How Retirement Age Tracks Social Security's Rules

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Back in 1983, as one of the steps taken to bolster the long-run finances of the Social Security System, was to phase in a rise in the "normal" or "full" retirement age. The normal retirement age for receiving full Social Security benefits had been 65, with "early retirement" with lower benefits possible at age 62. Under the new rules, the normal retirement age remained 65 for those born in 1937 or earlier--and thus turning 65 before 2002. It then phased up by 2 months per year, so that for those born six years later in 1943 or after, the normal retirement age is now 66. Written into law is a follow-up increase where a rise in the normal retirement age from 66 to 67 will be phased in, again at a rate of two months per year,  for those born from 1955 to 1960. 

How has this change altered actual retirement patterns? What are the reasons, either for retirees or for the finances of Social Security, to encourage still-later retirement?


Economists have long recognized that what a government designates as the "normal" retirement age has a big effect on when people actually choose to retire. Luc Behaghel and David M. Blau present some of the recent evidence in "Framing Social Security Reform: Behavioral Responses
to Changes in the Full Retirement Age," which appears in the November 2012 American Economic Journal: Economic Policy (4(4): 41–67). (The journal isn't freely available on-line, but many in academia will have access through a library subscription.)

Consider the following graphs from Behaghel and Blau. Each one is for those born in a different year, from 1937 up through 1942, as the normal retirement age phased up. These people are the ones hitting the normal retirement age of 65 in the early and mid-2000s. The solid line shows the probability of retirement at each age. The early retirement age of 62 is marked with a vertical red line; the previous normal retirement age of 65 is marked with a vertical red line; and the actual retirement age for that year as it phases up two months per year is marked with a vertical red line. The dashed line, which is the same in all the figures, shows for comparison the retirement pattern for those born over the 1931-1936 period.

The main striking pattern is that the probability of retiring at a certain age almost exactly tracks the changes in the normal retirement age: that is, the solid line spikes at the red vertical line showing the normal retirement age. There is also a spike at the early retirement age of 62. Here are the patterns.






The evidence here seems clear: People are making their retirement choices in synch with the government-set normal retirement age. This pattern isn't new, as the authors point out, a spike in retirement age at 65 became visible in the data back in the early 1940s, about five years after Social Security became law. Still, the obvious question (for an economist) is why people would make this choice. If you retire later than the normal retirement age, your monthly benefits are scaled up, so from the viewpoint of overall expected lifetime payments, you don't gain from retiring earlier. A number of possible explanations have been proposed: 1) people don't have other sources of income and need to take the retirement benefits as soon as possible for current income; 2) people are myopic, or don't recognize that their monthly benefits would be higher if they delayed retirement; 3) many people are waiting until age 65 to retire so that they can move from their employer health insurance to Medicare; 4) some company retirement plans encourage retiring at age 65.

However, none of these explanations give an obvious reason for why the retirement age would exactly track the changes in Social Security normal retirement age, so it seems as if a final "behavioral" explanation is that the "normal" retirement age announced by the government, whatever it is, is then treated by many people as a recommendation that should be taken. Choosing a retirement date in this way is probably suboptimal both for individuals and for the finances of the Social Security system.

From the standpoint of individuals, there's a widespread sense among economists that many retirees would benefit from having more of their wealth in annuities--that is, an amount that would pay out no matter how long they live. In the Fall 2011 issue of my own Journal of Economic Perspectives, 
Shlomo Benartzi, Alessandro Previtero, and Richard H. Thaler have an article on "Annuitization Puzzles," which makes the point that when you delay receiving Social Security, you are in effect buying an annuity: that is, you are taking less in the present--which is similar to "paying" for the annuity-- in exchange for a larger long-term payment in the future. They write: "[T]he easiest way to increase the amount of annuity income that families have is to delay the age at which people start claiming Social Security benefits. Participants are first eligible to start claiming benefits at age 62, but by waiting to begin, the monthly payments increase in an actuarially fair manner until age 70. "

They further argue that a good starting point to encouraging such behavior would be to re-frame the way in which the Social Security Administration, and all the rest of us, talk about Social Security benefits. Imagine that, with no change at all in the current law, we all started talking about a "standard retirement age" of 70. We pointed out that you can retire earlier, but if you do, monthly benefits will be lower. If the choice of when to retire was framed in this way, my strong suspicion is that many more people would react differently than when we announce that the "normal retirement age" is 66, and if you wait then your monthly benefits will be higher. Again, people seem to react to what the government designates as the target for retirement age.

However, this labeling change might encourage people to work longer, but it would not affect the solvency of the Social Security system, because those who wait longer to retire are, in effect, paying for their own higher monthly benefits by delaying the receipt of those benefits. However, the Social Security actuaries offer a number of illustrative calculations on their website about possible steps to bolster the financing of the system. One proposal about phasing back the normal age of retirement looks like this:  "After the normal retirement age (NRA) reaches 67 for those age 62 in 2022, increase the NRA 2 months per year until it reaches 69 for individuals attaining age 62 in 2034. Thereafter, increase the NRA 1 month every 2 years."

Thus, this proposal would represent no change in the rules for Social Security benefits for anyone born before 1960--and thus in their early 50s at present. Under this proposal, those born after 1960 would face the gradual phase-in--but of course, they would also benefit from having a program that is much closer to fully funded. would face the same phase-in as currently exists. The actuaries estimate that this step by itself would address about 44% of the gap over the next 75 years between what Social Security has promised and the funding that is expected during that time. Given the predicted shortfalls of the Social Security system in the future, and the gains in life expectancy both in the last few decades and expected in the next few decades, and the parlous condition of large budget deficits reaching into the future, I would be open to proposals to phase in a more rapid and more sustained rise in the normal retirement age for Social Security benefits.

China's Economic Growth: A Different Storyline

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When I chat with people about China's economic growth, I often hear a story that goes like this: The main driver's behind China's growth is that it uses a combination of cheap labor and an undervalued exchange rate to create huge trade surpluses. The most recent issue of my own Journal of Economic Perspectives includes a five-paper symposium on China's growth, and they make a compelling case that this received wisdom about China's growth is more wrong than right.

For example, start with the claim that China's economic growth has been driven by huge trade surpluses. China's major economic reforms started around 1978, and rapid growth took off not long after that. But China's balance of trade was essentially in balance until the early 2000s, and only then did it take off. Here's a figure generated using the ever-useful FRED website from the St. Louis Fed.

How does China's pattern of trade balances line up with argument about China's undervalued exchange rate? Here's a graph showing China's exchange rate over time in yuan/dollar. Thus, an upward movement on the graph means that yuan is weaker relative to the dollar, and a downward movement means that it is stronger relative to the dollar. The yuan does indeed get weaker relative to the U.S. dollar for much of the 1980s and first half of the 1990s--but this is the time period when China's trade balance is near-zero. China's exchange rate is pretty much unchanging for the five years or so before China's trade surplus takes off. Since 2006, the yuan has indeed been strengthening. Last week the yuan hit a record high against the dollar since 1994.

What about China's purportedly cheap wages? Here's a figure from the article by Hongbin Li, Lei Li, Binzhen Wu, and Yanyan Xiong, called "The End of Cheap Chinese Labor." As the figure points out, China's wages were fairly during much of the 1980 and 1990s, which is the time when China's trade was nearly in-balance. But whether the conversion is done using yuan/dollar exchange rates or by inflation in China (measured by the producer price index), wages in China have been rising at double-digit annual rates since the late 1990s. In other words, China's big trade surpluses of the last decade have co-existed with sharply rising wages.

Clearly, China's pattern of economic growth since the start of its reforms needs a different storyline than the basic tale of low wages, a cheap currency, and big trade surpluses. After working with these authors, my own view is that it's useful to think of China's economy since about 1978 in two main stages--although there isn't a clean-and-clear break between them.

The first stage of China's growth that went through the 1980s and a bit into the early 1990s was really about rural areas.  Yasheng Huang makes this argument strongly in his JEP article "How Did China Take Off?" Huang writes: "China’s take-off in economic growth starting in the late 1970s and its poverty reduction for the next couple of decades was completely a function of its rural developments and its internal reforms in general. During the golden era of rural industry in the 1980s, China had none of what are often thought of as the requisite features of the China growth model, like massive state-controlled infrastructural investments and mercantilism." This was the time period when the agricultural sector was allowed to operate under a market framework, and as agricultural output exploded, rural workers moved to employment in the "township and village enterprises." Huang makes a strong argument that these enterprises should be thought of a privately owned firms, operating with what was in many ways a private-sector financial market.


