Income mobility in the U.S.

Five weeks ago the Wall Street Journal (WSJ) commented on a study (pdf) by the Treasury Department on the income mobility of American families. The newspaper proudly reported that 58 percent of households who were in the lowest quintile (the poorest 20 percent) of the income distribution in 1996 had moved to a higher income category by 2005. Almost 25 percent jumped into the middle or upper-middle income groups, and 5.3 percent made it all the way to the highest quintile. (See Table 1.) Of those in the second lowest quintile, almost 50 percent moved up and 17 percent moved down. The WSJ’s comment on table 1 stopped there. The evidence was described as "a stunning show of income mobility."

Table 1. Income mobility of American households, 1996 to 2005 (click to enlarge)


Note: an entry in the table is the percentage of households that move from the row quintile (1996) to the column quintile (2005). Examples: 28.6 percent of households that were in the lowest quintile in 1996 had moved to the second quintile in 2005; 50 (26.7+15.1+7.9) percent of households in the second quintile moved to a higher quintile.

Let’s look a bit longer at this cup of water, and then decide whether it’s half full or half empty. First of all, look at how “thick” the NW-SE diagonal of that table is. The poorest households have a 42 percent chance of staying in their original group; no other group displays such a degree of immobility, except the very richest. In the second richest group, 70 percent of households stay put or move up; 69 percent of households in the top group stays on top.

So this is my one-line reading of Table 1: many people do move, but they don’t get far from the echelon they started at. (To be fair, people in the middle of the distribution do have a good shot at movin’ on up: 42 percent of them climb to the upper-middle or upper class; 25 percent join the lower or lower-middle class.)

Second, moving up one step when you’re poor means much less in terms of absolute income than when you’re rich. According to data from the Survey of Consumer Finances (SCF) (pdf), in 1995 the median family (*) in the lowest quintile had an income of $8,500 (in constant prices of 2004). If that household had moved to the next higher group in 2005, its earnings would have risen to $25,700, i.e. a $17,200 increase. A household that had moved from the middle to the fourth group would have seen its income increase from $37,800 to $68,100, that is, a $30,300 increase. (See Table 2.)

Table 2. Median incomes, by income percentile (thousands of dollars, at constant prices of 2004) (click to enlarge)


The WSJ also presented a graph with the increase in median income between 1996 and 2005, by groups (see chart nearby). The chart shows that “the poorer an individual or household was in 1996 the greater the percentage income gain after 10 years.” For households in the first quintile, for instance, income rose by 90.5 percent between 1996 and 2005, whereas households in the second quintile only got 34.8 percent richer. Families in the top 10 percent of the scale experienced a 2.9 percent raise.

A 90.5 percent increase doesn’t make you rich when you’re making so little money. Using data from Table 2, a family in the lowest quintile would have seen its earnings increase by $7,700 (90.5 percent over $8,500). For a household in the second quintile, income would have risen by $7,552. (See Chart 2.) Considering that their incomes in 2004 would have stood at $16,200 and $29,300, respectively, nobody would say that they "made it."

Chart 2. (click to enlarge)
















The US is a society of extreme inequality – there isn’t much argument about this. Inequality is less of a problem, however, if people have a chance of becoming significantly wealthier regardless of how poor they are. Inequality reflects the extreme rewards to success; income mobility measures the opportunities to achieve that success.

Unfortunately, my impression is that large income gains are less likely than the WSJ believes. Over the next ten-year period, I would expect most households to experience changes of plus or minus $10,000 – clearly not enough to climb the income ladder.

(*) The median family is the one in the middle of the income distribution, with half of the families having higher incomes and half having lower incomes.

Technorati tags: economics, income mobility, inequality, income inequality, upward mobility

Nouriel Roubini: "clear by now that a severe U.S. recession is inevitable in next few months."

Nouriel Roubini, a leading economist at New York University, is now saying that a US Recession is almost here:

"It is increasingly clear by now that a severe U.S. recession is inevitable in next few months. Those of us who warned for the last 12 months about a combination of a worsening housing recession, a severe credit crunch and financial meltdown, high oil prices and a saving-less and debt-burdened consumers being on the ropes causing an economy-wide recession were repeatedly rebuffed the consensus view about a soft landing given the presumed resilience of the US consumer."

"But the evidence is now building that an ugly recession is inevitable."

Roubini is a smart economist who often goes against the consensus view.

Obama vs. McCain, and The Four Stories of American Life

The following is adapted from a piece I did a couple of years ago for The New Republic. (Thanks to Brad DeLong for reminding me.)

I

Since Ronald Reagan, Republicans understood better than Democrats the art of the political narrative. They succeeded in speaking to the basic stories that have defined and animated the United States since its founding, while Democrats have tended to speak in technocratic terms. With Barack Obama, that is changing.

There are four essential American stories. The first two are about hope; the second two are about fear. Obama has reclaimed the former. His challenge -- especially when McCain is his opponent -- is to figure out how to reclaim the latter.

1. The Triumphant Individual. This is the familiar tale of the little guy who works hard, takes risks, believes in himself, and eventually gains wealth, fame, and honor. It's the story of the self-made man (or, more recently, woman) who bucks the odds, spurns the naysayers, and shows what can be done with enough gumption and guts. He's instantly recognizable: plainspoken, self-reliant, and uncompromising in his ideals--the underdog who makes it through hard work and faith in himself. Benjamin Franklin's Autobiography is the first in a long line of U.S. self-help manuals about how to make it through self-sacrifice and diligence. The story is epitomized in the life of Abe Lincoln, born in a log cabin, who believed that "the value of life is to improve one's condition." The theme was captured in Horatio Alger's hundred or so novellas, whose heroes all rise promptly and predictably from rags to riches. It's celebrated in the tales of immigrant peddlers who become millionaire tycoons. And it's found in the manifold stories of downtrodden fighters who undertake dangerous quests and find money and glory. Think Rocky Balboa, Norma Rae, and Erin Brockovich. The moral: With enough effort and courage, anyone can make it in the United States.

2. The Benevolent Community. This is the story of neighbors and friends who roll up their sleeves and pitch in for the common good. Its earliest formulation was John Winthrop's "A Model of Christian Charity," delivered on board a ship in Salem Harbor just before the Puritans landed in 1630--a version of Matthew's Sermon on the Mount, in which the new settlers would be "as a City upon a Hill," "delight in each other," and be "of the same body." Similar communitarian and religious images were found among the abolitionists, suffragettes, and civil rights activists of the 1950s and 1960s. "I have a dream that every valley shall be exalted, every hill and mountain shall be made low," said Martin Luther King Jr., extolling the ideal of the national community. The story is captured in the iconic New England town meeting, in frontier settlers erecting one another's barns, in neighbors volunteering as firefighters and librarians, and in small towns sending their high school achievers to college and their boys off to fight foreign wars. It suffuses Norman Rockwell's paintings and Frank Capra's movies. Consider the last scene in It's a Wonderful Life, when George learns he can count on his neighbors' generosity and goodness, just as they had always counted on him.

3. The Mob at the Gates. In this story, the United States is a beacon light of virtue in a world of darkness, uniquely blessed but continuously endangered by foreign menaces. Hence our endless efforts to contain the barbarism and tyranny beyond our borders. Daniel Boone fought Indians--white America's first evil empire. Davy Crockett battled Mexicans. The story is found in the Whig's anti-English and pro-tariff histories of the United States, in the antiimmigration harangues of the late nineteenth century, and in World War II accounts of Nazi and Japanese barbarism. It animates modern epics about space explorers (often sporting the stars and stripes) battling alien creatures bent on destroying the world. The narrative gave special force to cold war tales during the '50s of an international communist plot to undermine U.S. democracy and subsequently of "evil" empires and axes. The underlying lesson: We must maintain vigilance, lest diabolical forces overwhelm us.

