Saturday, May 27, 2017

Later School Starts for High School?

Would high school students learn more if school start-times were moved back? For example, the American Association of Pediatrics recommends that adolescents should have schedules that allow them to sleep until 8AM. Jennifer Heissel and Samuel Norris offer some actual evidence on the point in “Rise and Shine: The Effect of School Start Times on Academic Performance from Childhood through Puberty,” Journal of Human Resources, published online before print, April 19, 2017 (the abstract is here, but many readers will have access to the article through an institutional library subscription).

David Figlio has a nice overview at "Start high school later for better academic outcomes," a report posted at the Brookings Institution website (May 25, 2017). Rather than provide an inferior copy of his discussion (with includes mentions of some other evidence and a more in-depth discussion), I'll just offer some excerpts of his discussion of the Heissel and Norris paper.  Figlio writes:
"The authors focus their attention on the relationship between sunlight and sleep, and take advantage of the fact that the state of Florida, where they conduct their research, is divided into two time zones. The sun comes up an hour later, on the clock, in the Eastern Time Zone than a few miles west in the Central Time Zone, but schools only partially account for this difference when setting their start times, so, on average, students in the Central Time Zone in Florida have more than half an hour more sunlight before school starts than do their counterparts in the Eastern Time Zone, and some have an hour or more additional sunlight, depending on when school starts.
"One might be concerned that people living in different parts of Florida are somehow different in other ways as well, and Heissel and Norris are able to deal with this concern by concentrating on students who moved between time zones, while remaining in the northern part of Florida (typically called the Panhandle). Some students moved between the Eastern Time Zone and the Central Time Zone, thereby gaining extra sunlight in the morning before school, while others moved from the Central Time Zone to the Eastern Time Zone, thereby losing some sunlight before school starts. Their strategy, therefore, is to compare the same students’ test performance before versus after their cross-time zone moves. The authors found that people making these eastward and westward moves in the Florida Panhandle were similar across a large range of characteristics, and tended to follow similar over-time test score trends prior to their moves.
"What happens when children get an extra hour of sunlight before starting school? (The authors estimate the effect of each additional minute of pre-school sunlight, and I’m presenting the effects of a 60 minute difference for ease of explication.) If they are young, math scores are barely affected—the estimated score improvement is just one percent of a standard deviation—but reading scores increase by six percent of a standard deviation. But once they reach puberty (approximately at age 11 for girls and age 13 for boys) math scores improve by eight percent of a standard deviation and reading score improvements remain at six percent of a standard deviation. ...

"Heissel and Norris carried out a thought exercise in which, for every Florida panhandle school district, they assigned the school district’s earliest start times to elementary students, the middle start times to middle school students, and the latest start times to high school students. This calculation would move elementary school start times 22 minutes earlier, middle school start times 13 minutes earlier, and high school start times 44 minutes later, on average.
"Heissel and Norris estimate that making these scheduling switches would raise average math performance by six percent of a standard deviation and average reading performance by four percent of a standard deviation. While not earth-shattering performance changes, they are extremely impressive for a policy change that would cost school districts little to implement – and are approximately one-fourth the difference between an excellent-performing school and an average-performing school."
When I've heard discussions of later start times for high school, several issues usually come up. First, there is an aversion to having the youngest children start earlier. Frankly, this has always seemed a little odd to me. I've got no evidence on the point, but a lot of young children seem to wake up pretty early, and parents who are depending on school for child care have good reason to wish that their younger children were out the door a little sooner. Second, there's an argument that if the high school day starts later, it also needs to end later, which in turn means less time for high school sports and activities, or for after-school jobs. Third, there's an argument that lots of high school students are staying up until the middle of the night as it is, and if they can get up later, they will just stay up later.

"The American Academy of Pediatrics strongly supports the efforts of school districts to optimize sleep in students and urges high schools and middle schools to aim for start times that allow students the opportunity to achieve optimal levels of sleep (8.5–9.5 hours) ..."  But of course, getting a sufficient quantity of sleep is not just about school start times. It's about the outside-school load of homework, school activities, jobs, family life, social life--and about developing a habit where the regular bedtime is a hour or more before midnight, not after.


Friday, May 26, 2017

Algorithmic Pricing and Competition: The Small-Town Gas Station Example

An enormous number of pricing decisions in the modern economy, not only in financial markets but in many on-line markets in general, are facilitated by computer algorithms. Indeed, a market may include the interaction of several different computer algorithms from buyers, sellers, and market-makers. Maureen K. Ohlhausen, who is Acting Chairman of the U.S. Federal Trade Commission, asks "Should We Fear The Things That Go Beep In the Night?Some Initial Thoughts on the Intersectionof Antitrust Law and Algorithmic Pricing," in a speech given at the Concurrences Antitrust in the Financial Sector Conference on May 23, 2017. As as setting for her discussion of issue raised by algorithmic pricing, she offers a hypothetical example of small-town gas stations, which goes like this:
"I want you to imagine a small, rural town somewhere in the desert southwest. This little town is modest and utterly unremarkable in every way. But in the center of town, clustered around the only stoplight, are three gas stations. These three stations have the only gas for sale within 150 miles in every direction. The date is 1970, so this is a time with no internet, no personal computers, no cell phones, and certainly no algorithmic pricing. All three gas stations currently charge exactly the same price for a gallon of gas. Prices may go up and down as the wholesale price of gasoline moves, but all three stations generally charge identical prices, and have been charging essentially identical prices for years. 
"All of that is about to change. At 6:00AM one bright clear Monday morning, the owner of the first gas station gets out his ladder and leans it against the big price sign out front. He then climbs up the ladder and changes the price, making it five cents a gallon more expensive. Then he takes his ladder down, walks over to a lawn chair in the shade and sits down to have a cup of coffee. At 10:00AM, he gets the ladder back out and lowers his price back down five cents so his price is now the same as everybody else’s price. He repeats that same pattern of behavior every Monday morning. He never directly talks to his competitors about the prices he is charging or why he is doing what he did. 
"Has he violated the antitrust laws just by changing his price for four hours? If that is all he has done, the answer is no. Generally, firms are free to set whatever prices they choose, as long as they act independently. Nor would it be unlawful for one of the other gas stations to decide, on his own, to follow the lead of our analog-era friend with the ladder and start raising his own prices on Monday mornings. Even if all the stations in the town ultimately decide to follow the lead of the first station and raise prices five cents, then keep those high prices in place, the antitrust laws do not condemn this behavior. 
"So why don’t we enforcers take action in this situation to prevent conscious parallelism? The simple reason is that there is no sensible remedy here. In a free market, individual actors are free to set their prices on the basis of all the information legally available to them. It is axiomatic that we cannot tell firms to ignore the public behavior of their rivals when they set prices without deleting the “free” in free market. Enjoining this kind of behavior would inevitably lead to price regulation, which is completely inimical to the underlying purposes of the antitrust laws. Because we cannot police this sort of behavior directly, instead we try to make sure, primarily through our merger enforcement program, that the conditions that allow this kind of behavior to take place generally don’t arise in the first place. We also prohibit explicit agreements to set prices collusively and exchanges of competitively sensitive, non-public information between competitors. 
"Fortunately for all of us, there are many, many reasons why this kind of informal pricing interdependency frequently fails or breaks down in the real world. For example, when the products are highly differentiated, or the market participants have different cost structures, or transactions are relatively infrequent, it is very difficult to maintain stable, interdependent pricing just by watching the behavior of your rivals. So the specific facts of my gas station example are very important. 
"Everybody is selling the exact same commodity product. Transactions happen frequently, with each individual transaction relatively small and unimportant, so there is little risk of major losses associated with price leadership. Also, there are few participants in the market, making it easier to get to a point of tacit consensus. Finally, and most critically, there is complete price transparency because everybody can see the prices everyone else charges just by looking at those big signs. If we take away any one of those facts, the whole thing will generally fall apart on its own. For example, if firms could somehow secretly discount and steal market share from their rivals, they have a significant incentive to do that and so on. ...
"So while our friend with the ladder may eventually, informally lead everyone’s prices higher, things look a lot different from a legal perspective if he walks over to one of his competitors and starts talking to him about prices. Suddenly we now have conduct that has nothing to do with independently setting prices and reacting to market conditions. The policy considerations that tolerate unilateral but interdependent pricing no longer apply. Once competitors reach an agreement setting price or output, they are engaged in behavior with no social utility and an enforcement response by the government is warranted. So there is a critical legal difference between concerted behavior among competitors aimed at influencing prices and unilateral decision-making in light of observed market conditions. Setting prices together is illegal, while observing the market and making independent decisions is not." 

