Own to Rent Program in New Jersey

This program to assist overextended homeowners has only just begun, so it is way to early to say whether it will succeed, but it is an improved version of Dean Baker's "own to rent" idea.

Note that one of the elements, having a new bank buy the original lender out at the 70% of mortgage value for a failed or about to fail loan should be uncontroversial. My understanding is that in a normal market, a foreclosure typically leads to a 30% reduction in the value of the bank's asset (although one would assume smaller mortgages take a proportionately bigger hit). Since in most locales, this is far from a normal market, 70% ought to look like a very good deal. However, the program sponsors have found limited receptivity, in part because most mortgages are in securitized vehicles, and servicers make more on a foreclosure than on the sale of a loan.

Nevertheless, it is too bad only one small program like this is in process. The New Jersey effort could founder for reasons that have nothing to do with the merits of the concept. Since the amount ventured is so small ($6 million), it's too bad that there aren't 20 programs like this up and running to see if, either in its original form or with some tweaking, it has the potential to be useful on a large scale.

From the New York Times:

A second initiative, in New Jersey, is spearheaded by the Federal Home Loan Bank of New York, which lends money to roughly 300 local banks in New York, New Jersey, Puerto Rico and the United States Virgin Islands to finance mortgages.

Under this new initiative, called the Housing Assistance and Recovery Program, or HARP, the Home Loan Bank lent $6 million to Magyar Bank, based in New Brunswick, N.J.

The First Baptist Church of Lincoln Gardens, in Somerset, N.J., which provides counseling services through its First Baptist Community Development Corporation, identifies homeowners who are in danger of foreclosure, then negotiates with the lender to buy out the loan.

Using proceeds from the Federal Home Loan Bank, Magyar Bank puts up 70 percent of the remaining balance. HARP representatives expect that lenders who hold the distressed mortgages will write off much of the remaining 30 percent, rather than incur a foreclosure.

After the loan has been transferred, the homeowners become renters of their home, making payments to First Baptist, which holds the new mortgage from Magyar Bank. The rent level depends in part on what the family can afford.

First Baptist then offers financial counseling to tenants, with hopes of helping them rebuild their credit scores so they may eventually qualify for a new mortgage on the same home.

According to Alfred A. DelliBovi, chief executive of the Federal Home Loan Bank of New York, one family has completed the transition from homeowner to tenant, and four more families are soon to follow.

One obstacle for HARP in some cases, Mr. DelliBovi said, is finding the current lender. Loans are typically sold to investors, sometimes repeatedly.

Meanwhile, servicers, whom investors pay to collect mortgage payments from borrowers, often have no incentive to help borrowers find the ultimate holder of a loan, Mr. DelliBovi said. “Servicers make more money on a foreclosure than when the loan is worked out,” he said.

Despite the slow going, Mr. DelliBovi said his company is already negotiating with other banks and community organizations in New York and New Jersey to set up similar programs.

Ohio (Effectively) Halts Payday Lending

Ken Funnell at Bank Lawyer's Blog tells us that Ohio is about to put legislation into effect that will kill payday lending:

The new Ohio law would limit borrowers to four short-term loans a year and cap annual interest rates at 28 percent. The bill also would limit loan amounts to $500 per loan, or 25 percent of a consumer's base monthly pay, whichever is less.

Funnell is a proponent of the view that payday lenders offer consumers a useful choice and are preferable to loan sharks. Other defenders of payday loans argue that the cost of an advance is less than a bounced check fee.

The reality seems more complicated that than, particularly since the spending habits of the poor are not as heavily studied as those of the middle class. The reason that payday loans are viewed with distaste in some circles is that borrowers can become recidivists, unable to get off the treadmill of accessing their paycheck early and racking up large costs. Even worse, the payday lenders have an incentive to create customers of that sort.

And it isn't low lifes who fall into this trap; anyone who lives paycheck to paycheck (or close to it) can get caught. Armed Forces personnel were getting overstretched sufficiently often that the Pentagon decided to intervene:

The Pentagon is writing a rule to keep the minds of U.S. troops on their missions by shielding them from debt, but the prospect of the Defense Department as a regulator frightens the financial industry....

The rule will limit how much lenders can charge military personnel, and it could affect banks, credit unions, mortgage providers and payday lenders, among others.

The Pentagon is especially concerned about payday loans, which are typically two-week extensions of credit to cover quick cash needs between paychecks. They can have interest rates of 300 percent a year or more, pushing troops so deep into debt that they cannot focus on fighting.

Defense officials and some lawmakers argue that young, financially unsophisticated service members are particularly vulnerable to shady financial practices and deep debt, especially when lenders offering high rates and quick cash set up shop outside the gates of military bases.

The push against payday loans is part of a bigger effort to clamp down on financial practices the Pentagon sees as predatory. It follows efforts to boost standards for insurance sales after reports found the insurance industry had spent years offering unsuitable and expensive products to soldiers.

The limit on loan rates would be set at 36 percent -- a number meant to drive the payday loan industry out of military lending.

Now of course, one can argue that these moves are paternalistic. But overseas regulators have pointed out that the US now has fairly sophisticated financial products, combined with widespread financial illiteracy. Thus it isn't clear that the preferred remedy, disclosure, is as effective as it ought to be.

Another conundrum is that people are optimistic, and that trait is reinforced more strongly in the US than other cultures. It's also well documented that most (save the mildly depressed) overestimate the odds of things turning out for the best, and particularly overrate those probabilities when they are part of the equation. Thus an emotionally healthy person will overestimate his odds of his ability to repay a payday loan. This is a well proven cognitive bias, not (as is often asserted) character defect of the poor.

So the justification for intervention (via restricting access to the product) becomes more complex. What other recourse might the prospective borrower have? Lower income people frequently hit up family and friends for short-term loans; it isn't clear how often using payday loans is a necessity versus not wanting to embarrass oneself or go to the well once too often.

The downside may not have been fully captured either. What happens to chronic payday loan users? Do they in the end due to the overburden of financial charges, wind up losing important possession like their car, or make greater use of social services? One of the arguments for the controversial living wage is that without it, employers like Wal-Mart are getting de facto subsidies from the state as inadequately workers use food stamps and other benefits to survive. There may be insufficiently studied social costs of the chronically indebted. If it turns out those recidivist payday loan users wind up in some cases increasing taxpayer expenses, the total costs of the product bear examination.

Thus while Funnell laments the Ohio precedent, I think it's a great lab experiment. It's a given that banks will collect data to try to show what a profoundly bad idea this is. I hope social science researchers and other disinterested parties will do the same.

Thomas Palley Questions Housing Subsidies

An odd set of voices is beginning to question the wisdom of America's extraordinarily generous subsidies to homeowners. Paul Krugman once remarked that American like to consume houses, while the French prefer to consume vacations, but we shouldn't overlook the role of incentives in those choices.

