The National Taxpayer Advocate Speaks Up

Yes,.there is a National Taxpayer's Advocate, and her name is Nina E. Olson. She has just released the National Taxpayer Advocate 2012 Annual Report to Congress. The report covers a lot of ground, each year looking at issues like taxpayer rights, taxpayer rights, identity theft, and other topics. Here, I'll just focus on one topic:  "The most serious problem facing taxpayers — and the IRS — is the complexity of the Internal Revenue Code." Here are some samples of the comments (footnotes omitted): 

• "According to a TAS analysis of IRS data, individuals and businesses spend about 6.1 billion hours a year complying with the filing requirements of the Internal Revenue Code. And that figure does not include the millions of additional hours that taxpayers must spend when they are required to respond to IRS notices or audits. If tax compliance were an industry, it would be one of the largest in the United States. To consume 6.1 billion hours, the “tax industry” requires the equivalent of more than three million full-time workers. ... Based on Bureau of Labor Statistics data on the hourly cost of an employee, TAS estimates that the costs of complying with the individual and income tax requirements for 2010 amounted to $168 billion — or a staggering 15 percent of aggregate income tax receipts."
• "According to a tally compiled by a leading publisher of tax information, there have been approximately 4,680 changes to the tax code since 2001, an average of more than one a day."
• "The tax code has grown so long that it has become challenging even to figure out how long it is. A search of the Code conducted using the “word count” feature in Microsoft Word turned up nearly four million words."
• "Individual taxpayers find return preparation so overwhelming that about 59 percent now pay preparers to do it for them. Among unincorporated business taxpayers, the figure rises to about 71 percent. An additional 30 percent of individual taxpayers use tax software to help them prepare their returns, with leading software packages costing $50 or more."
• "IRS data show that when taxpayers have a choice about reporting their income, tax compliance rates are remarkably low. ... [A]mong workers whose income is not subject to tax withholding, compliance rates plummet. An IRS study found that nonfarm sole proprietors report only 43 percent of their business income and unincorporated farming businesses report only 28 percent. Noncompliance cheats honest taxpayers, who indirectly pay more to make up the difference. According to the IRS’s most recent comprehensive estimate, the net tax gap stood at $385 billion in 2006, when there were 116 million households in the United States. This means that each household was effectively paying a “surtax” of some $3,300 to subsidize noncompliance by others."
• "From FY 2004 to FY 2012, the number of calls the IRS received from taxpayers on its Accounts Management phone lines increased from 71 million to 108 million, yet the number of calls answered by telephone assistors declined from 36 million to 31 million. The IRS has increased its ability to handle taxpayer calls using automation, but even so, the percentage of calls from taxpayers seeking to speak with a telephone assistor that the IRS answered dropped from 87 percent to 68 percent over the
  period. And among the callers who got through, the average time they spent waiting on hold increased from just over 2½ minutes in FY 2004 to nearly 17 minutes in FY 2012."
• "The IRS receives more than ten million letters from taxpayers each year responding to IRS adjustment notices. Comparing the final week of FY 2004 with the final week of FY 20102, the backlog of taxpayer correspondence in the tax adjustments inventory increased by 188 percent (from 357,151 to 1,028,539 pieces), and the percentage of taxpayer correspondence classified as “overage” jumped by 316 percent (from 11.5 percent to 47.8 percent)."
• "In 2012, TAS [the Taxpayer Advocate Service] conducted a statistically representative national survey of over 3,300 taxpayers who operate businesses as sole proprietors. Only 16 percent said they believe the tax laws are fair. Only 12 percent said they believe taxpayers pay their fair share of taxes."
• "To alleviate taxpayer burden and enhance public confidence in the integrity of the tax system, the National Taxpayer Advocate urges Congress to vastly simplify the tax code. In general, this means paring back the number of income exclusions, exemptions, deductions, and credits (generally known as “tax expenditures”). For fiscal year (FY) 2013, the Joint Committee on Taxation has projected that tax expenditures will come to about $1.09 trillion, while individual income tax revenue is projected to be about $1.36 trillion. This suggests that if Congress were to eliminate all tax expenditures, it could cut individual income tax rates by about 44 percent and still generate about the same amount of revenue."

