Eight Bon Mots from Milton Friedman

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 Allen S. Sanderson has a nice tribute marking the 100th anniversary of Milton Friedman's birth in "Remembering Milton," which appears in the Second Quarter 2012 issue of the Milken Institute Review. (Available on-line, but free registration required.) The article offers a number of nice reminisces from Friedman's colleagues and students (two groups that often overlap).
Along with Friedman's status as one of the handful of most prominent economists of the 20th century, he also had a nearly wicked rhetorical ability to turn a phrase. Here are a few of Friedman's one-liners collected by Sanderson:

Concentratedpower is not rendered harmless by the goodintentions of those who create it.

Historysuggests that capitalism is a necessary condition for politicalfreedom. Clearly it is not a sufficient condition.

The problem ofsocial organization is how to set up an arrangementunder which greed will do the least harm; capitalism isthat kind of a system.

With somenotable exceptions, businessmen favor free enterprise in general butare opposed to it when it comes to themselves.

The free manwill ask neither what his country can do for him nor what he cando for his country.

The case forprohibiting drugs is exactly as strong and as weak as the case forprohibiting people from overeating.

If you put thefederal government in charge of the Sahara Desert, in five yearsthere’d be a shortage of sand.

Only a crisis —actual or perceived — produces real change. When thatcrisis occurs, the actions that are taken dependon the ideas that are lying around.

Wealth by Distribution, Region, and Age

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The Federal Reserve has published results from the most recent Survey of Consumer Finance, the triennial survey that is the canonical source for looking at the wealth of households. The results are in an article in the June 2012 issue of the Federal Reserve Bulletin called "Changes in U.S. Family Finances from 2007 to 2010: Evidence from the Survey of Consumer Finances," by a team of authors led by Jesse Bricker, Arthur B. Kennickell, Kevin B.Moore, and John Sabelhaus.

The headline finding from the report is that the median household wealth level fell from $126,000 in 2007 to $77,000 in 2010. Mean wealth is of course far higher than median wealth. It fell from 584,000 in 2007 to $499,000 in 2007. During a three-year period when housing prices and the stock market declined, a fall in wealth is expected. I'm still trying to digest the data, but here, I'll focus on three patterns in the evolution of wealth that just happened to catch my eye: changes across the distribution of wealth, across regions, and across age groups. Here's a table with the mean and median household values for the 2001, 2004, 2007, and 2010 surveys.


Changes in the Distribution of Wealth

Those in the 90-100th percentiles of the wealth distribution have median wealth of $1,864,000, and mean wealth of $3,716,000 in 2010. That's also the part of the wealth distribution that had the smallest percentage decline in the median and the mean from 2007 to 2010. 

"Median net worth fell for all percentile groups of the distribution of net worth, with the largest decreases in proportional terms being for the groups below the 75th percentile of the net worth distribution. From 2007 to 2010, the median for the lowest quartile of net worth fell from $1,300 to zero—a 100 percent decline; at the same time, the mean for the group fell from negative $2,300 to negative $12,800. For the second and third quartiles, the median and mean declines in net worth were smaller but still sizable; for example, median net worth for the second quartile fell 43.3 percent. Median and mean net worth did not fall quite as much for the higher net worth groups. For the 75th-to-90th percentile group, the median fell 19.7 percent while the mean fell 14.4 percent. For the wealthiest decile, the 11.0 percent decline in the mean exceeded the 6.4 percent decline in the median for that group; as was discussed earlier in the case of family income, this pattern of the changes in
the median and mean suggests that there was some compression of higher values in the wealth distribution."

Changes in Wealth by Region

The drop in housing prices hit especially hard in the western states, and the decline in median wealth was by far the highest in that region. Here's the Fed report: 

"Between 2007 and 2010, median net worth fell dramatically for families living in all regions of the country, but especially for those living in the West—a 55.3 percent decline. This pattern reflects the effect of the collapse of housing values in several parts of the West region. Median wealth in every other region fell 28.2 percent or more. As with the overall population and most other demographic groups discussed earlier, the decline in mean net worth within every region was smaller than the drop in the median. In the South and Midwest regions, the percentage decline in the median was about twice as large as the percentage decline in the mean, but in percentage terms, the median for the West fell four times as much as the mean."

