Larry Summers weighed in on the famous Reinhart-Rogoff Excel spreadsheet error in a Washington Post column this morning. His first big lesson from the debate is:

Anyone close to the process of economic research will recognize that data errors like the ones they made are distressingly common.

Summers immediately demonstrates the truth of this assertion as he tries to make a second point about inferring the future based on statistical regularities from the past.

Trillions of dollars have been lost and millions of people have become unemployed because the lesson learned from 60 years of experience between 1945 and 2005 was that ‘American house prices in aggregate always go up.’ This was no data problem or misanalysis. It was a data regularity until it wasn’t. The extrapolation from past experience to future outlook is always deeply problematic and needs to be done with great care.

The problem with Summers story is that American house prices in aggregate did not always go up. In fact, for the century from 1896 to 1996 they just kept pace with the overall rate of inflation. Here’s the story using government data from 1953. (Robert Shiller constructed a series going back to 1896 from a variety of data sources.)

Source: Bureau of Labor Statistics, Federal Housing Finance Authority, and Author’s calculations.

It was easy to see that house prices, adjusted for inflation, did not have a clear upward trend until the bubble started to propel prices upward in the late 1990s (yes, coinciding with the stock bubble, just like Japan). For some reason Larry Summers chose not to notice the data right in front of his eyes both at the time and apparently even to this day. (What is it about Harvard economists and data?) So yes, the tendency for economists to misread data is distressingly common and will probably continue to be as long as economists who make such errors face no consequence in terms of their career or public standing. (At least, this is what economic theory would predict.)

While it is tempting to end on this note, it is important to take issue with Summers’ lesson #3:

Third, while Reinhart and Rogoff’s work was shown not to support the claims made by prominent right-leaning U.S. and British figures regarding the urgency of deficit-reduction efforts, much of the joy taken on the left in their embarrassment is inappropriate. It is absurd to blame them for austerity policies. The authors of those policies chose the policies first and then cast about for intellectual ballast. While there may be no threshold beyond which debt becomes catastrophic, and while the British and American experiences both suggest that fiscal contraction in a slack economy where interest rates are near zero is inimical to growth, it is a grave mistake to suppose that debt can or should be accumulated with abandon.

It’s nice of Professor Summers to offer this lecture to the left. (Maybe he’ll offer an expanded version in a MOOC.) I suspect that just about everyone on the left knows that the politicians pushing austerity couldn’t care less about Reinhart and Rogoff’s arguments. However, their work was very valuable in providing intellectual cover. It is much easier for politicians to say that they are cutting programs like Social Security and throwing people out of work because they fear an economic crisis than to say they are doing it just to ensure that corporate profits stay high and rich people don’t have to pay higher taxes. For this reason, Reinhart and Rogoff’s work was very important for the austerity policies that have been implemented in much of the world.

As far as his point that, “it is a grave mistake to suppose that debt can or should be accumulated with abandon,” it would be interesting to know who he thinks he is arguing with. The vast majority of the left have argued that we need not worry about deficits now. There are few, if any, economists on the left or elsewhere who say that debt levels or deficits would never be a problem. So, let’s give Professor Summers a big victory over his straw man opponent!

Dean Baker is co-director of the Center for Economy and Policy Research. He also writes a regular blog, Beat the Press, where this post originally appeared.

Showing the sort of creativity that we have come to expect from economists, Tyler Cowen used his NYT column today to call for giving more money to the pharmaceutical industry as a way to deal with the risks of pandemics. Cowen moves from the true statement that research and development into prescription drugs and public health more generally has a substantial public good character, to the idea that we need to give pharmaceutical companies more money in order to get them to do the research.

In discussing the issue of protecting the public against pandemics Cowen tells readers:

“If anything, the American government — or, better yet, a consortium of governments — should pay more for pandemic remedies than what market-based auctions [of patent rights] would yield. That’s because, if a major pandemic does arise, other countries may not respect intellectual property rights as they scramble to copy a drug or vaccine for domestic distribution. To encourage innovations, policy makers need to bolster the expectation of rewards.”

