February 21, 2019 11:00AM

Are Child‐​Care Subsidies Actually “Good For The Economy”?

Commentators are already implying Democrat Elizabeth Warren’s new universal child-care plan will be "good for the economy."

Moody’s Analytics reckons subsidies will induce more mothers into the labor market, raising growth rates by 0.08 percent per year over a decade. Others say that cheaper out-of-pocket child-care will reduce time spent out of the labor force by working mothers, and this greater maternal labor market attachment will boost recorded productivity and women’s earning potential. Combined, it is said the universal program will raise the economy’s productive capacity and thus recorded level of GDP.

Such claims about heightened measured economic activity are not crazy. But previous research for England has found that the effects are unlikely to be as great as proponents imagine.

The roll-out of free child-care for three-year-olds there induced 12,000 extra mothers into work (coming at an extremely high cost of around $84,900 per job). This suggests government subsidies resulted in substantial crowd out of other informal or paid care, meaning overall the substitution effects (the higher effective wage inducing more labor supply) only narrowly exceeded the income effects (the higher effective wage reducing labor supply as people took more leisure with their child-care cost savings). Along the way, there was substantial “deadweight” - subsidies going to people who would work or stay attached to the labor market anyway.

But let’s suppose the proponents of Warren’s scheme are correct about their estimates of bigger effects here. Does any boost to measured GDP mean child-care subsidies are “good for the economy”? The answer is “probably not.”

GDP should not be confused with general economic welfare. Economists generally start from the view that free action in the economic sphere - people acting on their own preferences - maximizes economic welfare except in cases when there are market failures present. It is not clear what markets failures exist in relation to female labor force participation and child-care. That means subsidies to make child-care free, or nearly free, mask the opportunity cost to the parent of putting their kids in daycare in a way that harms broader economic welfare.

The idea that non-attachment to the labor market is a market failure needing correction is particularly peculiar.

Every day we freely opt not to maximize time at work or our productivity. These are choices that come with a significant opportunity cost, not least of time, after all. Some men and women obtain more “utility” from dedicating themselves to family life. Others may decide to work in vocational jobs, or part-time, or on activities that give them substantial non-pecuniary satisfaction, even if this does not maximize their productivity or wages. Some people decide not to invest in their own human capital to boost their earnings potential; others to care for an elderly relative nearing their end of life.

Why should government act to incentivize greater parental attachment to the labor market through child-care subsidies but not, say, incentivize French teachers to train to work on Wall Street or as engineers?

If failing to reach your labor market potential is a cause for intervention, then what about subsidies to other groups, such able-bodied retirees or non-working partners in single parent households with no children?

If child-care costs are too high to allow parents to be as productive as possible, then what about out-of-pocket housing, transport or training costs that prevent other people from working where they would be most productive?

Once you think about it, the idea that the role of government is to maximize labor force attachment and recorded productivity is bizarre – with huge implications that justify a whole host of new interventions.

And that would only be looking at one part of the equation too. Large new subsidies would ultimately have to be financed by raising taxes, as Warren acknowledges. Raising them on incomes for some would reduce their return to work and so labor force participation and human capital investment. Raising them on wealth, as Warren suggests, will reduce the return to saving and investment – which could reduce productivity. It is not clear what the net effect of this would be overall.

So is there ever a case for child-care subsidies under a “neutral” framework that allows preferences to be realized? Perhaps.

In some cases, the provision of means-tested welfare benefits without work requirements may reduce the incentive for parents to work. Targeted assistance to rebalance this disincentive may be desirable for those on low incomes, and indeed already exists in the form of the earned income tax credit.

More broadly though, if governments want to act neutrally in relation to children they should either operate no subsidies at all or else support families with children through tax allowances or distributions available to all children.

That way, parents get to decide what is best for their child without warping the financial incentives and structure of the child-care sector itself.

February 2, 2018 9:43AM

Economic Growth Under the Trump Immigration Plan

Economic growth is a poorly understood phenomenon by economists.  There are many schools of thought and models that try to understand it but we are far away from understanding it as well as how micro markets function.  We may never do so.  But there seem to be two non-mutually exclusive ways that growth increases.  The first is called intensive growth whereby our economy becomes more efficient and produces the same amount of output for equal or lesser inputs.  The second is called extensive growth whereby economic output increases because more factors of production are added such as capital, land, entrepreneurship, or laborers. 

