The Cost of Home Ownership

The last three years have seen a significant drop in the cost of housing in the United States, bringing prices back down from once astronomical levels.

Income Distribution by Country

It’s the Lorenz curve, a way economists measure what portions of the population are responsible for the income within a group of people, such as a nation.

U.S. Looks to Australia on Credit Card Fees

SYDNEY — When Steve Franklin bought four plane tickets on Qantas last June, he faced an unexpected expense: a surcharge of 7.70 Australian dollars on each of the 136.70 dollar ($126) tickets — just for using his Visa credit card.

Mr. Franklin, who planned to fly his parents and his 7-year-old twin daughters from Sydney to Adelaide, knew that changes to credit card rules had affected the cost of using plastic, but the extra 5.6 percent seemed excessive.

The charges were the consequence of changes in credit card rules in Australia that were aimed, in part, at reducing the cost of hidden fees for using plastic. But the law, passed six years ago, also allowed merchants to tack on new charges, and many have done just that, in some cases with fees that exceed the old ones.

Now, as Congress debates how to rein in credit and debit card companies in the United States, Australia’s experience is being pointed to as an example of just how tricky that can be: for one thing, if regulators limit one fee or rate, banks are likely to find another way to keep revenue flowing.

As in Australia, the stakes are high in the United States. American merchants, like their counterparts Down Under, complain that the high fees they must pay credit card companies and banks to accept their cards force them to increase prices on everything they sell — even for people who pay with cash — to make up the difference. In the United States, the Government Accountability Office last week issued a report showing that consumers who did not use credit cards “may be made worse off by paying higher prices for goods and services, as merchants pass on their increasing card acceptance costs to their customers.”

The main consumer federation in Australia, Choice, says that while regulations here have had a few unintended consequences, they have created incentives for retailers and consumers alike to rely more on debit cards, which have much lower processing costs, instead of credit cards. “It drives me crazy, people buying chewing gum on a credit card,” said Christopher Zinn, a spokesman for Choice, an Australian consumer group. “We all pay for it.”

Though many people may not realize it, out of every dollar charged on a credit card, merchants in many countries, including the United States, get about 98 cents and sometimes less; the other 2 cents go to banks and credit card companies. Banks use these fees to cover fraud losses, their loss of interest on money until the consumer pays the bill, computer systems and employees who process credit card transactions. The banks also pay Visa and MasterCard for their marketing and digital networks.

But the fees also generate tens of billions of dollars in revenue each year for banks that issue cards branded by Visa and MasterCard. In the United States alone, banks that issue credit cards get an estimated $40 billion to $50 billion in income annually from interchange fees, which are the biggest single component of fees charged to merchants. The banks and card companies are lobbying heavily against proposed changes. They warn that lower fees will lead them to squeeze credit and raise the cost of credit cards at a time when the economy thirsts for credit to sustain an economic recovery.

Some of this has already happened in Australia, where in 2003, after years of retailers’ complaints, the nation’s central bank required that the interchange fees that merchants pay banks that issue Visa and MasterCard cards be cut in half, to less than 1 cent. Merchant fees for American Express and Diners’ Club were not regulated because banks did not issue their cards. But both card companies cut merchant fees anyway, to 2 cents, from 2.46 cents, to avoid losing customers to Visa and MasterCard.

That difference may sound tiny — what’s a penny? — but banks and card companies say the lower fees have cost them about 1 billion Australian dollars annually, or $919 million. And they have turned to Australian consumers to make up the revenue.

Since the government policies went into effect, Australian banks have cut credit card perks and shrunk rewards programs, like frequent-flier miles. While it used to take 12,400 Australian dollars of spending on Visa or MasterCard from one of the country’s four biggest banks to earn a 100 dollar shopping voucher, for instance, now it takes 17,000 dollars.

Banks now also require customers to pay their bills faster. Interest starts accumulating on many cards 33 or 44 days after the start of a billing period, instead of the previous 55 days.

Annual fees have also climbed for credit cards with reward programs, to 140 Australian dollars a year for gold cards that carry rewards, up from 98 dollars before regulation of interchange fees. Basic cards without rewards still carry on average an annual fee of 29 Australian dollars.

Perhaps more vexing, Australian merchants, including retailers, restaurants and airlines, are imposing surcharges for each credit card transaction, even though fees the merchants pay card companies have fallen.

“I feel like Qantas was trying to nickel-and-dime me,” Mr. Franklin said. Qantas said that it was merely trying to recoup the fees it still had to pay to banks and card companies, a cost it does not incur when a customer pays cash or uses a debit card.

Indeed, after the Australian central bank allowed companies to start levying surcharges, many began to impose large and rising ones on credit card use. Some companies have even figured out a way to make a profit. For instance, Accor, a global hotel giant with 11 brands ranging from the luxurious Sofitel chain to Motel 6, introduced a 1.5 percent fee here last February for credit card users.

“It has aided our profit margins,” said Michael Issenberg, Accor’s chairman of the Asia and Pacific region, who added that the hotel chain had seen little consumer resistance.

Consumer advocacy groups see such profits as an unintended consequence for consumers of the central bank’s changes. Choice, an Australian consumer group, has joined with Visa and MasterCard to ask the government to restrict retailers from making gains from the surcharges. No one is suggesting outright surcharges for paying with a credit card in the United States, although one Congressional bill would make it easier for merchants to charge consumers less if they pay with debit cards or cash, something card companies oppose.

Visa, MasterCard and the banks that issue their cards prohibit retailers from charging extra if consumers pay with credit instead of cash, out of fear that more people would use cash if they knew that using plastic would cost more. Where exceptions are allowed, as in some gas stations, retailers must list the cash and credit card prices for each item. In Australia, the central bank overrode the banks’ and card companies’ rules, and authorized surcharges.

In addition, other bills in the House and Senate would allow merchants to band together to negotiate lower fees with Visa, MasterCard and others; now, retailers have little choice but to accept the terms they are offered or not accept credit cards, which could result in losing customers.

