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Rational Decisions and Pharmaceutical Regulation

Future of Education

U.S. vs. Europe

Medicare Proposal

Run Out of Oil?

Inappropriate Annuities

Lucas on Growth

Reagan's Economics in Context

Ronald Reagan's Economics

What Determines Exchange Rates?


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June 15, 2004

Rational Decisions and Pharmaceutical Regulation

Today's Washington Post contains another op-ed piece by a physician, and of course he is in favor of price controls on prescription drugs.

The pharmaceutical industry will intone its familiar mantra: The cost of drugs is a relatively small percentage of total health care costs; innovation requires investment; research-based companies need to realize an adequate return on investment; and companies often establish access programs for destitute patients. But these arguments are invalidated by the sheer magnitude of the pricing decisions, which constitute a formidable barrier to the flow of innovation from the research arena to public benefit.

My response to the last such op-ed piece still holds.

Meanwhile, Alexander Combs actually makes a constructive suggestion, which is to lower the cost of bringing drugs to market.

All new drugs sold in the U.S. must undergo a series of rigorous clinical trials in order to gain approval for sale. The pharmaceutical companies must prove not only safety, but efficacy as well. This process typically takes seven to ten years and can cost upwards of $900 million dollars per drug.

Although safe and effective medicine is a noble aim, there are unseen costs to this policy—costs which can greatly overwhelm the benefits. For every new treatment awaiting approval there are untold numbers of people who may die simply because they were denied access to it.

For Discussion. Imagine a science-fiction world in which a warning light tells us when we are making decisions emotionally rather than rationally. What consequences would this have?

Future of Education

I speculate on the future of education.

The first ongoing trend, one that affects the demand for education, is rapid technological change. As the pace of change continues, or even accelerates, it causes all human capital to depreciate more rapidly.

...The second ongoing trend, one that affects the supply of education, is progress in cognitive science. Researchers are beginning to obtain knowledge about how the brain functions, how people acquire various mental skills, and how to diagnose and treat more learning disabilities.

For Discussion. My essay suggests that individualized treatment and development will replace curriculum reform as the main strategies for improving education. What examples of this phenomenon can be seen today?

June 14, 2004

U.S. vs. Europe

Steve Antler points to a study by Fredrik Bergström & Robert Gidehag of various indicators of prosperity in the U.S. relative to countries of the European Union.

Most Americans have a standard of living which the majority of Europeans will never come any where near. The really prosperous American regions have nearly twice the affluence of Europe. It is worth reminding ourselves what this means. In these regions the average American can get exactly twice as much of everything as the average European. Which goes to show the importance of an economic policy to stimulate growth.

UPDATE: Tyler Cowen has an answer to my discussion question, plus more information, in a post that also links to the Bergström-Gidehag paper.

See also Anthony de Jasay.

For Discussion. It is argued that Europeans consume more leisure than Americans. Which do you think is more voluntary--our working more hours or Europeans working fewer hours?

Medicare Proposal

Laurence Kotlikoff suggests this.

All Medicare participants would receive individual-specific vouchers on October 1st of each year to purchase insurance coverage for the following calendar year. The size of the voucher would be based on the participant's current medical condition (an idea first suggested by Peter Ferrara of the Institute for Policy Innovation and John Goodman of the National Center for Policy Analysis). A healthy 67 year-old might get a voucher for $7,500, whereas an 85 year old with pancreatic cancer might get a voucher for $85,000. The vouchers would take account of the participant's age, region, sex, and other factors that affect health costs. Because those in the worst medical shape would get the largest vouchers, insurance carriers would be happy to sign them up.

For Discussion. Compared with the proposal for the government to provide catastrophic reinsurance, what are the benefits and drawbacks of Kotlikoff's idea?

Run Out of Oil?

George Will quotes Cafe Hayek's Russ Roberts' pistachio example.

Of course, oil supplies are, as some people say with a sense of profound discovery, "finite.'' But that distinguishes oil not at all from land, water or pistachio nuts.

Russell Roberts, an economist, says: Imagine that you love pistachio nuts and are given a room filled 5 feet deep with them. But you must eat them in the room and must leave the shells. When will you have eaten them all? Never. Because as it becomes increasingly difficult to find nuts amidst the shells, the cost of the nuts, in time and effort, will become too high. You will seek a substitute -- pistachios from a store, or another snack.

