« Cass Sunstein, Tyler Cowen, and Robin Hanson | Main | Around the web »
The Great Risk Shift
That is the new book by Jacob Hacker which should, and probably will, have a big impact on national debate. The main argument is that American incomes have been growing steadily riskier. (Here is a related article by Hacker, and here is U.S. Census data.) A few points:
1. The most convincing of the graphs is the one which shows "Americans' Chance of a 50 Percent or Greater Income Drop." In 1970 this risk was at about 7 percent; it has been rising upward and now stands at a little over 16 percent. I would be happier if the relatively wealthy were excluded from this diagram, although I doubt if those people are driving the results.
2. Chapter two blames the new ethic of personal responsibility, and associated policy changes, for increased income volatility. Data suddenly are absent, and I cannot help but note that most forms of domestic government spending, including social insurance programs, have grown steadily. Nor can Clinton welfare reform be blamed here. This is the weakest chapter in the book.
3. Chapter three on risky jobs is not strong on data compared to the contrasting results found in this working paper and also the writings of John Haltiwanger and others.
4. Chapter four on families discusses divorce, but we do not learn how much of the growth in income volatility stems from family splits. The author does point out that the divorce rate peaked in the 1980s yet income volatility continues to climb. The relative importance of divorce is the one question this book should have answered, and could have answered, but didn't answer.
While divorce raises income risk, it may lower utility risk, especially for women.
I am also dismayed that the author cites a U.S. savings rate of zero, overstates the risk of housing investments (if all homes exogenously became very cheap even homeowners are better off), and cites the dubious book The Two-Income Trap. There is not enough discussion of asset values and new possibilities for consumption smoothing. How volatile are the data on consumption?
5. Chapter five on risky retirement focuses on pensions and nails it.
6. I don't buy chapter six on "Risky Health Care." The real risk of dying too young, or being severely crippled too young, has never been lower. Again, risk is more than just financial risk.
The bottom line: We do need pension reform. Otherwise Hacker needs to separate out the importance of divorce and better distinguish financial risk from utility risk. If people are spending more money to lower their utility risk -- most of all spending on divorce and healh care -- the results are suddenly less troubling. I am far from certain this is the relevant scenario, but Hacker does not establish, or even try to establish, the contrary.
Addendum: Arnold Kling argues that, in a risky world, we should strengthen incentives to save.
Posted by Tyler Cowen on September 16, 2006 at 05:30 AM in Books, Economics | Permalink
Comments
very nice points, tyler. it's really difficlut to get to the heart of the matter when the author is writing a book for the masses & doesn't have the time nor the inclination to go into the logic behind the reasoning for the argument.i suspect the popular media will(as usual) tom-tom this book without really discussing it's implications. however, this is a good way to shine some light on the issue.
Posted by: sa at Sep 16, 2006 10:45:03 AM
Why increase incentives to save rather than increase ease of saving? There was a recent study where they found a minor change in the paperwork (opt out rather than opt in on retirement pensions) increased the rate of savings. Irrational? Certainly - the minor transaction cost should be outweighed by the financial gain. But this is how people actually behave.
Posted by: Ennis at Sep 16, 2006 10:58:00 AM
Thanks for skipping the rhetoric and going straight to the data. I look forward to blogging this.
Posted by: Harold at Sep 16, 2006 11:26:34 AM
Actually the problem with a universal drop in housing costs is that there will be many people who will be left with a larger mortgage than the price of the house and will most definitely be better off. I made that same error when I was a young buck just out of college, but I would think that an economics professor would know better.
Posted by: don Hosek at Sep 16, 2006 11:27:57 AM
Tyler, could you please specify what is dubious about "the two income trap"?
Posted by: michael vassar at Sep 16, 2006 12:26:01 PM
When I look at the paper about job stability by stephens and wonder how
much his results have been impacted by the nature of job loses.
Use to be a "lay-off" was a temporary thing in the highly cyclical
durables industry. Until recent years a typical "lay-off" was an auto worker who
would return to the same job in a few months and retain tenure. So when you
interview the current retriees your sample consist of people
who experienced these type of "lay-offs" and by the time they
were older they had too much seniority to be impacted.
But now job loses are not lay-offs. People who are laid-off now
do not go back to the same job so they lose their "tenure".
But current retires are too old to reflect most
of this change . So isn't the sample of retriees
a biased sample that mises the change in the nature of "lay-offs'
since the 1980s and consequent change in tenure.
Posted by: spencer at Sep 16, 2006 2:41:48 PM
if all homes exogenously became very cheap even homeowners are better off
I don't see this.
Posted by: bernard Yomtov at Sep 16, 2006 3:13:58 PM
"we should strengthen incentives to save". Who's "we", at whose expense should the strengthening take place, and why should "we" know better than me how much I should save?
Posted by: dearieme at Sep 16, 2006 4:29:12 PM
We do need pension reform.
Can you offer (or link to) a brief outline of why this is and what reforms would be helpful?
Posted by: MattJ at Sep 16, 2006 5:18:13 PM
Tyler, I don't understand your point 6. Obviously it's good that people are healthier and have a lower risk of becoming unhealthy (e.g. crippled). And it's bad that people face large financial risks if they become unhealthy. The important thing is that (at least at the policy level) there is almost no tradeoff between the two. Policies that reduce the financial risk of unhealthiness generally do not increase people's physical risks of becoming unhealthy - if anything, they tend to do the reverse (by improving access to health care). The question is not whether to go back in time and reverse decades of technological improvements and innnovations, it's whether to adopt policies like (like Kerry's or Galt's) that reduce the financial risk associated with health problems, so the fact that people's risk of being crippled or killed when they are young is lower than ever before is irrelevant.
