Economist's View

Methodological Issues in Economics

Continuing a recent conversation on methodological issues within economics, this is part of a much longer article "The Philosophy of Economics" from The Stanford Encyclopedia of Philosophy. It was written by Daniel M. Hausman:

2. Six central methodological problems

Although the different branches and schools of economics raise a wide variety of methodological issues, six problems have been central to methodological reflection concerning economics:

2.1 Positive versus normative economics

Policy makers look to economics to guide policy, and it seems inevitable that even the most esoteric issues in theoretical economics may bear on some people's material interests. The extent to which economics bears on and may be influenced by normative concerns raises methodological questions about the relationships between a positive science concerning “facts” and a normative inquiry into what ought to be. Most economists and methodologists believe that there is a reasonably clear distinction between facts and values, between what is and what ought to be, and they believe that most of economics should be regarded as a positive science that helps policy makers choose means to accomplish their ends, though it does not bear on the choice of ends itself.

This view is questionable for several reasons. First economists have to interpret and articulate the incomplete specifications of goals and constraints provided by policy makers (Machlup 1969b). Second, economic “science” is a human activity, and like all human activities it is governed by values. Those values need not be the same as the values that influence economic policy, but it is questionable whether the values that govern the activity of economists can be sharply distinguished from the values that govern policy makers. Third, much of economics is built around a normative theory of rationality. One can question whether the values implicit in such theories are sharply distinguishable from the values that govern policies. For example, it may be difficult to hold a maximizing view of individual rationality, while at the same time insisting that social policy should resist maximizing growth, wealth, or welfare in the name of freedom, rights, or equality. Fourth, people's views of what is right and wrong are, as a matter of fact, influenced by their beliefs about how people in fact behave. There is evidence that studying theories that depict individuals as self-interested leads people to regard self-interested behavior more favorably and to become more self-interested (Marwell and Ames 1981, Frank et al. 1993). Finally, people's judgments are clouded by their interests. Since economic theories bear so centrally on people's interests, there are bound to be ideological biases at work in the discipline (Marx 1867, Preface).

2.2 Reasons versus causes

Orthodox theoretical microeconomics is as much a theory of rational choices as it a theory that explains and predicts economic outcomes. Since virtually all economic theories that discuss individual choices take individuals as acting for reasons, and thus in some way rational, questions about the role that views of rationality and reasons should play in economics are of general importance. Economists are typically concerned with the aggregate results of individual choices rather than with particular individuals, but their theories in fact offer both causal explanations for why individuals choose as they do and accounts of the reasons for their choices.

Ray Fair: Interpreting the Predictive Uncertainty of Presidential Elections

A colleague emails to let me know about a new paper on presidential elections by Ray Fair (thanks Jeremy). The paper, which is forthcoming in the Journal of Political Economy, looks at the problem of determining the degree of uncertainty in predictions of election outcomes and argues that the standard errors released along with traditional polling data miss "an important type of predictive uncertainty..." Fortunately, the uncertainty "can be estimated using data from political betting markets." To adopt this betting market approach, the paper imposes a ranking assumption (explained below) to restrict the number of possible admissible outcomes. The paper then shows that if this assumption is correct, and there is empirical evidence from betting markets provided in support of the assumption, it implies that political parties "should spend all their money on a few states, which seems consistent with their actual behavior." So now you'll know why your state was either skipped or bombarded with advertising last presidential election:

Interpreting the Predictive Uncertainty of Presidential Elections, by Ray C. Fair, September 2006, International Center for Finance, Yale University, WP No. 06-25, Cowles Foundation, WP 1579: 1 Introduction A common way of assessing the uncertainty of election predictions is to use the standard errors that are released by polling organizations. Almost all polling organizations release both a mean prediction and a standard error of the mean prediction. This paper argues that there is an important type of predictive uncertainty that is not captured by these standard errors and that can be estimated using data from political betting markets. Section 2 presents this argument and uses data from the Intrade[1] political betting market to provide estimates. The idea is that there are a number of possible "states" or "conditions" of nature that can exist on election day, of which one is drawn on election day. The uncertainty is which condition will be drawn.

North Korea: Engage or Isolate?

Martin Wolf says we need discard the Bush foreign policy doctrine and start again:

Tear up the Bush doctrine, by Martin Wolf, Commentary, Financial Times: US voters have now repudiated those who sought to impose democracy by force abroad. ... George W. Bush is still president. But he is damaged political goods. That is good, because change is desperately needed.

The signal feature of this administration has not been merely its incompetence, but its rejection of the principles on which US foreign policy was built after the second world war. The administration’s strategy has been based, instead, upon four ideas: the primacy of force; the preservation of a unipolar order; the unbridled exercise of US power; and the right to initiate preventive war in the absence of immediate threats.

The response to the terrorist outrage of September 11 2001 reinforced the hold of all these principles. The notion of an indefinite and unlimited “war on terror” became the fulcrum of US foreign policy. It led to the idea of an “axis of evil” connecting Saddam Hussein’s Iraq to theocratic Iran and Kim Jong-il’s North Korea. It brought about the justified invasion of Afghanistan, but also the diversion into Iraq. Not least, the idea of the war on terror led to the indefinite imprisonment of alleged enemy combatants without judicial oversight, toleration of torture, “extraordinary rendition” of suspects, the extra-territorial prison at Guantánamo Bay and, by indirect means, the abuses at Abu Ghraib. ...

The US must now start again. It must design a foreign policy for the current age. In doing so, it should discard almost everything the Bush administration has proclaimed. ...

Here's one idea for North Korea from the comments at Martin Wolf's Economist's Forum:

Monty Graham: Martin Wolf is of course right - US foreign policy under the Presidency of George W. Bush, largely driven by the ideology of so-called “neo-conservatives”, has been one enormous fiasco, one whose repercussions are likely to reach quite a long time into the future. The urgent question of the moment is, how does one go about reversing this fiasco? ...

Let me make one modest and specific proposal for a reversal of US policy that affects one of the countries designated by Bush as part of the “Axis of Evil”; this country is North Korea. In the on-going negotiations between the US and South Korea to create a free trade agreement between the two countries, a demand by the South Korea government has been that products made in the Kaesong Industrial Complex, an “economic zone” located in North Korea but largely managed by South Korean firms, be included... To date, the US has indicated that this demand is unacceptable and ... it could be a “deal-breaker”...

But, in the long run, the demand is not unreasonable. Indeed, the process of economic reform and movement towards a market system in China ... began with Chinese experimentation with “special economic zones” during the 1980s, where these zones were not wholly unlike the Kaesong Industrial Complex. The success of the special economic zones in China emboldened a sometimes reluctant Chinese leadership to undertake widespread economic reforms in the early 1990s, reforms that directly led to the very rapid growth and development of the Chinese economy that has occurred during the past 15 years or so. There is no guarantee, of course, that the Chinese experience would be repeated in North Korea, but there is also no strong reason to believe that success at Kaesong might not embolden further economic reform in North Korea..., where the change would almost surely be for the better. Indeed, there is evidence that there is a rising generation of North Koreans (including importantly younger military officers) who seek market-driven reform as a means of improving North Korea’s economic performance. But current US policy, which is pretty much to do as much as possible to prevent North Korea from conducting any sort of commerce with the rest of the world, creates major disincentives for North Korea to undertake serious economic reform. ...

Thus, a change of attitude on the part of the US towards the status of the Kaesong Industrial Complex could prove to be a constructive first step towards a new and more fruitful policy towards North Korea. Moreover, such a step can be taken in the context of a negotiation being undertaken with South Korea and hence this step need not involve any direct interaction with North Korea itself. ...

Indeed, ...[this] might not even require that the US accede fully to the South Korean demand that products from Kaesong be covered under a Korea-US free trade agreement. Rather, the United States, ... could indicate that ... it would be willing to reconsider this issue at some time in the future subject to certain conditions being met. Such conditions might include ... that North Korea must stop its current practices of counterfeiting and circulating US currency and manufacturing for export narcotic drugs such as methamphetamine. Indeed, for the US to express even this little bit of flexibility in the free trade negotiations might send a signal to the North Koreans that there might be a better path for that nation to take than the one it is currently taking.

As noted, my proposal as outlined above is but a modest one, and a lot more than just this proposal will be needed to undo the damage that a misguided US foreign policy has created. However, as goes the Chinese proverb, the longest journey starts with a single step, and the step that I propose would be, I submit, in the right direction.

An Educated Immigration Policy?

Tyler Cowen proposes a solution to the immigration problem:

The Immigration Answer? It’s in Mexico’s Classrooms, by Tyler Cowen, Economic Scene, NY Times: Poorly functioning Mexican and Latino educational systems are a central problem behind current immigration dilemmas... If the United States took in a higher ratio of legal immigrants, and required more education, the entire North American region would be better off.

A high school diploma brings higher wages in Mexico, but in the United States the more educated migrants do not earn noticeably more... Education does not much raise the productivity of hard physical labor. The result is that the least educated Mexicans have the most reason to cross the border. In addition, many Mexicans, knowing they may someday go to the United States, see less reason to invest in education.

Mexican immigrants used to have higher-than-average levels of education, but today the average male Mexican migrant has lower-than-average education by Mexican standards. David McKenzie ... and Hillel Rapoport ... document this shift... (“Self-selection patterns in Mexico-U.S. migration: The role of migration networks” ). Less-educated migrants are more likely to bring crime and social problems, and they are less likely to assimilate.

In contrast to the men, female arrivals from Mexico still have above-average levels of education for their gender. A woman who migrates is most likely to have eight to nine years of education.

It appears that (relatively) educated Mexican women are more willing to break away from their families. Furthermore, Mexican women are less likely to work in agriculture or at hard labor, so education brings a higher wage in the United States. ... Nonetheless, illegal Mexican immigrants to the United States are usually male, if only because crossing the border is perilous and physically demanding.

This gender imbalance worsens the problems of immigration. Large numbers of young Mexican men have scant prospects for marriage ... in the United States. Men who marry tend to earn more money, behave more responsibly, commit less crime and assimilate more readily. Much of the so-called “immigration problem” stems from the illegality of immigration rather than from immigration itself. ...

A better immigration policy would tighten the border, while allowing in more legal immigrants from Mexico and other Latin countries, and require higher levels of education. Young Mexicans would see greater reason to invest in education, to the benefit of all Mexican society... The less educated Mexicans could be some of the biggest winners from immigration reform.

In the United States, employers have a greater incentive to train legal Mexican workers and combine their labors more effectively with capital investment... The legality and thus physical ease of immigration would also encourage the arrival of more Mexican women ,,, remedying the gender imbalance... In the short run, the greater number of immigrant children would raise costs in the United States for education and health care, but in the longer run those children would produce goods and services and pay taxes.

Taking in a higher proportion of women would relieve the migration-driven gender imbalance of rural Mexico. It is common for villages to have many unmarried young women, but virtually no young men. ...

Shutting the Mexican border is probably not possible, and it would paralyze American businesses and agriculture. ... The United States needs the courage to legalize a higher number of immigrant arrivals. The problems with current illegal migration are real. But most Americans benefit from Latino migration, even of the illegal kind, and they could benefit much more from legal and better-educated arrivals.

I don't always agree with Tyler, but having made a somewhat similar argument myself in Build It and They Will Stay Home, this time I do, at least with the idea that development within Mexico is the best long-run solution:

[I]n the long-run, the only real solution is to help poorer countries develop economically. ... If the wealth gap persists, we won't be able to build fences high enough, moats wide enough, or do anything else to stop people from trying to come here and from being successful in their attempts. We might reduce the flow, but no more than for, say, illegal drugs. Poverty prevents countries from doing all the things we think of as "fair," better environmental rules (but look back at the choices we made at similar stages of economic development before casting stones), health care, decent wages, etc. The very existence of poverty makes competition with wealthier countries look unfair to those affected by the entry of poor countries into the marketplace.

But how do we solve that? By isolating those countries from the world's wealth through protectionism, immigration restrictions, and other means so that the wealth gap persists while they try to develop on their own? Or are we better off engaging with poor countries economically and doing everything we can to help them develop and overcome the poverty that is holding them back while also helping the poorer residents of developed countries who might be affected by such policies?

People do not want to leave the place they grew up, leave their family and friends, and go illegally to a foreign country with a different language, a place where they are not generally welcome. It takes a powerful economic incentive to induce them to leave. I am not advocating opening our borders to anyone who wants to come here. But doing all we can to encourage investment in poor countries is the best way to solve the wealth gap and associated problems in the long-run, and that may mean accepting US companies outsourcing or moving to poorer countries during the transition period, and allowing more immigrants from those countries to come here and work. But by whatever means, economic development in poorer countries is the key to resolving many of the difficult problems we face and the only way to achieve a lasting solution.

The Advantages of Pay-As-You-Drive Insurance

In a recent Economic Scene article for The New York Times posted here, Hal Varian explains the benefits of per-mile auto insurance. He also *patiently* answers many of the questions that come up in comments to the post (his answers are here and there are more rounds of questions and answers in the comments to that post complete with supporting models).

In the article, Hal Varian discusses work by Aaron S. Edlin and Pinar Karaca-Mandic from their paper, “The Accident Cost From Driving.” In this article from Economist's Voice, Aaron Edlin summarizes work in this area with a focus on the political advantages of using per-mile auto insurance to reduce gasoline consumption:

If Voters Won’t Go for Taxing Oil to Conserve Energy, How Do We Do It?, by Aaron S. Edlin, Economist's Voice, November, 2006: ...Lowering our dependence on oil would give the United States considerably more flexibility in Middle East policy. It would also help us to fight global climate change. Yet precious little has been done. The obvious solution of European-size taxes on gasoline and other uses of oil is just too unpopular in the United States to become law. ...

What can be done to decrease America’s energy dependence, given the public’s apparently well entrenched fear of increases in the cost of driving? One way forward may be a simple reform to auto insurance: Pay as You Drive.

Pay-as-you drive-insurance: how it would work

Currently, auto insurance is largely, but not entirely, independent of the amount of driving a person does. If an individual drives 5,000 miles per year, instead of 25,000, then her insurance rate is reduced only slightly: often, by 15% or less. ...

Suppose that, instead, ... that auto insurers were required to quote premiums on a per-mile driven basis instead of a per-year basis.