But in the 1990s, the emphasis of China's economy began to change. New leaders favored urban development over rural development, and they cut the township and village enterprises down to size by re-nationalizing their sources of finance They began to reform the money-losing state-owned enterprises that still dominated China's urban economy as of the early 1990s. They moved China toward joining the World Trade Organization, which happened in 2001. For a sense of the transition in China's urban areas to private sector employment, here's another useful figure from Li, Li, Wu and Xiong:

But this process of change brought an unexpected macroeconomic imbalance. As Dennis Tao Yang point out in his JEP paper, "Aggregate Savings and External Imbalances in China," China's 11th Five-Year Plan for the years from 2006-2010 called for trade to be in balance overall--clearly an expectation that was not close to being met. Yang looks at a variety of reasons why savings rates took off in China: for example, after China joined the WTO in 2001, exports took off, but firms lacked useful ways in China's underdeveloped financial system to pass these savings to the household sector; as exports took off, China's government received an unexpectedly huge surplus, with budget surpluses upward of 8% of GDP; and households, concerned about retirement and health costs for themselves and their families, and with little access to loans for mortgages or consumer durables, continued to save at very high rates. Yang notes that in China, this combination of outcomes is sometimes criticized as the "Nation Rich, People Poor" policy.

Thus, although China's economy continues to grow rapidly, it is faced with many challenges. Along with the macroeconomic imbalances emphasized by Yang, Xin Meng raises another cluster of issues in her paper, "Labor Market Outcomes and Reforms in China": the extraordinary back-and-forth migration from rural to urban areas, now at well over 100 million people per year, and perhaps headed much higher; the growing inequalities in wages as labor markets move away from the administratively determined wages that were so common even just 20 years ago; the inequalities being created by the spread of education; and China's coming demographic bulge with many elderly and few young workers--a hangover of the one-child rules to limit population growth.

With little effort, one can compile quite a list of economic difficulties facing China: macroeconomic imbalances, an underdeveloped financial sector, inequalities in wages and across rural and urban areas, the demographic bulge, corruption, environmental problems, and more. Still, with all that said, it's worth remembering that China's economy still has enormous potential upside. China started from such a low per capita GDP back in 1978 that even now, productivity levels are only about 20% of the U.S. level. In yet another JEP paper, "Understanding China’s Growth: Past, Present, and Future," Xiaodong Zhu points out that when Japan and Korea and Taiwan had their rapid spurts of economic growth int he 1950s and 1960s and 1970s, they were essentially raising their productivity levels from 40-50% of the U.S. level up to 70-80% of the U.S. level. In other words, China is still far below the level that was the take-off point of rapid growth for countries like Japan, Korea and Taiwan. As Zhu points out, China is making enormous investments in education, physical capital investment, and research and development. In many ways, it is laying a framework for continued growth.

Surely, many things could go wrong for China's economy. For continued growth, it will need to transform its economy again and again. But it also seems to me that hundreds of millions of people in China have developed a sense of possibility, and of what their economic lives could hold for them. China's future growth is sure to have fits and starts, like every country, but its economy continues ot have enormous momentum toward a much higher standard of living.

Why Doesn't Someone Undercut Payday Lending?

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A payday loan works like this: The borrower received an amount that is typically between $100 and $500. The borrower writes a post-dated check to the lender, and the lender agrees not to cash the check for, say, two weeks. No collateral is required: the borrower often needs to show an ID, a recent pay stub, and maybe a statement showing that they have a bank account. The lender charges a fee of about $15 for every $100 borrowed. Paying $15 for a two-week loan of $100 works out to an astronomical annual rate of about 390% per year. But because the payment is a "fee," not an "interest rate," it does not fall afoul of state usury laws. A number of state have passed legislation to limit payday loans, either by capping the maximum amount, capping the interest rate, or banning them outright.

But for those who think like economists, complaints about price-gouging or unfairness in the payday lending market raise an obvious question: If payday lenders are making huge profits, then shouldn't we see entry into that  market from credit unions and banks, which would drive down the prices of such loans for everyone? Victor Stango offers some argument and evidence on this point in "Are Payday Lending Markets Competitive," which appears in the Fall 2012 issue of Regulation magazine.
Stango writes:

"The most direct evidence is the most telling in this case: very few credit unions currently offer payday loans. Fewer than 6 percent of credit unions offered payday loans as of 2009, and credit unions probably comprise less than 2 percent of the national payday loan market. This “market test” shows that credit unions find entering the payday loan market unattractive. With few regulatory obstacles to offering payday loans, it seems that credit unions cannot compete with a substantively similar product at lower prices.

"Those few credit unions that do offer a payday advance product often have total fee and interest charges that are quite close to (or even higher than) standard payday loan fees. Credit union payday loans also have tighter credit requirements, which generate much  lower default rates by rationing riskier borrowers out of the market. The upshot is that risk-adjusted prices on credit union payday loans might be no lower than those on standard payday loans."

The question of whether payday lending should be restricted can make a useful topic for discussions or even short papers in an economics class. The industry is far more prevalent than many people recognize. As Stango describes:

"The scale of a payday outlet can be quite small and startup costs are minimal compared to those of a bank. ... They can locate nearly anywhere and have longer business hours than banks. ... There are currently more than 24,000 physical payday outlets; by comparison there are roughly 16,000 banks and credit unions in total (with roughly 90,000 branches). Many more lenders offer payday loans online. Estimates of market penetration vary, but industry reports suggest that 5–10 percent of the adult population in the United States has used a payday loan at least once."

Payday lending fees do look uncomfortably high, but those with low incomes are often facing hard choices. Overdrawing a bank account often has high fees, as does exceeding a credit card limit. Having your electricity or water turned off for non-payment often leads to high fees, and not getting your car repaired for a couple of weeks can cost you your job.

Moreover, such loans are risky to make. Stango cites data that credit unions steer away from making payday loans because of their riskiness, and instead offer only only much safer loans that have lower costs to the borrower, but also have many more restrictions, like credit checks, or a longer application period, or a requirement that some of the "loan" be immediately placed into a savings account. Credit unions may also charge an "annual" fee for such a loan--but for someone taking out a short-term loan only once or twice in a year, whether the fee is labelled as "annual" or not doesn't affect what they pay. Indeed, Stango cites a July 2009 report from the National Consumer Law Center that criticized credit unions for offering "false payday loan `alternatives'" that actually cost about as much as a typical payday loan.

Stango also cites evidence form his own small survey of payday loan borrowers in Sacramento, California, that many of them prefer the higher fees and looser restrictions on payday loans to the lower fees and tighter restrictions common on similar loans from credit unions. Those interested in a bit more background might begin with my post from July 2011, "Could Restrictions on Payday Lending Hurt Consumers?" and the links included there.

The Lucas Critique

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The Society for Economic Dynamics has a short and delightful interview with Robert Lucas in the November 2012 issue of its newsletter, Economic Dynamics. Lucas, of course, received the Nobel prize in economics in 1995 and is, among other distinctions, the originator of the eponymous "Lucas critique," which the Nobel committee described in this way:

 "The 'Lucas critique' - Lucas's contribution to macroeconometricevaluation of economic policy - has received enormous attentionand been completely incorporated in current thought. Briefly, the'critique' implies that estimated parameters which werepreviously regarded as 'structural' in econometric analysis ofeconomic policy actually depend on the economic policy pursuedduring the estimation period (for instance, the slope of thePhillips curve may depend on the variance of non-observeddisturbances in money demand and money supply). Hence, theparameters may change with shifts in the policy regime. This isnot only an academic point, but also important foreconomic-policy recommendations. The effects of policy regimeshifts are often completely different if the agents' expectationsadjust to the new regime than if they do not. Nowadays, it goeswithout saying that the effects of changing expectations shouldbe taken into account when the consequences of a new policy areassessed - for instance, a new exchange rate system, a newmonetary policy, a tax reform, or new rules for unemploymentbenefits.