At the Milken Institute Global Conference, a true disciple of Milton Friedman. Gary Becker (University of Chicago), was the only one to argue that the considerable benefits lavished on homeowners didn't make for great policy. But for Becker, that is part of a general libertarian, anti-interventionist stance.

Thomas Palley, who comes from the opposite end of the political spectrum, is also opposed to housing incentives. He believes that they fed the housing bubble and are regressive, since taxpayers in higher income brackets get proportionally greater subsidies than the less well off (although in high income tax states, the AMT undercuts the writeoffs). He minces no words, describing a "cult of homeownership" and pointing out an unpleasant fact: tax breaks make housing more costly, so the subsidy, now that it is in place, is eroded by higher prices. To put it even more bluntly, the main beneficiaries are those who profit from higher priced housing units, namely, builders and brokers. But no one wants to see the sacred mortgage tax deduction as ineffective (in terms of its intended beneficiaries) and a hugely inefficient, expensive benefit to a small sector of the economy (the housing sector is 5% of GDP).

But Palley goes even further than that, claiming that the allure of homeownership leads to more dual income families which produces broader social costs. That claim isn't inconceivable; I know couples where one partner would be working less were it not for the home payments. But Palley's assertion begs for empirical support. Interest expenses have long been tax deductible; it was only in the 1980s that individual filers lost the ability to deduct interest on loans unrelated to housing. Similarly, mortgage interest was deductible in the 1950s, the Ozzie and Harriet age of stay-at-home moms. Other factors have contributed to two earner households, such as a long generation shift in attitudes toward debt and more attractive opportunities for women to work.

To Palley's credit, he provides a short list of reforms which would not be too painful to implement (but finding the political will to touch this third rail issue is a completely different matter). Note he does not discuss phasing out Fannie and Freddie, but that would seem to be part and parcel of this sort of program.

My view (and I suspect that of at least some readers) lies in the middle. Housing subsidies in America are sacrosanct. It would be easier to cut Social Security than housing benefits (not that I favor cutting Social Security; the entitlements problem is not as intractable as critics suggest). Yet from an efficiency standpoint, it's nuts to encourage so much investment in a sector that does nothing for our national competitiveness. With energy costs rising, the McMansions of the recent boom, the product of big tax deductions, are going to start looking like white elephants. Given our low savings rate and burgeoning federal deficits, we are going to have to make some tough fiscal choices. Housing is a logical, if controversial, place to cut.

From Palley:

The bursting of the recent house price bubble has focused attention on the failures of monetary and regulatory policy. However, tax policy also likely played a role by providing tax subsidies that contribute to a cult of home ownership. This policy is flawed. However, it is politically difficult to change because households see the benefits of tax subsidies and higher house prices but do not recognize the accompanying costs. By showing the downside of high prices, the housing bust provides an opportunity to escape this political trap.

Current tax law exempts capital gains on private homes up to $500,000 and treats mortgage interest as a deduction. Both measures are intended to help middle-class families, yet the reality is they distort the economy, are costly, and likely do little to make working families better off. That speaks for changing housing’s tax treatment.

The mortgage interest deduction is extremely expensive, costing the Treasury approximately eighty billion dollars in 2007. Moreover, it is highly regressive because high-income taxpayers get to deduct their interest payments at top marginal tax rates, whereas others deduct at lower tax rates. That means high-income taxpayers get a higher subsidy rate, and their subsidy is further increased because they also tend to have larger mortgages. Meanwhile, many poor workers get no housing assistance because they rent and rental expenses are non-deductible.

Both the mortgage interest deduction and housing capital gains exemption encourage home ownership. Mortgage interest deductibility encourages switching from renting to owning, while the capital gains exemption encourages owning housing instead of other forms of wealth.

This tax treatment has increased demand for houses, raising prices. However, higher house prices entail larger mortgages so that households end up with larger gross interest payments that offset much of the interest deduction. Additionally, larger mortgages make households more vulnerable to losses if they have to sell under unfavorable conditions – as is now happening.

Since most households lack capital, higher house prices also make it difficult to come up with down-payments. That has encouraged risky non-traditional mortgages such as zero-down products, and these products are a significant factor in the current housing crisis. Furthermore, these mortgages carry higher interest rates that further offset the benefit of mortgage interest deductibility.

At the social level, higher house prices mean both spouses have to work, which undermines family structure. It also puts downward pressure on wages by increasing labor supply. However, the system gives every family an incentive to buy a house to lock-in ownership, even though the system may make them collectively worse off.

Higher home prices are also very unfair from an inter-generational standpoint. Increasingly, younger workers cannot afford houses, and that promises to undermine the market with those buying last losing most.

Finally, excessive home ownership may increase unemployment. This is because workers become tied down to their homes by attached financial obligations, reducing responsiveness to changing job market conditions.

The tax system has helped create a cult of home ownership, and that cult appears to have been an ingredient in the recent house price bubble. Rather than creating wealth, the tax treatment of housing redistributes wealth inter-generationally and makes households financially vulnerable. That means tax policy should change. Here are some suggestions.

First, the capital gains exemption should be abolished for all new home purchases. Instead, the base cost of houses should be indexed to inflation so that homeowners are not taxed on inflation gains. Existing homeowners should be grand-fathered under current law to discourage selling to protect unrealized gains, which would destabilize the housing market.

Second, the ceiling (currently $500,000 per taxpayer) on mortgages qualifying for interest deductibility should be gradually lowered to zero over a ten-year period. Such a gradual phase-out can actually help existing middle-class homeowners because it will make top-end homes relatively less affordable compared to mid-market homes that retain the tax subsidy. That will shift demand toward the mid-market segment, helping maintain mid-market prices and thereby mitigating the housing slump.

Third, since everyone needs housing, the Federal government should phase in a refundable housing cost tax credit available to all, regardless of whether they own or rent. That credit can be financed with revenues generated by phasing out the mortgage interest deduction. During the transition every taxpayer should have the choice between taking either the available mortgage interest deduction or receiving the housing tax credit.

Current tax treatment of housing is intended to benefit working families, but it actually creates bad outcomes. The reality is current tax law distorts the economy, promotes house price speculation, renders households over-indebted and financially vulnerable, and undermines wages and family structure. There is a better way to help working families afford decent housing, and now is a good time for policy to transition in that direction.

"The prudent will have to pay for the profligate"

Martin Wolf takes a discursive route to make a fairly straightforward observation: no matter how the US deals with its debt hangover, the consequences are likely to be contractionary. But a rapid move to a sustainable savings rate (6%? 10%?) would produce tremendous dislocations. Hence, the public sector will throw sand in the gears, which inevitable means more expenditures, so the responsible will pay for the reckless.

