The Sovereign Mind

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Posts Tagged ‘economics

A Poor Man in a Rich Country

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In Timothy Noah’s last installment on his series on inequality, he makes the case that rising income inequality is a concern for our society. For the most part, I agree with him. But while addressing some of the common counter-arguments, I have to take issue with this one:

Quality of life is improving. This argument has been made by too many conservatives to count. Yes, it’s true that an unemployed steelworker living in the 21st century is in many important ways better off than the royals and aristocrats of yesteryear. Living conditions improve over time. But people do not experience life as an interesting moment in the evolution of human societies. They experience it in the present and weigh their own experience against that of the living. Brooks cites (even though it contradicts his argument) a famous 1998 study by economists Sara Solnick (then at the University of Miami, now at the University of Vermont) and David Hemenway of the Harvard School of Public Health. Subjects were asked which they’d prefer: to earn $50,000 while knowing everyone else earned $25,000, or to earn $100,000 while knowing everyone else earned $200,000. Objectively speaking, $100,000 is twice as much as $50,000. Even so, 56 percent chose $50,000 if it meant that would put them on top rather than at the bottom. We are social creatures and establish our expectations relative to others.

Ironically, the Woody Allen firm that the last words link to seem to make the counter-argument: that such thinking is wrong-headed and that what matters most is where the train is heading and not which car you’re on. But moving past that…

For one thing, in doing a little searching I found a study that claims to contradict the 1998 study that Noah refers to. I can’t read either of them without paying, so I can’t compare the two, but my point is just that the conclusion of one study doesn’t prove or disprove something. You have to look at how the study reached that conclusion and compare that conclusion with other similar studies. Most of the time, scientific studies make very narrow conclusions that are then generalized too far by the media. I suspect that might be going on here.

But what I really didn’t like about this argument was that Noah, despite I assume being knowledgeable about economics, doesn’t even mention a glaring flaw in the methodology as he describes it: money does not equal wealth. The number 200,000 doesn’t mean anything without knowing how much “wealth” or “quality of life” that buys. If everyone were to double their income tomorrow, but that wasn’t matched by a corresponding increase in productivity, that doubling of income would be meaningless since everything would cost twice as much. By asking the question in terms of dollar amounts, which are meaningless without a reference to the wealth that it represents, the question is clearly flawed. The assumption, it appears, is that people would think that in both scenarios a dollar has the same buying power. I don’t think that’s a valid assumption. Granted, most people don’t consciously make the distinction between money and wealth, but I think subconsciously people have an intuitive sense that your buying power does not depend only on the quantity of money that you have, but on the total quantity of wealth and the share of it that your money represents. If everyone earned two million dollars and you earned one million, do you think you’d be able to buy a mansion? I think it’s obvious to most that you wouldn’t, but in case it isn’t, ask yourself this question: who would build it?

Would you even be able to afford any house at all?


Written by Mike

September 28, 2010 at 9:44 pm

How to Mislead with Charts: Who’s Responsible for the Great Divergence?

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I’ve been following with interest Timothy Noah’s series on income inequality in the United States. In the latest installment, he cites Larry Bartels’ book in which Bartels supposedly proves that Republicans are responsible for the “great divergence”:

Bartels came to this conclusion by looking at average annual pre-tax income growth (corrected for inflation) for the years 1948 to 2005, a period encompassing much of the egalitarian Great Compression and all of the inegalitarian Great Divergence (up until the time he did his research). Bartels broke down the data according to income percentile and whether the president was a Democrat or a Republican. Figuring the effects of White House policies were best measured on a one-year lag, Bartels eliminated each president’s first year in office and substituted the year following departure. Here is what he found:

That looks pretty impressive. According to the chart, not only have Democratic presidents created more equitable income growth, but they’ve created larger growth for every income category! This seems to be a slam dunk case against Republicans. But there are some problems. Firstly, is it really right to consider only a one-year lag before a president is fully responsible for the economy? President Obama might object to that! Secondly, of course the president is not the only one who affects economic growth. We don’t live in a dictatorship. What about the congress? Again, you can ask President Obama how easy it is for a president to get exactly the policy he wants, even when his own party controls congress, much less when it doesn’t. I decided to take a look at these two questions.

