Sunday, March 26, 2017

Corporations in the Age of Inequality: A Skeptic's Take

Nick Bloom contributes an article to the Harvard Business Review: "Corporations in the Age of Inequality". It's also an interesting read, based on his "Firming Up Inequality" paper, which I also recommend. The story of inequality they tell is also one which is essentially technology based (IT and outsourcing), as they find that inequality is almost entirely driven by changes in between firm inequality. They deserve credit for presenting an interesting set of facts.

However, while intriguing, I'm not yet totally convinced this is the key to understanding inequality. Macromon also had an excellent discussion of this research awhile back. The key question she had is about the definition of a firm -- the authors use tax ID numbers, but the average # of tax ID numbers per corporation listed on the NYSE is 3.2. If it's just a story about a growing number of tax IDs per corporation, then it becomes much less interesting. A similar problem is that one could also imagine that if a firm used to employ a janitor, but then outsources it to a different company, within firm inequality could fall or be flat even as wages between the janitor and others working in the same building increase. Thus, their decomposition doesn't necessarily teach us much about why inequality is increasing, and is perfectly consistent with the institutions story I've told in a previous blog post (or many other stories one might dream up).

However, I did notice that the institutions story went unmentioned in their paper and in Bloom's article. As I wrote before, the insights of Piketty, Saez and coauthors seem to have had surprisingly little influence, particularly since the explanation seems perfectly adequate, and has a lot of explanatory power. (Actually, in his book, Piketty also barely mentions the institutions story, which is a major theme of some of his joint papers with Saez and coauthors...) This is where the lack of comment papers in economics is frustrating. Many top people apparently don't buy the institutions story. Why not? Perhaps they have good reasons to be skeptical. I'd like to know what they are. (I'd certainly like to know what Nick Bloom thinks...) The evidence looks quite compelling to me.

I took issue with this comment "Since 1980, income inequality has risen sharply in most developed economies". As my blog readers know, income inequality has not risen dramatically in Germany, France, Japan, or Sweden according to Alvaredo et al.. Thus, this comment threw me: "This means that the rising gap in pay between firms accounts for the large majority of the increase in income inequality in the United States. It also accounts for at least a substantial part in other countries, as research conducted in the UK, Germany, and Sweden demonstrates." Right, but the increases in inequality in Germany and Sweden have been quite minor relative to the US, and are also associated with changes in top marginal tax rates. So, between firm inequality isn't actually explaining much is what I'm hearing. 

Bloom attributes rising inequality to "the rise of outsourcing, the adoption of IT, and the cumulative effects of winner-take-most competition". I agree that outsourcing could be causing the rise of measured firm-level inequality, although this could be happening even while having scant impact on overall inequality. Particularly given that "One study found that from 1980 to 2008, the share of workers in Germany employed by temp agencies or cleaning, logistics, or security firms more than tripled, from roughly 2% to 7%." My question with adoption of IT is going to sound familiar: don't the Germans, Swedes, and Japanese also have IT? And why did winner-take-most competition only happen in Reagan-Thatcher countries since 1980? I would point to the savage cuts in top marginal tax rates, as well as to other institutional changes (other tax changes, declining importance of the minimum wage, and declining influence of labor). 

In any case, it's still a nice article and I found myself mostly agreeing with his policy recommendations. I particularly liked his focus on the role that luck plays in determining careers and income. If you take two people with the same skills, and put one at Google in 1999 and another at, say, General Motors, the one lucky enough to have chosen Google would have gotten wildly rich. This is another argument for higher top marginal tax rates, which I support. 

Friday, March 24, 2017

The Saga of Currency Unions and Trade

One of the first full papers I wrote was on currency unions and trade. I was taking Alan Taylor's field course at UC Davis, which was essentially and Open-Economy Macro History course, and the famous Glick/Rose findings that currency unions double trade was on the syllabus. Not to be outdone, Robert Barro and coauthors then found that currency unions increase trade on a 7-fold and 14-fold basis! This raised the prospect that Frenchman may suddenly go out and buy a dozen or more Volkswagens instead of settling for just one after the adoption of the Euro. Another paper, published in the QJE, found that currency unions even raise growth, via trade. In that case, one can only imagine what the Greek economy would look like if they hadn't joined the Euro. No result, it seems, can be too fanciful.