4. The Rot at the Top. The last story concerns the malevolence of powerful elites. It's a tale of corruption, decadence, and irresponsibility in high places--of conspiracy against the common citizen. It started with King George III, and, to this day, it shapes the way we view government--mostly with distrust. The great bullies of American fiction have often symbolized Rot at the Top: William Faulkner's Flem Snopes, Willie Stark as the Huey Long-like character in All the King's Men, Lionel Barrymore's demonic Mr. Potter in It's a Wonderful Life, and the antagonists that hound the Joad family in The Grapes of Wrath. Suspicions about Rot at the Top have inspired what historian Richard Hofstadter called the paranoid style in U.S. politics--from the pre-Civil War Know-Nothings and Anti-Masonic movements through the Ku Klux Klan and Senator Joseph McCarthy's witch hunts. The myth has also given force to the great populist movements of U.S. history, from Andrew Jackson's attack on the Bank of the United States in the 1830s through William Jennings Bryan's prairie populism of the 1890s.

Speak to these four stories and you resonate with the tales Americans have been telling each other since our founding--the two hopeful stories rendered more vivid by contrast to the two fearful ones. But the challenge isn't just to find a good speechwriter or a cunning political consultant, or to mine focus groups and polls. Candidates must say what they believe and speak the truth as they see it. (Americans can spot a fake thousands of miles away.)

These four mental boxes are always going to be filled somehow--if not by Democrats, then by Republicans--because people don't think in terms of isolated policies or issues. If they're to be understandable, policies and issues must fit into larger narratives about where we have been as a nation, what we are up against, and where we could be going. Major shifts in governance--in party alignments and political views--have been precipitated by one party or the other becoming better at telling these four stories.


II


In the early decades of the twentieth century, progressives and Democrats filled all four boxes. They accused leaders of big business of being the Rot at the Top. They argued that the large industrial concentrations of the era, the trusts, were stifling the upward mobility of millions of potential Triumphant Individuals and poisoning democracy. During his 1912 campaign, Woodrow Wilson promised to wage "a crusade against powers that have governed us ... that have limited our development, that have determined our lives, that have set us in a straightjacket to do as they please." The struggle to break up the trusts would be nothing less than "a second struggle for emancipation," by a national Benevolent Community intent on restoring freedom and democracy. Wilson's Mob at the Gates, meanwhile, was composed of the large, bellicose states of prewar Europe who posed similar challenges to democratic freedoms. Wilson grimly rallied Americans to "defeat once and for all ... the sinister forces" that rendered peace impossible.

Theodore Roosevelt, of course, shared Wilson's antipathy toward trusts, but, by the 1920s, Republicans were mostly apologists for big business and Wall Street. That was OK with Americans as long as the economy roared, but it left the Grand Old Party vulnerable in harder times, which soon came. Their approach to foreign policy was mainly to avoid the Mob at the Gates--close the doors to immigrants, erect tariff walls, and isolate the nation. They celebrated the wealth of Triumphant Individuals but didn't champion upward mobility or equal opportunity, and they offered no particular view of the United States as a Benevolent Community. As such, they stayed firmly in the minority most of the first half of the twentieth century.

Indeed, the Great Depression and World War II presented the United States with palpable illustrations of the Democratic stories. By the 1930s, the Rot at the Top included Wall Street as well as big business. In the 1936 presidential campaign, Franklin D. Roosevelt warned against "economic royalists" who had impressed the whole of society into service. "The hours men and women worked, the wages they received, the conditions of their labor ... these had passed beyond the control of the people, and were imposed by this new industrial dictatorship," he warned. What was at stake, he concluded, was nothing less than the "survival of democracy."

To cope with the Depression, Americans needed a national Benevolent Community. "I see one-third of our nation ill-housed, ill-clad, ill-nourished," FDR told a nation whose citizens clearly understood they were all in this together. He described the purpose of the New Deal as "extending to our national life the old principle of the local community." "We are determined," Roosevelt said, "to make every American citizen the subject of his country's interest and concern." The Social Security Act was not just a social insurance scheme, but the very symbol of national solidarity. Henceforth, all American families would share the risk of becoming unemployed or losing the family's breadwinner or retiring without adequate savings. And then, of course, came Adolf Hitler's war, which cemented this national unity as FDR led the country into battle with the most fearsome Mob at the Gates it had ever encountered, over the objections of Republican isolationists.

Democrats managed the transition from Depression and world war to postwar prosperity and the cold war with only slight alterations in story line. The Benevolent Community remained at the core of Harry S Truman's Fair Deal, John F. Kennedy's New Frontier, and Lyndon Johnson's Great Society. The upwardly mobile Triumphant Individual depended on federal provisions--the G.I. bill, government-backed mortgages, a guarantee of equal civil rights. Meanwhile, the Democrats continued their assault on the Mob at the Gates, but now the Mob was the dangerous and expansive Soviet Union. Truman stopped the communists in Korea. Kennedy stopped them in Berlin and during the Cuban missile crisis. And he tried to stop them in Vietnam, which he saw as "the finger in the dike" holding back the Soviets. Johnson, of course, tragically tried and failed to erect a dam against the North Vietnamese and their patrons. While Republicans continued to wrestle with the isolationists and nervous Nellies--such as Senator Robert Taft of Ohio--Democrats spoke of paying any price and bearing any burden to protect the United States.

But, in the '60s, the Rot at the Top gradually dropped out of the Democratic message. Gone were tales of greedy businessmen or unscrupulous financiers. This was partly because the economy had changed profoundly. Postwar prosperity allowed the middle class to explode in size and the gap between rich and poor to shrink. White-collar workers were now abundant, and blue-collar workers got generous wage increases that could be absorbed by the huge postwar market. Rot at the Top rhetoric was also a casualty of the Vietnam War, which spawned an anti-establishment and antiauthoritarian New Left and split Democrats down the middle. For many liberals, the Rot came to be personified by Johnson, his defense secretary, Robert McNamara, and even the federal government itself. (Ironically, Richard Nixon's White House and the Watergate scandal would hurt the Democrats, too, by confirming that the Rot at the Top was to be found in government rather than among business elites.)

The Vietnam War also undermined Democrats' confidence about the Mob at the Gates. Soviet communism remained dangerous, to be sure, but the McGovern wing of the party had no clear plan of action. Indeed, its approach seemed redolent of the Republican isolationists of the earlier part of the century, who wanted the United States simply to turn its back on the Mob. And, after President Carter and the hostage crisis, even when Democrats did try to tell this story, they seemed uncertain of themselves. In short, Democrats and progressives came off as confused and conflicted about the dangers the United States faced. They stopped talking both about the Rot at the Top and about the Mob at the Gates, and thus ceased giving Americans convincing stories about what the nation was up against.

Enter Ronald Reagan, master storyteller, who jumped into the conceptual breach that Democrats had left open. For Reagan, the Mob at the Gates was not merely a Soviet Union that needed to be contained, but an Evil Empire that had to be destroyed. The Rot at the Top was big government--Washington insiders and arrogant bureaucrats who stifled Triumphant Individuals--and the Benevolent Community's foundation was not New Deal-style programs but small, traditional neighborhoods in which people voluntarily helped one another, free from government interference. (Social spending could be cut, therefore, without threatening the mythology of benevolence.) The Triumphant Individual, meanwhile, was no longer the little guy in need of a helping hand, but the business entrepreneur who would spawn new companies and industries if unencumbered by government regulations and taxes. Through the alchemy of supply-side ("trickle-down") economics, his self-enriching triumphs would, it was said, help us all. Reagan's overall message was as hopeful and upbeat as FDR's: "America is back and standing tall," Reagan said in 1984. "We've begun to restore the great American values--the dignity of work, the warmth of family, the strength of neighborhood, and the nourishment of human freedom."

Democrats never regained the capacity to tell their versions of the stories. Even when the implosion of the Soviet Union ended one of the Republicans' most powerful stories and temporarily left the United States without a Mob at the Gates, the stories American politicians told remained Republican stories. The Rot at the Top was still big government. To be sure, Bill Clinton won the presidency in 1992 promising to "fight for the forgotten middle class" against the forces of "greed," but Clinton inherited such a huge budget deficit from George H.W. Bush that he couldn't put up much of a fight. And, after losing his bid for universal health care, Clinton himself announced that the era of big government was over--and he proved it by ending welfare. Clinton's Benevolent Community remained, as it was under his Republican predecessors, a nation of volunteers; Clinton appointed a commission on volunteerism and encouraged the private sector to offer jobs to former welfare recipients. And he urged would-be Triumphant Individuals (who were working harder than ever with no appreciable increase in pay and benefits) to embrace a new covenant of personal "opportunity and responsibility."


