Krugman’s argument for bloated government
Paul Krugman, Nobel Prize-winning economist and New York Times columnist, is once again banging the drum for federal aid for state and local governments. In theory, the federal government has the capacity to prop up states and municipalities by providing stimulus dollars to keep economic activity from stalling. However, this would require Congress to raise the debt limit and the Treasury to borrow from bond markets to get the money. Krugman contends that this would cost little and that the Obama administration is postponing the recovery by not fighting for more money from Congress:
The federal government has been pursuing what amount to contractionary policies as the last vestiges of the Obama stimulus fade out, but the big cuts have come at the state and local level. These state and local cuts have led to a sharp fall in both government employment and government spending on goods and services, exerting a powerful drag on the economy as a whole.
What Krugman’s analysis overlooks is that government at the state and local levels has been ballooning for decades and that a contraction may be necessary to purge the system of bureaucracy and outdated programs. Krugman’s borrowing plan would simply freeze budgets which, on their own, are basically unsustainable for state and local governments. As their costs increase, there is no more “fiscal space” in many state and local budgets to maintain the status quo without large tax increases. So after Krugman’s proposed federal stimulus expired, states and municipalities would likely have to raise revenues to support their expanded size.
Hoping that state and local government can provide a large number of jobs is unwise policy, since government employees have substantial attendant costs, notably generous pensions. Unlike private corporations, government cannot quickly add and reduce jobs as public budgets must go through the legislative process, which is infinitely more complex than corporate planning.
You can see the growth of government in the graph above, which plots state and local government employees per capita. In the early 1980s one government employee served 179 citizens. By 2002 one government employee served 155 citizens. This increase in employees either happened because governments took on more responsibilities, became less productive or padded the employee rolls as a result of political pressure (or a combination of all three).
A more striking example of the expansion of government is spending on law enforcement. As seen in the graph below, spending (in constant dollars) for law enforcement went from $192 in 1982 to $344 in 2007, far outpacing population growth. After watching police in riot gear break up peaceful Occupy protests and swat teams being used for small-time drug arrests, we might ask if there are too many public resources dedicated to “peacekeeping” already.
The ability to think and generate new ideas
The research department of the Federal Reserve Bank of New York released an interesting paper this week entitled “How Colleges and Universities Can Help Their Local Economies” (the video above is a good summary). The work centers on two ideas: 1) graduates can join the region’s educated workforce and contribute to economic growth; and 2) “human capital” is expanded when institutions team up with local business, or attract new businesses, to commercialize technology developed at the school.
I think these are good observations and help justify public support of higher education, but the analysis overlooks some big ways for institutions to drive economic growth more broadly. For example, Stanford University’s Engineering School is offering some of its most popular classes free of charge to students and educators around the world.
Here’s the best thinking from the New York Fed paper (page 2):
Higher levels of human capital in a region can contribute to higher levels of economic activity for several reasons. Human capital increases individual-level productivity and the generation of ideas. By extension, a region having more people with higher levels of human capital should have greater economic activity overall.
However, the total effect of higher levels of human capital on economic activity is larger than the sum of its parts. The geographic concentration of human capital facilitates what economists refer to as “knowledge spillovers”—the transfer of knowledge and skills from one individual to another. One person may, through observation and communication, learn skills from another; alternatively, the sharing of ideas among individuals may generate new insights that increase the knowledge of the group. When people increase their knowledge in these ways, they create a secondary pathway that increases human capital, which can further enhance regional productivity, encourage innovation, and promote growth.
The overall tone of this is right, but when the researchers say that the “geographic concentration of human capital facilitates what economists refer to as ‘knowledge spillovers’,” they miss a very important paradigm shift in American culture and economic activity. It’s as likely that we are facilitating knowledge spillovers with others who may not even live in our state or nation. If you search a little you can see the prevalence of this type of mission expansion by our great universities. Here’s a list of 400 free online university classes, and here are 10 university collections on YouTube. This is just the vanguard of progressive, first-class universities, and it mirrors how white-collar work is increasingly becoming virtual for many.
The challenge for the economists at the New York Fed and elsewhere is how to capture the value to economic growth this type of activity brings. There are no known quantifiables. But imagine the gain to human capital if workers were able to learn new skills virtually. There are actually few limits to virtual knowledge transfer. It’s happening, and we should nurture and measure it. America needs every possible tool to help it grow.
