Wednesday, April 16, 2014

Demand for Sand

These are boom times for the sand industry, which is actually a mixed blessing, resulting in high prices and even environmental risks. The Global Environmental Alert Service of the United Nations Environment Programme tells some of the story in a March 2014 report, "Sand, rarer than one thinks." As the report notes (citations omitted for readability): "Globally, between 47 and 59 billion tonnes of material is mined every year, of which  sand and gravel, hereafter known as aggregates, account for both the largest share (from 68% to 85%) and the fastest extraction increase ..."

To get a sense of the volume here,  consider this comparison: "A conservative estimate for the world consumption of aggregates exceeds 40 billion tonnes a year. This is twice the yearly amount of sediment carried by all of the rivers of the world, making humankind the largest of the planet’s transforming agent with respect to aggregates ..." Or to look at it another way, one major use of aggregates like sand and gravel is for concrete. "Thus, the world’s use of aggregates for concrete can be estimated at 25.9 billion to 29.6 billion tonnes a year for 2012 alone. This represents enough concrete to build a wall 27 metres high by 27 metres wide around the equator."  Sand and gravel are also used land in reclamation, shoreline developments, road embankments, asphalt, and by industries including glass, electronics, and aeronautics.

Dredging sand and gravel from oceans and rivers causes environmental disruption, which can in some cases become severe, leading to problems with erosion, greater vulnerability to storm surges, and destruction of habitat for plant and animals. "Lake Poyang, the largest freshwater lake in China, is a distinctive site for biodiversity of international importance, including a Ramsar Wetland. It is also the largest source of sand in China and, with a conservative estimate of 236 million cubic metres a year of sand extraction, may be the largest sand extraction site in the world. ... Sand mining has led to deepening and widening of the Lake Poyang channel and an increase in water discharge into the Yangtze River. This may have influenced the lowering of the lake’s water levels, which reached a historically low level in 2008 ..." (The Ramsar Convention is the nickname for the Convention on Wetlands of International Importance, which is an intergovernmental treaty for protection of key wetlands.) In general, economic growth in China has been one of the major reasons for the expansion of sand and gravel mining in the last decade.

Or to choose a more extreme case: "In some extreme cases, the mining of marine aggregates has changed international boundaries, such as through the disappearance of sand islands in Indonesia."
The qualities of sand and gravel matter for their eventual use. For example, "If the sodium is not removed from marine aggregate, a structure built with it might collapse after few decades due to corrosion of its metal structures. Most sand from deserts cannot be used for concrete and land reclaiming, as the wind erosion process forms round grains that do not bind well."

With a combination of research and development into alternative materials, along with different materials methods of landfill and construction, the use of sand and gravel could be reduced. Some possible alternative materials for various uses include quarry dust, incinerator ash, recycled concrete and glass, perhaps finding ways to use desert sand.

According to data from the U.S. Geological Survey, the U.S. economy used about 46 million tons of sand and gravel for industrial purposes in 2012, which represents nearly a doubling since 2003. In addition, the price of sand and gravel for industrial use rose from $18.30/ton in 2003 to $52.80/ton in 2012. Essentially, this kind of sand has a high silicon dioxide content, and a large portion of this run-up in demand is because this kind of sand is used in hydraulic fracturing, which now consumes about 62% of this kind of sand in the U.S.

Use of sand and gravel for construction purposes was much greater in the U.S economy, about 842 million tons in 2012. However, this was down from about 1,200 million tons per year during the housing and construction boom of the years leading up to the Great Recession. The USGS reports: "It is estimated that about 44% of construction sand and gravel was used as concrete aggregates; 25% for road base and coverings and road  stabilization; 13% as asphaltic concrete aggregates and other bituminous mixtures; 12% as construction fill; 1% each for concrete products, such as blocks, bricks, and pipes; plaster and gunite sands; and snow and ice control; and the remaining 3% for filtration, golf courses, railroad ballast, roofing granules, and other miscellaneous uses."

With all due apologies to the good people and productive firms working in this industry, it's a little difficult for me to imagine a more boring product than sand and gravel. As a first step toward getting out of my ivory tower and getting over this prejudice, I close here with some comments from a 1999 report by the U.S. Geological Survey, "Natural Aggregates—Foundation of America’s Future."

