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Harvard teaches us that hedge fund managers get rich even when they mess up

April 21, 2018 3 comments

from Dean Baker

While we all know that it is important for people to get a good education if they want to do well in today’s economy, it remains the case that who you know matters much more than what you know. Harvard has taught us this lesson well with the management of its endowment in recent years.

Businessweek reported that the returns on Harvard’s endowment over the last decade averaged just 4.4 percent annually. This performance trailed both stock index returns and the returns received by other major university endowments. This means that Harvard would have had considerably more money to pay its faculty and staff if it simply bought a Vanguard index fund.

If this were just bad luck, one could be sympathetic, but according to Businessweek, the school paid $242 million to the people who managed its money over the period from 2010 to 2014, an average of $48.4 million annually. While Harvard’s endowment fared poorly, these money managers did very well, with the top-paid managers undoubtedly pocketing paychecks well in excess of $1 million a year (approximately 8,000 food stamp months). In other words, Harvard’s money managers were paid huge sums to lose the school money. Nice work if you can get it.

It is difficult to understand how Harvard, or any university, could pay so much money to lose the school money. Harvard’s money managers surely have good credentials, and probably even good track records with their past performance. How could the university write contracts that allow these people to get huge paychecks that end up costing Harvard money due to their poor investment decisions?  Read more…

China’s “Currency Devaluation Game”

April 17, 2018 2 comments

from Dean Baker

Donald Trump was apparently angry about the value of the Russian ruble and the Chinese yuan against the dollar. He complained in a tweet that both are playing the “Currency Devaluation game” in a tweet yesterday.

Neil Irwin rightly points out that the complaint against Russia is bizarre, both because we don’t have much trade with Russia, but also because the most obvious reason its currency is falling is sanctions pushed by the United States and other western countries. The story with China is a bit more complicated.

China’s currency has actually been rising against the dollar over the last year, with the yuan going from 14.5 cents to 15.9 cents. So the claim that China is devaluing its currency is pretty obviously wrong.

There is however an issue of whether China is still deliberately depressing its currency against the dollar. As Irwin notes, China is no longer buying large amounts of dollars and other reserves, as it did in the last decade. This buying raised the value of the dollar and kept down the value of the yuan.

However China still holds a massive stock of foreign reserves, with its central bank holding more than $3 trillion in reserves and its sovereign wealth fund holding another $1.5 trillion in foreign assets. These huge stocks of assets have the effect of holding down the value of the yuan in the same way that the Fed’s holdings of assets keeps down interest rates.  Read more…

More evidence of the skills shortage in top management

April 13, 2018 9 comments

from Dean Baker

We all know about the skills shortage Harvard has to pay investment managers millions to lose the school a fortune on its endowment, Facebook can’t find a CEO who can avoid compromising its customers’ privacy, and restaurant managers apparently don’t understand that the way to get more workers is to offer higher pay. The NYT gives us yet another article complaining about labor shortages.

The complaint is that restaurants have small profit margins and therefore can’t afford to offer higher pay to their workers. The way markets are supposed to work is that businesses that can’t afford to pay the market wage go out of business. This is why we don’t still have half of our workforce employed in agriculture. Factories and other urban businesses offered workers better paying opportunities. Most farms could not afford to match the pay and therefore folded often with the farm owner themselves moving to new employment.

This is the story that we should expect to see with restaurants if there really is a labor shortage. We should start to see more rapidly rising wages. The restaurants that can’t pay the market wage go under. That may not be pretty, but that’s capitalism. We tell that to unemployed and low paid workers all the time.  Read more…

Why should the poor pay high drug prices?

April 8, 2018 3 comments

from Dean Baker

We have seen a lot of hyperventilating in political circles over Donald Trump’s recently proposed tariffs on steel and aluminum. While these do not seem like well-considered policies, and are likely to do more harm than good even from the narrow standpoint of increasing manufacturing employment, they are not by themselves the horror story being presented.

Steel prices often fluctuate by 20 or 30 percent over the course of a year, as they did in 2016. If tariffs raise the price in the US by 10 percent, that would be unfortunate for downstream industries, but not exactly a catastrophe.

However, more important than the specifics of a steel tariff is the implicit assumption that the country as a whole has an interest in stronger and longer patent and copyright protection. Many pundits have attacked Trump’s focus on steel and manufacturing because they argue, we should be more concerned about protecting US corporations’ patents and copyrights overseas. This doesn’t make sense.  Read more…

Disagreeing with Krugman: Is China stealing knowledge?