Does higher education spending spur growth?
Conventional wisdom says that to boost economic growth, the nation needs more workers who are highly educated. A 2011 study from Georgetown University’s Center on Education and the Workforce stated:
Over the past century, economic growth in the United States has been tied to technological change. First, it was the assembly line machines of the manufacturing age, and now it is computers and the Internet that have revolutionized skill needs in the workforce. America’s relentless engine of technological development, fueled by increasingly fierce global competition, has required an ever-growing pool of workers savvy enough to integrate these sophisticated new tools into their work routines. The growing need for technical sophistication has been coupled with a reduced need, often the result of automation, for unskilled labor. As an outcome of these technological changes, there has been a persistent and ongoing demand for more postsecondary education and training.
Many studies have proved that higher levels of education lead to higher incomes for workers. But I wonder if any studies have been done that prove economies grow more rapidly when more government resources are spent on education. As a quick check I mashed up data for the percentage of state budgets that are spent on higher education versus the growth of the state economies. There really doesn’t seem to be a direct correlation.
This chart only maps one year of the relationship between spending and growth, and doesn’t account for spending by private colleges and universities. There is a need to dig deeper into the data and verify the lack of relationship between state spending and growth. But the Council on State and Local Governments suggested in a February report that colleges should focus on increasing accountability rather than increasing their budgets. The report stated (emphasis mine):
States can adopt policies to assist college-goers obtain high-quality degrees and credentials. In addition, policies can be enacted to help institutions increase their capacity to serve more students and increase system productivity. Efforts to increase degree attainment can include: An emphasis on programs that help more students succeed in college by containing costs, reducing credit hours or offering credit for past experiences.
It’s not clear that more higher-education funding is the solution to creating more economic growth. Smarter education spending and more community college capacity, as suggested by President Obama, may be the way for states to spur economic growth.
Feifan Chang
The only way to help the students get a decent education from the public school system and not bankrupt the state any more is to eliminate the teachers union. End of story!
Are teachers a protected class?
State and local employees have not been as hard hit as the general economy. At 19 million strong, this workforce comprises about 14.6 percent of total U.S. non-farm employment. It looks as if education workers are particularly being shielded from job cuts.
Chris Mauro, Head of U.S. Municipals Strategy at RBC Capital Markets wrote today in a privately circulated research note (emphasis mine):
[O]n a percentage basis, the state general government (non-education) sector has seen the largest decline in employment since December 2007. As of October 2011, it is down almost 6% from its recent peak.
Similarly, local education employment is currently down about 3% from the peak and has now also declined by a greater percentage than in any of the prior three recessions.
State education employment, which has historically been very recession resistant, has been growing at a moderate rate since December 2007 but, here again, the growth rate has been slower than in any of the previous three recessions.
I’m fine with this as long as student performance increases and America turns out high school and college graduates who are ready to meet the 21st century with good reading and comprehension skills. It would be a sad thing, though, to devote increasing amounts of precious tax revenues to school systems and universities that are graduating barely literate students. If America is making a bet on education, it really needs to pay off.
The tax collections that support education workers have bifurcated recently. State revenues have returned to pre-recession levels thanks to strong sales and income tax collections, while local revenues have been lagging due to lackluster property tax collections. Though teacher salaries are mainly funded by local taxes, states do pass through significant revenues to local school districts, and higher education receives big cash flows via state funding and loans that students take out to attend college.
Outside of teachers, local governments employ a lot of firefighters, police officers and health and hospital workers. If education workers remain a protected class, then the layoffs will have to come from these areas. RBC’s Mauro comments on non-education local employment:
Teachers should not avoid the layoffs, especially if they do not achieve better results.
@Acetracy, I also have many relatives in education, my husband is in tech (at a university). He does work very long hours, both at work, and at home, for his job (salaried). He also is required to do his job with a much more then 50% success rate. In fact, in most other jobs, the employee would be gone with the failure rate of schools
Must infrastructure spending shrink along with muniland?
Paul Krugman at the New York Times has a good graph that shows a substantial withdrawal of government demand from the economy. He attributed this to the decline of federal government stimulus to state and local governments as the American Recovery and Reinvestment Act winds down. There is also another factor that is reducing government demand: state and local governments are issuing less debt, which in turn creates fewer building projects and construction jobs.
Municipal bond issuance is about $108 billion less this year than the same period in 2010. Several stories today highlight how states and cities continue to face fiscal challenges that cause them to lower the amount of municipal bonds that they issue for infrastructure projects.
