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Paul Solman Answers Students’ Economic Questions

BY Admin  October 27, 2009 at 11:00 AM EDT

back to school; istockphoto.com

Question: How does it happen that the whole world is in a recession? –Kavion, senior, Central High School, Phoenix, Ariz.

Paul Solman: The whole world isn’t in a recession. China is growing; so is India; so is Brazil. Among them, those three countries alone have something like two-thirds our GDP and maybe nine times as many people as we do.

As to the parts of the world that are in recession — largely in Europe — it looks like the reason is because their citizens borrowed and spent “beyond their means.”

Question: When, why and how did the economy begin to fall? – Chanessa, senior, Central High School, Phoenix, Ariz.

Paul Solman: When: late 2007.

Why: easy credit, easier regulation, a national mindset that we could have it all.

How: Scam artists got into the act and pushed the economy beyond the breaking point. You know Ben Stein, the guy chained to Shaquille O’Neal in those TV ads? His father, a famous economist, is known for Herb Stein’s Law: “If something cannot go on forever, it will stop.”

Question: If every other major economy in the world has universal health care why doesn’t the United States? –Kavion, senior, Central High School, Phoenix, Ariz.

Paul Solman: The excellent health economist Victor Fuchs gives four reasons:

1. Many organizations prefer the status quo. (Insurance companies, drug companies)

2. Machiavelli’s “Law of Reform” suggests that a determined and concentrated minority fighting to preserve the status quo has a considerable advantage over a more diffuse majority who favor reform.

3. Our country’s political system renders Machiavelli’s Law of Reform particularly relevant in the United States, where many potential “choke points” offer opportunities to stifle change.

4. Reformers have failed to unite behind a single approach.

I can’t do any better than that, except to add that health care’s opponents have spent a lot of money scaring Americans about “socialized” medicine, suggesting that government health care is simply not “American” because it doesn’t rely on the “free market.”

The vulnerability of Americans to such appeals was apparent when protesters at a Congressional town hallmeeting on health care said: “Keep your government hands off my Medicare!” But Medicare is a government program for all Americans over 65. It does not rely on the free market at all.

Question: If education helps to increase economic growth, why don’t politicians pay more attention to and spend more money on K-12 schools? –April, senior, Central High School, Phoenix, Ariz.

Paul Solman: Because economic growth is a long-term and iffy thing. Human beings don’t love giving up something today (money) on iffy outcomes years down the road. I’m not sure how appealing the politics of education spending would be even if it could be shown persuasively to increase economic growth. Since the results aren’t blindingly clear, the appeal is even less than it might otherwise be.

Question: Unemployment seems to be far worse than the government’s statistics show (currently just below 10 percent). Why is this so? –Liz, senior, Central High School, Phoenix, Ariz.

Paul Solman: Because lots of people who you (and I) might consider “unemployed” aren’t in the most commonly reported number, which only includes people who haven’t worked at all, or looked for work, in the past week. And even that number is from a sample that might misrepresent reality, if unemployed people are harder to find and survey than other Americans.

But assume the methods are sound. The government actually reports an official statistic called “Unemployment-6″ that includes everyone who has looked for work in the past year (but not past week) and who is looking for full-time work, but can’t find, and thus worked part-time in the past week. “U-6″ was 17 percent last month. And even that number didn’t include anyone who hadn’t looked for work in the past YEAR, because they were simply discouraged. Add in those people, and the unemployment number could be double the 10 percent you mention.

Question: Is unemployment going to get worse or better? –Miguel, senior, Central High School, Phoenix, Ariz.

Paul Solman: If you believe most economic forecasts, it’ll get worse right through the middle of next year. I can’t see any reason to argue strongly the other way. Since economies like ours tend to move up and down in cycles, I assume unemployment will get better some day.

Question: Because of the current economic conditions are we going to experience deflation or inflation in the future? –Kavion, senior, Central High School, Phoenix, Ariz.

Paul Solman: Beats me. “Deflation” is a drop in prices; “inflation,” a rise in them. Have you looked at the price of oil or gold lately? Rising. But what about wages? Housing? Clothing? All falling. The forces of deflation are consumers not spending, banks not lending. The forces of inflation are governments like ours creating more and more money. Right now, there’s a tug-of-war between the two forces.

Salt Lake City studentQuestion: Some people are saying that the worst is over, that the recession is coming to an end. Based on what you see in the economy right now and on your knowledge of previous recessions, is such a prediction on track? Are there specific indicators that you can point to that show that the economy will improve in the fall of 2009? –Jacob, senior, Judge Memorial Catholic High School, Salt Lake City, Utah (pictured at right, in center back)

Paul Solman: In the late 1980s, I think it was, I heard Harvard economist John Kenneth Galbraith say what has been my answer to questions like yours, Jacob, ever since: “There are two kinds of economists,” Galbraith said; “those who don’t know the future, and those who don’t know they don’t know.” Like Galbraith, I count myself firmly among those who know they don’t know. And that’s because, with regard to human events, the future is unknowable.