But banks in the United States warn that, as in Australia, American consumers may see the costs of using a credit card rise, and the benefits decline, if Congress passes legislation to reduce interchange fees. While American retailers had once pushed for changes unsuccessfully, there is new momentum this year after Congress passed credit card reforms in the spring aimed at curbing excessive fees and interest on credit cards.

Among retailers, 7-Eleven is leading a push to persuade Congress to adopt the “Australia option” and is calling on the Federal Reserve to cap and closely regulate merchants’ credit card fees. In September, 7-Eleven sent more than one and a half million signatures to Washington from customers who, the chain said, believed Congress should limit merchant fees because they tended to raise the price of goods.

“There’s certainly an awareness on Capitol Hill of Australia, and a lot of interest,” said Keith Jones, the government relations director for the Southland Corporation, which runs the 7-Eleven chain.

Introduction
Economics concerns the allocation of scarce resources. No scarcity, no economic problem – everyone can have as much as they desire. In more colloquial terms, economics is about how to portion out the cake. As dividing a growing cake is a much more pleasant problem than dividing a static cake (or, heaven forbid, a shrinking cake), much of economics is about growth. Capitalism has become the dominant economic framework for engendering world growth. (By capitalism, we refer to the risking of private capital for the prospect of reward and this implies certain things such as markets, property rights and the enforcement of contracts. We make no assumption regarding politics — for example, democracy.) The end of capitalism is therefore the ultimate extreme risk – constrained growth and the end of investing!
In this paper we consider investment risks – those that could affect asset returns (and, in some cases, the associated liabilities). We do not consider other extreme risks such as from longevity, operations, processes or systems.
In addition to the end of capitalism, we identify 14 further extreme risks which, while very unlikely, would impact economic growth and asset returns, should they occur. We do not claim this to be an exhaustive list.
All 15 risks are described in the appendix (and, for the interested reader, a fuller version of the appendix is available on request) but for the sake of brevity we group them into three categories – financial, economic and political
(including ‘other’) – and we comment on each of these categories.
The events of the last two years have demonstrated that risk management cannot afford to stop at the 95th percentile (VaR95). We need to find a way to include very unlikely, but potentially high impact, events.

Natural Gas Changes the Energy Map

David Rothman

Oct 28, 2009

To Lash's expert eyes, the wide band of black shale, which runs roughly parallel to the beach, reveals hundreds of millions of years of geological history. The shale formed more than 350 million years ago when organic muck settled at the bottom of the shallow sea that covered much of what is now the eastern United States; it was once buried more than two kilometers underground but has gradually risen to the surface. Now, the exposed rock shows telltale patterns of breaks and splits. "We've demonstrated that these fractures could only have formed as a result of the generation of hydrocarbons," says Lash.

This formation is the edge of vast deposits of black shale that stretch under tens of millions of acres below western New York, much of western and northern Pennsylvania, and parts of Ohio, West Virginia, Maryland, and Kentucky. The oldest and deepest layer is called the Marcellus shale, and if geologists like Lash are correct, it holds enough natural gas to help change the way the United States uses energy for decades to come.

Experts now believe that the country has far more natural gas at its disposal than anyone thought three or four years ago. The revised estimates are largely due to advanced drilling techniques that make it economically feasible to extract the fuel from shale. And while the Marcellus is the most recently discovered and possibly the largest shale-gas deposit, others are scattered throughout the country. The U.S. consumes about 23 trillion cubic feet (TCF) of natural gas a year, according to the Department of Energy's Energy Information Agency (EIA). The Potential Gas Committee (PGC), an organization headquartered at the Colorado School of Mines, put the country's potential natural-gas resources at 1,836 TCF in a biennial assessment released in June. That's 39 percent higher than its estimate of two years earlier. Add to that the 238 TCF that the EIA has calculated in "proved reserves" (the gas that can be produced given existing economic conditions) and the PGC pegs the future supply at 2,074 TCF. In other words, there is enough natural gas to supply the country for 90 years at current consumption rates. Even if we used natural gas to totally replace coal in generating electricity, domestic supplies would last for 50 years.

Almost all the newfound resources are in shale deposits, which are now estimated to contain 616 TCF of recoverable gas, says John Curtis, a professor of geology and geological engineering at the Colorado School of Mines and director of the Potential Gas Agency, which provides technical assistance to the PGC. Supplies in the Appalachian basin alone are calculated at 227 TCF, with the Marcellus accounting for the bulk of that. And Curtis says he expects that even more shale gas will "be in the mix" in the committee's next assessment.

Indeed, some geologists believe that gas supplies in the Marcellus and other shale deposits might be even more abundant than the PGC estimates. In January 2008, Lash and Terry Engelder, a colleague at Pennsylvania State University, calculated the amount of recoverable gas in the Marcellus deposit at 50 TCF. But initial drilling efforts in the region have gone so well that Engelder now puts the recoverable supply of gas at 489 TCF. If that's correct, it makes the Marcellus the second-largest natural-gas field in the world; only a massive offshore reserve shared by Iran and Qatar is larger.

Natural gas offers advantages over other fossil fuels. It burns cleaner than coal, producing much less carbon dioxide. Since coal-fired power generation is responsible for a third of U.S. carbon dioxide emissions, replacing at least some of that coal with gas could significantly reduce such pollution. And using natural gas to replace gasoline and diesel fuel in vehicles could reduce the country's reliance on foreign oil.

But it's still uncertain how the large supply of natural gas will actually change U.S. energy consumption. Coal is generally cheaper than natural gas, so it remains the fuel of choice for most power producers. Meanwhile, car and truck makers have no economic reason to start producing natural-gas-fueled vehicles, and there's no infrastructure in place to refuel them in any case. In the absence of federal policy changes, the EIA predicts, demand for natural gas will stay relatively flat for the next several decades.