Does reduced state and local infrastructure spending suggest a rationale for increased national infrastructure spending as hinted at by President Obama? Will his proposal be big enough to make up the shortfall of municipal spending on infrastructure? From Bloomberg:
Municipal bond sales this week and last are set to be the lowest for the period around Labor Day in seven years as issuers curb borrowing for infrastructure work.
Shrinking revenue prompted 69 percent of U.S. cities to delay or cancel infrastructure spending in 2010, according to a National League of Cities survey of local finance officers.
Cities also lowered spending with personnel cuts, service reductions, changes to health-care benefits and public-safety curbs, the October report showed. Eighty percent of finance officers forecast their cities will be less able to meet needs in 2011 than in 2010, the survey said.
Total municipal issuance so far this year has been $144.6 billion, according to data compiled by Bloomberg, $107.8 billion less than the same period in 2010, when federally subsidized Build America Bonds encouraged borrowing.
An AP story talks a little about the rationale for decreased muni bond issuance:
“There’s no question that this year some of the decline is simply budget problems that people have,” said John White, chief executive officer of the Public Financial Management Group, a Philadelphia-based investment advisory firm. “There is an atmosphere now where taxpayers are asking more questions about anything that’s debt-related than they have in the past.”
Money doesn’t make graduates
It is hard to make comparisons between different states’ data on public schooling because each one is faced with unique conditions. That said, the data above is pretty striking. The graph shows the public school dropout rate — the percentage of students dropping out annually — and the amount of public money spent per student per year, in thousands of dollars. You can see that there is not a lot of correlation spending and the dropout rate. Spending more doesn’t educate more students.
Of course this data only speaks to the dropout rate rather than educational achievement. So we can’t see the upside to higher spending. It’s always helpful to have bigger budgets but public schools, like all parts of muniland, will need to dig deeper and achieve more with less money. I’m confident that we can improve our educational system in the face of budget tightening.
I’m interested in all comments and references on the topic please leave them below.
Further:
US Department of Education: Public high school graduates and dropouts: 2007-08
For all the money and thought and resources we’ve poured into schools in impoverished neighborhoods, we’ve done little to raise the trajectory of those growing up in these communities. Brill believes that’s because of racalcitrant teachers’ unions. I believe it’s considerably more complicated than that.
http://blogs.reuters.com/great-debate/20 11/08/24/should-we-really-expect-schools -to-cure-poverty/
Muni sweeps: Derivatives transparency for dummies
Downdraft
The colorful chart above is from Lisa Pollock of Markit and shows the states which have the most traded credit-default swaps and their spreads to the benchmark. Bloomberg has more on that theme.
Derivatives transparency for dummies
Much of the damage that occurred in the financial crisis of 2007-09 came through the use of derivatives. Wall Street sold these products to sophisticated and unsophisticated investors across the globe. I wrote about the efforts of the Pennsylvania Auditor General Jack Wagner to develop a database of swaps for local governments. This effort should be lauded and hopefully copied by other states. But the value of the information in the database is not as great as having near real-time trade information to compare the pricing of a new derivative.
The Dodd-Frank Act has authorized a lot of transparency for the derivatives market. It’s very complex and arcane, so don’t worry if you haven’t figured it out yet. The law firm Reed Smith has created a “derivatives transparency for dummies” chart and I thought it would help us understand the changes.
Furthermore, regulators will be able to more effectively monitor the swaps markets for manipulative behavior, since ALL trades (both cleared and non-cleared) will be reported to swap data repositories.
Muni sweeps: Education reform for Illinois
Happy Friday all!
Illinois passes landmark education reform
The Chicago Sun-Times reports that the Illinois state legislature has passed a substantial education reform bill. The legislation severely restrains the power of the teachers’ unions:
The measure continues to allow unions to strike in Chicago and the suburbs, but it imposes a requirement that school boards and unions take longer to negotiate and publicly disclose their bargaining positions before a strike can be launched.
In Chicago, no strikes could occur until as long as 120 days after the dispute goes to a special panel — and then, only if the Chicago Teachers Union has given a 10-day notice of a strike and has 75 percent of its bargaining unit members in agreement. Currently, a strike only requires a simple majority of everyone who votes.
The legislation would let the Chicago Board of Education lengthen the school day or school year unilaterally.