"When Lucas's seminal article (1976) waspublished, practically all existing macroeconometric models hadbehavioral functions that were in so-called reduced form; thatis, the parameters in those functions might implicitly depend onthe policy regime. If so, it is obviously problematic to use thesame parameter values to evaluate other policy regimes.Nevertheless, the models were often used precisely in that way:Parameters estimated under a particular policy regime were usedin simulations with other policy rules, for the purpose ofpredicting the effect on crucial macroeconomic variables. Withregime-dependent parameters, the predictions could turn out to beerroneous and misleading."

Perhaps it's useful to add a specific example here. Say that we are trying to figure out how much the Federal Reserve can boost the economy during a recession by cutting interest rates. We try to calculate a "parameter," that is, an estimate of  how much cutting the interest rate will boost lending and the economy. But what if it becomes widely expected that if the economy slows, the Federal Reserve will cut interest rates? Then it could be, for example, that when the economy shows signs of slowing, everyone begins to expect lower interest rates, and slows down their borrowing immediately because they are waiting for the lower interest rates to arrive--thus bringing on the threatened recession. Or it may be that because borrowers are expecting the lower interest rates, they have already taken those lower rates into account in their planning, and thus don't need to make any change in plans when those lower interest rates arrive. The key insight is that the effects of policy depend on whether that policy is expected or unexpected--and in general how the policy interacts with expectations. The parameters for effects of policy estimated under one set of expectations may well not apply in a setting where expectations differ.

As the Nobel committee noted more than a decade ago, this general point has now been thoroughly absorbed into economics. Thus, I was intrigued to see Lucas note that the phase "Lucas critique" has become detached from its original context in a way that can make it less useful as a method of argument. Here's Lucas in the recent interview:

"My paper, "Econometric Policy Evaluation: A Critique" was written in theearly 70s. Its main content was a criticism of specific econometricmodels---models that I had grown up with and had used in my own work. Thesemodels implied an operational way of extrapolating into the future to seewhat the "long run" would look like. ... Of course every economist, then as now, knows that expectations matterbut in those days it wasn't clear how to embody this knowledge inoperational models. ... But the term "Lucas critique" has survived, long after that originalcontext has disappeared. It has a life of its own and means different thingsto different people. Sometimes it is used like a cross you are supposed touse to hold off vampires: Just waving it it an opponent defeats him. Toomuch of this, no matter what side you are on, becomes just name calling."

Lucas offers some lively observations on dynamic stochastic general equilibrium models, differences across business cycles, and microfoundations in macroeoconomic analysis. But his closing comment in particular gave me a smile. In answer to a question about the economy being in an "unusual state," Lucas answers:  "`Unusual state'? Is that what we call it when our favorite models don'tdeliver what we had hoped? I would call that our usual state."

The BP Spill: What's the Monetary Cost of Environmental Damage?

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 In April 2010, the BP Deepwater Horizon oil drilling rig suffered an explosion followed by an enormous oil spill. Here, I'll first lay out the question of much BP is likely to end up paying as a result of the spill, a number which is gradually being clarified by the passage of time and evolution of lawsuits. But beyond the question of what is going to happen, economists face a controversy about how best to place a dollar value on these kinds of environmental damages--and the most recent issue of my own Journal of Economic Perspectives has a three-paper symposium on the "contingent valuation" method.
A couple of weeks ago, Attorney General Eric Holder announced at a press conference in New Orleans: "BP has agreed to plead guilty to all 14 criminal charges – admitting responsibility for the deaths of 11 people and the events that led to an unprecedented environmental catastrophe.  The company also has agreed to pay $4 billion in fines and penalties. This marks both the single largest criminal fine – more than $1.25 billion – and the single largest total criminal resolution – $4 billion – in the history of the United States."
But as Nathan Richardson of Resources for the Future points out, the criminal penalty is a small slice of what BP will end up paying: "But remember that this criminal settlement is only a small part of BP’s liability. Earlier this year, BP reached a preliminary $7.8b class settlement with a large number of private plaintiffs (fishermen, property owners, etc.) harmed by the spill. That agreement is currently under review by a federal district court judge. This is in addition to $8b in payments made to private parties who agreed not to litigate (from BP’s oil spill “fund”). Future payments to private parties are likely as claims on the fund are resolved or as those who were not part of the class settlement pursue separate claims. BP also claims to have paid out $14b in cleanup costs.
But that’s not all. BP still must face civil suit from the federal government (and states) over natural resources damages. ... BP also faces civil penalties under the Clean Water Act, which would quadruple from $5.5b to $21b if gross negligence is found. In other words, BP will pay out the largest criminal settlement in U.S. history and it will be only a small share of its total liability."

I don't have anything new to say about the parade of events leading up to the spill, nor about the halting efforts to stop the flow and start a clean-up. For details on what happened, a useful starting point is the report from the National Commission on the BP Deepwater Horizon  Oil Spill and Offshore Drilling  that was released in January 2011. From the Foreword of that report: "The explosion that tore through the Deepwater Horizon drilling rig last April 20 [2010], as the rig’s
crew completed drilling the exploratory Macondo well deep under the waters of the Gulf of
Mexico, began a human, economic, and environmental disaster. Eleven crew members died, and others were seriously injured, as fire engulfed and ultimately destroyed the rig. And, although the nation would not know the full scope of the disaster for weeks, the first of more than four million barrels of oil began gushing uncontrolled into the Gulf—threatening livelihoods, precious habitats, and even a unique way of life. ... There are recurring themes of missed warning signals, failure to share information, and a general lack of appreciation for the risks involved.... But that complacency affected government as well as industry. The Commission has documented the weaknesses and the inadequacies of the federal regulation and oversight, and made important recommendations for changes in legal authority, regulations, investments in expertise, and management."

In editing the Fall 2012 issue of my own Journal of Economic Perspectives, I found myself focused on a narrower issue: How does one put a meaningful economic number on widespread environmental damage. The issue has three papers focused on a method called "contingent valuation," which involves using survey results to estimate damages. Catherine L. Kling, Daniel J. Phaneuf and Jinhua Zhao offer an overview of the disputes and issues surrounding this method. Then, Richard Carson makes the case that contingent valuation methods have developed sufficiently to be an accurate  estimating technique, while Jerry Hausman offers a skeptical view that contingent valuation surveys are so fundamentally flawed that their results should be completely disregarded. As usual, all JEP articles from the most recent back to the first issue in 1987 are freely available on-line, compliments of the American Economic Association.

From an economic perspective, the fundamental difficulty here is that not all the environmental damages affect economic output. A major oil spill, for example, affects production directly in industries like fishing and tourism and other industries directly, but it also affects birds and fish and beaches in ways that don't show up as a drop in economic output. In the economics literature, these losses are sometimes know as "passive use value." The notion is that even if I never visit the Gulf Coast around Louisiana and Mississippi, nor eat fish caught there, my utility can be affected by the environmental destruction that occurred. Thus, the argument goes that economic theory should take this "passive use" into account--roughly, the value that people place on the environmental damage that occurred--in thinking about lawsuits and policy choices.

The immediate objections to contingent value methods of setting such values are obvious: If people are just asked to place a value on environment damage, isn't it plausible that their answers will be untethered by reality? Richard Carson, a strong advocate of these methods, faces such skepticism head-on. He writes: "Economists are naturally skeptical of data generated from responses to survey questions—and they should be! Many surveys, including contingent valuation surveys, are inadequate." He also argues, "The best contingent valuation surveys are among the best survey instruments currently being administered while the worst are among the worst."

Carson emphasizes that a high-quality contingent valuation survey takes considerable care to provide what can be several dozen pages of focus-group-tested information to consider, and emphasizes to the responders that the results of the survey are likely to help guide policy outcomes. In such a setting, he argues that people have the information and incentives to answer truthfully. Hausman responds that such surveys are plagued by difficulties: for example, the "hypothetical bias" that people tend to overstate their value when they aren't actually paying; or that valuations can vary according to how questions are phrases, like whether the question asks about willingness-to-pay to avoid environmental damage or willingness-to-accept that the same amount of environmental damage will be done; or that when people value, say, three projects separately or the combination of those three projects, their answers often don't add up. Carson discusses how those who carry out such surveys seek to deal with these issues and others. Hausman says that legislatures, regulatory agencies, and courts, relying on expert opinion, are by far a preferable way to take passive use value into account. Kling, Phaneuf and Zhao point out that over 7,000 of these contingent valuation studies have been done in the last two decades, provide a background and framework for thinking about all of these issues. Of course, those who want all the ins and outs and gory details are encouraged to check out the articles themselves. 