For reasons that Cowen never bothers to mention, he excludes the possibility that patents may not be the best way to finance research. The patent system does provide any incentive to innovate but it also provides an enormous incentive to misrepresent research results and deceive the public and regulators about the quality and safety of drugs. We see this happening all the time, exactly as economic theory predicts. (Think of Vioxx.) The result is considerable damage to public health and an enormous economic waste as money is paid to pharmaceutical industry for drugs that are ineffective or possibly even harmful.

Patents also give an incentive for duplicative research. If a company has a major breakthrough drug that produces high profits then its competitors have a substantial incentive to try to duplicate this drug in a way that circumvents the patent. In a regime where patents provide a monopoly, the availability of potential substitutes will have the benefit of bringing the price down, however if the drug were already selling at its free market price, without a patent monopoly, no one would look to waste resources developing a second drug that essentially does the same thing as the first drug.

Patent financed research also slows progress by encouraging secrecy. Science advances best when results are shared as widely as possible. Companies that are relying on patent financing will only make the bare minimum of their research available to the larger scientific community, providing the information needed to secure patents. They have enormous incentive to withhold any additional information that could provide benefits to competitors.

Patent financing also distorts research toward finding patentable treatments for diseases. If a disease can be best controlled through diet, exercise, or controlling pollutants, patents will provide zero incentive to carry out research in the proper direction. Instead resources will be wasted on trying to develop a patentable drug.

There are alternative routes to supporting research. We already spend $30 billion a year on biomedical research through the National Institutes of Health. Even the pharmaceutical industry argues that this money is extremely well spent. There is no obvious reason that funding could not be doubled or even tripled with the idea of replacing the patent financed research currently undertaken by the drug industry.

The funding could be channeled through the private sector, even through the existing drug companies. The difference would be that all research findings would be made publicly available as soon as practical and all patents would be placed in the public domain.

The model for this sort of funding would be the defense industry. In spite of many incidents of over-payment and outright fraud, public funding in this sector has not prevented the United States from having by far the most powerful military in the world.

Furthermore, a public contractor system in the pharmaceutical sector would have the enormous advantage that everything would have to be made fully public as a condition of getting funding. While there are legitimate grounds for secrecy in the research of weapons systems, there are no legitimate grounds for keeping medical research secret.

Of course this route would likely damage pharmaceutical industry revenue and profits. The patent system allows drug companies to charge hundreds or even thousands of dollars for prescriptions that would sell for $5-$10 in a free market. These monopolies are equivalent to imposing a tax of $250 billion a year or $3.0 trillion over the next decade on the American people. Needless to say, they would be very unhappy about losing this taxing power in exchange for the nickels and dimes they would get paid for carrying through this research.

This might be why economists almost never discuss the topic. Instead we get endless harangues about the need to spend less on Social Security and Medicare as in Cowen’s piece today.

Carmen Reinhart

Kenneth Rogoff

Carmen Reinhart and Ken Rogoff, used their second NYT column in a week, to complain about how they are being treated. Their complaint deserves tears from crocodiles everywhere. They try to present themselves as ivory tower economists who cannot possibly be blamed for the ways in which their work has been used to justify public policy, specifically as a rationale to cut government programs and raise taxes, measures that lead to unemployment in a downturn.

This portrayal is disingenuous in the the extreme. Reinhart and Rogoff surely are aware of how their work has been used. They have also encouraged this use in public writings and talks. While it is unfortunate that they have “received hate-filled, even threatening, e-mail messages,” as one who works in the lower-paid corners of policy debates, let me say, welcome to the club.

This column is careful to halfway walk back the main claim of their famous paper, telling us:

Our view has always been that causality [between high debt levels and slow growth] runs in both directions, and that there is no rule that applies across all times and places.