But as we go down this road in America, we are likely to encounter a great deal of resistance. Remember, even in Japan, a society that has tremendous respect for authority, it was difficult to sell the public on bailing out the banking system. And here, a generation of free market ideology may backfire. That line of thinking led to a backlash against regulation which helped make the credit crisis possible (yes, there might have been some speculative froth even with tougher rules, but not to this degree). Now this may well have been cant on the part of business interests who will tack with the wind. But to the extent that they created true believers in their faith, they will have created a cohort of libertarians and conservatives who will be deeply opposed to rescuing the imprudent.

The next few months may reveal some of the fault lines.

From the Financial Times:

You have enjoyed a debt-financed spending spree. But times are now harder: you find it impossible to roll over your debt; you have to pay much higher interest rates than before; or you find that the value of the assets you pledged as collateral is now less than your loan. What can you do? Provided enough of you are in trouble, you call for help from the fairy government-mother.

Over-indebted individuals have just three choices: reduce spending below income, sell assets they own to somebody else or, if the worst comes to the worst, default. But one person’s debt is another person’s asset, one person’s expenditure is another person’s income; one person’s sale is another person’s purchase and one person’s default is another person’s loss.

If very many individuals reduce their spending, in order to pay down their debt, the economy slumps. If many try to sell assets they own, their prices crash. If many default on their debts, financial intermediaries implode. The economics of an entire economy are not the same as the economics of a single household. That was perhaps the most important point John Maynard Keynes made.

Thus, argues Mr Magnus, “there is a quite serious risk that the de-leveraging downturn could run amok: credit contraction causes economic contraction, which causes further write-downs and capital destruction, which leads to more credit contraction and so on”. On the upside, the fairy government-mother stood on the sidelines, applauding the enthusiasm of her charges. On the downside, she is dragged in, as risk-addiction turns into risk-aversion.

Between its low in the first quarter of 1982 and its high in the second quarter of 2007, the share of the financial sector’s profits in US gross domestic product rose more than six-fold. Behind this boom was an economy-wide rise in leverage (see chart). Leverage was the philosopher’s stone that turned economic lead into financial gold. Attempts to reduce it now risk turning the gold back into lead again.

Hélène Rey of the London Business School has demonstrated this process for the financial sector.** She describes three ways in which markets have malfunctioned: via the originate-to-distribute model, with its weak incentives to assess loan quality and wide diffusion of assets of unknown quality; via the vicious spiral in credit default swaps, with rising prices forcing a higher cost of funds on banks, so worse credit standing and so forth; and, finally, via tumbling market valuation of assets, with distressed sales in thin markets lowering solvency and forcing further sales.

Each drowning institution drags others down with it. The solution they all desire is for the government to act as lender of last resort against illiquid instruments and buyer of last resort of impaired ones. While the former activity has been known since the days of Walter Bagehot’s Lombard Street, the latter is an overt bail-out. But for the sector as a whole, any other way of reducing excessive liabilities is far too slow, collectively ruinous, or both.

Now consider a second crucial sector: US households. They have been spending more than their income for a decade. Indeed, this spending has been the single most important counterpart of the persistent US surplus on the capital account (or deficit on the current account). In the process, households have accumulated ever more debt.

How might households seek to reduce their indebtedness, collectively? They can try to sell assets. But they can sell houses only to one another, which would not, in aggregate, help. They can sell equities to the rest of the world, but their prices might crash first. They can default. Indeed, many seem likely to do so. But that would damage the financial sector’s solvency and, through that, either the government’s balance sheet, via bail-outs, or the balance sheet of other households, via losses on financial assets.


Finally, they can cut back on spending. But that would guarantee a recession, if not a slump. In the fourth quarter of 2007, household savings were still as low as ever, at 2 per cent of GDP. Imagine that they rose swiftly back to where they were in the early 1990s. That would be an increase of 4 percentage points of GDP. The result would be a deep recession. It is no surprise, therefore, that politicians are trying to rescue the housing market, while the Federal Reserve has been slashing interest rates with vigour.

In such predicaments, the government always emerges as the lender, borrower and spender of last resort. It will act by bailing out insolvent people and institutions, by either replacing or guaranteeing the lending activities of the private financial sector and, not least, by running larger fiscal deficits, as private-sector financial deficits shrink.

It should be no surprise, therefore, that the principal balance-sheet effect of Japan’s long crisis was a rise in the government’s gross debt from 70 per cent of GDP in 1990 to 180 per cent at the end of last year. Leverage did not so much disappear as become socialised.

Similarly, a rise in the indebtedness of the US government is an almost inevitable consequence of any prolonged financial crisis. A jump in public debt is an invisible increase in long-term private obligations. But this is socialised private debt: the prudent pay for the profligate.

An escape from the public sector’s debt trap exists: the mass default known as inflation. By destroying the purchasing power of money, the government can engineer a speedy reduction in indebtedness across the economy, at the expense of creditors, principally the elderly and foreigners. Inflation is a magic tax on creditors whose proceeds are directly transferred to debtors.

The bottom line is simple. Neither households nor the financial sector, as a whole, can de-leverage swiftly, other than via a calamitous mass default or by shifting their debt elsewhere, usually on to the government. For an entire economy, particularly a huge one, to recover from debt-addiction is hard. However much one may loathe the idea, a private-sector financial mania will finish up as public-sector pain.

Food Stamp Use to Reach Record Level

Belying the claim that (until recently) the economy was in good shape, the use of food stamps is rising and will hit an all time high this year. Admittedly, that is absolute numbers with underlying demographic growth. The percentage of people using this income supplement was highest in relative terms in 1994, when the parts of the country had not emerged from a recession. (the . While we may also be in one that has yet to be officially recognized, things certainly aren't going to get better near term. This may an indicator that economic stress among consumers is markedly worse than is widely recognized.

From the New York Times:

Driven by a painful mix of layoffs and rising food and fuel prices, the number of Americans receiving food stamps is projected to reach 28 million in the coming year, the highest level since the aid program began in the 1960s.

The number of recipients, who must have near-poverty incomes to qualify for benefits averaging $100 a month per family member, has fluctuated over the years along with economic conditions, eligibility rules, enlistment drives and natural disasters like Hurricane Katrina, which led to a spike in the South.

But recent rises in many states appear to be resulting mainly from the economic slowdown, officials and experts say, as well as inflation in prices of basic goods that leave more families feeling pinched. Citing expected growth in unemployment, the Congressional Budget Office this month projected a continued increase in the monthly number of recipients in the next fiscal year, starting Oct. 1 — to 28 million, up from 27.8 million in 2008, and 26.5 million in 2007....

“People sign up for food stamps when they lose their jobs, or their wages go down because their hours are cut,” said Stacy Dean, director of food stamp policy at the Center on Budget and Policy Priorities in Washington, who noted that 14 states saw their rolls reach record numbers by last December.

One example is Michigan, where one in eight residents now receives food stamps. “Our caseload has more than doubled since 2000, and we’re at an all-time record level,” said Maureen Sorbet, spokeswoman for the Michigan Department of Human Services.