III


Under George W. Bush, the stories have changed somewhat, but all continue to reflect Republican values, crowding out Democratic interpretations. The September 11 terrorist attacks, of course, powerfully revived the Mob at the Gates tale, and, although Bush never quite connected the dots between global terrorists and his Axis of Evil (including Saddam Hussein), the basic story line he offered was familiar enough to give the Bush presidency a compelling mission. By Bush's second inaugural, that mission had grown even larger--a battle against tyrants and oppressors all over the world, similar to those Wilson had railed against almost 90 years before, and perfectly fitting the mental box Americans have always reserved for the Mob at the Gates.

Bush's Triumphant Individual, meanwhile, is a property owner who achieves the "dignity and security of economic independence" by getting rich off his assets, as Bush put it in his second inaugural. The "ownership society" is intended, as Bush explained, to make "every citizen an agent of his or her own destiny." In this universe, there is no more need for national benevolence. In fact, Social Security--which had been the very symbol of FDR's Benevolent Community--is to be turned into private accounts that Triumphant Individuals can use to gain personal wealth. In Bush's retelling, the Benevolent Community is found in religious congregations--in "faith-based" organizations that "rally the armies of compassion in our communities to fight a very different war against poverty and hopelessness, a daily battle waged house to house and heart to heart." Not even the Indian Ocean tsunami initially deserved much by way of official government aid. U.S. benevolence found expression instead in the voluntary contributions of corporations and private citizens. "The greatest source of America's generosity is not our government," Bush explained when he appointed his father and Clinton to head a relief commission. "It's the good heart of the American people."

But it is in the retelling of the story about the Rot at the Top that the younger Bush and his cohorts have departed most from preceding Republican versions. Rather than big government, their Rot is lodged in America's "cultural elites"--depicted as influential liberals in prestigious coastal universities, the upper strata of New York and Hollywood, and the media. This Rot disdains ordinary working Americans, rejects religion and patriotism, celebrates Hollywood's licentiousness, and seeks to impose sexual permissiveness--including abortion and gay marriage--on good, God-fearing Americans.

A TV advertisement aired in 2003 by a conservative group during the Democratic primary campaign described this new Rot as a "tax-hiking, government-spending, latte-drinking, sushi-eating, Volvo-driving, New York Times-reading, body-piercing, Hollywood-loving, left-wing freak show," and, in the general election campaign, Republicans repeatedly attacked John Kerry as a "Massachusetts liberal" who was part of the "Chardonnay-and-brie set." Bush mocked Kerry for finding a "new nuance" each day on Iraq, drawing out the word "nuance" to emphasize Kerry's French cultural elitism. "In Texas, we don't do nuance," he said, to laughter and applause. House Republican leader Tom DeLay opened his campaign speeches by saying "Good morning, or, as John Kerry would say, 'Bonjour.'"

What were Democrats to do? All their stories had been replaced. In the 2004 election, Kerry argued forcefully that Bush's Iraq policy would not succeed against terrorism and that Bush's tax cuts for the wealthy should be repealed in order to generate enough revenue for a modest step toward universally affordable health care. But Kerry failed to place these and his other policy prescriptions into the four stories that Americans had always heard and that made sense of the world they knew. As a result, Kerry's policies lacked context and meaning. Where did Kerry want to take the United States? What did he stand for? Absent a clear narrative about the Mob, the Rot, the Benevolent, and the Triumphant, his policies were just ... policies. As such, they were no match for Bush's convictions about what America should do--no match, in other words, for Bush's recasting of the Mob at the Gates as vicious terrorists that had to be killed or would kill us (and against whom, he said, Kerry could not be trusted to use force); of the Triumphant Individual as people free to pursue individual wealth (whom Kerry would smother with taxes); of the Benevolent Community as a collection of religious people with heart (of whom Kerry was contemptuous); and of the Rot at the Top as an arrogant cultural elite (of which Kerry himself was a member).


IV


The challenge for Democrats and progressives is not simply to manufacture a new set of stories but to find and tell stories that match their convictions. The stories must also resonate with what Americans sense to be the truth. Democrats might say, for example, that the Mob at the Gates isn't global terrorism and it's not despotic tyrants. Terrorism is a technique, and tyrants exist all over the world (are we going to invade China?). There is a Mob out there, though. They are global gangs of thugs like Al Qaeda--and they are dangerous. They must be met by force. They must also be policed--their movements monitored, their access to dangerous weapons denied, their ranks infiltrated. But the United States can't police them alone. We need a new global alliance against terrorist organizations, led by the United States. (Democrats created nato; maybe now it's time for gato, a Global Anti-Terrorist Organization.) Meanwhile, America's potential Triumphant Individuals depend critically on two things to prosper in the new economy: a good education and good medical care. (This was the subtext of the riveting story Senator Barack Obama told at the 2004 Democratic National Convention.) Almost every American family is struggling to obtain them. Yet, if we join together in a Benevolent Community to provide them to every American citizen, all of us stand to gain. The rising tide of productivity and wealth will lift the nation as a whole.

In this retelling, the main thing holding us back is the Rot at the Top--concentrated wealth and power to a degree we haven't seen in this nation since the late nineteenth century. Mammoth corporations and hugely rich individuals have abused their power and wealth to corrupt our democracy, take over much of our media, give executives stratospheric pay packages while firing workers, and pad their nests with special tax breaks and corporate welfare. In this, they have been helped by a Republican Congress and White House whose guiding ideology seems less capitalism than cronyism, as shown time and again through legislative sops to the pharmaceutical industry, the credit card companies, and Wall Street. (Indeed, with its mounting ethical troubles, the GOP's congressional leadership is fast becoming another example of Rot at the Top--an example the Democrats could seize on as Gingrich and company did in 1994.) Or, as Al Gore said in 2000, in a remarkably prescient speech, George W. Bush was bankrolled by "a new generation of special interest power brokers who would like nothing better than a pliant president who would bend public policy to suit their purposes and profits." Gore came in for a lot of criticism after his defeat from Democrats who felt uncomfortable with his description of a nation divided between "the people" and "the powerful." But Al Gore was on to something. After all, he got the most votes.

As the contest unfolds between Obama and McCain, listen carefully for their stories of hope and fear.

Movie theaters vs distributors

A YouTube video is worth more than a thousand words. The website of the National Association of Theatre Owners, the other NATO, greets its visitors with an animated feature of theater food singing “Let’s all go to the lobby to get ourselves a treat.” (Watch it below.) No MGM lion or flashy presentation of digital theaters, no: animated pop-corn bags and cups of soda practically begging you to buy food when you go to the movies.



This funny detail is telling of how hard it is for theaters to turn a decent profit from ticket sales alone. With admissions at $10 and an endless series of blockbusters, what gives? At the risk of spoiling this movie, the answer lies in the distribution of power between distributors and exhibitors.

Let's have a look at the revenues and costs per patron of Regal Entertainment, the largest movie exhibitor in the US. (Data from the company's financial statements.) The average price of a ticket in 2006 was $6.98, $3.67 of which went to pay for the film’s rental and advertising, leaving the theater with $3.31 ($6.98 - $3.67) in gross operating margin. Food and beverage sales, on the other hand, brought $2.82 per patron, but cost Regal just $0.42, resulting in a gross operating margin of $2.40 per head from concession sales.

Chart 1 (click to enlarge)

Regal also incurred operating costs, corresponding to labor and capital shared by the movie and the concession operations (rent, salaries, depreciation and amortization, etc.). I impute 20 percent of those costs to concessions, which is probably an overestimation – after all, the pop-corn stand uses much less than 20 percent of the space, personnel and equipment. After including overhead costs, Regal lost $0.82 on every ticket sold, whereas it made a $1.36 margin on concessions. (See Chart 1.)

Given that the exhibitors’ profitability depends so critically on popcorn and Milk Duds, I wonder why they don’t market concession treats more aggressively. In most theaters patrons have access to the concession stand only after they have purchased and validated their movie ticket. Theaters could increase revenues by setting up sale points in front of the box office, not behind. In addition to feeding people who are standing in line to buy a ticket, those stands could generate sales from passers-by who have no intention to see a movie – I find it a bit odd, but many people seem to enjoy extra buttery popcorn and movie nachos even when they’re not distracted by a screen. I also wonder why, in general, theaters don’t sell movie merchandise – caps, T-shirts, Spiderman masks, golf balls with Gollum’s face on them, what have you.

