There is only one problem with DJ.  He doesn’t know squat about economics.  It’s not because I haven’t tried.  He refused to believe what I tried to share from my first economics class back in 69/70.  He’s refused to believe anything about economics that I’ve tried to teach him since.  DJ’s a communist, and he’s darn proud of it too, and he’s probably never going to learn, but I’m going to keep trying.

Which brings us to today’s topic.  DJ posted a link to this Robert Reich blog entry and a taunt on Facebook today.

In the blog, Reich correctly points out that inequality is a growing problem in America today.  Then, he starts getting things wrong, very wrong, basically coming to the conclusion that if we reduced managements’ incomes and increased workers’ incomes all would be well with the world.

I can’t believe that Reich really believes that if we just set a higher minimum wage and instituted a new maximum wage, we’d have prosperity for all.  It is well understood in economics that minimum wages increase unemployment and price ceilings create shortages.  Reich’s policy would cause output to fall, unemployment among lower-wage workers to dramatically increase, and management to move to someplace else, say Singapore or Hong Kong.

Inequality is problem, a serious problem and a growing problem.  The causes are a failed educational system, a completely inadequate safety net, and a lack of commitment to opportunity in far too many communities.

While returns to education have been increasing, our educational system has been declining.  The failure to prepare students for the workforce, particularly those who will not go to college, is paid for by the student.  It is paid for in lower income throughout their work life, and in more frequent and longer-lasting income interruptions.

Educational problems are not limited to k-12.  The rapid increase in the cost of a college degree is strong evidence that colleges and universities have managed to extract a significant portion of the gains to education, often leaving the student with debt that takes years to repay.  Too often that expensive, debt-funded, degree fails to provide the expected income, a result of a degree in a field with little market value or a program that lacked rigor.

The lack of an efficient safety net means that unemployed workers have an incentive to take the first available job offer.  That first job offer may be a perfect match, but it may not be.  The problem  is that without a safety net that would allow time for a search for a better match, or provide for geographic mobility, both  society and the worker are worse off.

Finally, communities limit opportunity in the service of quality of life, failing to recall that for many quality of life begins with opportunity.

I’ll stipulate his second point, but his first point is all wrong.

The data make it pretty clear that unemployment insurance increases unemployment in good times.  An amazing percentage of unemployed find jobs the last week of eligibility.   Of course, these aren’t ordinary times. Given the difficulties in finding a job in this market, and given the average duration of unemployment, it is easy to believe that there are very few people who are unemployed because of unemployment benefits.

Laffer presents the following chart, and he claims that is proves his point that unemployment benefits cause unemployment.

He says:

“As the chart nearby clearly shows, since the 1970s there’s been a close correlation between increased unemployment benefits and an increase in the unemployment rate. Those who argue that things are different today don’t have the data to back up their claims.”

There is a correlation, no doubt about that, but as Mr. Laffer has surely heard countless times, correlation does not imply causation.  It looks to me that the unemployment insurance lags unemployment.  That would imply that unemployment causes unemployment benefits.

Of course, that’s the way it seems to work in practice.  When unemployment becomes extraordinarily high and its duration long, governments extend benefits.  That seems like the right thing to do.  It’s not stimulus, and people who claim it is stimulus are uninformed or dissembling.  It’s just one of those humanitarian things we do to share the costs of a deep recession.  Think of it as mutual insurance.

Since we don’t see the insurance, I assume the reason has to do with asymmetrical information and problems creating a contract with the proper incentives.  The insurance company can’t know about the character of the student and how much effort they will make to get a job that allows repayment of the student loan, and just what would a contract that doesn’t provide a moral hazard problem look like?

Absent insurance, we would expect students to self insure.  How could they do that?  One way would be to major in degrees that are more likely lead to employment.  Higher grades would also be a signal to that all-important first employer.

The United States has chosen the second corner solution.  As best I can tell, there is no way to ever get rid of a student loan, except by paying it or death, regardless of financial and other circumstances.  They cannot be discharged  in bankruptcy.

Corner solutions are rarely optimal, but the current one is truly terrible.  Europe apparently has something like the first corner solution.  So did California at one time.  The original higher education pact assured Californians a tuition-free degree.  This is similar to making a loan and waiving repayment when the student leaves school.

Free is always a bad price.  Education is no exception.  If something is free, too much will be demanded.  Europe is looking for new ways to fund higher education, and California used the deception of calling tuition fees to renege on its commitment.

Free may not be the right price, but current policy is worse.  Not allowing student loans to be discharged in bankruptcy under any conditions is simply barbaric, just one step away from debtors prisons.

You want to have the correct incentives for people to pay the loan, but civilized societies long ago recognized the circumstances change, and we are all better off with efficient ways to adapt to those changes.  Bankruptcy is such an efficient process.  It has worked well for a very long time.

Today, many of our recent graduates are suffering because of student loans cannot be discharged, a result of a changing economy and a deep recession.

The Chronicle of Higher Education released a report, just today, that documents the extent of poverty among young graduates.  USA Today has a piece that puts a more personal face to the data.