I haven't actually read Hacker's book, so maybe your point makes more sense in that context, but as an argument against seeking policies to reduce the financial insecurity resulting from the costs of health care it seems like a red herring.
Posted by: Blar at Sep 16, 2006 5:55:57 PM
bernard Yomtov, try "if all cars exogenously became very cheap even carowners are better off."
Is housing all that different? I don't think so.
Posted by: Mike Linksvayer at Sep 16, 2006 6:33:06 PM
Tyler, you dismiss the book "The Two Income Trap." Yet, in your comments on it, you wrote:
"Having just overpaid for a house, to put my stepdaughter into a good school district, I can sympathize with this argument. But I don't understand the core logic as a more general claim."
C'mon, Tyler, you know perfectly well why it's getting harder to get your kid into a "good" public school district all across the country. You know that when you were deciding in your private life on what a "good" school district was, you were largely choosing based on the racial demographics of the student bodies, which are rapidly changing all across the country due to the illegal immigration you claim insn't much of a problem for America -- although it turns out just not to be a problem for people like you who can afford to buy in a "good" school district.
If you would just be honest about how you made this hugely crucial personal decision and apply it to your public pronouncements, you would be much less hypocritical and much more truthful.
Posted by: Steve Sailer at Sep 16, 2006 8:01:28 PM
I'm confused about the home prices decline thing. If I buy a house for $400K with $40K down and tomorrow all houses are worth 50% including mine being worth $200K, how is this not bad for me?
Sure the next house I buy will only cost $200K but right now I'm $160K upside down on a mortgage and my lazy brother who doesn't even have a job has a higher net worth than I do. What am I missing?
Posted by: BillWallace at Sep 16, 2006 8:12:26 PM
BillWallace,
In the case that you keep the house the rest of your life, you pay the $360k mortgage regardless of what happens to other prices.
In the case that you sell tomorrow and buy an equivalent home, you owe $160k for the old house and $200k for the new one, still a total of $360k. If you buy a better home your total debt would be lower than if prices hadn't halved.
Or you could default on the first mortgage and buy an equivalent house for $200k and only have debt of $200k, and presumably bad credit.
Perhaps "net worth" is misleading when consumer goods (homes to be lived in) are included. The real impact of a owned to live in home's value on your wealth would only be felt if you upgrade or downgrade.
There are doubtless serious flaws with my reasoning.
Posted by: Mike Linksvayer at Sep 17, 2006 1:01:59 AM
Mike L. -- The only flaw I see in your reasoning is that mortgages are usually "recourse loans," meaning that the lender can come after the homeowner's other assets if the mortgaged home itself is not worth enough to cover the amount due. So the only way to get out from under all the debt on the first house would be to file for bankruptcy, which would increase subsequent borrowing costs substantially.
Posted by: Guest 15 at Sep 17, 2006 10:27:45 AM
Mike L.
I follow, but you're making some assumptions. Like you're assuming that I don't suffer a loss of income that prevents me from being able to make the payments on the $360K loan. Before the price drop I can sell and presumably get some of my $40K back, after the price drop it's bankruptcy for me.
Or maybe I get married and my spouse already has a house that we're going to move in to?
Posted by: BillWallace at Sep 17, 2006 12:48:53 PM
Guest 15 and BillWallace, good points. If you downgrade (which income loss and consolidation due to marriage collapse to), you lose, at least in the short term. Decades from now I suspect you'll still be better off assuming you've moved a couple times, your kids are probably better off, and everyone who didn't downgrade or have investment property is no worse to much better off.
Aside: I'm more interested in falling prices due to better technology (e.g., robot construction) than typical real estate booms and busts.
So don't go deep into debt to hold a potentially rapidly depreciating asset.
Posted by: Mike Linksvayer at Sep 17, 2006 3:00:43 PM
"falling prices due to better technology (e.g., robot construction)"
I can see some price drop, but a lot of the price where I live (Bay Area) is due to the land value. Although now that I think about it, location based land value isn't a sure thing either. I could see the culture and tech changing enough that people are no longer willing to pay a premium to live near the nice cities.
Posted by: BillWallace at Sep 17, 2006 7:39:42 PM
The issue of divorce rates is misleading because it only measures families created by marriage. With more middle class couples opting to have children out of wedlock, the data you have to look at is single-parent households. Volatitilty would remain high whether the couple was legally married or not.
Posted by: Ted Craig at Sep 18, 2006 9:10:51 AM
"new ethic of personal responsibility"
Surely he jests. Looking at what we ask of our government, how could one conclude anything but that the ethic of personal responsibility has hit rock bottom and started to dig?
Posted by: Noah Yetter at Sep 18, 2006 12:14:33 PM
I'm very skeptical about the increasing risk meme, because it seems to me to contradict the other widespread meme of the day, that class mobility is decreasing. They can't both be true, and we can't at present measure either one very well, so it seems safest to me to assume that, since people are complaining vociferously about two incompatible changes, neither one is actually happening.
Posted by: wsm at Sep 18, 2006 1:47:00 PM
I'm pretty sure for "average wage Americans" (+- 10%) the income drop risk has not increased much over the (unknown minimum) 1950- 1960- 1970- 1980- 1990- decades. However, the one-year risk to higher earners is probably increasing, with more great years/ terrible years with respect to income.
I'd be surprised if there was much change in the "risk" for the lower two quintiles of income since 1970. But haven't looked closely.
Posted by: Tom Grey - Liberty Dad at Sep 20, 2006 9:31:41 AM