The breakdown of profits I showed above does not imply that selling movie tickets is a ruinous business. Remember: the unit profit from tickets is negative only after including overhead costs. Because those costs are largely invariant to the number of patrons, higher attendance would increase the average unit profit from admissions Cheaper tickets would raise patronage -- and the highly profitable concession sales that come with it. Unfortunately (for theaters) distributors have the upper hand.

Seven companies controlled the release of the top 20 films in 2007, which made up 44 percent of annual box office revenue as of December 15. The exhibition industry is on the opposite end of the concentration spectrum: the largest theater operator owns just nine percent of all sites; the second largest exhibitor owns about five percent. Theaters are in no position to choose who they rent films from.


Adding to their bargaining power, distributors derive an increasing share of their revenues from the rental and sale of DVDs. In a not too distant future, distribution could bypass theaters entirely. A recent paper in the Journal of Marketing estimated that film studios could increase revenues by 16 percent if films were simultaneously released in theater, on rental DVD and video-on-demand, with a three-month window to DVD retail. On the flip side, theater revenues would drop by 40 percent: a death sentence.

As a result, distributors are able to control ticket prices. The exhibitor would gladly set lower rates to increase patronage -- and the lucrative concession business that comes with it. The distributor, on the other hand, only cares about ticket sales, so it enforces an admission rate that is above the exhibitor’s optimum. (A related question is why ticket prices are uniform, but that may deserve a post of its own. In the meantime, read Tyler Cowen’s blog post at Marginal Revolution.)

Another manifestation of the power of distributors is the terms of exhibition contracts. Most agreements between exhibitors and distributors call for a sliding percentage of box office revenues. For example, a contract may specify a 90:10 split during the first week (10 percent for the exhibitor), 80:20 the second week, 70:30 the third week, and so on. In case a film does not perform up to expectations, the distributor also has the right to a certain minimum payment. That the distributor shares an increasing share of the revenue goes against the exhibitor, because demand for a film falls sharply over the weeks.

Chart 2. Movie-going market share (percentage of American population that attended a movie)
by week, between 1985 and 1999 (click to enlarge)

Last, but not least relevant, distributors control the timing of releases. Because the distributor earns most of its revenue over the first two or three weeks of the movie’s screen life, openings are tightly spaced -- at any rate, too tightly spaced from the theater’s point of view. The glut is apparent over the summer and on holiday weeks, when underlying demand is strongest (see Chart 2, from Orbach and Einav, 2007). And the trend seems to become stronger over time: 33 films are opening this December, compared with 21 over the same period in 1999 (data for 1999 come from Einav’s Stata data file).

The obvious solution to the conflict of interest between exhibitors and distributors is vertical integration. But a 1948 decision by the Supreme Court forbids it. The ruling followed an antitrust lawsuit between the federal government and the big studios. One of the objectives of the court was to allow exhibitors to select which movies they would show. In retrospect, and putting it kindly, the ruling fell short of meeting its goal.

An alternative strategy would be to join forces. An exhibitor with significant market share at the national level would have bargaining power against distributors. From a regulatory standpoint, a merger between theaters can pass an anti-trust test. Courts are usually concerned about the effect of industry concentration on the price, quality and selection of the final product. But a merger between theater chains need not raise such concerns if the merged company divests from local markets where it otherwise would have a monopoly.


Most recently, the ruling in the antitrust case between Whole Foods-Wild Oats and the Federal Trade Comission went along those lines. The government argued that integration of the two retailers would increase prices and reduce the quality of their foods. The court eventually decided in favor of the defendants – the reasoning was that, locally, the presence of other stores guaranteed a reasonable level of competition.

Some mergers have actually taken place in the recent past. Cinemark purchased Century Theaters in August of 2006; and AMC merged with Loews Cineplex in 2005. The latest move in the industry seems to be increasing the quality of the movie-going experience. As recently as December 7, AMC reached an agreement with Imax to buy 100 of its screens and digital equipment. Three other big chains –Regal, Cinemark and Carmike – are also investing in Imax technology, albeit at smaller scales. The idea, I can only imagine, is to charge a higher price for Imax shows.

My prediction is that, not too long from now, theaters will become advertising venues. They will show only big budget films with lots of special effects -- the kind that's really worth seeing on a giant screen and generates lots of DVD sales. Theaters will have the Beowulfs, Spidermans and Pirates. And, of course, they’ll always have Paris… I mean… popcorn.

Further reading and resources:

• Einav (2007) Seasonality in the U.S. motion picture industry (pdf)

• Orbach and Einav (2007) Uniform prices for differentiated goods: the case of the movie-theater industry (pdf)

• National Association of Theatre Owners (html)

• Vogel (2001) Entertainment industry economics: a guide for financial analysis (Google book)

• Box office data: Boxofficemojo.com, Media by Numbers

Technorati tags: economics, movies, movie exhibition, movie distribution, industrial organization

Economist: America's Vulnerable Economy

America's Vulnerable Economy

The Battle of the Century

I'm not talking about Hillary Clinton and Barack Obama, at least not at the moment. The battle is between Microsoft and Google.

Microsoft, the desktop-software giant, wants to move into the lucrative online search and advertising business. Google, the goliath of online search and advertising, naturally doesn't want it to. The pawn is the ailing Yahoo! Yahoo has said no to Microsoft's initial $44 billion bid, but it has few alternatives. Microsoft may sweeten the offer somewhat.

But if you think the final outcome will be decided by the shareholders of Yahoo and Microsoft, you don't know the real power plays, or players.

You see, Google and Microsoft both maintain armies of lobbyists and lawyers in Washington. Microsoft has had a big Washington presence for twelve years. Google opened its lobbying office two years ago. Both are hiring like mad, and feeding the stars of the Washington legal and lobbying fermament fat retainers. The two firms also have Political Action Committees which, according to the Center for Responsive Politics, have given generously to congressional leaders and members of antitrust committees on both sides of the aisle (as well as to a number of presidential candidates).

Now, I'm not suggesting outright payoffs, mind you. The money will
open important doors that the two armies of will enter with their paid experts and their finely-honed arguments and, of course, their implicit promises of future campaign donations. And eventually - after many months or even years, and millions more in payments from Microsoft and Google - one of these armies will win.

The official question to be debated in Congress and at the antitrust agencies will be whether it's more dangerous for Microsoft to be able to use Yahoo to extend its Windows operating system's market power on to the Internet, or for Google to gain increasing dominance over the Internet unopposed. But the answer will depend on which companies' Washington army is biggest, richest, and cleverest.

That's how lots of big economic decisions are made these days. Washington is engulfed by corporate lobbyists, lawyers, and campaign money because of just this sort of arm's race among big companies to gain competitive advantage over rivals through favorable laws and rulings.

Shareholders don't win. The public doesn't win. The only true winners are Washington's lobbyists and lawyers themselves (along with their public-relations staffs and hired-gun experts) -- whose numbers and earnings continue mushroom.

Here's where we get back to Clinton and Obama. Clinton is taking money from corporate lobbyists; she says there's nothing wrong with that. Obama isn't taking lobbyist money. Both have pledged to loosen the grip of lobbyists over Washington -- as has John McCain. But it won't happen until the corporate arm's race comes to an end.

How to end it? Let's hope our future president demands it. But one group that should join in the lead are the big institutional investors whose shareholders -- comprising investors in both Microsoft and Google -- would be better off if the race ended. The big institutions should be insisting on mutual de-escalation.

Insuring irreplaceable assets

Last Wednesday night my computer wouldn’t start up. This is my only computer, the laptop where I keep all my work, and which I haven’t backed up in a while. Understandably, I rush to contact the manufacturer’s support service. Diagnostic: dead hard-drive, DNR. The first technician I speak with suggests that I try to restart the computer with a back-up copy of the operating system, which, he tells me, “would erase everything in the HD.”

A personal computer full of data is a perfect example of an irreplaceable asset. And when I say “irreplaceable” I don’t necessarily mean it in a literal way. Many of my files can be downloaded from the internet or reconstructed, and I can redo my writings. But I would be willing to pay a lot more money than anybody else for that “replaceable” stuff.

Every possession has a personal value (how much it is worth to its owner) and a market value (the price the object would fetch in a sale). They’re equal for assets that the owner can substitute readily in the market. But the personal value can be higher than the market value for objects to which the owner attaches unique attributes. Those are the assets I call “irreplaceable*.”

