Government Resistance to Human Capital

James Heckman has a great paper called “Policies to foster human capital“. Apart from excellent integration of economics into government policies, this paper relentlessly reminds the reader about the lifetime aspects of investments in human capital:

Heckman and Carneiro - 2003 - Human Capital Policy
Heckman and Carneiro – 2003 – Human Capital Policy

Heckman refers to the evidences that late investments do not pay off. Late learning costs money, including foregone earnings, but it only modestly increases wage rates and generates less human capital, since investments are made closer to retirement.

Heckman also criticizes the excessive attention to formal education, which is all about a few narrow cognitive abilities and in any case just one of many ways to acquire skills.

This paper was published in 2000. To count how many of its insights made it into government policies, I looked into the 2013 Economic Report of the President. This report includes a chapter on human capital.

The chapter discusses three things. First, labor inputs of women and immigrants. Second, rising debt and enrollment bias in college education. Third, educational opportunities for adults. So, formal education and adult learning?

Why does this influential publication promote the exact policies that Heckman criticized fifteen years ago? Alan Krueger — who edited the 2013 report — is a brilliant labor economist himself. The entire Council of Economic Advisors is well staffed. So it’s not about competence.

The problem seems to be in the complexity of the policies that Heckman proposes. When economists remind the Congress about student debt, they have better chances of being heard than economists who suggest targeted programs in preschool education. Student debt is something that even US presidents had. Preschool education? TL;DR.

But rephrasing Neil deGrasse Tyson, science is true whether you read it or not. The complex stuff still explains well why policies fail when consensus is reached.

For the United States, this complex stuff is about fine-tuning the system that works well. For the middle-income countries, on the other hand, ignorance is costlier, not least because these countries tend to aggravate mistakes with more government intervention. Policy makers in these countries often frame human capital accumulation as another industrialization. Like, if we could raise savings-investments to 50% of GDP, we can accumulate human capital in the same way. Obviously, it doesn’t work this way; and for BRICS, it’s an important challenge.

As for the least developed countries, the major innovators out there are international organizations, which recently got an open letter from Chris Blattman asking to “stop hurting” poor people with skill training programs. For the same reason: the programs don’t work as intended; even if being accumulated, this human capital solves no important problem.

“Stop hurting” is a good suggestion because it encourages policy makers to do less, which is the idea they like. The second part is more difficult: stop hurting and accept better policies. Some of the better policies look unconventional but remain as simple as training programs. Their main disadvantage is that they are not invented here, that is, in government. And before anything happens, someone has to market these policies as if they were government’s genuine invention.

Marketing by Elon Musk

While the Uber story shows that a poorly regulated industry may be a good place to start a new company, Elon Musk suggests another opportunity borne by government:

But government is inherently inefficient. So it makes sense to minimize the role of government such that government does only what it has to do, and no more.

After this quote, some people cut their Social Security cards into pieces and run to a libertarian sea platform, away from government. This is, however, not what Musk means. Here’s some background.

It’s not a secret that, since 1958, NASA received $1 trillion dollars from federal budget to create the stack of technologies that SpaceX currently uses in its own commercial projects. SpaceX’s initial capital of $100 million makes 0.01% of this investment in space odysseys. The other 99.99% came from the government, which is presumably the necessary minimum mentioned by Musk.

And as Musk rightly reminds in the same interview:

But funded by the government just means funded by the people. Government, by the way, has no money. It only takes money from the people. [Laughter.]

So SpaceX took away dozens of engineers trained by publicly funded NASA and secured at least $500 million in government contracts.

Tesla Motors, another company founded by Musk, sells cars eligible for a $7,500-worth federal subsidy and numerous of state subsidies of a comparable amount. It’s about 20% off each car to help Tesla compete with fossil fuel vehicles.

His third company, Solar City, also advertises solar tax credits and rebates as its competitive advantage over traditional utilities. It promises that “some [state governments] are generous enough to cover up to 30% of your solar power system cost.”