Consider a given class of drivers ... whom insurance companies currently charge $1000 per year, and who currently drive 10,000 miles per year on average. Instead of charging these drivers $1000 per year, insurers might charge 10 cents per mile driven.

The average driver ... would continue to pay the same amount—$1000 per year— assuming no change in driving behavior. However, suppose this driver chooses to cut her driving in half, to 5,000 miles per year... Then she would save $500/year, much more than under the current pricing system. Moreover, if the same driver were to double her driving, she would double her insurance cost... Such a pricing system would give her a significant incentive to reduce her driving. Elsewhere, I have estimated that such pay-as-you-drive insurance could reduce driving and gasoline consumption by 10–15%.

The political advantage of pay-as-you-drive insurance over a gas tax is that it doesn’t increase the total cost of driving, at least on average. ... Prices at the pump, of course, stay the same—making the measure much more palatable... And rather than voters simply fearing negative consequences, they can enjoy some positive ones: lowered insurance prices as a reward for changes in behavior. ...

The change won’t be painless for everyone, of course. Those who drive twice the average will pay twice as much. But that’s only fair: They also cause more accidents, and burden the environment, and worsen our dependence issue, twice as much. And charging high mileage drivers more is exactly what will give people an incentive to drive less.

The peculiar all-you-can-drive way that auto insurance is currently priced

The late Nobel Laureate William Vickrey wrote almost forty years ago that “the manner in which [auto insurance] premiums are computed and paid fails miserably to bring home to the automobile user the costs he imposes in a manner that will appropriately influence his decisions.”

The costs to which Vickrey referred were accident costs, not terrorism, climate, and national security costs. The great thing, though, is that by switching our insurance system to pay-as-you-drive insurance, we can reduce accident costs with more efficient accident pricing, and reduce these other costs as a bonus. ...

Vickrey’s point is that with each mile we drive, there is a cost in the form of accident risk. When we don’t pay the costs we impose, the incentives are obvious: we drive more than is economically efficient, causing accidents as we go. If we paid as we drove, and were charged a per-mile premium we would choose to drive less and there would be fewer accidents. And that would be fair: we would simply be forced to pay for the externalities of our conduct. ...

If Americans are successfully incentivized to drive less by pay-as-you-drive insurance, [accident] costs will fall appreciably... Several insurance carriers have begun to experiment with pay as you drive insurance, but they have not rushed to charge per-mile premiums on their own. Too many of the gains would not be captured by the company changing the policies. They need some encouragement.

The political salability of mandating pay-as-you-drive

...Per-mile premiums ... could lower the cost of driving for most people because most people drive less than the average. (Because driving quantities follow a skewed distribution, the median is considerably lower than the mean). Moreover, such premiums give drivers additional control over their costs, so they can choose to lower them still further.

There would, of course, be opposition. Although more than 50% of people drive less than the arithmetic average, many obviously drive more ... and would tend to oppose the change, at least if they vote their pocket books. Moreover, oil companies, the highway lobby and gas stations can be expected to oppose any change that leads to less driving. ...

[A] full-scale national shift to pay-as-you-drive insurance is too much to hope for. Still, a shift could be made in stages: if each insurance carrier had to issue 5% of its policies at per-mile rates, no carrier would be at a competitive disadvantage. ...

There are many pieces to a sound national energy policy, but per-mile premiums should be high on the list. What is needed is a jump start.

Russian Market-Reform Advocate's Mysterious Illness Generates Intrigue

First, there is this story from November 23, the same day Russian spy Alexander Litvinenko died of radiation poisoning:

Gaidar's Daughter Hangs Anti-State Banner, The Associated Press: The daughter of former Prime Minster Yegor Gaidar, Maria, and a second protester rappelled off a bridge near the Kremlin on Thursday and hung a banner criticizing President Vladimir Putin's government for changes to election law.

The duo unfurled a 15-meter banner reading "Return the Elections to the People, Bastards!" and hung from the Bolshoi Kamenny Bridge for more than 30 minutes before police and emergency workers hauled them up and detained them. ...

Then, on November 24:

Unnatural' Illness Almost Killed Russia's Gaidar, by Sebastian Alison, Bloomberg: Russia's former prime minister Yegor Gaidar almost died of a mystery illness on Nov. 24, and his death would have suited opponents of the government, Anatoly Chubais, chief executive of OAO Unified Energy System, said.

Gaidar, 50, became ill in Ireland the day after former Russian spy Alexander Litvinenko, an opponent of President Vladimir Putin, died in London with a ''significant'' quantity of radioactive Polonium 210 in his system.

''Yegor Gaidar was within a hair's breadth of death on Nov. 24,'' Chubais told journalists in St. Petersburg today, in remarks e-mailed to Bloomberg News by his office. ''Could it have been some kind of natural illness? To judge by what the most professional doctors say, no.''

While Litvinenko had accused Putin of complicity in his death in a message dictated before he died, Chubais ruled out any involvement of the state in his friend's mystery illness. He said he didn't believe in ''a conspiracy of bloody pro-Putin secret police'' trying to eliminate Gaidar, and suggested the move may have been an attempt by the president's critics to discredit him. ...

''This deadly triangle of Politkovskaya-Litvinenko-Gaidar, which only didn't come off by a miracle, would have been extremely attractive for supporters of an unconstitutional, violent change of power in Russia,'' Chubais said.

Gaidar, who was prime minister for six months in 1992 under then-president Boris Yeltsin, was ''unconscious for three hours,'' his daughter Maria Gaidar told state broadcaster Russia Today...

More on Gaidar:

Gaidar Ill With Mystery Ailment, by Carl Schreck and Maria Levitov, The Moscow Times: Former Prime Minister Yegor Gaidar, the architect of Russia's turbulent transition to a market economy, became violently ill last week while in Ireland, prompting speculation he had been targeted for assassination. ...

Gaidar is best known for abolishing the country's price controls in early 1992. His "shock therapy," widely blamed for wiping out the life savings of millions of Russians, earned him widespread scorn.

When, in September 2003, Gaidar's party, the Union of Right Forces, announced that the Coalition Provisional Authority in Iraq had invited Gaidar to help craft a recovery plan, pundits joked that Washington was unleashing a weapon of mass destruction on the Iraqi people. ...

Echoing the state-controlled media's take on Litvinenko's death, State Duma Deputy and journalist Alexander Khinshtein said Gaidar might have been poisoned by those looking to discredit the Kremlin.

"I don't exclude [the possibility that there is] a systematic plan, developed in the West, to massively discredit top Russian officials, the security forces, as well as President Putin, by blatantly attempting to liquidate members and ideologues of the liberal wing of Russian politics," Khinshtein said by e-mail. ...

To confuse things a bit:

Gaidar's entourage denies radioactive poisoning, Interfax: The entourage of Yegor Gaidar, a former Russian acting prime minister, has categorically denied reports alleging that he was poisoned by radioactive isotopes.

"Yegor Timurovich [Gaidar] is in Moscow now. His health is satisfactory. He intends to get down to work in the near future," Gaidar's press secretary Valery Natarov told Interfax on Wednesday.

While the Washington Times reports tonight that:

Miss Gaidar, an opposition activist, told Reuters news agency ... "He is in Moscow and doctors are trying to come up with a diagnosis but they can't find one. His condition is satisfactory and he is speaking, but he looks very bad -- he looks pale and thin."

This caught my attention because of his role in market-reform and privatization. Not sure what to make of this. Intriguing. If you haven't read Polonium, Fresh from the Reactor at Brad DeLong's, it's worth taking the time to do so.

McCain Picks His Economic Adviser

As was widely reported today in the Washington Post and elsewhere, Glenn Hubbard and Greg Mankiw have agreed to serve as economic advisers for Mitt Romney who is believed to be planning to run for president in 2008.

The Economist blog, Free exchange, reports that John McCain has also selected an adviser:

We have also heard that Doug Holtz-Eakin, another former Bush administration official who went on to head the Congressional Budget Office, will be John McCain's top economic advisor. Mr Holtz-Eakin is giving up his current job ... to work full-time for the McCain team.

Dallas Fed: Making Sense of the U.S. Housing Slowdown

The Dallas Fed analyzes the slowdown in the housing market and finds it difficult to make strong predictions about how it will play out:

Making Sense of the U.S. Housing Slowdown, by John V. Duca, Economic Letter, Federal Reserve Bank of Dallas: A robust housing market buoyed the U.S. economy during the 2001 recession and fueled growth once recovery began. The record-setting building of single-family homes created construction jobs and spurred demand for building materials, appliances and home furnishings. Business was brisk for mortgage lenders and real estate brokers alike.

Perhaps even more significant, rapidly rising housing prices had allowed consumers to tap into their mounting home equity, providing them the financial wherewithal for a buying spree. By mid-2004, however, home prices had risen to the point where many analysts worried that markets were overheated, making homes less affordable, particularly for first-time buyers already facing the drag of rising energy prices.

Today, signs of a housing market slowdown are unmistakable.

Brad DeLong: Friedman and Keynes

Brad DeLong on Friedman and Keynes:

Friedman completed Keynes, by J. Bradford Delong, Project Syndicate:  ...From one perspective, [Milton] Friedman was the star pupil of, successor to, and completer of Keynes’s work. Keynes ... set out the framework that nearly all macroeconomists use today. That framework is based on spending and demand, the determinants of the components of spending, the liquidity-preference theory of short-run interest rates, and the requirement that government make strategic but powerful interventions in the economy to keep it on an even keel and avoid extremes of depression and manic excess. As Friedman said, “We are all Keynesians now.”

But Keynes’s theory was incomplete: his was a theory of employment, interest, and money. It was not a theory of prices. To Keynes’s framework, Friedman added a theory of prices and inflation, based on the idea of the natural rate of unemployment and the limits of government policy in stabilising the economy around its long-run growth trend...

Moreover, Friedman corrected Keynes’s framework in one very important respect. The experience of the Great Depression led Keynes and his more orthodox successors to greatly underestimate the role and influence of monetary policy. Friedman, in a 30-year campaign starting with his and Anna J Schwartz’s A Monetary History of the United States, restored the balance. As Friedman also said, “and none of us are Keynesian.”

From another perspective, Friedman was the arch-opponent ... of Keynes and his successors. Friedman and Keynes both agreed that ... powerful, but limited economic intervention by the government was necessary to maintain stability. But, while for Keynes, the key was to keep the sum of government spending and private investment stable, for Friedman the key was to keep the money supply — the amount of purchasing power in readily spendable form ... — stable.

A relatively minor, technical difference ... you might say. ... [But] this difference in means, tactics, and empirical judgments rested on top of deep gulf in Keynes and Friedman’s moral philosophy.

Keynes saw himself as the enemy of laissez-faire and an advocate of public management. Clever government officials of goodwill, he thought, could design economic institutions that would ... tweak the market with taxes, subsidies, and regulations to produce superior outcomes. It was simply not the case, Keynes argued, that the private incentives of those active in the marketplace were aligned with the public good. Technocracy was Keynes’s faith: skilled experts designing and fine-tuning institutions ... to make possible general prosperity...

Friedman disagreed vociferously. In his view, it usually was the case that private market interests were aligned with the public good: episodes of important and significant market failure were the exception, rather than the rule... Moreover, Friedman believed that even when private interests were not aligned with public interests, government could not be relied on to fix the problem.

Government failures, Friedman argued, were greater and more terrible than market failures. Governments were corrupt. Governments were inept. The kinds of people who staffed governments were the kinds of people who liked ordering others around.

At the same time, Friedman believed that even when the market equilibrium was not the utilitarian social-welfare optimum, and even when government could ... improve matters ..., there was still an additional value in letting human freedom have the widest berth possible. There was, Friedman believed, something intrinsically bad about government commanding and ordering people about — even if the government did know what it was doing.

I do not know whether Keynes or Friedman was more right in their deep orientation. But I do think that the tension between their two views has been a very valuable driving force for human progress over the past hundred years.

What Economists Can Learn from Evolutionary Theorists

Continuing with the topic of evolutionary theory and economics, Paul Krugman emails to remind me of this interesting piece he wrote on the topic for the European Association for Evolutionary Political Economy:

What Economists Can Learn from Evolutionary Theorists Synopsis, by Paul Krugman: (A talk given to the European Association for Evolutionary Political Economy)

Good morning. I am both honored and a bit nervous to be speaking to a group devoted to the idea of evolutionary political economy. As you probably know, I am not exactly an evolutionary economist. I like to think that I am more open-minded about alternative approaches to economics than most, but I am basically a maximization-and-equilibrium kind of guy. Indeed, I am quite fanatical about defending the relevance of standard economic models in many situations.

Why, then, am I here? Well, partly because my research work has taken me to some of the edges of the neoclassical paradigm. When you are concerned, as I have been, with situations in which increasing returns are crucial, you must drop the assumption of perfect competition; you are also forced to abandon the belief that market outcomes are necessarily optimal, or indeed that the market can be said to maximize anything. You can still believe in maximizing individuals and some kind of equilibrium, but the complexity of the situations in which your imaginary agents find themselves often obliges you - and presumably them - to represent their behavior by some kind of ad hoc rule rather than as the outcome of a carefully specified maximum problem. And you are often driven by sheer force of modeling necessity to think of the economy as having at least vaguely "evolutionary" dynamics, in which initial conditions and accidents along the way may determine where you end up. Some of you may have read my work on economic geography; I only found out after I had worked on the models for some time that I was using "replicator dynamics" to discuss the problem of economic change.

But there is another reason I am here. I am an economist, but I am also what we might call an evolution groupie. That is, I spend a great deal of time reading what evolutionary biologists write - not only the more popular volumes but the textbooks and, most recently, some of the professional articles. I have even tried to talk to some of the biologists, which in this age of narrow specialization is a major effort. My interest in evolution is partly a recreation; but it is also true that I find in evolutionary biology a useful vantage point from which to view my own specialty in a new perspective. In a way, the point is that both the parallels and the differences between economics and evolutionary biology help me at least to understand what I am doing when I do economics - to get, to be pompous about it, a new perspective on the epistemology of the two fields.

