Archive for June, 2008

U.S. Senate Outsources Its Own Restaurants

Kurt Brouwer June 30th, 2008

This is ironic. The U.S. Senate has been forced to privatize its own restaurant due to poor food and service, not to mention financial losses. Anyone who has ever run a restaurant knows how difficult it is to do. But the Senate has a captive audience and, by all rights, it should be able to run a profitable operation.

Senate Votes To Privatize Its Failing Restaurants (Washington Post, June 9, 2020, Paul Kane)

Year after year, decade upon decade, the U.S. Senate’s network of restaurants has lost staggering amounts of money — more than $18 million since 1993, according to one report, and an estimated $2 million this year alone, according to another.

The financial condition of the world’s most exclusive dining hall and its affiliated Capitol Hill restaurants, cafeterias and coffee shops has become so dire that, without a $250,000 subsidy from taxpayers, the Senate won’t make payroll next month.

The embarrassment of the Senate food service struggling like some neighborhood pizza joint has quietly sparked change previously unthinkable for Democrats. Last week, in a late-night voice vote, the Senate agreed to privatize the operation of its food service, a decision that would, for the first time, put it under the control of a contractor and all but guarantee lower wages and benefits for the outfit’s new hires.

The House is expected to agree — its food service operation has been in private hands since the 1980s — and President Bush’s signature on the bill would officially end a seven-month Democratic feud and more than four decades of taxpayer bailouts.

Sen. Dianne Feinstein (D-Calif.), chairman of the Rules and Administrations Committee, which oversees the operation of the Senate, said she had no choice.

“It’s cratering,” she said of the restaurant system. “Candidly, I don’t think the taxpayers should be subsidizing something that doesn’t need to be. There are parts of government that can be run like a business and should be run like businesses.”

In a letter to colleagues, Feinstein said that the Government Accountability Office found that “financially breaking even has not been the objective of the current management due to an expectation that the restaurants will operate at a deficit annually.”

In other words, the Senate thought running restaurants like a government operation instead of a real business was just fine. After all, aren’t annual deficits just part of the normal function of government? Amazingly enough, Senator Feinstein disagreed and helped push through the change. However, Senator Menendez did take note of the fact that he and other Senators have engaged in heated senatorial rhetoric condemning privatization or outsourcing. Now, the Senate will be doing what many of its members have long condemned when businesses have done it:

But Sen. Robert Menendez (D-N.J.), speaking for the group of senators who opposed privatizing the restaurants, said that “you cannot stand on the Senate floor and condemn the privatization of workers, and then turn around and privatize the workers here in the Senate and leave them out on their own.”

The Senate Restaurants, as the food service network is known, has a range of offerings, from the ornate Senate Dining Room on the first floor of the Capitol, where senators and their guests are served by staffers wearing jackets and ties, to the huge cafeteria in the Dirksen Building and various coffee shops throughout the Senate complex.

All told, they bring in more than $10 million a year in food sales but have turned a profit in just seven of their 44 years in business, according to the GAO.

Making money seven years out of 44 is difficult to justify though. And, that apparently has finally broken through the ideological barrier at the Senate. Although I suspect that wasn’t the real issue:

The rules committee began exploring its outsourcing options in 2005, when Republicans controlled the chamber. When Democrats took power last year, Feinstein ordered several studies, including hiring a consultant to examine management practices, before deciding privatization was the only possibility.

In a closed-door meeting with Democrats in November, she was practically heckled by her peers for suggesting it, senators and aides said.

“I know what happens with privatization. Workers lose jobs, and the next generation of workers make less in wages. These are some of the lowest-paid workers in our country, and I want to help them,” Sen. Sherrod Brown (D-Ohio), a staunch labor union ally, said recently. The wages of the approximately 100 Senate food service workers average $37,000 annually.

Feinstein made another presentation May 7, warning senators that if they did not agree to turn over the operation to a private contractor, prices would be increased 25 percent across the board…

It’s one thing to run losses as long as the taxpayer is footing the bill. But, when Senator Feinstein gave them the bad news, the Senators acted. Good stewardship can be put off, but the horror of a 25% price increase finally got some action:

Eventually, Democrats agreed to pass legislation that includes guarantees for those who go to work for Restaurant Associates. They would retain their current salaries and federal health and pension benefits. Employees who choose to leave instead would receive buyout packages of as much as $25,000 — paid by the Senate. Half the current employees are likely to take that deal.