It is good to hear the reference to causation from slow growth to high debt and that “no rule applies across all times and places.” However it is worth noting that Reinhart and Rogoff never felt the need to use their access to the NYT’s opinion pages to correct all the politicians who used their paper to argue the exact opposite: that their paper implied that countries with high debt levels could anticipate long periods of slow growth.

In addition to misleading the public about the role their work has played in policy debates, they also are not quite straight about two strictly factual points. The first sentence begins by referring to the publication of their article in May of 2010. This might lead readers to believe that this is when their claims about high debt slowing growth first began to affect public debate on stimulus and deficits.

This is not right as I know since my first e-mail requesting their data was written in January of 2010. In fact, their work first made a splash in international debates when they put out a version of this article as a National Bureau of Economic Research working paper in January, 2010. Their findings were already widely known by the time the paper was published in May, 2010.

The other point on which they mislead readers is the claim:

Our 2010 paper found that, over the long term, growth is about 1 percentage point lower when debt is 90 percent or more of gross domestic product. The University of Massachusetts researchers do not overturn this fundamental finding, which several researchers have elaborated upon.

Actually, their 2010 paper found that growth was 2.9 percentage points lower in countries with debt to GDP ratios above 90 percent than in the group with debt to GDP ratios in the 60-90 percent range as we can see in this nice chart from Robert Samuelson’s column yesterday.

People in policy debates would rightly view the prospect of annual growth slowing by 2.9 percentage points as being a very serious matter. That would imply a country with a debt rising above the 90 percent threshold would have an economy that is one-third smaller after a decade as a result of its high debt level. That is a very serious decline in living standards. If this sort of falloff in growth was a predictable result of letting the debt to GDP ratio rise about the 90 percent threshold, then policymakers would certainly be justified in taking strong measures to reduce deficits.

On the other hand, the 1.0 percentage point falloff they find in their corrected data would not come close to prompting the same reaction, especially since “causality runs in both directions.” The falloff they find in their corrected data is not even close to being statistically significant.

Furthermore, in their corrected data, the sharpest falloff in growth occurs at much lower debt-to-GDP ratios. If Reinhart and Rogoff were making policy recommendations based on what their data actually show they would be telling countries to maintain very low debt levels, in the range of 15-20 percent of GDP. Since they have never highlighted this point, one might reasonably question the extent to which their policy recommendations relate to their research.

One final point deserves mention in this discussion. Debt is one side of a balance sheet. Countries have assets. The United States government owns tens of trillions of dollars of land, mineral rights, fishing rights, broadcast frequencies and other assets that could in principle be sold. In most cases there are good reasons not to sell these assets. However if we really believed that high debt levels horribly hobbled growth, then it would likely be worth selling off some of these assets.

Suppose we believed the original Reinhart-Rogoff 2.9 percentage point growth falloff number. If our debt-to-GDP ratio were at 100 percent of GDP, we could sell off $3.2 trillion in assets to bring the debt-to-GDP ratio down to a safe 80 percent level. This would lead to a growth dividend of more than $28 trillion over the next decade. In other words, we would be able to pocket more than 8 times the market value of these assets in the form of added growth, and that is just over the first decade.

To my knowledge no one in public debate, including Reinhart and Rogoff, have advocated this sort of massive asset sale. Yet the payoff of more than 8 to 1, has to swamp the benefits from almost any other public policy imaginable. This seems pretty compelling evidence that no one really believes that high debt levels actually lead to slow growth.

In other words, this is a fig leaf. Reinhart and Rogoff’s work is a cover for political actors who do not want to take steps to boost the economy and lower the unemployment rate and who want to cut programs like Social Security and Medicare. It is not part of a honest policy debate.

Dean Baker is co-director of the Center for Economy and Policy Research. He also writes a regular blog, Beat the Press, where this post originally appeared.

I have a policy of not discussing items that directly refer to me in this blog, but I will make an exception today because the issues raised by Robert Samuelson are important. In his column Samuelson makes two key arguments. First, that the Reinhart-Rogoff conclusions about high debt leading to slow growth still stand even after the errors in the original paper were corrected, and second, that this work was never really the basis for austerity anyhow.