"Natural aggregates, which consist of crushed stone and sand and gravel, are among the most abundant natural resources and a major basic raw material used by construction, agriculture, and industries employing complex chemical and metallurgical processes. Despite the low value of the basic products, natural aggregates are a major contributor to and an indicator of the economic well-being of the Nation. Aggregates have an amazing variety of uses. Imagine our lives without roads, bridges, streets, bricks, concrete, wallboard, and roofing tiles or without paint, glass, plastics, and medicine. Every small town or big city and every road connecting them were built and are maintained with aggregates. More than 90 percent of asphalt pavements and 80 percent of concrete are aggregates. Paint, paper, plastics, and glass also require sand, gravel, or crushed stone as a constituent. When ground into powder, limestone is used as an important mineral supplement in agriculture, medicine, and household products. ... On the basis of either weight or volume, aggregates accounted for more than two-thirds of about 3.3 billion metric tons of nonfuel minerals produced in the United States in 1996."

Tuesday, April 15, 2014

When Government Pre-Fills Income Tax Returns

As Americans hit that annual April 15 deadline for filing income tax returns, they may wish to contemplate how it's done in Denmark. Since 2008, in Denmark the government sends you a tax assessment notice: that is, either the refund you can receive or the amount you owe. It includes an on-line link to a website where you can look to see how the government calculated your taxes. If the underlying information about your financial situation is incorrect, you remain responsible for correcting it. But if you are OK with the calculation, as about 80% of Danish taxpayers are, you send a confirmation note, and either send off a check or wait to receive one.

This is called a "pre-filled" tax return. As discussed in OECD report Tax Administration 2013: Comparative Information on OECD and Other Advanced and Emerging Economies: "One of the more significant developments in tax return process design and the use of technology by revenue bodies over the last decade or so concerns the emergence of systems of pre-filled tax returns for the PIT [personal income tax]."  After all, most high-income governments already have data from employers on wages paid and taxes withheld, as well as data from financial institutions on interest paid. For a considerable number of taxpayers, that's pretty much all the third-party information that's needed to calculate their taxes. The OECD reports: 

"Seven revenue bodies (i.e. Chile, Denmark, Finland, Malta, New Zealand, Norway, and Sweden) provide a capability that is able to generate at year-end a fully completed tax return (or its equivalent) in electronic and/or paper form for the majority of taxpayers required to file tax returns while three bodies (i.e. Singapore, South Africa, Spain, and Turkey) achieved this outcome in 2011 for between 30-50% of their personal taxpayers. [And yes, I count four countries  in this category, not three, but so it goes.] In addition to the countries mentioned, substantial use of pre-filling to partially complete tax returns was reported by seven other revenue bodies -- Australia, Estonia, France, Hong Kong, Iceland, Italy, Lithuania, and Portugal. [And yes, I count eight countries in this category, not seven, but so it goes.] Overall, almost half of surveyed revenue bodies reported some use of  prefilling ..."
For the United States, the OECD report notes that in 2011, zero percent of returns were pre-filled. Could pre-filling work in the U.S.?  Austan Goolsbee provided a detailed proposal for how prefilling might work for the United States in a July 2006 paper, "The Simple Return: Reducing America's Tax Burden Through Return-Free Filing." He wrote: 

"Around two-thirds of taxpayers take only the standard deduction and do not itemize. Frequently, all of their income is solely from wages from one employer and interest income from one bank. For almost all of these people, the IRS already receives information about each of their sources of income directly from their employers and banks. The IRS then asks these same people to spend time gathering documents and filling out tax forms, or to spend money paying tax preparers to do it. In essence, these taxpayers are just copying into a tax return information that the IRS already receives independently. The Simple Return would have the IRS take the information about income directly from the employers and banks and, if the person's tax status were simple enough, send that taxpayer a return prefilled with the information. The program would be voluntary. Anyone who preferred to fill out his own tax form, or to pay a tax preparer to do it, would just throw the Simple Return away and file his taxes the way he does now. For the millions of taxpayers who could use the Simple Return, however, filing a tax return would entail nothing more than checking the numbers, signing the return, and then either sending a check or getting a refund. ... The Simple Return might apply to as many as 40 percent of Americans, for whom it could save up to 225 million hours of time and more than $2 billion a year in tax preparation fees. Converting the time savings into a monetary value by multiplying the hours saved by the wage rates of typical taxpayers, the Simple Return system would be the equivalent of reducing the tax burden for this group by about $44 billion over ten years."
Most of this benefit would flow to those with lower income levels. The IRS would save money, too, from not having to deal with as many incomplete, erroneous, or nonexistent forms.  

