Jobs Increase, but So Does Unemployment Rate: Why?

The April 2010 employment report from the Bureau of Labor Statistics highlighted a paradox that often crops up in the early stages of a recovery. Payroll jobs rose by 290,000 in the month, the strongest growth in four years. The household job survey, which includes farm jobs and the self-employed, showed an even bigger gain of 550,000 jobs. Yet the unemployment rate rose from 9.7 to 9.9 percent, reversing its earlier decline. How can this be?

The answer lies in the way the unemployment rate is calculated, as the percentage of members of the labor force who are unemployed. With a few exceptions, to be counted in the labor force, a person must be either working or actively looking for work. That means "discouraged workers," who would like to work but don't look for a job because they think there is nothing out there, are not counted in the unemployment rate.

In the early stages of a recovery, there is often a period when an improving job market draws many previously discouraged workers back into the labor force. Some of these new job seekers, but not all, actually find work, so both the numerator and denominator of the unemployment rate increase. If the denominator (the labor force) increases proportionately more than the numerator (the number of unemployed), then the unemployment rate rises. That is exactly what happened in April, when 805,000 people entered the labor force but only 550,000 of them found jobs.

At times like the present, a less-noticed statistic, the employment-population ratio, can provide a more reliable indicator of the health of the job market. The Employment population ratio hit a low for the cycle in December 2009 and has risen each month since then, although it still lies well below its cyclical peak.

Follow this link to download a free set of PowerPoint slides interpreting the latest jobs reports. If you like the slides, please post a comment to let other readers know how you use them in your class.

GDP Data Show Continued Modest Growth

The advance GDP data for the first quarter of 2010 show continued moderate growth for the U.S. economy. The economy grew in the quarter at a 3.2 percent annual rate. Although slower than the 5.6 percent logged in Q4 2009, this was the third consecutive quarter of positive growth.

Consumer expenditure was the strongest driver of growth in the quarter. Private inventory accumulation, which turned positive for the first time since early 2008, also helped boost growth. Fixed investment was positive; a gain in its nonresidental component offset a slight fall in housing investment.

In the foreign sector, exports continued to grow, although less rapidly than in the previous quarter. Imports grew even more strongly, so net exports made a negative contribution to overall GDP growth. Government purchases grew slightly in absolute terms, but fell as a share of GDP, as stimulus spending winds down.

Overall, the report provides ground for cautious optimism. However, there are a few negative factors. One is the fact that consumer spending grew, in part, at the expense of saving, which fell to 3.0 percent of personal income. An increase in consumption at the expense of falling saving is not sustainable in the long run.

To download a free set of PowerPoint slides that presents the GDP data in a format you can use in your principles of economics course, follow this link. If you find the slides useful in your course, please post a comment!

Diamonds: How To Price a Finite Resource

What do you do if you are a company like De Beers, the South African diamond producer, and you own a resource that you believe to be finite? This is the actual situation faced by the mining giant, which believes that no big new diamond mines will be found in the foreseeable future. If the decision were up to you, how fast would you dig out the remaining diamonds that you own?

According to standard economic theory, the solution depends on opportunity cost. The opportunity cost of mining a diamond today is one less diamond to mine in the future, when the price may be higher. But the opportunity cost of leaving the diamond in the ground is less current revenue, which could be invested in some alternative asset like U.S. Treasury bonds. This reasoning suggests, then, that the interest rate on bonds is a good approximation for the opportunity cost of present vs. future production.

De Beers seems to think this way, too. Because it accounts for 40 percent of world diamond output, its supply decisions have a substantial impact on diamond prices, both now and in the future. It has recently announced that it will limit production to 40 million carats per year, well below the rate of production before the global economic crisis. Its aim in restraining production is to allow future diamond prices to rise at a target rate of about 5 percent per year. Could it be only coincidence that this is almost exactly the current yield on U.S. Treasury bonds?

Follow this link to download a free set of PowerPoint slides that discusses De Beers' pricing strategy in terms of supply and demand. You are welcome to use these slides in your economic course, either as part of your lectures, or as an independent reading for your students.