Taking these in order, Samuelson constructs a chart showing the originally reported and corrected relationships between debt levels and GDP growth.

He then tells readers:

“After recalculating the Reinhart/Rogoff data, the UMass economists confirm that high debt implies lower economic growth.”

No, that is not right. The recalculated numbers show that high debt levels in the countries examined by Reinhart and Rogoff were associated with lower growth. However as the paper by Thomas Herndon, Michael Ash and Robert Pollin that exposed the error clearly explained, the growth falloff for countries with debt-to-GDP ratios above 90 percent was not statistically significant. In fact, they found a much stronger negative relationship between debt and GDP growth at very low ratios of debt-to-GDP. This means that if someone was basing policy on the corrected Reinhart-Rogoff numbers they would be arguing for debt-to-GDP levels in the range of 15-20 percent. That is not what Reinhart and Rogoff or anyone what else in this debate is saying.

More importantly, there was always the issue of causality, which is ignored by Samuelson. It is just as likely that weak growth leads to high debt as high debt leads to weak growth. If the former is true, getting upset about high debt levels would be like saying that hospitals cause people to be sick. UMass economist Arindrajit Dube did a nice test of causation and found the causality from growth to debt is very strong, while finding no real evidence of causation in the opposite direction.

This is hardly surprising. Debt is an arbitrary category. Countries also have assets (e.g. land, mineral rights, fishing rights, broadcast frequencies etc.). If the debt side of the balance sheet could lead to a sharp slowdown in growth, then they would be foolish not to sell off some of these assets. This would lower the debt-to-GDP ratio and produce a huge growth dividend, if anyone believed the Reinhart-Rogoff story.

Of course no one advocated selling off large amounts of assets, which brings us to Samuelson’s second point, that Reinhart-Rogoff paper was never really the basis for policy. His argument was that political figures wanted to pursue austerity anyhow and just grabbed Reinhart-Rogoff as a fig leaf.

Samuelson will get little argument from me on that point. Why would political leaders want to pursue austerity? Well, let’s look at the impact of the policy. High unemployment has weakened workers’ bargaining power, allowing employers to get the vast majority of the gains from productivity growth over the last 5 years. While the rise in profit shares may not always offset the loss in profits due to weaker growth, this is likely true today in many countries, including the United States.

From this vantage point, austerity is just great for those on top. The pressure for austerity also opens the door for lowering tax rates on the wealthy in the future, for example by cutting back programs like Medicare and Social Security in the United States, and their equivalents overseas. If these sorts of social commitments can be reduced, then the wealthy can look forward to being able to keep more of their income 10-20 years in the future. And if we think there is nothing that the government can do about unemployment because of the demands of the austerity gods, then we can blame workers’ problems on their lack of skills and inability to deal with the technological advances of a global economy.

In short, austerity serves some very useful purposes for the rich and powerful. It would hardly be surprising to me that the political figures they support are more likely pursuing austerity to please them than because of anything that Reinhart and Rogoff wrote. On the other hand, it is extremely useful to have ostensibly reputable studies like Reinhart and Rogoff that can be used to make the case that austerity serves the general good and not just the rich.

However corrupt politics in the United States might be, it just doesn’t look good for the President of the United States to go on national TV and say that, “I am cutting back spending on Social Security and other important programs to keep the unemployment rate high so that my rich campaign contributors will get even richer.” It is far more respectable if he can hold up a paper by two professors from Harvard and tell the American people that we have no choice but to cut back spending or the economy will go down the toilet.

The research from the UMass crew has taken away the fig leaf. The question is whether the austerity gang will be able to continue to press their case for upward redistribution even in the full light of day.

Dean Baker is co-director of the Center for Economy and Policy Research. He also writes a regular blog, Beat the Press, where this post originally appeared.

The NYT appears to be following the pattern of journalism practiced by the Washington Post in openly editorializing in its news section. Today the news section features a diatribe against the Danish welfare state that is headlined, “Danes Rethink a Welfare State Ample to a Fault.” There’s not much ambiguity in that one. The piece then proceeds to present a state of statistics that are grossly misleading and excluding other data points that are highly relevant.

