The hidden costs of stock-market-first U.S. economic policies [feedly]

The hidden costs of stock-market-first U.S. economic policies
https://equitablegrowth.org/the-hidden-costs-of-stock-market-first-u-s-economic-policies/

The idea that sound U.S. economic policy begins and ends with a strong stock market is becoming pervasive. Advocates of what I call the stock-market-first approach want you to focus on the stock market when you pass judgment at the ballot box this November. Stock market indexes are back to pre-coronavirus pandemic levels and, until recently, were testing new highs. If you have a 401(k) savings plan, it probably soared over the past 4 years.

The dramatic jump in the stock market since the 2016 election is the only information that a true believer in stock-market-first thinks you need to know. There is no need for you to understand why the stock market has gone up. There is no need for you to understand how the policies that increased stock prices came at the expense of other things you also might care about.

But if you are planning to vote with your 401(k) in mind this November, then you might want to take the time to understand the why and the how of the recent stock market boom.

Stock prices are determined by three factors. The first is the profits that companies are expected to earn. The second is the safe rate of return on government debt set by the Federal Reserve. And the third is the risk premium that stock investors earn on top of the interest they would get if they held government debt instead.

Once you understand how movements in profits, interest rates, and risk premia together affect the stock market, it is a short jump to understanding the role of government policy. Nothing new has been discovered in recent years about how government policies affect stock prices. We have just reached the point of pushing policies that inflate the stock market without regard for the consequences.

Once you understand that government can move the stock market, you are entitled to ask whether and how government should move the stock market. If government policy creates imbalances between economic fundamentals and stock prices, those imbalances are revealed in time, and often with disastrous consequences, especially for 401(k) investors who are largely invested on autopilot.

And even if government takes extraordinary additional steps to avert the collapse of an overvalued stock market, the policy actions needed to keep stock prices inflated impose other costs. When government moves income, wealth, and debt around to boost stock prices, that money must come from somewhere. Your 401(k) account may have gone up, but the things you lost along the way are likely larger than the gains.

Think about your slow salary growth and low interest rates on your savings accounts. Think about funding for the programs such as Medicare and Social Security that you also will depend on. Or, even more broadly, think about the importance of sustained economic growth to you and your family, compared to a boom-and-bust economy characterized by soaring stock prices followed by swift and sometimes-deep recessions.

If you are content not knowing how government policy helped fuel the recent stock market boom and what that means for your future, you should stop reading. But if you would like to know a little more about the hidden costs of stock-market-first economic policies, you might want to read on.

What moves the stock market?

Business schools teach you that a share of corporate stock just represents the value of the legal claim today on expected future company profits. The value of the stock is simply that stream of future profits converted to a present value.

If I promised to pay you $10 per year for the next 10 years, what is that worth to you today? If you place no value on time (and ignore inflation), the answer is just the $100 total you will receive over the 10 years. 

But if time does have value to you—meaning $10 today is worth more than $10 next year, and so on—the present value of the 10 $10 payments is less than $100. In fact, if you value time at (say) 2 percent per year, then business schools teach you that the stream of promised $10 payments for the next 10 years is worth just less than $90.

If you prefer to think in forward-looking terms, this present-value calculation is the same as saying, "If you put $90 in the bank today at 2 percent interest, at the end of the 10 years, you would have $100."

Pretty basic math.

Stocks are more complicated because the future company profits are not a promise of certain payments; they are expectations about unknown payments. Analysts working on Wall Street make good money by predicting future profits, but there is uncertainty around even the best predictions.

Introducing uncertainty means the calculation of a stock's value needs one more input. In addition to valuing time, you need to value the uncertainty about the profits. If the government will pay you 2 percent interest with certainty, why would you buy a stock that paid an expected 2 percent return, knowing you could lose money if the company's profits are below expectations?

So, assume that instead of a 2 percent interest rate, the rate of return on the stock is expected to be 5 percent. That is, by switching from the guaranteed government interest rate of 2 percent to the stock, you will receive, on average, a 3 percent "risk premium" on the investment. Sticking with the $10 payment per year over 10 years, but using a discount rate of 5 percent, the stream of payments has a present value today of about $77.

Again, in forward-looking terms, that means investing $77 in the stock market today is expected to leave you with $100 in 10 years. But the only thing you really know is that the actual amount in 10 years will be centered around an expected $100, and it could be a lower or higher. That is what uncertainty means.

And remember, if you want to be sure you will have $100 in 10 years, you should invest $90 in the 2 percent government bond. That is, you can just pay $13 more now to avoid the uncertainty about having exactly $100 10 years from now.

These examples are intentionally simple, but they make it possible to introduce a key point about how stock prices move. When one of the pricing inputs changes, the effect on stock prices is magnified. So, if the profits of a company are expected to grow 1 percent per year for the 10 years instead of staying constant at $10, the stock price jumps 5 percent, to $81. In the real world, where companies earn profits for more than 10 years, this magnification effect is obviously much larger.

The same amplification principle holds for changes in the real interest rate on government debt and the risk premium. If the interest rate on government debt is decreased from 2 percent to 1 percent, then the present value of the 10-year stream of $10 payments is worth $81, a 5 percent increase in the stock price.

