Monday, October 21, 2013

Is Economics a Science?

Yes, says Raj Chetty:
But the headline-grabbing differences between the findings of these Nobel laureates are less significant than the profound agreement in their scientific approach to economic questions, which is characterized by formulating and testing precise hypotheses. I’m troubled by the sense among skeptics that disagreements about the answers to certain questions suggest that economics is a confused discipline, a fake science whose findings cannot be a useful basis for making policy decisions.

That view is unfair and uninformed. It makes demands on economics that are not made of other empirical disciplines, like medicine, and it ignores an emerging body of work, building on the scientific approach of last week’s winners, that is transforming economics into a field firmly grounded in fact.
He then compares economics to medicine, which is a good example of another field fueled by scientific inquiry but with similar probelms of using 'social' data where cause and effect are hard to isolate.
Health researchers have worked for more than a century to understand the “big picture” questions of how diet and lifestyle affect health and aging, yet they still do not have a full scientific understanding of these connections. Some studies tell us to consume more coffee, wine and chocolate; others recommend the opposite. But few people would argue that medicine should not be approached as a science or that doctors should not make decisions based on the best available evidence.
He then goes on to talk about the advances in empirical economics that are driving the quest to find answers to these questions.

I think he is mostly correct though he overstates our ability to isolate causal links in data and over-sells the promise of economics experiments like those of Esther Duflo that are a lot different than in medicine as they are always in a specific context where the generalizablilty can easily be questioned.  [For example, you can easily question how applicable a specific educational intervention is to the rural northeast India villages in which it was conducted but the results of a test of a new drug among the same population is much harder to question]

On the other hand I think we are much easier to accept the limited evidence we have for health issues and act on the best available evidence.  In economics we suffer the delusion that we can find the real answer and only when we convince ourselves that we have do we feel comfortable to offer policy advice.

Monday, October 14, 2013

Are Asset Markets Rational? The Economics Nobel

Eugene Fama, Lars Peter Hansen and Robert Shiller are this year's Nobel Prize winners in economics [insert here the snark about how economics Nobels are not real Nobels].  From The New York Times:  
Three American professors — Eugene F. Fama, Lars Peter Hansen and Robert J. Shiller — were awarded the Nobel Memorial Prize in Economic Science on Monday for competing theories about the movements of asset prices. The three men, who worked independently, were described as having collectively illuminated the financial markets by showing that stock and bond prices moved unpredictably in the short term but with greater predictability over longer periods. The prize committee said these findings showed that markets were moved by a mix of rational calculus and human behavior.
None of these folks is a surprise but the fact that Fama and Shiller have shared the prize is a surprise becuase in many ways Fama and Shiller are polar opposites. Fama is a died in the wool Chicago efficient markets type (aka freshwater - where markets are rational, forward looking and where bubbles don't exist, Shiller is a real saltwater type that challenges the idea that markets are always rational and efficient.

 That said the two are not contradictory. In large part Fama is correct about markets quickly incorporating information so that if you try to trade on what is on today's Wall Street Journal front page you are a sucker. Shiller's research could be described as challenging the notion that markets are operating with full information not that they process it badly.  For example the speculation on housing prices was part and parcel of a lack of a true understanding of the junky mortgages that were being written and the financial vehicles that were created with them.  In this sense traders might be boundedly rational: doing the best they can with the information available to them but having to make imperfectly informed decisions.

So in many ways it could be said that this Nobel prize is both a recognition of the seminal work of Fama that taught us that markets are incredible efficient at incorporating new information and Shiller's work that taught us to appreciate the lacuna in the informational environment in which markets operate.

Oh and what about Hansen? His contribution is more on the empirical side, allowing us to study asset price movements in data.  But almost all students of economics will have heard of his major contribution: the Generalized Method of Moments (GMM).

Kudos to all.

Thursday, October 10, 2013

Default Would be Bad

From the IGM Forum at the University of Chicago's Booth School of Business a question asked of 36 prominent economists, 31 of whom responded:

Question A: If the United States fails to make scheduled interest or principal payments on government debt securities, even as an unintended consequence of political brinksmanship, US families and businesses are likely to suffer severe economic harm.

[HT: NY Times Economix Blog]

Monday, October 7, 2013

Obamacare a Boon for Small Business?

Yes, or so says James Surowiecki of the New Yorker:
Of the countless reasons that congressional Republicans hate the Affordable Care Act enough to shut down the government, the most politically potent is the claim that it will do untold damage to the economy and cripple small companies. Orrin Hatch has said that Obamacare will be “devastating to small business.” Ted Cruz argues that it is already “the No. 1 job killer.” And the vice-president of the National Federation of Independent Businesses called it simply “terrible.” So it comes as some surprise to learn that Obamacare may well be the best thing Washington has done for American small business in decades.
The point is that private insurance market for health care, plagued by adverse selection was a huge obstacle faced by small businesspersons.  My brother is an example.  He ran is own Silicon Valley business for years until the cost of insuring himself, his wife and his kids was simply too costly to continue so he went to a corporate salaried job that came with an employer-provided health plan.