Liberal Washington-based lobbying groups, gas-industry interests, and environmental groups are pushing for policies to favor natural gas in the country's energy mix, citing its environmental and national-security benefits. If those groups can persuade legislators, incentives to increase use of the fuel could be a key part of the federal energy bill being debated in Congress this fall. Previously, policy makers presumed that natural gas was a "declining resource," says Reid Detchon, executive director of the Energy Future Coalition, a Washington-based advocacy organization. But now, he says, it's possible to develop an energy policy based on "as much gas as you need."

"It doesn't matter what the exact number is," says Mark Zoback, a professor of geophysics at Stanford University. "The numbers are all so big it means we have an extremely large domestic resource that is going to play a significant role in the country's energy future." Natural gas is not a complete solution, he cautions. Still, he says, "it's not unreasonable that over the next decade or two we could completely get off coal, using gas as the principal fuel for electricity generation. I don't think natural gas is an alternative to renewables, but I do think it is by far the best fuel to use as we transition away from fossil fuels."

Gas Country
The rush to drill the Marcellus shale for gas is already under way in Pennsylvania. According to a report released this summer by Penn State, drilling in the Marcellus will generate $3.8 billion and create more than 48,000 jobs in 2009. And the business of extracting natural gas from the deposit "is still in its infancy," says Robert Watson, an associate professor emeritus of petroleum and natural-gas engineering and coauthor of the report. "It's a brand-new industry."

Not only does natural gas lie under 60 to 65 percent of the state, Watson says, but many of the most promising drilling areas are adjacent to existing pipelines that can cheaply transport it throughout the Northeast, the world's largest market for the fuel. "Some of the pipelines go right over the heart of the Marcellus shale," he says. "You have a well, and next to it you have a [pipeline] that goes right into New York City." Watson predicts that gas drilling will generate $1 trillion over the hundred-year life of the shale development and create some 120,000 jobs for the state by 2020. "Pennsylvania has the potential to become an OPEC of natural gas," he says. "It's mind-boggling. It will have an impact on Pennsylvania's economy not seen since the collapse of the steel industry."

His seemingly hyperbolic assertion becomes more plausible when you visit southwestern Pennsylvania, an area known for steel production and coal mining. Tough times for steel have left behind abandoned, rusting factories and, until recently, economic hardship. These days, brand-new four-wheel-drive pickups and heavy industrial drilling equipment fill the rural roads. Tucked away among the rolling hills and small farms are dozens of new gas wells. Occasionally, a tall drilling rig peeps over a ridge­line.

One of the companies leading the Pennsylvania gas rush is Range Resources, a Fort Worth-based firm that drilled the first commercial wells in the Marcellus shale in 2004. At one of Range's drilling sites, about 45 minutes south of Pittsburgh, a massive, multimillion-dollar rig rises high above the quiet farmland. The rig will drill half a dozen wells spaced just a few feet apart; once it has finished drilling a well, hydraulic jacks will lift the tons of equipment and "walk" it into position for the next one. Beside the drilling site is a small pond lined with plastic, filling up with the mud and debris that spurt from the well.

Range and other gas producers rely on drilling techniques that have been used for the past decade in the shale-gas fields of northeast Texas. Inside the trailer that serves as a field office, the complexity of the task is evident. On a wall is a chart mapping the drilling plans. The drill bit will head down more than a thousand meters through various types of sediments. Then, over the course of roughly 275 meters, it will gradually turn 90°, so that when it enters the layer of Marcellus shale at around 2,000 meters, it will be traveling horizontally through the gas-rich rock. Drillers can control the location of the bit to within several centimeters. Staying within a six-meter window, the bit will follow the Marcellus layer for up to 1,600 meters. The horizontal approach is crucial, allowing the well to tap into a large area of the shale layer. Eventually, the several wells at the site will spread out underneath the countryside, draining gas from hundreds of acres of shale.

The trickiest part of the operation comes after the drilling is done and the large rig is removed. A small armada of specialized equipment, including dozens of tanker trucks filled with water, will move in to perform a procedure called hydraulic fracture stimulation, or hydrofracturing, which is designed to get the gas flowing efficiently into the well. Although the Marcellus shale is soaked with gas, the rock holds the hydrocarbon tightly trapped. To allow it to escape, engineers will force millions of gallons of water down the well and into the shale formation at high pressure. If all goes well, the natural gas will rush out of the shale and into the pipe after the water is pumped back out.

That the process works is a tribute to the wonders of geology and the ingenuity of the drilling engineers. Like the black shale on the shores of Lake Erie, the Marcellus shale is riddled with tiny natural fractures created million of years ago as the newly formed hydrocarbon gases expanded. The high-pressure water, which is mixed with fine sand and chemical additives, works to enlarge those cracks. The results: gas-permeable zones of damaged rock a hundred or more meters across, radiating out from the well pipe.

Geologists like Gary Lash and Terry Engelder have long known that the black shale in the Appalachian basin contains large amounts of natural gas. In fact, the nation's first natural-gas well was drilled in Fredonia, NY, in 1825, a few miles from Lake Erie; wooden pipes were built to transport the fuel so that it could light houses in the town. But the geologists have been surprised to discover that so much gas can be recovered economically. After Range released its initial drilling results in 2007, Engelder recalls, he was asked during a conference call with investors in New York just how much natural gas the Marcellus shale contained. It wasn't a calculation he had ever bothered to do. Engelder remembers pausing and then answering, "I'm not sure, but by the end of the day I will be dead certain." He did some calculations based on the size of the formation and the likely gas content of the rock; then he called Lash and asked him to do his own. The next day, Lash called back with his numbers. They had come to the same conclusion, says Engelder: "Holy cow, there's a lot of gas."

Building Bridges
The arguments in favor of using more natural gas and less coal and petroleum are, at least at first glance, straightforward. Coal-fired plants generate about 50 percent of the electricity used in the United States, but they produce 82 percent of the power industry's carbon dioxide emissions. Burning natural gas produces roughly half as much carbon dioxide as coal. What's more, plenty of existing gas-fired power plants already have excess capacity, since they are generally used as backup to coal plants at times of peak electricity demand.