April 7, 2018 17 comments

from Dean Baker

I would agree with pretty much all of Paul Krugman’s criticisms of Donald Trump’s trade war with China, but I would strongly disagree with one of his criticisms of China. He tells readers:

“In some ways, China really is a bad actor in the global economy. In particular, it has pretty much thumbed its nose at international rules on intellectual property rights, grabbing foreign technology without proper payment.”

The issue here is who set the rules and what is proper payment.

The problem is that it was largely the United States that has set the rules in this story and it is demanding ever more money for items protected by its patent and copyright monopolies. We do this through our control of trade arrangements, most importantly the WTO where we had the TRIPS provisions inserted as a late entry to the Uruguay Round that was concluded in 1994. These rules were about forcing developing countries to pay more money to companies like Pfizer and Microsoft for everything from drugs and medical equipment to seeds and software. It shouldn’t be surprising that developing countries like China might not like these rules.  Read more…

US wins trade war! China goes generic big time

April 5, 2018 3 comments

from Dean Baker

Donald Trump has proved the skeptics wrong, it seems that the American people stand to be big winners as a result of his trade war. The Chinese government announced a major initiative to promote the manufacture and use of generic drugs.

The reason this is potentially a big deal for the United States is that it could mean that China intends to push the envelope in replacing drugs protected by government-granted patent monopolies with drugs sold at free market prices. While the TRIPs provisions of the WTO do require members to respect patents and copyrights, there are flexibilities, such as compulsory licensing, to allow far more competition that what we see in the United States market.

Countries also have varying rules on what items can be patented. For example, India has far more stringent patent rules than the United States so that many drugs that are protected by patents in the U.S. are sold in a free market in India.

This can matter hugely for people in the United States since if China joins India as a mass producer of high quality generic drugs it will become increasingly difficult for the U.S. drug companies to maintain an island of protected prices in the United States. The gap between the patent protected price for drugs like the Hepatitis C drug Solvaldi and new cancer drugs is often more than 100 to 1 (equivalent to a 10,000 percent tariff) and can be as much as 1000 to 1.   Read more…

High CEO pay: It’s what friends are for

March 30, 2018 11 comments

from Dean Baker

The explosion in the pay of corporate CEOs is well documented. While the heads of major corporations were always well paid, we saw their pay go from 20- to 30-times the pay of ordinary workers in the 1960s and 1970s to 200- or 300-times the pay of ordinary workers in recent years. Paychecks of more than $20 million a year are now standard, and it’s not uncommon to see a top executive haul in more than $40 or $50 million in a single year.

Soaring CEO pay is an important part of the story of the rise in inequality over the last four decades. These people are all in the top 0.01 percent or even 0.001 percent of the income distribution.

The high pay of CEOs lifts the pay for other top executives. If the CEO is getting $25 million a year, it is likely that people directly under her are making salaries of $3 to $5 million, and quite possibly considerably more. If CEOs were earning $2 million, most likely the next  tier of workers would be earning in the neighborhood of $1 million. And, it’s just straight logic that higher pay at the top means less for everyone else.

In addition, the high pay at the top of the corporate ladder gets transmitted to other sectors. It is now common to see university presidents and heads of charities and other nonprofits get pay in excess of $1 million or even $2 million a year. They can truthfully say that they would get far higher pay if they ran comparably sized organizations in the corporate sector.  Read more…

Kudlow’s fossilized beliefs could lead Trump further astray

March 25, 2018 8 comments

from Dean Baker

Last week the Trump administration announced that it was picking Larry Kudlow as the new head of the National Economic Council .Kudlow was a mid-level official in the Reagan administration before moving to Wall Street, but his greatest notoriety came as an economics talk show host for two decades.

Kudlow made no bones about his views on his show. (Full disclosure: I was an occasional guest.)

He began each segment by proclaiming his belief in free markets, free trade and free enterprise.

Kudlow is an ideologue. This could be a serious problem with a president who often shoots from the hip without seriously considering the ramifications of his policies. Rather than trying to get Trump to consider various perspectives, Kudlow may just reinforce Trump in his ill-considered plans.

To take an important but largely overlooked area of policy, Kudlow shares Trump’s view that global warming is a hoax. In Trump World, the myth of global warming was invented by China to get the United States to waste a huge amount of money reducing its greenhouse gas emissions, thereby making its industry less competitive.  Read more…

The United States has not been pushing for open markets

March 24, 2018 5 comments

from Dean Baker

It is striking how the media universally accept the idea that patent and copyright monopolies are somehow free trade. We get that the people who own and control major news outlets like these forms of protection, but it is incredibly dishonest to claim that they are somehow free trade.

