The New England Patriots: Masters of the Salary Cap

The Patriots are back in the Super Bowl after a 3 year hiatus and are making their fifth appearance in eleven years.  Although a few other teams had comparable periods of success, they occurred before the 1994 collective bargaining agreement which introduced salary caps and free agency to the NFL.  Successful organizations were better able to retain their most valuable players and keep the core of their team intact before that landmark labor agreement.  An indication of how personnel decisions have changed is the Indianapolis Colts are likely to release Peyton Manning, one of the greatest NFL quarterbacks of all time, rather than pay a $28 million roster bonus.

The four years that elapsed since the Giants and Patriots played in Glendale is a generation when measured in football-years, because of the relatively short careers of most players.  In the pre-salary cap era 9 teams played in a Super Bowl four years after a previous appearance.  In the average return visit 12 of 22 starters had played in the earlier Super Bowl.  In contrast, only 6 Patriot starters on Sunday played in the 2008 Super Bowl.  Kicker Stephen Gostkowski is the only non-starter who played in Glendale.  The New York Giants are also making their second appearance in 5 years with 9 starters and 5 non-starters who played in the 2008 Super Bowl.

The Patriots organization differs from elite pre-salary cap teams because they have been consistently winning their Division while replenishing their roster and staying within the salary cap.  Returning to a Super Bowl in four years, with 16 starters new to the team, is unprecedented.  The Patriots nearly accomplished the same feat in 2008 when 14 of the starters in Glendale were not on the 2004 Super Bowl roster.

The Pittsburgh Steelers of the late 1970s may be the best team in the Super Bowl era, winning four titles in six years.  The key players on these historic teams remained Steelers; 63% of the starters appeared in all four Super Bowls between 1975 and 1980.  Chuck Noll and the Rooney family had unprecedented success, but they achieved it with the same core group of players.

Only Tom Brady, Kevin Faulk, and Matt Light have played on all 5 Patriots Super Bowl teams in the past decade.  The other constant has been Bill Belichick and the Patriots organization.  Belichick and the Patriots have devised a winning strategy in an era when personnel decisions depend as much on salary cap concerns as they do on gridiron performance.

Jobs, Autos and Krugman

Paul Krugman wrote a thought-provoking opinion piece in last week’s New York Times calling the auto industry bailout “the single most successful policy initiative of recent years.”  Krugman, an expert in the area of economic geography, wrote that “companies that make a large contribution to a nation’s economy — don’t exist in isolation. Prosperity depends on the synergy between companies, on the cluster, not the individual entrepreneur.”  He pointed out that successful manufacturing companies in China and Germany locate near specialized suppliers and specialized labor.  Krugman used this clustering argument to justify Federal help for Michigan automakers: “If G.M. and Chrysler had been allowed to go under, they would probably have taken much of the supply chain with them.”  In effect, he stood the infant-industry argument on its head and argued that large and previously successful companies should be bailed out even if they squandered the advantages provided by their economic cluster.

Foreign Automakers Have Avoided Michigan Despite the Synergies from Economic Clusters 

Over the past two decades foreign automakers located production facilities in Alabama, South Carolina, Mississippi and Tennessee even though these states lacked the clusters and synergies that should have made Michigan an ideal destination.  Michigan failed to attract new investment in auto manufacturing despite their experienced labor force and convenient supply chain.  According to the BLS, employment in motor vehicle manufacturing in Michigan fell by 68% between 1973 and 2011 but increased in the rest of the United States.  Economic clusters are important, but they aren’t enough to offset high marginal tax rates and labor laws that businesses view as unfriendly.

Large Companies Generally Grow More Slowly and Create Fewer Jobs

Krugman’s opinion piece was also meant to be a rejection of Governor Mitch Daniel’s claim that Steve Jobs was a big job creator.  Once a company becomes large and successful its rate of job creation generally slows.  Fortune’s list of the 50 largest companies in 1996 (based on 1995 revenue) includes a number of companies deemed “too big to fail”, including General Motors (1^st), Chrysler (9^th), Citicorp (19^th), AIG (25^th), Fannie Mae (32^nd), Merrill Lynch (33^rd) and Bank of America (37^th).  Apart from Walmart, which tripled the size of its workforce in the past 15 years, the rest of the Fortune 50 employed fewer workers worldwide in 2010 than they did in 1995.  Apple (which ranked 114 on Fortune’s 1996 list) also tripled the size of its workforce between 1995 and 2010.