To my knowledge, no contingent valuation surveys of the costs of the BP oil spill have yet been published. But it is interesting that after the Exxon Valdez spill, the eventual settlement roughly matched the estimates of the contingent valuation study. As Richard Carson notes: "Soon after the Exxon Valdez spill in March 1989, the state of Alaska funded a contingent valuation study, contained in Carson, Mitchell, Hanemann, Kopp, Presser, and Ruud (1992), which estimated the American public’s willingness to pay to avoid an oil spill similar to the Exxon Valdez at about $3 billion. The results of the study were shared with Exxon and a settlement for approximately $3 billion was reached, thus avoiding a long court case." As contingent valuation studies of the BP spill are published, it will be interesting to compare them with the amounts that BP is paying in the aftermath of the Deepwater Horizon spill.

How Retirement Age Tracks Social Security's Rules

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Back in 1983, as one of the steps taken to bolster the long-run finances of the Social Security System, was to phase in a rise in the "normal" or "full" retirement age. The normal retirement age for receiving full Social Security benefits had been 65, with "early retirement" with lower benefits possible at age 62. Under the new rules, the normal retirement age remained 65 for those born in 1937 or earlier--and thus turning 65 before 2002. It then phased up by 2 months per year, so that for those born six years later in 1943 or after, the normal retirement age is now 66. Written into law is a follow-up increase where a rise in the normal retirement age from 66 to 67 will be phased in, again at a rate of two months per year,  for those born from 1955 to 1960. 

How has this change altered actual retirement patterns? What are the reasons, either for retirees or for the finances of Social Security, to encourage still-later retirement?


Economists have long recognized that what a government designates as the "normal" retirement age has a big effect on when people actually choose to retire. Luc Behaghel and David M. Blau present some of the recent evidence in "Framing Social Security Reform: Behavioral Responses
to Changes in the Full Retirement Age," which appears in the November 2012 American Economic Journal: Economic Policy (4(4): 41–67). (The journal isn't freely available on-line, but many in academia will have access through a library subscription.)

Consider the following graphs from Behaghel and Blau. Each one is for those born in a different year, from 1937 up through 1942, as the normal retirement age phased up. These people are the ones hitting the normal retirement age of 65 in the early and mid-2000s. The solid line shows the probability of retirement at each age. The early retirement age of 62 is marked with a vertical red line; the previous normal retirement age of 65 is marked with a vertical red line; and the actual retirement age for that year as it phases up two months per year is marked with a vertical red line. The dashed line, which is the same in all the figures, shows for comparison the retirement pattern for those born over the 1931-1936 period.

The main striking pattern is that the probability of retiring at a certain age almost exactly tracks the changes in the normal retirement age: that is, the solid line spikes at the red vertical line showing the normal retirement age. There is also a spike at the early retirement age of 62. Here are the patterns.






The evidence here seems clear: People are making their retirement choices in synch with the government-set normal retirement age. This pattern isn't new, as the authors point out, a spike in retirement age at 65 became visible in the data back in the early 1940s, about five years after Social Security became law. Still, the obvious question (for an economist) is why people would make this choice. If you retire later than the normal retirement age, your monthly benefits are scaled up, so from the viewpoint of overall expected lifetime payments, you don't gain from retiring earlier. A number of possible explanations have been proposed: 1) people don't have other sources of income and need to take the retirement benefits as soon as possible for current income; 2) people are myopic, or don't recognize that their monthly benefits would be higher if they delayed retirement; 3) many people are waiting until age 65 to retire so that they can move from their employer health insurance to Medicare; 4) some company retirement plans encourage retiring at age 65.

However, none of these explanations give an obvious reason for why the retirement age would exactly track the changes in Social Security normal retirement age, so it seems as if a final "behavioral" explanation is that the "normal" retirement age announced by the government, whatever it is, is then treated by many people as a recommendation that should be taken. Choosing a retirement date in this way is probably suboptimal both for individuals and for the finances of the Social Security system.

From the standpoint of individuals, there's a widespread sense among economists that many retirees would benefit from having more of their wealth in annuities--that is, an amount that would pay out no matter how long they live. In the Fall 2011 issue of my own Journal of Economic Perspectives, 
Shlomo Benartzi, Alessandro Previtero, and Richard H. Thaler have an article on "Annuitization Puzzles," which makes the point that when you delay receiving Social Security, you are in effect buying an annuity: that is, you are taking less in the present--which is similar to "paying" for the annuity-- in exchange for a larger long-term payment in the future. They write: "[T]he easiest way to increase the amount of annuity income that families have is to delay the age at which people start claiming Social Security benefits. Participants are first eligible to start claiming benefits at age 62, but by waiting to begin, the monthly payments increase in an actuarially fair manner until age 70. "

They further argue that a good starting point to encouraging such behavior would be to re-frame the way in which the Social Security Administration, and all the rest of us, talk about Social Security benefits. Imagine that, with no change at all in the current law, we all started talking about a "standard retirement age" of 70. We pointed out that you can retire earlier, but if you do, monthly benefits will be lower. If the choice of when to retire was framed in this way, my strong suspicion is that many more people would react differently than when we announce that the "normal retirement age" is 66, and if you wait then your monthly benefits will be higher. Again, people seem to react to what the government designates as the target for retirement age.

However, this labeling change might encourage people to work longer, but it would not affect the solvency of the Social Security system, because those who wait longer to retire are, in effect, paying for their own higher monthly benefits by delaying the receipt of those benefits. However, the Social Security actuaries offer a number of illustrative calculations on their website about possible steps to bolster the financing of the system. One proposal about phasing back the normal age of retirement looks like this:  "After the normal retirement age (NRA) reaches 67 for those age 62 in 2022, increase the NRA 2 months per year until it reaches 69 for individuals attaining age 62 in 2034. Thereafter, increase the NRA 1 month every 2 years."

Thus, this proposal would represent no change in the rules for Social Security benefits for anyone born before 1960--and thus in their early 50s at present. Under this proposal, those born after 1960 would face the gradual phase-in--but of course, they would also benefit from having a program that is much closer to fully funded. would face the same phase-in as currently exists. The actuaries estimate that this step by itself would address about 44% of the gap over the next 75 years between what Social Security has promised and the funding that is expected during that time. Given the predicted shortfalls of the Social Security system in the future, and the gains in life expectancy both in the last few decades and expected in the next few decades, and the parlous condition of large budget deficits reaching into the future, I would be open to proposals to phase in a more rapid and more sustained rise in the normal retirement age for Social Security benefits.

China's Economic Growth: A Different Storyline

To contact us Click HERE
When I chat with people about China's economic growth, I often hear a story that goes like this: The main driver's behind China's growth is that it uses a combination of cheap labor and an undervalued exchange rate to create huge trade surpluses. The most recent issue of my own Journal of Economic Perspectives includes a five-paper symposium on China's growth, and they make a compelling case that this received wisdom about China's growth is more wrong than right.

For example, start with the claim that China's economic growth has been driven by huge trade surpluses. China's major economic reforms started around 1978, and rapid growth took off not long after that. But China's balance of trade was essentially in balance until the early 2000s, and only then did it take off. Here's a figure generated using the ever-useful FRED website from the St. Louis Fed.

How does China's pattern of trade balances line up with argument about China's undervalued exchange rate? Here's a graph showing China's exchange rate over time in yuan/dollar. Thus, an upward movement on the graph means that yuan is weaker relative to the dollar, and a downward movement means that it is stronger relative to the dollar. The yuan does indeed get weaker relative to the U.S. dollar for much of the 1980s and first half of the 1990s--but this is the time period when China's trade balance is near-zero. China's exchange rate is pretty much unchanging for the five years or so before China's trade surplus takes off. Since 2006, the yuan has indeed been strengthening. Last week the yuan hit a record high against the dollar since 1994.