The subsidies are, of course, not the point here. They are the second way toward clean and renewable energy, after complete pricing of fossil fuels (which is broadly supported by economists, see Pigou Club). In practice this transition will happen very much like what Tesla and Solar City do now.

But for anyone practically or intellectually interested in how this business works, executives happen to be a pretty misleading source. Even when these executives write long books about their companies or hire well-known economists without giving them complete data. Instead of the story how the company really works, the reader gets ideological cliches about business, management, and government. With teachers like them, it’s not a surprise that 9 out of 10 startups end up nowhere.

This happens mostly in hi-tech, with all this sudden success and media exposure. But the most competent executives manage to keep a low profile even here, because they know that they are best at running companies, not at teaching people how things work.

A Billion-Dollar Bill on the Sidewalk

A new $29 bn. stimulus announced by Japan reminds about how more effective the package could be if we knew more about the impact of fiscal spending. Christina Romer (2012) and Council of Economic Advisers (2014, Ch. 3, Appx. 2) update on traditional aggregate estimates, but any such spending is also an opportunity for randomized trials—that is, a missed opportunity.

The motivation for experiments in macro is, of course, omitted variable bias. Macro has natural experiments to handle it. That’s what you find in research like Romer and Romer, 1989; Card and Krueger on the minimum wage in New Jersey; Card on the Cuban immigrants in Miami. Natural experiments are pure luck in this sense: you need to look for pseudo-random assignments, which are rarely the case. In contrast, designed experiments make all kinds of random assignments at will, including those allowing for interactions between macro policies. Governments spend hundreds of billions on programs outside routine annual budgets. These programs have nice, open-minded goals of supporting specific sectors or people. However, a typical assignment is not random within target groups—and it greatly complicates estimation of how effectively the money has been spent.

The 2009 American Recovery and Reinvestment Act created arbitrary opportunities for a few evaluations to appear, but apart from these bottom-up initiatives, the stimulus was business as usual. Eventually, the 2014 Economic Report of the President recommended RCTs for microeconomic programs and grants (2014, Ch. 7). It was an important step with too little attention to macro RCTs, which will have to wait.

Waiting for randomized macro evaluations costs billions of dollars, as policy makers launch programs based on careful, but imprecise, expectations of the impact. That’s despite per-capita costs of evaluations in macro are lower than similar overheads of microeconomic programs. Assignment in macro is simpler; household and firm responses appear in regular statistical reports. Why not to run more evaluations? No sophisticated problems or conspiracies here. It just takes twenty years for any idea to travel from economists to policy makers. The stopwatch is somewhere in the middle right now.

That means yes, the joke about $10 bill on the sidewalk is actually not about economists.

Russian Government Needs Weak Ruble

During the last two weeks, the media say about the central bank of Russia defending the ruble. Though the bank did spend $110 bn. forex reserves over this year, the statement is not entirely correct.

CBR
CBR

Officially, the central bank is moving to the free-floating ruble. Kinda surprising for a petrocurrency, but the bank’s recent actions should be seen from this perspective.

The other important point concerns political consequences of exchange rate changes. The Russian general government budget infamously depends on oil prices. Falling oil prices have two effects. First, it’s a net loss because fossil fuels get sold for less. Second, the Russian tax system ensures that the central (federal) government remains a relative winner. Oil and gas exporters pay taxes proportionally to their forex revenues and pay them in rubles to the central government. Changes in exchange rates compensate the loss of dollar revenue, so the federal budget escapes a huge deficit. The central government is even a bigger winner under the free float regime, when the ruble rapidly depreciates after sanctions and declining oil prices:

FRED2
FRED2

Given the float currency policy and central government interests, the strong ruble has no strong supporters in Russia. The central bank spent $110 bn. trying to avoid sharp moves in exchange rates. People and businesses massively get rid of rubles when they discover vertical hikes in rates, which are familiar after hyperdepreciation of the 1990s. Government tried to avoid the side effects of rapid changes in exchange rates: bank runs, inflation, and underinvestment.