If the world becomes more uncertain, such that the risk premium jumps from 3 percent to 6 percent, then the stock price falls from $77 to $67. Small changes in stock-price determinants lead to big changes in stock prices.

Lest you think this is all that I think you need to know in order to make money in the stock market, remember that the relatively simple math just tells us what a share of stock should be worth. Expectations about future profits and the risk premium move with market participant beliefs. The stock you own is only worth exactly what the highest bidder is willing to pay for it.

In 2013, the Nobel Memorial Prize in Economic Sciences was split three ways. Each of the recipients had made significant contributions in the field of "asset pricing," which basically means thinking about what a share of stock should be worth. The fact that the prize was split between three economists with different views about what people believe and how they act is suggestive that the puzzle of valuing the stock market is far from solved.

Nobel Prizes are not given out for casual observation, but luckily, the details about "price earnings ratios" and "method of moments" and "three factor models" are not key to the message here. What matters is that the three key stock-price determinants—expected profits, interest rates, and risk premia—move together and reinforce each other.

The ways in which the three stock-price determinants move together is well-established. If the Fed lowers the risk-free interest rate or something happens to make investors think profits will increase, then the price goes up. If investors become more confident about a given profit prediction, then stock prices will rise further. When stock prices go up, there is a reinforcing effect on investor confidence, and stocks move up even more.

The existence of these positive feedback loops means stock prices move in waves. Stock market booms are generally slow and long-lasting, as the reinforcing effects of higher expected profits and confidence build on each other gradually.

Stock market busts are generally shorter-lasting but more intense because the truth about profits and risks are often revealed very suddenly. Investors know that maintaining optimistic beliefs while everyone else becomes pessimistic means they will be left holding stocks that others value less.

At the end of the day, the stock market is necessarily tied to economic fundamentals. The value of a stock is the expected value of the company's profits, discounted at some interest rate that includes a risk premium. Humans can make systematic mistakes about future profits and risk premia, but ultimately, those mistakes will be revealed.

How does government move the stock market?

The stock-price math taught in business schools tells us that the value of a stock boils down to the risk-free rate of interest you can earn on government debt, the company's expected profits, and the current risk premium added to the risk-free interest rate.

So, how can government move the stock market? By choosing policies that move the three inputs. Start with the Federal Reserve. The Fed controls short-term, risk-free interest rates directly. In times of financial crisis, the Fed also intervenes in other ways that impact expected profits and certainty.

One of the most poignant recent lessons about short-term interest rates and the stock market comes from 2018. In late summer of that year, Fed Chairman Jerome Powell began to signal the Fed's intention to "normalize" interest rates, meaning allow rates (adjusted for inflation) to increase back toward historical averages. Powell said clearly that interest rates were well-below neutral in early October.

The stock market plunged between October and December of 2018, erasing most of the gains registered over the preceding 2 years.

In late 2018, Fed officials began to speak publicly about how they may have overstated the need for future interest rate increases. By December, the Fed had walked back plans for further planned increases. Finally, in 2019, the Fed began cutting rates. The stock market applauded the action, regained its losses, and grew in 2019—achieving new highs at the onset of the coronavirus pandemic in early 2020.

The Fed proved that it could boost the stock market and provide economic stimulus by keeping interest rates low. But this was not a newly discovered magic bullet. Fed officials got their jobs because they got good grades in the business and economics classes where the basic stock market math is taught.

Cutting interest rates, however, while the U.S. economy was still expanding in 2019 was an unusual policy move. Historically, the fear was that keeping interest rates too low for too long will lead to an overheated economy and inflation.

One possibility is that the noninflationary (or "equilibrium") short-term interest rate has decreased in recent years. Historically, the Fed's short-term interest rate target was maybe 2 percent or 3 percent, adjusted for inflation. Historically, keeping rates below that target for a prolonged period did lead to higher inflation.

The fact that inflation did not surge after the 2019 interest rate cuts suggests that the equilibrium interest rate the Fed should target has changed. Indeed, in a recent speech, Powell focused on how the lack of inflation is a key indicator that interest rates are not too low.  

Economists believe that changes in the economy from a variety of factors—globalization, declining productivity, and the aging of the population—may have pushed the optimal short-term interest rate down. In this view, the Fed has just responded to the new economic environment and cut interest rates to keep the economy on track.

I will come back to this "new equilibrium interest rate" view of the stock market below, but first, we need to think about how other types of government policies also move the stock market.

In addition to what the Fed can do, the legislative and executive branches can affect stock prices directly through regulatory actions and tax policy, or indirectly through spending and deficit policies.

The easier plays—regulatory actions and tax policy that directly boost stock values—have been the clear choice of stock-market-first advocates. There are no great insights here, and one does not need an Ivy League business school degree to read the playbook on using such policies to increase stock prices:

• If we allow businesses to rely on cheaper, more environmentally destructive production techniques, then profits will go up.
• If we allow businesses to cut wages and benefits without regard for worker rights and well-being, then profits will go up.
• If we allow competition-destroying merger activity, then profits will go up (for the firms that survive) and overall industry profits will be higher.
• If we reduce taxes on corporate profits, then the profits available to pay out dividends to investors will go up.  