Based mainly on extensive growth, many economic models try to predict how changes in the U.S. population affect gross domestic product (GDP), itself an imperfect measure.  Immigration is the primary contributor to population growth in the United States both through their movement here and their subsequent birth of children.  More people in the United States, at a minimum, increase the quantity of two factors of production: labor and entrepreneurship.  Land is relatively fixed and capital adjusts based on population.  The National Academies of Sciences (NAS) report on immigration and economic growth concluded that (page 317):

Immigration also contributes to the nation’s economic growth. Most obviously, immigration supplies workers, which increases GDP and has helped the United States avoid the fate of stagnant economies created by purely demographic forces—in particular, an aging (and, in the case of Japan, a shrinking) workforce.  Perhaps even more important than the contribution to labor supply is the infusion by high-skilled immigration of human capital that has boosted the nation’s capacity for innovation and technological change. The contribution of immigrants to human and physical capital formation, entrepreneurship, and innovation are essential to long-run sustained economic growth. Innovation carried out by immigrants also has the potential to increase the productivity of natives, very likely raising economic growth per capita. In short, the prospects for longrun economic growth in the United States would be considerably dimmed without the contributions of high-skilled immigrants.

The NAS report argues that there are substantial technological spillovers that boost economic growth but those are impossible to predict.  Thus, I use a simple back of the envelope calculations to show how GDP growth through 2060 would alter under the Trump plan.  This includes Census population projections under the current policy.  I then subtract legal immigration and adjust births and deaths accordingly.  I assume annual GDP growth of 2 percent under the current policy but 1.75 percent under the Trump plan to take account of the Wharton Model’s findings concerning the Trump-inspired RAISE Act and the research of economist Joel Prakken.

GDP would be 15.5 percent lower in 2060 under the Trump plan than under the status quo according to this calculation (Figure 1).  U.S. GDP would grow from about $19 trillion today to $49 trillion under the Trump plan but it would have grown to $58 trillion under the continuation of the current immigration policy (2017 dollars).  According to this rough estimate, American GDP would be about 15.5 percent lower in 2060 under the Trump plan than it otherwise would be under the status quo.  My estimate is very similar to that of Prakken’s whose model says U.S. GDP would be 12.5 percent lower than baseline by 2045 under the Trump-inspired RAISE Act. 

Figure 1

GDP Under Trump’s Immigration Plan Versus the Status Quo 

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Source: U.S. Census, Author’s Calculations, Cato Institute, Joel Prakken.

The loss in GDP comes from a lower population which the Census expects to grow to 409 million under the current policy but would only be 383 million under the Trump plan (Figure 2).     

Figure 2

American Population Under Trump’s Immigration Plan Versus the Status Quo 

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Source: U.S. Census, Author’s Calculations, Cato Institute.

Most commentators and policymakers are interested in the minuscule and mostly positive effect that immigration has on wages.  In contrast, the impact of immigration policy on economic growth is far larger and more important.  The size of the economy is a great measurement of national wealth and material abundance that should be the focus of any debate over the economic merits of immigration policy.

June 28, 2016 10:34AM

Venezuela’s Death Spiral, Dollarization Is The Cure

With the arrival of President Hugo Chávez in 1999, Venezuela embraced Chavismo, a form of Andean socialism. In 2013, Chávez met the Grim Reaper and Nicolás Maduro assumed Chávez’s mantle.

Chavismo has not been confined to Venezuela, however. A form of it has been adopted by Rafael Correa – a leftist economist who became president of a dollarized Ecuador in 2007.

Even though the broad outlines of their economic models are the same, the performance of Venezuela and Ecuador are in stark contrast with one another.

The most telling contrast between Venezuela’s Chavismo and Ecuador’s Chavismo Dollarized can be seen in the accompanying chart of real GDP in U.S. dollars. We begin in 1999, the year Chávez came to power in Venezuela.

The comparative exercise requires us to calculate the real GDP (absent inflation) and do so in U.S. dollar terms for both Venezuela and Ecuador. Since Ecuador is dollarized, there is no exchange-rate conversion to worry about. GDP is measured in terms of dollars. Ecuadorians are paid in dollars. Since 1999, Ecuador’s real GDP in dollar terms has almost doubled.