It's also easy, from a technological perspective, to substitute natural gas for gasoline or diesel fuel in cars and trucks. Unfortunately, this wouldn't reduce greenhouse-gas emissions nearly as much as replacing coal in power production. A natural-gas car emits about 25 percent less carbon dioxide than a gasoline-powered vehicle, but since transportation accounts for only about a third of U.S. greenhouse-gas emissions, even switching over all the country's vehicles to natural gas would reduce overall emissions by just 8 percent. Still, using natural gas in a portion of the nation's fleet vehicles, such as buses and taxis, would be relatively simple and could help reduce dependence on imported petroleum.

In mid-August, the Energy Future Coalition and the Center for American Progress, an influential Washington group with close ties to the Obama administration, released a paper called "Natural Gas: A Bridge Fuel for the 21st Century." The timing of the report was triggered by the recent shale-gas findings and the desire to make natural gas a part of the discussion as Congress debates an energy bill. Proposed provisions in that bill, such as a cap-and-trade program that would effectively put a price on carbon dioxide emissions, could create a strong and growing market for this fuel. Once the carbon price reaches $20 to $30 a ton, says the Energy Future Coalition's Detchon, "it would be economically advantageous for utilities to switch to gas from coal." Detchon also favors a "low-carbon" mandate, which would require utilities to use natural gas for a certain percentage of their electricity production, and incentives for power producers to close down their oldest and dirtiest coal-fired plants.

Such policy changes are critical to encouraging further drilling in shale-gas deposits, says Jeff ­Ventura, the COO of Range. Prices for natural gas peaked at $13 per thousand cubic feet (MCF) last year, but oversupply and lackluster demand depressed them to around $3 per MCF this summer, the lowest level since December 2001. As a result, drilling slowed down, almost reaching a standstill in many regions of the country (though drilling in the Marcellus has actually increased). A "reasonable price" of around $6 to $8 per MCF, Ventura says, would enable drilling companies to more fully exploit shale gas. Getting back to that price will require not only an economic recovery but also policies that increase demand by influencing power generators to shift to natural gas. "That is something that could happen immediately," he says. "More power generation from natural gas would have an immediate impact."

Drilling for shale gas could also provide a less obvious environmental benefit, if research begun by the Stanford geophysicist Zoback is successful. Fossil-fuel power plants, whether they use coal or natural gas, will eventually need to capture and sequester their carbon dioxide emissions. That means finding a safe, economical way to store carbon dioxide so that it cannot leak out. Zoback believes that shale deposits might provide one solution.

Zoback is testing the feasibility of a process that could trap carbon dioxide in depleted natural-gas wells--and wring additional productivity from them at the same time. It is thought that at least some of the methane in the shale is adsorbed to the sediments: the gas molecules form a thin film that adheres to the surface of the organic material and clay in the deposits. Preliminary tests have shown, however, that carbon dioxide binds to these materials more strongly than methane does. Carbon dioxide pumped into wells that have grown less productive, Zoback believes, could displace the adsorbed methane, which would then flow out of the shale and into the well. If it works, the process would free extra natural gas in these wells while confining the carbon dioxide securely underground.

Zoback says it will be years before he knows whether the process works. "Of course, there is a long way from concept to implementation. And there are a hundred and one questions that need to be answered," he says. But, he suggests, the recent slowdown in gas drilling provides an opportunity to test the idea before the pace of drilling picks up again, as he expects it to in 2011 or 2012. Zoback notes that pipelines are now used to deliver carbon dioxide to oil-drilling sites to enhance production; a similar infrastructure, he says, could be built around shale-gas wells. And, he says, building some of that infrastructure while developing shale-gas drilling will make carbon storage much more practical.

Dream World
Still, not all experts think it's wise to rapidly expand the market for natural gas. Simply put, they worry that the country could become addicted to yet another fossil fuel--one that could turn out, over the long term, to be far less abundant and more expensive than many now predict.

The experience of Great Britain in the late 1980s provides a sobering example. The country was adjacent to an enormous, underdeveloped resource of natural gas in the North Sea. At the time, the Conservative government headed by Prime Minister Margaret Thatcher was fighting with the coal miners, and natural gas looked like an economically and politically attractive fuel. So government and industry pushed forward with what became known as the "dash for gas," allowing the use of that fuel in power plants for the first time. The country's coal industry all but disappeared, and nuclear power was largely neglected. "The whole country moved very rapidly toward building new gas-fired power stations," recalls Tony Meggs, who was then an executive at BP responsible for a building an export pipeline for the fuel. "We started exploiting the underdeveloped gas fields, and it was great. We were very happy."

But in retrospect, says Meggs, now a visiting engineer at MIT and codirector of the school's forthcoming report on natural gas, the rapid expansion of the market in Great Britain turned out to be "bad policy." These days, he says, the U.K. imports substantial amounts of the natural gas it depends on for much of its electricity generation; by 2020 it will be forced to import 70 percent, most of it from continental Europe. "So we went from a position of great supplies and security, with everyone saying there's a lot a gas, to a position that from an energy-security perspective is very unattractive," Meggs says. "It is very important that the U.S. doesn't go the same route, expanding markets and using resources inappropriately and then ultimately becoming import-dependent."

While Meggs calls the shale-gas supply in the United States a "great blessing," he cautions that it is still unclear how large a resource it will be, because drilling for it "is a relatively young phenomenon." Any energy policy must take those uncertainties into account, he says. MIT's natural-gas study, for example, will focus on "not just how much is there but how much it costs to get it out of the ground, how long it will last, and what is the range [of uncertainties], both in terms of cost and in terms of ultimate recoverability."

The worry, of course, is that much less gas than experts have estimated will turn out to be recoverable from shale at an acceptable environmental and economic cost. Jay Apt, executive director of the Carnegie Mellon Electricity Industry Center in Pittsburgh, is blunt: "We're in an early stage of a shale boom. Every practitioner in a boom thinks it will last forever and is surprised, in five or seven years, that it isn't going to last forever." Apt predicts "an inevitable downgrading of the number of cubic feet that these deposits can supply." After all, he says, "there is a difference between what Mother Nature gave you and what the town will allow you to extract." The gas producers' extensive land and water use is already creating a backlash in Pennsylvania, he says. And the danger of rapidly converting more electricity plants to natural gas is that once shale-gas supplies "top off," power producers will be reliant on imports and vulnerable to volatility in their prices.