Higher Powered Economics

Stephen Gordon at Worthwhile Canadian Initiative offers an explanation for why "explaining economics to non-economists is as difficult - and as frustrating - as explaining the theory of evolution to creationists":

The Intelligent Design theory of economics, Worthwhile Canadian Initiative: Mark Thoma at Economist's View has been wading through what non-economists think of economics, and he's finding the exercise somewhat frustrating. For someone who hasn't had formal training in the field, anti-economics is often more persuasive than the real thing. Paul Krugman ran into this particular brick wall a few years ago, and realised that the correct response to many criticisms of economics is "You just don't understand".

I used to think that the yawning gap between economists' understanding of economic issues and that of non-economists was primarily a problem of communication: we simply were not doing our job of explaining our ideas to the broader audience of non-specialists. But it sometimes seems as though explaining economics to non-economists is as difficult - and as frustrating - as explaining the theory of evolution to creationists.

Intelligent Design as applied to economics takes pretty much the same form as it does with biology: "What we observe couldn't have just happened; it's obviously the work of some Greater Power." When it comes to evolution, the Greater Power generally takes the form of an omnipotent diety. The counterpart in economics is the 'economic elite': the existence of inequality is interpreted as evidence that those who have done well did so by design.

Economists do of course try to explain that market outcomes are the result of decentralised interactions between self-interested agents - and that these interactions generally lead to socially desirable outcomes. (And even when those outcomes are not desirable, market-based solutions are generally better than those based on what a central planner could come up with.)  But once you've convinced yourself that elites are manipulating market outcomes, it's all-too-easy to persuade yourself that those who would argue otherwise must necessarily be bought-and-paid-for apologists for the omnipotent elites. And once you've persuaded yourself of that, it becomes pretty much impossible for anyone to say anything that will budge you from your position.

Stefan Geens at economonitor adds more:

Intelligent design vs. the invisible hand, by Stefan Geens: A truly wonderful post on Worthwhile Canadian Initiative posits that the reason many people have trouble understanding basic economic principles is the same reason many people have trouble accepting evolutionary theory: They instinctively prefer an intelligent designer...

The analogy even bears some straining: Economics and evolution are both driven by an "invisible hand" of decentralized interactions between selfish agents, and both sciences are susceptible to interpretations that fall prey to the naturalistic fallacy: If it happens in the market, then it is good. If it happens in nature, then it is good. Neither inference holds, of course, and so we remain free to make normative statements about how best to regulate markets or how to lead a moral life.

I can't say I fully understand the resistance to economics, so not sure I agree. I can say that one of the things I've been most surprised about since I started doing this is how little regard many people have for economists and their ideas. I guess we still have lots of work left to do.

While we're on the topic, there's also this from Brian Caplan at Econlog:

Difference in Deference, by Brian Caplan, Econlog: Over at Overcoming Bias, Robin Hanson amusingly contrasts the abject deference the public gives to physicists with the stubborn defiance the public gives to economists:

Consider how differently the public treats physics and economics. Physicists can say that this week they think the universe has eleven dimensions, three of which are purple, and two of which are twisted clockwise, and reporters will quote them unskeptically, saying "Isn't that cool!" ... I see the same pattern with my students - they'll easily believe physics claims, but are very reluctant to entertain standard economics claims. ... As Caplan emphasizes, the publics' problem with economics is not the things they don't know, it is the things they know that ain't so...

Is There an "Anti-Affirmative Action Wave Washing over America"?

Is America ready for the end of "the affirmative action era"? According to this, the answer is no:

The end of affirmative action?, by Erin Aubry Kaplan, Commentary, LA Times: At least a dozen times in the last decade, I've read or heard that the United States is coming to the end of the affirmative action era. I don't believe it.

Americans are always making premature or wrongheaded pronouncements about the ends and beginnings of eras... The guy making this case most recently is former University of California Regent Ward Connerly. Connerly has made a career out of being the black man who opposes affirmative action no matter what, and after a dozen years, he's satisfied that his work is close to done.

Proposition 209, which banned affirmative action in public education, hiring and contracts, was approved by California voters 10 years ago. Since then, the complexion of the UC student body has paled considerably. Measures modeled after 209 are passing in other parts of the country, including in Michigan earlier this month. On the federal level, the most conservative Supreme Court in modern history looks poised to limit or eliminate the federal mandate that created affirmative action.

Connerly is encouraged by all these good omens. He has said that he feels an "anti-affirmative action wave washing over America" and that he's following that wave to Oregon, Nevada and other states still in need of conversion. Spreading the gospel, apparently.

The gospel of what, exactly? What I find sad about this crusade, apart from the fact that its spiritual leader is a black man, is that it's so hellbent on destroying something meant to help folks but offers nothing helpful to take its place. It's a movement built on people in power gathering up all the marbles (which were mostly theirs to begin with) and going home. The best it can do is preach equality by doing nothing, a kind of free-market approach to solving deep-rooted racial problems. Such an approach only works for those controlling the free market. ...

The most troubling question raised by the potential end of the affirmative action era, however, is what kind of era we can expect next. For 40 years, affirmative action has been a modest political expression of a much bigger vision of America that emphasizes inclusion, and righting past wrongs where feasible, to make our social experiment into something truly great.

If Connerly is right, Americans are now admitting that this is too utopian for their tastes. Now they're ready to launch a new era in which it's perfectly OK to acknowledge that America doesn't really care about a level playing field, if it ever really did. Personally — and theoretically — I fear a future like that.

[For more on Proposition 209 and affirmative action, see Anti-bias law has backfired at Berkeley, by Robert J. Birgeneau, UC Berkeley Chancellor, March 2005.]

"Trade Obstructionism"

Robert Samuelson says globalization is a convenient scapegoat for many of our economic problems, but a closer look shows that "It would be insane to hamper our export prospects -- exactly what trade obstructionism threatens":

Globalization Makes an Easy Scapegoat, by Robert Samuelson, Washington Post: We may be about to shoot ourselves in the foot -- or maybe the chest -- on trade. In the name of "fair trade,'' we may punish our own exporters. In 2005, worldwide exports exceeded $10 trillion. Since 1980, they've more than tripled while the overall global economy doubled. Like it or not, massive international flows of goods and services (aka "globalization'') underpin all modern economies. We can accept this reality and try to benefit from it. Or we can rail against it. We seem to be edging toward railing.

Just last week, Democratic congressional leaders signaled they might oppose new trade agreements with Colombia and Peru. Who, if anyone, would benefit is unclear. ...[T]he agreements' darkened prospects have already led to layoffs in Colombia. In the United States, manufacturers believe the agreements would expand their exports. Peru's tariffs average about 10 percent, Colombia's about 11 percent... Most of these would go to zero under the agreements.

We are dealing with ... trade obstructionism: a reflexive reaction against almost any trade agreement. The idea is that much trade is inherently "unfair.'' ...[O]ther countries compete unfairly with low wages and substandard labor practices. (Indeed, the lax labor standards are cited to oppose the Peruvian and Colombian agreements.) Vast U.S. trade deficits measure the destructiveness. If trade is so unfair, why encourage more of it?

Much of this indictment is wrong or wildly exaggerated. For example, American trade deficits haven't destroyed U.S. job creation... Consider. From 1980 to 2006, the trade deficit jumped ... from less than 1 percent of gross domestic product to about 6 percent. Still, employment in the same period rose from 99 million to 145 million. Job creation defies the trade deficits, whose causes ... have little to do with "unfair'' trade practices. ...

U.S. jobs are destroyed for many reasons -- new domestic competition, new technologies, changing consumer tastes, the business cycle. A remarkable statistic: Every three months, 7 million to 8 million U.S. jobs disappear, and roughly an equal or greater number are created. Trade is a relatively minor factor in job loss.

It is, however, an easy scapegoat. It enables critics to blame foreigners and suggest a solution -- restrict trade. Globalization becomes a convenient explanation for many economic discontents, from job insecurity to squeezed living standards.

Hence, trade obstructionism. The timing could not be worse. The U.S. economy is now moving away from growth led by housing and consumer spending... Something will have to replace that spending if the economy is to continue to expand. The obvious candidates are exports and investment (in factories, machinery) related to exports.

It would be insane to hamper our export prospects -- exactly what trade obstructionism threatens. The world is quietly retreating from a multilateral trading system, where all countries simultaneously reduce trade barriers. The latest multilateral trade talks (the Doha round) are suspended; meanwhile, there are now more than 200 country-to-country and regional trade agreements. The United States has 13. But to negotiate more of them, the president needs so-called "trade promotion authority,'' and President Bush's expires in June.

If it's not renewed -- a good possibility -- the United States will effectively prevent itself from negotiating new trade agreements, while other countries are busily doing so. The European Union is now negotiating with India. The 10 Southeast Asian members of ASEAN are negotiating with Japan, South Korea and Australia. The hallmark of these agreements is that they discriminate against outsiders. So American exporters would face higher tariffs than many of their international competitors.

The next Congress must decide whether it embraces the symbolism or reality of trade. If it chooses symbolism, it will perversely harm many of the workers it's trying to help.

Bernanke: Inflation Risks Remain Elevated

Ben Bernanke says he remains concerned about the elevated risk of inflation. From Greg Ip at the the Wall Street Journal:

Bernanke Warns of Inflation Risks, Suggesting No Rate Cut Coming Soon, by Greg Ip, Wall Street Journal: Federal Reserve Chairman Ben Bernanke said he is still worried about inflation as tight labor markets fuel wage gains, and economic growth outside of housing remains solid.

Mr. Bernanke's hawkish remarks on inflation and upbeat view of the economy contrast with the emerging view on Wall Street that the economy is weakening and inflation risks have faded. Those views, in recent weeks, had led to rising expectations the Fed will cut rates in the next six months. ...

But Mr. Bernanke said the choice facing the Fed at present is whether to raise rates, not cut them. "Whether further policy action against inflation will be required depends on the incoming data," Mr. Bernanke said...

Mr. Bernanke said that both the economy and inflation had behaved much as expected when he testified on the economy in July. "Outside of the housing and motor-vehicle sectors, economic activity has, on balance, been expanding at a solid pace," he said. While trends in core inflation, which excludes food and energy, are less worrisome than in the spring, at 2.7% in October it "remains uncomfortably high," he said.

While much of the speech reiterated themes of other Fed commentary and his own testimony in July, Mr. Bernanke broke new ground by dwelling on the tight labor market and its potential to push up wages and prices. ... Furthermore, in another break from recent commentary, he said the fact the economy is operating with less spare capacity has "likely played some role in the rise in core inflation."

The primary reason for his new emphasis on these factors likely relates to the steady decline in the unemployment rate, hitting 4.4% in October. Back in July, Fed officials projected a year-end jobless rate of 4.75% to 5%. At the same time, hourly earnings growth and employment costs has accelerated. Job growth has also been solid, and with it, personal income growth -- the most important determinant of consumer spending. ... Mr. Bernanke said that outside housing, consumer spending has been growing at about the same rate through the current quarter that it has since late 2001.

He acknowledged the housing market remains a risk to the economic outlook. "The rate of home-price appreciation has slowed significantly," he noted, and the overhang of unsold homes is likely even larger than the sizable official figures. But he added that home sales seem to be "stabilizing," though construction could continue to decline for a while to bring the supply of unsold homes back in line with demand.

He acknowledged "the correction in the housing market could turn out to be more severe and widespread" than expected. But he also said the economy could rebound from the housing-induced slowdown more briskly than expected. On inflation, "the risks to the forecast seem primarily to the upside. Given the current level of inflation, a failure of inflation to moderate as expected would be especially troublesome."

Here is the entire Speech by Chairman Ben S. Bernanke on the economic outlook.

Update: See Calculated Risk for a different perception of Bernanke's speech.

Flip-Flop or Not?

Has anyone heard the administration say directly that private accounts are negotiable as part of a deal to restructure Social Security? The Wall Street Journal's Washington Wire wonders the same thing:

Singing the Social Security Song, by Deborah Solomon, WSJ Washington Wire: Treasury Secretary Henry Paulson continues to wave the Social Security olive branch towards congressional Democrats, but it still isn’t clear how much negotiating flexibility the White House has given him. Fielding questions from reporters on a trip to London, Paulson said Tuesday, “I am having preliminary discussions with a number of leaders on both sides of the aisle in Senate and House about their priorities and about the need for entitlement reform in the U.S. I am encouraging people on both sides of the aisle to be willing to enter into a discussion that is not preconditioned.”

Paulson’s rhetoric is being interpreted by some in Washington as a sign that the Bush administration won’t insist that Democrats agree to create private accounts as part of a Social Security fix, a sticking point in the past. President Bush, in a press conference the day after Republicans lost their House and Senate majorities, said he had “instructed Secretary Paulson to reach out to folks on the Hill to see if we can’t at least get a dialogue started” about Social Security and the other costly entitlement programs, Medicare and Medicaid. ...

The president and members of the administration have said clearly in the past that private accounts will remain part of the Social Security reform proposal so long as the president is in office. It would be easy for the administration to clear up the confusion over whether the president has flip-flopped or not if they were inclined to do so. [See also PGL at Angry Bear with Social Security: Is Bush Advocating Add-ons?]

Is Catastrophe Insurance Headed for Disaster?

Peter G. Gosselin of the LA Times describes recent changes in catastrophe insurance markets, some of which have shifted risk from insurance companies to the government and individuals. For example, in many states the government has capped the total amount insurance companies must pay to policyholders after natural disasters. In these cases, the government agrees to cover any costs over and above the cap limiting the insurance companies' exposure to risk.

But the big change is the ability of insurance companies to assess risk at the individual level to a greater degree than ever before. This allows them to design policies and rates to match an individual's characteristics. Whether this is good or bad overall is an open question. While it improves the efficiency of insurance markets in a variety of ways, if winners and losers can be predicted accurately in advance insurance markets break down because there is no way to pool risk across individuals. For example, if one out of ten people will face high losses after an earthquake, and you can tell which person it will be in advance, there is no way share the risk across these ten individuals. Instead, one will face very high costs and nine very low costs - same average, but a different distribution (all else equal, e.g. the individual who faces the high rate may take preventative measures to reduce risk lowering overall and average costs).

In addition, with individual pricing there is a worry that the poor will face very high rates and be unable to afford insurance coverage. With the ability to assess risks at the individual level and predetermine winners and losers, each individual will, in essence, enter into a savings program that covers lifetime disaster costs with an individualized monthly premium. But if those who are poor also happen to be high risk, then many will not be able to afford insurance. If so, this shifts risk to the government and to private sector agencies such as non-profits that deliver aid since they will have to step in and help to some degree after a disaster.