Always a doubting Thomas, I was instantly skeptical. For one, a doubling of trade implies an impact more than 10 times larger than what has been measured for the Smoot-Hawley tariff, while we already knew the effect didn't operate via the impact of exchange rate volatility on trade, thanks to an excellent paper by Klein and Shambaugh. For two, countries don't enter into (or exit) currency unions randomly. Obvious omitted variables alert! It was only a question what.

To his credit, Andrew Rose always provides his data online. This also helps citations, as the cost of extending or critiquing his papers are small. So, I fired up Stata, and after a solid 30 minutes, I discovered part of what was driving the seemingly magical effect. Roughly one-quarter of the CU changes were of countries that had former colonial relationships, many of them between the UK and its former colonies. It turns out that the impact of the "former colony" dummy in the gravity equation has been decaying slowly over time. This led to a more interesting insight -- that history matters for trade. In any case, many colonies had currency unions with the UK until the late-1960s/early 1970s. Thus, given the decay of trade for all former colonies, if you average trade before and after 1970, of course you get that there was relatively less trade after. However, if you add in a simple trend for trade between the UK and all its former colonies -- a rather mild control -- the magical "currency union" effect on trade disappears completely. Indeed, if you have two variables that exhibit trends, and you regress one on the other, you're almost guaranteed to find a significant correlation even if no relationship exists. I've since discovered that this is by far the most ubiquitous problem in empirical international trade, to the extent that I've been to conference sessions in which every paper regressed trending variables in levels on other trending variables. It doesn't mean that they were all wrong, necessarily, but showing robustness to trends is a best practice. Plotting pre-and post-treatment trends can also help. But the more relevant research question in this case is "How much does a currency union increase trade relative to trend?" Particularly when there are already strong upward or downward pre-trends. 

In any case -- back to currency unions. For other country pairs aside from colonies, there were other problems. India and Pakistan dissolved their currency union in 1964, after which trade declined. However, there's an obvious problem here: this occurred because of a brutal border war, and these two countries hate each to this day. A number of other examples were similar. You probably know less about what happened between Madagascar and Comoros in 1975. They dissolved a currency, and trade indeed collapsed. But two minutes of googling told me that, in the same year, there was an ethnic cleansing episode in Mahajanga, targeted at "island" peoples. (Yes, Madagascar is also an island, but this was apparently targeted at people from smaller islands, including the Comorians...) Same thing with the "Liberation War" that resulted in the overthrow of Ugandan dictator Idi Amin -- and also resulted in the tragic end of a currency union, depending on your view. And on and on the examples went. Wars, ethnic cleansing episodes, financial crises, currency crises, banking crises, communist takeovers. These are what cause currency unions to end. And if you take out the most obvious examples of cases where geopolitical events overshadow the change in CU status, there's not much left, and what is doesn't suggest that CUs have any effect on trade. And this is before one even blows up the error terms by adopting realistic assumptions about spatial correlation. 

In any case, in 2015, I deleted this paper and my regression and code from my webpage, and assigned the paper to my brilliant undergraduate students. They alerted me to the fact that Glick and Rose had recently written a mea culpa, where the authors declared that they could no longer have confidence in the results. I wasn't cited. Indeed, they probably hadn't seen my paper. Despite this, I was worried about having pissed them off in the first place, and I also wanted to get some love in the final version, so I wrote them an email and thanked them for sharing their data online, congratulating them for having the intellectual integrity to admit that they were wrong (even if their new paper still suffered from many of the same issues, such as not controlling for trends). 

This sounds like it should be the end of the story, correct? Particularly since the early evidence on the Euro and trade was not supportive. However, Glick and Rose changed their minds, and decided instead to double-down on a positive, measurable impact of currency unions on trade. This time, they concluded that the Euro has increased trade by a smaller, but still magical, 50%. And I did get some love, although not in the form of a citation -- instead they thanked me in the acknowledgments! I'm still quite happy to have been acknowledged, even though, admittedly, I hadn't commented on the substance of their new paper. 