The central bank sold about 20% of its forex reserves in a year. Meanwhile, the ruble did depreciate with all those undesirable effects. Was it a good idea to free the ruble when (a) state-owned corporations were seeking new sources of capital due to sanctions, (b) oil prices fell rapidly to decade-long lows, (c) uncertainty around Ukraine put pressure on the ruble, (d) import required time to respond to current balance hit by new oil prices? The market needed dollars to soften these shocks. Instead, the central bank quitted in the middle of the game with $500 bn. in forex reserves (25% of nominal GDP).

If not in crisis, what’s a better time for a central bank with a free-floating currency to spend reserves? An even worse crisis! It’s better to be wrong on this, of course, and instead, to assume that government just got the ruble down as smoothly as it could.

A Brief History of Russian Debt

Paul Krugman draws attention to the role of exchange rates in the Russian debt. I’d add a few notes on this in addition to yesterday’s overview.

External Debt Was Cheap

For two reasons:

  1. QEs and zero interest rates made the dollar and the euro very attractive currencies for borrowing.
  2. The ruble appreciated in nominal terms, while its PPP conversion factor (how much rubles you need to buy the stuff worth $1 in the US) grew steadily (Paul Krugman’s point). Here’s the movement between 2000 and 2008:
WDI 2013
WDI 2013

The ruble becomes de-facto weaker (red line), but the exchange rate (green line) moves in the opposite direction. Russian businesses thought that borrowing abroad at low interest rates was a great idea. A corporation borrows a dollar at 1% per year, exchanges it for rubles in 2004, holds rubles for one year while the exchange rate going down, and returns the principal and the interest to the lender in 2005. Okay, corporations did something else to this money and paid a higher interest, but ruble-denominated debt was still more expensive.

The Russian Private Sector Accumulated $650 bn. of External Debts

About 90% of Russia’s external debt is corporate, though the state owns many of these borrowers:

World Bank's Russia Report, 2014
World Bank’s Russian Report, 2014

It Was Time to Pay the Debts

Russian corporations had to pay about $100 bn. of debts by the second half of 2014, when the States and EU lifted the sanctions:

wb14_debt_payments
World Bank’s Russian Report, 2014

Meanwhile, the oil prices fell to $60 and the currency inflow halted. This led to the shortage of dollars in Russia, so several big borrowers could break the thin market when they started lurking for dollars inside Russia:

Bloomberg
Bloomberg

The Central Bank of Russia held about $500 bn. in reserves but it didn’t support the ruble much over the year:

The Economist
The Economist

It didn’t matter than Russia had a current account surplus of about 5% of GDP throughout the 2000s. These $700–900 bn. were export revenues. Exporters converted them into rubles to pay taxes, wages, and other expenses. So, $500 bn. ended in the central bank.

External Debt Became Expensive

The corporate borrowers panicked in December 2014. The Central Bank didn’t offer enough dollars when the market was running out of them. The exchange rate hiked on December 16. This 10% daily hike meant really large annual returns (try to calculate 1.1^365). The dollar became an attractive investment. Not only corporate borrowers, but the entire population wanted dollars for now. Companies and families bought dollars with their savings or newly borrowed rubles.

People also reasonably expected import to become more expensive and started shopping before retailers adjusted their prices for the new exchange rates. It ended with a daily inflation peak because retailers did react to the new demand.

After the government intervention, the ruble stabilized around 60 RUR/USD. But $720 bn. of external debt remained. Corporations now have to pay about 100% of real interest, adjusted for the exchange rate shift. Though many of them are exporters and sell for dollars, Russian banks naturally earn their revenues mostly in rubles, which makes it difficult to pay forex debts. (Banks can buy the dollars back after the hike, but the financial sector has many other problems now.)

Finally, Weather Forecast

Asian countries had a pretty severe recession after the 1997 currency devaluation:

asia_forex_gdp

As Paul Krugman noted, broken balance sheets created troubles for these countries. When you borrow the currency that is different from the currency of your operations, well, you must hedge. Did Russian corporations know the Asian lesson and hedge? We’ll see, soon.