Finally, I'm not the biggest fan of infographics,which often seem to me like overcrowded Powerpoint slides on steroids. But for those who like them, here's one from the National Taxpayer Advocate summarizing many of these points: 

FTC Data on Horizontal Merger Enforcement

The Federal Trade Commission has published Horizontal Merger Investigation Data: Fiscal Years 1996 - 2011. I found it interesting to notice the categories the report used to classify about horizontal merger enforcement: and the categorizes them along five dimensions: the Herfindahl-Hirschman Index before and after the proposed merger, the number of competitors in the market, the presence of "hot documents," the presence of "strong customer complaints," and ease of entry into the market.
 What surprised me was that the the notion of classifying merger policy along these kinds of categories is often de-emphasized in the recent economic research literature on industrial organization. Here, I'll first say a bit about the categories in the FTC report, and then compare it to the emphasis of recent empirical work in industrial organization.

The data for the FTC report comes from a requirement in the Hart Scott Rodino legislation, which I described in a post last June 14, "Next Merger Wave Coming? Hart-Scott-Rodino 2011," which reviewed some of the evidence from the annual HSR report. As I noted there: "The Hart-Scott-Rodino legislation requires that when businesses plan a merger or an acquisition above a certain price--typically $66 million in 2011--it must first be reported to the Federal Trade Commission. The FTC can let the merger proceed, or request more information. Based on that additional information, the FTC can then let the merger proceed, block it, or approve it subject to various conditions (for example, requiring that the merged entity divest itself of certain parts of the business to preserve competition in those areas)." Thus, the  most recent FTC report looks at those 464 horizontal merger cases from 1996-2011 where the FTC requested additional information, and whether those requests led to an enforcement action of some sort (either blocking the merger or placing conditions on it), or alternatively if the request was followed by closing the case without an enforcement action.

The firsts category discussed in the report is the Herfindahl-Hirschman Index (HHI): as the report says, "The HHI is the sum of the squares of the market shares of the competitors in the relevant market." In other words, if an industry has two firms, one with 60% of the market and one with 40% of the market, the HHI would be 60 squared, or 3600, plus 40 squared, or 1600, which would equal 5200. The highest possible HHI would be 10,000--that is, a complete monopoly with 100% of the market. The lowest HHI would be for an industry with many very small firms, each with only a miniscule portion of the market. After squaring these miniscule market shares and summing them up, the result would be a very low number.

Here's a table making HHI comparisons , with the columns showing how much the HHI would increase as a result of the merger and the rows showing the level of the HHI after the merger. This is measured across markets, where a given proposed merger often has implications across several different markets. Notice that none of the 14 cases where the post-merger HHI was less than 1700 and the rise in HHI was less than 99 led to an enforcement action. In the cells in the bottom right corner, if the post-merger HHI is above 3,000 and the gain in the HHI is above about 800, it's highly likely that an enforcement action will be taken. 

 
The next category in the FTC report is the number of competitors--which of course, in some ways, is based on the same information used to calculation the HHI. In the 20 cases with more than 10 competitors, there were no enforcement actions. But if the number of competitors is being reduced from 2 to 1, or 3 to 2, or 4 to 3, the request for additional information is very likely to lead to an enforcement action.

The FTC report then looks at a few other categories. "Hot documents" refers to a "cases where the staff identified one or more party documents clearly predicting merger-related anticompetitive effects." "Strong customer complaints" refers to cases "where customers expressed a credible concern that a significant anticompetitive effect would result if the transaction were allowed to proceed." And "ease of entry" is determined by an assessment by the FTC staff of the "timeliness, likelihood, and sufficiency" of entry. As one would expect, hot documents and strong customer complaints make enforcement actions more likely; ease of entry makes enforcement less likely.

 For teachers of undergraduate or high school courses in economics, this may all seem pretty straightforward, basically offering some background material for what is already being taught. But what was striking to me is that the direction of research in empirical industrial organization in recent years has tended to steer away from the HHI and such measures. For a nice discussion, I recommend
the discussion by  Liran Einav and Jonathan Levin of "Empirical Industrial Organization:A Progress Report," which appeared in the Spring 2010 issue of my own  Journal of Economic Perspectives. Like all articles in JEP going back to the first issue in 1987, it is freely available on-line courtesy of the American Economic Association.

