Wednesday, August 29, 2012

Once Again, University of Chicago Gets It Wrong

From John Cochrane

A really good example: What will the effect on output and employment be of ending 99 weeks of unemploment insurance? That's part of the fiscal cliff, and the CBO's analysis (see above) says that reducing unemployment insurance will lower GDP. Really? A standard economic analysis comes to exactly the opposite conclusion. Generous unemployment and disability means that some people choose to stay unemployed rather than take lower-paying jobs, or jobs that require them to move.  So long as you stay unemployed, you get a check from the government. Subsidizing anything produces more of it. So, a standard analysis says that cutting back unemployment insurance lowers unemployment, and raises output and this part of the fiscal cliff analysis should go the other way.

Before you go all nuts on how heartless I am, keep the question in mind. I didn't say what's good or bad, I said what raises or lowers GDP and unemployment. The standard analysis of unemployment insurance says, yes, it raises unemployment and lowers GDP, but it provides important insurance for the truly needy and unfortunate. It's something we do out of compassion even though it hurts us.

But the CBO didn't score national welfare, or a compassion index. They scored GDP and unemployment, and their model comes to the opposite conclusion, subsidizing unemployment causes more GDP and less unemployment. As well as being compassionate. How do we have our cake and eat it too? Well, that's the magic of Keynesian economics, on which I will not digress here.   

First, I understand that Mr. Cochrane is not making a value judgement.  However, his statement regarding the amount of benefits is completely and utterly false.  Consider the following:

Unemployment benefits are intended to partially replace lost wages, so the precise amount you receive will depend on what you used to earn. States use different formulae to calculate benefit payments, but all states take prior earnings into account in some way. Some states consider the employee's prior annual earnings, others look at the employee's earnings during the highest paid quarter or two quarters of the base period. (For more on the base period, see Nolo's article Unemployment Compensation: Understanding the Base Period.)

All states also set an upper limit on the total weekly benefit amount. A common formula is to pay half of what the employee used to earn, up to a cap that's tied to the average earnings in that state. This means that employees with higher wages may receive a larger overall benefits check, but a smaller percentage of what they used to earn. The maximum amount an employee can receive each week varies widely from state to state.

Some states provide an additional benefit amount to employees with dependents. These amounts tend to be small; most states that provide this benefit offer $25 or less per dependent per week in additional benefits.

Unemployment benefits are taxable. (Although the first $2,400 in unemployment benefits was not subject to federal income tax in 2009, that provision was not renewed for subsequent years.) You may elect to have up to 10% of your benefit amount withheld to pay federal income taxes.

And consider this:

The goal of the unemployment insurance program, according to the Center on Budget and Policy Priorities, is to provide people with about half their normal wage. However, it almost never works out that way. The average American collected $295 in weekly unemployment benefits in the third quarter of 2010, according to the most recent government data. But the average weekly salary in that same quarter was $865, which means the jobless benefits replaced just over a third of the average worker's salary.

According to Mr. Cochrane, benefits are so generous that they would keep people from working.  However, that is not the case.  Unemployment benefits pay a portion of what the unemployed person previous made with caps.  In addition, if there are dependents, they receive a small, additional amount -- but it's not that much.  Also consider these benefits are taxable, further lowering the amount received.

As the second excerpt shows, unemployment insurance really doesn't provide an incentive to remain unemployed -- unless making less than half of your previous wage is somehow and incentive (which it's not).   Put another way -- reality (facts, data, people living within a linear space/time continuum) completely contradicts Mr. Cochrane's views.

In case you're wondering, I found the information regarding the amount of unemployment benefits by using a tool called "Google."  It really helps with research.

I should also add, Mr. Cochrane is more than welcome to prove me wrong by happily living off of his statutorily calculated unemployment benefits for a period of 12 months.  Something tells me he won't take the bet.

Mr. Cochrane continues:

The CBO’s projections are deeply and explicitly Keyneisan, relying on “multipliers.” If the government borrows a billion dollars and blows it on some useless porkbarrel project, the CBO will project that this raises GDP  to the tune of one and a half billion dollars. In analyzing the “fiscal cliff,” reducing such projects is bad for the economy.  That’s the key source of their estimate that the fiscal cliff leads to recession. If you, like me, think that the government spending less money on useless projects (say, ethanol subsidies) has a positive effect on output, or that taking less money from A and giving it to B has little effect, then you will not be so worried. 

Note the assumption being made: all government spending is by definition bad and wasteful.  There's a complete dismissal of the good projects that government provides.  For example, I bet if we proposed completely eliminating the department of defense -- that department with the famed $100 toilet seat -- we'd hear howls of protest.  And what about eliminating all highway money?  Somehow I doubt FedEx or UPS would be on board for that one.  I tend to think the pharmaceutical industry would have issues with eliminating the NIH.  And think about all the great innovations that have been created and implemented by the nerds at NASA?  In short, there's a lot of good that comes from government spending which would take a Herculean effort not to see (although Mr. Cochrane is making just such an effort).

And it's not like the private sector is a glowing source of efficiency.  The entire housing bubble was a private sector phenomenon, greatly aided by massive deregulation.  Wall Street has been the home of several multi-billion dollar Ponzi schemes (Stanford and Madoff anyone?).   Private contractors cut corners everyday (endangering those who purchase real estate), lawyers, doctors and CPAs give plenty of bad advice on a regular basis ...  you get idea at this point.

The above points illustrate very clearly that Mr. Cochrane's basic assumptions underlying his analysis are completely wrong.  And that makes his arguments moot.