Changes in Wealth by Age

The age 35-44 group experienced the biggest falls in net worth. Oddly enough, the over-75 age group saw a modest rise in net worth from 2007 to 2010. This must mean that the over-75s were not as heavily exposed to the drop in housing prices and and the stock market. Here's the Fed:

"The survey shows substantial declines in median and mean net worth by age group between 2007 and 2010, with the exception that mean net worth rose modestly (1.3 percent) for the 75-or-more age group. The 35-to-44 age group saw a 54.4 percent decline in median net worth during the most recent three-year period, and the mean for that age group fell 36.4 percent. The wealth decreases for the less-than-35 age group were also large; the median fell 25.0 percent while the mean fell 41.2 percent. The declines in median and mean net worth for middle-aged families (the 45-to-54 and 55-to-64 age groups) were also large."

Next Merger Wave Coming?

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The Federal Trade Commission has released the Hart-Scott-Rodino Annual Report 2011.  Each year, it summarizes the number of  mergers and acquisitions, their size, and some trends in antitrust enforcement. At least in my reading, the data in the report hints that a new wave of mergers may be on the way.

The Hart-Scott-Rodino legislation requires that when businesses plan a merger or an acquisition above a certain price--typically $66 million in 2011--it must first be reported to the Federal Trade Commission. The FTC can let the merger proceed, or request more information. Based on that additional information, the FTC can then let the merger proceed, block it, or approve it subject to various conditions (for example, requiring that the merged entity divest itself of certain parts of the business to preserve competition in those areas).

Here are the total mergers reported for the last 10 years. You can see the wave of mergers and acquisitions that peaked in 2007--and what appears as if it could be the start of a new merger wave in the last couple of years.



The total value of merger transactions reported under Hart-Scott-Rodino isn't completely comparable across years, because the threshold at which transactions need to be reported has risen over time. But for what it's worth, here's the pattern of the total dollar value of reported transactions since the late 1990s.

"The total dollar value of reported transactions rose dramatically from fiscal years 1996 to 2000, from about $677.4 billion to about $3 trillion. After the statutory thresholds were raised, the dollar value declined to about $565.4 billion in fiscal year 2002, and $406.8 billion in fiscal year 2003. This was followed by an increase in the dollar value of reported transactions over the next four years: about $630 billion in fiscal year 2004, $1.1 trillion in fiscal year 2005, $1.3 trillion in fiscal year 2006, and almost $2 trillion in 2007. The total dollar value of reported transactions declined to just over $1.3 trillion in fiscal year 2008, and to $533 billion in fiscal year 2009, increased to $780 billion in fiscal year 2010, and $979 billion in fiscal year 2011."

And here's a table showing the size distribution of the reported mergers in 2011. About 28% of the transactions exceeded $500 million; 11% exceeded $1 trillion in size.

The FTC allows most mergers to proceed, which makes sense in a competitive market economy. As a general rule, those who run businesses are in a better position than government economists to plan strategies for their firms. In 2011, about 4.1% of the mergers reported to the FTC has a request for additional information. At the end of the day, the FTC actually challenged 20 mergers in 2011. Thirteen of these challenges went to court; 11 were settled by consent decree. Perhaps the best-known of these cases in 2011 was the FTC decision to block AT&T’s proposed acquisition of T-Mobile. With the other seven, two of the deals were abandoned, and the other five led to restructuring of the deal or changes in conduct.