Jobs are Created in Start-Ups and Young Businesses

The research of John Haltiwanger and co-authors has shown that jobs are created by young businesses and start-ups.  Many of these start-ups will fail, but the successful ones will create new products using new technologies and account for a substantial proportion of net job creation.  Entrepreneurs, innovators and risk-takers are important for job and productivity growth.   High marginal tax rates, that discourage investment in human and physical capital, will lower the rate of job creation by young businesses that are not yet “too big to fail.”

Hollywood and The 1%

Economic imbalances and social inequality pose a serious global risk according to the organizers of the World Economic Forum in Davos.  President Obama, in his State of the Union Address, called economic fairness “the defining issue of our time.”

Hollywood has been a big supporter of President Obama, and Democratic causes in general, although the recent disagreement over SOPA may create some tension in their relationship.  Hollywood’s support for a President and political party that wants to reduce income inequality is odd because the movie and television industries are home to some of the most unequal economic outcomes in the U.S.

Earnings Inequality is High in Hollywood

The earnings ratio between the 90^th and 10^th percentile is a common measure of inequality used by labor economists.  Actors at the 90^th percentile of the earnings distributions earn about 7.5 times as much as actors in the 10^th percentile (according to the Bureau of Labor Statistics).  To put these numbers into perspective the 90-10 earnings ratio is 3.2 for economists and 2.4 for high school teachers.

There is also considerable income inequality within Hollywood’s top 10%.  Ashton Kutcher reportedly earns $700,000 per episode for Two and a Half Men, or 150 times the Screen Actors Guild minimum for a “Major Role Performer” in a television series.

Movie Box Office Inequality has Sky-Rocketed since 2000

Blockbuster movies in Hollywood earn substantially more than the typical film, and that gap has grown over time.  The following graph shows the ratio of box office earnings for movies in the top 1% and top 10% to the earnings of the median film each year.  The median film is one that earned less than ½ the films and more than the other ½ of films.

In 2000 the average top 1% film earned 100 times as much and the average top 10% film earned 50 times as much as the median film.  Today these box office ratios are about 1400:1 and 550:1 for movies in the top 1% and 10% respectively.  In the past decade there has been an explosion of inequality in box office receipts in Hollywood.

Why Is Hollywood so Unequal?

Some movies are far more successful than others because the best actors are usually teamed with the best directors and scripts written by the best screenwriters.  When Leonardo DiCaprio works with James Cameron or Martin Scorcese, the movie is released at the most favorable time (e.g. during a holiday weekend) and has a larger promotional and marketing campaign, it has a huge advantage over the typical film.  When inputs are complementary and the production process is multiplicative it is efficient to team the best with the best.  This type of process, which Michael Kremer called the “O-Ring Theory” of production, also substantially increases economic inequality.

In his path-breaking article, Economics of Superstars, the late Sherwin Rosen explained how superstars are aided by technology.  Actors’ earnings have become more skewed because the best actors can now entertain millions of people simultaneously in movie theaters, on DVDs, television and the streaming of online videos.  Superstars’ earnings were more limited when actors had to be present at each live performance and audience size was limited by seating capacities.

The US Economy is Similar to Hollywood

Inequality is higher in markets, like Hollywood, where quantity is a poor substitute for quality.  Two inexperienced laborers can produce as much as an experienced one, but two bad movies are not as enjoyable as one good movie.  The same lack of substitutability applies to the markets for lawyers, engineers, architects, physicians and economists.  The quality of human capital is increasingly important in markets for skilled labor.  Policies to reduce economic inequality will be counterproductive if they distort incentives to invest in the human capital and technologies that set us apart and give us a comparative advantage in the global economy.    

Women and the Economic Recovery

News media coverage of the 2008 recession and the subsequent recovery has focused on changes in total employment and movements in the overall unemployment.  Although the change in the total number of jobs is an important economic indicator, a focus on overall employment and unemployment can mask important changes in the composition of the workforce.  I look beyond changes in total employment to illustrate why the 2008 recession is unlike any in U.S. history.  Job losses in recessions previously were concentrated in traditionally male-dominated jobs.  The 2008 recession was different.  Women lost jobs in record numbers and women have seen small job gains during the recovery.  This stands in stark contrast to previous recessions and recoveries.

The following graph illustrates changes in the full-time equivalent employment (a part-time job is counted as ½ of a full-time job) of men.  Four years after total employment started to decline, men’s employment recovered and grew to 4 to 5% above the pre-recession peak in the 1970’s and 1980’s, but only about 1% above the pre-recession peak after the 1990 and 2000 recoveries.  The recovery over the past two years has been especially weak.