What about China's purportedly cheap wages? Here's a figure from the article by Hongbin Li, Lei Li, Binzhen Wu, and Yanyan Xiong, called "The End of Cheap Chinese Labor." As the figure points out, China's wages were fairly during much of the 1980 and 1990s, which is the time when China's trade was nearly in-balance. But whether the conversion is done using yuan/dollar exchange rates or by inflation in China (measured by the producer price index), wages in China have been rising at double-digit annual rates since the late 1990s. In other words, China's big trade surpluses of the last decade have co-existed with sharply rising wages.

Clearly, China's pattern of economic growth since the start of its reforms needs a different storyline than the basic tale of low wages, a cheap currency, and big trade surpluses. After working with these authors, my own view is that it's useful to think of China's economy since about 1978 in two main stages--although there isn't a clean-and-clear break between them.

The first stage of China's growth that went through the 1980s and a bit into the early 1990s was really about rural areas.  Yasheng Huang makes this argument strongly in his JEP article "How Did China Take Off?" Huang writes: "China’s take-off in economic growth starting in the late 1970s and its poverty reduction for the next couple of decades was completely a function of its rural developments and its internal reforms in general. During the golden era of rural industry in the 1980s, China had none of what are often thought of as the requisite features of the China growth model, like massive state-controlled infrastructural investments and mercantilism." This was the time period when the agricultural sector was allowed to operate under a market framework, and as agricultural output exploded, rural workers moved to employment in the "township and village enterprises." Huang makes a strong argument that these enterprises should be thought of a privately owned firms, operating with what was in many ways a private-sector financial market.


But in the 1990s, the emphasis of China's economy began to change. New leaders favored urban development over rural development, and they cut the township and village enterprises down to size by re-nationalizing their sources of finance They began to reform the money-losing state-owned enterprises that still dominated China's urban economy as of the early 1990s. They moved China toward joining the World Trade Organization, which happened in 2001. For a sense of the transition in China's urban areas to private sector employment, here's another useful figure from Li, Li, Wu and Xiong:

But this process of change brought an unexpected macroeconomic imbalance. As Dennis Tao Yang point out in his JEP paper, "Aggregate Savings and External Imbalances in China," China's 11th Five-Year Plan for the years from 2006-2010 called for trade to be in balance overall--clearly an expectation that was not close to being met. Yang looks at a variety of reasons why savings rates took off in China: for example, after China joined the WTO in 2001, exports took off, but firms lacked useful ways in China's underdeveloped financial system to pass these savings to the household sector; as exports took off, China's government received an unexpectedly huge surplus, with budget surpluses upward of 8% of GDP; and households, concerned about retirement and health costs for themselves and their families, and with little access to loans for mortgages or consumer durables, continued to save at very high rates. Yang notes that in China, this combination of outcomes is sometimes criticized as the "Nation Rich, People Poor" policy.

Thus, although China's economy continues to grow rapidly, it is faced with many challenges. Along with the macroeconomic imbalances emphasized by Yang, Xin Meng raises another cluster of issues in her paper, "Labor Market Outcomes and Reforms in China": the extraordinary back-and-forth migration from rural to urban areas, now at well over 100 million people per year, and perhaps headed much higher; the growing inequalities in wages as labor markets move away from the administratively determined wages that were so common even just 20 years ago; the inequalities being created by the spread of education; and China's coming demographic bulge with many elderly and few young workers--a hangover of the one-child rules to limit population growth.

With little effort, one can compile quite a list of economic difficulties facing China: macroeconomic imbalances, an underdeveloped financial sector, inequalities in wages and across rural and urban areas, the demographic bulge, corruption, environmental problems, and more. Still, with all that said, it's worth remembering that China's economy still has enormous potential upside. China started from such a low per capita GDP back in 1978 that even now, productivity levels are only about 20% of the U.S. level. In yet another JEP paper, "Understanding China’s Growth: Past, Present, and Future," Xiaodong Zhu points out that when Japan and Korea and Taiwan had their rapid spurts of economic growth int he 1950s and 1960s and 1970s, they were essentially raising their productivity levels from 40-50% of the U.S. level up to 70-80% of the U.S. level. In other words, China is still far below the level that was the take-off point of rapid growth for countries like Japan, Korea and Taiwan. As Zhu points out, China is making enormous investments in education, physical capital investment, and research and development. In many ways, it is laying a framework for continued growth.

Surely, many things could go wrong for China's economy. For continued growth, it will need to transform its economy again and again. But it also seems to me that hundreds of millions of people in China have developed a sense of possibility, and of what their economic lives could hold for them. China's future growth is sure to have fits and starts, like every country, but its economy continues ot have enormous momentum toward a much higher standard of living.

Why Doesn't Someone Undercut Payday Lending?

To contact us Click HERE
A payday loan works like this: The borrower received an amount that is typically between $100 and $500. The borrower writes a post-dated check to the lender, and the lender agrees not to cash the check for, say, two weeks. No collateral is required: the borrower often needs to show an ID, a recent pay stub, and maybe a statement showing that they have a bank account. The lender charges a fee of about $15 for every $100 borrowed. Paying $15 for a two-week loan of $100 works out to an astronomical annual rate of about 390% per year. But because the payment is a "fee," not an "interest rate," it does not fall afoul of state usury laws. A number of state have passed legislation to limit payday loans, either by capping the maximum amount, capping the interest rate, or banning them outright.

But for those who think like economists, complaints about price-gouging or unfairness in the payday lending market raise an obvious question: If payday lenders are making huge profits, then shouldn't we see entry into that  market from credit unions and banks, which would drive down the prices of such loans for everyone? Victor Stango offers some argument and evidence on this point in "Are Payday Lending Markets Competitive," which appears in the Fall 2012 issue of Regulation magazine.
Stango writes:

"The most direct evidence is the most telling in this case: very few credit unions currently offer payday loans. Fewer than 6 percent of credit unions offered payday loans as of 2009, and credit unions probably comprise less than 2 percent of the national payday loan market. This “market test” shows that credit unions find entering the payday loan market unattractive. With few regulatory obstacles to offering payday loans, it seems that credit unions cannot compete with a substantively similar product at lower prices.

"Those few credit unions that do offer a payday advance product often have total fee and interest charges that are quite close to (or even higher than) standard payday loan fees. Credit union payday loans also have tighter credit requirements, which generate much  lower default rates by rationing riskier borrowers out of the market. The upshot is that risk-adjusted prices on credit union payday loans might be no lower than those on standard payday loans."

The question of whether payday lending should be restricted can make a useful topic for discussions or even short papers in an economics class. The industry is far more prevalent than many people recognize. As Stango describes:

"The scale of a payday outlet can be quite small and startup costs are minimal compared to those of a bank. ... They can locate nearly anywhere and have longer business hours than banks. ... There are currently more than 24,000 physical payday outlets; by comparison there are roughly 16,000 banks and credit unions in total (with roughly 90,000 branches). Many more lenders offer payday loans online. Estimates of market penetration vary, but industry reports suggest that 5–10 percent of the adult population in the United States has used a payday loan at least once."

Payday lending fees do look uncomfortably high, but those with low incomes are often facing hard choices. Overdrawing a bank account often has high fees, as does exceeding a credit card limit. Having your electricity or water turned off for non-payment often leads to high fees, and not getting your car repaired for a couple of weeks can cost you your job.

Moreover, such loans are risky to make. Stango cites data that credit unions steer away from making payday loans because of their riskiness, and instead offer only only much safer loans that have lower costs to the borrower, but also have many more restrictions, like credit checks, or a longer application period, or a requirement that some of the "loan" be immediately placed into a savings account. Credit unions may also charge an "annual" fee for such a loan--but for someone taking out a short-term loan only once or twice in a year, whether the fee is labelled as "annual" or not doesn't affect what they pay. Indeed, Stango cites a July 2009 report from the National Consumer Law Center that criticized credit unions for offering "false payday loan `alternatives'" that actually cost about as much as a typical payday loan.

Stango also cites evidence form his own small survey of payday loan borrowers in Sacramento, California, that many of them prefer the higher fees and looser restrictions on payday loans to the lower fees and tighter restrictions common on similar loans from credit unions. Those interested in a bit more background might begin with my post from July 2011, "Could Restrictions on Payday Lending Hurt Consumers?" and the links included there.