In any case, Jeff Frankel at Harvard apparently used to assign his Ph.D.'s students a "search-and-destroy" mission on the original CU effect. Thus, thanks to the fact that Andrew Rose still provides his data online -- for which I'm grateful -- I've just assigned my students a similar mission on the new EMU result. Thus, we get to see if they can overturn anything that the good referees at the European Economic Review may have overlooked. If I were a gambling man, and I am, I would put my money on my sharp undergraduates at the New Economic School over the academic publication process. If I were Croatia, or Greece, contemplating the relative merits of joining/staying in the Euro, I would write off the academic literature on this topic completely. 

Monday, March 20, 2017

Robots and Inequality: A Skeptic's Take

Paul Krugman presents "Robot Geometry" based on Ryan Avent's "Productivity Paradox". It's more-or-less the skill-biased technological change hypothesis, repackaged. Technology makes workers more productive, which reduces demand for workers, as their effective supply increases. Workers still need to work, with a bad safety net, so they end up moving to low-productivity sectors with lower wages. Meanwhile, the low wages in these sectors makes it inefficient to invest in new technology.

My question: Are Reagan-Thatcher countries the only ones with robots? My image, perhaps it is wrong, is that plenty of robots operate in Japan and Germany too, and both countries are roughly just as technologically advanced as the US. But Japan and Germany haven't seen the same increase in inequality as the US and other Anglo countries after 1980 (graphs below). What can explain the dramatic differences in inequality across countries? Fairly blunt changes in labor market institutions, that's what. This is documented in the Temin/Levy "Treaty of Detroit" paper and the oddly ignored series of papers by Piketty, Saez and coauthors which argues that changes in top marginal tax rates can largely explain the evolution of the Top 1% share of income across countries. (Actually, it goes back further -- people who work in Public Economics had "always" known that pre-tax income is sensitive to tax rates...) They also show that the story of inequality is really a story of incomes at the very top -- changes in other parts of the income distribution are far less dramatic. This evidence also is not suggestive of a story in which inequality is about the returns to skills, or computer usage, or the rise of trade with China.

With Lester Lusher, I've also waded into this debate (here and here). What we set out to do is show a variety of evidence all pointing to the conclusion that trade shocks have not caused a rise in inequality. First, we look at the two largest trade shocks in the US, the 1980s dollar bubble, and the late 1990s appreciation + rise of China shock. Perhaps surprisingly, neither hurt the wages of low-wage workers who worked in exposed sectors disproportionately. Sectors more exposed to the shocks also did not experience increases in inequality. We also found no association between capital upgrading by sectors, and inequality, or between TFP growth and inequality.  And then we looked at the cross-country evidence, and found that trade with China, trade deficits, trade levels, and changes in trade are all not even correlated with top income shares. As a last bit, we tested the Piketty, Saez, and Stantcheva results out-of-sample. Although we found that a slightly different functional form, and a dynamic model worked much better, we found that their results hold up out-of-sample. Interestingly, even though this was just a small part of our paper, referees protested that the result was not new. They apparently see no value in subjecting previously published work to additional testing, even if it is seminal work on a major policy topic that is also controversial enough that many top people (Krugman, Autor, Acemoglu, etc.) seem not to believe it. And this journal was second tier!

In any case, there is a long history of constructing mathematical models to show how international trade or skill-biased technological change can influence the wage distribution in theory. However, it's not clear to me this literature has been very successful empirically, in the end. It seems to me that any theory meant to apply to all countries will be a theory that doesn't apply to any country. And somehow it always seems that the contributors to this literature are not aware that there is already a perfectly good explanation for rising inequality that has explanatory power internationally (and out-of-sample).

Lastly, why are wages growing slowly? Well, let's not forget that the Fed has raised interest rates 3 times already since the Taper, despite below-target inflation and slow wage growth. The labor market has been bad since 2007 (or, in fact, since 2000 -- see my longer explanation here). Wages tend to grow slowly in bad labor markets, and tight money will keep them from growing quickly. There's no need here to draw parallelograms.

Sunday, March 19, 2017

The Myth and Reality of Manufacturing in America

That's the title of a small pamphlet on manufacturing by Michael J. Hicks and Srikant Devaraj which argues that "Almost 88 percent of job losses in manufacturing in recent years can be attributable to productivity growth..."

