Arnold Kling  

The State of the Economy, I

Do They Care?... The State of the Economy, II...

The financial crisis creates significant opportunity for long-term pessimists. Again, I recommend the podcast featuring Ken Rogoff and Niall Ferguson. Rogoff has been a gloomy person (in a fun way) for as long as I have known him, which is more than 30 years. His current thesis, based in part on the Reinhart-Rogoff book, is that we have not ended the financial crisis. We have merely pivoted from a banking crisis to a government debt crisis.

Right now, I happen to think that Rogoff and Ferguson are correct to believe that the U.S. is headed for a crisis in its ability to repay its debt. Meanwhile, the focus of Congress is a debate on how to spend even more money, on health care. Some day, historians will look back at this and shake their heads, the way we now shake out heads about the mortgage loans that were made a few years ago.

Another strand of pessimism looks backward and revises the two decades from 1985 to 2005 as being a false prosperity. Michael Mandel is in this camp. So is Steven Randy Waldman.

I think the United States has made terrible aggregate investment decisions over the last 30 years, and will continue to do so as long as a "ride the bubble then hide in banks" strategy pays off. Under the moderation dynamic, resource allocation is managed alternately by compromised capital markets and fiscal stimulators, neither of which make remotely good choices.

I think this overstates the case. I doubt that you could ever go back in history without being able to second-guess a lot of the investment that took place. But I think that one can make a case that the growth in GDP actually understates the economic gains of the past thirty years. When the choice set expands due to new goods and services, GDP statistics are biased downward.

Let me again cite the example of my oldest daughter, who moved to Arizona in September. She obtained a used car and found an apartment, without using a newspaper, a landline phone, or a map. She went on line the week before her move, found a car at a Carmax in Los Angeles, ordered it shipped to Arizona, and was met by the Carmax guy at the airport when she arrived. They drive back to Carmax, she buys the car, and then she goes to a McDonalds with free Wi-Fi, and uses her laptop to search for apartments. She then makes appointments using her cell phone and uses her GPS to supply directions. Thirty years ago, she would have spent much more time searching and probably wound up with a car and apartment much farther from her optimal choices.

As another example, the health care technology of 30 years ago was certainly adequate. But you would not want it, knowing what is available today. Your hospital and dental visits would involve a lot more pain and suffering if you did not have the latest equipment available.

I think that perhaps the most important trend of the past thirty years is the increased importance of cognitive skills relative to physical labor. Obviously, this has been going on for more than just the past thirty years, but during the past thirty years we saw an acceleration. This has had a number of consequences:

1. It changed the role of women. Their comparative advantage went from housework to market work.

2. This in turn, as Wolfers and Stevenson have pointed out, changed the nature of marriage. Men and women look for complementarity in consumption rather than in production.

3. This in turn leads to more assortive mating, with achievement-oriented men looking for interesting mates rather than for good maids.

4. This in turn leads to greater inequality across households. It also fosters greater inequality among children. The children of two affluent parents are likely to have much better genetic and environmental endowments than the children of two (likely unmarried) low-income parents.

5. Inequality is exacerbated by globalization and technological change. If your comparative advantage is basic physical labor, you have to compete with machines as well is with workers from the Third World.

The net result is an economy that has improved considerably for people with high cognitive skills, but which has improved only somewhat for people with relatively low cognitive skills.

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CATEGORIES: Economic History

COMMENTS (7 to date)
steve writes:

I think I agree with you. There have been many adjustments to the economy since the 80s. Many of them as you outlined have been exceedingly beneficial. I would however like to make a couple additional points.

The big losers over this period of time from an American point of view. Autos, consumer electronics, etc. seem to me to have been more then adequately handled by the market. They may not be made by American flagged companies but the quality, choice, price, etc. seems to be right there with the examples you gave. I would count this as a win for the market.

I believe this is good but hardly conclusive evidence that wages are very flexible on a global basis while not so much in America.

I would also like to point out that Banking is not immune to this dynamic. If the Fed and the American banking sector do not clean up their act the market will. In fact, it may already be too late to prevent the financial center of the world from moving to a different location.

Douglass Holmes writes:

Regarding your net result: If the economy has improved only slightly for low cognitave skills, why do so many people seek manual labor in the United States? Clearly, for those with high cognitive skills, the economy has done well. But the economy is pretty good for the rest of us as well. There are plenty of people who want to make it appear that the lower class in this country is moving backward and that the middle class is shrinking, but that is really an attempt to sell unionisation and social programs.

I am also concerned about our debt crisis. In an effort to eliminate the middle men, Congress has decided to make student loans directly rather than helping the banks make them. This will put even more upward pressure on the price of college and it will provide no incentive to improve the quality of college education. I suspect that a lot of capital is being directed to extending adolescence. This steals capital from projects that could make us more productive, just as building too many houses has taken capital from projects that could make us more productive.

CJ Smith writes:


I beleive the reason why "so many people seek work in the United States" is to leverage the currency exchange differentials between the US and foriegn countries.

Consider the following extremely simplified example:

Jose is a hypothetical manual laborer from a foriegn country, Z, whose currency is the Z$. Jose lacks the education, background or training to do anything other than unskilled manual labor.

For simplicity's sake, let's assume the following:

Ignore minimum wage laws and tax considerations in either country.

The cost of transferring funds and converting from one currency to another is negligible.

Jose will work the same amount of time in any job he is qualified for, regardless of location (use 40 hours a week), and the market for his work is large enough that unemployment is not a consideration, regardless of location.