The climb in food stamp recipients there has been relentless, through economic upturns and downturns, reflecting a steady loss of industrial jobs that has pushed recipient levels to new highs in Ohio and Illinois as well.....

Some states have experienced more recent surges. From December 2006 to December 2007, more than 40 states saw recipient numbers rise, and in several — Arizona, Florida, Maryland, Nevada, North Dakota and Rhode Island — the one-year growth was 10 percent or more.

In Rhode Island, the number of recipients climbed by 18 percent over the last two years, to more than 84,000 as of February, or about 8.4 percent of the population. This is the highest total in the last dozen years or more, said Bob McDonough, the state’s administrator of family and adult services, and reflects both a strong enlistment effort and an upward creep in unemployment.

In New York, a program to promote enrollment increased food stamp rolls earlier in the decade, but the current climb in applications appears in part to reflect economic hardship, said Michael Hayes, spokesman for the Office of Temporary and Disability Assistance. The additional 67,000 clients added from July 2007 to January of this year brought total recipients to 1.86 million, about one in 10 New Yorkers.

Nutrition and poverty experts praise food stamps as a vital safety net that helped eliminate the severe malnutrition seen in the country as recently as the 1960s. But they also express concern about what they called the gradual erosion of their value.

Food stamps are an entitlement program, with eligibility guidelines set by Congress and the federal government paying for benefits while states pay most administrative costs....

Because they spend a higher share of their incomes on basic needs like food and fuel, low-income Americans have been hit hard by soaring gasoline and heating costs and jumps in the prices of staples like milk, eggs and bread.

At the same time, average family incomes among the bottom fifth of the population have been stagnant or have declined in recent years at levels around $15,500, said Jared Bernstein, an economist at the Economic Policy Institute in Washington.

The benefit levels, which can amount to many hundreds of dollars for families with several children, are adjusted each June according to the price of a bare-bones “thrifty food plan,” as calculated by the Department of Agriculture. Because food prices have risen by about 5 percent this year, benefit levels will rise similarly in June — months after the increase in costs for consumers.

Advocates worry more about the small but steady decline in real benefits since 1996, when the “standard deduction” for living costs, which is subtracted from family income to determine eligibility and benefit levels, was frozen. If that deduction had continued to rise with inflation, the average mother with two children would be receiving an additional $37 a month, according to the private Center on Budget and Policy Priorities.

Both houses of Congress have passed bills that would index the deduction to the cost of living, but the measures are part of broader agriculture bills that appear unlikely to pass this year because of disagreements with the White House over farm policy.

"Bangladesh bank offers loans to US poor"

If this microfinance venture by Grameen Bank is as successful as I hope it will be, it will be an indictment of US banks who provide only very high priced products to the lower income and poor, and then justify it by claiming that they offer a useful service. They of course prey on the prejudice that the poor by definition are bad risks, and compensate by putting high credit spreads into their products.

Another approach would be to screen potential clients much more thoroughly, and find borrowers who looked capable of meeting their obligations. Doug Smith in Slate informed us that not-for-profit mortgage lenders had defaults comparable to prime borrowers in their subprime portfolios due to careful screening and borrower education. But that takes more work and is less lucrative. Competition will show whether the conventional view is correct or merely self-serving.

From the Financial Times:

Bangladesh’s Grameen Bank has made its first loans in New York in an attempt to bring its pioneering microfinance techniques to the tens of millions of people in the world’s richest country who have no bank account.

The bank’s entry into the US, its first in a developed market, comes as mainstream banks’ credibility has been hit by the mortgage meltdown and many people are turning to fringe financial institutions offering loans at exorbitant interest rates.

“Now is a good time because of . . . the subprime crisis and that highlights the issue that the financial system is not perfect,” Muhammad Yunus, the bank’s Nobel Prize-winning founder, told the Financial Times.

Grameen has lent $50,000 in the past month to groups of immigrant women in Jackson Heights in New York’s borough of Queens. During the next five years, it plans to offer $176m in loans within New York city, and then expand to the rest of the US.

In Bangladesh, Grameen lends to poor women seeking to start small enterprises who cannot borrow from banks because they do not have accounts or a high enough credit rating. The bank, which started with $27 in loans Mr Yunus made to 42 women in Bangladesh in 1976, has now made more than $6.5bn in loans to 7m people in the country.

In the US, about 28m people have no bank accounts and 44.7m have only limited access to financial institutions. People often do not hold bank accounts because they have had credit problems, have no access to a local branch or they distrust the mainstream financial system, said Jonathan Morduch, a microfinance expert at New York University.

Some microfinance experts doubt that Grameen could make an impact in the US where credit is widely available, and businesses and tax systems are much trickier to navigate than in developing countries.

After beginning with small loans to micro-entrepreneurs, Grameen plans to expand into other businesses such as remittances and mortgages.

Some Good News for White Collar Workers (Offshoring Edition)

Offhshoring, the practice of companies sending work overseas (whether to their own operations located in other countries or to foreign outsourcing companies) has become the new worry of the white collar class. The business media regularly reports on software development, legal research, and Wall Street grunt work being sent to India. And it seems that roughly half the customer support calls these days are similarly routed overseas. Worse, Princeton economist Alan Blinder has estimated that as many as 29% of US jobs are offshorable. Will the only safe havens be one like hairdressing, retail, hotel operations, and divorce counseling?

Two recent posts at VoxEU give some hope to the besieged office worker. The first, "Service offshoring: Same old trade with a new label?" by Keith Head, Thierry Mayer, and John Ries, finds that service offshoring isn't as easy to execute as proponents imagine, and distance serves as a barrier. Some key findings:

How much should service-sector workers in rich nations fear offshoring competition from much lower paid workers in India? New research suggests that distance still provides signification protection, almost as much in services as it does in goods. Once again the death of distance has been greatly exaggerated.

Pundits regularly invoke the notion of a world economy that is either “shrinking” or becoming “flat.” Explanations of this alleged flattening include technological innovations in transportation and communication that have enabled goods and ideas to flow more freely. The offshoring of service jobs, particularly call centers and computer software in India, has grabbed recent media attention. In his bestseller The World is Flat, New York Times columnist Thomas Friedman (2005) wrote of how he had “interviewed Indian entrepreneurs who wanted to prepare my taxes from Bangalore, read my X-rays from Bangalore, trace my lost luggage from Bangalore and write my new software from Bangalore.”....

Most economists, cognizant of the gains from trade, do not view a “flat” world as an alarming prospect...

Just as mainstream trade theory identifies gains from trade, it also shows that real wages of some workers tend to fall as a consequence of freer trade...

Our research investigates whether geographic separation limits offshoring trade, thereby shielding domestic workers from direct competition with their foreign counterparts. We develop a model that envisions employers searching globally for the most suitable workers for any given task and posits that distance raises the costs of using foreign workers. These higher costs reflect travel, training, or translation time associated with using workers that reside far from where their services will be consumed. Firms choose workers that offer the lowest costs after adjusting wages for productivity and distance-based service delivery costs.....