I think that insurance companies should be allowed to vary rates according to factors within an individual's control, but factors beyond an individual's control ought to be pooled even if they can be identified a priori. For example, the risks of being born with a costly genetic problem ought to be shared across the population even if a prenatal blood test will reveal it, while the risks from smoking ought to fall on the individual. This may be difficult to define in practice, e.g. if we expect the an unemployed person to take any job that is open or face a cut in their unemployment benefits, is the decision to move and take a job in an area with a high earthquake risk fully within the individual's control? But mostly the lines are clear and I think it's a good guiding principle:

Insurers learn to pinpoint risks -- and avoid them, by Peter G. Gosselin, LA Times: Hemant Shah is in the business of creating catastrophes. The computers at Shah's Silicon Valley company, Risk Management Solutions Inc., contain mathematical models of every U.S. disaster from the 1812 earthquake ... in St. Louis to the 9/11 assault ... in New York, as well as 100,000 synthesized "extreme events."

RMS runs its disasters through your community — and sometimes right through your home — to see how you'd fare in a hurricane, hailstorm, earthquake, epidemic or terrorist attack. The firm sells its knowledge to insurance companies to help them decide whom to cover and how much to charge.

Since Hurricane Katrina last year, those decisions have been running pretty much in one direction. Based in part on RMS' predictions, companies ... have gotten out of some lines of coverage altogether ... and ... have spent the year dropping or paring back policies... And this may only be the beginning.

"Between hurricanes along the East and Gulf coasts and earthquakes along the West Coast, it is an open question whether the private insurance industry will continue to insure the coastline at all," said University of Pennsylvania economist Howard Kunreuther, one of the country's foremost authorities on disaster.

Changes in the Distribution of Income and Taxes

New IRS data yields an updated look at how the distribution of income has changed over time, and at the winners and losers from tax cuts:

’04 Income in U.S. Was Below 2000 Level, by David Cay Johnston, NY Times: Despite significant gains in 2004, the total income Americans reported to the tax collector..., adjusted for inflation, was still below its peak in 2000, new government data shows. ... Total reported income, in 2004 dollars, fell 1.4 percent, but because the population grew during that period average real incomes declined more than twice as much, falling ... 3 percent...

Since 2004, the Census Department has found, the income of the typical American household has grown ... but at a slow pace that, until recent months, had barely kept ahead of inflation. The tax data, while not as up to date, helps spell out whose incomes were most affected in the recent downturn and why.

The overall income declines ... came despite a series of tax cuts that President Bush and Congressional Republicans promoted as the best way to stimulate both short- and long-term growth... The tax cuts contributed to a big decline in individual income tax receipts, which fell at a rate 14 times that of the drop in incomes.

In 2004 individual income tax receipts were 21.6 percent smaller than in 2000 — and indeed smaller than they were in 1997, the new I.R.S. report shows. ... [R]ather than pay for themselves through economic growth, the Bush tax cuts, at least through 2004, were financed with borrowed money. ...

A White House spokesman, Tony Fratto, said the decline in income through 2004 was a predictable result of “what we all know now was a bubble economy with inflated asset values, which is why $7 trillion of equity in the stock markets evaporated.” ...

Over all, average incomes rose 27 percent in real terms over the quarter-century from 1979 through 2004. But the gains were narrowly concentrated at the top and offset by losses for the bottom 60 percent of Americans, those making less than $38,761 in 2004.

The bottom 60 percent of Americans, on average, made less than 95 cents in 2004 for each dollar they reported in 1979, analysis of the I.R.S. data shows.

The next best-off group, the fifth of Americans on the 60th to 80th rungs of the income ladder, averaged 2 cents more income in 2004 for each dollar they earned in 1979.

Only those in the top 5 percent had significant gains. The average income of those on the 95th to 99th rungs of the income ladder rose by 53 percent, almost twice the average rate.

A third of the entire national increase in reported income went to the top 1 percent — and more than half of that went to the top tenth of 1 percent, whose average incomes soared so much that for each dollar, adjusted for inflation, that they had in 1979 they had $3.48 in 2004.

Because of cuts in the tax rate, the top tenth of 1 percent did even better than their rising incomes alone would suggest. For each inflation-adjusted dollar they had after tax in 1979 they had $3.94 left after taxes in 2004.

For the bottom 60 percent, their income taxes were so small in 1979 that the cuts did little to change their after-tax incomes. While their pretax average incomes fell by a nickel on the dollar from 1979 to 2004, their after-tax incomes fell by a fraction of a penny less.

Political Price Cycles in Gasoline Markets?

Are oil prices manipulated prior to elections? This paper provides evidence that they are based upon a sample of legislative elections for 32 countries over 27 years:

Do Politicians Manipulate Gasoline Prices?, by David Wessel WSJ Washington Wire: Before the recent U.S. congressional election, there were widespread, unsubstantiated assertions that the Bush administration somehow had manipulated gasoline prices so they’d fall before the November congressional elections. Economists pooh-poohed them. Now a couple of International Monetary Fund economists, looking through data on gas prices and legislative elections from 1978 to 2004 in 32 countries from Australia to the U.S., say there may be something to this conspiracy theory.

“Focusing on real” – inflation-adjusted – “gasoline prices alone, we observed that they declined 0.3%, on average, during ‘normal’ quarters and about 0.7% during quarters of electoral campaign. Moreover, in 15 countries of the sample, this difference exceeded 2 percentage points, whereas it exceeded 6 percentage points in seven countries,” economists Claudio Paiva and Rodriga Moita write in new IMF working paper. ...

Though the paper appears to be carefully done, I'm skeptical. In particular, though there is a theoretical model in the paper, how the price manipulation is carried out isn't completely clear. The paper says:

[A]nother assumption we make in using the gasoline market in the empirical part of our paper [is] that governments either determine gasoline prices directly through price regulation or exert strong influence on them through regulatory stocks, importation, taxes, subsidies, and when setting environment and safety standards.

Thus, the connection between government action prior to elections and gas price changes is assumed, not established empirically. I'm not saying the connection is or isn't there for the countries in the sample, just that it hasn't been shown to exist for the U.S.

Update: Here are the countries:

Australia, Austria, Belgium, Brazil, Canada, Switzerland, Denmark, Finland, France, Germany, Greece, India, Indonesia, Ireland, Italy, Japan, Korea, Mexico, Netherlands, New Zealand, Norway, Poland, Portugal, Romania, Slovak Republic, South Africa, Spain, Sweden, Thailand, Turkey, United Kingdom, United States

Was Friedman a "Great Conservative Partisan"?

Amid all of the deserved praise given to Milton Friedman recently, there is a detectable undercurrent that disagrees with the reverence his work receives.

I've made my soft-spot for Friedman evident, but I thought it would be worthwhile to present another view for discussion. This also touches upon the "economics as religion" arguments discussed here recently. Here it is:

Milton Friedman: The Great Conservative Partisan, by Thomas I. Palley: Milton Friedman died on November 16, 2006 at the age of 94. Without doubt, Friedman was one of the most influential (perhaps the most influential) economists of the second half of the twentieth century. Not only did he contribute to reviving belief in the economic efficacy of the market system, he also had a profound political impact by linking capitalism with freedom.

Friedman’s treatment of capitalism and freedom colored understandings so that many among America’s elite now see a simplistic identity between the two. However, the reality is a complicated tango whereby free markets promote certain dimensions of freedom but can also bruise others – including democracy, meritocracy, and equality of opportunity. To paraphrase George Orwell, in market systems we are all free but some are (a lot) freer than others.

In 1976 Friedman was awarded the Nobel Prize in economics for his contributions to scientific economics. These contributions are marked by two characteristics. First, they are imbued with an underlying conservative partisanship characterized by profound animus to government. Second, Friedman achieved public standing through his macroeconomic work, much of which has been discredited. In a sense, Friedman is the economist who lost the battle but ended up winning the war, convincing society to adopt his view of the world.

Sachs versus Easterly [continued]

First, Jeffrey Sachs said that Friedrich von Hayek was Wrong about the welfare state, it does not lead to serfdom. He used the Scandanavian countries as a counterexample. Tim Duy weighed in In Defense of Hayek, and William Easterly made many of the same points in his response to Sachs. Both say that Hayek was not opposed to social insurance and support their arguments with quotes from Hayek's book. Easterly also rebuts Sach's claim that the Scandinavian economies are robust despite their generous social insurance programs. In the latest installment, Jeff Sachs rebuts Easterly's rebuttal:

Vibrant Economies With High Taxes and High Social Welfare Spending, by Jeffrey D. Sachs, Letter to the Editor, WSJ: William Easterly is correct that Friedrich Hayek wrote "The Road to Serfdom" in 1946 to warn that central planning and state ownership would lead to the collapse of freedom ("Dismal Science," editorial page, Nov. 15). Yet in 1976, in the Preface to the Reprint Edition, Hayek made perfectly clear that he believed that the same outcome would occur through the welfare state. Noting that "socialism has come to mean chiefly the extensive redistribution of incomes through taxation and the institutions of the welfare state," Hayek wrote that "In the latter kind of socialism the effects I discuss in this book are brought about more slowly, indirectly, and imperfectly. I believe that the ultimate outcome tends to be very much the same . . ." (While the editors at Scientific American used the shorthand that Hayek wrote in the 1940s, my detailed paper on the Nordic economies makes explicit that Hayek's critique of the modern welfare state came in the 1970s, in the Reprint Edition).

Thirty years on, we can see the results of Hayek's prediction. Despite government revenues above 50% of GNP in the Nordic countries supporting an extensive social welfare state, those countries are vibrant democracies with open, competitive, and high-income economies and low rates of poverty. That is precisely the point of my Scientific American piece and a longer scholarly paper that Prof. Easterly wrongly attacks. He actually makes my point for me by pointing out that the Heritage Foundation/Wall Street Journal Index of Economic Freedom ranks Finland, Sweden and Denmark as "free economies," with Denmark ranked ahead of the United States, despite the fact of their extremely high rates of taxation and social welfare spending. Similarly, the Global Competitiveness Index of the World Economic Forum puts these three countries at ranks two, three and four in global competitiveness, ahead of the United States at rank six.

Mr. Easterly also repeats his favorite canard that I believe in central planning. Anybody who is at all familiar with my life's work and writings knows that I believe in market-led and open economies and was a leading economic adviser on the conversion of the former Communist economies to market economies. I do not believe in pure laissez faire, however. Nor do I believe that an antipathy to foreign aid is correct at a time when millions of children are dying each year as a result of extreme poverty unattended by practical help from the rich countries.

Update: Greg Mankiw also discovers Sach's letter.

Did Economics Crowd Out Sociology?

Have economic ideas displaced the ideas of sociologists in recent decades? According to this they have, but there may be room for sociology to make a comeback:

A call to arms, by Anthony Giddens, Commentary, The Guardian: All you sociologists out there! All you ex-students of sociology! All of you (if there are such people) who are simply interested in sociology and its future! I'd like to hear from you. We live in a world of extraordinary change, in everyday life, family relationships, politics, communications and in global society. We are witnessing, among other things, a return of the gods, as religion re-emerges as a major force in our societies, locally and on a worldwide level.

All grist to the sociological mill, one would have thought. Sociology was born at a period of transformative social change, during the early part of the 19th century. It was a time of the "three great revolutions" - secular political revolution, the industrial revolution, and the emergence of a predominantly urban society, replacing a predominantly rural one. It would be very difficult to say whether developments today are as far-reaching as those of 150 years ago. But we can probably all agree that this is a time of very large-scale change, for the first time happening on a truly worldwide level.

My question is: in such circumstances, why isn't sociology again right at the forefront of intellectual life and public debate? ...

A possible response might be to doubt the diagnosis. Perhaps it is a mistake to think that sociology isn't in the intellectual forefront any longer. Take the debate about globalisation... Haven't sociologists contributed significantly to this discussion? Indeed they have, but it has been driven far more by economists ... or those in the field of international relations. What about the impact of the communications revolution? Sociologists ... have written important works on the issue. But I don't believe sociology has been the main source of contributions to the field. ...

So what are the reasons for sociology's decline? I would suggest two main ones. First, sociology's star was dimmed by the rise of market-based philosophies from the early 1980s onwards. As a phase of government, market fundamentalism lasted some twenty years - roughly the period covered by the Reagan and Thatcher governments. Its overall influence lasted longer, since more sophisticated versions of it continue to guide international organisations, especially the IMF and World Bank... If markets settle most aspects of social life, including social justice, the scope of social factors - the prime province of sociology - is correspondingly reduced. The economic, as it were, predominates heavily over the social.

A second reason I would single out is the impotence many people feel in the face of the future. There are no longer utopian projects that would supply a source of direction for social reform and a source of motivating ideas. I'm not saying that sociology was ever itself a form of utopianism. But sociological thinking, born of the political and economic revolutions of the 19th century, certainly was regularly stimulated by an engagement with those who wanted to change the world for the better. ...

What is the remedy...? Well, in some part the world is moving in a propitious way for a recovery of the sociological imagination. Market fundamentalism is disappearing from the scene. The stage is set for a return to the social. After all, even the IMF these days gives social and political factors a significant place in development processes - and Mrs Thatcher is long gone. ...

The answer for me is a return to the style of thinking that originally drove the sociological enterprise. A little bit more utopian thinking might help too... We need more positive ideals in the world ... that link to realistic possibilities of change. Most of all, though, we need to confront the big problems..., and provide a field of debate for helping us understand them better. Globalisation itself is far more than just an economic phenomenon. It's a set of processes that increasingly links our personal lives, even intimate aspects of them, to global events - the controversy over the Islamic headscarf is just such an example. Why is religion seemingly again so influential in the world today? What accounts for the resurgence of ethnical conflicts in so many countries? Is the family dying or not? These are quintessentially sociological questions. Let's get to work to answer them.

Long ago, my dissertation adviser visited Caltech. He had a statistics question and tried to make an appointment to talk to one of the statisticians there. He was told, "I only have time for real scientists."

Since I've been bristling lately at how scientists view economics, I should admit that economists often display a similar lack of respect for other social sciences. We shouldn't do that.