For the U.S., the main  practical difficulty that prevents a move to pre-filling is that with present arrangements, the IRS doesn't get the information about wages and interest payments from the previous year quickly enough to prefill income tax forms, send them out, and get answers back from people by the traditional April 15 timeline. The 2013 report of the National Taxpayer Advocate has some discussion related to these issues in Section 5 of Volume 2. The report does not recommend that the IRS develop pre-filled returns. But it does advocate the expansion of "upfront matching," which means that the IRS should develop a capability to tell taxpayers in advance, before they file their return, about what their parties are reporting to the IRS about wages, interest, and even matters like mortgage interest or state and local taxes paid. If taxpayers could use this information when filling out their taxes in the first place, then at a minimum, the number of errors in tax returns could be substantially reduced. And for those with the simplest kinds of tax returns, the cost and paperwork burden of doing their taxes could be substantially reduced. 

Saturday, April 12, 2014

How Milton Friedman Helped Invent Income Tax Withholding

In one of the great ironies, the great economist Milton Friedman--known for his pro-market, limited government views--helped to invent government withholding of income tax. It happened early in his career, when he was working for the U.S. government during World War II. Of course, the IRS opposed the idea at the time as impractical. Friedman summarized the story in a 1995 interview with Brian Doherty published in Reason magazine. Here it is:

"I was an employee at the Treasury Department. We were in a wartime situation. How do you raise the enormous amount of taxes you need for wartime? We were all in favor of cutting inflation. I wasn't as sophisticated about how to do it then as I would be now, but there's no doubt that one of the ways to avoid inflation was to finance as large a fraction of current spending with tax money as possible.
In World War I, a very small fraction of the total war expenditure was financed by taxes, so we had a doubling of prices during the war and after the war. At the outbreak of World War II, the Treasury was determined not to make the same mistake again.
You could not do that during wartime or peacetime without withholding. And so people at the Treasury tax research department, where I was working, investigated various methods of withholding. I was one of the small technical group that worked on developing it.
One of the major opponents of the idea was the IRS. Because every organization knows that the only way you can do anything is the way they've always been doing it. This was something new, and they kept telling us how impossible it was. It was a very interesting and very challenging intellectual task. I played a significant role, no question about it, in introducing withholding. I think it's a great mistake for peacetime, but in 1941-43, all of us were concentrating on the war.
I have no apologies for it, but I really wish we hadn't found it necessary and I wish there were some way of abolishing withholding now."

Friday, April 11, 2014

Is the IRS Unravelling?

The central function of the Internal Revenue Service is intrinsically difficult. In 2013, the IRS processed  146 million individual income tax returns; 2.2 million corporate income tax forms, and overall about 10.5 million business tax returns (including C corporations, S corporations, and partnerships); nearly 30 million employment tax forms (on which employers, including the self-employed, report the income paid to employees and taxes withheld); 1.2 million excise tax forms from the businesses required to collect federal excise taxes on cigarettes, alcohol, and gasoline; and about 275,000 gift or estate tax forms. All of this needs to happen in a mobile and evolving U.S. economy, against the backdrop of an ever-more globalized world economy, and with a tax code that approaches 74,000 pages in length and changes every year.

Just in case this isn't enough, we have been loading up the IRS with additional major tasks, too. For example, a number of major income transfer programs like the Earned Income Tax Credit and the Child Tax Credit are now administered through refundable tax credits--that is, payments from the IRS to eligible families. U.S. policymakers count on the progressivity of the U.S. income tax--higher marginal tax rates on those with higher incomes--as a way to limit the rise in income inequality. The U.S. Department of Education often uses the IRS to withhold tax refunds as a way of repaying out-of-date student loans. The Patient Protection and Affordable Care Act was written to require that those who did not have health insurance would make a payment to the IRS, along with many other provisions affecting various business and investment taxes. The IRS is in the center of campaign financing issues with the decisions it makes (and how it makes those decisions) on what groups are eligible for certain kinds of tax-free status.