The U.S. labor force changed dramatically during the 1970s and 1980s.  The labor force participation rate of women increased from 43.3% to 57.5% between 1970 and 1990 but has leveled off since then.  The widespread reallocation of women’s human capital from household activities (not included in GDP) to paid market work had a profound impact on measured employment and GDP.  Employment and GDP increase, even though the same work is being done, when house cleaning and lawn care tasks are completed by paid service workers rather than by family members.

Cyclical employment fluctuations look very different for women.  The robust labor market recoveries of the 1970’s and 1980’s were fueled by the entry of women into the labor force.  Women’s employment grew by 15% between 1974 and 1978, and by 10% between 1981 and 1985, despite the deep recessions.

Job losses during recessions were largely confined to men until the 2008 downturn.  Women’s employment never fell by more than 1% in any recession prior to 2008.  In contrast, women’s employment fell by 5% between January 2008 and December 2009, and is still 4.6% below the pre-recession peak.

Future economic recoveries are unlikely to exhibit the robust employment gains that occurred during the 1970’s and 1980’s as millions of women moved from unpaid household work to jobs in the market sector.  This type of transformational change is unlikely to occur again.

The 2008 recession is unique because of the magnitude of employment losses sustained by women (although still smaller than for men) and the sluggish growth in women’s employment during the recovery.   In the past year both employment and labor force participation declined for women but increased for men.  Despite the labor market gains achieved by women over the past forty years, women face a somewhat new challenge – coping with substantial job losses in an economic downturn.

Sugar Beets and Lockouts

Yesterday’s New York Times describes how lockouts have become a more common tool in labor management negotiations. Management is more likely than ever to lockout union workers, hire replacement workers and pressure unions to accept wage and benefit concessions when contract re-negotiations become deadlocked.

The Times article focuses on American Crystal Sugar, the nation’s largest sugar beet processor, which is currently involved in a lockout with 1300 union workers employed at five plants. The article never mentions that profits and union compensation in the sugar beet industry rely on import tariffs, quotas on imported sugar, and protection from foreign competition.

It is simply cheaper and more efficient to import sugar than it is to process sugar from sugar beets in the US. As Mark Perry noted in his Carpe Diem blog two years ago, government intervention in the market for imported sugar has protected the sugar beet industry and raised the price of sugar for the American consumer. The sugar beet industry has received $242 million in subsidies over the past 15 years.  More importantly, as Perry explains, our policies have caused U.S. sugar prices to be about twice the world price for decades. In 2009 alone this cost consumers $2.5 billion dollars.

Remarkably, the topic of sugar subsidies was raised yesterday at the Republican debate. Newt Gingrich admitted that in all of his years in the House he was unable to eliminate sugar subsidies. His simple explanation for the durability of this anti-competitive policy was there are “just too many beet sugar districts in the United States.” This debate topic released a torrent of cynical (but funny) tweets . The consensus was: this is silly, aren’t there more important issues?

The story of sugar beets is a lesson in why inefficient government programs are difficult to eliminate. Every policy has winners and losers. The winners are the sugar beet processors and organized labor who are currently deadlocked over how to split the profits from operating in a market protected from foreign competition. The losers are American consumers. Unfortunately the stakes are so low per consumer, $8 per year, that we think it’s silly to question candidates about how they expect to change Washington if they can’t stop subsidizing and protecting sugar beets.

Textbook Inflation

Last week Apple Computers announced that it is entering the textbook market with an interactive textbook application for the iPad and software to help authors create digital textbooks on a Mac.  Although electronic textbooks have been available for years, Apple’s marketing chief Phil Schiller stated that “education is in the dark ages.”  Apple, Amazon, and other producers of tablets and e-readers may re-invent the textbook by encouraging the development of more interactive and effective methods of presenting information on more portable platforms.

The digital textbook market may evolve more slowly than other markets for digital content because instructors and school boards, rather than students and parents, decide which textbooks are adopted.  Whether students can choose the most effective and convenient textbooks is influenced by the selections and decisions of instructors.

Professors choose which textbooks are used even though students purchase them.  This separation of the selection and purchase decisions may contribute to higher textbook prices.  If professors are more concerned about textbook content than prices they may require more expensive textbooks even if they are only marginally better for students.  Textbook publishers will respond by competing less on price and more on features valued by instructors.

Price competition keeps prices lower, whether the product is a textbook, a prescription drug, or a barrel of oil.  The Bureau of Labor Statistics, which calculates the Consumer Price Index, collects price information for a variety of products and services purchased by college students including textbooks, tuition, and dormitory housing.  The following chart shows that textbook prices have risen faster than the prices of other goods and services purchased by students, including tuition. College textbooks cost about 39% more than they did five years ago.