As Einav and Levin point out, there was an older tradition in industrial organization called "structure-conduct-performance." It typically looked at the structure of an industry, as measured by something like the HHI, and then at how the industry behaved, and then at what profits the industry earned. But by the 1970s, it was clear that this approach had run into all kinds of problems. As one  example, the factors that were causing a certain industry structure might also be causing the high profits--so it would be muddled thinking to infer that the profits came from industry structure if both came from an outside factor. The available data on "profits" is based on accounting numbers, which differ in many ways from the economic concept of profits. More broadly, the whole idea that there should be common patterns across all industries in structure, conduct and performance seemed implausible.  They explain:

"Both the concerns about cross-industry regression models and the development of clearer theoretical foundations for analyzing imperfect competition set the stage for a dramatic shift in the 1980s toward what Bresnahan (1989) coined the “New Empirical Industrial Organization.” Underlying this approach was the idea that individual industries are sufficiently distinct, and industry details sufficiently important, that cross-industry variation was often going to be problematic ... Instead, the new wave of research set out to understand the institutional details of particular industries and to use this knowledge to test specific hypotheses about consumer or firm behavior, or to estimate models that could be used for counterfactual analysis, such as what would happen following a
merger or regulatory change. The current state of the fifi eld reflects this transition. Today, most of the influential research in empirical industrial organization looks extensively to economic theory for guidance, especially in modeling firm behavior. Studies frequently focus on a single industry or market, with careful attention paid to the institutional specifics, measurement of key variables, and econometric identification issues."

Einav and Levin go on to describe how this kind of research is done, and to evaluate its strengths and weaknesses. But my point here is that the summary of HHI, number of competitors and the rest across broad categories provided by the recent FTC report is quite different in spirit than how Einav and Levin are describing the research literature.

It seems to me that there are two possibilities here. The pessimistic view would be that the FTC just put together this report based on old categories and old thinking, and that it has little relevance to how antitrust analysis is actually done. But the more optimistic view, and the one that I prefer, is that the old traditional categories of measuring market structure with methods like the Herfindahl-Hirschman Index or a four-firm concentration ratio, as well as looking at factors like ease of entry, remain a more-than-adequate starting point for thinking about how antitrust enforcement is actually done. The more complex analysis described by Einav and Levin would then be applied to the hard cases, and discussion of the fine details of hard cases can be reserved for higher-level classes.

Interview with Elhanan Helpman

Douglas Clement has a characteristically excellent "Interview with Elhanan Helpman" in the December 2012 issue of The Region, published by the Federal Reserve Bank of Minneapolis. The main focuses of the interview are "new growth theory, new trade theory and trade (and policy) related to market structure." Here's Helpman:

On the origins of "new trade theory"

"When I was a student, the type of trade theory that was taught in colleges was essentially based on Ricardo’s 1817 insight, Heckscher’s 1919 insights and then Ohlin’s work, especially as formulated by [Paul] Samuelson later on. This view of trade emphasized sectoral trade flows. So, one country exports electronics and imports food, and another country exports chemicals and imports cars. This was the view of trade. The whole research program was focused on how to identify features of economies that would allow you to predict sectoral trade flows. In those years, there was actually relatively little emphasis on Ricardian forces, which deal with relative productivity differences across sectors, across countries, and there was much more emphasis on differences across countries in factor composition. ...

Two interesting developments in the 1970s triggered the new trade theory. One was the book by Herb Grubel and Peter Lloyd in which they collected a lot of detailed data and documented that a lot of trade is not across sectors, but rather within sectors. Moreover, that in many countries, this is the great majority of trade. So, if you take the trade flows and decompose them into, say, the fraction that is exchanging [within sectors] cars for cars, or electronics for electronics, versus [across sectors] electronics for cars, then you find that in many countries, 70 percent—sometimes more and sometimes less—would have been what we call intra-industry trade, rather than across industries....

The other observation that also started to surface at the time was that when you looked at trade flows across countries, the majority of trade was across the industrialized countries. And these are countries with similar factor compositions. There were obviously differences, but they were much smaller than the differences in factor composition between the industrialized and the less-developed countries. Nevertheless, the amount of trade between developed and developing countries was much smaller than among the developed countries.

This raised an obvious question. If you take a view of the world that trade is driven by [factor composition] differences across countries, why then do we have so much trade across countries that look pretty similar? ...


Then, on the theoretical front, monopolistic competition was introduced forcefully by both Michael Spence in his work, which was primarily about industrial organization, and [Avinash] Dixit and [Joseph] Stiglitz in their famous 1977 paper. These studies pointed out a way to think about monopolistic competition in general equilibrium. And trade is all—or, at least then, was all—about general equilibrium.

