Monthly Archives: September 2011

State and local pension plans: risky business?

The Washington Post reports on Census data that shows state and local pension plans on the mend.

The improvement in many state and local pension plans are a result of better recent stock market performance and increased contributions by both employers and workers as a result of pension reforms that were passed in 2009.  Additionally, some of the improvement is also due to lower payouts to current pensioners as a result of reforms to rein-in high benefit costs. But a caution is in order. Plans are still valuing their liabilities using discount rates that underestimate the potential for continued volatility in the stock market, potentially over estimating future expected market returns.  Rather, state and local pension plans should be using a discount rate based on Treasury rates that reflect the guaranteed, risk-free nature of these pension promises. In other words, the current accounting understates pension liabilities.

One claim strikes me in particular. According to one union official, plans are now starting to recover from Wall Street’s risky behavior. How does this remark square with the explicit outcome of how pensions are currently valued – that is- the incentive to take on more portfolio risk in order to realize high expected returns?

A Bill to Increase Discrimination Against All Workers?

According to Robert Pear of the New York Times, the President’s latest stimulus bill includes a provision allowing unsuccessful job applicants to sue if they believe they were denied a position because they are unemployed.

The advocates of the proposal, of course, are hoping that this will discourage discrimination against the unemployed. Indeed, we can be pretty sure that it would discourage open discrimination against the unemployed (according to the EEOC, some want ads openly say that the unemployed need not apply). But, of course, ending open discrimination doesn’t end actual discrimination. More importantly: might this have just a few unintended consequences?

Some critics worry that this would just lead to more costly, frivolous law suits. Probably. But I’d also guess it will lead to less employment of people.

The key to understanding why is to think of a worker the way a firm’s owner does: as one among many inputs in the production process. A worker helps a firm make its product or service, but there are other ways to skin that cat. Instead of hiring one more worker, the firm’s owner could just increase the hours of her current employees, or she could buy a few more machines to do the work, or she could outsource aspects of the production process to other companies (perhaps those who work in places without such laws?), or she could simply not expand. The point is that a firm has lots of choices and anything that makes one of those choices (probabilistically) more expensive will cause the firm to rely more-heavily on its other options.

Maybe this should be called the full-employment-for-machines act?

Spreading ideas through the urban process

A shorter version of this post originally appeared at Next American City, where I was live blogging at the 20th anniversary of Living Cities.

Steven Johnson and Paula Ellis, of the John S. and James L. Knight Foundation, discussed some of the themes in his new book, Where Good Ideas Come From: The Natural History of Innovation, including the unique environment for innovation that cities provide. Johnson draws on the work of Jane Jacobs and Geoffrey West to demonstrate that innovation is most likely to happen in places where humans are densely clustered because entrepreneurs rely on the work of others. Both to see through the uncertainties of the future to realize profitable ideas, and to overcome the challenges of product development, entrepreneurs need to live in urban areas.

Johnson began his conversation explaining that many of the ideals that emerged in the Scottish Enlightenment came out of coffeehouses, through the spontaneous conversations that many brilliant men had, and the evolution of their ideas in this urban space. Looking back to these Enlightenment ideals, we can see that Adam Smith, perhaps one of the original urbanists, explained that the division of labor is limited by the size of the market. Continued urban growth provides individuals with growing opportunities to specialize, as both the consumers and technological developments that fuel the market process are consolidated in the same place.

In West’s work that Johnson referenced, he explains that, unlike firms that become increasingly bureaucratic and inefficient as they grow, cities continue to become more productive as they grow in size and density. As Johnson explained, cities have a “liquid property because they have the convergence of diverse people sharing a space. This is an incredible asset.” West demonstrates that the relationship between city size and innovation is exponential. “What the data clearly shows, and what [Jacobs] was clever enough to anticipate, is that when people come together, they become much more productive.” Smith demonstrated that wealth grows through the exchange that urban environments make possible.

However, unlike other scholars of entrepreneurship, Johnson diminishes the importance of profit in facilitating entrepreneurial alertness. Megan McArdle points out that he places a greater importance on “openness and inspiration” than on the profit motive in facilitating entrepreneurial innovation. Of course, entrepreneurs don’t operate in vacuums. Entrepreneurs living in a densely populated city will draw on each other’s work — and find markets for their products — more so than in less densely populated places. And the legal environment surrounding intellectual property, or openness, certainly affects innovation. Despite these outside influences, though, the profit motivation and the essential feedback mechanism that profits and losses provide cannot be downplayed in the market process.

