Author Archives: James Kwak

A New Economic Vision, in 27 Words

By James Kwak

A couple of weeks ago I posted a 6,000-word essay laying out a new economic vision for the Democratic Party. It kind of vanished into the ether, although Stephen Metcalf was kind enough to say this:

So here it is, in 27 words:

All people need a few basic things:

  • An education
  • A job
  • A place to live
  • Health care
  • A decent retirement

Let’s make sure everyone has these things.

If you want more, there is always the long version.

The Importance of Fairness: A New Economic Vision for the Democratic Party

By James Kwak

A lot has been written recently about the direction of the Democratic Party. This is what I think.

I have been a Democrat my entire life. Today, the Democratic Party matters more than ever because it is the only organization currently capable, at least theoretically, of preventing the Republicans from turning the United States into a fully-fledged banana republic, ruled by and for a handful of billionaire families and corporate chieftains, with a stagnant economy and pre-modern levels of inequality. Yet I cannot find anything to disagree with in Senator Bernie Sanders’s assessment:

“The model the Democrats have followed for the last 10 to 20 years has been an ultimate failure. That’s just the objective evidence. We are taking on a right-wing extremist party whose agenda is opposed time after time and on issue after issue by the vast majority of the American people. Yet we have lost the White House, the U.S. House, the U.S. Senate, almost two-thirds of the governors’ chairs and close to 900 legislative seats across this country. How can anyone not conclude that the Democratic agenda and approach has been a failure?”

A central shortcoming of the party is that, on economic issues, it has nothing to say to people trapped on the wrong side of our country’s growing inequality divide. Hillary Clinton won the “working class” (household income less than $50,000) vote, but by a much smaller margin than Barack Obama in 2012 or 2008—despite Donald Trump’s ardent efforts to alienate African-Americans and Latinos. Some people voted for Trump because of racism or misogyny. But Clinton was also flattened by Trump among voters who feel their financial situation was worse than a year before or who think that life will be worse for the next generation. She lost the Electoral College in the “rust belt” states of the Upper Midwest, whose economies have never fully recovered from the decline of American manufacturing.

The Democratic Party was once the party of working people. So why is it increasingly becoming the party of well-educated, socially tolerant, cosmopolitan city-dwellers? Because, in an age of stagnant median incomes and a disintegrating social safety net, Democrats have no economic message for the many people who are struggling to make ends meet, to pay for college, to stay in a home, or to save for retirement.

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Economism and Arbitration Clauses

By James Kwak

As banking scandals go, Wells Fargo opening millions of new accounts for existing customers so that it could pump up its cross-selling metrics for investors is about as clear-cut as it gets. It’s up there with HSBC telling its employees how to get around U.S. regulations in order to launder money for drug cartels, or traders and treasury officials at several banks conspiring to fix LIBOR.

Holding Wells responsible, however, was a bit trickier. The bank agreed to restitution (i.e, refunding the fees it had collected from its customers for the phony accounts) and a paltry $185 million in fines. When customers sued for damages, however, Wells hid behind its mandatory arbitration clauses, which were so broadly written that they even applied to accounts that the customer never intended to exist and that the bank had fraudulently created. Wells eventually reached a settlement with the class of plaintiff customers, but the settlement amount was no doubt influenced by the bank’s ability to compel arbitration.

The Consumer Financial Protection Bureau has proposed to eliminate the Wells Fargo defense by prohibiting class action waivers—clauses that take away customers’ right to participate in class action lawsuits—in arbitration clauses of financial contracts. (Class actions are crucial to deterring and punishing systematic fraud against consumers, because the harm to any single person will not be worth the expense of pursuing a lawsuit; without a class action, no one will sue, and the company will escape unharmed.)

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How Markets Work

By James Kwak

The Congressional Budget Office’s assessment of the Republican health care plan, as passed in the House, is out. The bottom line is that many more people will lack health coverage than under current law—23 million by 2026—even though the bill allows states to relax the essential health benefits package, which should in theory attract younger, healthier people. This is not a surprise.

I just want to comment on the role of markets in all of this, which I think is not fully understood. For example, the Times article by the very up-to-speed Margot Sanger-Katz explains that the American Health Care Act of 2017 will make markets “dysfunctional.”

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This is consistent with the rosy view that many people, particularly centrist Democrats, have of health care: if we could only get markets to behave properly (correct for market failures, to use the jargon), everything would be great.

But that’s not how markets work.

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Fees Add Up

By James Kwak

Public pension funds are having a tough time. On the one hand, the average funding ratio (assets as a percentage of the present value of future obligations) is below 80% because of inadequate contributions by sponsors (states and municipalities) and poor investment returns since the collapse of the technology bubble in 2000. On the other hand, because pensions responded to low returns by shifting more of their money into hedge funds and private equity funds, a larger proportion of their assets is siphoned off as investment fees each year.

Unlike some people, I am not against hedge funds and private equity funds in principle. I think it’s highly likely that there are people who can beat the market on a sustained basis—particularly if they are people who are especially good with computers—both for theoretical reasons (someone has to be the first person to discover each relevant piece of information or actionable pattern) and empirical reasons (see Fama and French 2010, for example). Hedge funds have lagged the stock market in recent years, but what critics sometimes overlook is that they are supposed to trail the market in boom periods, because many target a beta of around 0.5. But I am mystified by the fact that, in what is supposed to be a highly competitive and innovative industry, the price of investing in a hedge fund has stayed virtually fixed at 2-and-20 (2% of assets, plus 20% of investment returns) for decades.