However, the accounting exercise they conduct to get that number contains a conceptual flaw. Namely, they start at 2000, and ignore the role of productivity growth before that. Productivity growth, if anything, fell after 2000. So, if one does a counterfactual job simulation from 1987 to 2000, one could say that without productivity growth, employment in the manufacturing sector would have increased 60%. In their exercise from 2000, they claim that, absent productivity growth, manufacturing employment would have declined just 12%. But the big question here is why did the "no productivity growth" counterfactual suddenly stop growing after 2000? What explains the difference in the trend? This is something they can't answer, since they decide not to look before 2000.

Yet, somehow this pamphlet keeps getting cited by major news outlets. 

An indication of the level of care in this article is that they cite "Acemoglu" as "Ocemoglu". Someone corrected this in the References, but left the citation in alphabetical order where the O should be. 

There is a huge hole in Trump's promise to bring back US manufacturing jobs

That's the title of an article from Business Insider.

There is much I like about these articles. This one is better than most, as it at least plots data. However, I don't quite understand why they focus on robots and productivity gains, rather than the slowdown in the growth of real manufacturing output. Real manufacturing output from 2007 to 2017 has barely increased at all. This is for sure a major factor in the decline of manufacturing employment. The article focuses on "manufacturing output hitting record highs in recent years, even as manufacturing employment continues its steady decline." Sorry, but a 1 or 2% increase in manufacturing output over a 10 year period is not a cause for celebration, even if we are now reaching "record highs". One could alternatively frame this performance as approaching "record lows" in terms of the 10 year growth rate of real output. 

The other problem with the argument that booming productivity and robots have caused the decline in US manufacturing output, aside from the fact that productivity growth hasn't increased, is that the period since 2000 has also seen the US share of manufacturing exports fall dramatically. Why would booming productivity lead to fewer exports and rising imports? Inquiring minds would like to know. 

Yet another problem is that the composition of productivity growth has changed. Productivity for the median sector declined from 2000 to 2010, while the computer sector saw very rapid productivity amidst declining sales. 

Friday, March 17, 2017

Links to Two Short Essays on Monetary Policy, One Good, One Bad

First, new FOMC member Neil Kashkari tells us why he dissented on this week's interest rate hike. It's a great essay. I laughed at "over the past five years, 100 percent of the medium-term inflation forecasts (midpoints) in the FOMC’s Summary of Economic Projections have been too high: We keep predicting that inflation is around the corner." That's some 20 forecasts all missed in the same direction. Impressive. 

This is exactly the problem with monetary policy in the US, Europe, and Japan. Central banks keep predicting that inflation will return to target. When it doesn't, however, they don't respond by loosening policy, or by updating their inflation forecasts. They just continue being predictably wrong. He makes a number of good points, including that the Fed shouldn't treat their target as though the risks are asymmetric, like they are driving near a cliff. They should occasionally miss by going over 2%. If anything, the worry should be that if the US had a negative shock again, the Fed would have more trouble managing the economy at the zero lower bound. The asymmetric risk is an economy growing too slowly. What he doesn't mention is that this logic should imply a higher inflation target -- but I'll give him a pass on this. Yet another good point he makes is that the rest of the developed world is currently suffering from very low inflation. How likely is it that the US will soon suffer from an inflation spiral that can't be controlled by repeated interest rate increases? When other developed countries have inflation close to zero? Core inflation in the US is just 1.74, he notes, up from 1.71% last year. We appear to be some ways away from an inflation spiral. 

Another thing he doesn't do is discuss the fact that, not only has the Fed repeatedly missed its inflation forecasts in the past few years, but it has also under-performed its GDP growth forecasts. You'd think, if you wanted to drive down the center of the road, when you notice your car heading off onto the shoulder that you'd adjust the steering wheel back toward the center. The Fed instead has repeatedly decided not to do this, and then been surprised that the car doesn't return to the center of the road by itself. Many academics then argue that maybe it's because the steering wheel doesn't work. I say the problem isn't with the steering wheel, but that the driver refuses to adjust.