Some energy experts say that even if supplies of natural gas remain abundant, it's unclear to what extent power producers will switch to the fuel, and how long it will take if they do. Many gas advocates display a "practical naïveté" about the conversion of coal-fired power production, says David Victor, director of the International Law and Regulation Laboratory at the University of California, San Diego. "If you look at the quantity of gas needed to replace all the coal plants in the United States, you're talking about increasing gas consumption by something like 50 percent," he says. "It's a huge number." Such a large increase in production will require extensive shale drilling, some of it in heavily populated locations. And, he says, "we don't know what [the shale-gas drilling] looks like on a truly massive scale." Many of those advocating a large-scale shift to natural gas are "living in a dream world," ­Victor says. "They haven't worked out the practical details."

Generating electricity with more natural gas and less coal could clearly decrease carbon dioxide pollution. Says Victor, "If shale gas plays out at very large volumes and at low cost, then it will be a cost-effective way of making substantial reductions in emissions." But, he says, those reductions won't be enough to meet the long-term goal of cutting the nation's overall carbon dioxide emissions 80 percent by 2050, as President Obama and a number of other political leaders have advocated. The switch to natural gas, he says, "buys you a little time" before other changes can be made, such as introducing more wind, nuclear, hydroelectric, solar, and other zero-carbon power sources. "The concern is that natural gas is a bridge to nowhere," Victor says. "And it could be a very costly bridge to an outcome that doesn't readily get you to the 80 percent reductions."

From a technology perspective, natural gas and renewable sources, such as wind and solar, could complement each other. Natural-­gas-fired turbines could be used to generate electricity when the wind isn't blowing or the sun isn't shining. But the economic and political relationship between natural gas and renewables is more complicated. If federal and state policies continue to mandate that power producers use more renewables, the electricity industry is likely to concentrate its new capacity on those technologies while keeping its low-cost coal-fired power plants. Policy will drive the use of renewables, and economics will drive the use of coal. Natural-gas plants will be squeezed out.

Then again, a focus on natural gas as a way to trim carbon dioxide emissions could divert attention--and money--from the need for zero-carbon technologies. "I am a big fan of clean natural gas, but there is a very big danger of getting everybody revved up about gas and losing sight of the fundamental technological transformation that is needed," says Victor.

The availability of vast natural-gas resources in the Marcellus shale and similar sediments around the United States has changed energy calculations in a fundamental way. The discovery of this large and seemingly economical new source of fossil fuel has surprised even geologists who have spent their careers studying the shale. Little wonder, then, that policy makers and politicians are just beginning to try to figure out what the discoveries mean.

It's not clear how--or even whether--those responsible for energy policy will take advantage of the opportunity. At best, the newly identified supplies of gas will buy time, providing a chance to reduce greenhouse gases while more innovative technologies are developed and deployed. At worst, the country will burn through large volumes of this fuel only to find that we haven't reduced carbon dioxide emissions very much--and that we've put off investing in research to create cleaner technologies.

The state's take

Nov 19th 2009
From The Economist print edition

Governments differ dramatically in how they tax—and how much they raise

THANKS to the collateral damage from the financial crisis, government deficits have surged across the rich world. Once the recovery is entrenched this fiscal deterioration will need to be tackled. Although spending cuts could, and should, be the preferred route to prudence, taxes are all too likely to be part of the mix—at least judging from the experience of those countries that have already acted. Spain will raise its value-added tax rate (VAT) from 16% to 18%. Ireland has raised its top income tax rate from 41% to 46%. In both Britain and America current law promises higher future tax rates on wealthier folk.

The economic consequences of raising taxes will depend not just on the scale of the tax increase, but also on how the revenue is raised. The less efficient the type of taxation, the greater the burden on the economy. There is already striking variation in the size of the state and the structure of taxation, both among advanced economies, and between them and their emerging counterparts. Comparing countries’ tax takes can offer useful clues to the most efficient ways to raise funds in future.

The table above compares government revenue and its sources for some of the world’s biggest rich and emerging economies. The state looms largest in France, where almost 50% of GDP flowed through the government’s coffers in 2007 (the most recent year for which statistics comparable across all countries exist). In China, in contrast, government revenue accounts for less than 20% of GDP. Broadly speaking, total government revenues (including both central and local) are a bigger share of the economy in continental Europe than in Anglo-Saxon economies, and are higher in richer economies than in poorer ones without generous social safety-nets. But not all emerging economies have a low tax burden. At almost 35% of GDP, Brazil’s government revenue is bigger relative to the size of its economy than America’s.

Taxes of varying kinds form the bulk of governments’ revenues. But non-tax receipts—such as profits from state-owned enterprises—are often significant sources of cash, especially for commodity exporters. Russia’s overall government revenue, which includes oil proceeds, is almost 50% of GDP. Its tax take is closer to 30%.

These broad ratios suggest that there is less room to increase taxes in Europe than elsewhere. But they mask big differences in how governments raise their funds. Anglo-Saxon economies tend to rely most on income taxes (on wages, profits and capital gains). In Australia 60% of tax revenue is raised from such levies. In America it is almost 50%. Most governments gain the bulk of their income-tax revenue from individuals, though in both Japan and South Korea almost half the total is extracted from firms. Contrary to popular perception, European countries rely much less on corporate taxes than America does.

European countries reap a bigger share of revenue from payroll taxes and other social contributions, as well as from indirect taxes on spending. France and Germany gain more than 40% of their tax take from social contributions and around a quarter from expenditure taxes, particularly VAT. America, the only industrial country without a VAT, gets only a sixth of its government revenue from expenditure taxes, most of that through sales taxes at the state and local level. Brazil’s tax structure roughly mirrors that of European countries, while China and India raise more money from indirect taxes than any other big economies. Over 60% of China’s central government tax revenue comes from expenditure taxes.

