Summary of Articles in Business Economics

By Robert Crow
Editor, Business Economics

“U.S. International Deficits, Debt, and Income Payments: Key Relationships Affecting The Outlook”

by John Kitchen

A variety of issues and relationships will be of fundamental importance in determining the future paths of the U.S. current account, international debt position, and net international income flows.  This paper describes the key relationships and presents projection results that illustrate the sensitivity of the outcomes to those relationships.  Although the base case scenario presented in the paper shows a relatively benign outcome based on Blue Chip projections and the likely continuation of historical relationships, alternative projections help to illustrate the risks – and the potential sources of those risks – for a more adverse outcome for U.S. international deficits, debt and income flows.

“Borrowing Without Debt? Understanding the U.S. International Investment Position”

by Matthew Higgins, Thomas Klitgaard, and Cédric Tille

Sustained large U.S. current account deficits have led some economists and policymakers to question whether future current account adjustment will occur smoothly or via a sudden and disruptive deprecation of the dollar and a sharp drop in U.S. consumption.  Two factors that, to date, have cast doubt on such concerns are the stability of U.S. net external liabilities and the minimal net income payments made by the United States on these liabilities.  The authors show that the stability of the external position reflects sizable capital gains stemming from strong foreign equity markets and a weaker dollar – conditions that could be reversed in the future.  They also show that while minimal U.S. net income payments reflect a much higher measured rate of return on U.S. foreign direct investment (FDI) assets than on U.S. FDI liabilities, ongoing borrowing is likely to overwhelm this favorable rate of return, pushing the U.S. net income balance more deeply into deficit.  In addition, they review the argument that the United States holds large amounts of intangible assets not captured in the data – assets that would bring the true U.S. net investment position close to balance. The authors argue that intangible capital, while a relevant dimension of economic analysis, is unlikely to be substantial enough to alter the U.S. net liability position.

“The Valuation of Hidden Assets in Foreign Transactions: Why ‘Dark Matter’ Matters”

by Ricardo Hausmann and Federico Sturzenegger
 
This paper clarifies how the valuation of hidden assets -- what we call “dark matter” -- changes our assessment of the U.S. external imbalance. Dark matter assets are defined as the capitalized value of the return privilege obtained by U.S. assets.  Because this return privilege has been steady over recent decades, it is likely to persist in the future or even to increase, as it becomes leveraged by an increasingly globalized world. Once this is included in future projections of U.S. current accounts, the U.S. external position looks much more balanced than depicted in official statistics.

“Financial Literacy and Retirement Preparedness: Evidence and Implications for Financial Education Programs”

by Annamaria Lusardi and Olivia S. Mitchell

Economists are beginning to investigate the causes and consequences of financial illiteracy to better understand why retirement planning is lacking and why so many households arrive close to retirement with little or no wealth. Our review reveals that many households are unfamiliar with even the most basic economic concepts needed to make saving and investment decisions. Such financial illiteracy is widespread: the young and older people in the United States and other countries appear woefully under-informed about basic financial computations, with serious implications for saving, retirement planning, mortgages, and other decisions. In response, governments and several nonprofit organizations have undertaken initiatives to enhance financial literacy. The experience of other countries, including a saving campaign in Japan as well as the Swedish pension privatization program, offers insights into possible roles for financial literacy and saving programs.

“Does Prepayment Risk of Mortgages Affect Excess Returns of Bank Stocks?”

by Ling T. He

This paper explores the relationship between the prepayment risk embedded in conventional, fixed-rate residential mortgages and excess returns for bank stocks.  There are two interesting findings in this study.  First, commercial banks traded in the Nasdaq market are more mean-variance efficient than the other seven groups of industrial stocks.  Second, the prepayment risk factor is significant for these banks.  The prepayment risk mainly reflects a call option embedded in a mortgage plus foreclosure costs associated with a mortgage put option. This risk is measured by a remaining part of mortgage rates after excluding the influence of real estate market, maturity, and default risks on mortgage rates.  The results of this study suggest that the prepayment risk factor does significantly affect excess returns for bank stocks in the period with high levels of mortgage refinancing activities.

“The Link Between Gasoline Prices and Vehicle Sales”

by Walter McManus

This paper examines the link between fuel prices and sales of cars and trucks.  U.S. automakers have long denied that such a link exists.  One source of this false belief is an obsession with the crude count of units sold, equating Hummers with Minis. Another source is the conventional “wisdom” that Americans are unwilling to pay for fuel economy.  The paper presents theoretical reasons and market evidence that refute Detroit’s conventional wisdom.  American manufacturers’ reaction to rising fuel prices over the last few years revealed the shortcomings of the U.S. automakers’ recent product and power train strategies. The effect of rising fuel prices has, in effect, been offset by reducing prices of vehicles in inverse proportion to fuel economy.  Thus, unit sales of large SUVs could be maintained, but their revenue (and profit) fell because vehicle prices were cut, directly or indirectly.  The paper concludes with a few practical guidelines that business economists should use to prevent their companies from experiencing the recent massive losses experienced by the U.S. automobile industry.

Forum On Emerging Issues
“Cost-Benefit Analysis: Regulatory Reform or Favoring the Regulated?”

by Thomas A. Hemphill

An overview of issues concerning cost-benefit analysis in the federal government

Focus On Industries And Markets
“Windows and Doors around the World -- The Global Market for Fenestration Products”

by Kenneth Long and Andrew Gross

A survey of the factors that shape the supply and demand for fenestration products and the organization of the industry.

BOOK REVIEWS

Two books are reviewed.  The first, Microeconomics for MBAs: The Economic Way of Thinking for Managers, by Richard B. McKenzie and Dwight R. Lee, is an innovative presentation of traditional subject matter that is likely to be stimulating to professionals as well as students.  It is reviewed by Gerald L. Musgrave. 

The second, Leaving Women Behind: Modern Families, Outdated Laws, by Kimberley A. Strassel, Celeste Colgan, and John C. Goodman, “is an eye-opening summary of the dramatic transformation of women and the United States economy,” that emphasizes the extent to which laws and regulations are lagging this transformation and the economic and social consequences of these lags.  It is reviewed by Douglas Holtz-Eakin.

Find the January issue on line at http://nabe.com/publib/be/0701/