The fact that textbook prices are increasing faster than other costs of attending college does not prove that professors ignore their students’ interests when selecting textbooks, but it suggests that features such as test banks and lecture materials may be more important for a textbook’s success than price or convenience to the student.  Apple and Amazon will help digital textbooks become more interactive and portable over the next few years.  This innovation will be even more effective if professors internalize the preferences of their students when deciding which textbooks to adopt.

Why This Recession was Different

It has been four years since private sector employment peaked.  Last week’s jobs report was the best we have seen in months and yesterday’s new jobless claims figures were promising.  It’s a good time to take a look back at the last four years and compare our current situation to previous recessions.

Construction projects and durable goods purchases are delayed in a recession which greatly reduces the demand for workers in these sectors.  From the 1970s through 2008 more than 70% of the jobs lost in recessions were in construction and durable goods.

Only one in 7 jobs heading in to the 2008 recession were in construction and durable goods.  Even though many of the jobs most vulnerable to a downturn were either outsourced or replaced by robots over the past few decades we still lost 8.8 million private sector jobs, or 7.6% of total employment, between January 2008 and February 2010.  Most of the jobs lost were in sectors that previously had been immune to recessions.

The graph below compares employment changes in the construction and durable goods manufacturing sectors in five recessions and recoveries.  In the recessions before 2008 employment in these sectors fell by 10% to 15%.  In the 1970s and 1980s employment recovered after one year of decline.  In the 1990 and 2000 recessions employment fell less sharply for almost two years and only a small fraction of the lost jobs were added back during each recovery.  The 2008 downturn combines the worst features of both types of recessions.  Employment fell sharply for two years until 22% of construction and durable goods jobs were lost.  In the two years since the recovery began job gains have been modest.

The next graph compares employment changes in the rest of the private sector.  In the recessions prior to 2008 employment fell by no more than one or two percent.  It is troubling that employment growth has been less vigorous with each ensuing recovery.  The 2008 recession is different because employment outside of construction and durable goods fell by more than 5% and remains 2.5% below the pre-recession peak two years into the recovery.

The depth of the 2008 labor market downturn is surprisingly severe when one considers the small fraction of jobs in construction and durable goods when the recession began.  More than one in five jobs in construction and durable goods have been lost since 2008, more than in any recession since the Great Depression.  Job losses in recessions used to be concentrated in these sectors and employment used to snap back as the demand for construction projects and durable goods recovered.  If the pattern of recent recoveries holds true few of the durable goods manufacturing jobs that were lost will return to the US.

The 2008 recession is unique because 6 of 10 jobs lost were in relatively recession-proof sectors, such as services, trade, and information.   Increases in durable goods orders will likely restore a small fraction of the jobs lost since 2008.  I expect the labor market to recover slowly over the next few years.

Carolinas and our Manufacturing Base

Unemployment is about 10% in the Carolinas as their regional economy has been hard hit by the recession. The economy is likely to be a key issue when voters go to the polls for the Republican Presidential primary in South Carolina, and later this year when Democrats nominate President Obama for re-election at their convention in Charlotte.

Forty years ago the Carolinas employed the highest fraction of workers in the manufacturing sector, accounting for almost 40% of all jobs. Textiles and apparel manufacturers were the largest employers with more than half of all manufacturing jobs.

When President Obama and the Republican Presidential candidates advocate policies to restore our manufacturing base shuttered steel mills and automobile manufacturing plants in the Rust Belt come to mind. No states have been more adversely impacted by globalization and foreign competition than the Carolinas. China now accounts for 40% of US imports of textiles and apparel, up from 12% two decades ago. Over the same time foreign imports have more than tripled while the US has lost 80% of jobs in the apparel and textile industries.

Today Indiana is the most manufacturing intensive state in the US, with about 19% of private sector jobs in manufacturing. The Indiana legislature is about to debate legislation that would make it the only right-to-work state in the “Rust Belt”. The lesson from the Carolinas is clear. When foreign labor and production costs are sufficiently low, as they are in textiles and apparel, neither tax incentives nor “right-to-work” laws will be enough to preserve manufacturing jobs. Our manufacturing base in the 21^st century will be concentrated in industries where skilled labor and sophisticated capital equipment give us a comparative advantage.

400,000 New Jobless Claims Per Week are Troubling Despite the WSJ’s Number of the Week

In Saturday’s Wall Street Journal Phil Izzo explained that the “Number of the Week” is 450,000 because employment now increases when first-time unemployment insurance (UI) claims fall below that level. In 2010 and 2011 the average number of new UI claims was 430,000 per week but employment grew by 1% per year. Previous conventional wisdom held that employment gains would occur only if new UI claims dipped below 400,000 per week.