So combining these new analytical tools with the empirical observations enabled scholars to approach these empirical puzzles with new tools. And this is how the new trade theory developed."

On trade and inequality: an inverted U-shape?

"Most of the work on trade and inequality in the neoclassical tradition was focused on inequality across different inputs. So, for example, skilled workers versus unskilled workers, or capital versus labor, and the like. There was a lot of interest in this issue with the rise in the college wage premium in the United States, which people then found happened also in other countries, including less-developed countries. ...The other interesting thing that happened was that labor economists who worked on these issues also identified another source of inequality. They called it “residual” wage inequality, which is to say, if you look at wage structures and clean up wage differences across people for differences in their observed characteristics, such as education and experience, there is a residual wage difference, and wages are still quite unequal across people. In fact, it’s a big component of wage inequality.

Our aim in this research project, which has lasted now for a number of years, was to try to see the extent to which one can explain this inequality in residual wages by trade. It wasn’t an easy task, obviously, but the key theoretical insight came from the observation that once you have heterogeneity in firm productivities within industries, you might be able to translate this also into inequality in wages that different firms pay. ...We tried to combine these insights, labor market frictions on the one hand and trade and firm heterogeneity on the other ...We managed eventually, after significant effort, to build a model that has this feature but also maintains all the features that have been observed in the data sets previously. It was really interesting that the prediction of this model was that if you start from a very closed economy and you reduce trade frictions, then initially inequality is going to rise. However, once the economy is open enough, in a well-defined way, then additional reductions in trade friction reduce the inequality. Now, it is not clear that this is a general phenomenon, but our analytical model generated it. ... [I]t’s an inverted U shape ..."

On how the gains from research and development spill across national borders

"We computed productivity growth in a variety of OECD [Organisation for Economic Co-operation and Development] countries in this particular paper. We constructed R&D capital stocks for countries ... Then we estimated the impact of the R&D capital stocks of various countries on their trade partners’ productivity levels. And we found substantial spillovers across countries. Importantly, in those data, these spillovers were related to the trade relations between the countries. And we showed that you gain more from the country that does more R&D if you trade with this country more. This produced a direct link between R&D investment in different countries and how trading partners benefit from it. ...

 The developing countries don’t do much R&D. The overwhelming majority of R&D is done in industrialized countries, and this was certainly true in the data set we used at the time. So we asked the following question: If you look at developing countries, they trade with industrialized countries. Do they gain from R&D spillovers in the industrialized countries, and how does that gain depend on their trade structure with these industrialized countries? We showed empirically that the less-developed countries also benefited from R&D spillovers. And the more they trade with industrialized countries that engage heavily in R&D, the more they gain. ...


One of the important findings—which analytically is almost obvious, but many people miss it—is that, if you have a process that raises productivity, such as R&D investment, then this also induces capital accumulation. So then, the contribution of R&D to growth comes not only from the direct productivity improvement, but also through the induced accumulation of capital. When you simulate the full-fledged model with these features, you get a very clear decomposition. You can see how much is attributable to each one.

With this, we could handle a relatively large number of countries in all different regions of the world, and [run some] interesting simulations. We could ask, for example, if all the industrialized countries raise their investment in R&D by an additional half percent of gross domestic product, who is going to benefit from it? Well, you find that the industrialized countries benefit from it a lot, but the less-developed countries benefit from it also a lot. It was still the case that the industrialized countries would benefit more, so in some way it broadened the gap between the industrialized and the less-developed countries. Nevertheless, all of them moved up significantly."

Are Loss Leaders an Anticompetitive Free Lunch?

All experienced shoppers understand the concept of a "loss leader." A store offers an exceptionally low price on a particular item that is likely to be popular--indeed, the price is so low that on that item, the seller may lose money. But by advertising this "loss leader" item, the store hopes to bring in consumers who will then purchase other items as well that are not marked down. Of course, from the consumer point of view, the challenge is whether, in buying the loss leader item and making other purchases at that store, you actually end up with a better deal than if you bought the loss leader and then went to another store--or perhaps even did all your shopping in one stop at a different store. 

The terminology of loss-leaders is apparently nearly a century old. The earliest usage given in the Oxford English Dictionary is from a 1922 book called Chain Stores, by W.S. Hayward and P. White, who wrote: "Many chains have a fixed policy of featuring each week a so-called ‘loss leader’. That is, some well known article, the price of which is usually standard and known to the majority of purchasers, is put on sale at actual cost to the chain or even at a slight loss..on the theory..that people will be attracted to this bargain and buy other goods as well. Loss leaders are often termed ‘weekly specials’."