Ohlhausen uses the small-town gas station example to argue that the issues raised by algorithmic pricing are reasonably familiar, that similar issues have come up in well-known cases in the past, and so the antitrust authorities will have power to act if needed.

For example, one concern about algorithmic pricing is that the players in the market may use it as a way of colluding with each other behind the scenes, in a way that isn't easily visible in market prices. Ohlhausen points out that more than 20 years ago, back in 1993, airlines were using the information on-line reservation systems as a way of limiting competition, but the antitrust authorities and the courts had no trouble understanding the problem and addressing it. She writes: "This is because the type of technology used to communicate with competitors is wholly irrelevant to the legal analysis. Whether it is phone calls, text messages, algorithms or Morse code, the underlying legal rule is the same – agreements to set prices among competitors are always unlawful."

Ohlhausen proposes the "guy named Bob" rule: " "Everywhere the word `algorithm' appears, please just insert the words `a guy named Bob'. ... If it isn’t ok for a guy named Bob to do it, then it probably isn’t ok for an algorithm to do it either."

My sense is that Ohlhausen is surely correct about the underlying law here: that is, doing something with an algorithm does not offer any protection or immunity against antitrust rules. I also like the small-town gas station metaphor and the "guy named Bob" rule, as nice concrete ways of illustrating these issues. But I do worry that while algorithmic pricing doesn't alter the rules of antitrust, it may make collusion easier.

As one example, a few years back there was a scandal about the LIBOR benchmark interest rate (that is, London Interbank Offered Rate). The rate was set by having a number of big banks send in the interest rates they were being charged for borrowing. But it turned out that the individual actually submitting the rates were not sending actual numbers, but instead shading them up or down. As a result, the LIBOR would be a little higher or lower than it should have been. The effect was only a small amount for a short time, but LIBOR is linked to something like $300 trillion of financial instruments around the world, so a trader who knew that the rate was artificially high or low could find a way to cash in. This manipulation went on for years, and led to prosecutions at 15 major global financial institutions.

Yes, this particular case was eventually detected and prosecuted. But having algorithms ready to pounce on small and short-term movements in LIBOR clearly helped to facilitate the entire scheme. One wonders about the possibility of other cases, perhaps using market benchmarks or interest rates that are less prominent than LIBOR and involving far fewer participants, which are not detected. The problem here is not specifically algorithms, but rather that the internet offers lots of possibilities for those who wish to collude, and algorithms can make it easier to cash in on such collusion.

There are other cases where the algorithms themselves may become problematic. Algorithms are starting to offer the possibility of "personalized pricing," which refers to presenting online shoppers with a carefully designed series of options and prices and "if-you-buy-now" sales that--in combination with their past buying patterns and well-known behavioral biases--push that person toward a certain choice.

In other cases, as we move deeper into the world of big data and artificial intelligence, algorithms for buying and selling and setting prices are increasingly moving beyond basic rules, like buying only when a price falls below a certain level. Algorithms are now analyzing past patterns of players in the market, including how those player have reacted in the past, and then planning and implementing a potentially multi-step strategy. My guess is that some point there will be an antitrust case featuring the "algorithm defense," which basically says: "Hey, I just set up the smart learning algorithm and let it run. How could I know that it would interact with other smart learning algorithms in a way that led to collusion?" And the antitrust authorities (or other law enforcement) will need to argue that when a guy named Bob sets up and signs off on an algorithm, Bob needs to be personally responsible for what that algorithm does.

Wednesday, May 24, 2017

The State of Global Financial Integration

Before the Great Recession, cross-border financial assets were on the rise. Since then, the overall rise in cross-border assets has leveled off and the pattern of cross-border assets has shifted somewhat from international debt  to foreign direct investment--and also by the rise of global "financial centers." Philip R. Lane and Gian Maria Milesi-Ferretti lay out the patterns in "International Financial Integration in the Aftermath of the Global Financial Crisis," which appears as IMF working paper WP/17/115 (May 10, 2017). They summarize:
"In particular, we have shown how the very fast growth in cross-border positions in relation to global GDP has come to a halt since the financial crisis, reflecting both a retrenchment of cross-border banking activity and the increased weight of less-financially-integrated emerging and developing economies in global GDP. Across country groups, we have documented the disproportionate role played by financial centers—both small offshore centers and a few larger advanced economies—in total holdings, as well as the growing but still relatively modest role played by emerging and developing economies. Across financial instruments we have shown how the retrenchment in cross-border banking activity and the much more modest increase in portfolio positions relative to pre-crisis trends has been offset by rapidly increasing FDI [foreign direct investment] positions. These have reflected to an important extent claims on and from financial centers, where pass-through financial vehicles as well as the shifting domiciles of multinationals have played a crucial role."
Here's an illustrative figure of global financial external assets and liabilities. The height of the bars shows the rise up to 2007, and the leveling out since then. The colors of the bars show three categories, the fairly familiar categories of advances and emerging/developing countries, and the perhaps less familiar category of "financial centers," which in this paper includes "advanced economies with sizable financial center activity (Belgium; Hong Kong S.A.R.; Ireland; Luxembourg; Netherlands; Singapore; Switzerland; and the United Kingdom), emerging economies with similar characteristics (Mauritius and Panama) as well as small financial centers (such as Bermuda and the
Cayman Islands)." The authors note of these financial centers that "as of 2007, these accounted for close to 10 percent of world GDP but over 43 percent of global financial assets. By 2015, their share in world GDP had declined to 8 percent, but their global share of external assets remained around 43 percent."


When the authors look at these international asset holdings in more depth, holdings related to international banking and overall do debt are falling in recent years, but the level of asset holdings related foreign direct investment is rising. In turn, this offsetting rise in FDI seems to be driven in substantial part by activities occurring through the financial centers.  They write: 
We also document how cross-border FDI positions have continued to expand, unlike positions in portfolio instruments and other investment. This increase is primarily explained by FDI positions vis-à-vis financial centers, which include an important role for so-called special purpose vehicles. This suggests that the increased complexity of the corporate structure of large multinational corporations is playing an important role in this respect. ...

While most of the larger financial centers have important multinational corporations with
extensive cross-border activities, other factors play an important role in explaining both the size and composition of FDI claims and liabilities as well as their dynamics.
The first is the growing importance of Special Purpose Entities. These are legal entities with “little or no employment; or operations, or physical presence in the jurisdiction in which they are created by their parent enterprises which are typically located in other jurisdictions (economies)” (OECD, 2008). Such vehicles are used to raise capital or hold assets/liabilities and generally perform no production activities. Statistics on the relative importance of SPEs in total FDI are only available for a limited set of countries. Helpfully, those include the Netherlands and Luxembourg, which are the countries with the largest stocks of FDI claims and liabilities after the United States. The vast majority of their FDI claims and liabilities (over ¾ for the Netherlands and over 90 percent for Luxembourg) are indeed SPEs. Total FDI claims by SPEs for just these two countries have grown by over $3.5 trillion between 2007 and 2014—over ¼ of the increase in the stock of global FDI claims during the same period.
The second factor is the increased tendency of multinational companies to move their
domicile to a financial center. To the extent that the company is moving from a country
where it has larger production facilities than in the financial center this will generally
increase the stock of global FDI (think for instance of a U.S. pharmaceutical company with important local production facilities moving its headquarters to Ireland). In that case, global FDI would increase by the value of the U.S. production facilities minus the value of any facility previously located in Ireland. Indeed, the stock of FDI claims overseas by Ireland has increased by $600 billion between 2007 and 2014, and by that date it is over 5 times Irish GDP. The counterpart to an increase in FDI assets in the countries hosting re-domiciled firms is a matching increase in foreign portfolio equity liabilities, given that the underlying shareholders of the entities remain the same.
My own interpretation of these patterns is that the kind of foreign direct investment which involves a company taking real management interest in running a firm elsewhere, and which often involves transfers of skill and technology, may well be in decline. However, the kind of foreign direct investment that involves setting up foreign headquarters and foreign financial vehicles as a way of pushing back against tax and regulatory issues is on the rise. 

Tuesday, May 23, 2017

Meat Substitutes:Soy, Mealworms, and Crickets

Meat, and especially beef, has a heavy environment footprint by the time you take into account the farm products and land needed to produce it. In particular, if one looks out at the emerging and not-yet-emerging markets across the global economy, and start calculating what kinds of farm output would be needed for a large share of the world to have the meat consumption of high-income countries, it's hard to see how it would work. However, there are ongoing efforts to think about how one might increase world production of protein with a smaller environmental footprint.