But this sounds like a cop-out, right? Even if the future is just a matter of probabilities, a guy like me who’s covered economics for 32 years should be able to guess the odds better than a high school student, shouldn’t I?

OK, so here’s my best guess, though please don’t bet any money on it: We’re in for years of very slow economic growth. Unemployment will remain high by historical standards. The beneficiaries of what economic growth there will be? The top few percent of the economy, as has been the case for decades.

Why am I so gloomy? Because so much of our recent growth was built on borrowing and spending. Not only do I think many Americans have realized that’s not a safe way to provide for their future, but investors worldwide are less willing to lend to us.

Even you high school students must have heard the phrase about Americans: “We’re living beyond our means.” Well, what happens to an economy when the high living stops? Less spending; fewer jobs.

Question: How is the economy measured? – Alex, senior, Judge Memorial Catholic High School, Salt Lake City, Utah (pictured above, on the left)

Paul Solman: By the Gross Domestic Product: the amount of goods and services it produces, as measured by their sales. Anything that gets bought counts as part of the final number, but what we buy from abroad is subtracted from what we sell abroad.

There are two famous problems with GDP as a measure of the economy. One is that it includes things that don’t necessarily make us better off, like cigarette sales. The other: that it excludes goods that simply aren’t traded in the marketplace. So a parent who hires a nanny and then goes to work himself adds to GDP two ways, but if he does the same job himself by staying home to care for his children adds nothing to the GDP.

Question: Is the stimulus plan a success or a failure? How can we tell? Are there other solutions to the economic downturn other than bailouts and stimulus packages? – Riley, senior, Judge Memorial Catholic High School, Salt Lake City, Utah (pictured above, on the right)

Paul Solman: We can’t tell for sure about success or failure, Riley, because, as with everything in human history, we can’t run an experiment that repeats the conditions we had when the stimulus plan was launched. It seems pretty safe to say that without the stimulus, unemployment would be worse and thus it’s a “success” compared to the alternative. The federal government has been spending money that consumers haven’t been spending, and that’s true the world over. In the short run, that would seem to helping rather than hurting economies like ours.

But will the stimulus be a success in the long run, you might ask. Well, in the long run, we’ll really never know. That’s because so many other things will happen to influence the economy. Experts still argue over why the American economy was so successful after World War II. They will be arguing over the impact of the stimulus when you’re my age.

Your third question concerns alternatives. One would have been for government to do nothing. Let labor, houses, commercial real estate and everything else in the economy drop in price until the point that people with money were willing to buy at the new low prices. It’s not easy to imagine that alternative being tried in a democracy like ours. Moreover, it’s far from certain that it would work.

Question: What changes has President Obama made to American economic policy? — Anthony, senior, Carle Place High School, Carle Place, N.Y.

Paul Solman: It’s hard to say, isn’t it? I mean, we’ll never get to run the experiment a second time, with a different president, much less a different Congress or Federal Reserve to see what changes could be made, would have been made absent Obama.

If you read history, you’ll find the greatest experts disagreeing about the effect previous presidents had on economic policy.

I don’t mean to duck the question, though. President Obama is clearly on one side of a great divide in economic thinking: the side of greater control of markets, more regulation, a more progressive tax system, greater sharing. This marks a major change from the economic theory that’s been in control of American policy for most of the time since 1981 and the coming of Ronald Reagan: freer markets, less regulation, a less progressive tax system. Democratic President Bill Clinton leaned the country back in the somewhat more government-oriented direction, but he too emphasized DE-regulation and free markets. George W. Bush then pushed this philosophy even further — until the crisis of 2008. At that point, he lurched back the other way, or allowed his Treasury Department to do so.

So my answer is: President Obama has made a major change in the U.S. economic policy of recent decades, though it’s not clear any other president, faced with crisis, might not have done the same.

Obama has not, however, gone as far as many of his supporters wished (and many of his opponents feared). He did NOT nationalize U.S. banks, meaning he did not declare them bankrupt and take them over. That would have punished those who ran them (executives), those who owned them (stockholders), and those who loaned money to them (bondholders). Instead, the government loaned money to the banks on favorable terms (to them).

Nor did the president push as hard as many wanted him to push — for a bigger stimulus package (more government spending); for tougher limits on greenhouse gases; for more universal health care.

On the other hand, he has taken steps to address all three problems — unemployment, global warming, health care — with government solutions. That’s a major change in economic strategy.