How Retirement Age Tracks Social Security's Rules

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Back in 1983, as one of the steps taken to bolster the long-run finances of the Social Security System, was to phase in a rise in the "normal" or "full" retirement age. The normal retirement age for receiving full Social Security benefits had been 65, with "early retirement" with lower benefits possible at age 62. Under the new rules, the normal retirement age remained 65 for those born in 1937 or earlier--and thus turning 65 before 2002. It then phased up by 2 months per year, so that for those born six years later in 1943 or after, the normal retirement age is now 66. Written into law is a follow-up increase where a rise in the normal retirement age from 66 to 67 will be phased in, again at a rate of two months per year,  for those born from 1955 to 1960. 

How has this change altered actual retirement patterns? What are the reasons, either for retirees or for the finances of Social Security, to encourage still-later retirement?


Economists have long recognized that what a government designates as the "normal" retirement age has a big effect on when people actually choose to retire. Luc Behaghel and David M. Blau present some of the recent evidence in "Framing Social Security Reform: Behavioral Responses
to Changes in the Full Retirement Age," which appears in the November 2012 American Economic Journal: Economic Policy (4(4): 41–67). (The journal isn't freely available on-line, but many in academia will have access through a library subscription.)

Consider the following graphs from Behaghel and Blau. Each one is for those born in a different year, from 1937 up through 1942, as the normal retirement age phased up. These people are the ones hitting the normal retirement age of 65 in the early and mid-2000s. The solid line shows the probability of retirement at each age. The early retirement age of 62 is marked with a vertical red line; the previous normal retirement age of 65 is marked with a vertical red line; and the actual retirement age for that year as it phases up two months per year is marked with a vertical red line. The dashed line, which is the same in all the figures, shows for comparison the retirement pattern for those born over the 1931-1936 period.

The main striking pattern is that the probability of retiring at a certain age almost exactly tracks the changes in the normal retirement age: that is, the solid line spikes at the red vertical line showing the normal retirement age. There is also a spike at the early retirement age of 62. Here are the patterns.






The evidence here seems clear: People are making their retirement choices in synch with the government-set normal retirement age. This pattern isn't new, as the authors point out, a spike in retirement age at 65 became visible in the data back in the early 1940s, about five years after Social Security became law. Still, the obvious question (for an economist) is why people would make this choice. If you retire later than the normal retirement age, your monthly benefits are scaled up, so from the viewpoint of overall expected lifetime payments, you don't gain from retiring earlier. A number of possible explanations have been proposed: 1) people don't have other sources of income and need to take the retirement benefits as soon as possible for current income; 2) people are myopic, or don't recognize that their monthly benefits would be higher if they delayed retirement; 3) many people are waiting until age 65 to retire so that they can move from their employer health insurance to Medicare; 4) some company retirement plans encourage retiring at age 65.

However, none of these explanations give an obvious reason for why the retirement age would exactly track the changes in Social Security normal retirement age, so it seems as if a final "behavioral" explanation is that the "normal" retirement age announced by the government, whatever it is, is then treated by many people as a recommendation that should be taken. Choosing a retirement date in this way is probably suboptimal both for individuals and for the finances of the Social Security system.

From the standpoint of individuals, there's a widespread sense among economists that many retirees would benefit from having more of their wealth in annuities--that is, an amount that would pay out no matter how long they live. In the Fall 2011 issue of my own Journal of Economic Perspectives, 
Shlomo Benartzi, Alessandro Previtero, and Richard H. Thaler have an article on "Annuitization Puzzles," which makes the point that when you delay receiving Social Security, you are in effect buying an annuity: that is, you are taking less in the present--which is similar to "paying" for the annuity-- in exchange for a larger long-term payment in the future. They write: "[T]he easiest way to increase the amount of annuity income that families have is to delay the age at which people start claiming Social Security benefits. Participants are first eligible to start claiming benefits at age 62, but by waiting to begin, the monthly payments increase in an actuarially fair manner until age 70. "

They further argue that a good starting point to encouraging such behavior would be to re-frame the way in which the Social Security Administration, and all the rest of us, talk about Social Security benefits. Imagine that, with no change at all in the current law, we all started talking about a "standard retirement age" of 70. We pointed out that you can retire earlier, but if you do, monthly benefits will be lower. If the choice of when to retire was framed in this way, my strong suspicion is that many more people would react differently than when we announce that the "normal retirement age" is 66, and if you wait then your monthly benefits will be higher. Again, people seem to react to what the government designates as the target for retirement age.

However, this labeling change might encourage people to work longer, but it would not affect the solvency of the Social Security system, because those who wait longer to retire are, in effect, paying for their own higher monthly benefits by delaying the receipt of those benefits. However, the Social Security actuaries offer a number of illustrative calculations on their website about possible steps to bolster the financing of the system. One proposal about phasing back the normal age of retirement looks like this:  "After the normal retirement age (NRA) reaches 67 for those age 62 in 2022, increase the NRA 2 months per year until it reaches 69 for individuals attaining age 62 in 2034. Thereafter, increase the NRA 1 month every 2 years."

Thus, this proposal would represent no change in the rules for Social Security benefits for anyone born before 1960--and thus in their early 50s at present. Under this proposal, those born after 1960 would face the gradual phase-in--but of course, they would also benefit from having a program that is much closer to fully funded. would face the same phase-in as currently exists. The actuaries estimate that this step by itself would address about 44% of the gap over the next 75 years between what Social Security has promised and the funding that is expected during that time. Given the predicted shortfalls of the Social Security system in the future, and the gains in life expectancy both in the last few decades and expected in the next few decades, and the parlous condition of large budget deficits reaching into the future, I would be open to proposals to phase in a more rapid and more sustained rise in the normal retirement age for Social Security benefits.

China's Economic Growth: A Different Storyline

To contact us Click HERE
When I chat with people about China's economic growth, I often hear a story that goes like this: The main driver's behind China's growth is that it uses a combination of cheap labor and an undervalued exchange rate to create huge trade surpluses. The most recent issue of my own Journal of Economic Perspectives includes a five-paper symposium on China's growth, and they make a compelling case that this received wisdom about China's growth is more wrong than right.

For example, start with the claim that China's economic growth has been driven by huge trade surpluses. China's major economic reforms started around 1978, and rapid growth took off not long after that. But China's balance of trade was essentially in balance until the early 2000s, and only then did it take off. Here's a figure generated using the ever-useful FRED website from the St. Louis Fed.

How does China's pattern of trade balances line up with argument about China's undervalued exchange rate? Here's a graph showing China's exchange rate over time in yuan/dollar. Thus, an upward movement on the graph means that yuan is weaker relative to the dollar, and a downward movement means that it is stronger relative to the dollar. The yuan does indeed get weaker relative to the U.S. dollar for much of the 1980s and first half of the 1990s--but this is the time period when China's trade balance is near-zero. China's exchange rate is pretty much unchanging for the five years or so before China's trade surplus takes off. Since 2006, the yuan has indeed been strengthening. Last week the yuan hit a record high against the dollar since 1994.

What about China's purportedly cheap wages? Here's a figure from the article by Hongbin Li, Lei Li, Binzhen Wu, and Yanyan Xiong, called "The End of Cheap Chinese Labor." As the figure points out, China's wages were fairly during much of the 1980 and 1990s, which is the time when China's trade was nearly in-balance. But whether the conversion is done using yuan/dollar exchange rates or by inflation in China (measured by the producer price index), wages in China have been rising at double-digit annual rates since the late 1990s. In other words, China's big trade surpluses of the last decade have co-existed with sharply rising wages.

Clearly, China's pattern of economic growth since the start of its reforms needs a different storyline than the basic tale of low wages, a cheap currency, and big trade surpluses. After working with these authors, my own view is that it's useful to think of China's economy since about 1978 in two main stages--although there isn't a clean-and-clear break between them.