And while this is happening, funding and personnel levels at the IRS have been cut in the last few years. This combination of higher responsibilities and lower resources was a main focus of the Nina E. Olson, who holds the position of National Taxpayer Advocate, in the 2013 annual report of her office to Congress. The report goes into detail on many concerns, but for me, the heart of the report is that on one hand the IRS should follow a "Taxpayer Bill of Rights" which would enshrine the assumptions under which the tax collectors should operate, and on the other hand, the IRS needs to be funded and supported if it is going to operate to the desired standard.

Here's a list of what Olson would propose including in a Taxpayer Bill of Rights. She writes: "At their core, taxpayer rights are human rights. They are about our inherent humanity. Particularly when an organization is large, as is the IRS, and has power, as does the IRS, these rights serve as a bulwark
against the organization’s tendency to arrange things in ways that are convenient for itself,
but actually dehumanize us. Taxpayer rights, then, help ensure that taxpayers are treated in a humane manner."

Olson writes of difficulties the IRS faced in 2013, including the problems arising from the 16-day government shutdown as well as when the IRS found "itself mired in a scandal relating to tax-exempt organizations, resulting in the resignation or retirement of the acting Commissioner and other members of the IRS senior leadership." But she argues: "[A]ll of these short-term crises mask the major problem facing the IRS today — unstable and chronic underfunding that puts at risk the IRS’s ability to meet its current responsibilities, much less articulate and achieve the necessary transformation to an effective, modern tax agency. ... [W]ithout adequate funding, the IRS will fail at its mission."

Here are some statistics from inside the IRS to back up Olson's judgement. "Since fiscal year (FY) 2010, the IRS budget has been cut by nearly eight percent. Over the same period, inflation has risen by about six percent, further eroding the IRS’s resources. ... The IRS workforce has been reduced from nearly 95,000 full-time equivalent employees in FY 2010 to about 87,000 in FY 2013, a decrease of eight percent."

Between the increased in tasks and the drop in resources, standards of service from the IRS are slipping. Here's a figure showing the record on phone service. The blue line shows what share of calls reach a Customer Service Representative: it was 87% back in 2004, but now is 61%. For those who get through, the average waiting time is up from about 2 minutes in 2004 to 17 minutes.

What about answering the mail? "When the IRS sends a taxpayer a notice proposing to increase his or her tax liability, it typically gives the taxpayer an opportunity to present an explanation or documentation supporting the position taken on the return. Each year, the IRS typically receives around ten million taxpayer responses, known collectively as the “adjustments inventory.” The IRS has established timeframes for processing taxpayer correspondence, generally 45 days. During the final week of FY 2004, the IRS failed to process 12 percent of its adjustments correspondence within its timeframes. During the final week of FY 2013, the IRS was unable to process 53 percent of its adjustments correspondence within the timeframes. As a corollary, the number of pending pieces of adjustments correspondence in open inventory increased as well. At the end of FY 2004, open inventory stood at about 348,000 letters. At the end of FY 2013, it consisted of about 1.1 million letters."

What about ongoing training for IRS employees so that they can understand all the changes in tax law? As part of the budget cuts, the training budget has been cut, too. "Per-employee spending dropped from nearly $1,450 per full time equivalent employee in 2009 to less than $250 in 2013. Most of the IRS operating divisions that interact directly with taxpayers fared worse than the agency as a whole."

Other issues abound. [T]he IRS has abandoned return preparation in its walk-in sites, which was already limited to the most vulnerable populations of taxpayers — the elderly, the disabled, and the low income. It also has shut down tax law assistance on the phones after April 15, and has significantly limited the scope of questions it is willing to answer during the filing season. Thus, in the United States today, tax preparation and filing assistance is now, for the most part, privatized. That is, for a taxpayer to comply with his or her requirement to file a tax return, the taxpayer generally must pay for assistance, pay for software, and pay for advice. This is an unprecedented change in tax administration and it is not a good one. It is particularly devastating when one considers that over 50 percent of prepared individual returns are completed by unenrolled return preparers— the very preparers the IRS is now hamstrung over regulating because of pending litigation in the federal courts. So while we hash out this issue in the courts, millions of taxpayers are exposed to the risk of incompetent and even fraudulent return preparers."