Who Should Celebrate, Who Should Mourn on Tax Day?

On Tax Day, April 15, protesters gathered on town squares and along city streets around the country. "BORN FREE, TAXED TO DEATH!" was the text of one popular sign. Who were these protesters? For which taxpayers does protest of the federal income tax, and other taxes, really make sense?

Not, it seems, for taxpayers in lower income brackets. According to IRS estimates, for the 2009 tax year, some 47 percent of all households will pay no federal income tax. Many of those will actually receive payments from the government under the Earned Income Tax Credit, and other tax credits.

In 2007, the most recent year for which full data are available, tax units in the lower half of the income distribution paid just 3 percent of all federal income taxes. (Tax units are not quite the same as households. One household may contain more than one tax unit, for example, spouses filing separately.) The top 1% of tax units paid 40% of all income taxes. The middle class, defined as tax units with $32,000 to $113,000 adjusted gross income, paid a surprisingly light 16% of the total.

Of course, the federal income tax is not the only tax, even if the most vigorous protests occur on the day income taxes are due. For lower income taxpayers, the payroll tax (Social Security and Medicare) is the most burdensome tax. Upper bracket taxpayers pay substantial sums in estate, capital gains, and corporate income taxes. State and local taxes are another burden that nearly everyone shares. The average rate for such taxes is 9.7 percent, varying widely from state to state.

Compared with the rest of the developed world, Americans are lightly taxed. Japan is the only high-income country with a lower average tax rate than the United States. Taxpayers in Denmark and Sweden are at the top of the list, forking over just under half of their total incomes to their governments.

So should we celebrate or mourn on tax day? We should celebrate the fact that our tax burdens are fairly low by world standards. However, that does not mean that all is well with the U.S. tax system. Our tax system is inefficient and overly complex. Whether we think the average tax burden should be lowered, raised, or left the same, the tax system calls out for reform. Proposed reforms will be the subject of future posts.

To download a free set of PowerPoint slides on the distribution of the U.S. tax burden, follow this link. If you find the slides useful in your economics courses, please post a comment and become a follower of this blog.

The Economics of a Soda Tax

Taxes go in and out of fashion. The hottest tax fad of 2010 is the "soda tax," usually interpreted as a tax extending to all sugary beverages, not just carbonated soft drinks.

The popularity of a soda tax is driven by claims that it attacks two of the country's biggest public policy issues: government budget deficits and health care costs. These claims are based on studies in the medical literature that show a strong link between soda consumption and obesity, and in turn, between obesity and rising health care costs. Several states, most recently Washington, have already instituted soda taxes, and the proposal is under consideration at the federal level.

The effects of a soda tax would depend, among other things, on the elasticity of demand for soft drinks. Many discussions of the policy cite an estimated demand elasticity of .79 put forward by Yale University's Rudd Center for Obesity and Food Policy. (Follow this link to the Center's policy brief on the topic.) Closer examination suggests, however, that the research underlying this number is not terribly solid. The .79 estimate comes from a meta-analysis by the Rudd Center's Tatiana Andreyeva and colleagues. The 14 previous elasticity studies they consulted included estimates ranging from 0.13 to 3.18. Revenue estimates put forward by the center assume perfectly elastic supply, so that the tax would be fully passed along to consumers.

A soda tax would produce both revenue for the government and a potential deadweight loss of foregone producer and consumer surplus. However, proponents maintain that like "sin taxes" on alcohol and tobacco, a soda tax would provide offsetting gains in the form of reduced deadweight losses from negative externalities. Potentially, a properly calibrated soda tax would both boost government revenue and raise economic efficiency.

To download a free set of PowerPoint slides on the economics of the soda tax, ready for use in your principles of economics course, follow this link. If you find the slides useful, please post a comment.

Appreciation of the Yuan: Good for the US, Good for China, Too

From 2005 until the onset of the global economic crisis, China had allowed its currency, the yuan, or RMB, to appreciate gradually relative to the U.S. dollar. The appreciation was halted in July 2008. Since that time, China has held the exchange rate fixed at close to 6.8 yuan per U.S. dollar. Now China may soon allow the yuan to begin appreciating again. Why?