For Discussion. Do you think that it is possible that over the next fifty years the cost of oil in terms of labor will decline?

June 10, 2004

Inappropriate Annuities

Are annuities appropriate for the elderly? The Securities and Exchange Commission and the National Association of Securities Dealers say not necessarily.

The SEC also today issued an alert to remind investors that variable annuities are not suitable for all consumers, especially investors who need the money in the short term or who borrow against their home mortgage in order to purchase a variable annuity or variable life insurance product.

"We've seen a lot of sales to the elderly, and your money is tied up for so long that it can create real issues for people who need it for health care," said Mary Schapiro, vice chairman of NASD, the main self-regulatory body for brokers. "We want to get ahead of the issue."

I doubt that elderly people who maintain their assets in lump sum format rather than as annuities are as irrational as Diamond and others suggest. In the real world, the elderly face many more sources of uncertainty than just their date of death. For most other sources of uncertainty, a lump sum provides better protection than an annuity.

For example, take the risk of a sudden jump in expenses, due to a medical problem or other crisis. If you have a lump sum, you can handle the spike in cash needs without having to take out a loan.

So, on the one hand the government forces senior citizens to annuitize their income through Social Security. On the other hand, it accuses the private sector of being too aggressive in marketing annuities and that annuities are not necessarily appropriate for all seniors.

For Discussion. Peter Diamond argued that seniors should annuitize more of their income, and that Social Security is a good thing because it forces them to do so. The SEC/NASD report says that seniors should not necessarily annuitize their income. Can those two positions be reconciled?

June 09, 2004

Lucas on Growth

Robert E. Lucas, Jr. (Nobel, 1995), sounding much like Brad DeLong, gives a historical overview of economic growth which is Malthusian up until around 1800 (meaning that population growth ate up, so to speak, increases in production), followed by a steadily increasing standard of living. The theory Lucas uses to tie together these two disparate growth patterns and to explain the transition between the two is Gary Becker's (Nobel, 1992) theory of quality vs. quantity of children.

Technological advances occurred that increased the wages of those with the skills needed to make economic use of these advances. These wage effects stimulated others to accumulate skills and stimulated many families to decide against having a large number of unskilled children and in favor of having fewer children, with more time and resources invested in each. The presence of a higher-skilled workforce increased still further the return to acquiring skills, keeping the process going.

For backward economies, dealing on a day-to-day basis with more advanced economies is the central element in success. [Trade addresses] the need to get up to world standards, to learn to play in the big leagues. The only way learning and technology transfer can take place is for producers to compete seriously internationally. Learning-by-doing is perhaps the most important form of human capital accumulation.

...of the vast increase in the well-being of hundreds of millions of people that has occurred in the 200-year course of the industrial revolution to date, virtually none of it can be attributed to the direct redistribution of resources from rich to poor. The potential for improving the lives of poor people by finding different ways of distributing current production is nothing compared to the apparently limitless potential of increasing production.

Reagan's Economics in Context

I decided to put my thoughts into a longer essay.

When Ronald Reagan defeated Carter's re-election bid, "incomes policies" were a proven failure. Notwithstanding Milton Friedman's comments quoted above, by 1980 it took a lot less courage to stand by a monetary approach to disinflation than it did a decade earlier. I believe that Carter would also have stuck with Volcker through the recession, and if that is the case, then the behavior of the economy in the 1980s would have been about the same regardless of who had been President.

...I believe that President Reagan made a positive difference for the economy. However, unlike most analysts, I do not focus on his tax cuts. Instead, I think that Reagan's main contributions were on energy policy, tax reform, and resisting government expansion.

I try to make several points in the essay. One is that looking at the performance of macroeconomic variables during a President's term of office is a poor way to judge economic policy. Related to that is my view that supply-siders engage in contortionism by choosing to "throw out" the 1981-1982 recession from Reagan's record, even though the disinflation that came from the monetary policy of that period had great lasting benefit.

Another point that I make is that the experience of the 1970's discredited one of the most important left-wing ideas for government intervention--the idea that "incomes policies" rather than monetary policy could be used to fight inflation. Finally, I believe that supply-siders overstate the virtues of Reagan's tax cuts, as opposed to other policies that I think were more clearly constructive.