Firstly, I wanted to reproduce Bartels’ data. Unfortunately the Census Bureau’s historical tables that I found only go back to 1967, so I had to start from there. In any case, that’s about when the “great divergence” started, so that should be the most interesting data set anyway. I get similar results as Bartels:

But what happens when I tweak the parameters to have a two-year lag instead of a one-year lag?

Now we see a slightly different picture. Republican presidents still help the rich more, at the expense of the middle class, but the over-all economic growth picture is more fuzzy. Is a two-year lag better than a one-year lag? I don’t know. The point is that Bartels’ decision to use a one-year lag is arbitrary, and I’ve demonstrated that we get a very different result by just tweaking one arbitrary parameter. That’s not a sign of solid scientific evidence. What if I were to tell you that a climate model could be tweaked to predict global cooling instead of global warming just by tweaking one little parameter that was chosen arbitrarily to begin with?

Ok, but still even my tweaked graph doesn’t look good for Republicans: it still supports the argument that Republican presidents help the rich at the expense of the middle class. But what about congress? What if we looked at which party held the majority and ran the same analysis? I did that, dropping the years were there was a split legislature with one party controlling the senate and the other controlling the house. I’m actually left with only a handful of years with Republicans in control of both chambers, but that illustrates yet another problem with Bartels’ methodology: we’re talking about precious few data points to begin with, not to mention we’re not controlling for any other variables. In any case, here’s the result with a one-year lag:

Hmm… this graph looks very different from the first one we saw. Never fear, Democrats, using a two-year lag makes things look a little better for you:

So, which party’s policies are contributing more to income inequality? Which party is better at producing economic growth? My point is not to answer those questions. My point is to show that Bartels’ guess is no better than yours or mine. His methodology is interesting, but unfortunately fatally over-simplified.

Written by Mike

September 11, 2010 at 10:30 pm

Why Does Health Care Cost So Much in the US?

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Matthew Yglesias cites an NPR prodcast exploring the question: Why does an MRI cost 10 times as much in the US as it does in Japan? (Note: I haven’t listened to the podcast but the same question is explored by NPR in text form here).

This question is a variant of one that has been asked before many times: Why does health care cost so much in the US, compared to other nations? Many times the assumed answer is that the difference is because of waste and excess profits in the system. While I don’t dispute that there is some of that, there are also many other logical reasons why health care costs differ from country to country. The argument from those who propose a single-payer system, or at least that we move in that direction, are based on the implied assumption that our costs would be as low as other nations if we would just mimic their system. That is not true because there are factors that influence the price that are completely independent of the health care system itself.

The two main components of health care costs are technology and people. Let’s look at each one individually.


The CBO estimates that the adoption of new technology is the leading contributor to rising health care costs. However, rising costs isn’t the question here. The CBO also says that health care costs are rising in all nations. The question here is not the increase in costs, but why there is a difference between costs in the US and elsewhere.

There are a number of reasons for this, some of which were touched on in the NPR article above. I want to explore one of them that also applies to the pharmaceutical industry. When NPR asked US doctors and hospitals why MRI machines cost so much less in Japan than in the US (emphasis mine):

Japan sets the price they pay for MRIs super low. And so to get into the Japanese market, the manufacturers lower their prices. They charge more here in the U.S. because we will pay more. How come? Well, I called a number of American hospitals and doctors and I got basically two reactions. The first and most popular: a shrug. We could never get those prices.

So, MRI manufacturers are selling the machines in Japan at a lower price than they are selling them in the US. Why is this? Maybe it’s the same reason that drugs cost less in Canada:

They are engaging in what economists call “price discrimination”–that is, charging different prices to different buyers of the same product. Price discrimination works in the drug industry because drugs are very expensive to develop, but fairly cheap to manufacture. As long as companies can recoup their research and development costs by charging high prices in the United States, they can make a profit in Canada and elsewhere by merely covering the cost of making the pill (or tube of ointment or whatever).

To restate, developing a drug (and I imagine the same hold true of advanced medical equipment like an MRI machine) the cost to develop the product itself is high. Once you have a design that works, you can crank them out on the assembly line relatively cheaply. So, if there is a market that is only willing to pay a certain price you can still make a profit by selling to them, but only if you have another market that you can sell to for more in order to recoup the cost of R&D. In other words, if the US set price controls for MRI machines like Japan does, or if Americans were not as wealthy and could not afford the high cost of the machines, there wouldn’t be any MRI machines because manufacturers wouldn’t be able to recoup the cost of R&D and therefore they would not be profitable.