For example, I've written before about "First Burger Grown from Stem Cells Served in London" (January 21, 2014). In "Tradeoffs of Cultured Meat Production" (May 16, 2016), I pointed to some studies suggesting that "carneries"--that is, factories that produce meat--could have a much smaller effect on land use and associated environmental costs than traditional meat production.

In a forthcoming issue of Global Food Security, Peter Alexander, Calum Brown, Almut Arneth, Clare Dias, John Finnigan, Dominic Moran, Mark D.A. Rounsevell ask the question: "Could consumption of insects, cultured meat or imitation meat reduce global agricultural land use?" A "corrected proofs" version article has been freely available online since April 22, 2017, but at some point when the article is published in the journal it will only be available through libraries and subscriptions. (The doi address will remain https://doi.org/10.1016/j.gfs.2017.04.001.)

Here's an illustrative figure from the paper. The top panel shows calories per unit of agricultural land; the bottom panel shows protein per unit of agricultural land. On both measured, beef is the lowest producer on the far right-hand side. The most efficient producer in both cases is soybean curd, followed by mealworm larvae and adult crickets. Cultured meat is in the middle of the pack, not too different from eggs, poultry, and pork.


As the authors note (citations omitted): "The results here assume that insect feed uses the same mix of feeds currently used for conventional livestock. However, if half of food discarded by consumers could be used as feed for mealworms, this would replace 8.1% of current animal production." 

From a US perspective, mealworms and crickets may not sound like culturally acceptable alternatives. But there are lots of places around the world where demand for calories and protein is rising sharply, and where eating insects or worms is, if not always common, by no means taboo, either. Perhaps more to the point, after a certain amount of processing, protein from mealworms or crickets may not look or taste all that different from the mystery meat that already shows up in a number of places. Nuggets are nuggets, right? 

Monday, May 22, 2017

Rising Job Tenure and Its Tradeoffs

Given the tumultuous changes in the US economy in recent years, I would have guessed that average "job tenure"--that is, the average time that someone with a job has held that job--was declining. My guess would have been wrong. Henry R. Hyatt and James R. Spletzer present the evidence that job tenure has been mostly on the increase since about 2000 in "Shifting Job Tenure Distribution" (U.S. Census Bureau, Center for Economic Studies, May 2016, CES 16-12R). For example, they write:
"According to published statistics from the Current Population Survey (CPS), the proportion of workers with five or more years of tenure on their main job has increased from 44% to 51% from 1998 to 2014, and the proportion of workers with one year or less of tenure on their main job has decreased from 28% to 21%. We document a similar shift in the job tenure distribution for the years 1998 to 2013 using LEHD [Longitudinal Employer-Household Dynamics] microdata, which is nearly identical to the CPS tenure distribution once differences between these source data are accounted for." 
Here are a couple of illustrative figures. The top panel shows median job tenure in the Current Population Survey data, going back to 1951. The bottom panel shows the share of jobs that fall into certain job tenure categories: for example, the top line shows the share of employed people who have held a job for at least five years.
Here's a figure based on the Longitudinal Employer-Household Dynamics data, which is a database in which state governments send administrative records about who works where to the US Census Bureau, which combines them in a way that preserves anonymity for workers and employers. The database covers 95% of private sector jobs. Again, you can see the rise in the share of jobs held for more than five years.


What's going on behind these numbers? Hyatt and Spletzer forthrightly answer: "While there is ample evidence that the labor market is shifting toward more stable jobs, the causes and consequences of declining dynamics and increasing stability remain unknown." But they do massage the data in way that offers some clues. For example, they note that older workers tend to have stayed at their jobs longer, and the US workforce is getting older. So they ask: To what extent does the rise in job tenure just reflect an older workforce? Or they note that the US economy has been experiencing a slowdown in the start-up rate of new companies for about 20 years now, so more workers are with older firms. Again, to what extent does the rise in job tenure reflect the the fact that US firms are older?

The answers to these questions vary with whether they are using Census or LEHD data, but in rough terms, the older workforce can explain about one-third of the rise in job tenure and the growing age of firms can explain about one-sixth of the change, but about half of the rise in job tenure is not explained by the factors they are able to consider.

There is a knee-jerk temptation to feel as if longer job tenure is likely to be a good thing--more stability for workers. But there are tradeoffs.

1) To the extent that longer job tenure is being driven by fewer start-ups and a smaller share of the US workforce being employed at new firms, it is clearly a mixed blessing.

2)The US labor market "churns," as economists sometimes say. There are always millions of people separating from jobs and being hired for new jobs. In good times, the new jobs outnumber the separations; in bad times, it's the reverse. But along with the lower rate of start-up companies, the US labor market has been less showing less churn in the last 15-20 years. Both rates of hiring and of separation rates dropped off for the first decade of the 2000s, although they have rebounded a bit since then. Of course, some of the reason that job separation rates fell around 2007 is that, in a weak economy, workers have a greater tendency to hold on to the job they've got. In addition, jobs where someone has just been hired are on average shorter-term, and so the drop in the hiring rate seems linked to longer job tenure. But of course, a less flexible job market with lower hiring rates is a mixed blessing, too.

3) The job tenure calculations are based on workers with jobs. Thus, a worker who is unemployed for  a time and then returns to the workforce in a new job will tend to reduce job tenure. But there has also been a decline in the US labor force participation rate--that is, a greater number of adults who don't have jobs and aren't looking for a job. I suspect that if some of of these people had stayed in the labor force, they might have been more likely to be moving in and out of various jobs, which would have pulled down the average job tenure.

4) One benefit of longer job tenure is that workers develop experience and skills which make them a good "match" for their employers, and thus enable them to get wage increases. But at least in the last 10 years or so, "The increase in average real earnings since 2007 is less than what would be predicted by the shift toward longer-tenure jobs because of declines in tenure-held-constant real earnings. Regression estimates of the returns to job tenure provide no evidence that the shift in the job tenure distribution is being driven by better matches between workers and employers." Of course, earnings after about 2007 are sharply affected by the Great Recession.

But overall, the picture that emerges is that job tenure rates aren't up because of workers who are more productively  matched to stable jobs. Instead, job tenure rates are up from a combination of a less dynamic economy and a less fluid labor market, combined with a Great Recession that caused more workers to cling to the job they had.

Friday, May 19, 2017

Pass-Through Corporations (Which Don't Pay Corporate Income Tax)

When most people think of corporations and corporate taxes, they think of a company with shareholders, and buying and selling stock. But that's only one form of corporation, called a C-corporation in tax law. There are also corporations that don't issue shares of stock to the public. This category includes sole proprietorships, partnerships, and what are called S-corporations. These are "pass-through" corporations, in which the income earned by the corporation goes straight to the owners, and thus is taxed under the personal income tax rather than the corporate income tax. The pass-through sector of the economy is growing, as  Aaron Krupkin and Adam Looney review the evidence in "9 facts about pass-through businesses" (Brookings Institution,  May 15, 2017).

As they explain, "Of the 26 million businesses in 2014, 95 percent were pass-throughs, while only 5 percent were C-corporations." But most businesses are very small: for example, 41% of those 26 million businesses were sole proprietorships. Moreover, 99% of all companies and 95% of C-corporations had receipts of less than $10 million.

The share of total business income in C-corporations is falling, and share in partnerships and S-corporations is rising, to the point where pass-through corporations now receive more than half of all business income.

The tax rules are different in a variety of ways across these corporate forms. For example, if you receive a payment from a company for your labor, you owe Social Security and Medicare payroll taxes on that amount, but if you receive a share of profits, then then you don't owe those payroll taxes. The decision about what is a payment for labor and what is a share of profits contains a large element of discretion.  Thus, substantial time and energy goes into finagling the legal structure of the corporation, in part to take advantage of tax differences.