The consequences of these high prices are added up in The Big Squeeze, a new report sponsored by the American Federation of Teachers. Because true investment fees are usually not disclosed—fund managers insist that they are confidential and require investors not to divulge them—the report simply quantifies the potential savings from reducing fees from 1.8-and-18 to 0.9-and-9. This may seem arbitrary, but I know anecdotally that some funds, even big ones, are charging something like 1-and-10 even to ordinary investors. Since state pension funds are some of the biggest investors that exist, you would think they would be able to negotiate even lower fees.

Not surprisingly, the numbers involved add up quickly. Lower fees over the past five years would have saved the average pension fund included in the study $1.6 billion; to put things in perspective, it would have improved the aggregate funding ratio for these funds by more than two percentage points, which is nothing to sneeze at.

The important question is why high fees persist despite the potential market power of big pension funds. There are probably multiple explanations. One is a culture of secrecy, which makes it difficult for any fund to find out what other funds are paying. Another is the marketing prowess of fund managers, who are adept at explaining when their fund is unlike any other in the world and therefore merits its high fees. A third is that pension fund managers are playing with other people’s money (in this case, the other people are the fund’s beneficiaries—teachers, firefighters, and other government employees)—and may be more interested in ingratiating themselves with the asset management industry than with getting the best deal they can. (This is even more likely the case for the investment consultants who match pension funds with asset managers.) But in a political climate that makes tax increases on rich fund managers unlikely, state governments could achieve the same results by taking a harder line on investment management fees: requiring public disclosure of all fees or even imposing hard fee caps for pension fund investments. With the amount of money involved, it’s hard to imagine that major pension funds couldn’t find anyone competent to take their money for 0.9-and-9.

Soak the Poor, Feed the Rich

By James Kwak

After the dangerous clown show that has been the Trump White House, it’s comforting to return to some good, old-fashioned conservative policymaking: bashing the poor to cut taxes on the rich. I’m talking, of course, about the Republican plan to repeal and replace Obamacare.

Health care financing can sometimes seem like a complicated topic. Adverse selection, risk adjustment, blah blah blah. But it’s easy to understand the American Health Care Act or, as it is sure to be known, Trumpcare. In the medium term, financing policies have little effect on the price of health care. At most we can hope to “bend the [long-term] cost curve.” So health care policy essentially comes down to a single question: Who pays?

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Review Copies of Economism

By James Kwak

If you teach introductory economics or introductory micro, at either the high school or university level, and you’re interested in possibly using Economism in your class, let me know and I’ll send you a (free) review copy. Just email me at james.kwak@uconn.edu from your school account, tell me what class you are thinking of assigning the book to, and let me know your shipping address, and I’ll order a copy for you.*

Quick summary: The central theme of Economism is that some of the basic models taught in “Economics 101” have acquired disproportionate influence in contemporary society and are routinely and systematically misapplied to important policy questions. The problem is not that introductory models are wrong, but that too many people forget their limitations and believe that their simple conclusions can be reflexively applied to the real world. As Paul Samuelson said in the first edition of his textbook, the idea that “any interference with free competition by government was almost certain to be injurious … is all that some of our leading citizens remember, 30 years later, of their college course in economics.” In chapters on labor markets, taxes, trade, and other topics, Economism first walks through the implications of introductory models before explaining how a richer understanding of economic reality, including empirical research, teaches different and more interesting lessons.

If you worry that the typical first-year curriculum produces too many students who think unregulated markets are the answer to every problem, Economism may be the antidote you need. In the Financial Times, Martin Sandbu wrote, “Economics lecturers, take note: include [Economism] on your syllabus and set aside ample time to discuss its arguments in class.” The book has also received praise from many economists including Ian Ayres (Yale Law School), Jared Bernstein (former chief economic adviser to Vice President Joe Biden), Heather Boushey (chief economist, Washington Center for Equitable Growth), Simon Johnson (MIT Sloan; former chief economist, IMF; and my frequent co-author), Dani Rodrik (Harvard), and Noah Smith (Bloomberg View).

For more about the book, you can visit economism.netThe Atlantic also published an excerpt. (It’s basically the first half of the labor market chapter, on the minimum wage; the second half of that chapter deals with the compensation of very high earners.) And again, email me if you want a review copy.

(Note: I’m not doing this for the money; I’m doing it to get the book in the hands of as many students as possible. I have donated all of my royalties from 13 BankersWhite House Burning, and Economism to charitable organizations. I can’t anticipate my financial situation for the rest of my life, but I will donate all royalties from Economism for at least the next five years.)

* The fine print (updated): In the past twelve hours, the large majority of requests I’ve gotten have not actually been from people who teach introductory economics classes, so here are some clarifications:

  • You know how publishers send you review copies of textbooks, hoping that you’ll assign them to your students? This is the same thing. That’s why I ask that you tell me what class you might use the book in. If it isn’t introductory economics or introductory micro, or if you don’t specify a class, I may send you a review copy, but only after seeing how many requests I get from people who are teaching those classes.
  • I’m not actually going to try to check what your teaching schedule is, so this is on the honor system. But please remember that I’m paying for these books, not the publisher.
  • Let me know if you prefer hard copy or Kindle. If the latter, I need to know the email address of your Amazon account.
  • Non-U.S. requests: I can’t send hard copies outside the U.S. because I’m ordering the books individually from Amazon. (It’s too much work for me to mail them individually.) I can send you a Kindle copy. So please send me the email address of your Amazon U.S. account; I don’t think the book is for sale from most other Amazon subsidiaries, and in any case I’m buying the books with my Amazon U.S. account.