New employees, however, will not receive federal benefits, though they will be allowed to unionize.

By one estimate, Restaurant Associates would turn a large profit within three years and would begin paying about $800,000 annually in commissions to the Senate.

In the final days of negotiations, Feinstein rolled her eyes and took a deep breath before explaining the ordeal that the Senate Restaurants had become for her.

“It’s clearly not the sort of thing that I ran for the Senate to do,” she said. “But somebody has to do it.”

Kudos to the good Senator from San Francisco. You don’t think this could represent a trend do you?

Unemployment Rates for High School and College Grads — Chart of the Day

Kurt Brouwer June 30th, 2008

Source: Carpe Diem

Just looking at this chart should be definitive for anyone questioning the value of education. Those who did not finish high school have an unemployment rate of 8.1%. Yikes. That is tough. High school graduates have 4.7% unemployment, which is quite a bit lower, but college graduates only have 2.3% unemployment. If you want to see how this same distinction works out in terms of money, see also Higher Education Means Higher Income — Chart of the Day.

Does the Government Understate Inflation? — Don Boudroux & Russell Roberts Say No

Kurt Brouwer June 26th, 2008

This is the third post in a series on this question — does the government understate inflation?

If you have not read the previous posts, you may want to do so:

Part One: Does the Government Understate Inflation?

Part Two: Does the Government Understate Inflation? — Bill Gross Says Yes

Now, we are going to explore the arguments of two eminent economists who believe that the Consumer Price Index (CPI) compiled by the U.S. Bureau of Labor Statistics does not understate inflation. In addition, they believe the CPI actually overstates inflation. The two economists — Donald Boudroux and Russell Roberts — are both professors of economics at George Mason University. Boudroux and Roberts also are prolific authors and bloggers at Cafe Hayek.

The root of their argument that inflation is overstated has to do with how the CPI deals with two factors:

  • Price
  • Quality

They believe that the CPI does not adequately reflect lower-cost distribution outlets such as Wal-Mart, nor does it reflect consumer behavior changes such as buying items when they are on sale or substituting similar products when one is too expensive or even just adjusting the quantity of an item that is pricey. They also believe that the CPI does not adequately compensate for the vast improvements in the quality of the products and services we buy.

Here is a summary of their argument that CPI overstates inflation using excerpts from several posts and articles by Boudroux and Roberts [emphasis in the original]:

CPI Bias II (Cafe Hayek, October 9, 2020, Russell Roberts)

…I want to discuss the magnitude of my concerns about quality measurements and the surveys of inflation that miss the role of Wal-Mart and other discounters that make up an increasing portion of the marketplace.

How big are those effects?

… I should emphasize that these measures of the bias in the CPI are measured in percentage points per year. The CPI isn’t off by 1.6%. It is off by 1.6 percentage points a year. So that when measured inflation is stated to be 3%, it is actually 1.4%. This is a massive error that when cumulated over even a short period of time grossly understates the growth in real income and standards of living.

… The bottom line is that when inflation is overstated by at least one percentage point a year at a time when the overall rate of inflation is under 5%, the numbers are broken. They are unreliable. They are not good for measuring changes in standard of living over short periods of time or long periods of time.

Let’s assume for the moment that Professor Roberts is correct — that CPI does overstate inflation by 1.6 percentage points per year. That would mean that real (adjusted for inflation) economic growth has been severely understated for years. GDP is generally calculated on a real or net of inflation basis. So, for example if actual or nominal economic growth was 5% and inflation (CPI) was 3%, then real economic growth would be 2% (5-3=2). However, if CPI is overstated by 1.6 points, then CPI would have only been 1.4% and real GDP would be adjusted upwards from 2% to 3.4% growth (5-1.6=3.4).

Here is one example of what why Roberts believes the CPI overstates price inflation. This is from a paper he referenced in another post. The paper can be found here [emphasis added]:

...the current BLS procedure does not treat correctly outlet substitution bias and acts as if Wal-Mart does not exist. Yet, Wal-Mart offers identical food items at an average price about 15%-25% lower than traditional supermarkets. The BLS “links out” Wal-Mart’s lower prices.

Assuming this is correct, the net impact of ignoring Wal-Mart would be to inject upward bias in consumer prices. Incidentally, I recently saw an estimate of the savings consumers achieved by shopping at Wal-Mart and it was over $100 billion per year.