How best to inflict pain

Which of these combinations is best for economic growth? In theory, expenditure taxes are better than income taxes, since they do not punish saving. Flat tax-rates on a broad base are less distortive than high marginal rates on a narrow base. By the same token, taxes on things that cannot be moved easily, such as property, are less distortive than taxes on mobile economic agents, particularly firms. Among expenditure taxes, a flat tax-rate on final goods is less distortive than a panoply of excise taxes since it affects spending decisions less. (That said, sometimes, such as with carbon taxes, the goal is to influence decisions.)

An analysis of the relationship between tax structure and growth in 21 rich countries between 1970 and 2004 by Jens Arnold of the OECD bears out these theoretical insights. He found property taxes were the least damaging to growth, followed by consumption taxes. Income taxes were the least growth-friendly, especially those levied on firms. The study suggests that shifting tax revenues from income to consumption and property taxes could have a significant impact on GDP per head.

Most tax systems have become more growth-friendly in recent decades. The top rate of marginal income tax in OECD economies, for instance, has fallen from an average of almost 70% in 1981 to just over 40%, with the biggest declines in Japan and America. Still, America’s tax system stands out as one of the least efficient. The heavy reliance on income taxation is compounded by the narrowness of the tax base, thanks to oodles of complexity-inducing deductions. Though Europeans still rely too much on job-deterring social contributions, they have been able to extract higher revenues overall thanks to greater use of more efficient taxes, especially VAT.

Expenditure taxes are not always well designed, however, particularly in federal countries. Brazil has long been trying to reform its VAT, which is levied in a fragmented manner at the state rather than national level. India, too, is trying to reform its potpourri of expenditure taxes. China’s heavy reliance on consumption taxes may not be optimal in an economy that saves too much and spends too little.

Nor is tax policy only about efficiency. Politicians also care about fairness and political appeal. Property taxes may be non-distorting, but they are deeply unpopular with voters. Tax progressivity is often at odds with efficiency. A VAT, for instance, falls disproportionately on poorer people who spend a higher share of their income than richer folk. Thanks to its reliance on income taxes, America—by some measures—has the most progressive tax system in the OECD. Different countries will always strike different compromises between efficiency, fairness and simplicity. But as their debt burdens rise, the world’s big rich economies would do well to focus most on efficiency.

Go forth and multiply a lot less

Oct 29th 2009
From The Economist print edition

Lower fertility is changing the world for the better

SOMETIME in the next few years (if it hasn’t happened already) the world will reach a milestone: half of humanity will be having only enough children to replace itself. That is, the fertility rate of half the world will be 2.1 or below. This is the “replacement level of fertility”, the magic number that causes a country’s population to slow down and eventually to stabilise. According to the United Nations population division, 2.9 billion people out of a total of 6.5 billion were living in countries at or below this point in 2000-05. The number will rise to 3.4 billion out of 7 billion in the early 2010s and to over 50% in the middle of the next decade. The countries include not only Russia and Japan but Brazil, Indonesia, China and even south India.

The move to replacement-level fertility is one of the most dramatic social changes in history. It manifested itself in the violent demonstrations by students against their clerical rulers in Iran this year. It almost certainly contributed to the rising numbers of middle-class voters who backed the incumbent governments of Indonesia and India. It shows up in rural Malaysia in richer, emptier villages surrounded by mechanised farms. And everywhere, it is changing traditional family life by enabling women to work and children to be educated. At a time when Malthusian alarms are ringing because of environmental pressures, falling fertility may even provide a measure of reassurance about global population trends.

The fertility rate is a hypothetical, almost conjectural number. It is not the same as the birth rate, which is the number of children born in a year as a share of the total population. Rather, it represents the number of children an average woman is likely to have during her childbearing years, conventionally taken to be 15-49.

If there were no early deaths, the replacement rate would be 2.0 (actually, fractionally higher because fewer girls are born than boys). Two parents are replaced by two children. But a daughter may die before her childbearing years, so the figure has to allow for early mortality. Since child mortality is higher in poor countries, the replacement fertility rate is higher there, too. In rich countries it is about 2.1. In poor ones it can go over 3.0. The global average is 2.33. By about 2020, the global fertility rate will dip below the global replacement rate for the first time.

Modern Malthusians tend to discount the significance of falling fertility. They believe there are too many people in the world, so for them, it is the absolute number that matters. And that number is still rising, by a forecast 2.4 billion over the next 40 years. Populations can rise while fertility declines because of inertia, which matters a lot in demography. If, because of high fertility in earlier generations, there is a bulge of women of childbearing years, more children will be born, though each mother is having fewer children. There will be more, smaller families. Assuming fertility falls at current rates, says the UN, the world’s population will rise from 6.8 billion to 9.2 billion in 2050, at which point it will stabilise (see chart 1).

Behind this is a staggering fertility decline. In the 1970s only 24 countries had fertility rates of 2.1 or less, all of them rich. Now there are over 70 such countries, and in every continent, including Africa. Between 1950 and 2000 the average fertility rate in developing countries fell by half from six to three—three fewer children in each family in just 50 years. Over the same period, Europe went from the peak of the baby boom to the depth of the baby bust and its fertility also fell by almost half, from 2.65 to 1.42—but that was a decline of only 1.23 children. The fall in developing countries now is closer to what happened in Europe during 19th- and early 20th-century industrialisation. But what took place in Britain over 130 years (1800-1930) took place in South Korea over just 20 (1965-85).

Things are moving even faster today. Fertility has dropped further in every South-East Asian country (except the Philippines) than it did in Japan. The rate in Bangladesh fell by half from six to three in only 20 years (1980 to 2000). The same decline took place in Mauritius in just ten (1963-73). Most sensational of all is the story from Iran.