For example, the shares of C-corporations are "closely held" by a small number of investors, which can make them similar in some ways to S-corporations. Krupkin and Looney write:
"While they are not “pass-throughs,” many closely-held C corporations in which the owners are also managers share certain similarities with pass-throughs and, in practice, the income of their owners is often taxed much like that of sole proprietors. Owner/managers of closely-held C corporations often pay themselves wages, which are deductible from corporate-level tax, in lieu of dividends, which are not. This way, they maintain the limited liability and legal benefits of incorporation, but avoid the two levels of corporate tax by receiving their income as wages. As a result, the taxes they face are more similar to general partners or sole proprietors than to, say, publicly-traded C corporations."
Conversely, it is increasingly common for large firms to organize themselves as partnerships and S-corporations: indeed, there are now even hybrid forms like partnerships which issue stock that is publicly traded.
"Large businesses are responsible for nearly all of the sales and profits of C-Corporations, and a substantial majority of sales and profits of partnerships and S-corporations. Among sole proprietorships, in contrast, only 9 percent of sales and less than 1 percent of profits came from large businesses. Most hedge funds, private equity funds, law, consulting, and accounting firms are partnerships; these businesses can be large, global enterprises. Indeed, in 2014, about a quarter of partnership business income was earned in finance, real estate, and holding companies sectors, and about 13 percent by law firms. With the advent of publicly-traded partnerships, a few pass-throughs are now owned by thousands of shareholders and trade on stock exchanges like public C-corporations. Similarly, large S-corporations compete directly with large C-corporations in industries like engineering and construction, trade, and professional services."
In thinking about corporate tax reforms, it's important to remember that the shareholder-owned C-corporation is actually less than half of all business income. Any sensible reform has to take into account the entire universe of US corporations. Krupkin and Looney cite one prominent estimate: "According to one U.S. Treasury study, if the relative shares of pass-through and C-corporate activity were held at 1980 levels, the average tax rate on business income in 2011 would have been 28 percent instead of 24 percent. This translates to more than $100 billion in lost revenue in 2011 alone."

In thinking about "corporations" more broadly, it's also important to remember there are huge differences between mega-giant C-corporations like Walmart, Apple, and ExxonMobil and the overwhelming number of other corporations out there--not only on the obvious dimension of size, but also in their legal form.

For some previous takes on this subject, see:

Thursday, May 18, 2017

Associational Life in America

The concept of "social capital" is slippery to measure or analyze, but the OECD, for example, defines it as “networks together with shared norms, values and understandings that facilitate co-operation within or among groups.” The great economist Kenneth Arrow wrote in a 1972 essay on "Gifts and Exchanges" (Philosophy & Public Affairs, 1:4 (Summer 1972), pp. 343-362): 
"Many of us consider it possible that the process of exchange requires or at least is greatly facilitated by the presence of several of these virtues (not only truth, but also trust, loyalty, and justice in future dealings). Now virtue may not always be its own reward, but in any case it is not usually bought and paid for at market rates. In short, the supply of a commodity in many respects complementary to those usually thought of as economic goods is not itself accomplished in the marketplace ... Virtually every commercial transaction has within itself an element of trust, certainly any transaction conducted over a period of time. It can be plausibly argued that much of the economic backwardness in the world can be explained by the lack of mutual confidence ... "
Any discussion of American networks soon starts quoting the French writer Alexis de Tocqueville,who noted an oddity about Americans in his classic Democracy in America (published in two volumes in 1835 and 1840): Americans had a predilection what he called associations. He wrote:
"Americans of all ages, all conditions, and all dispositions, constantly form associations. They have not only commercial and manufacturing companies, in which all take part, but associations of a thousand other kinds—religious, moral, serious, futile, extensive, or restricted, enormous or diminutive. The Americans make associations to give entertainments, to found establishments for education, to build inns, to construct churches, to diffuse books, to send missionaries to the antipodes; and in this manner they found hospitals, prisons, and schools. ... Nothing, in my opinion, is more deserving of our attention than the intellectual and moral associations of America. The political and industrial associations of that country strike us forcibly; but the others elude our observation, or if we discover them, we understand them imperfectly, because we have hardly ever seen anything of the kind. It must, however, be acknowledged that they are as necessary to the American people as the former, and perhaps more so. In democratic countries the science of association is the mother of science; the progress of all the rest depends upon the progress it has made."  
But while the idea that social capital is important is far from new, it's nonetheless interesting that the staff of the Joint Economic Committee of Congress has just published a report "What We Do Together: The State of Associational Life in America  (Social Capital Project Report 01-17, May 2017). It's studded with quotations from authors like Tocqueville and Robert "Bowling Alone" Putnam.

Before listing some facts about changes in what the report calls "associational life" in America, it's perhaps useful for me to confess that while I can easily believe that social capital is generally important, the specific processes by which it is created and reinforced are not clear to me. It would be peculiar and anachronistic to yearn after the good old days of 1840. If the people of 1840 had radio, television, and the internet, not to mention the ability to hop in a car or a plane and travel, then the "associations" observed by Tocqueville would have looked rather different. The question of what social institutions are most useful to inculcate the growth of a citizens with a predisposition to cooperation and trust is a vast ocean, and I am just a guy in dinghy, padding around with one small oar.

In other words, I think it's important and useful to think about how associational life is shifting: that is, who we rely on, who relies on us, and how we interact with other citizens in a variety of cross-cutting forums. It does feel as if we are, along a number of dimensions, living in a lower-trust time. But whether or how to address these changes is beyond my remit. Here are some of the patterns mentioned in the Congressional report, which include associations related to family, religion, community, politics, and work.  For those with a taste for Tocqueville, I'll include some additional context from Democracy and America below:

Some changes in family associations

  •  Between 1973 and 2016, the percentage of Americans age 18-64 who lived with a relative declined from 92 percent to 79 percent. The decline was driven by a dramatic 21-point drop in the percentage who were living with a spouse, from 71 percent to 50 percent.
  • In 1970, there were 76.5 marriages per 1,000 unmarried women aged 15 and older. As of 2015, that rate had declined by more than half to 32 per thousand. 
  • In 1970, 56 percent of American families included at least one child, but by 2016 just 42 percent did. The average family with children had 2.3 children in 1970 but just 1.9 in 2016. Among all families—with or without children—the average number of children per family has dropped from 1.3 to 0.8. 

Some changes in religious associations

  • In the early 1970s, nearly seven in ten adults in America were still members of a church or synagogue. While fewer Americans attended religious service regularly, 50 to 57 percent did so at least once per month. Today, just 55 percent of adults are members of a church or synagogue, while just 42 to 44 percent attend religious service at least monthly. 
  • In the early 1970s, 98 percent of adults had been raised in a religion, and just 5 percent reported no religious preference. Today, however, the share of adults who report having been raised in a religion is down to 91 percent, and 18 to 22 percent of adults report no religious preference. 

Some changes in community associations

  • Between 1974 and 2016, the percent of adults who said they spend a social evening with a neighbor at least several times a week fell from 30 percent to 19 percent.
  • Between 1970 and the early 2010s, the share of families in large metropolitan areas who lived in middle-income neighborhoods declined from 65 percent to 40 percent. Over that same time period the share of families living in poor neighborhoods rose from 19 percent to 30 percent, and those living in affluent neighborhoods rose from 17 percent to 30 percent.
  • Between 1972 and 2016, the share of adults who thought most people could be trusted declined from 46 percent to 31 percent. Between 1974 and 2016, the number of Americans expressing a great deal or fair amount of trust in the judgement of the American people “under our democratic system about the issues facing our country” fell from 83 percent to 56 percent.
  • Between 1974 and 2015, the share of adults that did any volunteering who reported volunteering for at least 100 hours increased from 28 percent to 34 percent.