The question is not whether these policies can increase profits and stock prices, at least temporarily. They can. But adopting these policies does raise two other questions.

The first question is whether regulatory and tax policies lead to a permanent increase in profit levels or, even better, to a higher growth rate for profits. If the effects on profits are temporary, then these actions are fueling a stock market bubble because profit expectations will rise and then fall.

And even if the increases in profits are permanent, we need to ask whether the higher profits represent an efficient reallocation of the nation's resources. If we are just transferring more of our national wealth to business owners, then are you better-off? Your 401(k) investments may be increasing in value, but at the expense of what else that is important to your economic health and well-being?

Are we in a stock market bubble?

The first question we should ask about stock-market-first government policy actions is whether we are creating a stronger economy or just generating wild swings in the stock market. If policy is fueling booms and busts, then we may be at or near the top of one of those cycles.  

Distinguishing short- and long-run movements in stock prices is easy in hindsight. Stock market bubbles are declared to have happened after the bubble bursts, not while the bubble is expanding. But what we can do, at a point in time, is to look at the relationship between stock prices and the underlying economy in which everyone operates.

The famed stock market value investor Warren Buffet has long advocated that we simply look at the ratio of overall stock market value to the size of the economy, and, by that measure, the stock market is grossly overvalued.

More technical valuation measures are based on the three principles above—government interest rates, expected profits, and the risk premium—but those more technical measures also indicate stock market values are at historical peaks.

In short, even if you believe that the policy-driven increase in profits will persist and you believe the Fed will keep rates low, then stocks still are at the top of their historical range. The imbalance between economic fundamentals and stock prices is already here.

It might be the case that there is a new stock market math at play, and it goes hand-in-hand with the new equilibrium interest rate view. Inflation is not rising, which suggests that the economy is not overheated, and stock prices simply reflect the new equilibrium interest rate.

The lack of inflation is a mystery to the Fed and economists generally, but that may be because we are looking for inflation as the product of a "demand-pull" effect. The idea of demand-pull in this context just means that higher stock market wealth increases demand for goods and services and that bids up prices in an otherwise fully employed economy.

We are indeed collectively spending more in recent years, and that has led to increased employment. But inflation is not budging. Why?

There is another way to look at inflation, known as the cost-push effect. The term cost-push was coined in the 1970s, when unions and oil prices seemed to "push" businesses to raise their output prices to remain profitable.

What may be happening in recent years is that cost-push inflation is working in reverse. Government undertakes regulatory and tax policies that lower costs for all businesses, and businesses do what they teach in business school—they compete on price.

If firms operating in the same competitive market all experience the same cost decrease, then they will eventually lower the prices of the goods and services they are selling to maintain their market shares. The only possible exception to the rule is industries where there is a lack of competition—industries where government has not enforced antitrust laws.

But in general, an economist looking at recent regulatory and tax policy changes might wonder why someone would have ever expected a long-run increase in profits. If every business in a specific market is forced to follow the same regulations and pay the same taxes, then the costs are mostly just passed forward to consumers. That process works in reverse as well. Cutting the same costs for all businesses means lower prices or, at least, less pressure on further price increases.

But the goods are not truly cheaper. We consumers just stopped paying for things such as environmental protection and decent wages and meaningful health benefits for the workers at those firms.

The lower interest rates needed to prop up the inflated stock market are also impacting retirees and those saving for retirement. If you have practiced good financial hygiene and kept some of your savings in fixed-interest bonds, then you are earning a lot less on that part of your portfolio.

There is no free lunch, but sometimes, the price is hidden.  

If cost-push forces are really what is keeping inflation low in recent years, as seems likely, then the path to resolution of an overvalued stock market is through profits and the risk premium. When businesses compete away the reduced costs handed to them through regulatory and tax policies, the temporary boost in profits disappears.

And when the temporary boost to profits disappears, we are left staring at an overvalued stock market, with interest rates already close to zero, wondering when the bubble will burst. The only solutions are even more regulatory action or tax cuts and even lower interest rates.

If that sounds familiar, it is because you have been hearing about the need for more deregulation and lower taxes from stock-market-first advocates for decades. But lest you worry, the true believers in stock-market-first will tell you the next regulatory or tax fix is going to take care of everything, once and for all.

And yes—the stock-market-first agenda sounds more like a drug problem than good economic policy.

So, how should government move the stock market?

Even if stock-market-first policies do lead to some real economic growth, the follow-up questions we should ask are whether those policies are worth the cost and whether there is an alternative.

There are two ways that government policy can spur economic growth. The first is to engineer increases in stock prices using deregulation and corporate tax cuts, and we know that is possible. It even feels good on the way up. If we make stock owners wealthier, then they spend more, and the additional spending leads to increased employment and income for everyone else.

Giving up things such as environmental protections, decent wages, or a fair rate of return on risk-free retirement savings might just be the price of continued economic growth. But that higher growth does not mean you are personally better-off. You may reap some of the benefits of stock-market-first economics through a higher 401(k) balance, but you also pay the costs.