We should not expect technology to cost the same in different countries. There are many factors that play a role in the cost, and this is just one of them.


The second major component of health care costs is people: doctors, nurses, lab technicians, and many other high-skill professionals. Health care is inherently a labor-intensive industry, and not just any labor: high-skill labor. According to the International Average Salary Income Database, general physicians and nurses in the US make about 75% more than their Japanese counterparts. Although the numbers for more specialized physicians aren’t listed, we know that in the US they make much more than general physicians and so the gap is likely to be even larger.

So the solution to our cost problem is simple, right? As one commenter on Yglesias’ post said (I’m not sure if he or she was serious): “force nurses, doctors and teachers to work a lot longer for a lot less money.” Not so fast. First, we need to look at the reasons why health care professionals are paid so much more here. Are they just more greedy? Well, how about we compare them to similarly educated professionals in other industries. The US pays a much higher price for high-skill labor across all industries, while the price of low-skill labor is comparable to other nations. This should come as no surprise to those familiar with the high and rising income gap in the US.

So what would happen if we force doctors and nurses to accept lower wages? Fewer post-grad students would choose to go into medicine, and instead would choose other paths such as law or dentistry. That would quickly lead to shortages of medical professionals, something already being experienced by nursing staffs. I believe one of the best ways we can combat this problem is improving our education system so that we produce more highly educated graduates to compete for those jobs, but that is a different discussion. The point is that, at least with respect to this contributor to health care costs, it is not the health care system that is the problem. The labor cost is driven by factors outside of the health care system that cannot be adequately addressed by health care reform alone.


Again, let me reiterate that I do believe there are steps that can be taken to lower the high cost of health care. However, comparing the cost of health care in the US with the cost in other nations exaggerates the problem since it does not take into consideration factors that are beyond the scope of the health care system itself, and some of which are not necessarily bad things. We should focus on reducing the growth of health care costs, but let’s not fool ourselves into thinking we can cut it by a factor of 10, or even that we should.

(I should note that I am doing some research on the side regarding the rising cost of health care. I was going to do a post, or a series of posts, in the future. I wanted to response to Matthew’s post, however, so my arguments in this post are a work in progress. Critique, as always, is welcome.)

Written by Mike

November 23, 2009 at 11:23 pm

The Housing Crisis: Rethinking Rent vs. Buy

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A few years ago, when my wife and I were looking to buy our first home, we had a conversation with a seller’s realtor that went something like this:

Realtor: “Well you know, when your considering how much you can afford for your home, you should take into account that your mortgage interest will be tax deductible.”

Me: “Yeah, that’s true. But this home still seems like it might be out of our price range.”

Realtor: “Really? Well, that tax deduction will save you a couple hundred dollars on a house like this.”

Me: “Actually, I’ve looked at the numbers, and that assumes that we are currently itemizing. Since we’re not, a lot of that tax deduction will just go to getting us over the line where taking the itemized deduction is better than taking the standard deduction on our tax returns. In our case, I think it will only save us about a hundred dollars.”

Realtor: “Oh… well, you should really talk to a financial advisor about that… so, let’s take a look at the basement…”

During our home buying experience we were bombarded by anecdotes about how much money people make from their home. People would tell me that they sold their home for $50,000 more after 5 years, but completely ignored the fact that they paid almost that much in mortgage interest and property tax over that same amount of time.

We did end up buying a house (not from that realtor), but I didn’t think of it as an investment primarily. What we wanted was difficult to find in a rental, and we wanted our own space. We bought in a location that was not part of the bubble for the most part, we got a fixed rate loan, and made sure we could afford the payments. I can’t say we were completely responsible: we did get a zero down payment loan.

My personal story aside, let’s re-think the rent vs. buy assumptions:

Most of the angst regarding the current housing crisis is related to this common theme:

Why should the little guy suffer because banks and real-estate investors made bad decisions?

That seems like a reasonable question. If the real estate market tanks, it makes sense that the investors and banks should lose money. They are the ones that had the money to invest and were making the decisions. But I have bad news: If you own a home, you are a real-estate investor, and a pretty badly diversified and leveraged one at that. And you’re not only invested in the real estate market, but also in all of the financial system that decides how it is managed. So that’s why the little guy (or at least the little real-estate investor) suffers because of the housing crisis.