Of course, no one weeps over budget cuts at the IRS. But such cuts are foolish. Those at the IRS point out that if they have more money, they can do more enforcement, and will collect greater tax revenue. While this point is probably true, it requires an extremely stunted sense of public relations to think that the citizenry will make a clarion call for more tax enforcement.

To me, the more central problem is that 98% of the revenue collected by the IRS comes from voluntary efforts by citizens, and only 2% from enforcement actions.  The IRS collected $2.86 trillion in revenue last year. The 98% that is from volnntary compliance would be about $2.8 trillion. If the poor and declining service from the IRS leads to a drop in voluntary compliance of even 1%, that would be a revenue loss of $28 billion--and the total IRS budget is about $11 billion. If the voluntary compliance system were to break down more thoroughly, the costs and difficulties of rebuilding that system would be enormous. Nobody needs to love the IRS, but it only can function if most people who are complying voluntarily believe that it is focused on its job in an even-handed way. Both by becoming enmeshed in politics, and through declining service levels, the IRS is in danger of losing that minimally necessary level of public goodwill.

Thursday, April 10, 2014

American Centenarians

As a red-blooded economist, I have of course considered how long I am likely to live, with a suitable margin for error on either side, and then thought about best to arrange my lifetime patterns of earning and consuming income. Concerning life expectancy, my rule-of-thumb assumption has been that I won't live longer than 100 years. Partly this assumption is just round-number bias on my part. But it also meant that when I saw a just-released report by Brian Kincel of the U.S. Census Bureau on "The Centenarian Population: 2007–2011," my ears perked up.

Kincel notes that only about 55,000 Americans are over the age of 100--that is, 0.02% of the U.S. population. Census Bureau projections from 2012 suggest that the number of American centenarians will roughly double to 106,000 by 2020. By the time of my 100th birthday in 2060, the projections are for 690,000 centenarians, who at that point would be 0.16% of the U.S. population. 

Of course, given my gender, my chances of living to 100 are lower. Women make up 57% of the Americans 65 years of age or older, and 81% of those 100 or older. Partly as a result, 23% of men who are 100 years or over are married, compared with only 3% of women centenarians. However, 65% of male centenarians and 85% of women centenarians are widowed. 

For my financial planning purposes, it's distressing to note that 17.3% of those over 100 live in poverty, compared with 9.3% of those age 65 and older. As to sources of income, 83% of those over 100 receive Social Security, and they average $11,933 in annual income from the program. Only 24% of the centenarians get other retirement income, including survivor or disability pensions. For those receiving such income, it averages $13,408 per year. Only about 7% of centenarians receive Supplemental Security Income and 2% receive other cash public assistance income. Of course, these figures don't include in-kind public assistance in the form of Medicare or Medicaid (which pays for a lot of nursing home care).

The Census data also shows that about 1,600 centenarians are still earning income, and for this group, average earnings were $51,050. I can't figure out whether I want to be in this category when I grow up, or not.

I need to mull whether this information should cause me to alter my planning: perhaps I should plan my lifetime profiles of income and consumption based on the assumption that I don't live longer than 105 years?

Wednesday, April 9, 2014

Here Come the Robots?

A Czech playwright named Karel Čapek wrote a play called "Rossum's Universal Robots" in 1920, which was translated into English and performed in New York by 1922. The new word--"robot"--spread quickly into newspapers and public discussion. According to the Oxford English Dictionary, the term was suggested to Čapek  by his brother Josef. It referred back to the robot, which the OED defines as a "central European system of serfdom, by which a tenant's rent was paid in forced labour or service. Now hist. The system was abolished in the Austrian Empire in 1848."

Now, countless stories and movies later, there are ongoing predictions that the age of robots may be near. I'm not talking about automated factory robots, stuck in one place on a factory floor, little more than a swinging arm performing a repetitive function. The current discussion is about robots that are mobile, able to receive a variety of commands, and with the capability to carry them out. For example, the March 29 issue of the Economist has a lengthy cover story on the "Rise of the Robots." But I'll focus here on Stuart W. Elliott's article, "Anticipating a Luddite Revival," which discusses how robots will affect the future of human work. It appears in the Spring 2014 edition of Issues in Science and Technology.  Elliott did a literature review of the robot capabilities that are cutting edge and now becoming feasible as discussed in AI Magazine and IEEE Robotics & Automation Magazine from 2003 to 2012. Here, I'll refer to his discussion of the more recent capabilities of robots in  four areas: language capabilities, reasoning capabilities, vision capabilities, and movement capabilities.