There is an alternative, but it requires understanding that although we can achieve the same or even better economic growth and employment, the nature of that growth will be different. The alternative would be more equitable, because we would not be relying on ever-increasing wealth inequality to grow the economy.

In addition to having regulatory and tax levers, government can grow an economy by investing or supporting investment in people, places, and things. Those sorts of investments can change one of the major underlying drivers of the "new" equilibrium interest rate environment by boosting productivity growth.

A slowdown in economic growth is not inevitable, but we need to realize that the types of investments we need to grow our economy are simply not seen as immediately profitable to people who already have a lot of money. If companies were already making these investments, then we would not be wondering why we are failing to grow an economy with so much obvious potential. Specifically:

• We need to invest in people so that more people are qualified to work at the jobs the rest of us truly value in a technologically evolving world.
• We need to invest in places, which means both in direct public infrastructure and in programs to direct loans away from big business and toward small businesses and private ownership of homes.
• We need to invest in things, especially technology. And we need to understand that much of the technology we see today began in universities and large public research organizations and, beyond that, often involves private and public partnerships.
• We need to cooperate in new ways on healthcare, retirement programs, and income security. Government created these sorts of cooperative programs because private markets failed to give us what we needed, and we should focus on making those programs better, not defunding and destroying them.
• We need to stop listening when some politicians say that taxes are a destructive force for innovation and growth. We need to hear instead that the income generated from a stronger and more productive economy is, in part, a return on our public investments, and failure to tax that income is the same as foregoing our collective rights to those investments.

Most importantly, we need to get past the fundamental principle espoused by stock-market-first advocates. They want you to believe that anything of value to the rest of us must involve people who already have a lot of money making even more money using that money. 

Sound economic policies will boost the stock market because higher productivity means higher wages and higher profits. More importantly, the boost will be permanent and consistent with economic fundamentals. Low interest rates are not needed to prevent a stock market collapse. 

Consider policies that did not exist when our oldest voters were born. Social Security, Medicare, Unemployment Insurance, the GI Bill, the national highway system, the Environmental Protection Agency, NASA, support for higher education, and research by the National Institutes of Health. Those policies made us better-off because we worked together, made investments, and reaped the rewards.

And acknowledge that every one of those policies was subject to the same screams about excessive government that stock-market-first advocates regularly employ. But voters chose not to listen. They knew better.

And policy today? The imagination of stock-market-first politicians has become limited to undoing the environmental and workplace safeguards we value and lowering taxes to boost profits and the stock market.

History and logic tell us that sort of game can indeed ratchet the stock market to new levels, but it does not change long-term growth rates. History and logic tell us there is a cost to supporting inflated stock prices. Just look most recently at the costs to our economy of the Great Recession of 2007–2009. Or the costs evident in our current pandemic economy.

The Fed is running out of levers to accommodate policy failures and prop up inflated stock values. Interest rates are already effectively zero, and the Fed is now relying on interventions that directly target the problems generated in the name of free market efficiency.

At the onset of the coronavirus pandemic and resulting recession, the Fed was forced to guarantee the excessive debt issued by corporations during the preceding stock market run-up. Much of that debt was issued by corporations to buy their own stock and further inflate stock prices during the boom.

Had the Fed not stepped in to guarantee corporate debt, the risk premium would have shot up because investors would rightly fear a surge in bankruptcies, stocks would have tanked, and the economy would have imploded.

Lowering interest rates and guaranteeing corporate debt was the right thing to do, given the situation the Fed was facing.

The point here is that the Fed should have never faced that situation. The situation was created by the disastrous regulatory and tax policies put in place before the pandemic. The situation stemmed from choices made by stock-market-first politicians. The situation was not inevitable.

And what about the future? Current stock prices are out of sync with economic fundamentals. But there is not a lot more the Fed can do, beyond buying corporate stock directly.

The pressure to reconcile even current stock values with future profits in our low-growth economy suggests that corporate owners will lobby to further increase their share of the pie, lest the imbalance between actual and expected profits be revealed.

The pressure from economic fundamentals means corporate owners will lobby for more ways to lower your wages and benefits. That means your Social Security and Medicare are less secure. That means your health insurance will cost you more. That means your safe retirement income will be even lower.

The costs to you of stock-market-first U.S. economic policies

Advocates of stock-market-first economic policies would have you focus on new stock market highs as proof they know what is best for the economy. Specifically:

• They want you to overlook the fact that they are using government to get an increasingly larger share of the economic pie for themselves.
• They want you to ignore that their policies are inhibiting overall growth in the very economic pie from which they are taking that bigger share.
• They want you to ignore that government-organized economic cooperation is often the key to real economic growth shared equitably between workers and business owners.
• They want you to ignore that the absence of worker bargaining power is gutting the middle class.
• They want you to ignore that failure to enforce antitrust laws has led to a lack of competition in key industries.
• They want you to ignore that the impending technological change associated with automation is likely to make cooperation between government, business, and labor even more important in the years ahead.

And they want you to ignore that improved working conditions, higher wages, better retirement and health security, and a cleaner environment were choices that you voted for all your life because they have real value.