When the clerical regime took over in 1979, the mullahs, apparently believing their flock should go forth and multiply, abolished the country’s family-planning system. Fertility rose, reaching seven in 1984. Yet by the 2006 census the average fertility rate had fallen to a mere 1.9, and just 1.5 in Tehran. From fertility that is almost as high as one can get to below replacement level in 22 years: social change can hardly happen faster. No wonder the explosion on the streets of Iran this year seemed like a clash between two worlds: 15-29 year-olds, one-third of the population, better educated and with different expectations, against the established regime and the traditionalists.

Why has fertility fallen so fast, so widely? Malthus himself thought richer people would have more children and, as any biologist will tell you, animal populations increase when there is more food around.

To understand why wealthy people differ from well-fed animals, imagine yourself a dirt-poor (male) peasant 50 years ago. Your fields are in the middle of nowhere. Your village has no school, hospital or government services, certainly no pensions. Few goods come into it from outside, though disease is rampant and security fragile. Ploughing and reaping are done by hand. But if the harvest is normal, you usually have enough to go round. In these circumstances, the benefit of an extra pair of hands to gather the harvest outweighs the cost of feeding an extra mouth (which anyway falls on your wife more than you). And when you can no longer work in the fields, your children will be the only ones to look after you. In such a society, all the incentives point to having large families.

The abandoned hamlet

Now imagine you are a bit richer. You may have moved to a town, or your village may have grown. Schools, markets and factories are within reach. And suddenly, the incentives change. A tractor can gather the harvest better than children. Your wife may get a factory job—and now her lost wages must be set against the benefits of another baby. Education, thrift and a stake in the future become more important, and these middle-class virtues go hand in hand with smaller families. Education costs money, so you may not be able to afford a large family. Perhaps the state provides a pension and you no longer need children to look after you. And perhaps your wife is no longer willing to bear endless offspring. Higher living standards, better communications and more education enable you to rely on markets and public services, not just yourself and your family.

Macroeconomic research bears out this picture. Fertility starts to drop at an annual income per person of $1,000-2,000 and falls until it hits the replacement level at an income per head of $4,000-10,000 a year (see chart 2). This roughly tracks the passage from poverty to middle-income status and from an agrarian society to a modern one. Thereafter fertility continues at or below replacement until, for some, it turns up again (see article).

The link between living standards and fertility exists within countries, too. India’s poorest state, Bihar, has a fertility rate of 4; richer Tamil Nadu and Kerala have rates below 2. Shanghai has had a fertility rate of less than 1.7 since 1975; in Guizhou, China’s poorest province, the rate is 2.2. So strong is the link between wealth and fertility that the few countries where fertility is not falling are those torn apart by war, such as Congo, Liberia and Sierra Leone, where living standards have not risen.

Family research adds detail to this sketch. Indonesia’s Family Life Survey showed that, on average, each birth reduced by a fifth the likelihood that a woman would have a job—lowering household income and pushing some families into poverty. So smaller families made middle-class status more likely. Between 1974 and 1996, Bangladesh turned a district called Matlab into a giant demographic experiment: some villages and households got family planning, others did not. According to one study of the results, fertility in the areas that received help declined by around 15% more than in those that did not. And over the two decades of the experiment, indicators of the well-being of women and their children—health, earnings, household assets and so on—were all higher in the villages that got the planning. Does this suggest that lower fertility causes wealth, or that wealth lowers fertility? It would be better to say that the two things go together.

What parents want

The link between wealth and fertility does not explain everything. In some countries, poor women have the same number of children as rich ones. This suggests that other factors are at work. The most obvious is that many people in poor countries want fewer children, and family planning helps them get their wish.

A surprising amount is known about how many children parents want, thanks to a series of surveys by the Demographic and Health Surveys programme. The picture it paints is of huge numbers of unplanned pregnancies. In Brazil, for example, the wanted fertility rate in 1996 (the most recent year available) was 1.8; the actual fertility rate then was 2.5. In India the wanted rate in 2006 was 1.9, the actual one, 2.7. In Ghana the figures for 2003 were 3.7 and 4.4. The rule seems to be that women want one child fewer than they are having (except in some rich countries, where they say they want more).

One study in 2002 estimated that as many as a quarter of all pregnancies in developing countries in the 1990s were unintended. Yet another found that more African women say they want to use contraceptives but cannot get them (25m) than actually use them (18m). Unmet demand in turn implies that fertility in some countries could be even lower than it actually is if more family planning were available. The proportion of women using contraception in Latin America and East Asia is four times the African rate.

That points to another big reason why fertility is falling: the spread of female education. Go back to the countries where fertility has fallen fastest and you will find remarkable literacy programmes. As early as 1962, for example, 80% of young women in Mauritius could read and write. In Iran in 1976, only 10% of rural women aged 20 to 24 were literate. Now that share is 91%, and Iran not only has one of the best-educated populations in the Middle East but the one in which men and women have the most equal educational chances. Iranian girls aged 15-19 have roughly the same number of years of schooling as boys do. Educated women are more likely to go out to work, more likely to demand contraception and less likely to want large families.

Lastly, a special case: China’s one-child policy, which began nationwide in the early 1970s. China’s population is probably 300m-400m lower now than it would have been without it. The policy (which is one of population control, not birth control) has had dreadful costs, including widespread female infanticide, a lopsided sex ratio and horrors such as mass sterilisation and forced abortions. But in its own terms, it has worked—20m people enter the workforce each year, instead of 40m—and, to the extent that China is polluting less than it would have done, it has benefited the rest of the world.

The Goldilocks moment

Higher standards of living, then, reduce fertility. And lower fertility improves living standards. This is what China’s government says. It is also the view that has emerged from demographic research over the past 20 years.* In the 1980s, population was regarded as relatively unimportant to economic performance. American delegates told a UN conference in 1984 that “population growth is, in and of itself, neither good nor bad; it is a neutral phenomenon.” Recent research suggests otherwise.