Financial troubles are disasters for the individuals and families caught up in them.  Marriages are destroyed.  Families are destroyed.  Lives are destroyed.  Some will commit suicide.

We don’t have to make it particularly easy to discharge student loans, but we do have to provide a release.  The current recession is forcing many of our young people to start their adult lives under extraordinarily challenging circumstances.  Research has shown that  the bad economy will limit the  income of many for their entire career.  Why make it harder by imposing a burden from an unsuccessful past?

We need to give the kids a break.

Benjamin Powell has a nice piece on immigration.   In it he addresses the standard arguments against immigration.  I particularly like the following paragraph on the fear that immigrants take jobs away from the native born:

If immigrants really did take jobs, on net, from existing native-born workers without new jobs also being created, the same should be true any time we add more workers to the economy. Is it? Since 1950, there has been massive entry of women, baby boomers, and immigrants into the work force. As Figure 1 shows, the civilian labor force grew from around 60 million workers in 1950 to more than 150 million workers today. Yet there has been no long-term increase in the unemployment rate. In 1950, the unemployment rate was 5.2 percent, and in 2007, the year before the current recession started, the unemployment rate was 4.6 percent. As more people enter the labor force, more people get jobs.

Powell also covers topics such as the effect of immigration on wages, crime, and the impact of immigration on the welfare state.  It’s an easy read, and a worthwhile one.

The WSJ claims that extending unemployment insurance is causing unemployment, and that their opinion is consistent with Summers’ past statements. Unemployment insurance can exacerbate unemployment in times of full employment, but these are not times of full employment. We know that employers have cut millions of jobs. That is why we see unemployment. It is not even disingenuous to argue that the insurance is causing our current unemployment. It is just dumb.

Summers’ response starts out reasonably enough. He gives the argument I gave in the previous paragraph. Then, though, Summers starts claiming that unemployment is stimulus. That’s pretty silly too.

Unemployment insurance has a minor counter-cyclical impact, but that is not why we have it. We have unemployment insurance because we’re compassionate. We want to help people in tough times, and if that creates a little inefficiency, who cares?

Extended unemployment, such as we are seeing now, is catastrophic for families. Unemployment insurance helps a little. We should extend unemployment insurance, but Summers diminishes himself by pushing the party line and claiming it is stimulus.

Why would they do this? Countries join hoping to benefit from increased trade efficiency and access to markets. Are the benefits of joining the Eurozone worth the costs? That depends on how correlated a country’s economy is with the Eurozone economy.

If a country’s economy is highly correlated with the Eurozone economy, then that country will be happy with the European Central Bank’s monetary policy, and the fiscal constraints will likely be relatively minor irritants. However, if a country’s economy is not highly correlated with the Eurozone economy, the European Central Bank’s monetary policy could be counter-productive, and the constraints on fiscal policy can be painful. It can put a country in a bind.

That is exactly where countries such as Spain and Greece find themselves today, in a bind. If they could, these countries would follow a much more expansive monetary policy and an expansive fiscal policy. The price they pay for membership is higher unemployment, a slower-growing economy, and the potential for social unrest. For these countries, joining the Eurozone is starting to look like a deal with the devil. We may see some countries leave.

So, today’s data release showing a second consecutive weekly increase in new unemployment claims surprised many. The press called it unexpected. It was not unexpected or surprising here at CERF. In fact, it is entirely consistent with our forecast.

We think that GDP will decline modestly in the current quarter and in the first quarter of 2010. Then, we expect a very slow recovery, held back by over-leveraged consumers and businesses, but especially by a weak banking system. The recovery in jobs will likely be weak and trail the GDP recovery by a few quarters.

To answer the question, we think the recession is not yet over, and it probably ends in the second quarter of 2010.

According to the release, there were just under 5 million people (4,934,000) who had been unemployed more that 27 weeks in July. This is up over 700,000 from June’s 4,218,000. It is up over 3 million from the previous year. Those are big increases, and they explain why we saw the big increase in “Discouraged Workers.” These are people who have left the workforce, because they see no chance for employment. Their leaving resulted in the decline in the unemployment rate.

Twenty-seven weeks is a long time to be unemployed, long enough to result in the unmeasured costs of unemployment. These include broken families, domestic violence, drug and alcohol abuse, crime, and the like. Lives have been ruined, as many of these people may never again be part of the mainstream economy.

About a quarter million Americans lost their job in July. Almost another three-quarter of a million moved to Long-Term-Unemployed status. I’m having a hard time understanding how this is good news.

There is also a problem in the unemployment data.

It may have occurred to you that it is a bit strange to lose hundreds of thousands of jobs and lower the unemployment rate at the same time. It is a bit strange.

The problem is discouraged workers. These are people who have given up on finding a job. They may have retired, gone back to school, or just stayed home. Whatever they do, they are not working, and they are not looking for a job. So, the government doesn’t count them as part of the labor force, and unemployment falls while we lose hundreds of thousands of jobs. You gotta love statistics.

So, why the optimism? Beats me.