So how did that happen? You wouldn’t take out a loan at 7% to borrow $200,000 to invest in the stock market, would you? That would be very risky because even if the stock market drops 1%, you are now short $2,000, or more considering your interest is still added in good times and bad. Of course you wouldn’t do that unless you have money to burn, but that’s what you are doing when you buy a home. Some thought the real-estate market was a safe investment (it’s not as volatile as a stock), but that was foolish thinking. If it can go up fast (which it did in many markets), it can come down fast. That is a basic principle of investment: The more reward, the more risk.

Not only that, but home ownership also makes you less mobile, making it more difficult to find new jobs in new places during economic trouble.

This lesson comes too late for the 10% of home owners that find themselves upside down in their loans, and there’s no doubt that mortgage brokers who sold them on false hopes have their (big) share of blame as well. But what about the future? What should be done to prevent this from happening again?

I think the answer is simple:

The concept of home ownership should no longer be part of the American dream.

Apparently I’m not alone. Even Barney Frank, who has been one of the biggest proponent of the home ownership for all (otherwise known as the “everyone should be a highly-leveraged and badly diversified real-estate investor” policy), is now saying that perhaps home ownership for all was not the right policy to pursue:

One of the problems that we got into was we did way too much home ownership and way too little rental housing. And [we need to start] getting the federal government back in the business of rental housing. And passing legislation to restrict bad subprime loans will be high on our priority list.

I’m not sure I agree with his knee-jerk reaction that the government needs to provide said rental housing, but I agree that “we did way too much home ownership” as both a government and a society.

For years people have been saying that renting is “throwing your money away” and promoting home ownership as the basic status symbol of economic prosperity. Who has been saying this? Well, the same Barney Frank for one. His own website touts the benefits of the “Expanding American Homeownership Act of 2007”, some of which include lower down payments and more mortgages to higher risk borrowers.

But politics aside, I hope we will learn this lesson from this crisis: The American Dream cannot be purchased with a credit card. The American Dream is not about what you own; it is not about short-cuts or get rich quick schemes; it’s about what you do; it is about freedom: freedom to work, be smart, innovate, struggle, and succeed.

Written by Mike

February 6, 2009 at 9:19 pm

Economics 101

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Wow, could I think of a more boring title for a blog post?

Economics is probably considered one of the most boring of topics, but it also happens to be at the root of many policy debates. As I browse some blogs in my free time, I’ve noticed that it seems a lot of people are clueless when it comes to economics. Am I especially troubled by the characterization (which is gaining supporters recently) that the free market as a failed experiment. Certainly there are aspects of our economic system that have problems and have let to our current recession, but to characterize the free market as the cause of everything that is bad is to desecrate the system that has allowed us to become the most productive society in the world.

Many policy debates between liberals and conservatives hinge on a fundamental question: What economic factors should be controlled by government, and what factors should be left to the control of the free market? Of course that’s a simplification, but that’s the root of it. In debating this question, I’ve heard statements from both sides (but not necessarily representative of everyone on their respective sides) that I believe indicate a flawed understanding of basic economics. Here are two paraphrased examples from both sides:

From the left: Businesses should be taxed more because they are lucky to be running in such a prosperous nation (the U.S.) that we live in. Business should have the pay a high premium to be allowed to do business here.

From the right: Since consumers would usually buy a cheaper car that is worse for the environment than a more expensive car that is better for the environment (all other factors being equal), that means that consumers don’t value environmental conservation. Environmentalist shouldn’t be pushing for more environmentally friendly cars if the free market won’t produce those cars by itself.

Today I stumbled across a useful website: I think I will use it to link to in response to such statements. Specifically, the first comment (from the left) exhibits a lack of understand of the negative effects of business taxes, and the second comment exhibits a lack of understanding of externalities.

Why is this important? Is it just a game for political junkies? I don’t think so. These issues are important to the future of our world–the one our kids and grandkids will live in. So I hope more people (particularly those who seek to promote government policy) will educate themselves in basic economics. And I will hold myself to the same standard. The website I linked to seems to be an unbiased economics introduction. But if you feel it leaves out important information or is biased, please feel free to offer a link of your own.

Written by Mike

December 21, 2008 at 9:45 pm

Posted in government

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