A classic example is bottles of wine. A 1995 Bordeaux can be purchased in a store now, say, for $60; yet many people who bought a bottle of the exact same wine back in 1995 would not sell it for less than $80.

Assets acquire owner-specific attributes in multiple ways. Sometimes it’s the way in which the owner took possession (family heirlooms); some other times it’s the memories accumulated through years of use (clothes), or the memories they bring back (pictures). But oftentimes the reasons are less sentimental. I value my hard-drive above its market price because it contains information specific to my work, and nobody else’s.

Just as in the case of any other worthy asset, risk-averse individuals would insure irreplaceable assets against loss. And the insured amounts would not be based just on their market value, but on their higher, personal value. Nothing special here. Irreplaceable objects become an interesting economics topic, however, if their loss can shift the utility that their owners derive from wealth. In economics parlance, when people display state-dependent preferences.

As an illustration, consider the case of wealth and parenthood. Parents face two states of the world: in state one the children die, in state two they live. Of course, parents are better off if the kids survive than if they die. But it’s also true that they derive greater utility from an extra dollar of wealth if their kids survive.

State-dependent preferences affect the demand for insurance of assets. If insurance is purchased, an individual foregoes some wealth (the insurance premium) in the good state and receives a certain sum (the insured amount) in the bad state. Because an extra dollar is worth less in the bad state than in the good one, insuring the asset whose loss triggers the bad state is not a good deal. In any case, the premiums and insured amounts are smaller if preferences are state-dependent.

Continuing with the example above, would you buy life insurance for your kids? Most parents don’t. They save themselves the life insurance premiums, which they can spend with their kids in the good state. If the children die, the parents don’t get any money. But the loss of a child puts parents in a state where they don’t get much of a kick out of spending money anyway.


To use an example from the recent news: many American families choose not to have health insurance. Many millions more have low insurance coverage. I don’t mean to play down asymmetric information issues, which can make high coverage unaffordable. But it makes sense that a sick person, who is limited in the range of goods and services that she can consume, gets less utility out of an extra dollar of income than her healthy self. One must seriously consider the possibility that the observed heterogeneity in health insurance coverage arises simply from differences in state-dependent preferences across people.

In civil court cases it’s common to give a monetary compensation to the victim. The practice is as unavoidable as it is inefficient. Let’s say that an individual breaks his femur at work and becomes permanently disabled. The court finds that the accident was caused by the employer’s negligence and grants damages of one million dollars: $750K for lost earnings and $250K for the physical pain and psychological suffering. The $250K may not produce much utility now that the victim can’t walk or drive. And yet, what other form of compensation can be provided? Would an apology be any better?

Investments in prevention are usually more efficient than insurance at protecting individuals in the case of state-dependent preferences. Installing fire-proof ceilings and clearing brush will protect a house in a forested area when the inevitable wildfire occurs. Colonoscopies can prevent the occurrence of the bad state itself (colon cancer). Backing up the content of your hard drive avoids disaster when the bad state strikes.

This morning I called a company specialized in hard-drive recovery. They’ve told me that because the hard drive didn’t suffer any physical damage they should be able to retrieve most, if not all, of my data – which is all I needed to hear to switch to a more pleasant state (of mind) in which to spend my day.

* In this as in the rest of this post I follow the seminal analysis of Philip Cook and Daniel Graham, published in 1977 in the Quarterly Journal of Economics.

Technorati tags: economics, insurance, state dependent utility, irreplaceable asset, optimal insurance

Economy Slowing Says Calculated Risk

Great Blogger, Calculated Risk "Clearly the economy is slowing sharply"

The Huge Hole in Unemployment Insurance

We learned last Friday that payrolls shrunk by 17,000 in January, a job loss not seen since the tail end of the last recession, in 2003. And last week, the number of laid off workers filing applications for unemployment benefits soared by 69,000 to 375,000. It was the most new claims in one week since October, 2005, when Hurricane Katrina and other storms decimated the Gulf Coast.

Appropriately enough, the Senate is considering whether to lengthen the period of time people can collect unemployment benefits if they still can’t find a job after six months, which is how long unemployment insurance is now available. That’s sensible, but it doesn't fill a huge hole in the unemployment insurance system.

A new study by the Economic Policy Institute estimates almost 2 million job losers will run out of unemployment benefits this year unless benefits are extended. It’s not unusual to extend benefits during a recession, because recessions often last longer than six months and businesses don’t start hiring again until the economy picks up. And there are few better ways to stimulate the economy. Unemployment benefits put cash directly in the hands of people who need it most, and are most likely to spend it.

But running out of benefits isn’t the biggest problem facing job losers. It’s not getting benefits to begin with. The troubling fact is most people who lose their jobs simply don’t qualify.

That’s because the unemployment insurance system was designed more than a half century ago when most people who lost their jobs had been employed full-time for years, and when most households had one wage earner. Even though those realities have changed, the rules haven’t. In most states, you’re eligible for unemployment insurance only if you’ve lost a full-time job that you’ve had for quite a while.

This leaves out just about everyone who’s lost one or more part-time jobs. And also excludes any full-time worker who had been at the job less than a year before they got canned. It also excludes people who had to leave their job to accompany a working spouse to another city or state. Altogether, the current rules leave out more than half of the American workforce.

So it’s not enough merely to extend unemployment benefits. If Congress really wants to help the millions of Americans who will lose their jobs in the coming recession, and also stimulate the economy, it should make sure job-losers get benefits in the first place.

Questioning the virtues of the flat income tax

This Thursday I attended a seminar by the Cato Institute, a libertarian think tank, where one of the speakers presented “Will America become a French-style welfare state?” Cato’s answers to that question and to its normative counterpart were no surprise. What sounded out of tune was the claim that a flat tax will keep government growth in check. And that got me thinking that, maybe, we expect too much from it.

A flat tax is not necessarily more efficient

Strictly speaking, a flat income tax consists of a uniform tax rate on earnings. Everyone pays a given percentage of their taxable income, period. The flat tax eliminates the disincentive to work created by graduated tax rates, and reduces the payoff from tax avoidance shenanigans. Lower, flatter marginal tax rates thus raise total revenue. It’s as if the IRS adopted the latest Coca Cola mantra: “You give a little love and it all comes back to you.” But bigger tax revenues mean a bigger government. And a bigger government means bigger distortions, from larger farm subsidies and expanded welfare programs for example. It also means larger mismanaged health and education systems.

A subtler point is that governments seem to be less politically constrained to raise a uniform tax rate than a progressive one. For evidence we can look at a flat income tax the US has used since 1917 – we call it the Social Security (SS) tax. In 1955, the rate paid by workers was only 1.7 percent, but it more than quadrupled to 7.7 percent by 2006. On the other hand, the average income tax rate for a four-person family with median income was 5.7 percent in 2006 as well as in 1955. (See Chart 1.) Yes, the income tax increased till the early 1980s and then decreased. But that’s my point: the flat-rate SS tax has never decreased.





Chart 1 (click to enlarge)


Between 1962 and 2006 the ratio of social insurance taxes to GDP more than doubled; its income tax counterpart, on the other hand, didn’t change. (Revenue figures here, GDP data here.) Who’s to say that a flat income tax wouldn’t spiral up the same way the flat SS tax did?

I’m not sure what the reasons for this lack of political restraint are when it comes to jacking up the SS tax rate. Economists themselves may have contributed to it, by cheering on flat taxes on the grounds of economic efficiency. (Still, this doesn’t explain why the government didn’t offset those raises with reductions of the inefficient progressive income tax.)

In a political vacuum, a flat tax is more efficient than a progressive one. We just don't happen to live in one of those.

A flat tax is not necessarily simpler

As a reader of The Economist put it one time: “Computing a progressive income tax requires a subtraction, a multiplication and an addition. Computing a flat tax eliminates the addition.” A flat tax can be as complicated as one wants – it all depends on how many steps it takes to calculate taxable income.

A simple tax, on the other hand, doesn’t need to be a flat tax. Republican candidate Fred Thompson reports the Wall Street Journal.