Some changes in political associations
• Between 1972 and 2012, the share of the voting-age population that was registered to vote fell from 72 percent to 65 percent, and the trend was similar for the nonpresidential election years of 1974 and 2014. Correspondingly, between 1972 and 2012, voting rates fell from 63 percent to 57 percent (and fell from 1974 to 2014).
• Between 1972 and 2008, the share of people saying they follow “what’s going on in government and public affairs” declined from 36 percent to 26 percent.
• Between 1972 and 2012, the share of Americans who tried to persuade someone else to vote a particular way increased from 32 percent to 40 percent.
Some changes in work associations
 • Between the mid-1970s and 2012, the average amount of time Americans between the ages of 25 and 54 spent with their coworkers outside the workplace fell from about two-and-a-half hours to just under one hour.
• Work has become rarer, in particular, among men with less education. From the mid-1970s to 2012, hours at work fell by just 2 percent among men with a college degree or an advanced degree, compared with 14 percent among those with no more than a high school education.
• Between 1995 and 2015, workers in “alternative work arrangements” (e.g., temp jobs, independent contracting, etc.) grew from 9 percent to 16 percent of the workforce.
• Since 2004, median job tenure has been higher than its 1973 level, indicating that workers are staying in their jobs longer than in the past.
• Between 1970 and 2015, union membership declined from about 27 percent to 11 percent of all wage and salary workers.
For those who need a larger dose of Tocqueville, here's a more extended quotation from his discussion of Americans and "associations" in Book II, Chapters 5-7 of Democracy in America 
(the Project Gutenberg edition). Toward the end of the excerpt, in particular, Tocqueville argues that freedom of association in political, civic, and economic interactions is all intertwined: when people learn how to form associations, it spreads across these varied contexts.
"The political associations which exist in the United States are only a single feature in the midst of the immense assemblage of associations in that country. Americans of all ages, all conditions, and all dispositions, constantly form associations. They have not only commercial and manufacturing companies, in which all take part, but associations of a thousand other kinds—religious, moral, serious, futile, extensive, or restricted, enormous or diminutive. The Americans make associations to give entertainments, to found establishments for education, to build inns, to construct churches, to diffuse books, to send missionaries to the antipodes; and in this manner they found hospitals, prisons, and schools. If it be proposed to advance some truth, or to foster some feeling by the encouragement of a great example, they form a society. Wherever, at the head of some new undertaking, you see the government in France, or a man of rank in England, in the United States you will be sure to find an association. ... The English often perform great things singly; whereas the Americans form associations for the smallest undertakings. It is evident that the former people consider association as a powerful means of action, but the latter seem to regard it as the only means they have of acting. ...
Aristocratic communities always contain, amongst a multitude of persons who by themselves are powerless, a small number of powerful and wealthy citizens, each of whom can achieve great undertakings single-handed. In aristocratic societies men do not need to combine in order to act, because they are strongly held together. Every wealthy and powerful citizen constitutes the head of a permanent and compulsory association, composed of all those who are dependent upon him, or whom he makes subservient to the execution of his designs. Amongst democratic nations, on the contrary, all the citizens are independent and feeble; they can do hardly anything by themselves, and none of them can oblige his fellow-men to lend him their assistance. They all, therefore, fall into a state of incapacity, if they do not learn voluntarily to help each other. If men living in democratic countries had no right and no inclination to associate for political purposes, their independence would be in great jeopardy; but they might long preserve their wealth and their cultivation: whereas if they never acquired the habit of forming associations in ordinary life, civilization itself would be endangered. ... 
As soon as several of the inhabitants of the United States have taken up an opinion or a feeling which they wish to promote in the world, they look out for mutual assistance; and as soon as they have found each other out, they combine. From that moment they are no longer isolated men, but a power seen from afar, whose actions serve for an example, and whose language is listened to. The first time I heard in the United States that 100,000 men had bound themselves publicly to abstain from spirituous liquors, it appeared to me more like a joke than a serious engagement; and I did not at once perceive why these temperate citizens could not content themselves with drinking water by their own firesides. I at last understood that 300,000 Americans, alarmed by the progress of drunkenness around them, had made up their minds to patronize temperance. ...
Nothing, in my opinion, is more deserving of our attention than the intellectual and moral associations of America. The political and industrial associations of that country strike us forcibly; but the others elude our observation, or if we discover them, we understand them imperfectly, because we have hardly ever seen anything of the kind. It must, however, be acknowledged that they are as necessary to the American people as the former, and perhaps more so. In democratic countries the science of association is the mother of science; the progress of all the rest depends upon the progress it has made. ...
In order that an association amongst a democratic people should have any power, it must be a numerous body. The persons of whom it is composed are therefore scattered over a wide extent, and each of them is detained in the place of his domicile by the narrowness of his income, or by the small unremitting exertions by which he earns it. Means then must be found to converse every day without seeing each other, and to take steps in common without having met. Thus hardly any democratic association can do without newspapers. There is consequently a necessary connection between public associations and newspapers: newspapers make associations, and associations make newspapers; and if it has been correctly advanced that associations will increase in number as the conditions of men become more equal, it is not less certain that the number of newspapers increases in proportion to that of associations. Thus it is in America that we find at the same time the greatest number of associations and of newspapers. ...

There is only one country on the face of the earth where the citizens enjoy unlimited freedom of association for political purposes. This same country is the only one in the world where the continual exercise of the right of association has been introduced into civil life, and where all the advantages which civilization can confer are procured by means of it. ...  Civil associations, therefore, facilitate political association: but, on the other hand, political association singularly strengthens and improves associations for civil purposes. In civil life every man may, strictly speaking, fancy that he can provide for his own wants; in politics, he can fancy no such thing. When a people, then, have any knowledge of public life, the notion of association, and the wish to coalesce, present themselves every day to the minds of the whole community: whatever natural repugnance may restrain men from acting in concert, they will always be ready to combine for the sake of a party. Thus political life makes the love and practice of association more general; it imparts a desire of union, and teaches the means of combination to numbers of men who would have always lived apart. ... 
Men can embark in few civil partnerships without risking a portion of their possessions; this is the case with all manufacturing and trading companies. When men are as yet but little versed in the art of association, and are unacquainted with its principal rules, they are afraid, when first they combine in this manner, of buying their experience dear. They therefore prefer depriving themselves of a powerful instrument of success to running the risks which attend the use of it. They are, however, less reluctant to join political associations, which appear to them to be without danger, because they adventure no money in them. But they cannot belong to these associations for any length of time without finding out how order is maintained amongst a large number of men, and by what contrivance they are made to advance, harmoniously and methodically, to the same object. Thus they learn to surrender their own will to that of all the rest, and to make their own exertions subordinate to the common impulse—things which it is not less necessary to know in civil than in political associations. Political associations may therefore be considered as large free schools, where all the members of the community go to learn the general theory of association. ...
It is therefore chimerical to suppose that the spirit of association, when it is repressed on some one point, will nevertheless display the same vigor on all others; and that if men be allowed to prosecute certain undertakings in common, that is quite enough for them eagerly to set about them. When the members of a community are allowed and accustomed to combine for all purposes, they will combine as readily for the lesser as for the more important ones; but if they are only allowed to combine for small affairs, they will be neither inclined nor able to effect it. It is in vain that you will leave them entirely free to prosecute their business on joint-stock account: they will hardly care to avail themselves of the rights you have granted to them; and, after having exhausted your strength in vain efforts to put down prohibited associations, you will be surprised that you cannot persuade men to form the associations you encourage. ... 
When you see the Americans freely and constantly forming associations for the purpose of promoting some political principle, of raising one man to the head of affairs, or of wresting power from another, you have some difficulty in understanding that men so independent do not constantly fall into the abuse of freedom. If, on the other hand, you survey the infinite number of trading companies which are in operation in the United States, and perceive that the Americans are on every side unceasingly engaged in the execution of important and difficult plans, which the slightest revolution would throw into confusion, you will readily comprehend why people so well employed are by no means tempted to perturb the State, nor to destroy that public tranquillity by which they all profit. ... 
Is it enough to observe these things separately, or should we not discover the hidden tie which connects them? In their political associations, the Americans of all conditions, minds, and ages, daily acquire a general taste for association, and grow accustomed to the use of it. There they meet together in large numbers, they converse, they listen to each other, and they are mutually stimulated to all sorts of undertakings. They afterwards transfer to civil life the notions they have thus acquired, and make them subservient to a thousand purposes. Thus it is by the enjoyment of a dangerous freedom that the Americans learn the art of rendering the dangers of freedom less formidable.

Tuesday, May 16, 2017

The Market for US Prescription Drugs

In 2015, the US spent $328 billion on retail drugs, and another $129 billion on "non-retail" drugs,  which are the drugs purchased by hospitals, nursing homes, and other health care providers and added to your bill. The operation of  the market for prescription drugs is a tangle, in ways that suggest competition is often being hindered--or even throttled.

Matan C. Dabora, Namrata Turaga, and Kevin A. Schulman provide a useful diagram summarizing the US prescription drug market in their article, "Financing and Distribution of Pharmaceuticals
in the United States,' which appears in the May 15, 2017 issue of the Journal of the American Medical Association (pp. E1-E2).

The manufacturers of prescription drugs are at the center top of the figure. The drugs themselves work down the left-hand-side of the figure, through distributors and retailers, before reaching the patients. The various arrows in the center and right of the diagram show flows of payments, including AMP (Average Manufacturer Price), WAC (Wholesale Acquisition Cost), and then a maze of chargebacks, negotiated rebates, and payments from patients and private and public health insurance, often mediated through "pharmacy benefit managers."