There are a number of reasons to suspect that a new wave of mergers may be coming, nicely reviewed in an article in the Economist magazine of May 19 called "Surf’s up: Merger waves mean that markets can consolidate rapidly. The next one is coming."' Mergers often happen when there are lots of struggling firms and excess capacity, which creates lots of willing sellers and good deals for possible buyers. When firms have a lot of cash on their balance sheets, like now, mergers start to look attractive. When interest rates are low, borrowing money to finance a merger or acquisition looks more attractive, and the alternative possible investments for corporate funds look less attractive.  
Waves of mergers often happen in waves. Once a few mergers happen in an industry, other companies start to feel as if they need to find a merger partner as well. In short, the broad economic conditions are ripe for a wave of mergers and the data for 2011 suggests that such a wave may just be getting underway. The FTC and the antitrust division over at the U.S. Department of Justice should be on their toes. 

On the Job for 100 Issues of JEP

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I was hired by Joseph Stiglitz 26 years ago to start a new economics journal, the Journal of Economic Perspectives. It took us a year from the starting line to mailing our first issue in the mail, but the Spring 2012 issue, now available on-line, is the 100th issue. Like all issues of JEP back to 1994, it is freely available to all, courtesy of the American Economic Association. The first three articles are about the journal: one by current editor David Autor on the effect of the journal within the economics profession, one by Joe Stiglitz remembering the early years and commenting on how the journal has evolved, and one by me called "From the Desk of the Managing Editor."

Here are the two opening paragraphs and the closing paragraph of my essay:

"Editing isn’t “teaching” and it isn’t “research,” so in the holy trinity of academic responsibilities it is apparently bunched with faculty committees, student advising, and talks to the local Kiwanis club as part of “service.” Yet for many economists, editing seems to loom larger in their professional lives. After all, EconLit indexes more than 750 academic journals of economics, which require an ever-shifting group of editors, co-editors, and advisory boards to function. Roughly one-third of the books in the annotated listings at the back of each issue of the Journal of Economic Literature are edited volumes.

Editors are gatekeepers, and editors are road-blocks—or perhaps these are essentially the same task. Editors shape “the literature,” both what and who is included and how it is presented. I’ve come to believe that “editing” is no more susceptible to a compact single defifi nition than “manufacturing” or “services.” But here is one take on the enterprise of editing from someone who has been sitting in the Managing Editor’s chair for all 100 issues of the Journal of Economic Perspectives since before the first issue of the journal mailed in Summer 1987. ...

My job as Managing Editor of JEP has been a pride and a pleasure for these last 25 years. It’s consistently interesting work: after all, my job is to do close readings of the highly varied work of a succession of prominent economists who are trying to explain their thinking—and then to ask them questions until they explain it all to me! Editing an academic journal also offers the psychic frisson of leaving something behind: 100 issues and counting, to be precise. When I visit another college or university, I sometimes walk through the periodical stacks just to see JEP on the shelf. Running an academic journal for a long time offers a pleasing sense of place within the discipline of economics, spinning a web of personal contacts from the up-and-comers to the well-established in academic institutions around the world. Some of my friends refer to my job at the journal as “the guy who gets thanked” at the end of articles. There are worse epitaphs."

Unconventional Natural Gas and Environmental Issues

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"Unconventional" natural gas production is booming in the U.S.: that is, shale gas, coalbed methane, and "tight gas," which is similar to shale gas but found in low-permeability formations.  However, there are two sets of environmental concerns. One involves protecting the environment while actually extracting this gas. The second involves how finding a substantial new source of energy might affect air pollution, including the carbon emissions that pose a risk of global warming.  The International Energy Agency discusses the issues in "Golden Rules for a Golden Age of Natural Gas." (The IEA is an autonomous international agency with 28 member countries and a staff of 260. It was founded back in 1973-74 as part of the response to the oil price shock at that time.)

As a starting point, here's an overview of the U.S. situation, with a map showing where the main deposits are located:

"Until recently, unconventional natural gas production was almost exclusively a US phenomenon. Tight gas production has the longest history, having been expanding steadily for several decades. Commercial production of coalbed methane began in the 1980s, but only took off in the 1990s; it has levelled off in recent years. Shale gas has also been in production for several decades, but started to expand rapidly only  in the mid-2000s, growing at more than 45% per year between 2005 and 2010. Unconventional gas production was nearly 60% of total gas production in the United States in 2010. While tight gas and shale gas account for the overwhelming bulk of this, shale gas is expected to
remain the main source of growth in overall gas supply in the United States in the coming
decades. The United States and Canada still account for virtually all the shale gas produced
commercially in the world ... There are large resources of all three types of unconventional gas across the United States. Of the 74 trillion cubic metres (tcm) of remaining recoverable resources of natural gas at end-2011, half are unconventional; in total, gas resources represent around
110 years of production at 2011 rates."