Those results indicate that geographic barriers offer high-wage workers substantial insulation from low-wage competitors based in remote countries. Distance has long acted as a serious impediment to international transactions. Unfortunately, most of what we know about the effects of distance on international transactions is based on studies of trade in goods. A consensus appears to be forming that freight costs cannot explain the strength and functional form of the distance effect for goods.1 Instead, physical distance seems to be picking up some combination of the barriers imposed by cultural differences, the continued desire for face-to-face communication, and the geographically-biased structure of social and business networks. These factors apply to services as well as goods...

How much should high-wage workers fear competition from much lower paid workers in India and China? Our findings suggest that distance still provides signification protection. Since these estimates reflect averages across a range of services, there are surely services where competition is especially acute. Moreover, service delivery costs associated with distance appear to have fallen over the last decade to a level that is slightly below the level estimated for goods. Unfortunately, the data do not clearly indicate whether distance costs for services will continue their downward trend or level off. We suspect that persistent cultural differences, as well as locally-biased social networks, will maintain distance costs at a high enough level to forestall the small, flat world envisioned by some journalistic accounts.

A second post, using empirical data rather than a model, reaches similar conclusions. Indeed, this work is particularly powerful because the study used data from Italy, a country that had suffered declining productivity and therefore ought to show strong improvement from outsourcing. Yet the researchers, Francesco Daveri and Cecilia Jona-Lasinio, concluded in "Offshoring, not enough to beat Italy's productivity slowdown," that while sending work abroad boosted productivity for manufacturing, it occurred only for certain types of goods. Conversely, offshoring did not help service productivity; indeed, in some cases, it appeared to reduce it:

The public debate on offshoring has created more heat than light to date, but researchers are beginning to get a picture of its real economic impact. New evidence from Italy, based on firm-level data and a direct measure of offshoring, shows that offshoring of parts and components boosts domestic productivity while offshoring of services does not.

The offshoring of activities of manufacturing firms and industries often features at the centre-stage of the political arena for its allegedly negative effects on domestic employment. During the 2004 US presidential campaign, the concern that outsourcing had gone too far creating more hardships than necessary for American unskilled workers was one of the hot political issues. Not by chance academic research on this topic (Feenstra and Hanson, 1996 and 1999, being perhaps the most celebrated contributions in this area)1 has mostly focused on such effects.

Yet the fear of potentially adverse labour market outcomes of offshoring ended up obscuring in the public debate the very reason that pushes a company to delocalize its activities: the search for efficiency gains. Luckily, an array of McKinsey2 and other business consultancy studies have also found that offshoring has been a crucial ingredient to enable the American economy to take full advantage of the potential productivity gains brought about by the IT revolution. And consistent with this evidence, the statistical analysis for US firms and industries (see Amiti and Wei, 2006)3 has also indicated that the offshoring of services and, less strongly, of intermediates has been associated with productivity gains. The same correlation seems to hold in the French and German manufacturing sector and in the British and Irish business services.

In a recent paper,4 we provide empirical evidence on the relation between offshoring and productivity growth in the Italian manufacturing industries. In the last few years, Italy has been on a declining productivity path. Yet this occurred in parallel with an acceleration of the opening up of the economy, also implemented by delocalizing abroad the manufacturing activities previously carried out within the domestic borders. Hence our research question is whether manufacturing offshoring has counteracted or possibly added to the declining productivity trends lately experimented by the Italian economy.5...

Overall, our statistical evidence shows a remarkably consistent pattern of correlation between offshoring and labour productivity growth with various statistical techniques. First of all, it appears that not all types of offshoring positively correlate with productivity growth. The type of good being outsourced indeed matters: the offshoring of intermediates is positively related to productivity growth, while the international outsourcing of services is either not related or - at times - even negatively related to productivity growth....

Our analysis is based on an original data set inclusive of input-output tables recently released by the Italian statistical institute. Such tables, by splitting the imported and domestic content of the inter-industry transactions of goods and services in the economy, allow us to directly measure the extent of intermediate and services off-shoring on the part of manufacturing industries. This is different and – in our opinion – preferable to using the methodology previously employed by Feenstra and Hanson (and repeatedly used in the other studies in this area). Since their measure is unobserved, the extent of outsourcing has to be inferred from trade data assuming that any purchasing industry would import intermediates or services in the same proportion as any other industry in the economy.

Our calculations do not have to rely on such assumptions that are restrictive and which our data suggest are unwarranted. We provide a direct measure of offshoring not based on untested assumptions and then we econometrically test whether using our indicator or the Feenstra-Hanson indicator makes a big difference. It seems it does. We find a positive relation between intermediate offshoring and productivity growth when using our (direct) measure of offshoring. However, the correlation disappears altogether when the standard Feenstra-Hanson measures of external outsourcing are employed.

We find our results of general interest, over and above the discussion of the case of Italy and we intend to pursue this line of research further in the close future.

One in Five Working Families Struggling

The proponents of a "living wage" in the US have argued that setting minimum wages at a level that leaves full time workers at below subsistence level is bad policy, both economically and socially. While opponents argue that increasing pay for the lowest earners will reduce the number of jobs, elasticity of demand isn't all that high. A 10% increase in wages only results in a 2-3% decrease in employment, resulting in a marked gain in aggregate earnings.

Further confirmation of the downside of low wages comes in this article from MarketWatch. It's noteworthy that the authors have fallen into the Wal-Mart syndrome of looking for explicit public subsidies to compensate for inadequate wages. But does it make sense for taxpayers to augment the incomes of the working poor, rather than require employers to pay adequate wages? The issue needs to be addressed explicitly.

From MarketWatch:

About 1 in 5 Americans in working families can't afford basic needs, and many are scraping to get by on insufficient income and government aid, policy researchers conclude in a report released Wednesday.

Many of these workers earn too much to qualify for "work supports" such as Medicaid and food stamps, while their employer-provided health insurance doesn't cover enough of their basic medical costs, according to the report by the Center for Economic and Policy Research and the Center for Social Policy at the University of Massachusetts.

"We no longer live in a world where having a job means you're automatically able to make ends meet," said Heather Boushey, co-author of the report. "Our work-support policies need to be updated to support the millions of families with earners in bad jobs."

About 41 million people in working families can't afford such basic necessities as health care and housing, according to the report. The study, which examined conditions in nine states and the District of Columbia, found that government programs close abut two-fifths of the "hardships gap" -- a measure of the difference between a family's income, including all aid programs, and the local costs of goods and services.

"Families fall into the hardships gap because the low-wage labor market provides meager pay and few employment-based work supports for low- and moderate-wage workers," the report noted.

The report's authors recommend steps such as focusing on better wages and mandates for employers to provide employment-based benefits, and simplifying the eligibility criteria and application requirements for work supports.