The first stage of China's growth that went through the 1980s and a bit into the early 1990s was really about rural areas.  Yasheng Huang makes this argument strongly in his JEP article "How Did China Take Off?" Huang writes: "China’s take-off in economic growth starting in the late 1970s and its poverty reduction for the next couple of decades was completely a function of its rural developments and its internal reforms in general. During the golden era of rural industry in the 1980s, China had none of what are often thought of as the requisite features of the China growth model, like massive state-controlled infrastructural investments and mercantilism." This was the time period when the agricultural sector was allowed to operate under a market framework, and as agricultural output exploded, rural workers moved to employment in the "township and village enterprises." Huang makes a strong argument that these enterprises should be thought of a privately owned firms, operating with what was in many ways a private-sector financial market.


But in the 1990s, the emphasis of China's economy began to change. New leaders favored urban development over rural development, and they cut the township and village enterprises down to size by re-nationalizing their sources of finance They began to reform the money-losing state-owned enterprises that still dominated China's urban economy as of the early 1990s. They moved China toward joining the World Trade Organization, which happened in 2001. For a sense of the transition in China's urban areas to private sector employment, here's another useful figure from Li, Li, Wu and Xiong:

But this process of change brought an unexpected macroeconomic imbalance. As Dennis Tao Yang point out in his JEP paper, "Aggregate Savings and External Imbalances in China," China's 11th Five-Year Plan for the years from 2006-2010 called for trade to be in balance overall--clearly an expectation that was not close to being met. Yang looks at a variety of reasons why savings rates took off in China: for example, after China joined the WTO in 2001, exports took off, but firms lacked useful ways in China's underdeveloped financial system to pass these savings to the household sector; as exports took off, China's government received an unexpectedly huge surplus, with budget surpluses upward of 8% of GDP; and households, concerned about retirement and health costs for themselves and their families, and with little access to loans for mortgages or consumer durables, continued to save at very high rates. Yang notes that in China, this combination of outcomes is sometimes criticized as the "Nation Rich, People Poor" policy.

Thus, although China's economy continues to grow rapidly, it is faced with many challenges. Along with the macroeconomic imbalances emphasized by Yang, Xin Meng raises another cluster of issues in her paper, "Labor Market Outcomes and Reforms in China": the extraordinary back-and-forth migration from rural to urban areas, now at well over 100 million people per year, and perhaps headed much higher; the growing inequalities in wages as labor markets move away from the administratively determined wages that were so common even just 20 years ago; the inequalities being created by the spread of education; and China's coming demographic bulge with many elderly and few young workers--a hangover of the one-child rules to limit population growth.

With little effort, one can compile quite a list of economic difficulties facing China: macroeconomic imbalances, an underdeveloped financial sector, inequalities in wages and across rural and urban areas, the demographic bulge, corruption, environmental problems, and more. Still, with all that said, it's worth remembering that China's economy still has enormous potential upside. China started from such a low per capita GDP back in 1978 that even now, productivity levels are only about 20% of the U.S. level. In yet another JEP paper, "Understanding China’s Growth: Past, Present, and Future," Xiaodong Zhu points out that when Japan and Korea and Taiwan had their rapid spurts of economic growth int he 1950s and 1960s and 1970s, they were essentially raising their productivity levels from 40-50% of the U.S. level up to 70-80% of the U.S. level. In other words, China is still far below the level that was the take-off point of rapid growth for countries like Japan, Korea and Taiwan. As Zhu points out, China is making enormous investments in education, physical capital investment, and research and development. In many ways, it is laying a framework for continued growth.

Surely, many things could go wrong for China's economy. For continued growth, it will need to transform its economy again and again. But it also seems to me that hundreds of millions of people in China have developed a sense of possibility, and of what their economic lives could hold for them. China's future growth is sure to have fits and starts, like every country, but its economy continues ot have enormous momentum toward a much higher standard of living.

Why Doesn't Someone Undercut Payday Lending?

To contact us Click HERE
A payday loan works like this: The borrower received an amount that is typically between $100 and $500. The borrower writes a post-dated check to the lender, and the lender agrees not to cash the check for, say, two weeks. No collateral is required: the borrower often needs to show an ID, a recent pay stub, and maybe a statement showing that they have a bank account. The lender charges a fee of about $15 for every $100 borrowed. Paying $15 for a two-week loan of $100 works out to an astronomical annual rate of about 390% per year. But because the payment is a "fee," not an "interest rate," it does not fall afoul of state usury laws. A number of state have passed legislation to limit payday loans, either by capping the maximum amount, capping the interest rate, or banning them outright.

But for those who think like economists, complaints about price-gouging or unfairness in the payday lending market raise an obvious question: If payday lenders are making huge profits, then shouldn't we see entry into that  market from credit unions and banks, which would drive down the prices of such loans for everyone? Victor Stango offers some argument and evidence on this point in "Are Payday Lending Markets Competitive," which appears in the Fall 2012 issue of Regulation magazine.
Stango writes:

"The most direct evidence is the most telling in this case: very few credit unions currently offer payday loans. Fewer than 6 percent of credit unions offered payday loans as of 2009, and credit unions probably comprise less than 2 percent of the national payday loan market. This “market test” shows that credit unions find entering the payday loan market unattractive. With few regulatory obstacles to offering payday loans, it seems that credit unions cannot compete with a substantively similar product at lower prices.

"Those few credit unions that do offer a payday advance product often have total fee and interest charges that are quite close to (or even higher than) standard payday loan fees. Credit union payday loans also have tighter credit requirements, which generate much  lower default rates by rationing riskier borrowers out of the market. The upshot is that risk-adjusted prices on credit union payday loans might be no lower than those on standard payday loans."

The question of whether payday lending should be restricted can make a useful topic for discussions or even short papers in an economics class. The industry is far more prevalent than many people recognize. As Stango describes:

"The scale of a payday outlet can be quite small and startup costs are minimal compared to those of a bank. ... They can locate nearly anywhere and have longer business hours than banks. ... There are currently more than 24,000 physical payday outlets; by comparison there are roughly 16,000 banks and credit unions in total (with roughly 90,000 branches). Many more lenders offer payday loans online. Estimates of market penetration vary, but industry reports suggest that 5–10 percent of the adult population in the United States has used a payday loan at least once."

Payday lending fees do look uncomfortably high, but those with low incomes are often facing hard choices. Overdrawing a bank account often has high fees, as does exceeding a credit card limit. Having your electricity or water turned off for non-payment often leads to high fees, and not getting your car repaired for a couple of weeks can cost you your job.

Moreover, such loans are risky to make. Stango cites data that credit unions steer away from making payday loans because of their riskiness, and instead offer only only much safer loans that have lower costs to the borrower, but also have many more restrictions, like credit checks, or a longer application period, or a requirement that some of the "loan" be immediately placed into a savings account. Credit unions may also charge an "annual" fee for such a loan--but for someone taking out a short-term loan only once or twice in a year, whether the fee is labelled as "annual" or not doesn't affect what they pay. Indeed, Stango cites a July 2009 report from the National Consumer Law Center that criticized credit unions for offering "false payday loan `alternatives'" that actually cost about as much as a typical payday loan.

Stango also cites evidence form his own small survey of payday loan borrowers in Sacramento, California, that many of them prefer the higher fees and looser restrictions on payday loans to the lower fees and tighter restrictions common on similar loans from credit unions. Those interested in a bit more background might begin with my post from July 2011, "Could Restrictions on Payday Lending Hurt Consumers?" and the links included there.

International Capital Flows Slow Down

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I'm not sure why it's happening or what it means, but some OECD reports are showing that international investment flows are slowing down in late 2012, whether one looks at international merger and acquisition activity or at flows of foreign direct investment.

For example, the OECD Investment News for September 2012, written by Michael Gestrin, is titled "Global investment dries up in 2012." The main focus of the report is on international merger and acquisition activity, and Gestrin writes:

"After two years of steady gains, international investment is again falling sharply. After breaking $1 trillion in 2011, international mergers and acquisitions (IM&A) are projected to reach $675 billion in 2012, a 34% decline from 2011(figure 1) ... At the same time as IM&A has been declining, firms have also been increasingly divesting themselves of international assets. As a result, net IM&A (the difference between IM&A and international divestment) has dropped to $317 billion, its lowest level since 2004 ..."