In their short comment, Dabora, Turaga, and Schulman point out that there is a fairly high amount of concentration at a number of places in this market schematic (footnotes omitted):
"The US distributor market is highly consolidated, with 3 companies accounting for more than 85% of market share: AmerisourceBergen, Cardinal Health, and McKesson.The estimated combined revenues from drug distribution for these 3 firms in 2015 was $378 billion. ... 
"In 2015, an estimated 4.4 billion drug prescriptions were dispensed in the United States ... There are approximately 60 000 pharmacies in the United States, of which 38 000 are part of retail chains and 22 000 are independent pharmacies. The retail pharmacy market can be divided into 3 major categories: chain pharmacies and mass merchants with pharmacies, independent pharmacies, and mail-order pharmacies. The 15 largest firms, including CVS, Walgreens, Express Scripts, and Walmart, generated more than $270 billion in revenue in 2015 through retail and mail-order pharmacy, representing approximately 74% of retail prescription revenues.
"PBMs [pharmacy benefit managers] developed in the 1980s as employers added outpatient prescription drug coverage to their health insurance plans. By 2015, industry consolidation had resulted in 3 PBMs—CVS Caremark, Express Scripts, and UnitedHealth’s Optum—controlling a 73% share of the PBM market.
"Health insurance generally includes prescription drug insurance in both public and private health insurance plans. In 2015, 42%of prescription drug spending was from private health insurance, 30% from Medicare, 10% from Medicaid, and 14% from private out-of-pocket payments.
"In addition to the usual product discounts and allowances for product returns, manufacturers provide a series of cash payments to health plans, PBMs, and distributors in the form of rebates and chargebacks as a result of complex pricing arrangements across the industry. The end result of these complex transactions is that in 2015, $115 billion, or 27% of total pharmaceutical sales,was paid by manufacturers to various entities throughout the drug distribution and financing systems.

Aaron S. Kesselheim, Jerry Avorn, and Ameet Sarpatwari provided an overview of the research literature in "The High Cost of Prescription Drugs in the United States Origins and Prospects for Reform." which appeared in the Journal of the American Medical Association late last summer in the August 23/30, 2016, issue (pp. 859-871). They start with the basic facts that Americans spend more on prescription drugs that people in other countries, and that a number of popular brand-name drugs cost a lot more in the US than in other countries. Here's a figure on per capita spending on prescription drugs: 

On the topic of drug prices across countries, they write: "List prices for the top 20 highest-revenue-grossing drugswere on average 3 times greater in the United States than the United Kingdom. These disparities are reduced but remain substantial even after accounting for undisclosed discounts (“rebates”) that manufacturers offer to US payers. In 2010, estimated average postrebate prices for medications were 10% to 15% higher in the United States than in Canada, France,
and Germany (Table 1)."
Kesselheim, Avorn, and Sarpatwari sort through the research literature, looking for a potential reasons for these high levels of drug prices and drug spending. My own list of some of the reasons from their article would look like this: 

1) Prices are rising for brand-name drugs, and competition between brand-name drugs doesn't seem to bring down prices. 

"Although brand-name drugs comprise only 10% of all dispensed prescriptions in the United States, they account for 72% of drug spending. Between 2008 and 2015, prices for the most commonly used brand-name drugs increased 164%, far in excess of the consumer price index (12%). The annual cost of a growing number of “specialty drugs”—high-cost, often injectable biologic medications such as eculizumab (Soliris), pralatrexate (Folotyn), and elosulfase alfa (Vimizim)—exceeds $250 000 per patient. ...
"In practice, however, competition between 2 or more brandname manufacturers selling drugs in the same class does not usually result in substantial price reductions. For example, of the 8 cholesterol-lowering statins that the FDA has approved, 2 have until recently remained patented: rosuvastatin (Crestor) and pitavastatin (Livalo). Despite the similar performance of these drugs in decreasing low-density lipoprotein cholesterol to other off-patent statins, the price of rosuvastatin increased 91% between 2007 and 2012, from $112 to $214 per prescription.  During the same time, the price of the comparably effective atorvastatin decreased from $127 to $26 per prescription owing to the expiration of its patent protection in 2011. Similar effects have been observed for other drug classes."

2) While competition from generic drugs often does help to bring down prices, that competition faces a number of limits. Brand-name manufacturers often find ways to push back competition from generics, and when a generic for a relatively rare condition has a monopoly, the price for the generic skyrockets, too. 

"The only form of competition that consistently and substantially decreases prescription drug prices occurs with the availability of generic drugs,which emerge after the monopoly period ends.With FDA approval, these products can be substituted for bioequivalent brand-name drugs by the pharmacist under state drug product selection laws.In states with less restrictive drug product selection laws, generic products comprise up to 90% of a drug’s sales within a year after full generic entry. Drug prices decline to approximately 55% of brand-name drug prices with 2 generic manufacturers making the product, 33% with 5 manufacturers, and 13% with 15
manufacturers. In 2012, the US Government Accountability Office estimated that generic drugs accounted for approximately 86% of all filled prescriptions and saved the US health care system $1 trillion during the previous decade. ...
"Entry of generic drugs into the market, however, is often delayed. For pharmaceutical manufacturers, “product life-cycle management” involves preventing generic competition and maintaining high prices by extending a drug’s market exclusivity. This can be achieved by obtaining additional patents on other aspects of a drug, including its coating, salt moiety, formulation, and method of administration. ... For their part, generic manufacturers have engaged in litigation with brand-name manufacturers that could lead to the patents being invalidated, but these suits are frequently settled. Historically, brand-name manufacturers have offered substantial financial inducements as part of these settlements to generic manufacturers to delay or even abort generic introduction. Settlements involving large cash transfers are called “pay for delay”; for example, in a patent challenge case related to the antibiotic ciprofloxacin (Cipro), the potential generic manufacturer received upfront and quarterly payments totaling $398 million as part of the settlement and agreed to wait until patent expiration to market its product.
"Although brand-name drugs account for the greatest increase in prescription drug expenditures, another area that has captured the attention of the public and of policy makers has been the sharp increase in the costs of some older generic drugs. In 2015, Turing Pharmaceuticals raised the price of pyrimethamine (Daraprim), a 63-year-old treatment for toxoplasmosis, by 5500%, from $13.50 to $750 a pill. The company was able to set the high price despite the absence of any patent protection because no other competing manufacturer was licensed to market the drug in the United States.
Significant increases in the prices of other older drugs include isoproterenol (2500%), nitroprusside (1700%), and digoxin (637%). Even though the prices of most generic drug products have remained
stable between 2008 and 2015, those of almost 400 (approximately 2% of the sample investigated) increased by more than 1000%. ...
3) The big government purchasers of drugs, Medicare and Medicaid face legislative limits in encouraging or requiring the purchase of cheaper drugs or generic drugs.
"Medicare, for example, accounts for 29% of the nation’s prescription drug expenditure, but federal law prevents it from leveraging its considerable purchasing power to secure lower drug prices while requiring it to provide broad coverage, including all products in some therapeutic categories, such as oncology. Based in part on considerable lobbying and arguments that government negotiating power could decrease revenues for the pharmaceutical industry, Congress included a provision in the law that created the Medicare drug benefit program, prohibiting the Centers for Medicare & Medicaid Services from negotiating drug prices or from interfering with negotiations between individual Part D vendors and drug companies. ...
"Similarly, state Medicaid programs are generally required by law to cover all FDA-approved drugs, even if a particular medication has alternatives that are safer, are more effective, or offer greater economic value. However, Medicaid is also entitled to receive a rebate of at least 23.1%of the average manufacturer price for most branded medications and is protected from price increases exceeding inflation.
4) Prescription benefit managers are typically paid according to the total revenues of the drugs they manage, and thus lack a strong incentive to negotiate for lower prices. 
"In the 1990s, prescription benefit management companies became prominent intermediaries whose role would be to help employers or insurers promote appropriate prescription drug use and decrease its cost. There have been some recent isolated examples in which pharmacy benefit managers have doneso for specific drugs (most prominently for drugs treating hepatitis C or the pro-protein convertase subtilisin/kexin type 9 inhibitors to reduce cholesterol levels). However, aggressive price negotiation is not the norm. This is not surprising because part of pharmacy benefit managers’ annual fees are based on a given payer’s spending on drugs. Although the details of such payments are rarely disclosed, when one of the largest pharmacy benefit managers became a publicly traded entity, it was obliged to disclose its business model, much of which depended on payments from drug makers for shifting market share to their products from others in its class."
5) State-level  laws also tend to protect brand-name drugs by hindering competition from generics. 
"Notwithstanding high generic drug use rates, problems at the state level can diminish the capacity of generic drugs to help contain costs. Thirty states have drug product selection laws that allow but do not require pharmacists to perform generic substitution; in 26 states, pharmacists must secure patient consent before substituting a generic version of the same molecule. The latter obligation was estimated to have cost Medicaid $19.8 million in 2006 for simvastatin (Zocor) alone. In addition, all states allow physicians to issue dispense-as-written prescriptions that pharmacists cannot substitute with a generic product, further contributing to hundreds of millions of dollars in spending on branded drugs for which generic versions are available."
6) Large self-insured employers have traditionally felt that the potential cost savings from negotiating hard over drug prices, or pushing for alternative and cheaper drugs, wasn't worth the risk of bad public relations episode.
"Even large, self-insured employers have avoided aggressive attempts to negotiate prices directly with drug suppliers or to curtail their formularies to avoid paying for prescriptions that are less cost effective.  A common reason for this reluctance is that because pharmacy benefits have traditionally comprised less than 15% of health
care budgets, the organizational concern that could be caused by denying payment to an employee or retiree for a particular drug was  seen as overwhelming the modest savings that could be realized. This may change as drug prices increase, particularly for widely used products, and as drug spending consumes a greater share of health budgets."
Overall, the consequences of this lack of competition contribute to high and rising prescription drug prices. One tradeoff is less money in household and government budgets to spend on other priorities. Another tradeoff is that people facing high drug costs become less likely to take the drugs on time and in full, which leads to preventable health problems.