Stock-market-first advocates want you to believe that a booming stock market is always a good thing for you. But you should know now that it depends on how we got there. You should know now that the stock market math will add up one way or another at the end of the day, and the people in charge of the reckoning will not be the ones making sacrifices.

Rising wealth inequality is more than just unfair and discriminatory. Rising wealth inequality is the result of disastrous economic policies that generate unfair and discriminatory outcomes. The beneficiaries of those disastrous economic policies want to sustain that rising wealth inequality for their benefit, not yours.

Even if you do own a 401(k).

 -- via my feedly newsfeed

CEO/Worker Pay Ratios: Some Snapshots [feedly]

CEO/Worker Pay Ratios: Some Snapshots
https://conversableeconomist.blogspot.com/2020/07/ceoworker-pay-ratios-for-different.html

Each year, US corporations are required to report the pay for their chief executive officers, and also to report the ratio of CEO pay to the pay of the median worker at the company. Lawrence Mishel and Jori Kandra report the results for 2019 pay in "CEO compensation surged 14% in 2019 to $21.3 million: CEOs now earn 320 times as much as a typical worker"(Economic Policy Institute, August 18, 2020). 

Back in the 1970s and 1980s, it was common for CEOs to be paid something like 30-60 times the wage of a typical worker. In 2019, the ratio was a multiple of 320. 

A result of this shift is that while CEOs used to be paid three times as much as the top 0,1% of the income distribution, now they are paid about six times as much. 

What is driving this higher CEO pay ratio? In an immediate sense, the higher pay seems to reflect changes in the stock market. The left-hand margin shows CEO pay; the right-hand margin shows the stock market as measured by the S&P 500 index. 

This rise in CEO/worker pay ratios has led to a continually simmering argument about the underlying causes. Does the rise reflect the market for talent, in the sense that that running a company in a world of globalization and technological change has gotten harder, and the rewards for those who do it well are necessarily greater? Or does it reflect a greater ability of CEOs to take advantage of their position in large companies to grab a bigger share of the economic pie? One's answer to this question will turn, at least in part, on whether you think CEOs have played a major role in the rise of the stock market since about 1990, or whether you think they have just been riding along on a stock market that has risen for other reasons. For an example of this dispute from a few years ago in the Journal of Economic Perspectives (where I work as Managing Editor), I recommend: 

• Steven N. Kaplan and Joshua Rauh. 2013. "It's the Market: The Broad-Based Rise in the Return to Top Talent." Journal of Economic Perspectives, 27 (3): 35-56.
• Josh Bivens and Lawrence Mishel. 2013. "The Pay of Corporate Executives and Financial Professionals as Evidence of Rents in Top 1 Percent Incomes." Journal of Economic Perspectives, 27 (3): 57-78.

Without trying to resolve that dispute here, I'd offer this thought: Notice that pretty much all of the increase in CEO/worker pay ratios happened in the 1990s, and the ratio has been at about the same level since then. Thus, if you think that the market for executive talent was rewarding CEOs appropriately, you need an explanation for why the increase happened all at once in about a decade, without much change since then. If you think the reason is that CEOs are grabbing a bigger share of the pie, you need an explanation for why CEOs became so much more able to do that in the 1990s, but then their ability to grab even-larger shares of the pie seemed to halt at that point. To put it another way, when discussing a change that happened in the 1990s, you need an explanation specific to the 1990s. 

I don't have a complete explanation to offer, but one obvious possible cause was in 1993, when  Congress and the Clinton administration enacted a bill with the goal of holding down the rise in executive pay (visible in the first graph above). Up into the 1980s, most top executives had been paid on via annual salary-plus-a-bonus. However, the new law put a $1 million cap on salaries for top executive, and instead required that other pay be linked to performance--which in practice meant giving stock options to executives. Although this law was intended to hold down executive pay, the was The stock market more-or-less tripled in value from late 1994 to late 1999, and so those who had stock options did very well indeed. My own belief is that combination of events reset the common expectations for what top executives would be paid, and how they would be paid, in a way that is a primary driver of the overall rise in inequality of incomes in recent decades. 

 -- via my feedly newsfeed

Africa is Not Five Countries [feedly]

Tim Taylor asks -- Economists treat Africa like it was not composed of 57 countries. Is it just a slip, or a racist one: as in, "they all [African nations] look alike."

Africa is Not Five Countries
https://conversableeconomist.blogspot.com/2020/09/africa-is-not-five-countries.html

Scholars of the continent of Africa sometimes feel moved to expostulate: "Africa is not a country!" In part, they are reacting against a certain habit of speech and writing where someone discusses, say, the United States, China, Germany, and Africa--although only the first three are countries. More broadly, they are offering a reminder that Africa is a vast place, and that generalizations about "Africa" may apply only to some of the 54 countries in Africa. 