We get this story yet again in a NYT piece complaining about China’s “theft” of intellectual property, while telling readers about how Trump’s proposed tariffs show his:

“resolve to turn away from a decades-long move toward open markets and integrated world economies and toward a more starkly protectionist approach that erects barriers around a Fortress America.”

While we are supposed to be alarmed about tariffs of 10 percent and 25 percent on steel and aluminum, patents and copyrights are effectively tariffs of many thousand percent, often raising the price of protected items tenfold or even a hundredfold. The economic impact of increased protectionism of this type has been enormous.

This can be seen clearly in the case of prescription drugs, where spending went from around 0.4 percent of GDP in the 1960s and 1970s to 2.4 percent of GDP ($450 billion) in 2017, as shown below.

Book3 4096 image001

Read more…

China as Number One: The relative size of the U.S. and Chinese economies

March 21, 2018 5 comments

from Dean Baker

Eswar Prasad makes the case in an NYT column that we should be paying attention to the selection of Yi Gang to head China’s central bank as a result of China’s status as the world’s second-largest economy. Prasad is right about the importance of China’s central bank in the world economy, but it is worth noting that by purchasing power parity (PPP) measures China is already by far the world’s largest economy.

Purchasing power parity calculations of GDP attempt to measure all the goods and services produced by a country with a common set of prices. This means we add up all the cars, tables, haircuts, knee surgeries etc. produced in both the US and China and assume that each item costs the same in both countries.

According to the projections from the IMF, China’s GDP is already 25 percent larger by this measure and will be almost 50 percent larger by the end of the projection period in 2022, as shown in the figure below.

Book3 11021 image001

Source: International Monetary Fund. Read more…

Steel tariffs and doctors: a teachable moment?

March 14, 2018 25 comments

from Dean Baker

Donald Trump’s tariffs on steel have elicited near universal condemnation. In addition to issuing warnings from retaliation by our trading partners, the media have also been giving us economics lessons on how steel tariffs will mean higher prices for consumers.

If we pay 10 percent more for our steel, then the price of cars and other items that use large amounts of steel can be expected to rise. This will reduce demand for these products and might cause consumers to buy more foreign cars and fewer US made cars, possibly leading to a loss of jobs in the auto industry.

This economics lesson can be useful, but perhaps we can extend this teaching moment to other areas. The basic point economists have been making is that large segments of the population benefit from having access to lower cost imported steel even if it means fewer jobs and lower pay for US steelworkers.

Over the last four decades our trade policy had been quite explicitly designed to put steelworkers and other manufacturing workers in direct competition with low-paid workers in the developing world. Trade deals made it as easy as possible for US corporations to locate factories in Mexico and other developing countries and import their production back into the United States.

We can take the same approach to trade of highly paid services, specifically the services provided by doctors, our highest paid professionals. Doctors in the United States earn on average more than $250,000 a year. That’s more than twice the average for their counterparts in other wealthy countries.  Read more…

It wasn’t the market that made elites incredibly rich, it was elites rigging the market to make themselves incredibly rich

February 27, 2018 11 comments

from Dean Baker

It is amazing how frequently we hear people asserting that the massive inequality we are now seeing in the United States is the result of an unfettered market. I realize that this is a convenient view for those who are on the upside of things, but it also happens to be nonsense.

Today’s highlighted nonsense pusher is Amy Chua, who warns in a NYT column about the destructive path the United States is now on where an disaffected white population takes out its wrath on economic elites and racial minorities. The key part missing from the story is that disaffected masses really do have a legitimate gripe.

We didn’t have to make patent and copyright monopolies ever longer and stronger, allowing folks like Bill Gates to get incredibly rich. We could have made Amazon pay the same sales tax as their mom and pop competitors, which would mean Jeff Bezos would not be incredibly rich. We could subject Wall Street financial transactions to the same sort of sales taxes as people pay on shoes and clothes, hugely downsizing the high incomes earned in this sector. And, we could have rules of corporate governance that make it easier for shareholders to rein in CEO pay.  Read more…

Bitcoin, efficient markets, and efficient financial sectors

February 16, 2018 5 comments

from Dean Baker

John Quiggin had a good piece in the NYT, pointing out how the sky-high valuations of Bitcoin undermine the efficient market hypothesis that plays a central role in much economic theory. In the strong form, we can count on markets to direct capital to its best possible uses. This means that government interventions of various types will lead to a less efficient allocation of capital and therefore slower economic growth.