Varian: Observe, Theorize, Measure, and Test

Here's one last post, for now, related to methodology. This is Hal Varian from a 2002 New York Times article:

Observe, theorize, measure, test and don't overlook what goes wrong. Nobel experiments, by Hal Varian, New York Times, October, 2002: You can learn a lot when an experiment goes wrong.

Edward Chamberlain, a professor of economics at Harvard in the 1950's, pioneered the concept of ''monopolistic competition,'' a hybrid of the pure monopoly and pure competition models that were then the staple of economics courses.

To demonstrate the problems with those theories, he would run an experiment in his classroom in which students were given hypothetical values of consuming or costs of supplying a good, and they would wander around the room trying to make deals with one another.

Milton Friedman: The Methodology of Positive Economics

Let's go back a bit in time to one of the classic papers on the "Is economics a science" question discussed below. Here's the first part of Milton Friedman's essay from 1953, "The Methodology of Positive Economics." It runs a bit long, but I thought some of you might be interested in it:

"The Methodology of Positive Economics," by Milton Friedman, In Essays In Positive Economics (Chicago: Univ. of Chicago Press): Introduction In his admirable book on The Scope and Method of Political Economy John Neville Keynes distinguishes among “a positive science … a body of systematized knowledge concerning what is; a normative or regulative science…, a body of systematized knowledge discussing criteria of what ought to be…; an art…, a system of rules for the attainment of a given end”; comments that “confusion between them is common and has been the source of many mischievous errors”; and urges the importance of “recognizing a distinct positive science of political economy.”[1]

This paper is concerned primarily with certain methodological problems that arise in constructing the “distinct positive science” Keynes called for - in particular, the problem of how to decide whether a suggested hypothesis or theory should be tentatively accepted as part of the “body of systematized knowledge concerning what is.”  But the confusion Keynes laments is still so rife and so much of a hindrance to the recognition that economics can be, and in part is, a positive science that it seems well to preface the main body of the paper with a few remarks about the relation between positive and normative economics.

Points of Agreement between Rubinites and Populists

The New York Times has another story about the split in the Democratic Party between the populist/protectionist faction and the free-trade advocates:

Here Come the Economic Populists, by Louis Uchitelle, Commentary, NY Times: For years, the Clinton wing of the Democratic Party, exercising a lock on the party’s economic policies, argued that the economy could achieve sustained growth only if markets were allowed to operate unfettered and globally.

Overcoming protests from labor unions, a traditional constituency, the Clinton administration vigorously supported free trade agreements like Nafta and agreed to China’s admission into the World Trade Organization. If there was damage to workers, then the Clinton camp proposed dealing with it after it occurred — through wage insurance, for example, or worker retraining and other safety-net measures. ...

Over time, this combination — called Rubinomics after the Clinton administration’s Treasury secretary, Robert E. Rubin — became the Democratic establishment’s accepted model for the future.

Not anymore. With the Democrats now a majority in Congress, and disquiet over globalization growing, a party faction that has been powerless — the economic populists — is emerging and strongly promoting an alternative to Rubinomics.

Was Adam Smith Wrong About the Invisible Hand?

Another "economics is a speculative philosophical discourse, not a deductive or inductive science" argument:

Economics: The Invisible Hand of the Market, by Peter Steinfels, NY Times: Duncan K. Foley [has a] ... new book... [F]or his survey of more than 200 years of economic thought, ... he chose the title “Adam’s Fallacy: A Guide to Economic Theology.”

Adam? Theology? The Adam in question is ... the founding father of modern economics, Adam Smith.

So what is “Adam’s Fallacy”? ... It is the idea that the economic sphere of life constitutes a separate realm “in which the pursuit of self-interest is guided by objective laws to a socially beneficent outcome,” Professor Foley wrote, a realm unlike all the rest of social life, “in which the pursuit of self-interest is morally problematic and has to be weighed against other ends.”

“This separation of an economic sphere,” he wrote, “with its presumed specific principles of organization, from the much messier, less determinate and morally more problematic issues of politics, social conflict and values, is the foundation of political economy and economics as an intellectual discipline.”

Professor Foley’s book is simultaneously an introduction to economic theory and a critique of it. ... How “Adam’s Fallacy” will serve as an introductory text is for others to decide. What is pertinent here is the author’s contention that economists, all along, have been writing theology. ...

Thinking is Hard

In the post above this one, it says '"thinking like an economist comes hard to many people."' This tries to explain why:

Revealed: Why understanding economics is hard, by Andrew Cassel, Philadelphia Inquirer Columnist: I finally understand why economics is so hard for many people to grasp.

It's not because of complexity. The rules of supply and demand aren't inherently more difficult to fathom than those that apply to, say, politics, or cooking, or sports.

Yet while most people have no trouble wrapping their brains around these subjects - indeed, millions will be eagerly absorbing their finer points this weekend - (What are you watching: Meet the Press, celebrity chefs or college football?) - few have a similar appetite for economics.

And now I know why, thanks to Alan Fiske ..., a professor of anthropology at UCLA... His conclusion: Just as every human language is composed of the same grammatical elements (subjects, verbs, etc.), all relationships are built from exactly four kinds of interactions.

Fiske labels these communal sharing, equality matching, authority ranking and market pricing. Here's what he means:

Communal sharing is how you treat your immediate family: All for one and one for all. Or as Marx put it: From each according to ability, to each according to need.

Equality matching, by contrast, means we all take turns. From kindergarten to the town meeting, it's all about fair shares, reciprocity, doing your part.

Authority ranking is how tribes function, not to mention armies, corporations and governments. Know your place, obey orders, and hail to the chief.

Market pricing, of course, is the basis of economics. It's what we do whenever we weigh costs and benefits, trade up (or down), save or invest.

Don't get Fiske wrong: He's not saying that each relationship in your life fits into one of these four slots. Rather, these are paradigms - mental models - that we use to help make sense of our interactions.

When there are conflicts, moreover, Fiske maintains it's often because we aren't all using the same model.

For example, you might see housework as a communal-sharing function, while your spouse approaches it as equality-matching. Neither is wrong, yet you still end up angry or guilty when the laundry isn't done.

The same problem can afflict whole societies, as Fiske described to me recently. "The Danes pride themselves on being fair," he said. "They can't understand why they don't get along with their Middle Eastern immigrants."

But Fiske does: "The immigrants expect authority ranking. The Danes expect strict equality matching. Each side sees people constantly violating the models." ...

But what is particularly interesting is the role of market pricing, which Fiske speculates might have been the last to evolve in our prehistoric ancestors' brains.

It makes sense. For hunter-gatherers in small bands, sharing, matching and ranking were probably as fundamental to survival as eating and breeding. But market pricing involves complex choices based on mathematical ratios.

"It's the difference between addition and subtraction on one hand, multiplication and division on the other," Fiske says.

Commerce and global trade, of course, require a finely honed version of the market-pricing model. But if humans developed this model relatively late, it might well be less than universal, even today.

In other words, to have an intuitive grasp of economics, you might just need to take a step or two up the evolutionary ladder.

Just Enough to Live On

We hear a lot about the overly generous European welfare state. How generous is it? I'll let you decide in the case of Germany. Germany has defined the minimum monthly amount needed to subsist, €345 per month (approximately $450, or, about $15 per day) plus rent and heating:

What's the Price of Life?, by Max Henninger, Spiegel Online International: How much cash does a person need to survive? Germany's welfare institutions have calculated a precise answer, now confirmed in a decision by the Federal Social Court: €345 per month is officially considered the minimum subsistence income, rent and heating not included.

Where All the Peers Are Above Average...

Executive compensation is often set through comparisons to peer groups. But how are the peers chosen? Does the process yield defensible compensation levels?:

Peer Pressure: Inflating Executive Pay, by Gretchen Morgenson, NY Times: Like Lake Wobegon, Garrison Keillor’s fictitious Minnesota town where all the children are above average, executive compensation practices often assume that corporate managers are equally superlative. When shareholders question lush pay, they are invariably met with a laundry list of reasons that businesses use to justify such packages. Among that data, no item is more crucial than the “peer group,” a collection of companies that corporations measure themselves against when calculating compensation.

But according to a handful of pay experts..., many of these peer groups are populated with companies that are anything but comparable. They also say corporate managers themselves ... are selecting which companies make it into a peer group. And because these companies are often inappropriate for comparison purposes, their use has helped inflate executive pay in recent years. ...

What's the Probability of a Recession?

The San Francisco Fed assesses the chance of a recession and finds that "while the probability of a recession over the next year may now be somewhat elevated, it does not appear to be nearly as high as the yield curve suggests":

Is a Recession Imminent?, by John Fernald and Bharat Trehan, FRBSF Economic Letter: The sharp slowdown in housing and the inverted yield curve have led to concerns that the odds of a recession have risen. For instance, Dow Jones Newswire reported on November 2 that one model based on the yield curve put the probability of a recession over the next four quarters at more than 50%. This Letter presents and discusses various estimates of the probability of recession. Our review of the evidence suggests two conclusions: First, recessions appear difficult to predict; second, while the probability of a recession over the next year may now be somewhat elevated, it does not appear to be nearly as high as the yield curve suggests.

Indicator models for predicting recessions

One way to predict the likelihood of a recession would involve simulating a large structural model of the U.S. economy. But economists disagree about the structure of the economy, so several have suggested using indicator models instead. The indicator models constructed by James Stock and Mark Watson (SW) are among the best known. Their work in this area preceded the 1990-1991 recession and continued through December 2003 (see, for instance, SW 1989). Their recession index (which estimates the probability of recession six months hence) and variations thereof are themselves a function of two indexes for Leading and Coincident Indicators. Unfortunately, their real-time performance has not been wholly satisfactory. The first index failed to predict the 1990-1991 recession, and a variation failed to predict the 2001 recession.

Of course, the SW indicators are not the only ones that failed. SW (2003) discusses this widespread failure and argues that it is hard to predict recessions because each is caused by a unique set of factors. For instance, income and consumption data did not provide much evidence portending a recession in 2001, but industrial production data did, because the recession was associated with IT manufacturing. By contrast, in the 1990-1991 recession, consumption did slow. Thus, "without knowing these shocks in advance, it is unclear how a forecaster would have decided in 1999 which of the many promising leading indicators would perform well over the next few years and which would not" (p. 88).

It should be noted that the SW approach definitely has had successes; the version used by the Chicago Fed, for instance, did a reasonably good job in real time of signaling a (coincident) slowdown in activity early in the 2001 recession. What does the index say now? As of October 25, the three-month average of the Chicago Fed's National Activity Index (2006) stood at -0.25. A value below zero implies that growth is below trend; values below -0.7 are associated with an "…increasing likelihood that a recession has begun" (p. 2).

Information from the yield curve

The yield curve is perhaps the best known of all the indicator models used to predict recessions. We begin with a model developed by Wright (2006) that uses information on the term spread and the funds rate. As Figure 1 shows, this model has done a reasonably good job of predicting recessions. Based on data for November 8, the model estimates a 47% probability of recession over the next four quarters. As a reference point, note that over 1964:Q1-2005:Q2, 27% of the four-quarter periods after any given quarter contained a recession; however, over 1984:Q1-2005:Q2, a period when output growth was noticeably less volatile than before, this frequency falls to only 15%.

Criticism of Sarbanes-Oxley Legislation is "Utter Nonsense"

Robert Reich says Treasury Secretary Henry Paulson is "either naive or doesn’t want you to know the truth" when he utters the nonsense that Sarbanes-Oxley legislation "could be damaging America’s economic standing":

Oh Henry, by Robert B. Reich, America Prospect: Treasury Secretary Henry Paulson issued a solemn warning this week. He said public companies are going private at a record pace because of regulatory burdens like the Sarbanes-Oxley legislation, which could be damaging America’s economic standing.

This is utter nonsense. If Paulson thinks public companies are going private because of regulations like Sarbanes-Oxley, he’s either naive or doesn’t want you to know the truth.

Companies that go private return to the public market within a few years. That’s the whole point... When they go public again, their stock sells at a far higher price than what the equity firm that took them private originally paid for it. ...

Sarbanes-Oxley has absolutely nothing to do with it. That law, remember, was put into place to regain the confidence of investors ... who got clobbered when CEOs looted their companies by pumping up share prices with false accounting, and then cashing in their stock options before reality caught up. Enron was the tip of a huge iceberg.

That iceberg is still with us. In fact, public companies are restating financial results at a higher pace than ever before. ... The Securities and Exchange Commission reported ... that more than half these restatements are due to companies misapplying basic accounting rules or having the wrong data... Without Sarbanes-Oxley, investors would never know the truth.

Paulson says he’s worried that Sarbanes-Oxley is causing public companies to go private. He’s got it backwards. He ought to be worried about the real reason so many public companies are going private. It amounts to a new kind of CEO looting.

CEOs advise their directors and public shareholders that the private buyout is in the best interests of the company. Then after the public shareholders sell out to the private equity firm, the CEOs stay on. At this point the CEOs typically make fixes -- new products, additional job cuts, new deals with suppliers or distributors -- that increase company profits. The result is to drive share prices sharply up when the company goes public again.

Had the CEOs made these fixes before the private equity deal, the original shareholders would have benefited from the increase in the share price. By making the fixes after the deal is done, CEOs and their equity partners take all the booty for themselves.

It’s a scam. ... If [CEOs] give any advice at all, they shouldn’t be allowed to remain with the firm after it goes private. If Paulson wants small investors to stay confident the market isn’t rigged against them, he should not seek to weaken Sarbanes-Oxley. To the contrary, he should expand the law to prevent this new form of CEO looting.

Links: Stiglitz and Sachs

I'm on the road today. Here are a couple of quick links as I head out the door. This and the two posts that follow will go up later today.  First, Joseph Stiglitz on fighting corruption:

Guard against those who would corrupt fight against corruption, by Joseph Stiglitz, Project Syndicate: At its recent annual meeting, World Bank officials spoke extensively about corruption. ... But the World Bank would do well to keep four things in mind.

First, corruption takes many forms, so a war on corruption has to be fought on many fronts. ...

Second, it’s fine for the World Bank to deliver anticorruption sermons. But policies, procedures and institutions are what matter. ...

Third, the World Bank’s primary responsibility is to fight poverty... [S]eldom will it be the case that the best response is simply to walk away.

Finally, while developing countries must take responsibility for rooting out corruption, there is much that the west can do to help. ...