But every economist knows at least one example of the classic loss leader from the late 19th century, the "free lunch." At that time, a number of bars and saloons would advertise a "free lunch," but customers were effectively required to purchase beer or some other drink. If you tried to eat the free lunch without purchasing a drink, you would likely be thrown out. Thus, the origins of the TANSTAAFL abbreviation: "There ain't no such thing as a free lunch."

What I had not known is that there is a serious argument in the industrial organization literature over whether loss leaders should be treated by antitrust authorities as an anticompetitive practice. In 2002, for example, Germany's highest court upheld a decision of the Germany's Federal Cartel Office that Wal-Mart was required to stop selling basic food items like milk and sugar below cost as a way of attracting customers. Ireland and France have also been known for their fairly strict laws prohibiting resale below cost.

The theory of "Loss Leading as an Exploitative Practice" is laid out by Zhijun Chen and Patrick Rey in the December 2012 issue of the American Economic Review. (The AER is not freely available online, but many academics will have access to this somewhat technical article through library subscriptions.) Their approach has two kinds of sellers: large firms that sell a wide range of product, and smaller firms that sell a more limited range of products. It also has some buyers who have a high time cost of shopping--and thus prefer to shop at one or a few locations--along with other buyers who have a lower time cost of shopping and thus are more willing to shop at many locations. They then build up a mathematical model in which large firms use loss leaders as a way of sorting consumers and attracting those who are likely to do all their shopping in one place. Once they have those consumers inside the store, they can then charge higher prices for other items. Thus, the result of allowing "loss leaders" in this model is that a number of consumers end up paying more, and large stores with a wide product range may tend to drive smaller stores out of the market.

Of course, the fact that it is possible put together a certain theoretical model with this outcome doesn't prove that it is the only possible outcome, or that it's the outcome that should be of greatest practical concern. Back in 2007, the OECD Journal of Competition Law and Policy hosted a symposium on "Resale Below Cost Laws and Regulations." The articles can be read freely on-line with a slightly clunky browser here, or again, many academics will have on-line access through library subscriptions.  The general tone of these articles is that loss leaders should not be viewed as an anticompetitive practice. In no particular order, and in my own words, here are some of the points that are made:

• In general, business practices that reduce prices of at least some items to consumers should be  presumptively supported by anticompetition authorities, unless there is a very strong case against them. In general, regulators should spend little time second-guessing prices that are too low, and more time looking at prices that are too high or practices that are clearly unfair to consumers. 
• There are a number of reasons why loss leaders might tend to encourage competition. Offering a loss leader can encourage consumers to overcome their inertia of buying the same things at the same prices and try out a new product or a new store. Sometimes producers may want to reward customers who are especially loyal or buy in especially large volumes. It may be far more effective for a store to advertise low prices on a few items than to advertise that "everything in the store is on average 2% cheaper than the competition." Loss leaders may be linked to other things the seller desires, like become a provider of credit to the buyer or raising the chance of getting detailed feedback from the buyer. Loss leaders may especially useful to new entrants in markets, seeking to gain a foothold.
• Evidence from Ireland suggests that the grocery products where loss leaders are prohibited tend to have higher or rising prices, compared with other products. Since the products where loss leaders are prohibited tend to be more essential products, the prohibition on selling such items below cost tends to weigh most heavily on those with lower income levels.
• In general, there has been a trend in retailing toward big-volume, low price retailers. But this trend doesn't seem to have been any slower in places where limitations on resale-below-cost were in place. And if the policy goal is to help small retailers, there are likely to be better targeted and less costly approaches than preventing loss leaders. Indeed, small firms may in some cases wish to entice buyers by offering loss leaders themselves.
• It's not clear how to apply prohibitions against loss leaders to vertically integrated firms, since they have considerable ability to use accounting rules to reduce the "cost" of production--and then to resell at whatever price they wish. Even in a firm that is not vertically integrated, invoices for what is purchased can often include various discounts and allowances, and it is an administrative challenge for rules preventing resale-below-cost to take these into effect. If a firm buys products at a high wholesale price, and then the market price drops, presumably a resale-below-cost rule would prevent the firm from selling its products at all.
• It's worth noting that laws preventing loss leaders are not the same as laws that block "predatory pricing," where the idea is to drive a competitor out of business with with very low prices and then to charge higher prices on everything. This intertemporal scenario is quite different from what happens in a prohibition of loss leaders.
• Allowing loss leaders doesn't mean allowing deceptive claims, where for example there is a very low price advertised but the item is immediately out of stock, or of unexpectedly low quality.