"IM&A has declined more sharply than overall M&A activity. This is reflected in the projected drop in the share of IM&A in total M&A from 35% in 2011 to 29% in 2012 (figure 2). IM&A is declining three times faster than domestic M&A, suggesting that concerns and uncertainties specific to the international investment climate are behind the recent slide in IM&A, rather than IM&A simply following a broader downward trend."

The main exception to these downward trends seems to be a continuing rise in state-owned enterprises, particularly from China, carrying out more mergers and acquisitions, especially in transactions aimed at energy and mining operations in the Middle East and Africa. Here's one figure showing the drop in international investment, and another showing the drop as a share of total M&A activity.



In the October 2012 issue of FDI in Figures, a similar pattern emerges for foreign direct investment--which includes merger and acquisition activity. "According to preliminary estimates, global foreign direct investment (FDI) flows continued shrinking in the second quarter of 2012 and declined by -10% from the previous quarter (-14% from a year earlier) to around USD 303 billion, similar to the value of FDI flows recorded in Q2 2010. The stock of global FDI at end-2011 was estimated at USD 20.4 trillion." As with M&A activity, there is something of a bounce-back in FDI between 2010 and 2011--although there is some fluctuation as well--but the first two quarters of 2012 are showing a decline. Here are graphs showing inflows and outflows of FDI for the world as a whole, as well as for the OECD countries, the G-20, and the EU (which are subgroups with overlapping memberships!).

 

In absolute dollars, China and the U.S. economy dominate these FDI flows, with China receiving about twice as much FDI in 2012 as the U.S. economy: "As from the beginning of 2012, China became the first destination for FDI, recording USD 64 billion in Q1 2012 and USD 54 billion in Q2 2012. Corresponding figures for the United States are USD 22 billion and USD 33.5 billion, respectively." Other major countries for FDI inflows are France, Netherlands and the United Kingdom, Brazil and India. As far as outflows: "Next to the United States outflows of USD 79 billion in Q2 2012 (-32% decrease from Q1 2012), the second largest investing economy was Japan at
USD 37 billion (or 61% increase) followed by Belgium at USD 16 billion (or 130% increase), China at USD 13 billion (or -10% decrease), Italy at USD 12.2 billion (or 16% increase), France at USD 12.1 billion (or -29% decrease) and Germany at USD 12.1 billion (or -66% decrease)."

As I said at the start, I'm not sure what to make of these patterns. Perhaps they are just random fluctuation that will sort itself out. But another a plausible interpretation would involve "concerns and uncertainties specific to the international investment climate," as Gestrin put it. Without trying to itemize those concerns here across the euro area, the U.S., China, Russia, India, and elsewhere, we may be seeing a movement toward a situation in which in exporting and importing to other countries, without seeking a management interest in firms in those other countries, is looking relatively more attractive than a few years ago.


(For those shaky on their definitions, the report defines "foreign direct investment" this way: "Foreign Direct Investment (FDI) is a category of investment that reflects the objective of establishing a lasting interest by a resident enterprise in one economy (direct investor) in an enterprise (direct investment enterprise) that is resident in an economy other than that of the direct investor. The lasting interest implies the existence of a long-term relationship between the direct investor and the direct investment enterprise and a significant degree of influence (not necessarily control) on the management of the enterprise. The direct or indirect ownership of 10% or more of the voting power of an enterprise resident in one economy by an investor resident in another economy is the statistical evidence of such a relationship.")

What's Good for General Motors ...

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As President Obama and Mitt Romney jostled back and forth about the bailout of General Motors and Chrysler during the debate last night, I was naturally reminded of the 1953 confirmation hearings for Charles E. Wilson for Secretary of Defense. Wilson had been president of GM since 1941, overseeing both the company's transformation to wartime production and then its return to peacetime. Much of the confirmation hearing revolved around how he would sell off or insulate his financial holdings from his government job--and more broadly, the difficulties of separating his role at GM from the role of Secretary of Defense.

On January 15, 1953, Wilson had this famous exchange with Senator Robert Hendrickson, a Republican from  New Jersey:

"Senator Hendrickson. Mr. Wilson, you have told the committee, I think more than once this morning, that you see no area of conflict between your interest in the General Motors Corp. or the other companies, as a stockholder, and the position you are about to assume.
Mr. Wilson. Yes, sir.
Senator Hendrickson. Well now, I aminterested to know whether if a situation did arise where you had to make a decision which was extremely adverse to the interests of your stock and General Motors Corp. or any of these other companies, or extremely adverse to the company, in the interests of the United States Government, could you make that decision?
Mr. Wilson. Yes, sir; I could. Icannot conceive of one because for years I thought what was good for our country was good for General Motors, and vice versa. The difference did not exist. Our company is too big. It goes with the welfare of the country. Our contribution to the Nation is quite considerable. I happen to know that toward the end of the war—I was coming back from Washington to New York on the train, and I happened to see the total of our country's lend-lease to Russia, and I was familiar with what we had done in the production of military goods in the war and I thought to myself, "My goodness, if the Russians had a General Motors in addition to what they have, they would not have needed any lend-lease," so I have no trouble—I will have no trouble over it, and if I did start to get into trouble I would put it up to the President to make the decision on that one. I cannot conceive of what it would be.
Senator Hendrickson. Well, frankly, Icannot either at the moment, but we never know what is in store for us.
Mr. Wilson. I cannot conceive ofit. I do not think we are going to get into any foolishness like seizing the properties or anything like that, you know, like the Iranians are in over there, when they got into ---
Senator Hendrickson. I certainly hopenot.
Mr. Wilson. You see, if that onecame up for some reason or other then I would not like that. I do not think I would be on the job; I think I would quit because I would be so out of sympathy with trying to nationalize the industries of our country. I think it would be a terrible thing. That is about the only one I can think of. Of course, I do not think that is even a remote possibility. I think the whole trend of our country is the other way."

I've quoted here from the transcript of the actual hearings as printed in "Nominations: Hearings before the Committee on Armed Services, United States Senate,Eighty-third Congress, first session, on nominee designates Charles E. Wilson,to be Secretary of Defense; Roger M. Kyes, to be Deputy Secretary of Defense;Robert T. Stevens, to be Secretary of the Army; Robert B. Anderson, to beSecretary of the Navy; Harold E. Talbott, to be Secretary of the Air Force ..." January 15, 1953. 

But the hearing had been closed to the public, and the transcript didn't come out for a few days. When reporters asked what had been said, they were told that Wilson had simply replied: "What's good for General Motors is good for the country." Democrats picked up the phrase on the campaign trail and used it against Republicans for being overly pro-business. The highly popular Li'l Abner comic strip had a character named General Bullmoose who often said: "What's good for General Bullmoose is good for the U.S.A.!"

The story goes that for a few years, when the quotation came up, Wilson would try to offer some context, but after awhile he stopped bothering. When he stepped down as Secretary of Defense in 1957, he said: " "I have never been too embarrassed over the thing, stated either way."
 didn't come out for


Of course, it's interesting that the Democratic party that bashed Charlie Wilson back in 1953 now finds itself in the position of arguing the modern version of "what's good for General Motors is good for the country." For those who want details about the actual bailout, my May 7 post on "The GM and Chrysler Bailouts" might be a useful starting point.

Here, I would just make the point that while GM remains an enormous company today, it was relatively much larger in the 1950s. In the Fortune 500 for 1955, General Motors was far and away the biggest U.S. company ranked by sales. GM had $9.8 billion in sales in 1955, with Exxon running second at $5.6 billion, U.S. Steel third at $3.2 billion, followed by General Electric at $3 billion. The GDP of the U.S. economy in in 1955 was $415 billion, so for perspective, GM sales were 2.3% of the U.S. economy.

In 2012, GM's sales are $150 billion, but in the Fortune 500 for 2012, it now runs a distant fifth in sales among U.S. firms. The two biggest firms by sales were Exxon Mobil at $450 billion in sales, just a few billion ahead of WalMart. The GDP of the U.S. economy is about $15 trillion in 2012, so GM sales are now more like 1% of GDP, rather than 2%. And many of those who argue that it was in the national interest to give GM more favorable government-arranged bankruptcy conditions, rather than the usual bankruptcy court, would likely be quite unwilling to give bailouts to Exxon Mobil or to WalMart--despite how much larger they are.