The proposed system is voluntary. Tax filers would be allowed use the current tax code instead. But who in his right mind would do that? Well, probably a few wealthy people with lots of loopholes to exploit. The vast majority, I reckon, would choose the simple tax – maybe even if they were saving a few bucks with the old one. And this is the great tragedy of our current tax code. It provides incentives to hire tax consultants, buy tax preparation software, and spend countless hours trying to figure out which deductions tax filers can use. In terms of tax savings, the return on all that labor is small or negative. Give taxpayers the mere option to bypass the mess, and you’ll wipe out all that waste.

We don’t know whether a flat income tax promotes growth

Gung-ho advocates routinely bring up evidence from countries that have implemented the flat tax. Aside from the tiny islands of Jersey and Guernsey, and the city of Hong Kong, all these countries are in Eastern Europe and Central Asia (Kazakhstan and Kyrgyzstan). (See map; the light-blue countries will introduce the flat tax in 2008, except for Poland, which is still thinking about it.)

Most, if not all of them, experienced increases in macroeconomic growth, tax revenues, tax compliance and investment. It just so happens that those countries went through a lot of other reforms. For example, they improved on the protection of property rights and the enforcement of contracts.

They also slashed the corporate tax rate. But Ireland has attracted massive investments and has grown very rapidly by providing a business-friendly environment and offering ultra-low corporate tax rates. And it doesn’t use a flat-rate income tax. (To his credit, Mr. Thompson does want to cut the corporate tax rate to 27 percent from 35 percent.)

Finally, some of them joined the European Union or were about to do so when they implemented the tax. In general, governments took many deliberate steps to attract foreign investment. Hence empirical studies by the IMF have had a very hard time estimating the effect of the flat-rate tax.


Libertarians and economists push for flat taxes on the grounds of efficiency, simplicity and economic growth, sometimes without much empirical support. Once you let those fizzy claims dissipate, the flat tax looks rather… well, flat.

Technorati tags:economics, taxes, flat tax, income tax, efficient tax

Risk Factors For A 2008 Recession

Here are the top risk factors for 2008 US Recession:

• Continuing Housing Bust
• High Oil Prices
• Security Issues
• Credit Crunch
• High Consumer Debt
• Large Trade Deficit
• Consumer Spending is slowing (it makes up 70% of the US GDP)
• Commercial Construction decline
  

Krugman Still Has it Wrong on Obama's and Hillary Clinton's Health Care Plans

I don't command any space on the New York Times oped page, but for those of you want to know the truth about the health-care plans of Obama and Clinton -- rather than the rather lopsided arguments Paul Krugman keeps making in his column on that page, as he did again today -- please see my blog (below) for January 13, 2008,
"Democrats Should Stop Squabbling Over Healthcare Mandates."

The ugly consequences of consumer protection

Millions of homeowners won’t be able to make their mortgage payments in the next five years, leading to a surge in defaults and foreclosures. It all started with the home-buying frenzy of 2003-2006. Many borrowers didn’t understand the contracts they were signing. Many others did know what they were doing, but thought that refinancing would always be an option. Congress now works on legislation that will let more Americans keep their homes – at the expense of increasing the cost of borrowing in the future and reducing the amount of credit available.

Four congressmen have introduced bills that would amend Chapter 13 of the Bankruptcy Code. All four share two features. First, they allow courts to cap the debtor’s obligations at the market value of the property. This provision is relevant because home prices have fallen since 2006, making it likely that in the near future the debts of a bankrupt consumer are worth more than his house. It is also relevant for homeowners who initially follow a “negative amortization” scheme, under which mortgage payments are less than accrued interest, so total debt increases over time, possibly above the value of the property.

The second feature allows courts to set interest rates below those in the original loan contracts – current legislation prohibits the modification of a mortgage on the principal residence (§1322(b)(2) of Chapter 13).

The bills therefore potentially reduce the obligations of homeowners who file for Chapter 13. This increases the interest rate that borrowers are willing to pay on their mortgages, as well as the fraction of borrowers who file for bankruptcy – because the legislation protects them from foreclosure. From the lenders’ point of view, receivables decrease and the proportion of loans in default rises, both of which increase the interest rate that lenders are willing to offer for any given loan – because the expected losses from defaults increase. Both the demand and the supply shifts make the cost of mortgages go up – their combination makes them go up even more. (A wealth of academic research, most of it by professor Michelle White, supports my analysis. Read this paper and this one.)

The New York Times says that it doesn’t make sense to claim that increasing consumers’ protection raises borrowers’ cost. Lenders – the newspaper correctly points out – would rather deal with a bankruptcy filing than with a foreclosure, because the losses from the latter are larger.

The NYT’s error comes from two places. First, it confounds the effects of the legislation on the amount of losses from defaults with its effects on the probability of default. The bills increase the fraction of borrowers that try a debt renegotiation (file for Chapter 13 bankruptcy) instead of letting the bank foreclose. This reduces the cost of default for the bank, because a foreclosure is costlier than a debt renegotiation. On the other hand, the proposed legislation increases the fraction of borrowers that default -- and banks always incur a loss when a mortgage goes bad. Total losses – the product of the average loss from default times the fraction of bad loans – may thus well increase.

The second error of the NYT is to confuse the banks’ losses from bankruptcy under the current legislation with those under the new one. Under the 2005 Bankruptcy Code, banks almost always incur a bigger loss from a foreclosure than from a debt renegotiation. If the proposed amendments lower the banks’ receivables from bankrupt consumers, it’s not clear that lenders prefer renegotiation to foreclosure any more.

And what’s wrong with foreclosures anyway?

Consumers with weak credit histories would be affected the most, because they are the most likely to default. Lenders would turn down applicants with the worst credit scores – the same ones who were getting risky mortgages not long ago, no questions asked. People shouldn't get loans they can’t afford in the first place, and Congress should certainly not provide the incentives to do so.

The proposed legislation encourages consumers to file for bankruptcy under Chapter 13. Under that section of the Code, the borrower proposes a repayment plan that pays off the arrears over five years. If the court approves of (i.e. confirms) the plan, the borrower gets to keep the house. Confirmation of the plan depends on whether the borrower has enough disposable income – after all expected expenses – to pay off her debt.

Chapter 13 is the right option for people who fall behind their payments because of a temporary financial setback. But everyone else would be better off filing for Chapter 7. Under this alternative, the borrower forfeits some home equity to pay off her debt. In many cases, banks foreclose and the mortgagees become renters. These are people who have neither enough equity to pay off their arrears nor enough income to afford the mortgage.

The sensible thing to do

So what should Congress rather do? First of all, settle on a bankruptcy text and stick to it. The latest overhaul of the Bankruptcy Code took place as recently as 2005. Regulatory uncertainty inhibits lenders.

Second, lawmakers should give the two parties in a contract more leeway to renegotiate their loans. I applaud the congressmen’s proposals to allow modifications of the terms of the original loans, but they could go further. For example, they should allow converting 30-year adjustable rate mortgages (ARM) into 50-year fixed-rate mortgages.

The modifications could be proposed by the court, but then they should require consent from both mortgagee and lender. Two of the bills under consideration -- the ones by Senator Durbin (D-IL) and Representative Miller (D-NC) -- allow the bankruptcy court to modify the terms of the loan without restrictions, not even agreement in writing between the parties. Giving such power to the court has at least two effects. First, it tilts the balance towards the consumer -- in a free negotiation between mortgagee and bank, the latter would have the upper hand. Second, it increases the uncertainty of the bank's payoffs. Both effects reduce the supply of debt.

Congress should also modify the Code so that the least creditworthy borrowers have more incentives to file for Chapter 7 instead of Chapter 13.

Going beyond the current problems, better ex ante disclosure would be welcome. Most borrowers don’t understand 95 percent of the legal mumbo jumbo on their contracts. Mortgage applicants should be given worst-case scenario simulations of their monthly payments.

We could also set a floor on “teaser” introductory mortgage payments. Hybrid ARM's, for example, start out carrying a low, fixed rate. Two to five years later the interest rate resets to a higher, floating level. Option ARM's let the borrower initially make interest-only payments, minimum payments (often below the interest accrued), or fixed, low-rate payments, also until the first reset date. Any of those schemes make mortgages affordable, but only for the first few years. Legislation could provide, for example, that initial monthly payments never be below 80 percent of the expected payment after the first reset date.