WSJ readers learned that job losers are more likely than ever to file for UI benefits. This is why 450,000 first-time claims is the new threshold for employment growth. We should not conclude, however, that 400,000 new jobless claims per week is good news in today’s economy. It is an ominous sign that workers lack confidence in our economic recovery. Let me explain why.

First, here is the good news. When next month’s turnover (JOLTS) survey is released by the BLS it will almost surely indicate that there were fewer layoffs in 2011 than any time in the 11 year history of the survey. This is not surprising. After shedding millions of jobs in the recession, companies are no longer downsizing.

Now, here is the bad news. In 2011 nearly everyone who was laid off filed a claim for UI benefits: 21.1 million persons filed for first-time UI benefits, while 20.1 million people were laid off or discharged according to JOLTS (lagged one month to allow time to file a claim). Although workers are eligible for UI if they have been laid off but not if they quit their previous job, the Department of Labor acknowledges that some ineligible individuals apply for and receive UI benefits. This could explain why there were 105 new UI claims for each 100 layoffs last year. To put this in perspective in 2007 new UI claims were 74% of layoffs.

The “take-up” rate for the UI program has reached 100%. Nearly all job losers file for benefits because many are eligible to receive benefits for 99 weeks and even more lack confidence in the economic recovery. They are correct to be skeptical. Job openings and new hires are 30% and 25% below their pre-recession levels, respectively.

Two years of mass layoffs and downsizing are behind us. Unless we head into another recession it is impossible for new UI claims to average more than 400,000 per week in 2012. There is no guarantee, however, that employment will grow if 400,000 workers lose their jobs and file for UI benefits each week. If this continues even a modest 4% decline in hiring would eliminate all employment growth in 2012.

Two New NCAA Regulations That Will Improve College Football

Last month Tyler Cowen and Kevin Grier offered an explanation of the persistence of the college football bowl system.  They believe the BCS will continue despite the greater revenue generated by a championship tournament, because schools benefit from bowl game publicity and players gain from the bowl experience. The sparse attendance and low ratings of many lesser bowl games makes me skeptical of their publicity value. There are impediments to change, however, so here I propose two new regulations to ease the transition to a playoff system. First, allow non-bowl teams to hold practices until a national champion has been crowned and second, require teams to evenly split gate receipts for regular season non-conference games.

Practice times and player contact is restricted by the NCAA during the off-season. An important non-financial gain from bowl participation, especially for younger teams with more returning players, is the ability to schedule additional practices. If all teams were allowed the same practice time, regardless of their bowl status, teams would be less interested in participating in minor bowl games.

Defenders of the status quo argue that the bowl system makes college football’s regular season the most compelling in sports; one loss could eliminate a team from BCS title consideration. The status quo also encourages many boring September games because Athletic Directors rationally schedule very weak non-conference opponents. The past 12 participants in the BCS championship game played 45 non-conference games. Two thirds of their opponents were not ranked in the top 80 teams, and one of three was outside the top 125 teams in the country. The implication is clear: to improve chances of advancing to the BCS title game a team should schedule 2/3 of nonconference games against vastly overmatched opponents.

The NCAA encourages non-conference mismatches by allowing a team to keep all gate receipts after paying a nominal fee to a weak opponent to come to its campus. The NCAA should require gate receipts to be split evenly with the visiting team (as in the NFL) for all non-conference games. This simple rule would reduce the financial return to scheduling weak opponents. Teams would also take more scheduling risks with a 16 team playoff because a single loss would not end a team’s title hopes.

Many of the 35 bowl games that are played each year would be interesting inter-conference match-ups if they were played in September and replaced the annual parade of lopsided games. Television revenue would be enhanced by the promise of more and better early non-conference games.

I prefer a 16 team tournament that culminates with a game between the last two surviving teams, whether or not they are the “best” teams in the country. Sports contests are entertaining because upsets are possible and outcomes are uncertain. March Madness would be far less compelling if the selection committee chose the country’s 4 highest seeded teams as the Final Four and replaced the rest of the tournament with 60 meaningless basketball “bowl” games.

The rules changes I have proposed are sensible even with a bowl system. First, colleges and universities would be treated uniformly with respect to gate receipts and practice times, whether or not they are football powers. Second, powerful teams would be discouraged from scheduling games against vastly weaker opponents which should result in better non-conference regular season games.