Picking the winners is still up to the government. The Central Bank has plenty of options here. It can use the remaining reserves to bring exchange rates down. It can keep the interest rate high (but not for long because businesses need credit). Or it can pick winners one-by-one.

More notes on the consequences are coming.

Free Cheese, not in the Mousetrap

OECD has a nice cost-benefit analysis of returns to education. First, what a high school gives to students:

Source
Source

Okay, huge net benefits for a degree. Even more interesting is the “unemployment effect.” Here lies a monetary value of higher employment security. The degree holder spends less time unemployed due to job security during crises and later retirement. This component is especially high in Slovak and Czech Republic. These countries have one of the lowest wealth inequality in the world, but it looks like the effect of relatively low incomes in the top quantiles. Their labor markets need more highly educated employees, as the market quickly absorbs high skilled candidates and low-skilled workers remain jobless (unemployment rates of 14 and 7% for Slovakia and Czech Republic, respectively). You can compare it to Korea, which has a more balanced labor market: a degree holder earns more but not because she gets jobs faster.

Net lifetime gains from having Bachelor’s, Master’s, or PhD:

screenshot

Eastern Europe could do a lot better given its middle-income status. Slovenia and Czech Republic would greatly benefit from more educated workers. A Hungarian with a tertiary degree creates more benefits for others than for herself, which makes a case for government support. It’s not necessarily support for education spending in this particular case. Free labor migration within the EU creates difficulties for public spending on education. Political support for these subsidies is low because students who get free education may migrate to high-income Germany and United Kingdom. High returns to tertiary education in Eastern Europe discourage this move, but they cannot fully offset the income gap between the West and the East.

So, it’s a case of the European Union without unity. Countries still have independent budgets (with exception of “stability and growth” rules), collect and spend their public revenues, but have to distort policies in response to other members stealing employment, demand, capital, or workforce. So, hypothetically, net beneficiaries from the brain drain should compensate losers for free public education.

But the point is, countries with fewer emigrants keep the returns to education and should invest in it more. Both by increasing public spending and by facilitating student loans. It’s not rocket science, just more care about people’s future.

Nobel for the Evident

Jean Tirole got this year’s Nobel for showing how to regulate big firms better. His work may be confusing to non-technical audience, but it makes millions of customers happier. When you pay your phone bills or mortgage, recall Tirole. Without him, these bills would be more expensive.

The Nobel committee published a summary, which also explains how economics relates to the real world. This point is not evident even to graduate students in economics, because professors pay attention to techniques of, not motivation for, economic analysis. Like education in general.

A relevant example from the summary. The 2008 crisis was triggered by the shift in the quality of financial assets. Assets that seemed safe were not so. But market participants were unsure which ones. Sellers knew their assets better than potential buyers. Buyers expected sellers to put toxic assets on market first, and no one wanted to buy suspicious property. The market would be still when sellers needed cash and other things in exchange for their (perhaps) good assets.

The government had to intervene to prevent the negative impact on the economy. What should it do? Whose assets to save first? In less fortunate countries, the answer was evident: the assets of public officials’ friends. That’s not the best choice, unless the friends had the worst assets, which Jean Tirole recommends to buy first. Then the government should provide financing to the owners of mediocre assets, without buying the assets themselves. In the end, according to Tirole, only high-quality stuff remains on the market, so normal buyers are no longer afraid to act.

Sure, “it’s evident.” But on the way to the evident you need to reject hundreds of other evident hypotheses. Second, you need to prove it. Not just few facts leading to a desirable conclusion, but a coherent model that prevents tricks like 2+2=5 in reasoning (happens more often than many think). It matters for those billions of people who suffer from very confident policymakers who know everything without proofs.

In other words, the committee awards the Prize for the path, not the result. And even a great path needs some explanatory background to appreciate it fully and demand something similar from those who make key decisions.