So here's a sensible policy on consumer protection: NO to protecting Americans who want to keep homes they can't afford; YES to protecting them from getting unaffordable mortgages in the first place.

Technorati tags:
economics, bankruptcy, mortgage, mortgage crisis, real estate

Recession Fears Grow

Reuters reports that "Unsold goods are piling up in warehouses as the housing meltdown and soaring oil prices strain consumers, raising fears that already glum fourth-quarter growth prospects may tip toward recession."

"The sluggishness is apparent in the retail sector, where 70 percent of chain stores posted weaker-than-expected October sales results, according to research firm Retail Metrics.

"We expect the challenging retail environment to continue for the foreseeable future," Mike Ullman, chairman and chief executive officer of department store chain J.C. Penney (JCP.N: Quote, Profile, Research), said last week. He added that the company would keep inventory levels tight through 2008."

Respected economist Nouriel Roubini writes "Any recession call for the U.S. is clearly dependent on US consumption faltering. Since residential investment is only 5% of even a worsening housing recession cannot – by itself – trigger an economy-wide recession. Rather, since private consumption is over 70% of aggregate demand a sharp and persistent slowdown in consumption growth – below 1% or even negative - is necessary to trigger a full blown recession

The Real Recession Problem: Consumers Are at the End of Their Ropes

Perhaps the silliest part of an already silly stimulus bill is a provision giving corporations big tax deductions this year on the costs of new machinery, instead of spreading those deductions over several years, as is normally the case. The idea is to get businesses to invest in more machinery, which will stimulate the economy.

But accelerated depreciation, as it’s called, doesn’t work. Almost the same tax break was enacted in 2002 and studies show just about no increase in business investment as a result. Why? Because companies won’t invest in more machines when demand is dropping for the stuff the machines make. And right now, demand is dropping for just about everything.

This tax break exemplifies the illogic of what’s called supply-side economics. If you reduce the cost of investing, so the thinking goes, you’ll get more investment. What’s left out is the demand side of the equation. Without consumers who want to buy a product, there’s no point in making it, regardless of how many tax breaks go into it.

Which gets us to the real problem. Most consumers are at the end of their ropes and can’t buy more. Real incomes are no higher than they were in 2000, while food and energy and health care costs are all rising faster than inflation. And home values are dropping, which means an end to home equity loans and refinancing.

Most of what’s being earned in America is going to the richest 5 percent, but the rich devote a smaller percent of their earnings to buying things than the rest of us because, after all, they’re rich -- which means they already have most of what they want. Instead of buying, the rich invest most of their earnings wherever around the world they can get the highest return.

Add all this together and there’s just not enough consumer demand out there to keep the American economy going. We’re finally reaping the whirlwind of widening inequality and ever more concentrated wealth. Supply-siders who want to cut taxes on corporations and the rich just don’t get it. Neither does most of official Washington.

Who's Paying For Your Fix?

by Kate Duncan

May/Jun 2003 Issue

Unless your morning latte was a fair trade blend, it probably cost more than what the farmer who picked the beans earns in a day.

Conventional coffee prices are at their lowest in a century, even below the cost of production. Farmers have been leaving the fruit to rot on the tree, pulling the kids out of school, abandoning the family land and pouring into the cities to find non-existent work. That’s why, as the most heavily traded commodity after oil, and the most common beverage after water, coffee is a major focus of the fair trade movement.

If your morning latte was a fair trade brew, it means the person who farmed the beans is earning enough to support his family. This is all well and good, but the way fair trade is usually explained - with prices, numbers and statistics - ignores it’s lasting benefits. The true point of fair trade is the cultural, communal, and environmental stability it bolsters.

A farmer who sells through fair trade is a member of a cooperative that is a vehicle for community empowerment. And not just a neighborhood watch: The people typically organized via fair trade are those whom the free market has filtered to the lowest economic stratum. Rather than maneuvering them into a position where they’re forced to take what they can get, fair trade recognizes farmers as equal partners, a platform from which they can command more control over their business and lives.

'Fair trade is a different kind of business relationship between the producer and buyer, which has been an inspiration to help these communities pull together instead of caving to the pressure of all the things trying to blow them apart,' says Monika Firl. Monika heads up producer relations for Cooperative Coffees, and as such, led half a dozen coffee roasters and me (as a grateful representative of Idyll Development Foundation, one of Cooperative Coffee’s funders) on a buying trip to farmers’ co-ops in Nicaragua, Guatemala, and Mexico in February, where we were able to see the effect for ourselves. [Clamor]

How to eliminate flight delays, now

For the moment, the FAA is focused on airports in the North East. With a selective application, however, the cap-and-trade scheme would turn out a double-edged sword. On one hand, airlines could move operations from restricted to unrestricted airports; this would happen at fields that can function as substitutes of each other, such as Newark and JFK. On the other hand, the beneficial effect of unclogging one airport would ripple through the entire network: one fewer take-off in one place means one fewer landing somewhere else, less clustering at a few airports implies that landings are more spread out over the day at the rest. This would happen at airports that can complement, rather than substitute, each other.

So far the FAA has championed efforts to promote efficiency only at the La Guardia, JFK, O’Hare and Ronald Reagan airports. The agency requires companies to use their slots at least 80 percent of the time, or else surrender them. Unused slots are not sold to the highest bidder, unfortunately, but reassigned by lottery.

Got any other ideas?

The industry hates both caps and slot trading. They claim that variable prices won’t be effective. Bill DeCota, aviation director at the Port Authority of New York and New Jersey, told the Wall Street Journal “There is no price that you could put in effect that would impact demand.” I guess the fundamental laws of economics don’t apply to air travel.

Airlines clamor for an upgrade of navigation instruments instead. Satellite technology will let planes keep shorter distances from each other during take-off and landing, increasing the traffic volume that airports can handle. The diligent Federal Aviation Administration has already proposed a system, “NextGen.” The toy, alas, won’t be on the shelves for Christmas. Not until 2025.

So-called “demand management” would make air travel less appealing to consumers: tickets would be more expensive, layovers more frequent and longer. But consider the alternative: as airlines cram their schedules with more flights to keep up with rising demand, delays will become longer, cancellations more frequent. At some point travelers will not be able to plan their trips at all: planes will take-off, literally, whenever they can. That may suit college students going home for the summer just fine, but I can’t imagine whom else.

A cap-and-trade system should not be a substitute for increasing capacity. In fact, to resort to cutting out flights amounts to an admission of failure. The industry should (and will) invest in new airports, expand existing ones, and adopt technologies that increase the number of slots per airport. Unfortunately, for the next 20 years, efficient rationing is the best we can do.

*American Airlines, United Airways, Continental, Delta, Northwest Airlines and US Airways

Technorati tags: economics, flight delays, air travel, congestion, cap-and-trade

Housing Bubble Sites

National Sites

• The Housing Bubble
• The House Bubble
• Housing Panic
• Paper Economy a US Real Estate Bubble Blog
• Housing Doom Housing Bubble
• Doctor Housing Bubble
• Bubble Markets Inventory Tracking
• Priced Out Fovever
• HousingTracker
• Matrix
• The Real Estate Bloggers
• The Mortgage Lender Implode-O-Meter
• Housing Bubble Casualty
• Housing Bubble Bust
• Bubble Pictures
• Bubble News Network
• Lawrence Yun Watch
• Is There a Housing Bubble
• Real Estate Comments

Regional Sites

• DC Home Prices
• Greater Northern VA Housing Bubble Fallout
• Frankly Realty (Virginia)
• Baltimore Metro Area Housing Blog
• Baltimore Housing Bubble
• Chicago Bubble Blog
• Irvine Housing Bubble
• The Jersey Shore RE Bubble
• New Jersey Real Estate Report
• Socket Site (San Francisco)
• Patrick.net (San Francisco)
• Bay Area Real Estate Blog
• Burbed (San Francisco)
• Marin Real Estate Bubble
• Sonoma Housing Bubble
• Seattle Bubble
• Calgary Contrarian
• Vancouver Housing Market Blog
• SoCal Real Estate Bubble Blog
• Flippers in Trouble (Sacramento)
• Portland Housing
• Proffesor Piggington (San Deigo)
• Pacific Beach Bubble
• Boston Bubble
• California Housing Forecast
• Massachusetts Housing Market
• Vancouver Condo Info
• New York City Housing Bubble