Economic research on "Africa" apparently runs some risk of falling into this trap. Obie Porteous has published a working paper that looks at published economics research on Africa: "Research Deserts and Oases: Evidence from 27 Thousand Economics Journal Articles" (September 8, 2020). Porteus creates a database of all articles related to African countries published between 2000-2019 in peer-reviewed economics journals. He points out that the number of such articles has been rising sharply: "[T]he number of articles about Africa published in peer-reviewed economics journals in the 2010s was more than double the number in the 2000s, more than five times the number in the 1990s, and more than twenty times the number in the 1970s." His data shows over 19,000 published economics article about Africa from 2010-2019, and another 8,000-plus from 2000-2010. 

But the alert reader will notice how easy, as shown in the previous paragraph, to slip into discussing articles "about Africa." Are economists studying a wide range of countries across the continent, or are they studying relatively few countries. Porteous has some discouraging news here: "45% of all economics journal articles and 65% of articles in the top five economics journals are about five countries accounting for just 16% of the continent's population."

The "frequent 5" five much-studied countries are Kenya, South Africa, Ghana, Uganda, and Malawi. As Porteous points out, it's straightforward to compile the "scarce 7": the seven countries Sudan, D.R. Congo, Angola, Somalia, Guinea, Chad, and South Sudan,with the same population as the frequent 5, but account for only 3.5% of all journal articles and 4.7% of articles in the top 5 journals.

What explains what some countries are common locations for economic research while others are not? Porteous writes: "I show that 91% of the variation in the number of articles across countries can be explained by a peacefulness index, the number of international tourist arrivals, having English as an official language, and population." It's certain easier for many economists to do research in English-speaking countries that are peaceful and popular tourist destinations--and that's what has been happening. There's also evidence that even within the highly-researched countries, some geographic areas are more often researched than others. 

Of course, it's often useful for a research paper to focus on a specific situation. The hope is that as such papers accumulate, broad-based lessons begin to emerge that can apply beyond the context of a specific country (or area within a country). But local and national context is often highly relevant to the findings of an economic study. It seems that a lot of what economic research has learned about "Africa" is actually about a smallish slice of the continent. 

 -- via my feedly newsfeed

Stock Buybacks: Leverage vs. Managerial Self-Dealing [feedly]

Tim Taylor does a great dive into stock buybacks -- and you do not need a masters in economics to get it. :)

Stock Buybacks: Leverage vs. Managerial Self-Dealing
https://conversableeconomist.blogspot.com/2020/09/stock-buybacks-leverage-vs-managerial.html

Consider a company that has been earning profits, and wants to pay or all of those earnings to its shareholders. There are two practical mechanisms for doing so. Traditionally, the best-known approach was for the firm to pay a dividend to shareholders. But in the last few decades, many US firms instead have used stock buybacks. How substantial has this shift been, and what concerns does it raise? 

Here, I'll draw upon a couple of recent discussions of stock buybacks. Siro Aramonte writes about "Mind the buybacks, beware of the leverage," in the BIS Quarterly Review (September 2020, pp. 49-59). Kathleen Kahle and René M. Stulz tackle the topic from a different angle in "Why are Corporate Payouts So High in the 2000s? (NBER Working Paper 26958, April 2020, subscription required). 

Kahle and Stulz present the evidence both that overall corporate payouts to shareholders are up in the 21st century, and that stock buybacks are the primary vehicle by which this has happened. They calculate that total payouts from corporations to shareholders from 2000-2017 (both dividends and share buybacks) were about $10 trillion. They find that corporate payouts to shareholders have risen substantially post-2000, and that stock buybacks are the main vehicle through which this has happened. They write: 

In the 2000s, annual aggregate real payouts average roughly three times their pre-2000 level. ... Specifically, in the aggregate, higher earnings explain 38% of the increase in real constant dollar payouts and higher payout rates account for 62% of the increase. ...

In our data, the growth in payout rates, defined as the ratio of net payouts to operating income, comes entirely from repurchases. This finding is consistent with the evidence in Skinner (2008) on the growing importance of repurchases. Dividends average 14.4% of operating income from 1971 to 1999 and 14% from 2000 to 2017. In contrast, net repurchases, defined as stock purchases minus stocks issuance, average 4.8% of operating income before 2000 and 18.3% from 2000 to 2017.

The tax code offers obvious reasons for share buybacks, rather than dividends, as economists were already discussing back in the 1980s.  Dividends are subject to the personal income tax, and thus taxed at the progressive rates of the income tax. However, the gains of an investor who sells stock back to the company are taxed at the lower rate for capital gains. In addition, when a company pays a dividend, all shareholders receive it, but when a company announced a share buyback, not all shareholders need to participate, if they do not wish to do so. Thus, share buybacks offer investors more flexibility about when and in what form they wish to receive a payout from the firm. 

In addition, economists have also recognized for some decades that corporations will sometimes find themselves in a position of "free cash flow," where the company has enough money that it can make choices about whether it can find productive internal investments for the funds, or whether it will fiud a way to pay out the money to shareholders, or whether it will use the money to pay bonuses and perquisites to managers. If we agree that lavishing additional benefits on managers is not a socially attractive choice, and if the firm honestly doesn't see  how to use the money productively for internal investments, then paying the funds out to shareholders seems the best choice. 