Market competition is a multidimensional affair, happening along many dimensions at once. I lack confidence that government regulators with a mandate to block overly low prices will end up acting in a way that will benefit consumers. 

Size of Global Capital Markets

While browsing through the Statistical Appendix to the October 2012 Global Financial Stability Report from the IMF (and yes, it's the sort of thing I do), I ran across these numbers on the size of the global financial sector. In particular, the sum of the value of global stocks, bonds, and bank assets is 366% of the size of global GDP.

Of course, there is some mixing of apples and oranges here: bank assets, debt, and equities may overlap in various ways. But contemplate the sheer size of the $255 trillion total!

Given this size, and given the financial convulsions that have rocked the world economy in the last few years, it seems time to remember an old argument and put it to rest. The old argument was whether finance should be considered part of economics. For me, the most memorable statement of that position occurred back when Harry Markowitz, who was later to win the Nobel Prize in economics for his role in developing portfolio theory, was defending his doctoral dissertation on this work back in 1955.

Markowitz had taken a job at RAND, and so was flying back to the University of Chicago to defend his dissertation. He often told this story in interviews: here's a version from a May 2010 interview.

"I remember landing at Midway Airport thinking, 'Well, I know this field cold. Not even Milton Friedman will give me a hard time.' And, five minutes into the session, he says, 'Harry, I read your dissertation. I don't see any problems with the math, but this is not a dissertation in economics. We can't give you a Ph.D. in economics for a dissertation that isn't about economics.' And for most of the rest of the hour and a half, he was explaining why I wasn't going to get a Ph.D. At one point, he said, 'Harry, you have a problem. It's not economics. It's not mathematics. It's not business administration.' And the head of my committee, Jacob Marschak, shook his head, and said, 'It's not literature.'

"So we went on with that for a while and then they sent me out in the hall. About five minutes later Marschak came out and said, 'Congratulations, Dr. Markowitz.' So, Friedman was pulling my leg. At the time, my palms were sweating, but as it turned out, he was pulling my leg ..."

It's not clear to me that Friedman was just goofing on Markowitz. Yes, Friedman wasn't willing to block this dissertation. However, in a later interview, Friedman did not recall the episode but said: "What he [Markowitz] did was a mathematical exercise, not an exercise in economics."

But Markowitz had the last word after winning the Nobel prixe. In his acceptance lecture back in 1990, he ended by telling a version of this story, and then said: "As to the merits of his [Milton Friedman's] arguments, at this point I am quite willing to concede: at the time I defended my dissertation, portfolio theory was not part of Economics. But now it is."

The old view of economics and finance was that, except perhaps for a few exceptions like major bubbles, the real economy was the dog and the financial economy was the tail--and the tail couldn't wag the dog. But trying to study the problems of the modern world economy without taking finance into account would be incomprehensible.

Classroom Evaluation of K-12 Teachers

Proposals for evaluating the classroom performance of K-12 teachers are typically based on hopes and fears, not on actual evidence. Those who support such evaluations hope to improve the quality of teaching by linking evaluations to teacher pay and jobs. The teacher unions who typically oppose such evaluations fear that they will be used arbitrarily, punitively, even whimsically, but in some way that will make teaching an even harder job.

The dispute seems intractable. But in the December 2012 ssue of the American Economic Review, Eric S. Taylor (no relation!) and John H. Tyler offer actual real-world evidence on "The Effect of Evaluation on Teacher Performance."  (The AER is not freely available on-line, but many in academia will have access through library subscriptions.)

Taylor and Tyler have evidence on a sample of a little more than 100 mid-career math teachers in the Cincinnati Public Schools in fourth through eighth grade. These teachers were hired between 1993–1994 and 1999–2000. Then in 2000, a district planning process called for these teachers to be evaluated in a  a year-long classroom observation–based program, which then occurred some time between 2003–2004 and 2009–2010. The order in which teachers were chosen for evaluation, and the year in which the evaluation occurred, were for practical purposes random. The actual evaluation involved observation of actual classroom teaching. But the researchers were also able to collect evidence on math test scores for students. Although these scores were not part of the teacher evaluation, the researchers could then look to see whether the teacher evaluation process affected student scores. (Indeed, one of the reasons for looking at math teachers was because scores on a math test provide a fairly good measure of student performance, compared with other subjects.) Again, these were mid-career teachers who typically had not been evaluated in any systematic way for years. 