One part of the report tried to enunciate a set of "golden rules" that should be followed to protect the environment while extracting this gas. There is a lengthy discussion of these "golden rules," but the overall tone can be discerned from the main headings (each of which has several subheadings): Monitor, disclose and engage; Watch where you drill; Isolate wells and prevent leaks; Treat water responsibly; Eliminate venting, minimise flaring and other emissions; Be ready to think big; Ensure a consistently high level of environmental performance.

Intriguingly, the IEA finds that the costs of implementing this "golden rule" environmental agenda are quite manageable in the context of the overall cost of these projects: "We estimate that applying the Golden Rules could increase the overall financial cost of development a typical shale-gas well by an estimated 7%."  I would interpret this finding as saying that there is no cost-based justification for not undertaking at least this level of environment projection, if the exploitation of unconventional gas reserves is to proceed. 

The other main environmental issue is the concern that abundant natural gas will add to air pollution, including both conventional pollutants and carbon emissions that bring a risk of climate change. The IEA modelling suggests several effects would take place. Natural  gas will reduce the need for burning coal to generate electricity and burning oil for heating and transportation, which tends to reduce carbon emissions. But on the other side, cheaper natural gas will also slow the deployment of more expensive non-carbon energy sources, and the quantity demanded of natural gas will rise as it gets cheaper. Overall, these counterbalancing effects would lead to a modest reduction in carbon emissions. The IEA writes:

"[I]t is difficult to make the case that a reduction in unconventional gas output brings net environmental gains. The effect of replacing gas with coal ... is to push up energy-related CO2 emissions, which are 1.3% higher [without added natural gas] than in the Golden Rules Case. ...  Additional investment in coal-fired generation locks in additional future emissions, since any new coal-fired power plant has an anticipated operating lifetime in excess of 40 years. Though many of those concerned with environmental degradation may find it difficult to accept that unconventional gas resources have a place in a sustainable energy policy, a conclusion from this analysis is that, from the perspective of limiting global greenhouse gas emissions, a Golden Rules Case has some advantages ... while also bringing with it other benefits in terms of the reliability and security of energy supply."

The IEA immediately goes on to say that a strategy of encouraging development of unconventional natural gas isn't enough to ameliorate climate change concerns:

"[R]reaching the international goal of limiting the long-term increase in the global mean temperature to 2°C above pre-industrial levels cannot be accomplished through greater reliance on natural gas alone. Achieving this climate target will require a much more substantial shift in global energy use, including much greater improvements in energy efficiency, more concerted efforts to deploy low-carbon energy sources and broad application of new low-carbon technologies, including power plants and industrial facilities equipped for carbon capture and storage. Anchoring unconventional gas development in a broader energy policy framework that embraces these elements would help to allay the fear that investment in unconventional gas comes at the expense of investment in lower carbon alternatives or energy efficiency."

 My own grand compromise proposal is for the "Drill Baby Carbon Tax." On one side, it calls for making a national commitment to using domestic energy resources including natural gas, coal and oil, for the jobs, the lower energy prices, and the reduced dependence on imported energy. On the other side, it also calls for a carbon tax so that the prices paid by consumers for energy sources that pollute the air reflect the full social costs of that energy production, and thus will also encourage development of cleaner energy sources.  Indeed, one can envision a future for electricity generation where there is increasing reliance on noncarbon sources over time, but when the sun isn't shining and the wind isn't blowing, we have abundant natural gas as a reliable backup.