Professor Don Boudroux also weighs in on the issue of price bias in the CPI [emphasis added]:

Calculating Real Wages (Pittsburgh Tribune-Review, February 19, 2020, Donald J. Boudroux)

But can we trust the CPI? I think not. For a variety of reasons, it significantly overstates the amount of inflation we’ve suffered…

…To calculate inflation, statisticians cannot literally look at all goods and services that consumers buy. Instead, statisticians who compile the CPI choose a “basket” of goods and services that represents what the typical American family purchases. Changes in the prices of these goods and services are then used to measure inflation.

How, though, to select which goods and services to put into this basket? The obvious answer is to choose those items that ordinary consumers routinely buy. Putting in a loaf of bread makes sense; putting in a Tahitian vacation does not.

The problem arises because the set of things consumers routinely buy is itself affected by prices. The lower the price of something, the more likely is the typical American family to buy that something. In contrast, something whose price is quite high won’t be routinely purchased and, hence, isn’t a good candidate for inclusion in the CPI basket.

Prices, though, change over time. Because consumers can and do switch their consumption patterns to adjust for these price changes — buying lesser quantities of items whose prices rise and buying greater quantities of items whose prices fall — the CPI basket chosen today gives too little weight to items whose prices fall tomorrow and too much weight to items whose prices rise tomorrow.

The result — the CPI overstates inflation.

Here’s an example to make the point clearer. Back in 1972, basic pocket calculators cost $100. They were so expensive that ordinary Americans didn’t buy them. So statisticians at the Bureau of Labor Statistics understandably excluded calculators from the basket of items used to determine the CPI.

As time passed, of course, the price of calculators plummeted. A calculator similar to one priced at $100 in 1972 sells today for about $7.95. (In real terms, this is a price decline of about 98 percent.) So, ordinary Americans now routinely buy calculators. But because calculators weren’t suitable to be added to the basket of items used for calculating the CPI until their prices dropped and they became affordable, much of the price decline of calculators was ignored by the CPI.

Relatedly, as consumers substitute away from goods whose prices rise and into goods whose prices fall, the relative importance to consumers of these higher-priced goods declines as the importance of the lower-priced goods rises — but the weights that the CPI gives to these goods aren’t immediately adjusted.

The result is that, in the CPI, items whose prices rise are weighted too heavily while items whose prices fall are weighted too lightly — or (as in with the calculator) not at all.

Boudroux and Roberts also believe that the methodology of the CPI undervalues quality improvements over the past 30 years and, therefore, CPI overstates inflation. Here is Boudroux on this point [emphasis added]:

Beware of Official Data On Inflation (Pittsburgh Tribune-Review, February 26, 2020, Donald J. Boudroux)

…A major problem with this [CPI] data is that adjusting prices and wages for inflation is a surprisingly tough challenge. In addition to the difficulty that I discussed in my earlier column, an even bigger problem with the way statisticians adjust prices and wages to account for inflation is that quality changes are often ignored.

In 1976 a mid-priced new car cost about $5,000. A mid-priced car today costs about $20,000. We all know, though, that the dollar bought more in 1976 than it buys today. So everyone agrees that it’s wrong to say that a mid-priced car today is four times more expensive than was such a car in 1976. Before determining how much a car today costs compared to a car in 1976, we must adjust prices to account for the inflation that took place since then.

The most common way to do this adjustment is to track changes in the Consumer Price Index (CPI). The CPI shows that it takes $3.55 today to buy what $1 bought on Jan.1, 1976. So the “real” price of that new car today, expressed in 1976 dollars, is $5,633.80.

Although not four times more pricey than its 1976 counterpart, today’s new car, according to official data, nevertheless does cost more in “real” dollars — an additional 633.8 1976 dollars, to be precise (or an additional 2,250 2006 dollars).

So official data conclude that Americans today pay more real dollars for automobiles.

The problem with this conclusion is that the thing we today call a “car” differs vastly from the thing that we called a “car” in 1976. Unlike a mid-priced car today, the mid-priced car in 1976 had no air bags, no power windows, no power door locks, no heated seats, no tilt steering wheel, and no CD player. It got fewer miles per gallon, needed tune-ups much more frequently and was more likely to kill its occupants in collisions. Its exterior rusted sooner.