Indeed, one reason for the so-called “natural resource curse” ... is the prevalence of corruption...

Next, Jeffrey Sachs

A new direction, by Jeffrey Sachs, Project Syndicate: On January 1, 2007, Ban Ki-Moon, South Korea's former foreign minister, will become United Nations secretary general, following Kofi Annan's 10 year tenure. ... With the recent elections in the United States and the rise of Asia's global influence, there is an opportunity to turn the world's attention to the most critical challenges facing our planet.

In addition to the long-term challenges of poverty, the environment, nuclear proliferation, and UN reform, the new secretary general will inherit a long list of hotspots: Iraq, Iran, Afghanistan, Palestine, Lebanon, Somalia, Myanmar, Sudan, North Korea, and others. Recent attempts to influence developments in these countries through threats and sanctions, and sometimes war, have failed. Most are less stable today than they were five years ago. Clearly, a new approach is needed. ...

If the United States works more closely within the UN framework, it will find willing partners in the rising Asian powers, which are intent on using their influence and resources to solve today's challenges. After all, Asian countries are interested in global stability to underpin their own long-term development.

They are acutely aware of their increasing influence around the world, as investors, trading partners, and as contributors to and victims of environmental change. Behind the scenes, the Asian powers can help to defuse the crises in Darfur, North Korea, Myanmar, and elsewhere. And they will be crucial to forging new cooperative approaches to climate change, water scarcity, and the like.

Paul Krugman: When Votes Disappear

Paul Krugman wonders why, with "as clear a demonstration as we’re ever likely to see that warnings ... about the dangers of paperless electronic voting are valid," there has been so little national attention devoted to the issue:

When Votes Disappear, by Paul Krugman, Missing Votes, Commentary, NY Times: You know what really had me terrified on Nov. 7? The all-too-real possibility of a highly suspect result. What would we have done if the Republicans had held on to the House by a narrow margin, but circumstantial evidence strongly suggested that a combination of vote suppression and defective — or rigged — electronic voting machines made the difference?

Fortunately, it wasn’t a close election. But ...[t]here were many problems with voting in this election — and in ... one Congressional race, the evidence strongly suggests that paperless voting machines ... delivered the race to the wrong candidate.

Here’s the background: Florida’s 13th Congressional District is currently represented by Katherine Harris, who as Florida’s secretary of state during the 2000 recount famously acted as a partisan Republican... This year Ms. Harris didn’t run for re-election, making an unsuccessful bid for the Senate instead. But according to the official vote count, the Republicans held on to her seat, with Vern Buchanan ... narrowly defeating Christine Jennings, the Democrat.

The problem is that the official vote count isn’t credible. In much of the 13th District, the voting pattern looks normal. But in Sarasota County, which used touch-screen voting machines ..., almost 18,000 voters — nearly 15 percent of those who cast ballots using the machines — supposedly failed to vote for either candidate.... That compares with undervote rates ranging from 2.2 to 5.3 percent in neighboring counties.

Reporting by The Herald-Tribune ... strongly suggests that the huge apparent undervote was caused by bugs in the ... software. About a third of those interviewed ... reported that they couldn’t even find the Congressional race on the screen. ... Moreover, more than 60 percent of those interviewed ... reported that they did cast a vote in the Congressional race — but that this vote didn’t show up on the ballot summary...

If there were bugs in the software, the odds are that they threw the election to the wrong candidate. An Orlando Sentinel examination of other votes cast by those who supposedly failed to cast a vote ... shows that they strongly favored Democrats, and Mr. Buchanan won the official count by only 369 votes. ...

Although state officials have ... promised an audit of the voting machines ..., don’t get your hopes up: as in 2000, state election officials aren’t even trying to look impartial. To oversee the audit, the state has chosen as its “independent” expert Prof. Alec Yasinsac of Florida State University — a Republican partisan who made an appearance on the steps of the Florida Supreme Court during the 2000 recount battle wearing a “Bush Won” sign. ...

[F]or the nation as a whole, the important thing ...[is] whether the voting disaster ... leads to legislation requiring voter verification and a paper trail. ...[T]he omens aren’t good. I’ve been shocked at how little national attention the mess in Sarasota has received. Here we have as clear a demonstration as we’re ever likely to see that warnings from computer scientists about the dangers of paperless electronic voting are valid — and most Americans probably haven’t even heard about it.

As far as I can tell, the reason Florida-13 hasn’t become a major national story is that neither control of Congress nor control of the White House is on the line. But do we have to wait for a constitutional crisis to realize that we’re in danger of becoming a digital-age banana republic?

_________________________
Previous (11/13) column: Paul Krugman: True Blue Populists
Next (12/1) column: Paul Krugman: Economic Storm Signals

Inequality, Education, and Government Policy

Federal Reserve chairman Ben Bernanke says "the most important factor" in rising inequality "is the rising skill premium, the increased return to education." According to this view, widening inequality is justified by differences in productivity. Others, however, believe government policy plays an important role in generating inequality.

In general, those who believe rising inequality is due to a rising skill premium dismiss arguments that government action in areas such as minimum wage legislation, changes in taxes, and anti-union policies are behind changes in equality. On the other side, there are strong arguments against the skill-based technological change argument that inequality is due to market forces rewarding higher productivity.

However, as this editorial shows, even if education based differences in productivity are the source of rising inequality, the underlying cause can still be government policy that has reduced the ability of the disadvantaged to get the education they need:

Shrinking Opportunities, Editorial, Washington Post: Guess which high school graduate is more likely to go to college: the ill-prepared student who is financially well-off or a high-achieving student from a low-income family? According to a new study, they have pretty much the same chance -- and that is an embarrassment to the American educational system.

The sad story of the obstacles low-income and minority students face in enrolling and graduating from college has been documented in two recent reports by the Education Trust. Giving the lie to a perception that there has been progress in widening educational opportunities, the independent research and advocacy organization shows greater disparities between the haves and have-nots than there were 30 years ago. It rightly takes aim at federal, state and college policies and practices. Particularly troubling was the group's finding that the nation's flagship universities, generally the oldest and most prestigious public campuses, are becoming less accessible to low-income and minority students. Or, in the words of Education Trust Director Kati Haycock, America's top public schools are getting "whiter and richer" as high school graduating classes are becoming more diverse.

At the heart of the problem are growing inequities in how financial aid is apportioned. There are fewer state resources, and the stagnant federal policy on student aid has not kept pace with soaring tuition. But the universities also bear responsibility for decisions that divert money from low-income students who can attend college only if they receive financial assistance. In a bid to enhance their prestige by becoming more selective, public universities are using financial aid to compete for high-income students who are able to go to college without assistance.

Consider that the average institutional grant aid in 2003 to students from families earning more than $100,000 a year was higher -- at $3,823 -- than the $3,691 awarded to students with family incomes of less than $20,000. ... An estimated 400,000 students each year aren't able to attend a four-year college because of financial considerations...

Fed Watch: Heading into the Holiday Shopping Season

Tim Duy with a Fed Watch. Tim sent this to me yesterday, but due to travel I am only now getting it posted:

Heading into the Holiday Shopping Season, by Tim Duy: So much data, so little time. There never seems to be enough time to fully dig into each data release, leaving me always a little behind by the end of the week or, in this case, two or three weeks. As a form of catch-up, I thought some comments on the consumer were particularly appropriate, just two days before Black Friday. 

But for the consumer, I need to start with housing. Last time I wrote I said that I expected the direct contribution of housing to be somewhere around a 1% drag on GDP growth for at least the next two quarters.  October’s 14.6% drop in housing starts fits with that story, maybe pushing more weakness into 4Q06 than 1Q07. Of course, nobody was really expecting any miracles from the housing market at this point. More important is when will the housing downturn be felt more broadly outside of housing – when will the wealth effect begin to bite. I think it already is biting into the consumer, just not as violently as many had been expecting.

Which brings us back last week’s retail sales report. There was a bit of hand wringing over the retail sales report, which revealed a 0.2% drop from September. But these are nominal numbers, a realization that is often overlooked on the first pass of the data. Interpreting the report is especially challenging when you have large relative price changes, such as the plunge in gas prices we have seen in the past two months. 

My sense was that, in real terms, the retail sales report was consistent with consumer growth of roughly 3% annualized in October. Sure enough, turning to the Wall Street Journal ($) the next morning:

While downward revisions showed that September retail sales were weaker than previously thought, sales excluding gas, autos and building materials rose 0.9% in the two months taken together. The numbers point to a rise in inflation-adjusted consumer spending in the current quarter of about 3% -- below the 10-year average of 3.7%, but still healthy. "That's a good start to the quarter," said Brian Jones, senior economist at Citigroup Inc. "You've got to think that we're going to have a pretty decent holiday shopping season."

The St. Louis Fed publishes a quick and dirty version of real retail sales, simply retail sales deflated by the CPI. Given the 0.5% drop in headline CPI in October, real retail sales were up 3.3% annualized in October. This probably understates the real gain – the weightings in the CPI are not equivalent to the mix of retail sales. Still, as an initial estimate of real personal consumption expenditures, it is not bad:

My take is that the retail sales report is consistent with my contention that real consumer spending is not falling off a cliff, but is easing back to a 2-3% y-o-y range. Interestingly, this might be an underestimate as well. The supposedly “weak” November reading on consumer confidence is signaling a solid consumer well into 4Q, with year over year real spending growth in the 3-4% range:

So where’s that housing effect? Truth be told, if spending comes in ahead of my estimates, it will be a little challenging to argue that housing is having much of an impact at all. To tease out the wealth effect, remember that given the relatively strong details of the October employment report, it would not be surprising to see that nominal wage and salary disbursements, which were up 7.6% y-o-y in September, posted another strong gain in October. Considering the inflation drop, the real equivalent would be even higher. On the surface, the household looks to have plenty of real spending power to push through the end of the year.

But maybe they have less than it seems. Switching back to nominal for the moment, the strong wage gains and flat retail sales suggest a rise in the savings rate. Notice the three month trend in the savings rate ending in September: -0.8, -0.5, and -0.2%. I wouldn’t be surprised to see the savings rate push into positive territory in October. But that doesn’t mean I think people are actually saving more in the commonly used sense of the term. I doubt that there has been a mass shift to higher 401k contributions for instance. We need to remember that part of the downward shift in the savings rate was driven by an artifact of the data. I make a capital gain on a housing sale. That gain is not counted as personal income, but when I buy a new car, the purchase is counted as consumption. Without that easy source of mortgage equity withdrawal (the result of a declining housing market), the associated spending dries up, and the savings rate rises in tandem.

In short, the acceleration of wage gains (now, with energy prices easing, both real and nominal gains) looks to be offsetting a portion of the housing impact, just as the housing impact offset weak wage gains in the wake of the recession. Of course, I could be wrong and households might have been caught by surprise by their spending power in October and now have some money burning a hole in their pocket (I doubt I am very wrong on the downside; we need to see some significant job losses to really pull the rug out from under the consumer. Those losses might still be in the pipeline, but don’t look to be showing up just yet).  Not my baseline scenario, but maybe I am undershooting. From the Wall Street Journal ($):

Investors will also focus on consumer spending as the holiday season ramps up. A new survey by the International Council of Shopping Centers shows consumers may cooperate. On average, consumers plan to spend $676 on holiday purchases this year, up 9% from last year, according to the survey, helped by declining gasoline prices.

Given discounting, a 9% nominal gain would likely be a pretty solid real gain. There will, of course, still be considerable worry about the consumer throughout the holiday season, regardless of confidence or real retail sales figures that are unquestionably solid. After all, black moods about the consumer are the spirit of the season, partly because, in my opinion, retailers face a serious expectations problem. 

Consumers know that their holiday spending is discretionary – there are very few must have items. Consumers know that if they hold out long enough, retailers will start slashing prices. And consumers know that if retailers managed to hold off the price slashing until after the holidays, the optimal strategy for consumers is to give a gift card, boosting the real purchasing power of the gift by pushing the actual purchase into the post-Christmas sales season. (As an aside, I believe that discounting by Wal-Mart is a false tell. It says less about the state of the consumer than of Wal-Mart’s market saturation.)

Bottom Line: The consumer looks weakened, but thanks to solid earning gains and declining inflation, not ready to give up the ghost. Mass job losses, however, would do more to put the nail in the coffin.

Turkey Externalities

I have an uncle who lives in the Sutter Buttes in California. He is a farmer and Thanksgiving at their house always means fresh turkey, as fresh as they come.

But he didn't raise turkeys for food, that was a positive externality. It turns out that turkeys are good for killing rattlesnakes, a big problem if you live in the Buttes, or at least that's what I was always told. Peacocks too, apparently, but they were too messy so after trying them for awhile, they go rid of them.

I always wondered if turkeys really do help to control rattlesnakes, but you don't argue with a farmer who has the accumulated knowledge of several generations living on and working the same land. He knew it worked and that was that, so I never questioned it much as a kid, I assumed it was true and repeated it often. But before repeating it here, I thought I should finally check to see if it really is true. A search with Google doesn't help much. Anecdotally:

I asked the owner if he had ever seen any rattlesnakes around.

"No," he said. "There used to be some around years ago, but since the turkeys became so abundant, I haven’t seen any. I guess the turkeys eat the babies."

I thought that sounded pretty logical.

And, from Wikipedia:

They also eat small vertebrates like snakes, frogs or salamanders.

But are turkeys up to the task? Are they brave like an eagle?:

The idea that Benjamin Franklin preferred the Turkey as the national bird comes from a letter he wrote to his daughter in 1784 criticizing the choice of the Eagle as the national bird and suggesting that a Turkey would have made a better alternative.

For my own part I wish the Bald Eagle had not been chosen the Representative of our Country. He is a Bird of bad moral character. He does not get his Living honestly. You may have seen him perched on some dead Tree near the River, where, too lazy to fish for himself, he watches the Labour of the Fishing Hawk; and when that diligent Bird has at length taken a Fish, and is bearing it to his Nest for the Support of his Mate and young Ones, the Bald Eagle pursues him and takes it from him.

With all this Injustice, he is never in good Case but like those among Men who live by Sharping & Robbing he is generally poor and often very lousy. Besides he is a rank Coward: The little King Bird not bigger than a Sparrow attacks him boldly and drives him out of the District. He is therefore by no means a proper Emblem for the brave and honest Cincinnati of America who have driven all the King birds from our Country . . .