The public response to firms that pay dividends is often rather different than when a firm does a share buyback--even when the same payout is flowing from the firm to its shareholders. The concern sometimes expressed is that corporate managers have an unspoken additional agenda with stock buybacks, which is to pump up the price of the company's stock--and in that way to increase the stock-based performance bonus for the managers.

Sirio Aramonte also documents the substantial rise in stock buybacks in recent decades. He points out that a primary cause for stock buybacks is for firms to increase their leverage--that is, to increase the proportion of their financing that happens through debt. He writes: "Corporate stock buybacks have roughly tripled in the last decade, often to attain desired leverage, or debt as a share of assets." This pattern especially holds true if the firm finances the stock buyback with borrowed money, rather than out of previously earned profits. He writes: 

In 2019, US firms repurchased own shares worth $800 billion (Graph 1, first panel; all figures are in 2019 US dollars). Net of equity issuance, the 2019 tally reached $600 billion. Net buybacks can turn negative, and they did during the GFC [global financial crisis of 2007-9], as firms issued equity to shore up their balance sheets. ... Underscoring the structural differences between dividends and buybacks, the former were remarkably smooth, while the latter proved procyclical and co-moved with equity valuations ...

Aramonte crisply summarizes the case for share buybacks: 

In a number of cases, repurchases improve a firm's market value. For instance, if managers perceive equity as undervalued, they can credibly signal their assessment to investors through buybacks. In addition, using repurchases to disburse funds when capital gains are taxed less than dividends increases net distributions, all else equal. Furthermore, by substituting equity with debt, firms can lower funding costs when debt risk premia are relatively low, especially in the presence of search for yield. And, by reducing funds that managers can invest at their discretion, repurchases lessen the risk of wasteful expenditures.

What about the concern that corporate managers are using share buybacks to pump up their stock-based bonuses? Aramonte's discussion suggests that this may have been an issue in the past--say, pre-2005--but that the rules have changed. Companies have been shifting away from bonuses based on short-term stock prices, and toward bonuses based on long-term stock value for executives who stay with the firm. There are increased regulations and disclosure rules to limit this practice. Also, if CEOs were using stock buybacks in a short-term pump-and-dump strategy, then the stock price should first jump after a buyback and then fall back to its earlier level--and we don't see this pattern in the data. Thus, this concern that managers are abusing stock buybacks seems overblown. 

What about the linkages from stock buybacks to rising corporate debt? Aramonte provides some evidence, and also refers to the Kayle/Stulz study: 

[B]uybacks were not the main cause of the post-GFC rise in corporate debt. After 2000, internally generated funds became more important in financing buybacks. For one, economic growth resulted in rising profitability. In addition, firms exhibited a higher propensity to distribute available income. Kahle and Stulz (2020) find that cumulative corporate payouts from 2000 to 2018 were higher than those from 1971 to 1999 and that two thirds of the increase was due to this higher propensity.

In short, the overall level of rising corporate debt in recent years is a legitimate cause for concern (as I've noted here, here, and here). Share buybacks are one of the tools that US firms have used to increase their leverage, but the real issue here is whether the higher levels of debt have made US firms shakier, not the use of share buybacks as part of that strategy. The pandemic recession is likely to provide a harsh test of whether firms with more debt are also more vulnerable. As Aramonte writes: 

There is, however, clear evidence that companies make extensive use of share repurchases to meet leverage targets. The initial phase of the pandemic fallout in March 2020 put the spotlight on leverage: irrespective of past buyback activity, firms with high leverage saw considerably lower returns than their low-leverage peers. Thus, investors and policymakers should be mindful of buybacks as a leverage management tool, but they should particularly beware of leverage, as it ultimately matters for economic activity and financial stability.

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It’s not Vaccine Nationalism, It’s Vaccine Idiocy [feedly]

Dean Baker at his best passive aggressive assault on stupidity.

It's not Vaccine Nationalism, It's Vaccine Idiocy
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Last week an official with China's Center for Disease Control and Prevention (CDC) said that the country may have a vaccine available for widespread distribution by November or December. This would almost certainly be at least a month or two before a vaccine is available for distribution in the United States, and possibly quite a bit longer.

While we may want to treat statements from Chinese government officials with some skepticism, there is reason to believe that this claim is close to the mark. China has reported giving its vaccines to more than 100,000 people. In addition to giving it to tens of thousands of people enrolled in clinical trials, it also has given them to front line workers, such as medical personal, through an emergency use authorization. 

This may not have been a good policy, since these workers faced the safety risks associated with a vaccine that has only undergone limited testing, but it does mean that a large number of people have now been exposed to China's leading vaccine candidates. If there were serious side effects, it would be hard for China to bury evidence of large numbers of adverse reactions. If no such evidence surfaces, we can assume that bad reactions to the vaccines were either rare and/or not very serious.

Of course, the evidence to date tells us little about long-term effects. But that would be true even if we had a couple more months of testing. Evidence of long-term effects may not show up for years. Ideally, researchers would have enough understanding of a vaccine so that they would largely be able to rule out problems showing up years down the road, but we know they do sometimes overlook risks. In any case, the possibility of longer-term problems would still be there with a longer initial testing period.