Question: Would the world economy be better if all countries used the same currency? –Kevin, senior, Carle Place High School, Carle Place, N.Y.

Paul Solman: Interesting question, Kevin. Yes, the world economy might be better off with a single currency. Think of the convenience: You never have to change money from one currency to another. Think of the savings: You don’t have to pay middlemen (currency traders) for the service; countries don’t have to maintain their own separate mints, spend money to police counterfeiting, etc.

In fact, Europe now has one currency instead of several dozen. And the International Monetary Fund has created a world currency for use by countries, though not individuals.

But think of the problems. Say the United States is in a deep recession and the rest of the world isn’t. Hard to imagine, maybe, but not impossible, right? Tens of millions of Americans decided to specialize in the wind turbine industry, let’s say — designing them, manufacturing them, installing them, advertising them — and then suddenly, oh, I don’t know, it turns out that turbines so disrupt weather patterns that great droughts and monsoons alternate everywhere and the industry has to be shut down at once.

America is a democracy. With so many laid off, the United States feels the need for a stimulus package. But investors won’t lend it the money, given America’s huge strategic mistake: its investment in wind. How will we ever pay back the lenders?

Historically, the other option would be to create more dollars, which we’d use to maintain or re-employed those out of work. But how can we do that if there ARE no dollars and we don’t have the ability to print (or electronically generate) more of the new currency?

In other words, if a country doesn’t have its own currency, it’s got a lot less control over its own economic destiny. This might be a good thing in the long run. But, as a famous English economist said almost 100 years ago: “In the long run, we’re all dead.”

Question: What are 529′s and are they good investments? — Pranav, senior, Carle Place High School, Carle Place, N.Y.

Paul Solman: They are savings accounts set aside for college tuition and exempt from income taxes. Here’s a definition from the Web site savingforcollege.com:

A 529 Plan is an education savings plan operated by a state or educational institution designed to help families set aside funds for future college costs. It is named after Section 529 of the Internal Revenue Code which created these types of savings plans in 1996.

And further: “Tax Benefits: As long as the plan satisfies a few basic requirements, the federal tax law provides special tax benefits to you, the plan participant….Some states (but not all) offer tax incentives to investors as well….

529 plans are usually categorized as either prepaid or savings plans…Prepaid Plans let you pre-pay all or part of the costs of an in-state public college education. They may also be converted for use at private and out-of-state colleges. The Independent 529 Plan is a separate prepaid plan for private colleges. Educational institutions can offer a 529 prepaid plan but not a 529 savings plan (the private-college Independent 529 Plan is the only institution-sponsored 529 plan thus far).

So much for the rules. But is a 529 a good investment? Well, it’s always worthwhile to your personal (or family’s) finances to avoid paying taxes if you can. Here, the government is using that incentive to induce people to save for college. But HOW good an investment depends on what the 529 is invested in, Pranav.

If all the money is invested in one hot high tech stock, say, you might find that it’s all gone by the time the person for whom it’s invested reaches college age. Invested in a well-diversified and above all LOW-COST mutual fund is clearly a safer bet. Safest of all: TIPS — Treasury Inflation-Protected Securities. These are government bonds that pay you a very modest interest rate — around 2 percent a year these days — PLUS the underlying inflation rate in addition, which isn’t much at the moment. But if inflation takes off…

Question: What are different ways to get the country out of a severe recession? — Amanda, senior, Carle Place High School, Carle Place, N.Y.

Paul Solman: One way is the way we’ve chosen to go: Spend our way out of the hole. It sounds odd, maybe, but think of it like this. Your classmate, Anthony, suddenly loses his job due to the recession, through no fault of his own. (We all know Anthony works his tail off at Carle Place Virtual Reality, the video game designer where he was employed testing new products.)

Without an income, Anthony can no longer afford to take his dog for training at Pranav’s K-9 Kompound. That forces Pranav to lay off Kevin, who in turn can no longer to buy those superb discount subs you sell at Amanda’s Four-Dollar Footlongs. This is the famous, and famously feared, downward spiral of recession. How to stop it, turn it around?

A stimulus package! It includes money for education grants, one of which might go to Carle Place Virtual Reality to teach economics to high school students via a video game featuring some respected elder — let’s say that bald senior citizen with the mustache on public TV: Call of Duty 5: Way Old Warfare.

Anthony gets his job back, takes the dog to Pranav’s again. He hires Kevin; Kevin is back in the market for $4-foot-longs, and the spiral is back in the upward direction.

Now some folks would prefer more tax cuts (there are plenty already in the current stimulus package) and less outright government spending. “Let the people decide how to spend their own money,” is how the argument goes.