Language capabilities. "[T]he tasks included screening medical articles for inclusion in a systematic research review, solving crossword puzzles with Web searches, answering Jeopardy questions with trick language cues across a large range of topics, answering questions from museum visitors, talking with people about directions and the weather, answering written questions with Web searches, following speech commands to locate and retrieve drinks and laundry in a room, and using Web site searches to find information to carry out a novel task."

Reasoning capabilities. "[T]he tasks included screening medical articles for inclusion in a systematic research review, processing government forms related to immigration and marriage, solving crossword puzzles, playing Jeopardy, answering questions from museum visitors, analyzing geological landform data to determine age, talking with people about directions and the weather, answering questions with Web searches, driving a vehicle in traffic and on roads with unexpected obstacles, solving problems with directions that contain missing or erroneous information, and using Web sites to find information for carrying out novel tasks. One of the striking aspects of the reasoning systems was their ability to produce high levels of performance. For example, the systems were able to make insurance underwriting decisions about easy cases and provide guidance to underwriters about more difficult ones, produce novel hypotheses about growing crystals that were sufficiently promising to merit further investigation, substantially improved the ability of call center representatives to diagnose appliance problems, achieved scores on a chemistry exam comparable to the mean score of advanced high-school students, produced initial atomic models for proteins that substantially reduced the time needed for experts to develop refined models, substituted for medical researchers in screening articles for inclusion in a systematic research review, solved crossword puzzles at an expert level, played Jeopardy at an expert level, and analyzed geological landform data at an expert level."

Vision capabilities. "[T]he tasks included recognizing chess pieces by location, rapidly identifying types of fish, recognizing the presence of nearby people, identifying the movements of other vehicles for an autonomous car, locating and grasping objects in a cluttered environment, moving around a cluttered environment without collisions, learning to play ball-and-cup, playing a game that involved building towers of blocks, navigating public streets and avoiding obstacles to collect trash, identifying people and locating drinks and laundry in an apartment, and using Web sites to find visual information for carrying out novel tasks such as making pancakes from a package mix."

Movement capabilities. "[T]he tasks included moving chess pieces, driving a car in traffic, grasping objects in a cluttered environment, moving around a cluttered environment without collisions, learning to play ball-and-cup, playing a game that involved building towers of blocks, navigating public streets and avoiding obstacles to collect trash, retrieving and delivering drinks and laundry in an apartment, and using the Web to figure out how to make pancakes from a package mix."

Elliott compares the emerging capabilities of robots to the capabilities that the U.S. Department of Labor says are necessary for many jobs, and find that about 80% of U.S. jobs have the capacity to be substantially disrupted by the new robots. But of course, the concern that automation and robots will lead to dramatic changes in the world of work have long been with us. Back in the 1960s, for example the concern that automation would reduce the number of jobs was strong enough that in 1964, Lyndon Johnson signed into law a National Commission on Technology, Automation, and Economic Progress. Here are a few of his comments from a half-century ago:
"Automation is not our enemy. Our enemies are ignorance, indifference, and inertia. Automation can be the ally of our prosperity if we will just look ahead, if we will understand what is to come, and if we will set our course wisely after proper planning for the future. ... The techniques of automation are already permitting us to do many things that we simply could not do otherwise. Some of our largest industries, some of our largest employers would not exist and could not operate without automation ... We could not provide our great shield for the security of this country and the shield for the security of the free world if we did not have automation in the United States. If we understand it, if we plan for it, if we apply it well, automation will not be a job destroyer or a family displaced. Instead, it can remove dullness from the work of man and provide him with more than man has ever had before."
Maybe this wave of robots and automation will be more disruptive than anything which came before, but it's worth remembering that previous technological shifts, like the movement away from farms to cities, were highly disruptive as well. Automation has been proceeding in the high-income economies for about two centuries, and it hasn't yet caused a long-run upward trend in the unemployment rate. Lest we forget, the U.S. unemployment rate was under 6% for four consecutive years from 2004-2007. 