Urban scholars from Jacobs to West to Johnson have built on the insight that dense populations facilitate innovation, where the size of the market is continually growing. While it’s often easy to fall into critiques of urban policies and focus on the challenges facing individuals in cities, yesterday’s conversation struck a happily optimistic note.

 

New Research: Why is the bill for public employees a surprise?

A new working paper is on our website today, authored by Roman Hardgrave and myself. We explore the cost of public employees facing two New Jersey municipalities: Englewood Cliffs and Garfield.

The motivating question is this: why are rising costs for public worker benefits such a surprise to so many state and local governments? In addition to the core problem facing all plans: the misvaluation of pension liabilities based on flawed discount rate assumptions (and the practice of asset smoothing), there are things unique to individual state and local governments. In the case of New Jersey, pension policy is set by the state government, as are the accounting guidelines used by local governments (They do not use GAAP). This had led to a tangle of accounting assumptions that have had the effect of (temporarily) lowering the annual bill. Costs were pushed forward to become a policy problem for today.

While these municipalities report the total cost for public employee compensation as requiring about half of their budgets, when fully accounting for costs, public employee compensation including unfunded liabilities for earned benefits rises to about 86 percent of these budgets. This is an unpleasant surprise in a state with high property taxes and it is certain to make budgeting more challenging in the coming years for both the state and its many municipal governments.

Are Indices of “Business Climate” Useful?

In a recent paper titled “How Friendly To Entrepreneurs Are “Business Friendly” Policies? Some Preliminary Results,” Joshua Hall and I closely examine six national indices that are often used as indicators of how “business friendly” a state is relative to its neighbors. We find that many of these indices are not useful in explaining the variation in entrepreneurial activity among the 50 US states.

In fact, of the three indices that were statistically significant in our regression analysis, only one index had the empirical relationship that we had predicted. This means that not only were many of the indices not useful but some of them suggest that states that are more business friendly have lower levels of entrepreneurial activity.

The overall results of our research are, therefore, a bit puzzling. Why would a “good” business climate be associated with less entrepreneurial activity?  One possible explanation is that because of the way the Kauffman Index of Entrepreneurial Activity is measured it picks up a lot of necessity entrepreneurship (i.e. people who self employ because of a lack of other opportunities). It may also be the case that some measures of how conducive a state’s policies are to businesses many not actually be good measures of whether they are conducive to entrepreneurship.

Our paper is not, however, meant to show that the indices we examined are necessarily bad indices. In fact, after researching each of them it is clear that they do contain very useful economic data. Moreover, it is clear that many of these business climate indices are popular tools in the policy arena and thus it would be useful for future research to further examine the relationship between these indices and entrepreneurship.

 

 

Microfinance for urban entrepreneurs

I’m at the Living Cities 20th Anniversary today, liveblogging on the discussions that panelists are having here. This post originally appeared at Next American City.

Patrick McCarthey of the Annie E. Casey Foundation articulated one of the missions of the Living Cities collaboration as helping Americans in the bottom 40 percent of the income distribution. As the collaboration seeks to help cities develop, it also seeks to improve the development of human capital in these communities. To this point, Dudley Benoit of JP Morgan Chase suggested that improved efficiency in capital markets is key to achieving this goal.

While microfinance has flourished in developing countries, investors have not been as eager to provide small loans to small businesses in the United States. While philanthropic organizations focused on community development have often focused on the making top-down improvements to the physical landscape of urbanites, Benoit brings up that the human capital that allows cities to facilitate economic innovation is more important than their physical components, and that economic development must be a bottom-up process.

Living Cities’ President and CEO Ben Hecht points out that no one individual can solve the problems that a city poses – as Jane Jacobs and Friedrich Hayek both identified, complex human systems must draw on decentralized knowledge that cannot be centrally compiled. Access to capital for urban entrepreneurs is essential for the economic rebirth of cities that Living Cities fosters.

Getting People Back to Work

Germany’s unemployment rate is only 6.2 percent today. This is pretty remarkable given the severity of the recent recession, the slow growth of Germany’s trade partners (including the U.S.) and the unfolding fiscal crisis in the Eurozone.

NPR’s Caitlin Kenney attributes Germany’s relative success to a number of reforms adopted a decade ago. Kenney reports:

To figure out how Germany got where it is today, you need to go back 10 years. In 2002, Germany looked a lot like the United States does now, they had no economic growth and their unemployment rate was 8.7 percent and climbing. The country needed help, so the top man in Germany at the time, Gerhard Schroder, the German chancellor, made in an emergency call to a trusted friend.