Private sector and economic development

Failures of development programs for Africa led to the opinion that tens of billions of dollars are just wasted. This belief is very comfortable to the small-government types. The evidences seemingly prove something about ineffective governments. The favorite ideological conclusion predicts that the private sector would eradicate poverty if foreign governments reduced their involvement in Africa.

But the private sector was there for the last 10,000 years. It didn’t succeed at all. And there’s no reason to expect anything else. The history of economic development is the history of governments building suitable conditions for the private sector to work. In fact, we have stories of economic growth without private sector (the Soviet Union’s output more than quadrupled in 1917–1991) and no stories of growth under small government.

The private sector is necessary but not sufficient for improving Africa’s performance. Free markets degenerate into monopolies once some market participant gets ready to capture political power. Monopolists select the government. This clientelist government serves the interest of the few, and under some mutations appear as single-party dictatorships or oligarchies. Latin America’s past is full of these examples.

The worst enemy of the private enterprise is businesspeople who say that they’d be better off without the government. Maybe some of them will, but at the expense of private businesses in general. Kinda class enemy within.

Economic development consists of building constructive state capacity that ensures sustainable competition and certain public goods, such as education. And here billions spent on Africa by international donors make sense. International programs improved over the last fifty years. They also helped understand development at large. Very few now agree that buying lots of machinery is enough to create sustainable growth.

This expertise is valuable, but societies need more of it. This is why foreign aid to developing regions should be larger, not smaller. Many efforts are more effective there, than in Western Europe or North America. Providing right medications in Africa can save a human life at the cost of a movie ticket in California. In these cases, the best idea is not to reduce development efforts, but to make them more responsive to new evidences.

Ordinary government failures

(comparing public policies against one of the deadliest diseases; source)

Governments make mistakes. But not those that typically get into the press.

Stories about government failures—sort of Brooking’s and Heritage Foundations stories here and there—are inconclusive. It’s unclear where a “failure” starts because you have no baseline for “success.” In result, the press and think tanks criticize governments for events anyone can be blamed for. Mostly because of huge negative effects.

The financial crisis of 2008 is a conventional government failure in public narratives. September 11 is. But neither was predicted by alternative institutions. Individual economists who forecasted the burst in 2008 came from different backgrounds, organizations, and countries. These diverse frameworks—though being very valuable dissent—are not a systematic improvement over mainstream economics. Predicting 9/11 has even a weaker record (Nostradamus and similar).

Governments make other, more systematic, mistakes. Studying and reporting these mistakes make sense because a government can do better in next iterations. The government can’t learn from the Abu Ghraib abuse, however terrible it was. But it can learn to improve domestic prisons, in which basically similar things happen routinely.

Systematic problems are easier to track, predict, and resolve. A good example unexpectedly comes from the least developed nations. Well, from international organizations and nonprofits that run their anti-poverty programs there. These organizations use randomized evaluations and quasi-experimental methods to separate out the impact of public programs on predefined goals. The results show manifold differences in efficacies of the programs—and it’s a huge success.

Organizations such as the MIT Poverty Action Lab and Innovations for Poverty Action evaluated hundreds of public policies over the last ten years. Now, guess how much press coverage they got. Zero. The NYT can’t even find the Lab mentions among its articles. Google returns 34 links for the same query, most of them to hosted blogs.

One explanation is the storytelling tradition in newspapers. Journalists are taught to tell stories (which is what readers like). Presenting systematic evidences makes a bad story. You have little drama in numbers, however important they are. And telling numbers reduce your readership, which is incompatible with a successful journalist career. Even new data journalism comes from blogs, not well-establised publishers.

More fundamentally, mass media’s choice of priorities leads to little attention to systematic problems in general. Each day brings hot news that sound interesting, however irrelevant and impractical they may be. Reporting public policy research can’t compete in hotness with political speeches and new dangerous enemies around. It took a couple of decades for climate change to become a somewhat regular topic. And survival rates of other important issues are much lower.