Cutting the fertility rate from six to two can help an economy in several ways. First, as fertility falls it changes the structure of the population, increasing the size of the workforce relative to the numbers of children and old people. When fertility is high and a country is young (median age below 20), there are huge numbers of children and the overall dependency ratio is high. When a country is ageing (median age above 40), it again has a high dependency ratio, this time because of old people.

But the switch from one to the other produces a Goldilocks generation. Because fertility is falling, there are relatively few children. Because of high mortality earlier, there are relatively few grandparents. Instead, countries have a bulge of working-age adults. This happened to Europe after the baby boom of 1945-65 and produced les trente glorieuses (30 years of growth). It is happening now in Asia and Latin America. East Asia has done better than Latin America, showing that lower fertility alone does not determine economic success. Eventually developing countries will face the same problems of ageing as Europe and Japan do. But for the moment, Asians and Latinos are enjoying fertility that is neither too hot, nor too cold. According to David Bloom of the Harvard School of Public Health, the “demographic dividend” (his term) accounted for a third of East Asian growth in 1965-90.

Slowing fertility has other benefits. By making it easier for women to work, it boosts the size of the labour force. Because there are fewer dependent children and old people, households have more money left for savings, which can be ploughed into investment. Chinese household savings (obviously influenced by many things, not just demography) reached almost 25% of GDP in 2008, helping to finance investment of an unprecedented 40% of GDP. This in turn accounted for practically all the increase in Chinese GDP in the first half of this year.

Lastly, low fertility makes possible a more rapid accumulation of capital per head. To see how, think about what happens to a farm as it is handed down the generations in a country without primogeniture. The more children there are, the more the farm is divided. Eventually, these patches become so tiny they cease to be efficient. This is occurring in Bangladesh.

The importance of tackling such problems, which go by the ugly name of “capital shallowing”, was discounted in the 1980s but has recently made a comeback. Hu Angang of Tsinghua University estimates that half of Chinese growth per person in 1978-98 can be attributed to the increase in capital stock per head.

This link between growth and fertility raises awkward questions. In the 1980s the link was downplayed in reaction to Malthusian alarms of the 1970s, when it was fashionable to argue that population growth had to be reined in because oil and natural resources were running short. So if population does matter after all, does that mean the Malthusians were right?

Not entirely. Neo-Malthusians think the world has too many people. But for most countries, the population questions that matter most are either: do we have enough people to support an ageing society? Or: how can we take advantage of having just the right number for economic growth? It is fair to say that these perceptions are not mutually exclusive. The world might indeed have the right numbers to boost growth and still have too many for the environment. The right response to that, though, would be to curb pollution and try to alter the pattern of growth to make it less resource-intensive, rather than to control population directly.

The reason is that widening replacement-level fertility means population growth is slowing down anyway. A further reduction of fertility would be possible if family planning were spread to the parts of the world which do not yet have it (notably Africa). But that would only reduce the growth in the world’s numbers from 9.2 billion in 2050 to, say, 8.5 billion. To go further would probably require draconian measures, such as sterilisation or one-child policies.

The bad news is that the girls who will give birth to the coming, larger generations have already been born. The good news is that they will want far fewer children than their mothers or grandmothers did.

Is more choice better? Ten years ago the answer seemed obvious: Yes. Now the conventional wisdom is the opposite: lots of choice makes people less likely to choose anything, and less happy when they do choose.

The most famous supporting evidence is an experiment conducted by two psychologists, Mark Lepper and Sheena Iyengar. They set up a jam-tasting stall in a posh supermarket in California. Sometimes they offered six varieties of jam, at other times 24; jam tasters were then offered a voucher to buy jam at a discount.

The bigger display attracted more customers but very few of them actually bought jam. The display that offered less choice made many more sales – in fact, only 3 per cent of jam tasters at the 24-flavour stand used their discount voucher, versus 30 per cent at the six-flavour stand. This is an astonishingly strong effect – and utterly counter to mainstream economic theory.

One practical response to such experiments is that choice can be a good thing overall even if it does discourage us. I may find the choice between Robertson’s jam and Wilkin and Sons’ jam irritating and of no practical consequence to me, but you can bet that it has consequences for the two companies. We are often offered an apparently pointless choice between two equally good products, not appreciating that they are only good because we have been offered the choice.

The counter-argument was once put in a sketch about TV deregulation by Stephen Fry and Hugh Laurie: a waiter whisks away silver cutlery from a politician responsible for the proliferation of channels before dumping a sackful of plastic coffee stirrers in his lap. “They may be complete crap, but you’ve got choice, haven’t you?” Funny, but Fry and Laurie had it backwards. Zero choice is the fastest route to low quality.

But a more fundamental objection to the “choice is bad” thesis is that the psychological effect may not actually exist at all. It is hard to find much evidence that retailers are ferociously simplifying their offerings in an effort to boost sales. Starbucks boasts about its “87,000 drink combinations”; supermarkets are packed with options. This suggests that “choice demotivates” is not a universal human truth, but an effect that emerges under special circumstances.

Benjamin Scheibehenne, a psychologist at the University of Basel, was thinking along these lines when he decided (with Peter Todd and, later, Rainer Greifeneder) to design a range of experiments to figure out when choice demotivates, and when it does not.

But a curious thing happened almost immediately. They began by trying to replicate some classic experiments – such as the jam study, and a similar one with luxury chocolates. They couldn’t find any sign of the “choice is bad” effect. Neither the original Lepper-Iyengar experiments nor the new study appears to be at fault: the results are just different and we don’t know why.

After designing 10 different experiments in which participants were asked to make a choice, and finding very little evidence that variety caused any problems, Scheibehenne and his colleagues tried to assemble all the studies, published and unpublished, of the effect.

The average of all these studies suggests that offering lots of extra choices seems to make no important difference either way. There seem to be circumstances where choice is counterproductive but, despite looking hard for them, we don’t yet know much about what they are. Overall, says Scheibehenne: “If you did one of these studies tomorrow, the most probable result would be no effect.” Perhaps choice is not as paradoxical as some psychologists have come to believe. One way or another, we seem to be able to cope with it.