During the worst phase of the crisis, a weak yuan served Chinese interests well. Preventing appreciation helped keep the price of Chinese exports low for buyers in the United States and elsewhere. At the same time, it raised the price of imports to Chinese buyers. As a result, China's current account surplus shrank only moderately during the crisis. Together with other expansionary policies, including a huge government stimulus package and encouragement of rapid growth of bank lending, the currency policy allowed China to keep its economy expanding through 2008 and 2009. It its worst quarter, growth of Chinese GDP never fell below 6 percent.

 The effects of China's currency policy were not so welcome in the United States. A weak yuan meant that importing from China was more attractive and exporting to China was harder. That kept the U.S. current account surplus high and slowed U.S. recovery from the recession. Angry voices in Washington and elsewhere have labeled China a "currency manipulator" and demanded renewed appreciation of the yuan.


China's leaders would be very reluctant to be seen to revalue the yuan in response to foreign pressure. However, they have other reasons to consider a change in currency policy. A weak yuan has unpleasant unintended consequences for China, too. In order to prevent appreciation of the currency, the Chinese central bank must purchase billions of U.S. dollars to add to its currency reserves. Those dollars a paid for with newly issued yuan, causing China's money stock to grow at an annual rate averaging more than 30 percent.

Although the central bank has used administrative controls, sterilization, and other tools to help contain inflation, it is getting harder and harder to stem the tide. After several months of mild deflation in mid-2009, the Chinese consumer price index is beginning to rise again. Although CPI inflation is still moderate at about 2% (as of February), inflationary pressures are more strongly felt in the labor market and the housing market of coastal cities.

The bottom line: Chinese leaders now seems poised to allow the yuan to begin appreciating again, not because of U.S. pressure, but primarily to restore macroeconomic balance to their own economy.

To download a free set of PowerPoint slides with graphs and discussion related to Chinese currency policy, follow this link. If you find these slides useful in your economics classes, please post a comment or send me an e-mail.

The Greek Budget Crisis: Some Comparisons with the United States

In recent weeks, the European Union, especially the 16 countries that share the euro as their currency, has been shaken by a fiscal policy crisis in Greece.

Greece has the worst fiscal policy position of any EU country, with net government debt of more than 100 percent of GDP and a budget deficit of more than 12 percent of GDP. Official euro area fiscal policy rules mandate a debt ratio of no more than 60 percent, and a deficit of no more than 3 percent.

After last year's elections, fear that the Greek government was unable to manage its finances frightened lenders. By February, they were willing to roll over Greek government debt only at punitively high interest rates, more than 3 percentage points higher than those paid by countries like Germany and the United States.

Faced with this kind of crisis, a government has only three options: default on its debt;  pay its bills with newly issued money (even at the risk of runaway inflation); or implement harsh fiscal reforms. As a member of the euro area, Greece lacks an independent central bank, so the option of monetization is technically impossible. As a member of the European Union, default was unthinkable. In the end, Greece was pressured by its neighbors into painful tax increases and spending cuts, at the cost of strikes and violence in the streets.

How does the fiscal situation of Greece compare with that of the United States? Side-by-side comparisons of Greek and US data show some sobering parallels. Neither country took advantage of the boom years of the mid-2000s to put its fiscal house in order. During the crisis, the US deficit has risen as high as that of Greece, and the US national debt is fast approaching the 100 percent level that Greece has already breached.

The bottom line: The middle of a recession is the worst time to carry out painful tax increases and spending cuts. However, that is exactly what countries are forced to do if they do not make timely reforms during years of prosperity. The United States still has a strong credit rating, at least for the time being, so it has escaped a Greek-style budget emergency during the current recession. Unfortunately, projections by the U.S. Congressional Budget Office show no sign on the horizon of needed reforms. If business-as-usual continues in Washington, a crisis is only a matter of time.

Follow this link to download a free set of PowerPoint slides with a discussion of the Greek budget crisis, including graphs with side-by-side comparisons of Greek and US data. If you find this material useful in your courses, please post a comment or send me an e-mail.