Here's how the evaluation process worked: "During the TES [Teacher Evaluation System] evaluation year, teachers are typically observed in the classroom and scored four times: three times by an assigned peer evaluator—high-performing, experienced teachers who are external to the school—and once by the principal or another school administrator. Teachers are informed of the week during which the first observation will occur, with all other observations being unannounced. The evaluation measures dozens of specific skills and practices covering classroom management, instruction, content knowledge, and planning, among other topics. Evaluators use a scoring rubric, based on Charlotte Danielson’s Enhancing Professional Practice: A Framework for Teaching (1996), which describes performance of each skill and practice at four levels: “Distinguished,” “Proficient,” “Basic,” and “Unsatisfactory.” ...After each classroom observation, peer evaluators and administrators provide written feedback to the teacher, and meet with the teacher at least once to discuss the results. "

A common pattern is often found in these kinds of subjective evaluations: that is, the evaluators are often pretty tough in grading and commenting on lots of specific skills and practices, but then they still tend to give a high overall grade. This pattern occurred here, as well. The authors write: "More than 90 percent of teachers receive final overall TES scores in the “Distinguished” or “Proficient” categories. Leniency is much less frequent in the individual rubric items and individual observations ..."

In theory, teachers who were fairly new to the district could lose their job if their evaluation score was low enough, and those who scored very high could get a raise, but because almost everyone was ending up with fairly high overall scores, so the practical effects of this evaluation in terms of pay and jobs was pretty minimal.

Nevertheless, student performance not only went up during the year that the evaluation happened, but student performance stayed higher for teachers who had been evaluated in previous years. "The estimates presented here—greater teacher productivity as measured by student achievement gains in years following TES evaluation—strongly suggest that teachers develop skill or otherwise change their behavior in a lasting manner as a result of undergoing subjective performance evaluation in the TES system. Imagine two students taught by the same teacher in different years who both begin the year at the fiftieth percentile of math achievement. The student taught after the teacher went through comprehensive TES evaluation would score about 4.5 percentile points higher at the end of the year than the student taught before the teacher went through the evaluation. ... Indeed, our estimates indicate that postevaluation improvements in performance were largest for teachers whose performance was weakest prior to evaluation, suggesting that teacher evaluation may be an effective professional development tool."

By the standards typically prevailing in K-12 education, the idea that teachers should experience an actual classroom evaluation consisting of four visits in a year, maybe once a decade or so, would have to be considered highly interventionist--which is ludicrous. Too many teachers perceive their classroom as a private zone where they should not and perhaps cannot be judged. But teaching is a profession, and the job performance of professionals should be evaluated by other professionals.  The Cincinnati evidence strongly suggests that detailed, low-stakes, occasional evaluation by other experienced teachers can improve the quality of teaching over time.  Maybe if some of the school reformers backed away from trying to attach potentially large consequences to such evaluations in terms of pay and jobs, at least a few teachers' unions would be willing to support this step toward a higher quality of teaching.

Note: Some readers might also be interested in this earlier post from October 3, 2011, "Low-Cost Education Reforms: Later Starts, K-8, and Focusing Teachers." 

Will the U.S. Dollar Lose its Preeminence?

I get asked once a month or so if the U.S. dollar is likely to lose its global preeminence.  John Williamson has a nice discussion of this topic in "The Dollar and US Power," which is available at the website of the Peterson Institute of International Economics.

Williamson first points out that the dollar is indeed the preeminent global currency (citations omitted): " The US dollar is absolutely dominant as the intervention currency: Most countries intervene in nothing except dollars. It is the major unit in which about 60 percent of official foreign exchange reserves are held ... It was estimated in the past that close to a half of all international trade was invoiced in dollars (Hartmann 1998), as opposed to under 12 percent of world trade that involved
the United States in 2011. So far as foreign exchange trading is concerned, most takes place against the dollar, resulting in a share of foreign exchange trading of about 85 percent ... For the moment, the dollar is quite unrivalled."