Quiggin points out that this view is hard to reconcile with the dot-com bubble of the late 1990s and the housing bubble of the last decade. Massive amounts of capital were clearly directed towards poor uses in the form of companies that would never make a profit in the 1990s and houses that never should have been built in the last decade.

But Bitcoin takes this a step further. Bitcoin has no use. It makes no sense as currency and it is almost impossible to envision a scenario in which it would in the future. It has no aesthetic value, like a great painting or even a colorful stock certificate. It is literally nothing and worth nothing. Nonetheless, at its peak, the capitalization of Bitcoin was more than $300 billion. This suggests some heavy-duty inefficiency in the market.  Read more…

Jeff Bezos’ quest to find America’s stupidest mayor

February 14, 2018 2 comments

from Dean Baker

With the Super Bowl now behind us, America eagerly awaits the next big event: the announcement of the winner in Jeff Bezos’ contest to determine which combination of state and local governments is prepared to give him the most money to be home to Amazon’s new headquarters.

Narrowed from a field of more than 200 applications, 20 finalists now wait with baited breath for the news, expected sometime later this year. But while the politicians who join Bezos for the photo op are going to be treated as big winners, it is likely that the taxpayers they represent will be big losers, dishing out more to Amazon than they will ever get back in benefits.

Bezos’ “HQ2” contest is simply an extension of a game that corporations have been playing with state and local governments for the last four decades. Rather than making location decisions based on standard economic factors, like the availability of a skilled labor force, quality infrastructure, land prices and tax rates, they have persuaded governments to bid against each other with company-specific benefit packages ― usually a basket of tax concessions and sometimes even including commitments to build company-specific infrastructure like port facilities or roads.

However, most research indicates that the cost to state and local governments for these subsidies typically outweighs the benefits in terms of employment and tax revenue, including in the cases of Amazon’s growing network of fulfillment centersRead more…

One way to protect democracy is to stop pushing policies that redistribute income upward.

February 13, 2018 15 comments

from Dean Baker

That one is apparently not on the agenda, at least according to Amanda Taub’s NYT “The Interpreter” piece. The piece notes the declining support for center right and center left parties in most western democracies. While it notes that people feel unrepresented by these parties, it never states the obvious, these parties have consistently supported monetary, fiscal, trade, and intellectual property policies that redistribute an ever-larger share of income to people like Bill Gates and Robert Rubin.

It should not be surprising that most of the public is not enthralled with this outcome and the parties that promote it. And yes, there are alternatives, as I point out in my (free) book, Rigged: How Globalization and the Rules of the Modern Economy Were Structured to Make the Rich Richer

More thoughts on the stock crash

February 6, 2018 13 comments

from Dean Baker

Before anyone starts jumping off buildings, let me give you a few items to think about.

1) The stock market is not the economy. It moves in mysterious ways that often have little or nothing to do with the economy. In October of 1987 it plunged more than 20 percent in a single day. GDP grew 4.2 percent in 1988 and 3.7 percent in 1989. The market did recover much of its value over this period, but we don’t know whether or not it will recover the ground lost in the last week either.

2) The market has gone through an enormous run-up over the last nine years. The current level is more than 230 percent above its 2009 lows. That translates into an average nominal return of more than 14.0 percent annually, before taking into account dividends.

The gains have been even more rapid over the last two years. Even with the recent drop the market is more than 40 percent above its February 2016 level. Most people would have considered it crazy to predict the market would rise by 40 percent over the next two years back in February 2016. In other words, people who have invested heavily in the stock market have nothing to complain about. If they didn’t understand that it doesn’t always go up then they should keep their money in a savings account or certificates of deposit.  Read more…

The stock market plunges, a major blow against inequality!

February 4, 2018 10 comments

from Dean Baker

The stock market tumbled by 2.0 percent on Friday. Given that the top 1.0 percent hold a grossly disproportionate share of stock wealth, this means they took a big hit. Are we more equal as a society now?

Those who like to focus on wealth measures on inequality would have to say yes. And if the market continues to fall (not a prediction, but it certainly is possible that the correction will continue) then we will see further gain on the inequality front. Suppose it falls 30 to 40 percent, bringing price to earnings ratios closer to historic averages. Will the country then look much different than it does today?