In my own life, I think about how much time I spend each week on tasks like driving, doing laundry, folding and putting away clothes, making the bed, loading and unloading the dishwasher, setting the table, food preparation. Household robots would free up time, and ultimately, we all face an unbreakable  constraint that each week has only 168 hours. For the US economy as a whole, prosperity, jobs, and a rising standard of living are a lot more likely to be found in ways that workers of all skill levels can use robots to complement their efforts, than in attempting to freeze technology in place. And remember, in a globalized economy the US could conceivably decide not to limit the use of robots here, but it will not stop them from being widely deployed elsewhere.

Tuesday, April 8, 2014

Will Real Interest Rates Bounce Back?

Back around 1983, I remember visiting friends in San Diego and making a day-trip over into Mexico. As we crossed the border, I remember billboards advertising that banks were paying an interest rate of 80% on deposits, which sounds like a good deal, unless you also happened to recognize that the interest rate was being paid in Mexican pesos, and Mexican inflation at that time was spiking over 100%.  The real interest rate--the nominal rate minus inflation--was negative.

The world economy has been going through a period with extremely low real interest rates in the last few years, and the IMF examines the causes and likely future patterns in Chapter 3 of the most recent World Economic Outlook report: "Perspectives on Global Real Interest Rates."

Here's a figure to get a sense of real interest rates in the last few decades. The blue line shows the nominal interest rate paid on 10-year government bonds: it's an average for the United States, Germany, France, and the United Kingdom. The red line shows average annual inflation across these countries. The spike in global inflation in the 1970s meant that real interest rates were near-zero for a few years. But after inflation dropped in the mid-1980s, real interest rates were positive until the global financial crisis; for example, around 2000 real interest rates were typically in the range of 3-4%. But in the aftermath of the global financial crisis, real interest rates have been near-zero.

What factors explain this change, and are real interest rates likely to bounce back in the near future? As the figure shows (if you squint just a bit), the drop in real interest rates is not purely an effect from the Great Recession. The inflation rate has been more-or-less the same at about 2% per year since the early 1990s, but the nominal interest rate on 10-year government bonds has been in steady decline--which together imply a falling real interest rate over time.

Of course, the real interest rate is just a price. It's the price you pay pay for borrowing, or the price you receive for saving. When a price falls, economists look to the basic supply-and-demand model to organize their thinking. Either a rise in the supply of savings going into the low-risk government bonds or a fall in the demand for borrowing, or both, could result in a lower real interest rate. Increases in the supply of saving at the global level can come from higher private saving, higher government saving (that is, lower budget deficits or budget surpluses), or monetary policy. The demand for borrowing can come from private-sector investment demand or from a shift in portfolios in which many investors looking for lower risk decide to shift some of their funds toward government bonds and away from other assets. After looking at the data, the IMF lays out the main patterns over time this way:

On the demand or investment side, global investment relative to GDP has stayed relatively constant over time, but the ratio has risen sharply since 2000 for emerging market economies while falling in advanced economies. Of course, this change has implications for where growth will occur in the future. The IMF suggests that investment levels in advanced economies are not likely to recover to pre-crisis levels for the next five years, so there is unlikely to be a surge of demand for borrowing from this area that would drive up real interest rates.

On the supply side, the global economy has seen more saving along with portfolio shifts that lead more of that saving to be invested in safe assets like government bonds : "A large increase in the emerging market economy saving rate between 2000 and 2007 more than offset a reduction in advanced economy public saving rates. ... Portfolio shifts in the 2000s in favor of bonds were due to higher demand for safe assets, mostly from the official sector in emerging market economies, and to an increase in the riskiness of equity relative to that of bonds. These shifts led to an increase in the real required return on equity and a decline in real rates—that is, an increase in the equity premium." Here's a figure showing the rise in savings rates relative to GDP in emerging markets.

Finally, monetary policy can of course affect interest rates, inflation, and the gap between them; indeed, the IMF argues that the story of real interest rates in the 1970s and 1980s is largely about monetary policy. But at least in the next few years, it seems unlikely that central banks will seek to push up real interest rates.

Thus, the overall prediction is that investment in advanced economies will rise a bit, and the savings rate in emerging economies will sag a bit, but the rise in real interest rates will be muted for the next few years. As the IMF writes: "In summary, real [interest] rates are expected to rise. However, there are no compelling reasons to believe in a quick return to the average level observed during the mid- 2000s (that is, about 2 percent)."