How does the preeminence of the U.S. dollar benefit the U.S. economy? Williamson points out the classic tradeoff. On one side, the advantages of "seignorage;" on the other side, an inability to control one's own exchange rate. Here's Williamson on seignorage:

"The standard economic analysis holds that the United States gains by international use of the dollar because of the collection of seigniorage. Historically the term seigniorage meant the ability of the sovereign to make a profit when it minted metal into money. In our context the term is used to signify the ability to make a profit from international holding of the currency. There are generally reckoned to be two sources of profit from foreign holdings of the dollar. One arises from holdings of dollar bills (in practice, $100 bills) by foreigners (in practice, mainly drug dealers): In effect, the US gains an interest-free loan to the extent that foreigners hold dollar bills. The other arises from the fact that many foreigners wish to hold dollar assets. The preferred form of assets are US Treasury bills, and therefore the interest rate on US Treasury bills is somewhat lower than it otherwise would be; and the saving is regarded as a part of seigniorage."

However, the gains from zero-interest loan of the use of U.S. currency to drug dealers, along with those who borrow in U.S. dollars getting an interest rate that's a tiny bit lower, are not large. The tradeoff is that when everyone else is using your currency, then the exchange rate value of that currency will be largely determined in global markets.


Williamson also tackles the question of whether the preeminence of the U.S. dollar gives the U.S. government additional power in the practical world of power politics. He writes:"I have the impression that the additional national power which stems from commanding an international currency tends to be exaggerated by strategic thinkers. One needs to designate the specific mechanisms which would be involved rather than assuming the result."

The one possible exception, he argues, is that a U.S. dollar standard might make it more possible for the U.S. government to enforce financial sanctions on unfriendly governments. "It is difficult to see how US power in many dimensions is enhanced by virtue of the widespread private international use of the dollar. For example, the US ability to wage war in Iraq and Afghanistan was in no way dependent upon private international use of the dollar. ... There seems to be one large exception: the ability of a country to enforce a financial blockade, such as that currently directed against specified Iranian entities. ... The United States can order its own companies not to do business with Iran, but this power is present in any sovereign government and is in no way dependent on the role of the dollar. But because third countries generally pay Iran in dollars, the United States government does have additional leverage. Any payment in dollars ultimately involves a transfer on the books of the Federal Reserve banks ...  The Fed can require that any institution for which it does business has to certify that it either has no prohibited connection with Iran or is in receipt of a waiver. They can similarly require that an institution that contracts with the Fed impose similar requirements on the institutions on behalf of which they are acting. (Of course, the Fed does not inspect each transaction, but depends upon financial institutions to do the screening, with stiff penalties possible if prohibited transactions slip through. A recent example occurred when Standard Chartered Bank was accused by the New York state Department of Financial Services of having hidden some $250 billion of financial transactions with Iran.) Thus the United States has the ability to stop transactions in terms of dollars. Insofar as foreign institutions insist on paying out of their dollar holdings, and/or Iran insists on receiving dollars, Iran is going to be vulnerable to US pressure."


In a global economy where the total size of China's economy will probably exceed that of the U.S. within the next few years, can the U.S. dollar stay on top? As Williamson points out, the key issue here is not the size of a nation's domestic economy, but rather the fact that  the U.S. dollar is already being extensively used for international transactions gives it a kind of momentum, making it likely that it will continue being used for this purpose for at least a few decades into the future. Williamson writes:

"Those who wish to transact in this [global] market are not greatly interested in the fact that the good citizens of Idaho overwhelmingly use the dollar, but they are vitally interested in the fact that the dollar is already used extensively in London, Frankfurt, Dubai, Singapore, Hong Kong, and wherever else international trades are executed. This factor gives a great deal of inertia to the international role of currencies. Because of inertia, I see the dollar having a great advantage over any other national currency for the next quarter of a century. (However, I would hesitate to forecast for as long as 50 years.)"

Similarly to Williamson, I don't see the global preeminence of the U.S. dollar as a large-scale advantage for the U.S. economy, although it should make it at least a little easier for U.S. banks and firms to operate in world markets. One can draw up schemes and scenarios in which the U.S. dollar is replaced by some mix of the euro, China's renminbi yuan, Japan's yen, India's rupee, and perhaps a few others. But such a change would require an enormously high level of international financial cooperation, and thus seems highly unlikely. By default, the U.S. dollar seems likely to remain the preeminent global currency for some decades to come.