Jose will receive Z$100 for 40 hours of labor in country Z.
Jose will recieve US$100 for 40 hours of labor in the US, either equal to what US workers would make, or more likely, a fraction of what US workers would want to do the same work.

Jose's individual cost of living as a percentage of his individual total income is constant, regardless of location (use 75% as an example). The percentage over cost of living goes to support of his family and extended family or is discretionary spending.

The exchange rate between the US$ and the Z$ is 1:10, thus US$1 = Z$10.

Jose has two options:
1. Stay in Z, work 40 hours, get paid Z$100, spend Z$75 for cost of living.

Jose gets Z$25 to support his family or for discretionary spending.


2. Move to the US, work 40 hours, get paid US$100, spend US$75 for cost of living.

Jose gets US$25 to support his family or for discretionary spending, BUT
Jose's family is still in Z, so Jose sends the US$25 to Z, where it is converted to Z$250 (2.5 times Jose's total income if he has stayed in Z).

Which is why Jose and everyone in his town is trying to get into the US.

Oversimplified? Not realistic? Come down to the Cuban enclaves in Florida where I live, or the Mexican enclaves along the US Mexican border. It's not only happening, its a GOOD THING. The US gets unskilled labor for jobs US workers won't touch at the equivalent price (McDonalds workers are offered twice minimum wage in many parts of North Miami Beach, they bus day labor into Key West for free to have a domestic work force); Jose is fully employed without displacing an American worker; and Jose's family is demonstrably richer, in real terms, than if Jose had stayed in Z.

More to your point, ceteras paribus, a 1% increase in wage level in the US means Jose gets a 0.25% increase in his US net income, which equates to 2.5% increase in wealth to his family. Great for Jose's family, but bad for John and his US family, who only see a 0.25% increase in wealth, but basic international economics in action.

I won't touch your debt crisis/student loan concern for two reasons - first, you are conflating two items that I beleive really don't have that significant a relationship (although I don't have empirical support, I suspect that the aggregate dollar amount of student loans in the market versus total dollars lent is not significant in relative terms; second, I am admittedly biased with regard to this matter. I would not have the education, training, and position I have now if I had not had access to US guaranteed educational loan programs, which I am both happy to have paid back, and happy to not have now - I replaced them with a home mortgage on a house worth twice the value, in inflation adjusted terms, of the best house my parents ever owned, and they were both fully employed as a grade school teacher and a newpaper editor.

Douglass Holmes writes:

I believe that minimum wage laws, taxation, and labor laws have a great deal to do with this, but I want to stick to my real point. I really do believe that the economy is significantly better, even for those at the bottom of the economic scale in this country. Your point is certainly valid for the case of those who come here to work and send the money back home. But lots of Mexicans come here and bring their families. It would be nice to know the percentage. I suspect that it is different depending on how close you are to the Mexican border or to transportation hubs with easy access to Latin America. Here in the heartland, we see a lot of Mexican families. Some money may still be going home to Mexico, but there are plenty of Mexicans trying to raise their families here. (and I am not complaining about it)
I am aware that a huge amount of money gets sent back to Mexico, but wouldn't that eventually affect the exchange rate?
Back to the loan issue, it isn't just a student loan problem, although that's part of it. Whenever the government picks some winners in the marketplace to receive loans, by guaranteeing them or by pressuring mortgage companies to make more risky loans, I believe the capital markets will be distorted. I believe we are paying the price for that now. But, really, I don't have any hard data to go by that would point to student loans being a part of the most recent crisis.
What I see is a parallel to the housing market debacle. Part of the mortgage crisis is that people kept assuming that mortgages were low risk investments because they were based on houses whose values covered the amount of the loan. It turns out the value of the houses didn't quite cover the amount of the loans for many people. So, is the value of a college education really enough to cover the cost of the loans? In your case, it appears to have been so. But my younger sister spent years working at or near the minimum wage, struggling to pay off her student loans.
If anyone can provide a source for actual data on this issue, I would be interested.

Alison Cummins writes:

Do you have data to support your assortative mating hypothesis?

When women have the potential to be primary breadwinners, it takes more than dollars to woo us. We aren't just sitting in a lineup waiting for the best financial offer - knowing that ultimately we will be forced to accept an offer of some kind, no matter how distasteful. Sure, we are looking for someone with complementary skills to contribute to a relationship. But if we can earn our own money, we have the option of being lesbians, staying single, or holding out for someone who is good with his hands, or good with kids.

Also: there is much more to running a household than being a good maid. I find this comment extremely insulting. There's more to running a restaurant than being good at running the dishwasher. Men have always sought cognitive skills in their partners. (Not all men of course. But men who didn't seek them in the past are probably not seeking them today either. I don't see a good reason to assume this would have changed significantly.)

You could be right. But you need data, because you could just as well be wrong.

Robin Hanson writes:

Globally, inequality is down over the last thirty years. More here. Seems a bit provincial to focus so much on the US changes without even mentioning the bigger changes that matter more.

Nick writes:


"Whenever the government picks some winners in the marketplace to receive loans, by guaranteeing them or by pressuring mortgage companies to make more risky loans, I believe the capital markets will be distorted. I believe we are paying the price for that now."

The difference is one cannot be absolved of a student loan by much of anything short of death. Unlike a mortgage they cannot reposes your education and even bankruptcy cannot absolve the debt.

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