"Public policy has not caught up to the reality that even working families may need public work supports," the authors wrote. "Without public work supports, they and their families go without health insurance, adequate child care, safe housing, or other necessities. Many of those in the hardships gap earn too much, or do not meet other eligibility criteria, to qualify for work supports, even through they are low-income."

In 2005, about one-fifth of workers were in "bad jobs" -- those that paid less than the median wage in 1979 in inflation-adjusted dollars, and did not offer health insurance or a retirement plan, according to the report. Employer-based benefits are good for people with access to them, but most low-wage workers aren't offered or can't them, the report said.

"While workers with moderate or high earnings commonly receive health insurance, paid time off, and retirement plans, low-wage workers most often do not," the report noted.

The median monthly hardship gap for families in the states covered by the report was $1,524. After work supports, that gap decreased to $855. Therefore, the typical family with a hardships gap sees a savings of about $8,000 in work supports.
"However, we find that many low-income working families are either ineligible for work supports, or do not receive the supports to which they are entitled," the authors wrote.

Part of the problem is that the work supports don't reach all who are eligible due to a complex registration process and a lack of resources.

Boushey said government financial aid programs could draw a lesson from the earned income tax credit, which has a relatively straightforward system for eligible recipients to receive benefits.

Unions on the Rise?

A good article by Clive Crook of the Financial Times discusses the improving fortunes of unions in America. Crook looks at some of the indicators their rising influence (key sign: fawning Democratic hopefuls) and how they can aid as well as impede economic activity.

Even though Crook's piece is helpful, he somehow seems wide of the mark. He may not understand the roots of the antipathy towards unions in America. Even in their heyday, organized labor was held in less than high esteem, and it wasn't due as much to their obstructionist role in commerce (America wasn't in the thrall of corporate interests back then) as to their rampant corruption. Even today, quite a few union members seem ambivalent. While they acknowledge that they do better with the union than they would without, many feel the union extracts too high a toll (in terms of dues) relative to the benefits delivered. In other words, they suspect self-dealing.

And Crook misses why unions have become a more respectable cause. One reason is the widespread disgust with CEO pay. The less sympathetic executives become (and they've had plenty of warning that they ought to rein in their behavior, which has gone unheeded), the more measures to clip their wings look justified. If investors can't pressure a CEO to cut his pay package, perhaps a worker revolt may. Mind you, that isn't literally what the public is thinking, but the abuse of the power of the office by many CEOs calls for a countervailing force, and labor could credibly step into that breach.

A second reason is the Wal-Martization of workers. Employment at will and America's weak safety nets seemed viable in a robust economy when employers felt some loyalty toward their workers. But now many companies see them as disposable, a cost rather than an asset. The degradation of job quality and security is producing a pushback.

Third is that some unions are moving away from the traditional reflexive opposition to management and are working to craft win-win situations, in which they work to improve the standing of the industry and also make certain they share in the gains. Andrew Stern, the head of the Service Employees International Union, which is the largest and fastest-growing union in America. A 2005 New York Times article discussed Stern's approach at considerable length:

Over the years, union bosses have grown comfortable blaming everyone else -- timid politicians, corrupt C.E.O.'s, greedy shareholders -- for their inexorable decline. But last year, Andy Stern did something heretical: he started pointing the finger back at his fellow union leaders. Of course workers had been punished by forces outside their control, Stern said. But what had big labor done to adapt? Union bosses, Stern scolded, had been too busy flying around with senators and riding around in chauffeur-driven cars to figure out how to counter the effects of globalization, which have cost millions of Americans their jobs and their pensions. Faced with declining union rolls, the bosses made things worse by raiding one another's industries, which only diluted the power of their workers. The nation's flight attendants, for instance, are now divided among several different unions, making it difficult, if not impossible, for them to wield any leverage over an entire industry.

Stern put the union movement's eroding stature in business terms: if any other $6.5 billion corporation had insisted on clinging to the same decades-old business plan despite losing customers every year, its executives would have been fired long ago.....

Having grown up around his father's small-business clients, and having spent much of his adult life at bargaining tables, Stern had learned a few things about the way business works. He came to embrace a philosophy that ran counter to the most basic assumptions of the besieged labor movement: the popular image of greedy corporations that want to treat their workers like slaves, Stern believed, was in most cases just wrong. The truth was that companies in the global age, under intense pressure to lower costs, were simply doing what they thought they had to do to survive, and if you wanted them to behave better, you had to make good behavior viable for them.

Stern's favorite example concerns the more than 10,000 janitors who clean the office buildings in the cities and suburbs of northern New Jersey. Five years ago, only a fraction of them were unionized, and they were making $10 less per hour than their counterparts across the river in Manhattan. Stern and his team say they were convinced from talking to employers in the fast-growing area that the employers didn't like the low wages and poor benefits much more than the union did. Cleaning companies complained that they had trouble retaining workers, and the workers they did keep were less productive. The problem was that for any one company to offer better wages would have been tantamount to an army unilaterally disarming in the middle of a war; cheaper competitors would immediately overrun its business.

The traditional way for a union to attack this problem would be to pick the most vulnerable employer in the market, pressure it to accept a union and then try to expand from there. Instead, Stern set out to organize the entire market at once, which he did by promising employers that the union contract wouldn't kick in unless more than half of them signed it. (Getting the first companies to enter into the agreement took some old-fashioned organizing tactics, including picket lines.) The S.E.I.U. ended up representing close to 70 percent of the janitors in the area, doubling their pay in many cases, from minimum wage to more than $11 an hour. Stern found that by bringing all of the main employers in an industry to the table at one time, rather than one after the other, he was able to effectively regulate an entire market.

This is a huge departure from the union thinking of old, and the SEIU's success is likely to bring other unions around to a similar posture.

From the Financial Times:

The US has an unusually low rate of union membership. Barely 10 per cent of its workers are members (and as few as 7 per cent in the private sector), down from about 35 per cent in the 1950s. Whether you see this as a strength or a weakness most likely depends on whether you think the US economy is succeeding or failing. Weak unions make for flexibility and rapid growth in productivity, the engines of US economic pre-eminence. To see what strong unions do for industrial competitiveness, look at GM. But weak unions also squeeze wages at the bottom, worsen inequality and create economic insecurity, the issues that most preoccupy the country and its politicians.

Avidly courting union endorsements in the approaching presidential primaries, all the Democratic candidates are taking a pro-union stance...These are not just rhetorical commitments. All the candidates are supporting legislation promoted by the labour movement that would make it easier for unions to organise...

American workers have often been cool towards unions. In the mid-1990s polls generally found that only about a third of non-union workers wanted to join one. In the past few years, the proportion has risen to more than half. The Democrats’ beefed-up pro-union line is faithfully reflecting this shift in mood. Both spring from the economic strains and insecurity of which so many Americans complain.

