evidence was overwhelming that the companies should pay the state damages, politicians (even those that agreed with Barry) lined up against the suit, led by Governor Bobby Jindal. It looks like the lawsuit will fail, although the bill that would “kill the lawsuit” will be put in front of a Federal District Judge in November to rule on its constitutionality. I hope the bill gets struck down and the lawsuit moves forward. The state of Louisiana deserves as much by my reading of the situation.

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Why are there millions of Americans without bank accounts? Banks.

You might think that it would be better for banks to be inclusive and have as many customers as possible with as many good products as possible. That is apparently not the case.

From the FDIC as of 2011:

  • 8.2 percent of US households are unbanked. This represents 1 in 12 households in the nation, or nearly 10 million in total.
  • The proportion of unbanked households increased slightly since the 2009 survey. The estimated 0.6 percentage point increase represents an additional 821,000 unbanked households.
  • 20.1 percent of US households are underbanked. This represents one in five households, or 24 million households. The 2011 underbanked rate in 2011 is higher than the 2009 rate of 18.2 percent, although the proportions are not directly comparable because of differences in the two surveys.
  • 29.3 percent of households do not have a savings account, while about 10 percent do not have a checking account. About two-thirds of households have both checking and savings accounts.

It is difficult for me to conceive of the fact that nearly 3 in 10 households in the U.S. do not have savings accounts, let alone checking accounts. It seems like the first thought for most people, and for many researchers previously is: well, poor people probably couldn’t have a checking or savings account anyway; or those people must not be financially educated enough to have a bank account; or it’s probably their own fault!

In thinking that, you would probably be wrong.

Research by Prof Claire Célérier and Adrian Matray strongly suggests “supply-side factors” are important drivers in the huge number of unbanked households. They say it best:

There is an urgent need to identify the drivers of the unbanked phenomenon. Holding a bank account is indeed key to accumulate savings. In addition, unbanked households are charged very high fees by alternative financial services, which they largely use.

One of the main questions is whether being unbanked is driven by supply- or demand-side factors (see, for example, Barr and Blank 2008). The ‘demand-side’ view attributes the unbanked phenomenon to cultural determinants – the poor may distrust financial institutions or may not have culture of saving – or to a lack of financial literacy. Alternatively, the ‘supply-side’ view suggests that standard bank practices create hurdles for the poor. Minimum account balances, overdraft fees, a large distance between branches, and the proliferation of formal steps to open an account result in costs that may be too high for poor households to manage (Washington 2006, Barr and Blank 2008). These two radically different explanations have different policy implications. While the demand-side view predicts interventions at the household level through financial literacy programmes, for example, the supply-side view suggests that banking regulation, by giving banks incentives to change their behaviour, may reduce the share of unbanked households.

Their conclusion:

We find evidence consistent with supply-side factors driving the large share of unbanked households. This result suggests that being unbanked is not only driven by cultural factors, preferences, or low financial sophistication, but also by bank practices that tend to ration certain types of households.

It sounds like banks that have little competition are profit maximizing, so they take advantage of consumers where possible and exclude consumers where convenient. More consumer protection and more competition sound mighty appealing.

Evidence below: Continue reading

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