I am on this account not displeased that the Figure is not known as a Bald Eagle, but looks more like a Turkey. For the Truth the Turkey is in Comparison a much more respectable Bird, and withal a true original Native of America . . . He is besides, though a little vain & silly, a Bird of Courage, and would not hesitate to attack a Grenadier of the British Guards who should presume to invade his Farm Yard with a red Coat on.

This letter to Franklin's daughter was written after congress spent six years choosing the eagle as the emblem of the newly formed country. While Franklin's disapproval with the choice of the Bald Eagle was evident, it is not apparent that he ever officially advocated for the turkey.

But for me, for today, just thanks.

I hope you all enjoy the day. I plan to.

[This is kind of a "turkey post," and not sure I should post it. Ah, what the heck, mostly just want to say thanks to all of you, it won't surprise anyone to learn I'm thankful for everyone who stops by here, even the cranky ones - you all make this work, I have little to do with it.]

Milton Friedman's Social Welfare Program

Not everyone realizes that Milton Friedman is the "architect of the most successful social welfare program of all time":

The Other Milton Friedman: A Conservative With a Social Welfare Program by Robert Frank, Economic Scene, NY Times: Milton Friedman ... was the patron saint of small-government conservatism. Conservatives who invoke his name in defense of Social Security privatization and other cutbacks in the social safety net might thus be surprised to learn that he was also the architect of the most successful social welfare program of all time.

Market forces can accomplish wonderful things, he realized, but they cannot ensure a distribution of income that enables all citizens to meet basic economic needs. His proposal, which he called the negative income tax, was to replace the multiplicity of existing welfare programs with a single cash transfer — say, $6,000 — to every citizen. A family of four with no market income would thus receive an annual payment from the I.R.S. of $24,000. For each dollar the family then earned, this payment would be reduced by some fraction — perhaps 50 percent. A family of four earning $12,000 a year, for example, would receive a net supplement of $18,000 (the initial $24,000 less the $6,000 tax on its earnings). [giving a total income of 30,000]

Mr. Friedman... was above all a pragmatist... If the main problem of the poor is that they have too little money, he reasoned, the simplest and cheapest solution is to give them some more. He saw no advantage in hiring armies of bureaucrats to dispense food stamps, energy stamps, day care stamps and rent subsidies.

As always, Mr. Friedman’s policy prescriptions were shaped by his desire to minimize adverse economic incentives, a feature that architects of earlier welfare programs had largely ignored. Those programs ... typically reduced a family’s benefits ...[with] each increment in earned income. ...[A] family ... might see its total benefits fall by $2 for each extra dollar it earned. ...[N]o formal training in economics was necessary to see that working didn’t pay. In contrast, someone who worked additional hours under Mr. Friedman’s plan would always take home additional after-tax income.

The negative income tax was never adopted in the end, because of concern that a payment large enough to support an urban family of four might induce many to go on the dole. ... Instead, Congress adopted the earned-income tax credit, essentially the same program except that only people who were employed received benefits. ...[T]he earned-income tax credit has proved far more efficient than conventional programs, just as Mr. Friedman predicted. Yet because it covers only those who work, it cannot be the sole weapon in society’s antipoverty arsenal.

This month, economic populists like Jim Webb, Jon Tester and others were elected to Congress on pledges to strengthen the social safety net. In pursuing this task, they should take seriously Milton Friedman’s concern about incentives. How might they expand support for the unemployed without undermining work incentives?

One possibility is government-sponsored employment coupled with negative income tax payments that are too small to live on... For others, government would stand as an employer of last resort. With adequate supervision and training, even the unskilled can perform many useful tasks. They can plant seedlings on eroding hillsides, for example, or remove graffiti from public spaces. ... Coupled with low negative income tax payments, wages from public service or private employment could lift everyone from poverty. This combination would provide no incentive to go on the dole.

Mr. Friedman, of course, would not have welcomed an expansion of the federal bureaucracy. But ... guaranteeing employment at low wages would require no such expansion. By inviting companies to bid for program contracts, government could harness market forces to control costs.

In the face of huge budget deficits, is such a program affordable? In ... 1943, ... Mr. Friedman proposed a progressive consumption tax as the best source of revenue to meet critical national objectives. ... High tax rates on consumption by the wealthy, Mr. Friedman argued, would generate additional revenue with only minimal sacrifice. So if providing greater economic security for low- and middle-income families is an important national objective, ... there are ways to pay the bill.

By all accounts, Mr. Friedman was a generous and compassionate man, someone more keenly aware of good luck’s contribution to individual prosperity than many of his disciples. Careful students of his work will be inspired not to dismantle the social safety net but to make it more effective.

Welfare Spending and Incarceration Rates

Interesting correlations both across countries and across U.S. states between welfare spending and incarceration rates. When welfare spending goes up, incarceration rates go down:

Crime doesn't pay, by Tom Clark, Commentary, The Guardian: ... Looking across 18 developed countries, David Downes and Kirstine Hansen find a striking, negative link between the share of national income devoted to the welfare state on the one hand, and the number behind bars on the other. All seven of the nations most given to incarceration have below-average welfare spending; and, all but one of the eight countries with the lowest prison population spend atypically heavily on welfare.

Criminologists have long seen the US as the archetypal penal state, with 2 million people - or 2% of the male labour force - locked up each day. In line with the general pattern, their mass jailing comes alongside austere welfare. But America is far from homogenous, with the substantial freedom that individual states enjoy over both punishments and income support giving rise to big variations on both counts. This provides another test..., and the authors point to evidence showing ... that the same negative relationship holds. There are counter-cases - Japan has few prisoners and modest welfare, while in Britain record levels of jailing have recently arrived in tandem with new Labour's extra welfare expenditure. But ... the ... overall pattern is clear, and has become clearer over the years.

The researchers establish that the link is statistically significant - i.e. unlikely to be explained by any chance quirk of the data - but they do not settle the question of why it arises, which is all-important for policy. One interpretation, which I read Downes and Hansen as preferring, is that more generous welfare cuts poverty and exclusion, and with it the risk of crime and incarceration. If that were right, governments could cut imprisonment by raising benefits. But in theory, it could also be that jails somehow cut welfare bills - for example, by taking out of society people who would otherwise be on benefits, a conclusion that might encourage some governments to lock more people up. ...[A] third account is also possible, one that sees both mass imprisonment and minimal welfare as flowing from some single underlying factor, such as a particular strain of political culture. ...

Only more research - and particularly, closer working between economists, welfare specialists and criminologists - will definitively unpick the striking relationship that Hansen and Downes have uncovered. Ensuring that this is done should be a priority for anyone concerned about either the rising prison population or broader questions of economic equality.

It's certainly possible that a third variable causes both, e.g. the same attitudes that lead to high incarceration rates might also cause low social spending, and other explanations for why the correlation might be spurious are possible. But if the relationship holds up and is causal, I wonder what the return, in terms of lowered incarceration costs, an extra dollar of spending on welfare programs would bring?

Rupert Murdoch: Predatory Capitalist?

Is Rupert Murdoch a threat to democracy due to the market power he has attained in markets for information? Peter Wilby is worried about his control over information in Britain and elsewhere:

A predatory capitalist who stifles competition and delivers mediocrity, by Peter Wilby, Commentary, The Guardian: I do not usually admire middle America, but on this occasion I wonder if it should be an inspiration to us all. OJ Simpson ... was about to give the world, courtesy of Rupert Murdoch, a "hypothetical" account of how he could have committed the crime. Murdoch's News Corporation had a book lined up, a TV interview that would be syndicated across America and, no doubt, countless spin-offs in other countries and media. Public opinion ... cried "enough". For once Murdoch couldn't do what he liked. On Monday he agreed to stop the project... Gosh, the great man even apologised for an "ill-considered project", which is a bit like an ayatollah admitting he'd misread the Qur'an.

But this, I fear, will cause just a ripple in the Murdoch empire: the emperor can afford to behave decently from time to time, and we are all very grateful - just as when he decided to stop publishing rubbish from global-warming deniers and take an interest in saving the planet. Of more importance is [the] sudden purchase ... of 17.9% of ITV shares. ...

Though Murdoch is just within the 20% limit for cross-media ownership of ITV shares, the media regulator Ofcom is to investigate. But don't expect spectacular results. The Times assured us yesterday that Labour was "happy" and the Conservatives "content", and that only the dear old dotty Lib Dems were at all bothered. So that's all right, then.

The Other Battleground

Fareed Zakaria says the U.S. is ignoring the battleground that matters most, the one that ultimately determines the balance of international power:

International Commerce Is the True Battleground, by Fareed Zakaria, Newsweek: President Bush ... is preoccupied almost entirely by Iraq, Iran, Israel, Lebanon, North Korea and, if he has time enough in a day, by Venezuela and Russia. His counterparts in Asia are focused primarily on something quite different: their own economic growth. And while roadside bombs may be what makes the daily headlines, it's ultimately economics that's likely to determine the international balance of power.

Consider a paradox: over the past five years, political turmoil has swept the world. It began with the attacks of 9/11, followed by bombings in Bali, Casablanca, Istanbul, Madrid and London. There have been two major American-led wars, in Afghanistan and Iraq, which are ongoing, protracted, expensive and increasingly destabilizing. Add to this the war between Israel and Lebanon, deadlock in Palestine, Iran's bid for regional supremacy, North Korea's nuclear test and Russia's growing clashes with some of its neighbors.

During this same period, the world economy has experienced its fastest five-year growth spurt in more than three decades. In fact, per capita GDP growth ... is higher than any comparable period in recorded history. ...

Markets are supposed to be smart. What are they telling us? That the current era of globalization is more powerful, widespread and resilient than many people realize. Today we are living through something practically unique—simultaneous growth worldwide. The United States, Europe and Japan are all doing well, but so are China, India, Brazil, Turkey and a whole slew of former Third World countries. ...

If this sounds as if everything will work out fairy-tale style, it won't. Global growth has its own complications. Demand for raw materials and energy is high and will keep rising. Countries that possess such resources—Iran, Russia, Venezuela, Saudi Arabia—become islands of exception to the very rules of markets and trade that are sweeping the world. Thus global capitalism produces its own well-funded anti-capitalists. Growth is also producing environmental degradation on a colossal scale. ...

For the industrialized world, the new global economy produces new stresses and strains. With hundreds of millions, if not billions of new entrants to global markets, Western workers fear for their wages. With new players in the global economy, industries of all kinds face new competitors.

There is no way to turn off this global economy, nor should one try. Every previous expansion of global capitalism has led to greater prosperity across the world. The story of the past 100 years is one of an ever-expanding pie. But this is a massive, complex process and requires enormous focus and attention. And while other nations around the world, from China to Chile, are playing to win, the United States as a government has barely focused on any of the major challenges or opportunities that it presents. We're too busy settling disputes between Sunnis and Shiites in downtown Baghdad.

A century ago, another great global power was similarly occupied halfway across its world, fighting a war and organizing the constitutional arrangements of Dutch farmers in the Southern Transvaal. Great Britain eventually won the Boer War, but it lost its focus on the economic challenges it faced. And finally it lost something else: its standing as one of the great global powers.

Avoiding a Family Feud

Two visions of the types of economic policies Democrats should pursue:

The Democrats' Economy Wars, by Harold Meyerson, Commentary, Washington Post: ...All wings of the Democratic Party seem to understand the extent of America's economic problem. The architects of Bill Clinton's economic and trade policies, as well as their more liberal critics, all agree now, in the words of Clinton Treasury secretary Lawrence Summers, that "the vast global middle is not sharing the benefits of the current period of economic growth -- and that its share of the pie may even be shrinking." ...

Concerned that the American dream is fading for the middle class, and fearful that said middle class may turn against the global free-trade order he helped erect, Rubin has created the Hamilton Project, which ... proposes ... greater public investment in education, health care, research and development, and infrastructure; balancing the budget; and wage insurance for workers compelled to take lower-paying jobs in our Wal-Mart-ized economy.

But are these solutions remotely adequate to the problem...? Even its proponents seem not to think so. "Let us be frank," Summers wrote... "[More] education [can't] be a complete answer at a time when skilled computer programmers in India are paid less than $2,000 a month." When Rubin was pressed ... as to whether he thought the project's proposals would arrest or offset the global convergence of wages, he said, "I don't know the answer to that. I would guess that the answer to that question is no."

For the Democrats who now run Congress, not to mention those planning to run for president, the fact that the party's economic gurus have devised a policy that they themselves believe isn't up to the challenge ... can't be greatly heartening. Happily, this is not the only project whose work the Democrats will be able to access. This June, ... a group of some 50 liberal economists loosely affiliated with the Economic Policy Institute (EPI) began work of their own. Their project, yet to be named (its founders have resisted the temptation to call it the Aaron Burr Project), will be unveiled in January. ...

For starters, EPI's project will call for a pay-or-play health insurance system (employers can cover their own employees in private plans or pay taxes into an expanded version of Medicare that will cover everyone else) and for a retirement system in which employers can offer their employees pensions or, with their employees, pay into a system administered by Social Security. It will suggest a series of policies to decouple globalization from downward pressure on wages -- adding some enforceable labor standards, for instance, to the rules of the World Trade Organization. ...

Over the next two years, both projects will barrage the Democrats with their ideas. At times their perspectives may converge. (Rubin seems to be edging closer to acknowledging a need to reestablish workers' rights to join unions, long a priority of the EPI crowd.) But the creation of EPI's project balances the scales in the Democratic universe. The Hamilton Project is the policy voice of the party's largest business donors. In the project to be unveiled in January, the party's voters get a policy voice, too.

This division is evident in comments, though I think the commenters identifying with the EPI group are, if not more numerous, certainly more vocal. There's no reason to expect or want everyone in the Democratic Party to always agree. There will be some issues - protectionism comes to mind - where Democrats will not agree and no amount of debate will change that. It will be disappointing if the initial policy proposals come in the divisive areas where the two groups disagree when there are so many other important policy areas where there is general agreement on what needs to be done. What policies should come first?

Update: Kash at The Street Light has more.

No Preconditions on Social Security Reform?