The friend was Peter Hartz, a former HR director whom Schroder knew from his VW days. Schroder put Hartz in charge of a commission, the mission of which was to find a way to make Germany’s labor market more flexible. The Hartz commission made it easier to hire someone for a low-paying, temporary job, a so-called “mini job”:

A mini-job isn’t that great of a deal for workers. In these jobs, they can work as many hours as the employer wants them to, but the maximum they can earn is 400 Euros per month. On the plus side, they get to keep it all. They don’t pay any taxes on the money. And they do still get some government assistance.

They also reduced the generosity of unemployment benefits:

Here’s what you get if you’re out of work for more than a year in Germany: 364 euros a month – that’s about $500 – subsidized rent and heat, and a job counselor. Before the Hartz commission, you would get around 50 percent of your last income indefinitely for as long as you were unemployed.

Kenney says that Hartz “wanted to make unemployment uncomfortable so that people would get off of it quickly.”

These changes haven’t made Peter Hartz a popular figure in Germany. His legacy is controversial. He was convicted of paying off union leaders at Volkswagen to go along with his cutbacks.

But no matter how people feel about Hartz, it’s hard to argue with the huge drop in the country’s unemployment rate.

One country’s experience is not dispositive. But a number of carefully designed studies — relying on more sophisticated models and larger data sets — have reached much the same conclusion. Generous unemployment insurance and regulations that add to the cost of employment tend to make for a static, unhealthy labor market. Though designed to make life better for workers, these policies may do them more harm than good.

 

Providence, R.I. bond deal: capital improvement or budget tactic?

Issuing municipal bonds for capital improvements of government buildings may seem like a routine use of debt. However, as Michael Corkery of The Wall Street Journal reports, sometimes the proceeds are used for very different purposes. Providence, Rhode Island issued a $35 million “green monetization”bond, $30 million of which was used to balance the city’s budget. The remaining $5 million was spent on upgrades to Providence City Hall and the Department of Public Works. The city needed and received state permission to issue the bond. Revenue director, Rosemary Gallogly, warned Providence officials that this green project was not so much a capital improvement deal as it was a clear case of deficit financing. They city got a pass because of other measures they had taken to balance their budget.

Other cities have recently done the same. Newark, N.J. Faced with a large deficit the city had to decide among service cuts, property tax hikes, or issuing debt. Newark pursued a 20 year lease-back of 16 city properties including the Courthouse, police and fire headquarters and Newark Symphony Hall. The deal means the city gave control of the buildings to Essex County Improvement Authority, which then issued a $73 million bond for improvements. Of that total, $40 million went to Newark’s general fund, $22 million went to building upgrades, and $11 million to paying down existing debt.

The cities are upfront about their “green monetization” intentions: balance city budgets while avoiding tax hikes. At least for now as a bond is taxation deferred.

 

Society Progresses When We Connect and Exchange

The crowd-sourced, wikinomic cloud is the new, new thing that all management consultants are now telling their clients to embrace. Yet the cloud is not a new thing at all. It has been the source of human invention all along. Human technological advancement depends not on individual intelligence but on collective idea sharing, and it has done so for tens of thousands of years. Human progress waxes and wanes according to how much people connect and exchange.

Those are the opening lines of Matt Ridley’s OpEd from this weekend’s Wall Street Journal. It is a nice synopsis of Ridley’s book, The Rational Optimist. It is one of the best books I have read in years and should be required reading for anyone interested in understanding how societies progress (or don’t).

Taxi protests around the world

Yesterday, in Athens, taxi workers went on strike to protest the country’s recent deregulation of their industry. To comply with IMF recommendations, Greece has increased the number of permits available for taxi drivers.

This policy is not an austerity measure per se, but rather a liberalization of the taxi industry, not requiring a change in government spending or taxation. As taxi drivers protest, other Greeks should be celebrating this measure — it will mean more cabs are available at lower prices.

Here in Washington, DC, taxi drivers are also up in arms. Two drivers associations are suing Mayor Vincent Gray and the DC Taxi Commission because of the 2008 switch from fares based on zones to meters. Some drivers say their pay has dropped by 30 percent as a result. They are correct that the meter rate is determined arbitrarily, but most likely the current rate is higher than the market rate would be. As in Athens, the  number of cabs allowed to operate in DC is artificially capped. Jim Epstein writes at Hit & Run:

Since 2010, the D.C. Taxi Commission hasn’t been issuing licenses to new cabbies. There’s no official waiting list, but a representative from the commission told me she receives calls “all day, every day” from potential applicants. In other words, want-to-be cab drivers are clamoring to get into the industry at the going rate.

In both cities politicians have earned favor with cab drivers by restricting their number to keep rates high. But liberalizing taxi policies will benefit all city residents — especially potential new cab drivers — except those who have historically been sheltered from competition.