The counter-argument is that tax cuts won’t get people to spend these days; they’re too afraid to. Instead of spending, they’ll simply save the money, or pay down their debts instead. That won’t get the economy moving in the right direction.

The argument for this approach? It’s worked in the past. In the long run, confidence returns and economic growth again takes off.

The argument against doing nothing was made by a famous English economist who said, in the long run… You can finish the sentence yourself.

Question: What can the average middle class person do to improve their finances during a recession? — Melissa, senior, Carle Place High School, Carle Place, N.Y.

Paul Solman: How does anyone improve their finances EVER? By spending less than they earn. By specializing so that you’ll have skills to sell according to what I call “The Golden Rule of Work”: “Do unto others in exchange for what you would have them do unto you.” That is, success in any economy is selling your fellow citizens something they can’t buy at a better price, given the quality, from someone else.

Now as a practical matter, WHO you know tends to be more important than WHAT you know, if only because getting the opportunity to show what you CAN do almost always involves a measure of trust at first. That’s why admission to a prestigious college is so valuable: who you’re going to know as a result of having gone there. Plus the pedigree that itself bestows a level of trust.

Question: Should “golden parachutes” and bonuses be regulated by the government, especially in companies that have been bailed out by the government because of poor lending practices and mismanagement? — Steven, senior, Carle Place High School, Carle Place, N.Y.

Paul Solman: I don’t see why not. If we the taxpayers own a significant portion of the stock of companies we’ve bailed out (by investing in them to keep them from bankruptcy), we’re the owners, right? So why shouldn’t we be able to monitor all executive contracts and pay?

Question: Ben Bernanke says that the recession is over. When will the middle class see the results of the end of the recession? — Pranav, senior, Carle Place High School, Carle Place, N.Y.

Paul Solman: “Middle class” is a category into which almost all Americans put themselves these days. So let’s say you’re asking when the recession will end for “most Americans” (all save the poorest and very richest).

My answer? Not for quite awhile. How, I ask myself, could it be otherwise? Most Americans spent more than they earned — for years. Now they’ve got to cut back because they’ve come to their senses. And lenders won’t extend them more credit — certainly not at attractive interest rates.

But consumer spending is a huge part of our economy, so if it goes down — as it has been — the economy is unlikely to pick up much.

The rest is the economy is BUSINESS spending, GOVERNMENT spending, and selling more abroad (in exports) than we import. Business spending isn’t likely to grow much given how many Americans — nearly 30 million — are unemployed and underemployed. And now that the stimulus package has come under so much criticism, no matter how unjustified some of the criticism may be, it’s hard to see how more government spending should be expected.

>As for more exports and fewer imports stoking the domestic economy, well, America is still running a trade DEFICIT of several hundred billion dollars a year, so that isn’t helping any.

One final piece of pessimism. The economic growth reported recently (at an annual rate of 3.5 percent) reflected the “cash for clunkers” buy-a-car-now! program, increased government spending (including an 8 percent rise for defense), and a build-up of inventories (goods produced for sale, but not yet sold). How sustainable is any of that?

Question: Why is the financial gap between rich and poor continuing to get wider? — Stephanie, senior, Carle Place High School, Carle Place, N.Y.

Paul Solman: In America, you mean? Numerous explanations are given. Let me count the ways.

1) “Skilled” Americans have more to sell to the rest of the world; “unskilled” Americans have less, because they’re competing with similarly unskilled workers the world over, who are willing to take less for their work.

2) Because of communications technology, the highly skilled can make more than ever, since they can sell their goods or services the world over.

3) Because the tax code has become so much less progressive. When Ronald Reagan became president in 1980, the top marginal rate (on the highest income earners) was 70 percent. It went as low as 28 percent, and today it’s 35 percent. The capital gains tax on investment income has gone down too. If you tax rich people less, they’ll keep more of what they earn and move away from the rest.

There’s a nice graph on Wikipedia that depicts what’s happened to America’s income distribution the past 60 years.

Here’s Frank Levy, an economist who has long studied income distribution, writing for the Library of Economic and Liberty’s Concise Encyclopedia of Economics:

The 1990s and early 2000s witnessed the establishment of a growing body of work, increasingly precise, describing how the income distribution has changed.

The distribution of pretax income in the United States today is highly unequal. The most careful studies suggest that the top 10 percent of households, with average income of about $200,000, received 42 percent of all pretax money income in the late 1990s. The top 1 percent of households, averaging $800,000 of income, received 15 percent of all pretax money income.

In the longer view, the path of income inequality over the twentieth century is marked by two main events: a sharp fall in inequality around the outbreak of World War II and an extended rise in inequality that began in the mid-1970s and accelerated in the 1980s. Income inequality today is about as large as it was in the 1920s.

The distribution of wealth, by the way, is even more unequal.