For Discussion. How did the experience of the 1970's shift the consensus within the economics profession concerning macroeconomic theory and policy?

June 07, 2004

Ronald Reagan's Economics

Jane Galt writes,

High inflation was the result of a dozen years of bad fiscal and monetary policy under two Republicans -- Nixon and Ford -- and two Democrats -- Johnson and Carter -- that was brought under control only when Paul Volcker, the Carter-appointed head of the Federal Reserve, jammed interest rates up to national-heart-attack levels and left them there until inflationary expectations were well and truly tamed. Reagan had nothing to do with unemployment and interest rates falling; that was the inevitable result of a drastic monetary tightening finally working its way through the economy.

Jane Galt continues,

To my mind, the single greatest achievement of Reagan's presidency was tax reform--not marginal rate reduction, but the simplification of the tax code.

Alan Blinder's book Hard Heads, Soft Hearts, which contains extensive attacks on Reagan-era supply-side economics, also pays homage to the tax reform of 1986, much of which was undone by the Clinton Administration, notwithstanding the fact that Clinton appointed Blinder to some top policy positions.

My personal opinion is that Reagan's greatest economic policy was the decontrol of oil prices. The left and the media viewed this as madness, sure to exacerbate inflation and knock the stuffing out of the American consumer. Instead, OPEC was soon on its knees. Unlike the typical contemporary politicians, who espouses government intrusion in the name of "energy independence," President Reagan seems to have understood Oil Econ 101.

For Discussion. To me, supply-side economics means cutting taxes without cutting spending. President Reagan made supply-side economics the staple of the Republican Party. Is this a good thing?

What Determines Exchange Rates?

Tyler Cowen meditates on the topic of exchange rates.

I am headed back from Poland to France, for one more day in Europe. I cannot help but wince at the especially high prices in France, compared to the United States. You may recall my mention of the five dollar chocolate bar; at home I could get the same for less than three dollars.

So a microeconomist might conclude that the U.S. dollar should rise over time. Arbitrage will cause people to buy more in the United States, helping out the dollar.

...Let's bring the macroeconomist into the picture. He tells us that the United States has unsustainably high trade and budget deficits. The only way to clear these deficits, he says, is for the dollar to fall at least thirty percent.

The first point I would make is that it is very dangerous to extrapolate the relative cost of goods and services in two countries on the basis of one product. I am sure that there are goods that Tyler could find that are much cheaper in France than they are here.

He is calculating one real exchange rate, which is the price of a candy bar in euros in France, converted to dollars, relative to the price of a candy bar in the U.S. in dollars. If goods were costlessly tradable and prices were flexible, then the two prices would have to be equal and the real exchange rate would always be one--one candy bar for one candy bar. However, in the real world there are trading costs, and there are many goods and services, which makes it very difficult to measure "the" real exchange rate.

In a previous life, I helped to popularize some international cost of living comparisons as part of the Salary Calculator. Those comparisons are very tenuous and controversial. There is local lifestyle bias, so that an Italian might say that Japan is expensive based on the price of pizza, while a Japanese might say that Italy is expensive because of the cost of sushi. There are all sorts of tax issues, regulatory issues, and retailing customs that affect relative prices. What Cowen calls the "microeconomic" view of exchange rates is sort of a straw man, in that it assumes away all of these factors and instead predicts that prices will move in the direction that they would if international goods markets were perfectly integrated.

The model of exchange rate determination that was popular when I was in graduate school was based on the view that asset markets adjust quickly, while goods prices adjust slowly. So when investors decide they want more dollar-denominated assets, the value of the dollar goes up. In the goods market, the price of Toyotas stays steady in yen, and since a dollar can buy more yen, our dollars can buy more Toyotas.

The mirror image of strong demand for dollar-denominated assets is a U.S. trade deficit. What Cowen calls the "macroeconomic" view is simply a forecast that at some point foreign investors will want to stop increasing their dollar-denominated holdings, and when they do so the dollar will fall. I find this a compelling forecast, but someone else could take the view that the appetite for dollar-denominated holdings might increase going forward.

For Discussion. Which relative prices in the economy adjust particularly quickly, and which prices adjust particularly slowly?