To obtain a comparable real GDP for Venezuela is somewhat more complicated. We begin with Venezuela’s real GDP, which is measured in terms of bolívars. This bolívar metric must be converted into U.S. dollars at the black market (read: free market) exchange rate. This calculation shows that, since the arrival of Chávez in 1999, Venezuela’s real GDP in dollar terms has vanished. The country has been destroyed by Chavismo.

 

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Venezuela is clearly in a death spiral. The only way out is to officially dump the bolívar and replace it with the greenback.

June 21, 2016 11:38AM

That Saudi Sinking Feeling

The rate of growth in a country’s money supply, broadly measured, will determine the rate of growth in its nominal GDP. For Saudi Arabia, the following table presents a snapshot of the relationship between the growth in the money supply (M3) and nominal GDP.

 

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The chart below shows the course of M3. Following the oil price plunge of September 2014, the growth in M3 has slowed. The rate of nominal GDP growth will follow.

Why is the money supply growth rate declining? Since the plunge in oil prices, the Saudis’ current account has dipped into negative territory. This has to be financed, and the Saudis have used their stash of foreign reserves to do the financing.

When the Saudi Arabian Monetary Agency (SAMA) sells foreign currency to finance the current account deficit (and maintain the Riyal/USD peg), it debits the reserve accounts (in Riyals) of the Saudi banks at the SAMA. This causes the domestic money markets to tighten, which works its way through the banking system. Not surprisingly then, there has been a marked slowdown in the growth of broad money since the oil price plunge and associated current account deficit.

 

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So, a slowdown in Saudi nominal GDP is already baked in the cake. The Saudis should get used to that sinking feeling, which will only abate if oil prices continue to rise.

February 20, 2015 9:14AM

Europe: A Fiscal & Monetary Reality Check

Led by Alexis Tsipras, head of Greece’s newly-elected, left-wing coalition, some other leading political lights in Europe—Messrs. Hollande and Valls in France and Renzi in Italy—are raising a big stink about fiscal austerity. Yet they always fail to define austerity. Never mind. They don’t like it. The pols have plenty of company, too. Yes, they can trot out a host of economists—from Nobelist Paul Krugman on down—to carry their water.

But public expenditures in Greece, Italy and France are not only high, but growing as a proportion of the economy. One can only wonder where the austerity is. As the first chart shows, only five of 28 European Union countries now spend a smaller proportion of national income on government than they did before the current crisis. For example, Greece spent 47.5% of national output on government in 2007 and 58.5% in 2013, an increase of 11 percentage points. 

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Government expenditures cut to the bone? You must be kidding. Even in the United States, where most agree that there is plenty of government largesse, the government (federal, plus state and local) still accounts for “only” 38.1% of GDP.

As Europe sinks under the weight of the State, fiscal austerity is nowhere to be found. The only form of austerity in the Eurozone is monetary austerity. Indeed, Eurozone credit to the private sector has fallen like a stone (see the second chart).

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This is a consequence of regulators continuing to force banks to deleverage. As a result, credit austerity will continue and so will Europe’s travails. Money rules.

January 22, 2015 4:28PM

The World Misery Index: 108 Countries

Every country aims to lower inflation, unemployment, and lending rates, while increasing gross domestic product (GDP) per capita. Through a simple sum of the former three rates, minus year-on-year per capita GDP growth, I constructed a misery index that comprehensively ranks 108 countries based on "misery."

Below the jump are the index scores for 2014. Countries not included in the table did not report satisfactory data for 2014.

The five most miserable countries in the world at the end of 2014 are, in order: Venezuela, Argentina, Syria, Ukraine, and Iran. In 2014, Argentina and Ukraine moved into the top five, displacing Sudan and Sao Tome and Principe.

The five least miserable are Brunei, Switzerland, China, Taiwan, and Japan. The United States ranks 95th, which makes it the 14th least miserable nation of the 108 countries on the table.

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October 31, 2014 10:41AM

The World Misery Index: 109 Countries

Every country aims to lower inflation, unemployment, and lending rates, while increasing gross domestic product (GDP) per capita. Through a simple sum of the former three rates, minus year-on-year per capita GDP growth, I constructed a misery index that comprehensively ranks 109 countries based on "misery." Below are the index scores for 2013. Countries not included in the table did not report satisfactory data for 2013.

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