How Digital Check Imaging is Saving $3 Billion Per Year

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Back in the 1980s and 1990s, there was an occasional outbreak of controversy around the idea of the check "float," defined as how long after you deposited a check in your account were the funds actually available to you. Banks were often accused of failing to credit deposited checks to accounts as quickly as they could, because if they could hang on to the money for a few days longer, they could earn a bit of additional interest. The Expedited Funds Availability Act of 1987 was passed to limit the ability of banks to hold checks and benefit from the "float" (For example, here a 1997 article on some aspects of the check float controversy from the Federal Reserve Bank of Richmond.)

But the events of September 11, 2001, led--along with a host of considerably more important consequences--to a movement away from paper checks and to digital images of checks, thus largely ending the check float controversy. David B. Humphrey and Robert Hunt tell the story in "Getting Rid of Paper: Savings from Check 21," just published as Working Paper 12-12 for the Federal Reserve Bank of Philadelphia.

Here is their description of the past process in clearing checks: "The Uniform Commercial Code has long required U.S. checks to be physically presented to the banks they are drawn on for payment. ... [T]he required physical presentment generated expensive air and land courier transportation costs. It also led to delays in check collection of from 1 to 5 days, averaging 1 day for local or within-city checks and usually 2 to 3 days for non-local items such as checks going from one city to another across the country."

But the events of 9/11 led to legislation allowing banks to accept digital images of checks that could be transmitted electronically.  "On September 11, 2001, planes were grounded and check fl‡oat—--the value of checks in the process of transportation and collection—--rose to $47 billion (about eight times the normal daily level), while electronic payments were unaffected. Although the technology has been available for almost two decades to digitize check images and collect checks electronically on a same-day basis, the legal requirement of physical presentment inhibited its adoption. ... The September 2001 disruption spurred the Federal Reserve to ask Congress to allow a paper representation of the digital image of the front and back of a check (called a substitute check) to be legally the same as the original physical item for purposes of collection and presentment. This legislation, adopted in 2003 and known as Check 21 (Check Clearing for the 21st Century Act), along
with other initiatives, currently permits almost all of the 24.5 billion checks paid annually in the U.S. (worth $32 trillion) to be collected electronically on a same-day (or next-day) basis once they are deposited at a bank. The original check is imaged and transported electronically, and a substitute check is printed close to where the paying bank is located. The substitute check is then physically
presented for payment. Since accepting billions of substitute checks is more costly than accepting and paying the electronic image itself, almost all paying banks now receive and pay the image."


 As the figure shows, digital images of electronic checks rapidly took over from paper checks between about 2005 and 2008. The figure shows checks processed by the Federal Reserve, but commercial banks have also moved dramatically to using digital images of checks.

The Check 21 legislation has shortened the float, so that it often happens in the same day or in one day, and never in more than two days. "Since with Check 21 geography no longer matters, all deposited checks must be made available within 2 business days under Regulation CC (which implements the 1987 Expedited Funds Availability Act). Previously, some transit items could have had a maximum delay of up to 5 days when collection was physically difficult."

Allowing banks to transmit digital images of checks, rather than paper checks themselves, led to three main areas of cost savings:

• Savings in the physical cost of processing checks. It cost the Federal Reserve 9.6 cents to process a paper check in 2006, but 2.5 cents to process an digital image of a check in 2010. Applied to the 8.4 billion checks the Fed processed in 2010, and the 7.9 billion more processed by commercial banks, Humphrey and Hunt estimate: "The total production cost savings from Check 21 for the U.S. payments system during 2010 is thus estimated to have been $1.16 billion." 
• Savings to businesses receiving checks from being able to collect the money a day earlier. "[B]usiness payees may have saved $1.37 billion in working capital costs by being able to collect checks a minimum of one day earlier because of Check 21."
• Savings to consumers who can hold on to their money for a day or two longer before paying their credit cards or other debts. "Combining all of this information leads to a rough estimate that consumers may have saved $0.64 billion from Check 21."

Along with this $3 billion or so in itemized gains, participants in the financial system would also have benefited from the greater certainty of knowing that your money would be available sooner.