But is a recovery of union power a good answer to those problems? GM notwithstanding, the idea should not be dismissed out of hand. Certainly, enough of the wrong kind of union activity can wreck an economy. Britain made that clear in the 1960s and 1970s. But unions need not be so obtusely adversarial and self-destructive. Unions and works councils in Germany and Japan have not impoverished those countries. Unions do raise wages, sympathetic economists point out. When they do, it is usually in industries where product markets are not very competitive and there is a rent for managers to share with labour. When product markets are competitive, there is no rent to divide: the effect of unions on wages is then typically smaller and no economic harm is done.

Pro-union economists also point to evidence that productivity may actually be higher when a union is present, provided that the enterprise is well run to begin with. Perhaps higher wages enable managers to hire better workers, or else encourage companies to invest in labour-saving machinery. This could make for a productive, profitable company with contented workers – although not without losers, one must remember. Because of higher-than-competitive wages, employment is lower than it would have been. The insiders gain, in the best case at little or no cost to shareholders. But outsiders are worse off.

As a rule, though, unions are bad at accommodating disruptive change – the very thing the US does best. The weakness of the country’s unions is surely no coincidence: they are weak because the economy is dynamic, and vice versa. American unionism has modernised lately, but much of what remains is still political and adversarial. Its body language says, we are out to get the bosses. It seeks a voice not just for workers in the office or factory, but for labour in the aggregate. Its agenda is anti-competitive and stridently protectionist, and consequently anti-growth.

The late Rudiger Dornbusch, ever a fount of economic wisdom, was fond of the maxim, protect the worker not the job. Unions are wired to ignore that good advice. Their leaders’ power and pay is bound up with the existence of particular jobs. They are institutionally opposed to creative destruction and economies need a lot of that to thrive. But if workers, not jobs, are to be protected, governments do need to step in. The list is familiar, and has a strongly Democratic flavour: more generous employment subsidies for the low-paid, high-quality education, universal health insurance and help for workers who fall victim to restructuring.

Dani Rodrik Questions Conventional Wisdom on Labor Market Rigidities

Harvard's Dani Rodrik in a recent post questioned the role of labor market rigidities (such as restrictions on firings and generous unemployment) in Europe's higher unemployment. (As an aside, readers will know even that factoid is disputed. Barry Ritholtz has argued that if we calculated unemployment the same way Europeans did, the rates wouldn't be very different, and one reader pointed out employment/population ratios for working age men also shows that supposedly sclerotic France has higher workforce participation than the US).

Rodrik cites an article by David R. Howell, Dean Baker, Andrew Glyn, and John Schmitt, "Are Protective Labor Market Institutions at the Root of Unemployment? A Critical Review of the Evidence." In short, the analyses that claim to prove that labor market restrictions lead to higher unemployment aren't compelling. The abstract:

A rapidly expanding empirical literature has addressed the widely accepted claim that employment-unfriendly labor market institutions explain the pattern of unemployment across countries. The main culprits are held to be protective institutions, namely unemployment benefit entitlements, employment protection laws, and trade unions. Our assessment of the evidence offers little support for this orthodox view. The most compelling finding of the cross-country regression literature is the generally significant and robust effect of the standard measure of unemployment benefit generosity, but there are reasons to doubt both the economic importance of this relationship and the direction of causation. The micro evidence on the effects of major changes in benefit generosity on the exit rate out of unemployment has been frequently cited as supportive evidence, but these individual level effects vary widely across studies and, in any case, have no direct implication for changes in the aggregate unemployment rate (due to ``composition" and ``entitlement" effects). Finally, we find little evidence to suggest that 1990s reforms of core protective labor market institutions can explain much of either the success of the ``success stories" or the continued high unemployment of the large continental European countries. We conclude that the evidence is consistent with a more complex reality in which a variety of labor market models can be consistent with good employment performance.

Rodrik provides some observations, starting with comments made on the paper:

In his comment on this paper, Jim Heckman agrees that the cross-national evidence is weak and fragile. But:

In the absence of better data, and better measurement frameworks, prior beliefs will continue to dominate how one interprets the evidence. This is not as much about dogmatism or conspiracy as it is about good science. In the absence of empirical evidence, logically consistent stories that accord with intuition have great appeal.....

In at least one area of labor-market intervention, employment protection (firing restrictions), the orthodox expectation is not the only "logically consistent" story that accords with economic intuition. If you make it harder to fire an employee, you essentially give that employee some property rights over the job he occupies. Now, according to the Coase theorem, how property rights are allocated (to the employer versus the employee) has no effect on efficiency in the absence of bargaining and other transaction costs. If eliminating a job is the efficient thing to do, an employer can do it either by fiat or by paying the employee to leave. There are distributional implications (obviously the employer is worse off in the latter case), but nothing to stop the efficient thing from getting done. This is an idea I associate with my Harvard colleague Richard Freeman.

The paper by Howell, Baker, Glyn, and Schmitt did not offer new theories in place of the prevailing one, but one way in which it may err is in viewing employees strictly as economic agents. People are social beings, and in a world where other institutions, like church and community, play diminished roles, work is the primary social network in many people's lives. That fact alone might offset to a considerable degree the concern that citizens will suck on the tit of the state as long as they can, and work only if required to. It's too bad the behavioral finance crowd hasn't gotten around to labor market issues.

The notion that transferring property rights away from one party to another is a zero sum game also bears investigating. Consider a real estate example. New York city still has some apartments that are rent stabilized. That means that rent increases are regulated (they roughly track inflation) and the landlord cannot deny a tenant a lease renewal if they have paid their rent on time. There's another wrinkle, that if the rent rises above a certain level and the tenant has sufficiently high income, the apartment is subject to "luxury decontrol," meaning the landlord can charge a market rent.

Now most landlords in New York are very aggressive in trying to decontrol apartments, But I know of one (and he has the reputation of being stingy) who doesn't. In fact, from what I have heard, they don't even try.

Why would that be? Tenants in his building, who know they have property rights (remember, the landlord cannot deny lease renewal), often fix up the apartments on their own. And I don't mean paint. One tenant spent well over a million dollars on renovations.

Trying to decontrol apartments would make any tenant think twice about putting even a penny into his unit. The landlord finds it better to keep good tenants in place, since a high proportion have invested in their apartments, which benefits him. But don't expect him to spend money on the lobby.

Conference Board Review on Prejudice and the Glass Ceiling

Our colleague Susan Webber of Aurora Advisors has a new article, "Fit vs. Fitness," in the current issue of The Conference Board Review. The editors were initially skeptical that anything new could be said on the subject of the glass ceiling, but this article persuaded them otherwise. We hope you'll agree. She draws on personal observations her days at Goldman, McKinsey, and Sumitomo Bank. Frank Dobbin, a Harvard professor of sociology who has investigated what diversity practices are effective in a corporate setting (and whose work in cited in the piece), commented, "A wonderful job of summarizing lots of social science research, and teasing out insights that should be useful in the workplace."

Some excerpts:

No one would dream of calling you a bigot.....