How big an effect will this be for the US economy?  Hard to say, but Surowiecki claims it will be large:, "our small-business sector is among the smallest in the developed world, and has one of the lowest rates of self-employment."  It is often argued that entrepreneurialism is a key factor in economic growth, if so this could have a substantial impact.  I am not equipped to judge.

To me, this was a interesting little historical tidbit that had heretofore escaped my attention:

The fact that most Americans get their insurance through work is a historical accident: during the Second World War, wages were frozen, so companies began offering health insurance instead. After the war, attempts to create universal heath care were stymied by conservatives and doctors, and Congress gave corporations tax incentives to keep providing insurance. The system has worked well enough for big employers, since large workforces make possible the pooling of risk that any healthy insurance market requires. But small businesses often face so-called “experience rating”: a business with a lot of women or older workers faces high premiums, and even a single employee who runs up medical costs can be a disaster.

I had not read this account of employer-provided health care. Not that it matters much for the current debate - it is pretty clear that we have an inefficient patchwork health care system whatever the origin.

Thursday, October 3, 2013

View from the Ground

A close friend who works for the VA counseling vets with PTSD and other mental health issues sent this outraged text yesterday (edited for content):
I'm working all day at our Portland "Stand Down" outreach for homeless veterans and other disabled veterans in need.  All our Veterans' Benefits counselors are furloughed at home with no pay.  We literally cannot process benefits claims...even for my suicidal patients!  People are going to die.  


Say what you want about the grand bargain it demonstrates what a governor can do when he/she exhibits strong leadership.  After eight years of largely tepid leadership from Ted Kulongoski, John Kitzhaber has shown himself to be a masterful leader.

And yes, there is lots for everyone to dislike in this grand bargain but as a advocate for school funding I am largely pleased (and in saying this I recognize that I have come a long way in accepting the political realities that distort good policy).  Public education in the state needed a strong champion and in Kitzhaber the state has found one.  Kudos.

Tuesday, October 1, 2013

Fred Thompson: Property Tax Assessment in Oregon

Another Dispatch from the desk of Fred Thompson:
Reliance on an ad valorem property tax is, perhaps, the most distinctive feature of the American tax system. Most students of public finance appreciate property taxes. Indeed, our foreign counterparts frequently view the US property-tax system with envy (although not our system of land registration). This is because property taxes are both fairer and more efficient than other taxes and also because high property taxes tend to promote high levels of civic engagement.
Unfortunately the comparative advantages of the property tax depend upon the strength of the relationship between tax payments and real property values. Where the linkage is strong, the tax does a really nice job of matching local tax burdens to the benefits that result from local public spending. Where this relationship is severed, the tax is neither fair nor efficient. Once upon a time, or so the City Club of Portland claims, Oregon had a property tax system that was the envy of the world, but as the result of a series of initiatives and referenda (Measures 5, 47, and 50), it is now a mere shadow of its former self. Is this claim correct? As will be seen, not entirely.
What Measure 5 did was cap property tax bills at 1.5 percent of market value (RMV) and reform the assessment process so that assessments accurately reflected market value. (The measure also shifted responsibility for school funding from local government to the state, but that is another story.) Measure 5 was enacted in 1990 and was scheduled to be fully operational in the 1995-96 tax year. Measure 50 was enacted in 1997,. It rolled residential tax assessments back to whichever was less: the last pre-Measure 5 assessment, that of 1994–95, or 90% of the 1995–96 assessment and limited future increases in tax assessments, except for new construction or additions, to 3 percent per year. We call this quantity ‘Measure 50 assessed value’ (M50AV); it is currently ≤175 percent of 1995 market value, which is on average about 60 percent of current market value. The actual assessment used for tax purposes (TAV) is the lessor of M50 and RMV. Currently the average statutory property tax rate in the state is about 2.2 percent. Consequently, Measure 5 limits are binding only where the ratio of M50AV/RMV is greater than 65 percent.