I’m inclined to say no, at least if the distribution of income has not changed. To my view, the major story on inequality over the last four decades has been the more than doubling of the share of income that goes to the 1.0 percent, from less than 10 percent in the 1970s to slightly more than 20 percent today. The top 0.1 percent have been the biggest gainers in this picture.

Wealth has not always followed the same pattern, since so much of the wealth of the rich is tied up in stock. We had two big plunges in the stock market during this period, 2000 to 2002, when it fell by more than half, and again between 2007 and 2009. It’s hard to see how the poor and middle class were doing any better at these troughs in wealth (2002 and 2009) than they were when wealth was at its peaks before the crashes.   Read more…

Former AIG director Martin Feldstein warns of stock and housing bubbles

January 15, 2018 2 comments

from Dean Baker

That’s one of the things we learn from reading Robert Samuelson’s Washington Post columntoday, although Samuelson identifies Feldstein only by his professorship at Harvard, not his moonlighting work on AIG’s board. (In addition to requiring a massive government bailout during Feldstein’s tenure as a director, AIG was also rocked by an accounting scandal that forced the resignation of its Maurice Greenberg, its longtime CEO.) I’m one of those old-fashioned types who think that track records should matter in assessing the accuracy of economists’ assessments, which is why it is appropriate to mention AIG here.

While it would have been enormously valuable if a person of Feldstein’s prominence had warned of the housing bubble back in 2003 or 2004, before it had grown so large as to pose a major threat to the economy, his warning now is off the mark according to some of us who did see the earlier bubbles. High stock prices and housing prices are justified by extraordinarily low interest rates we have been seeing in the last decade.

While this could change (interest rates could rise) it would not be nearly as harmful to the economy as the collapse of the housing bubble in 2007-2009 or the collapse of the stock bubble in 2000-2002. Unlike in those two earlier periods, the high asset prices in these markets are not driving the economy. Investment and housing construction are not especially strong, so there is no reason to think they would plummet even if prices in both markets were to fall 20 or 30 percent. Consumption is somewhat high, and could fall back 1-3 percentage points of GDP in response to the loss of wealth implied by these sorts of declines. That would slow growth, but need not lead to a recession.

Tesla, Amazon, and Bitcoin

January 9, 2018 13 comments

from Dean Baker

The soaring price of Bitcoin is a useful lesson about markets for people who seem to very quickly forget the last lesson. Bitcoin, a digital algorithm, backed by absolutely nothing, has been selling for more than $16,000.

Perhaps Bitcoin’s price will double or triple again. After all, who knows how badly people need digital currencies that are not really currencies? But more likely the market will run out of people who are willing to trade real money for nothing. At that point Bitcoin’s price will plunge and may approach its underlying value of zero.

In the meantime the price surge shows us that markets are capable of enormous amounts of irrationality. This is helpful for people who can’t remember the stock bubble at the end of the 1990s. Favored stocks, like AOL, often reached price to earnings ratios in the stratosphere, if they even had earnings. In AOL’s case, its market valuation topped out at more than $220 billion in December of 1999. When it was sold to Verizon sixteen years later the company was worth just over $4 billion. Many other high flyers of the bubble years, like Webvan and Pets.com, simply went out of business.

For those who consider 1999 and 2000 the distant past, we need only go back to 2006 and 2007 when subprime mortgage backed securities (MBS) all got top investment grade ratings from the bond rating agencies. These MBS were worth just a small fraction of their face value a couple of years later after the housing bubble burst. Nonetheless, “informed” investors placed trillions of dollars in MBS assuming them to be almost as safe as U.S. government bonds.  Read more…

Diverting class warfare into generational warfare: round LVIII

January 3, 2018 8 comments

from Dean Baker

With the Republicans having just passed a $1.5 trillion tax cut, the bulk of which goes to the richest one percent, it was inevitable that the generational warriors would come out of the woodwork and resume the attack on Social Security and Medicare. Generational warriors try to divert attention away from how our economy has redistributed income upwards over the last four decades, and convince a large portion of today’s workers that their real problems stem from their parents’ and grandparents’ overly generous retirement benefits.

The opening shot in this new round of generational warfare showed up earlier this month in The Atlantic Magazine. It told the classic story about how seniors are getting too much money back from Social Security and Medicare, the same thing we’ve been seeing for decades. (There is little expectation of originality if you’re in the business of promoting generational warfare.)

In fact, middle-income seniors will get somewhat less back from Social Security than they paid into the system. The cost of Medicare benefits does exceed their taxes, but this is because Americans pay twice as much for our doctors, drugs, medical equipment and other health care items than people in other wealthy countries.   Read more…