But when you look around, your good intentions and actions have had little impact. Above a certain level in your company, the demographics haven’t changed much in the last decade. Every promotion decision, individually, seemed justified, yet the aggregates would support a charge of bias. And across corporate America, your experience has been replicated at dozens of companies.

Why does this problem persist? Why, despite all the exhortations, training programs, acknowledgment of the business case, and headline-making litigation, is it so hard to get minorities and women into executive ranks? We can talk about the usual suspects: the limitations of the talent pool or pipeline, the fact that minorities of various sorts often don’t get adequate mentoring or lack robust internal networks, that women face work/family conflicts. But these don’t completely explain the phenomenon.

I believe that prejudice is still a factor—yes, even after all these years of soul-searching and anti-discrimination workshops, even in the most enlightened corners of the country. And it’s not about only women and Hispanics and African-Americans......

[These cases point up a fundamental issue: Are companies making unduly conservative choices based on their beliefs about what makes a successful candidate, when those may not be grounded in fact?....

Columbia University professor Amar Bhide coined the phrase “novelty aversion,” to describe how investors shun ventures that are unprecedented—notably, both Federal Express and Cisco found it difficult to secure early funding. It isn’t much of a stretch to extend his logic to hiring and promotion. Both venture capitalists and corporations are in the business of picking winners—the former attractive investments, the latter talented employees.....

Consider the experience of Oakland A’s general manager Billy Beane, the hero of Michael Lewis’s Moneyball: The Art of Winning an Unfair Game. The baseball industry has always measured players’ skill and achievements by a handful of well-known statistics, but in recent years researchers have questioned the value of those traditional measures. To make the most of a limited budget, Beane used the new principles to sign low-salaried players whom his analysis showed were dramatically undervalued. The result: The team, with one of baseball’s lowest payrolls, has placed first or second in its division each of the last eight years.

Here, then, you have a business where the recruiting is unusually transparent, the basic rules have remained unchanged for decades, competitive encounters are in full view, and the incentives for success are high. This would seem to be the perfect environment for developing good decision rules, yet the entire industry was largely wrong.

The full article is here. Enjoy! If you post a comment, we'll arrange for her to respond if appropriate.

Americans No Longer Tallest

Height is influenced by the quality of nutrition in childhood and as a result, in many societies, it has also been a class indicator. One example: Winston Churchill, who as a Liberal Party member and Home Secretary, was instrumental in the passage of minimum wages and the Liberal Reforms, which among other things, provided for free school meals for children and made it illegal to sell alcohol or tobacco to children (this in the 1906-1914 period). Churchill later said he could see the results of these programs. In the Great War, there was a visible difference between the puny, scrawny enlisted men, who came from the working classes, and the taller aristocratic officers. By World War II, you couldn't tell a man's class by his build.

An Associated Press story tells us that Americans are not only no longer the tallest nation in the world, but that quite a few nations have surpassed us:

Even residents of the formerly communist East Germany are taller than Americans today. In Holland, the tallest country in the world, the typical man now measures 6 feet, a good two inches more than his average American counterpart.

Compare that to 1850, when the situation was reversed. Not just the Dutch but all the nations of western Europe stood 2 1/2 inches shorter than their American brethren.

Does it really matter? Does being taller give the Dutch any advantage over say, the Chinese (men 5 feet, 4.9 inches; women 5 feet, 0.8 inches) or the Brazilians (men 5 feet, 6.5 inches; women 5 feet, 3 inches)?

Many economists would argue that it does matter, because height is correlated with numerous measures of a population's well-being. Tall people are healthier, wealthier and live longer than short people. Some researchers have even suggested that tall people are more intelligent.

It's not that being tall actually makes you smarter, richer or healthier. It's that the same things that make you tall — a nutritious diet, good prenatal care and a healthy childhood — also benefit you in those other ways.

That makes height a good indicator for economists who are interested in measuring how well a nation provides for its citizens during their prime growing years. With one simple, easily collected statistic, economists can essentially measure how well a society prepares its children for life....

Height tells you about a segment of the population that is invisible to traditional economic statistics. Children don't have jobs or own houses. They don't buy durable goods, or invest in the stock market. But obviously, investments in their well-being are critical to a nation's economic future....

Not surprisingly, rich countries tend to be taller simply because they have more resources to spend on feeding and caring for their children. But wealth doesn't necessarily guarantee that a society will give its children what they need to thrive.

In the Czech Republic, per capita income is barely half of what it is in the United States. Even so, Czechs are taller than Americans. So are Belgians, who collect 84 percent as much income as Americans.

And those height differences translate into real benefits. A number of studies have shown that disease and malnutrition early in life — the same things that limit a person's height — increase a person's chances of developing heart disease and other life-shortening conditions later on. Though tall people are more likely to get cancer, they suffer less mortality overall than short people....

International statistics bear it out. Life expectancy in the Netherlands is 79.11 years; in Sweden it's 80.63. America's life expectancy of 78.00 years puts it in somewhat shorter company, just above Cyprus and a few notches below Bosnia-Herzegovina.

"Obviously America is not doing badly. It's not at the level of developing nations," Komlos said. "But it's also not doing as well as it could."

His latest research paper, published in the June issue of Social Science Quarterly, suggests the blame may lie with America's poor diet and its expensive, inequitable health-care system.

"American children might consume more meals prepared outside of the home, more fast food rich in fat, high in energy density and low in essential micronutrients," wrote Komlos and co-author Benjamin E. Lauderdale of Princeton University. "Furthermore, the European welfare states provide a more comprehensive social safety net including universal health care coverage."

In the United States, by comparison, an estimated 9 million children have no health insurance.

Thomas Schaller, in "The Long and the Short of It," on the Guardian's website, provides further comments:

America has dropped to 27th in the world in average male height.

Conservative politicians and pundits in the United States like to point to comparative rates of economic growth on both sides of the Atlantic as evidence that the larger welfare states of European economies are inferior to America's leaner, meaner public sector and more vibrant economy. But when it comes to head-to-toe yardsticks, comparisons clearly favour the Old Country, where Dutch males are the tallest, the United Kingdom ranks 17th, and most countries outside the Iberian peninsula are taller than America.

Even Iraqi men - ranked 21st - are taller, on average, than the Americans who joined the Brits in invading that country more than four years ago....

Ohio State University economist Richard Steckel has shown that American height deficits compared to northern Europeans is attributable to lack of growth during infancy and adolescence, which he believes is partly a result of junk food diets. "If these snack foods are crowding out fruits and vegetables, then [Americans] may not be getting the micronutrients we need," Dr Steckel told The New Yorker magazine a few years ago.

The same article cites a British study, conducted earlier this decade, in which one group of schoolchildren was fed hamburgers and French fries for lunch, while another was given World War II-style ration like corned beef and cabbage. Sure enough, in just eight weeks, the latter group was taller and slimmer than the ones on the typical modern diet.