A few weeks ago on May 21, I posted about "Illustrating Economies of Scale," and the conversion from paper checks to digital images offers an example. Humphey and Hunt argue that as digital electronic checks ramped up, they were able to take advantage of economies of scale to reduce averae per-unit costs. On the other side, as paper checks were phased out, they lost the advantages of economies of scale and thus saw per-unit costs rise. Here's the figure:
The story of the transition from paper checks to digital checks isn't a major economic episode. But it's one more nice illustration of how digital technology and the Internet have been transforming the ways in which economic activity is conducted.

U.S. Government: Some International Perspective

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I found myself checking some facts about the relative size of U.S. government revenues, expenditures, and debt in the OECD publication "Government at a Glance 2011." Just to be clear, this data sums up all levels of government together, so for the United States, it includes federal, state, and local government.

Revenues

As a share of GDP, U.S. government revenues for all levels of government are well the OECD average in 2009, at a shade over 30% of GDP. Of course, this was a year when the Great Recession hit the U.S economy with particular force and held down incomes and tax payments quite substantially. In this group, the northern European economies like Norway, Denmark, Sweden and Finland lead the way by collecting more than 50% of GDP as government revenue. However, because the U.S. economy is richer on a per capita basis, even though U.S. government revenues as a share of GDP are low, government revenues in absolute dollars per personare actually just a bit above the OECD average--and similar to government revenues per person in Canada and the United Kingdom.



 
Expenditures

When it comes to spending as a share of GDP, the U.S. government at all levels ranks below the average for the OECD comparison group, but in spending, the U.S. isn't as much of an outlier as it is in expenditures. For example, expenditures as a share of GDP in the U.S. are quite similar to Canada, and above Japan and Australia. Again, because the U.S. economy is richer on a per capita basis, U.S. government expenditures on a per person basis are higher than the average for the group: for example, higher than expenditures per person in France, Germany, Italy and the United Kingdom.


How are government expenditures in the U.S. allocated differently than in the rest of the OECD comparison group? Not surprisingly, the table shows that 11.9% of all U.S. government spending goes to defense, compared with 3.8% in the other countries. More surprising, to me at least, is that the share of U.S. government spending going to health is substantially higher than the average for the comparison group: 20.5% in the U.S. compared with an average of 14.7%. Health care costs so much in the U.S. that our government ends up spending a larger share of its resources on health than the other countries, even though most of those countries have national health insurance systems. U.S. government as a whole also puts a greater share of its expenditures into education compared with the comparison group: 16.6% to 13.1%. The major area where U.S. government at all levels spends much less is the category of "social protection," which is non-health and non-housing spending to aimed primarily at those with below-median incomes. U.S. government puts 19.4% of its spending into this category, compared with 33.5% for the comparison group.



Debt 

The calculation here is "gross" government debt, not "net." The difference is that many governments owe some debt to themselves; in the U.S., for example, the $2.7 trillion or so in the Social Security Trust Fund is invested in Treasury bonds, which means that one part of the government owes the money to another part of the government. In a U.S. context, it is often common to look at "debt held by the public," and thus to leave out the case where government owes a debt to itself. But for purposes of international comparisons, using gross debt is common.

Japan far and away leads the pack on gross debt, at a debt/GDP ratio of about 200%. But Japan is also a special case with an extremely high domestic savings rate, and limited possibilities for Japan's consumers to invest those savings outside the country. Japan has financed its own public debt, without a need for an inflow of foreign capital. But not far behind are some of the problem children of the euro area: Greece, Italy, Portugal and Ireland. Spain, despite the recent travails of its banking system, was actually a bit below the average for public debt/GDP ratio in 2010.

The U.S. position in 2010 is uncomfortably high: a bit behind some of Europe's problem cases like Greece and Italy and Ireland, but with a higher debt/GDP ratio than Germany, Canada, or the UK. It's also interesting to me that the high-tax, high-spending economies of northern Europe--Sweden, Denmark, Norway, and Finland--are all below the average on debt/GDP ratio. Their governments do spend more, but in this comparison group, they do a reasonable job of collecting the revenues to pay for it.