Bill Clinton's Old Politics

I write this more out of sadness than anger. Bill Clinton’s ill-tempered and ill-founded attacks on Barack Obama are doing no credit to the former President, his legacy, or his wife’s campaign. Nor are they helping the Democratic party. While it may be that all is fair in love, war, and politics, it’s not fair – indeed, it’s demeaning – for a former President to say things that are patently untrue (such as Obama’s anti-war position is a “fairy tale”) or to insinuate that Obama is injecting race into the race when the former President is himself doing it. Meanwhile, the attack ads being run in South Carolina by the Clinton camp which quote Obama as saying Republicans had all the ideas under Reagan, is disingenuous. For years, Bill Clinton and many other leading Democrats have made precisely the same point – that starting in the Reagan administration, Republicans put forth a range of new ideas while the Democrats sat on their hands. Many of these ideas were wrong-headed and dangerous, such as supply-side economics. But for too long Democrats failed counter with new ideas of their own; they wrongly assumed that the old Democratic positions and visions would be enough. Clinton’s 1992 campaign – indeed, the entire “New Democratic” message of the 1990s – was premised on the importance of taking back the initiative from the Republicans and offering Americans a new set of ideas and principles. Now, sadly, we’re witnessing a smear campaign against Obama that employs some of the worst aspects of the old politics.

Sugar Giants Shove Their Sweetener

by Chris Tenove

Jul/Aug 2003 Issue

What does anybody know about the sugar industry? The people who put the frosting on the frosted flakes keep a low profile and are happy when folks are too busy eating to ask a lot of questions. Now, though, a dust-up with the World Health Organization (WHO) has flushed them into the limelight, where they're pitting profits against public health.

The conflict was inflamed by a new set of dietary guidelines drawn from two years of research by the WHO and the UN Food and Agricultural Organization. The guidelines are part of a worldwide strategy to tame the swelling epidemic of obesity, diabetes, osteoporosis and cardiovascular diseases. One recommendation is that free sugars (i.e. sugar added to foods) should make up no more than 10 percent of our daily caloric intake. The sugar lobby reacted to that suggestion like a toddler asked to hand back his Halloween booty...

'It was particularly stupid for them to put in writing that they're going to try to get Congress to take away WHO's money,' says Michael Jacobsen, executive director of the Center for Science in the Public Interest. 'It gave consumers a chance to see the kind of bullying that is usually done behind closed doors.' [Adbusters]

The WSJ follows my call

The Wall Street Journal is warming up to my idea that the Federal Reserve should stop caring about growth. In an editorial today, the newspaper says that “the Full Employment and Balanced Growth Act of 1978 deserves to be repealed. Also known as the Humphrey-Hawkins, this is the law that mandates that the Fed consider both price stability and full employment in making monetary policy decisions. […] this dual mandate makes it impossible for the Fed to target only inflation the way, say, the European Central Bank is mandated to do.” The WSJ wraps up with these words "setting monetary policy by a genuine price rule would be better." (Read the editorial here.)

The editorial comments on yesterday’s speech by Ben Bernanke. The Fed's chairman brought up the virtues of inflation targeting, but was very careful to point out that the Fed should continue to put equal weight on growth and inflation.

It's nice to hear, though, that an American mainstream paper supports the idea of a more hawkish, ECB-style central bank.

Keyword search in Technorati: economics, monetary policy, Federal Reserve, inflation, interest rates

Happy Thanksgiving

Happy Thanksgiving to everyone! Enjoy!

The Politics of an Economic Nightmare

A possible economic meltdown is worrisome enough, but a possible meltdown in an election year is downright frightening. For months now, Republicans have been pushing the White House to take some action that looked and sounded big enough to give them some cover if and when things got worse. President Bush has now responded with a stimulus package more than twice as large as the one Bill Clinton briefly entertained at the start of 1993 but couldn't get passed.

Not to be outdone, Democrats want to appear at least as bold, which means they'll suspend pay-go rules and throw fiscal responsibility out the window. In other words, hold your noses, because the "bipartisan" stimulus package that's about to be introduced could be a real stinker, including tax cuts for everyone and everything under the sun -- except, perhaps, for the key group of lower-income Americans. These are the people who don't earn enough to pay much if any income taxes, but who are the most likely to spend whatever extra money they get and therefore are most likely to stimulate the economy. The real behind-the-scenes battle will be over whose constituencies get what tax cuts, and for how long. Don't be surprised if the only thing Congress really stimulates is campaign contributions.

Meanwhile, Fed chairman Ben Bernanke and Co. have surprised everyone with a rate cut larger and sooner than expected. The three-quarters of a percentage point ("75 basis points" in biz-speak) cut announced Tuesday morning may not sound like much, but it's bigger than any rate cut in decades. The politics here are more subtle because Bernanke and his Federal Reserve governors are supposed to be independent of politics. But as witnessed under the reign of previous chairman Alan "it's prudent to reduce the surplus with a tax cut" Greenspan, Fed chairs can have political agendas. Bernanke has been under a lot of pressure lately to cut rates big-time -- and the pressure has come not only from Washington Republicans but from panicked Wall Street Democrats, including, apparently, my old colleague Robert Rubin, formerly President Clinton's treasury secretary. (By the way, what could Rubin have been thinking when he allowed Citicorp to sell all those fancy securitized debt instruments, while agreeing to buy them back if they couldn't be resold?) Expect lots and lots more Washington activity -- enough seemingly bold strokes to convince voters that our nation's capital is doing whatever is necessary to stop whatever seems to be going wrong with the economy.

The problem is, people have different views about what's going wrong. Wall Street sees it as a credit crisis -- a mess that seems never to reach bottom because nobody on Wall Street has any idea how many bad loans are out there. Therefore, nobody knows how big the losses are likely to be when the bottom is finally reached. And precisely because nobody knows, nobody wants to lend any more money. A rate cut won't change this. It's like offering a 10-pound lobster to someone so constipated he can't take in another mouthful.

Main Street sees it as a housing crisis. As I've noted, homes are the biggest assets Americans own -- their golden geese for retirement and their piggy banks for home equity loans and refinancing. But home prices have been dropping quickly. It's the first time this has happened in many decades -- beyond the memories of most Americans, which is why they never expected it to happen, why they bought houses so readily when credit was so easily available, and why so many people bought two or more of them, speculating and fixing up and then flipping. But now several million Americans may lose their homes, and tens of millions more have only their credit cards to live on and are reaching the outer limits of what they can spend. As consumer spending shrinks, companies will reduce production and cut payrolls. That has already begun to happen. It's called recession.

How much worse can it get? As I said before, the housing bubble drove home prices up 20 to 40 percent above historic averages relative to earnings and rents. So now that the bubble is bursting, you can expect prices to drop by roughly the same amount, and new home construction to contract. The latter plunged last month to its lowest point in more than 16 years. A managing partner of a large Wall Street financial house told me a few days ago the scenario could get much worse. He gave a 20 percent chance of a depression.

Even if a stimulus package were precisely targeted to consumers most likely to spend any money they received, the housing slump could overwhelm it. According to a recent estimate by Merrill-Lynch, the slump will hit consumer spending to the tune of $360 billion this year and next. That's more than double the size of the stimulus package President Bush or any leading Democrat is now talking about. And the Merrill-Lynch estimate is conservative.

In reality, the crisis is both a credit crunch and the bursting of the housing bubble. Wall Street is in terrible shape and Main Street is about to be in terrible shape. And there's not a whole lot that can be done about either of these problems -- because they are the results of years of lax credit standards, get-rich-quick schemes, wild speculation on Wall Street and in the housing market, and gross irresponsibility by the Fed, the Treasury and the Comptroller of the Currency.

As a practical matter, our only real hope for avoiding a deep recession or worse depends on loans and investments from abroad -- some major U.S. financial firms have already gotten key cash infusions from foreign governments buying stakes in them -- combined with export earnings as the dollar continues to weaken. But this is something no politician wants to admit, especially in an election year. So we're going to go through weeks of posturing about stimulus packages of one sort or another, and then see enacted the big fat bonanza of a temporary tax break that will likely have little effect. That, perhaps along with a few more rate cuts by the Fed. The presidential candidates will be asked what should be done about the worsening economy, and they'll give vague answers. None will likely admit the truth: We're going to need the rest of the world to bail us out.