There is also a potential tradeoff between cheaper drugs today and incentives for innovation leading to the new and improved drugs for the future. There are a variety of ways to provide additional incentives for innovation, including more government support or tax incentives for R&D, and reform of the Food and Drug Administration protocols so that testing and bringing a new drug to market is not so difficult and costly. In comparison, having drug companies that seek out generic drugs where they can be the sole producer and then jack up the price doesn't seem an especially useful incentive.  
There's an solid economic case for patents and intellectual property, which offer some protection from competition, but whether it's drugs or some other product, the case for patents doesn't imply that the remaining competitive forces should be stripped out of broad areas of the market.

State and Local Government Business Incentives: Data Tells a Story

When a state or local government offers a tax incentive to a business for locating or expanding in its jurisdiction, cross-cutting motives are at work. For the business, it's a chance to get a tax break--maybe for a business decision that would have happened anyway. For the government, it's a chance to show that it's "doing something" to help the economy and to claim credit for the location or growth of certain businesses--even if those are business decisions that would have happened anyway. The issue of the extent to which tax incentives actually alter business decisions or help a local economy overall is difficult to sort out, but for any social scientist, the starting point is to have some actual data.

Timothy J. Bartik has compiled "A New Panel Database on Business Incentives for Economic Development Offered by State and Local Governments in the United States" (Upjohn Institute, February 2017). For a short overview of this work, see Bartik's article "Better Incentives Data Can Inform both Research and Policy" in the Upjohn Institute Employment Research newsletter for April 2017. As Bartik writes in the newsletter:
"Using data from 1990 to 2015, the “Panel Database on Incentives and Taxes” estimates marginal business taxes and business incentives for 45 industries in 33 states; the industries compose 91 percent of U.S. labor compensation, and the states produce over 92 percent of U.S. economic output. The database has data for a new facility starting up in each of 26 “start years.” Compared to prior studies, the new database provides more incentive details, such as how incentives are broken down by different incentive types (e.g., job creation tax credits vs. property tax abatements), and the time pattern by which incentives are paid out over a facility’s life cycle." 
For some questions, it can be hard to extract an answer from data, and involved a lot of assumptions and calculations. But for some questions, the data comes close to telling the story. 

For example, are state and local tax incentives for business rising or falling in the last 25 years? Here's a figure. Here's a time trend in business incentives, expressed as a percentage of the gross stat and local taxes paid by business. Clearly, the level is dramatically higher than 25 years ago. Bartik notes that a big reason for the jump around the year 2000 is the expansion of the "Empire Zone" incentives in New York. 


Of course, this overall increase conceals differences across states.
"From 2001 to 2007, big increases in incentives occurred in New Mexico, Missouri, Indiana, North Carolina, Nebraska, and Texas. This includes some Southern and Midwest states plus the Great Plains state of Nebraska and the southwestern state of New Mexico. Over this same time period, New York significantly reduced incentives, from 5.79 percent to 5.20 percent, although New York incentives remained high. From 2007 to 2015, big incentive increases occurred in Tennessee, New Jersey, Wisconsin, Minnesota, Colorado, Oregon, and Arizona. What is noteworthy here is that some states that previously had very low incentives, such as Tennessee, Wisconsin, Minnesota, Colorado, and Oregon, began to use incentives at a much higher level. But over this same time period, big decreases in incentives occurred in New York, Michigan, and Missouri. The big decreases in New York were due to the demise of the Empire Zone program. In Michigan, Governor Rick Snyder jettisoned the expensive MEGA incentive program as part of a policy package that rolled back general business taxes. The Missouri decrease is due to the Quality Jobs program (a JCTC) being replaced with a less costly job creation tax credit, Missouri Works."
Looking at the data also can raise some basic questions about the structure of these incentives, both in terms of the form in which the incentives are being provided and in terms of the extent to which such incentives are front-loaded.

Here's the issue with front-loading incentives. A business thinking about making a location or an expansion decision is focused on the relatively short-term. Bartik cites an estimate that businesses often discount revenues earned off in the future by about 12% per year. As a result, a tax break that is 10 or 20 years in the future decisions has relatively little effect on their decision. However, for the government, that tax break is very likely to end up being cashed in--at least if the business continues over that time.

Thus, if a state or local tax incentive is spread over a long period of time, the government is effectively offering something of real cost (the tax break), which doesn't affect the business decision all that much. If business incentives are to be offered at all, it makes more sense to front-load them. The figure shows the pattern of tax incentives over tine in Oregon (black line), which heavily front-loads incentives, and in Tennessee (green line), which doesn't front-load much. The blue line shows the overall pattern in the data in 2000, and the red line shows the data pattern for 2015--showing that front-loading has become just a little more common in the last 15 years.
Bartik writes: "As of 2015, in the average U.S. state, incentives are substantially front-loaded. This front-loading has increased over time, but front-loading is arguably not as great as it should be. And some states tend to provide very long-term incentives that probably do not have large payoffs in swaying business location decisions."

What about the form in which incentives are given? The data from the survey reveals: 
"[O]f the total cost of incentives in the average state in 2015, the largest incentive type was JCTCs [job creation tax credits], which were almost half of total incentive  costs (44.9 percent). Another quarter of incentive costs (27.4 percent) were due to property tax abatements. The remaining three incentive types (ITCs [investment tax credits], R&D tax credits, customized job training) together constituted about one-quarter of incentive costs. ...
"Over time, how has the use of different incentive types changed? ... [A]veraged across all states by far the biggest change is that JCTCs have gone from virtually nothing in 1990 to 45 percent of all incentives today, or from 0.01 percent of value-added to 0.64 percent of value-added. Of the 0.96 percentage point increase in overall incentives from 1990 to 2015 (from 0.46 percent to 1.42 percent), about 0.63 percent is due to increased JCTC usage, or about two-thirds of the total incentive increase. ...
"Although nationally JCTCs were most important, some states whose overall incentives were above the national average had little or no JCTCs: Alabama, DC, Iowa, Kentucky, and Pennsylvania. Property tax abatements were particularly important (greater than 1.30 percent of value-added versus the national average of 0.39 percent) in DC, Michigan, New Mexico, Pennsylvania, and Tennessee. Investment tax credits were particularly large (greater than 0.9 percent of value-added versus the national average of 0.20 percent) in Alabama, Kentucky, Nebraska, and South Carolina. R&D tax credits are usually not very large, but in some states with overall low incentives (less than 0.55 percent in overall incentives as percent of value-added), R&D tax credits were a large share of what incentives are provided: California, Maryland, Massachusetts. Customized job training is also usually not a very large incentive, but it was well above the national average (greater than 0.30 percent versus national average of 0.07 percent) in New Mexico, Iowa, and Missouri."
Which approach is most likely to be effective? Bartik is suitably cautious here, and careful to label various results as preliminary. But he does write in the newsletter (citations omitted): 
"Incentives designed as customized services may be more effective than tax incentives. For example, customized job training is a very effective incentive. Research suggests that, per dollar, customized job training might be 10 times more effective than tax incentives in encouraging local business growth. Other effective customized services include manufacturing extension programs, which have been shown to improve productivity. Why are such customized services more cost-effective? They tend to be more targeted than tax incentives at small and medium-sized businesses, whose location and expansion behavior is easier to affect than large businesses’. Because obtaining quality job training services or business advice may be difficult for smaller businesses to do on their own, the value of such services may exceed their costs. Finally, customized services provide up-front assistance, helping the business be more productive immediately. However, despite the greater cost-effectiveness of customized services, state and local incentives are more focused on tax incentives. For example, the typical state only spends $1 on customized job training for every $20 devoted to tax incentives."
What about the hardest question of all--that is, in how many cases does the incentive actually alter the choice a business makes, rather than just adding a little gravy to the choice that would have been made anyway? Appropriately hedged, Bartik writes:
The database suggests incentive effects toward the low end of prior estimates: the average incentive package, 1.4 percent of value-added, might tip the location decision of 6 percent of incented businesses— the other 94 percent of the time, the state would have experienced similar growth without the incentive. This typical 6 percent tip rate of incentives is a low batting average. To have benefits greater than costs, incentives must do something special— they either need unusually high benefits per job created, or incentive designs must exceed the typical batting average, lowering costs per job created. ...
Although the rate of growth of incentives has slowed down, it is still more likely that states will significantly increase rather than decrease incentives. New states have entered more vigorously into the incentive competition. Incentives are still far too broadly provided to many firms that do not pay high wages, do not provide many jobs, and are unlikely to have research spinoffs. Too many incentives excessively sacrifice the long-term tax base of state and local economies. Too many incentives are refundable and without real budget limits. States devote relatively few resources to incentives that are services, such as customized job training. Based on past research, such services may be more cost-effective than cash in encouraging local job growth.
So if your state or local government is considering incentive, the first step is to think  a second, and then a third time, and perhaps even a fourth time about whether it actually makes sense. If the decision is to proceed, then the discussion should move to issues of design: for example, a front-loaded payment that supports customized training for a high tech firm that has a good chance of  generating local spinoffs has a better chance of being a good deal for the taxpayers and the local economy than a 20 year tax break.