The first paragraphs describe the generosity of the welfare state then we get this ominous warning in the 5th paragraph:

“But Denmark’s long-term outlook is troubling. The population is aging, and in many regions of the country people without jobs now outnumber those with them.”

oooooh, scary! Yeah people are living longer in Denmark, that’s something that’s been happening for a couple of hundred years or so. Like every other wealthy country people live longer in Denmark than in the United States. While there are projected to continue to see gains in life expectancy and further aging of the population, the increase is actually going to much slower than in the United States.

From 2012 to 2025 the percentage of the Danish population over age 65 is projected to rise from 17.8% to 21.2%, an increase of 3.4 percentage points. By comparison, in the United States the share of the population over age 65 is projected to rise from 13.6% to 18.1%, an increase of 4.5 percentage points over the same period, from a considerably smaller base. The impact of aging on the economy and the government budget will clearly be much larger in the U.S. than Denmark, especially since the government first starts paying for health care for people after they turn age 65 in the United States. (Like every other wealthy country, Denmark has national health insurance.)

The concern that, “in many regions of the country people without jobs now outnumber those with them,” is especially touching. In the United States we have such a region, it’s called the “United States.” In March, 143.3 million people were employed out of a total population of 323,000,000 for a ratio of workers to population nationwide of roughly 44.4 percent. In many parts of the country it would be much lower.

The piece then goes on to describe the extent of the Danish welfare state with its 56 percent top marginal income tax rate, telling readers:

“But few experts here believe that Denmark can long afford the current perks. So Denmark is retooling itself, tinkering with corporate tax rates, considering new public sector investments and, for the long term, trying to wean more people — the young and the old — off government benefits.”

Hmmm, it would be interesting to know what data the experts are looking at. According to the IMF, Denmark had a ratio of net debt to GDP at the end of 2012 of 7.6 percent. This compared to 87.8 percent in the United States. Its deficit in 2012 was 4.3 percent of GDP, but almost all of this was do the downturn. The IMF estimated its structural deficit (the deficit the country would face if the economy was at full employment) at just 1.1 percent of GDP. Furthermore, the country had a huge current account surplus of 5.3 percent of GDP in 2012, more than $800 billion in the U.S. economy. This means that Denmark is buying up foreign assets at a rapid rate. By contrast, the United States has a large current account deficit.

If there is something unsustainable in this picture, it is not the sort of data that economists usually look at. Is marijuana legal in Denmark?

Then we find the real problem is that no one in Denmark is working:

“In 2012, a little over 2.6 million people between the ages of 15 and 64 were working in Denmark, 47 percent of the total population and 73 percent of the 15- to 64-year-olds.

“While only about 65 percent of working age adults are employed in the United States, comparisons are misleading, since many Danes work short hours and all enjoy perks like long vacations and lengthy paid maternity leaves, not to speak of a de facto minimum wage approaching $20 an hour. Danes would rank much lower in terms of hours worked per year.”

So in spite of the generous Danish welfare state a higher percentage of its working age population works than in the United States. (Actually Denmark ranks near the top of the world in employment to population ratios.) Yet, somehow this doesn’t really count because people in Denmark get vacations, work shorter hours, and have a higher effective minimum wage.

This ranks pretty high in the non sequitur category, apparently when you want to bash the welfare state, the rules of logic apparently do not apply. Danes, like most Europeans, have opted to take much of the gains in productivity growth over the last three decades in the form of shorter work years rather than higher income. (One interesting result of this practice is that we have some hope to save the planet from global warming — greenhouse gas emissions are highly correlated with income.) Of course Danes still work about 8 percent more hours on average than hard-working Germans, according to the OECD. If there is a problem in this picture, the NYT might want to devote a few paragraphs to telling readers what it is.