Thus I want to flag another short article, on Japan, which argues exactly this. Sayuri Shirai writes that Japan's non-standard monetary policies since it reached the zero lower bound have not been effective, and argues that Japan should thus raise interest rates. One tell that the author is overselling the ineffectiveness of MP at the ZLB is that although she credits Japan's MP easing with weakening the Yen after 2013, she writes "the yen’s depreciation has reduced the prices of exports but increased those of imports so that the net positive impact has not been as large as in the more distant past." How could a Yen devaluation simultaneously reduce the price of exports and increase import prices? Presumably, many of Japan's exports to the US, for example, are actually priced in dollars. In Yen terms, these prices are thus likely to rise substantially with a fall in the value of the Yen. The article doesn't back up these claims.

The author also doesn't back up other claims, such as that the negative interest rate policy supposedly caused a rash of bad effects, such as "a deterioration in households’ sentiments" and "potential financial instability risk". If either of these were the case, it could easily be documented using high-frequency data from surprise announcements. But that isn't what people who look at the impact of MP announcements at the ZLB typically find. Interestingly, although much of the article is about the negative interest rates, the author never mentions that Japanese rates are just -.1%. Color me skeptical that a change of just .1% is really going to have these dramatic negative effects proposed in the article. Keep in mind that back before the ZLB episode, the BOJ once raised interest rates 3.5% in one year to fight inflation, and in the 1970s, they cut interest rates as much as 6% in a loosening cycle over 2-3 years to fight a recession. That's 60 times more medicine than a move from 0 to -.1%.  To provide a similar amount of ammunition now, of course an enormous balance sheet expansion would be in order. It's clearly foolish to conclude that since things haven't gone better since Japan cut interest rates from 0 to -.1%, that Japan should now raise rates. 

Aside from the fact that announcements have tended to move things in the right direction for Japan, the author also misses that many times, even as new data comes in which is below the BOJ's forecast, they've declined to take on more stimulative policies, occasionally disappointing markets and tightening monetary conditions. It's hard not to watch this and conclude that the Bank is not totally committed to its growth and inflation targets. A good analogy is your friend who states he wants to lose weight, but refuses to go to the gym more than once a month. Since going to the gym once a month isn't working, why go at all? That's what Shirai is telling us. 

Wednesday, March 15, 2017

A Quick Argument Why Not to Raise Interest Rates

I teach today, so this will be quick. Why am I opposed to raising interest rates?

First, I should mention this is a debate which we've had before. When the Fed decided to leave it's balance sheet unchanged for all of 2009 and 2010 -- while the economy burned -- I thought it was a mistake. When Ben Bernanke raised the discount rate in 2010, I wondered if he had lost his marbles. The result was a 63 seat loss in the House for the Dems and a full decade of Tea-Baggers in the Congress (and maybe more, depending to what extent gerrymandering affects local House elections which will then affect the next redistricting). Given that the economy continued to grow slowly after that, I think I was justified.

Next, after QE2 at the end of 2010, I believed the Fed should have acted sooner than the end of 2012 for QE3, given the fact that growth was slower than it anticipated.

Then, I thought 2014 was too soon to taper, given that inflation was below target and GDP growth was below trend.

At the end of 2015, I also, not suprisingly, thought it was too soon to tighten. Once again, 2016 was a year of slow GDP growth and below-target inflation. So, in retrospect, I think that was the right call. The last two rate hikes, I believe, are also premature. Unemployment is now super low, and employment gains the past several months indeed look solid. Thus it isn't crazy to hike now. But the unemployment rate and current headline inflation rates are not the only numbers the Fed should be looking at. The Core PCE is still pretty stable, below 1.8% for the last reading, and while headline inflation is now close to 2% and will soon likely move higher if current trends continue, this measure was also close to zero as recently as 2015, a year in which the Fed actually raised interest rates. The Fed shouldn't ignore that inflation has been below it's target for most of the period since 2008, that the employment-to-population ratio for prime-aged workers, while trending in the right direction, still has a lot of room to recover, and that RGDP is some 20-25% below it's long-run trend. Given that inflation has been below target for so long, why not let inflation run above target for awhile to allow GDP to catch up with its previous trend?

And, add to this that our inflation target is too low. Clearly, the Fed has trouble managing the economy at the zero lower bound. A 2% inflation target means that any large shock will push us into a liquidity trap. This seems more-or-less obvious. Why not raise the target to 3%?

The only silver lining here for Democrats is that this hurts Trump and Republicans. But they've been pushing the Fed for tighter policy for years. One wonders if they will soon start to change their tune.