It also would empower Downstate and suburban school districts to use performance, not strictly seniority, in determining teacher layoffs and impose first-ever performance benchmarks for teachers to gain tenure.
Under the legislation, tenure would be granted only if a teacher had attained two “proficient” or “excellent” ratings during the last three years of the four-year period required for tenure.
The timeline for dismissing a tenured teacher would be shortened in both Chicago and elsewhere.
MSRB releases Q1 trade data
The Municipal Securities Rulemaking Board (MSRB) released for the first time market statistics, including Q1 trading data and other figures, for the $2.9 trillion municipal bond market. From the MSRB statement:
- The par amount traded in the municipal securities market in the first quarter of 2011 totaled $842,088 million, down nearly 8 percent from the $915,207 million traded in the same period last year.
- Total number of trades of municipal securities during the first quarter of 2011 increased to 2.95 million, compared to 2.55 million trades in the first quarter of 2010.
Don’t educate, don’t grow
New analysis from Daniel Berger of Thomson Reuters Municipal Market Data suggests that greater levels of advanced education equals higher growth and muni bond ratings.
Put more simply, smart communities do better.
From Municipal Market Data:
Most of America’s older and generally industrial Midwest and Eastern cities have rapidly changed during the past forty years.
For example, cities such as Minneapolis and Boston have become very attractive regions for innovative high‐tech and biomedical companies due, in large part, to the high numbers of college graduates (over 40% of residents aged 25 years and older have college degrees).
This contrasts sharply with a couple of cities (Detroit and Cleveland) where the population of residents aged 25 and older are less prone to possess a college degree.
City % BA or + Moody’s S&P Fitch Minneapolis 43.3% Aaa AAA AAA Boston 42.9% Aaa AA+ AA+ Detroit 12.1% B1 BB BB Cleveland 13.7% A1 AA A+Detroit and Cleveland have suffered a long‐standing “brain drain” (although they may possess a few suburbs where the rate of higher education is high.)
It is striking to us that these cities have among the lowest ratings of the 50 largest US cities. We agree with Professor Edward Glaeser’s thesis that, “Education proved the best source of urban resurgence.”
Given the low rate of educational attainment in Cleveland you might think that the community is making an effort to revitalize education spending. Rather it seems to be pouring more capital into buildings.
County Council, part of a charter government that replaced commissioners in January, is asking just how a project first envisioned as a $50 million detention center grew to a grand $189 million structure.
“The needs of the center were just totally underestimated, from what I’m finding,” said Councilwoman Sunny Simon, who chairs the justice affairs committee. “I’m not sure if it was lack of planning or just lack of understanding of what was going to be involved with getting this operational.”
Simon and her colleagues toured the center this month, gaping at a $25,000 custom-made conference table, $21,500 in staff exercise equipment and a $5,100 Viking fridge in the magistrates’ lounge.
They are now being asked to approve digital audio equipment and computer contracts, totaling $2.3 million. Each of the judges are requesting three computers, said court Administrator Marita Kavalec — one for their office, one for the bench and one for audio-visual recording.
No one’s assuming blame for the tower of costs.
The commissioners signed off on all spending up to December, but they point to a lawsuit judges filed over the East 93rd and Quincy Avenue site and a 2006 settlement that mandated the county hire a South Carolina court-planning firm and that the complex include a full-service cafeteria, among other things.
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Resident Muniland expert
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The federal debt interest rate is literally below inflation, adding to the federal debt is currently not a problem.
The increased spending on police and education reflects the ramping up of education standards worldwide. I understand the need for reform, but cutting funding to education isn’t the solution. The same can be said for law enforcement.
In many ways, the idea of cutting government spending in a recession makes no sense. Programs like education and law enforcement a) directly pump money into the economy, raising employment and b) have overarching benefits for society, no matter where the economy is. If those programs are not worth our spending, I don’t know what is.
As for unsustainable local/state governments, there is definitely a problem there. I advocate a serious resturucturing on a state-by-state basis, but only AFTER unemployment reaches normal levels. There’s no point in sacraficing jobs for a balanced budget: there is no short-term benefit, and the long term benefits won’t be realized if we keep ourselves in this rut for too long.
For those who say “stop spending money we don’t have,” I say stop looking at marcoeconomic policy like you would a personal bank account. Large governments like the USFG can handle the debt burden. WWII proved that, an example classical economists would love to forget.