Thursday, May 11, 2017

The Economics of the 'Stans

The semi-official name for the region is "Central Asia," but I confess that I usually think of it as "the 'Stans"--that is, Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan and Uzbekistan. These countries have now been independent of the former Soviet Union for 25 years. Taken together, they have nearly 70 million people, comparable to the population of the United Kingdom or France. As someone who is driven by curiosity and guilt, it bothers me that I do not know more about this region. Thus, I was delighted to find that  Uuriintuya Batsaikhan and Marek Dabrowski have written a primer on the economics of this area, "Central Asia at 25" (Bruegel Policy Contribution #13, May 2017).

From a broad-brush perspective, some of the economic experience of this region looks similar to other "transition economies" that separated from the Soviet Union: that is, they first experienced several years of severe recession and hyperinflation, but then adjusted and have performed somewhat better. For illustration, here's a graph showing growth rates for these five economies in the last 25 years.


And here's a figure showing inflation rates over that time. Notice that the left-hand axis measures inflation on a logarithmic scale, so the upper numbers on the left-hand side represent inflation in the range of several hundred percent per years.
The economic and political legacy of these countries as they gained autonomy from the Soviet Union also has some similarities. Batsaikhan and Dabrowski write:
Similarly to other parts of the Soviet Union, agriculture was forcibly collectivised in the early 1930s. The human costs of the Soviet modernisation of Central Asia were enormous. They included several rounds of famine in the 1920s and 1930s, repression and terror in the 1930s, the building of a large network of labour camps (the so-called Gulag system) where political opponents from the entire Soviet Union were imprisoned and where they perished in large numbers, and mass-scale resettlements (ssylka in Russian) of populations from the European part of the Soviet Union. The latter affected social groups such as the kulaks (better-off farmers) and included the deportation of entire ethnic groups in the 1940s, including Volga Germans, Chechens, Ingush, Crimean Tatars, Crimean and Caucasian Greeks, Meskhetian Turks, Koreans, Karachays and Poles.
After the death of Stalin in 1953 and the partial dismantling of the Gulag system, the Soviet-type forcible modernisation and industrialisation continued but with the use of less coercive methods. These included the conversion of pastures (‘virgin land’ or tselina in Russian) in northern Kazakhstan into large-scale wheat farms, the building of the Main Turkmen and Karakum canals, and the operation of the Semipalatinsk Nuclear Test Site and the Baikonur Cosmodrome (both in Kazakhstan). Many of those projects caused severe environmental damage (such as the disappearance of the Aral Sea and radioactive pollution over large areas of Kazakhstan), which have not been overcome yet. ...
The rapid and forcible industrialisation of the Soviet era (with a strong focus on military needs) was associated with huge structural distortions and microeconomic ineffectiveness. After the dissolution of the Soviet Union, many industrial enterprises in Central Asia lost their previous markets and were unable to compete under the new market conditions. Partial de-industrialisation in the post-Soviet period was thus no surprise. After a painful transition period, growth picked up in 2000s, largely driven by growing exports of commodities such as oil and natural gas (Kazakhstan, Turkmenistan and Uzbekistan), aluminium (Tajikistan), gold (Kyrgyzstan), cotton (Tajikistan and Uzbekistan) and other metals (Kazakhstan).
Although the nations of Central Asia have some similarity in their economic challenges, there are notable differences, too. At the simplest level, they vary considerably in population: "Uzbekistan is the most populous country with 31.3 million people, followed by Kazakhstan, 17.5 million, Kyrgyzstan, 6 million, Tajikistan, 8.5 million and the least populated Turkmenistan, 5.4 million."

Moreover, the standard of living in these countries varies considerably. The figure shows GDP per capita since independence. The solid lines are the five countries of Central Asia: the dashed lines are some nearby comparison economies. The figure shows that Kazakhstan and Turkmenistan have seen substantial economic growth in the last couple of decades, while Kyrgyzstan, Tajikistan, and Uzbekistan have not.



Geopolitically, these countries sit between Russia and China. (To help remain oriented, the three countries to the west of the Caspian Sea, unlabelled on this map, are on map, are Georgia, Armenia, and Azerbaijan.)



As the map illustrates, "the region is distant from the major centres of world economic activity: North America, Western Europe, East and South East Asia. ... [A]ll countries are landlocked (Kazakhstan is the largest landlocked country in the world and Uzbekistan is double landlocked, ie it borders only landlocked countries) with limited transportation connections inside and outside the region."

(Trivia question: Other than Uzbekistan, onlyy one other country is double-landlocked. It's Liechtenstein, sitting between Switzerland and Austria).

The map also shows the main energy and transportation infrastructure that is being built across the region, much of which connects the region with China. Here's a figure showing trade with China and Russia: both are up a lot in the last 15 years or so, but trade with China seems to be taking the lead. As one example:  "Turkmenistan’s exports to China constituted 1 percent of its total exports in 2009, increasing to almost 80 percent by 2015, almost all of which is natural gas; Turkmenistan’s second largest trading partner, Turkey, takes only 5 percent of its total exports."



But while trade with China has been on the rise, and the infrastructure projects will likely keep it on the rise, the three lagging economies of the region are especially dependent on remittances from workers who have taken jobs abroad. Most of these jobs are in Russia, presumably because of the long-standing historical ties, but other substantial destinations for migrant workers from this region include Turkey and relatively well-off Kazakhstan.



Overall, what does the reform agenda look like in Central Asia?
All Central Asian countries are doing poorly in the areas of governance and enterprise restructuring and competition policy, pointing to their limited progress in more complex institutional and legal reforms.  ... Corruption remains a major problem in the region, particularly in Turkmenistan and Uzbekistan .... The largely authoritarian character of the political systems in Central Asia is the main cause of their poor governance and business climate, and their insecure property rights and rule-of-law deficit. According to the Freedom House Freedom in the World 2017 report, only Kyrgyzstan is rated as ‘partly free’, while the others are ‘not free’. Uzbekistan and Turkmenistan belong to the group of the 10 most politically oppressive countries in the world, alongside North Korea and Eritrea. ...
The list of required reform measures differs between countries but also contains a
common agenda for the entire region. Turkmenistan and Uzbekistan must complete basic market reforms: domestic price liberalisation, reducing explicit subsidies for food, energy and water, and cross-subsidisation (in public utilities), unification of exchange rate and current account convertibility, trade liberalisation, WTO accession, greater privatisation and elimination of barriers to private entrepreneurship, both domestic and foreign, and building financial market infrastructures.
On the other hand, all Central Asian countries, Kazakhstan and Kyrgyzstan where reforms are more advanced, face the same challenges of oppressive and predatory post-Soviet states. These are deeply rooted corruption, rent seeking, state capture, administrative harassment of business and more broadly, a high degree of business uncertainty and insecurity over property rights. The situation looks particularly bad in all areas where economic management interacts with authoritarian political systems and legal institutions, especially those related to the judiciary, law enforcement agencies and public administration. ... Closer intra-regional cooperation would also improve the business and investment climate. Given the region’s remote geographical location, its complicated borders, infrastructure inherited from Soviet times and cultural proximity, unrestricted movement of goods, services, people and capital between Central Asian countries would greatly contribute to their economic development. Closer cooperation would also help Central Asian countries to jointly promote their interests vis à vis those of their major neighbours.