This is a pretty complicated arrangement and it has obviously attenuated the linkage between local property values and tax burdens (under Measure 5), but like most things the relevant questions are how much and compared to what? Fortunately, every exit is an entrance somewhere else. Oregon’s idiosyncratic property-tax arrangements have left us an extremely accurate system of measuring property values (RMV), a system of assessment that has held relative values constant for 17 years (M50AV), and a cap on property tax bills. These data allow us to answer several important questions: how good are current assessments, why aren’t they better, how fast do assessments degrade in the absence of reassessment and what drives this process?
Moreover, when measure 50 was enacted, it is unlikely that anyone thought about how it would operate in a recessionary environment. Although Oregon’s economy went through a deep slump from 2002-2004, housing inflation continued, steadily widening the gap between M50AV and RMV. But, as in much of the rest of the United States, home prices fell sharply after 2007. This had two effects. It narrowed the gap between M50AV and RMV, but, more importantly, it made Measure 5 limits binding on an increasing portion of homes. At present, Measure 5 limits go into effect when M50AV > 65 percent of TMV. The same data that allow us to understand the dispersion of MAV with respect to TMV over time and the direction and bias associated those measures, also allows us to assess the relationship between market valuation and tax payments over time and from the peak to the trough of the business cycle under Oregon’s property tax system.
Finally, these data would allow us to simulate the effects on dispersion and tax fairness of various policy modifications, including most importantly reassessment to RMV at title transfer, but of other policies as well, although we haven’t done that.
Looking at these data the first thing we learn is that most of the discrepancies between M50AV and RMV were present at the creation. Rolling assessments back to 1994-5 wiped out the gains in assessment uniformity from the more accurate methods mandated by Measure 5, as well as the capitalized increases in market values that Measure 5 triggered. As a result, the discrepancies we see now in TAR/RMV ratios from residence to residence largely reflect discrepancies that existed prior to the implementation of Measure 5. The figure to the right shows average assessment ratios by zip code from 2003 to 2012 (the shallow U shape reflects the fact that the numerator was growing at a more or less constant rate of 3 percent per year, while the denominator grew faster than nominator prior to 2008 and slower after or in many cases actually fell). Clearly the difference between zip codes is greater than the difference within codes, although how clear may not be apparent until you see the next figure). Consequently, it follows that most of the departures from assessment quality wrought by Measure 50 resulted from the rollback and not from post-enactment price movements.
This conclusion is reinforced when we look directly at the variance in the ratio of all TAVs to RMV and the coefficient of dispersion (CD) over time.  Again, the bottom line is that assessment quality didn’t degrade very much between 2003 and 2012 (the period for which we have data in individual residences). The standardized variance was 20 percent in 2003 and 22.5 percent in 2008; it deteriorated only a little faster after 2008, to >27 percent in 2012, Price depreciation has evidently been slightly more uneven than the earlier appreciation, when a rising tide did apparently lift all boats. Using the CD, assessment quality declined overall from 14 percent in 2003, to 18 percent in 2008 and 22.5 percent in 2012. Even so, overall assessment quality in Oregon is not measurably worse by this standard than it was prior to Measure 5 and is much better than in many earlier periods.
Moreover, looking at Multnomah County, the within zip code CDs are remarkably consistent over time and reflect good assessment quality. Across all zip codes, 1997 CDs explain 2/3 of the variation in 2012 CDs. The actual CDs ranged across zip codes from four percent to 26.3 percent in 1997 and from 5.7 percent to 25.7 in 2012. In 1997, CDs in two of 31 zip codes exceeded 15 percent, the standard established by the National Association of Real Estate Appraisers; by 2012 that standard was topped by only five.
The box and whiskers chart (above) shows the mean (the solid bar), the standard deviation (the box), and the range (the whiskers) of residential assessment ratios for each year from 2003 to 2012. Clearly, there was a fair amount of dispersion in assessments and, apparently, after 2008, the dispersion increased. One of the questions raised by this observation is whether or not assessments favor one class of residences or another. The Multnomah zip-code data tell us that there are substantial neighborhood effects. Does this imply, for example, that deviations from mean assessment ratios were or are biased in favor of high or perhaps low-value residences? Property appraisers use an instrument called the price-related differential (PRD) to measure this bias. A PRD equal to 1 indicates no bias; a PRD greater than 1 indicates a bias in favor of higher valued properties. From 2003 to 2010, the PRD was slightly less than 1 (.98 to .99); in 2011 and 2012, slightly greater than 1 (1.006, 1.014). This shift can be seen in the following figure; the assessment ratios of residences in the lowest quartile of value started lower or faster than did those in the higher value quartiles; more recently they have evidently lost value faster.
Note this does not necessarily mean that the owners of low-valued residences face significantly higher effective tax rates (where property taxes are concerned, the effective tax rate is found by dividing the tax bill by RMV) than the owners of higher valued properties. This is because more than half of the owners of low-value residences (the first quartile) are now subject to Measure 5 tax limits. In absolute terms, some have even seen a decrease in their tax bills as the result of Measure 5 tax compression.