This point is irrefutable. Cars are better today than they were 30 years ago. For example, consider maintenance and reliability. Today, cars routinely go 40,000 miles on a set of tires. In the 1970s, a set of tires lasted perhaps 20,000 miles. Similar improvements have been made in brakes, engines and other areas. Back then, after 100,000 miles, a car was worn out. Today, a car with 100,000 miles on it has plenty of life left in it. In addition to being safer and more reliable, today’s cars pollute significantly less than the cars of the 1970s. That certainly is an improvement we all value.

But, compared to gas or groceries, we buy cars infrequently and when we do buy them, we do not really factor in the quality improvements. In fact, I suspect most of us actually take the improvements for granted. Here is an interesting chart that shows the average annual increase in gasoline, overall CPI and new cars for the past 30 years:

Source: Carpe Diem

As we see from the chart, the price of new cars has not kept up with inflation even in terms of actual price. No telling what the impact would be if the CPI adequately factored in the known improvements in automotive quality we discussed above.

But, what about improvements in quality, not just in cars, but across the spectrum of things we buy? Boudroux continues:

…the quality of almost everything we buy today is much higher than in the past. For example, houses are larger and better equipped, the returns to higher education have increased substantially (see Higher Education Means Higher Income — Chart of the Day) and medical care is less invasive, less painful and more successful than 30 years ago. Because procedures for adjusting for inflation largely ignore these quality improvements, official data on prices and wages significantly underestimate the improvements in our living standards.

I would agree with this point as well. Whether we are thinking of computers, cars, cameras or even cardiac care, most goods and services are better today than they were 30 years ago. In many cases, particularly consumer goods, products are cheaper today too.

For these reasons, Professors Boudroux and Roberts believe that the CPI substantially overstates inflation. Their arguments are meatier than the arguments from Bill Gross in our previous post on this topic. Yet, the argument that the CPI understates inflation has merit too. Obviously, both sides cannot be correct. It cannot be that the CPI both understates and overstates inflation, can it?

Inquiring minds want to know. However, that will be the topic for our final post in this series. Stay tuned…

Fed Says Steady As She Goes…

Kurt Brouwer June 25th, 2008

No Change In Rates…But For How Long? (Wall Street Journal - MarketBeat Blog, June 25, 2020, David Gaffen)

The committee elected to leave the federal-funds target rate unchanged at 2%, which was largely expected. What is up for grabs is whether the Fed will raise rates in the near-future, as the market seems to expect, or remain on hold, which appears to be the opinion of most economists.

“Today’s pause — it remains unclear whether it’s a temporary break or the first step along a tightening path — strikes a tenuous balance between the wounded consumer and the specter of commodity-driven inflation,” writes Guy Lebas, Janney Montgomery fixed income strategist.

The expectation was that the committee would speak more hawkishly on inflation, and in the last few weeks market participants have priced in aggressive expectations from the Fed, a more activist response than most believe the Fed will take. That’s been reconsidered in the wake of this statement.

The Committee expects inflation to moderate later this year and next year,” they wrote, a slight change from their previous expectation for inflation to moderate “in coming quarters.” They added, however, that “in light of the continued increases in the prices of energy and some other commodities and the elevated state of some indicators of inflation expectations, uncertainty about the inflation outlook remains high.”…

We expect higher short-term interest rates, but not until late this year or early in 2009. In a recent post (see How Far Has the Dollar Fallen? And Why? — What’s Next?), we wrote:

The Fed’s current posture is that we should not expect any additional cuts to the Fed Funds rate. And, in all likelihood, we will see higher Fed Funds rates late this year or early next year as the economy begins to pick up steam. As a result, the dollar has shown a little strength lately. So the dollar should stabilize roughly around this level or a bit higher for a while and then we should see some strengthening when interest rates begin moving up…

See also Dollar Rallies — Three-Month High vs. Euro.

Home Prices Still Falling — Chart of the Day

Kurt Brouwer June 24th, 2008

The downturn in residential real estate is nationwide although the variation among cities is significant. The chart above illustrates what has happened in two groupings of cities. However, the Case Shiller Index covers annual rates of growth or decline in home prices. It does not demonstrate the actual value of these homes over time. With the fall in home prices, it is generally accepted that home prices in much of the country are back to the levels of 2004.

However, the table below illustrates the wide range of falling prices across the country. Clearly, homeowners in Charlotte are happier than their counterparts in Phoenix, Las Vegas or Miami.

For the complete report, go here.

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