As far as the $20 an hour effective minimum wage, isn’t the problem of a high minimum wage supposed to be that it creates unemployment. But the NYT just told us that Denmark has higher employment rates than the United States. (My brain hurts.)

Okay, we get it. The NYT doesn’t like Denmark’s welfare state. It doesn’t really have any data to make the case that Denmark’s welfare state is falling apart and leading to all sorts of bad outcomes, but they can wave their arms really fast and hey, they are the New York Times.

Dean Baker is co-director of the Center for Economy and Policy Research. He also writes a regular blog, Beat the Press, where this post originally appeared.

The New York Times ran a front page piece warning readers that the cost of treating dementia are “soaring.” The piece tells readers of the findings of a new study by the Rand Corporation that shows the cost of dementia doubling by 2040 from its 2010 level.

Are you scared? Are you shaking in your boots? Thinking about pulling the plug on these costly old-timers?

Well our friend, Mr. Arithmetic, reminds us that the Congressional Budget Office projects that the size of the economy is projected to roughly double over this period. This means that the Rand study’s finding implies that dementia will impose pretty much the same burden on the economy in 2040 as it does today.

This story follows a common practice among the Washington elite. They continually highlight and exaggerate costs associated with an aging population. Of course as a practical matter there is little that we can do about these costs, although we can redistribute the burden. The implicit and explicit intent behind much of this discussion is that the elderly and their children should bear more of these costs, as opposed to the government.

Keeping the costs of an aging population front and center in public debate obstructs discussion of the massive upward redistribution of income over the last three decades. This upward redistribution has shifted roughly ten percentage points of GDP ($1.6 trillion annually) to the richest one percent of the population at the expense of the rest of the population. The impact of this upward redistribution on the living standards of the bulk of the population dwarfs the impact of any taxes that might be associated with caring for an aging population through Social Security, Medicare, and other government programs.

If issues were treated in proportion to their importance to the public we would be seeing daily pieces on proposals for breaking up the big banks, taxing financial speculation, ending patent monopolies for prescription drugs, free trade in health care services and other measures that would reverse the upward redistribution of income over the last three decades. However, importance to the public is apparently not a major criterion for determining news coverage. Hence we get misleading front page pieces in the NYT on the cost of dementia.

Dean Baker is co-director of the Center for Economy and Policy Research. He also writes a regular blog, Beat the Press, where this post originally appeared.

When it comes to high medicare costs, the blame lies with our unreasonably expensive healthcare system.

The New York Times ran a piece with a headline complaining “public misconception of government benefits makes trimming them harder.” The piece goes on to explain that the cost of the Medicare benefits received by a typical beneficiary vastly exceeds the taxes they will have paid into the system using standard discount rates. The piece tells readers that most readers do not recognize this fact, so they get upset at the idea of cutting benefits.

The desire expressed in the piece to cut Medicare benefits indicates a misconception by the NYT and the experts cited on the nature of Medicare costs. The United States pays more than twice as much per person for its health care as the average for other wealthy countries. If it paid the same amount as Germany, Canada, or any other wealthy country with comparable health care outcomes, most or all of the gap between taxes and benefits would disappear.

This enormous gap in expenditures is not associated with better care, it is the result of the fact that doctors, hospitals, medical equipment suppliers and other providers get paid far more in the United States than in other countries. In effect, the NYT and the experts cited in the piece want to see Medicare beneficiaries accept lower quality care because we pay too much to doctors and other providers.

It is likely that most people would find their policy prescription somewhat perverse. It is hard to see why Medicare beneficiaries should feel guilty because the specialists who treat them can make $500,000-$600,000 a year. The more obvious response would be to force doctors and other providers to accept compensation that is more in line with world standards. (We could also give beneficiaries the option to buy into lower cost systems in other countries and split the savings.)

Of course the route of cutting payment to providers would mean confronting powerful interest groups. Many policy experts are reluctant to pursue this path.

Dean Baker is co-director of the Center for Economy and Policy Research. He also writes a regular blog, Beat the Press, where this post originally appeared.