It is possible that the vaccines are not as effective as claimed. Since China has been very successful in controlling the pandemic, even front-line workers would face limited risk of exposure. However, they have been doing Phase 3 testing in Brazil, Bangladesh, and other countries with much more severe outbreaks. 

On this issue, it is worth noting that the United Arab Emirates (UAE), one of the countries in which China is conducting its phase 3 trials, just granted an emergency use authorization for one of its vaccines to be given to frontline workers there. Presumably this reflects positive results of the trial, since it is unlikely that the UAE would grant this authorization simply to please China's government. 

The companies have not yet shared their data, so it's possible that the evidence does not support the claim of this Chinese CDC official. But here too, the value of making an obviously false claim would be limited. If the companies either fail to produce their data, or the data does not show solid evidence of a vaccine's effectiveness, the official and China's government would end up looking rather foolish.

Since they are not just trying to bluff their way through an election, but are rather concerned about China's longer term standing to the world, it's hard to see why they would make a claim that would soon be shown to be false. In short, the promise of a vaccine being distributed in November or December is quite likely true. 

I suppose this will get those hoping that the United States would win the vaccine "race" very angry. But it should get the rest of us asking why we were having a race. 

Why Is Cooperative Research So Hard to Understand?

In the early days of the pandemic there was large degree of international cooperation, with scientists around the world quickly sharing new findings. This allowed for our understanding of the virus to advance far more rapidly than would otherwise be the case. 

But we quickly shifted to a path of nationalistic competition. Donald Trump led the way down this path, with his "Operation Warp Speed." Other countries followed a similar route, even as they maintained some commitment to the World Health Organization's efforts to promote sharing with developing countries.

But the issue was not just nationalism, it is also the monopolization of research findings. If Moderna, Pfizer, or one of the other U.S. drug companies ends up developing a safe and effective vaccine, they fully intend to sell it at a considerable profit, and they will be sharing the money with their top executives and their shareholders, not the American people. This outcome makes sense if the point of the policy is to maximize drug company profits. It makes no sense if the policy goal is to produce the best health outcomes at the lowest possible cost.

The United States did not have to take the patent monopoly nationalistic route. Suppose that all the money from Operation Warp Speed went to fully open research. This would not just be an accidental outcome, it would be an explicit condition of the funding. If a drug company received money from this program, all its results must be posted on the Internet as quickly as practical, and any findings would be in the public domain.

Since we would not just want to pay for the rest of the world's research, we could have negotiated commitments from other countries to make payments that are proportionate, given their size and per capita income. Of course, there is no guarantee that they would all go along, especially with Donald Trump as president. But in principle, this would be a mutually beneficial agreement for pretty much everyone. 

They would contribute their share of funding to the research pool and they would then have the right to produce any vaccines or treatments that are developed. If it turned out to be the case that a U.S. drug company was the first to come up with an effective vaccine, any company with the necessary manufacturing facilities would be able to freely produce and distribute the vaccine anywhere in the world. They would not need to negotiate over patent rights.

The same would be true if, as now seems to be the case, China turned out to develop the first effective vaccine. Our manufacturers would be free to start producing the vaccine as soon as it received the necessary approvals from the Food and Drug Administration. There would be no issue of people here going without the vaccine just because the developer was a Chinese company.

It's not surprising that Donald Trump did not go the route of cooperative development. His first priority is advancing his own political prospects and if he thinks that means having the U.S. win a vaccine race, that is what he is going to do. And, he certainly has no intention of pursuing a course that could limit drug company profits.

But the big question is where were the Democrats? If they were objecting to the path of vaccine nationalism and monopoly, it was not easy to hear their complaints. And, I'm not talking just about centrist Democrats like Biden, Pelosi, and Schumer, I also didn't hear complaints from the Bernie Sanders or Elizabeth Warren wing of the party. Why were there no objections to the Trump course and advocacy for a cooperative alternative?

Going a cooperative route would not just offer benefits in the context of developing vaccines and treatments for the coronavirus, although these benefits would be incredibly important. It also could have provided a great model of an alternative path for financing the development of prescription drugs. 

We will spend over $500 billion this year on prescription drugs. We would pay less than $100 billion if these drugs were available in a free market without patent monopolies and related protections. The $400 billion in annual savings is more than five times what we spend on food stamps each year. It comes to close to $3,000 per household. In other words, it is real money.

Patent and copyright monopolies are also a big part of the upward redistribution of income over the last four decades. If we had alternatives mechanisms for financing innovation and creative work, people like Bill Gates would be much less rich, and the rest of us would have far more money.

Again, it is easy to understand why Donald Trump would have zero interest in promoting world health and reducing inequality. It's also understandable that politicians who are dependent on campaign contributions from those who have benefitted from upward redistribution, would not want to pursue routes that call into question the mechanisms of upward redistribution. 

But where were the progressive voices? The pandemic gave us an extraordinary opportunity to experiment with an alternative mechanism for financing research that could have enormously benefitted public health, both in the United States and elsewhere. The failure to have a visible alternative will cost both lives and money long into the future.  

The post It's not Vaccine Nationalism, It's Vaccine Idiocy appeared first on Center for Economic and Policy Research.

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