Is the administration willing to drop its insistence on private accounts as a condition for Social Security reform? Some people think so:

Social Security Up for Discussion Treasury Chief Says 'No Preconditions', by Lori Montgomery, Washington Post: With ... Democrats poised to take control..., the Bush administration is making a fresh push to persuade them to help rein in the rising costs of Social Security and government health-care programs by offering to open talks with "no preconditions."

Treasury Secretary Henry M. Paulson Jr. ... said in an interview yesterday that he has had "a number of . . . very, very general, very preliminary conversations" with lawmakers from both parties about the issue since Election Day, Nov. 7.

So far, "it's too early in the aftermath of the election to know whether we're going to get traction," Paulson said, adding that he is "going to make a huge effort to persuade people to engage in a bipartisan discussion where we don't precondition our discussion."

"No preconditions," Paulson said, means both sides get a chance to put their ideas on the table. In regard to Social Security, administration officials said that means President Bush will continue to advocate ... private retirement accounts, a proposal Congress roundly rejected last year.

It also means that the White House is willing to listen to other ideas... "We're in a listening mode," said Rob Portman, director of the Office of Management and Budget... "The president wants to listen. He wants to hear what the leaders on Capitol Hill think is the best way to go. He's not wed to any particular approach."

Political analysts said the outreach campaign is a sign that Bush may be willing to compromise to make progress on Social Security... Bush may see Social Security as an issue on which he could score points before leaving office in 2009, analysts said.

Bush's former chief economic adviser, Lawrence B. Lindsey, added to that speculation on Monday, after writing in the Wall Street Journal that Bush "may be willing to raise taxes as part of a 'deal' on entitlement reform." Specifically, Lindsey wrote, the administration might agree to lift the cap that limits Social Security payroll taxes to the first $90,000 of income...

While Paulson and Portman are talking about consensus, some Democrats worry that Bush is still determined to pursue the idea of private accounts. ... That fear was fanned last week when Bush appointed Andrew G. Biggs, a proponent of Social Security privatization, to the agency that runs the program.

"This nomination of Biggs is very troublesome," said Rep. Sander M. Levin (D-Mich.), who is in line to chair a House subcommittee on Social Security. "The president is sending signals that what he's really after is privatization. And that's just a non-starter." ...

Just to be clear about what "no preconditions" means. From a Wall Street Journal article on the same topic:

Will Bush Bargain to Save Social Security?, by Jackie Calmes, WSJ (free): For Mr. Bush, private accounts are ... central to his concept of an "ownership society" in which Americans rely less on government...

Publicly, the White House isn't budging. "Private accounts are part of our proposal and we're interested in having others put things on the table, not taking things off," says administration spokesman Dana Perino.

For those who nonetheless see a Bush concession ahead, perhaps the biggest reason is this: If Mr. Bush doesn't drop private accounts, it is virtually certain that nothing will happen on Social Security, the issue he has called the top domestic priority of his second term. ...

This week, ... Mr. Paulson dodged a question about the Democrats' demand that the administration drop the private-accounts idea. "Only by taking a bipartisan approach, not conditioning the discussion" might an agreement be reached, he said.

Some listeners wondered whether Mr. Paulson was signaling administration willingness to quit prescribing the accounts. Administration officials privately said that wasn't the case. ...

Saying that private accounts have to be part of any deal sounds suspiciously like a precondition. There is this is the same article though:

Chief of Staff Bolten got a similar query about private accounts... According to one attendee, Mr. Bolten "came as close as he could in a quasi-public setting to saying that carve-out accounts could be dropped if that were the price of reform." A second audience member supported that interpretation.

But there's this too:

Messrs. Rangel and Baucus each tried to get Mr. Bush to drop private accounts in the past. Mr. Rangel tried at a White House encounter in April 2005. He said afterwards that Mr. Bush sternly replied, "I'm the president, and private accounts will stay on the table until I leave."

As far as I can tell, there's nothing new here. The administration is hoping that by giving in on other issues, it can get private accounts into place, but private accounts will not be dropped as part of any compromise. So long as that's the case, this is nothing but a waste of time, time that could be spent on much bigger problems such as reforming health care.

Update: Andrew Samwick at Vox Baby follows up on the statement "As far as I can tell, there's nothing new here" and explains what is different this time.

Update: PGL at Angry Bear responds to Andrew, and has additional comments as well.

Update: Brad DeLong continues the discussion.

RE: McCain and Iraq

An email takes me to task for my post about John McCain:

Mark,

...I was a bit miffed to read your post today attacking McCain's position on Iraq. That's certainly fair game, but you said  that "there were plenty of people saying that troop levels were inadequate from the onset of the war, where was he? Why didn't we hear from McCain then?" This is a bit shocking to hear someone say because McCain's been one of the few war supporter's who has been calling for more troops since the early months of the war (back when the war had 60-70% support).

In November of 2003, McCain gave a lengthy speech on Iraq to the Council of Foreign Relations. He said:

The simple truth is that we do not have sufficient forces in Iraq to meet our military objectives. I said this in August, after I returned from visiting Iraq, and before the security situation deteriorated further. It is even more obviously true today. ...

It was clear during the summer that we didn't have sufficient forces to conduct counterinsurgency operations within the Sunni triangle, secure necessary facilities, guard the borders to prevent foreign jihadists from flooding across or responding to an upsurge in violence if it occurred. ...

American military commanders have acknowledged that the Iraqi resistance shows signs of being centrally planned and coordinated. Yet the number of American forces in Iraq has not increased. Given the large support tail required of such a force, it is estimated that the number of American troops on patrol in Iraq at any given time is under 30,000. This is an insufficient number of troops to even play defense, much less take the fight to our enemy and create the conditions for the lasting peace that will enable Iraqis to assume full political authority and Americans to go home. Our overall troop level in Iraq does not reflect a careful assessment of what it takes to achieve victory. It reflects the number of American forces who were in Iraq when the war ended, minus the Marines who were sent home. Simply put, there does not appear to be a strategy behind our current force levels in Iraq, other than to preserve the illusion that we have sufficient forces in place to meet our objectives.

That was on November 5th, 2003. You can check out the whole speech here. McCain has been a constant critic of this war, while at the same time continuing to believe it was the right thing to do. It's not impossible to do both.

Fair enough, though it seems the volume is loudest around elections. My point is that he should have made this point over and over until even I couldn't have missed or forgotten his opposition in the early years of the war. It should have been as evident then as it is now. And I still don't see how you can simultaneously say troop levels are inadequate for achieving victory, yet be supportive of the president. For instance:

He lavished extravagant praise on President Bush for his leadership in the war on terror, even though McCain criticized most of Bush's specific decisions, such as letting Osama bin Laden escape and invading Iraq with too few troops.

If he disagreed with the president on policy, and he thought even one person might die needlessly because of it, we should have heard more. The call for more troops is a bit disingenuous anyway since he knows it won't and can't happen. This is from a recent interview with the Financial Times:

FT: Is there any sense that your colleagues ... are prepared to think about more troops...

JMC: [T]here is not going to be any increase...

FT: You are saying there should be more troops, not a discussion about drawing down troops because the US is stretched too thin?

JMC: But that is like saying I would also like to see a mission to Mars. I just don’t think it is going to happen.

This is a political ploy. He knows there aren't enough troops available. As he says in the speech to the Council of Foreign Relations linked above, just to maintain the current effort will require people to serve extra time:

[W]e have to increase the size of the military in the long run. We just have too many commitments and too many challenges to face around the world. [T]he Pentagon is ... very reluctant, but they're going to have to face the facts and they're going to have to increase the size of the military in the long run.

In the short run, we have to depend on, and I think we can depend on, the loyalty, the patriotism, the professionalism and the outstanding qualities of these young men and women who will be required to serve an extra amount of time.

Why is he calling for a solution he believes has as much chance as "a mission to Mars"?

"Unsupported Theories Dressed in Needlessly Complex Methods with a Side Order of Jargon"

I don't think Kim, a sociologist who contributes at Marginal Utility, is very impressed with this paper:

From the Files ..., by Kim: ... of "Unsupported Theories Dressed in Needlessly Complex Methods with a Side Order of Jargon," I present this article, from the most recent issue (71[5]) of American Sociological Review:*

The Institutionalization of Fame: Achievement, Recognition, and Cultural Consecration in Baseball, by Michael Allen and Nicholas Parsons**

"This article examines the history of the Baseball Hall of Fame as a cultural consecration project. It argues that the legitimacy of any consecration project depends on the cultural authority of the organization initiating the project, the rigorous selection procedures used by this organization, the relative selectivity of its outcomes, and the existence of objective differences in merit between the consecrated and the unconsecrated. However, prior research suggests that the relationship between merit and consecration is mediated by a series of social characteristics and contextual factors. This study proposes a theory of cumulative recognition, which asserts that the likelihood of consecration is affected by the cumulative effects of social characteristics and circumstances, prior social recognition, and media discourse, as well as by objective differences in achievement. The results of discrete-time event-history analyses of the outcomes of the Hall of Fame elections over the past four decades provide substantial confirmation of this theory. Overall, it is concluded that the procedural and substantive rationality exhibited by the Hall of Fame contributes greatly to its cultural legitimacy as a consecration project."

Translation of the results: When casting their Hall of Fame ballots, sportswriters are more likely to vote for players about whom sportswriters have written a lot of articles than to vote for equally productive players about whom sportswriters haven't written a lot of articles.

Yet simpler translation: Sportswriters vote for (i.e., they like) players who they write about (i.e., they like, usually).

Broader implication of results: Different measures of the same group's opinions are often correlated.

Thanks for clearing that up.

Now, about that support for the theory of legitimacy in cultural consecration projects...

---

* Lest you think I'm just picking on the abstract, the paper contains a series of dropped balls, strike outs, errors, and blown saves. If I had unlimited time, I'd write up a full critique (if only to get to use all these puns). But I don't.
** No, not THAT Parsons.

Is Venezuela a Success?

The Venezuelan economy under Hugo Chavez:

Comment: Chavez reign defies economic analysis, by Oscar Raul Cardosa, Project Syndicate: Hugo Chavez's almost eight years in power in Venezuela — which he will seek to extend in presidential elections next month — seems to defy economic analysis. Indeed, any and all economic examination of Chavez’s Venezuela confirms Edgar R. Fiedler’s quip that if you "ask five economists something, you will get five answers... or six if one of them is a Harvard graduate".

Some people see in Chavez an innovative statesman who has seized an almost magical moment — the windfall Venezuela has received from sky- high oil prices — to change the rules of the game in his country. ... In that two-year period, Chavez stepped on the gas for his social reforms — education, healthcare, etc – and also in regard to breaking down the country’s excessive concentrations of wealth. ...

With oil prices now six times higher than they were when he came to power, Chavez presided over economic growth of nine per cent in 2005 and ... the first quarter of 2006. Above all, however, he has achieved a 6.3 per cent effective reduction of poverty, after taking over a country whose vast majority — 80 per cent — was perched between poverty and squalor.

Seen in this angle, Chavez appears to have real achievements. But there is another, darker, angle from which to view his presidency. It is possible to see in Chavez but another Latin American populist sorcerer’s apprentice, one whose political shelf life will expire whenever oil prices begin their inevitable shift backward. To those who think that this is the case, Chavez is not an innovator but someone who is merely squandering Venezuela’s oil wealth in the same way that governments did following the oil shocks of the 1970s.

The notion of specific "Chavist" growth can also be challenged. The highest growth achieved in the Chavez years is lower than Venezuela’s average during the second half of the 1990s, when oil was the exclusive domain of the private sector.

Moreover, growth under Chavez seems to reflect an increase in domestic consumption resulting from the flow of petrodollars and nothing more fundamental... So nothing Chavez has done translates into a fundamental improvement in, or diversification of, Venezuela’s economy. ...

True, businessmen have tempered their criticisms of Chavez and seem eager to participate in the profit feast brought about by increased consumption. But they may also be waiting for the first external shock to puncture the Chavez balloon before they pounce.

These two versions of the Chavez years are both distorted — to a certain degree — by nostalgia. Those who see him as successful have the 1960s and 1970s as their dream fantasy. Their main arguments are reminiscent of the arguments put forward by those who backed the Cuban Revolution.

Those who revile Chavez often do so in the name of the "Washington Consensus"... Chavez is portrayed as a return to the Latin American populist heresy, a heresy that must be resisted because it affects not only the country with the largest oil reserves outside the Middle East, but also because it may tempt the rest of Latin America down that road.

But history never truly repeats itself. The years of the biggest transformation demands in Latin America or those of its docility to economic orthodoxy will not come back because we can remember them. Especially, the view of the Washington Consensus seems irretrievable...

Yet one thing is clear: Chavez was the first ruler of his generation to recognise the region’s fatigue and disillusion with neo-liberalism, and to propose new rules of the game. In the end these may not be the rules he envisions today, but neither are they a spent force. To believe that one can accurately foresee what will become of Chavez and Venezuela brings to mind another warning by Fiedler: "He who lives by the crystal ball must sooner or later learn to chew glass."

There seems to be a presumption that more equality equates with lower growth. For example, while discussing policies Democrats might pursue to reduce inequality, David Wessel asks today in the Wall Street Journal:

What can Democrats do to resist inequality in a way that doesn't choke off economic growth? Can government slice the economic apple more evenly without shrinking it?

And later adds:

Republicans as prominent as Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke recently have warned ... of risks posed by widening inequality. But many conservatives fear taxing the rich in response would reduce incentives for innovation, entrepreneurship and education -- and thus reduce economic growth to the detriment of all. Their counsel: Try to lift incomes of the poor and middle class, and don't worry if the rich do even better.

That is, growth must not be reduced even if it means we must accept widening inequality. However, it hasn't been established that more equality is harmful to economic growth, so I don't accept the presumption that lower economic growth is a necessary consequence of higher equality (and even if it were the case that efficiency and growth are reduced, there may be equity considerations that justify promoting more equality, i.e. the standard efficiency-equity tradeoff and related arguments).

Richard Freeman and Alexander Gelber recently looked into the question of how effort varies with inequality:

Optimal Inequality/Optimal Incentives: Evidence from a Tournament, by Richard B. Freeman and Alexander M. Gelber, NBER WP 12588, October 2006 [open link]: Abstract This paper examines performance in a tournament setting with different levels of inequality in rewards... We find that that total tournament output depends on inequality according to an inverse U shaped function: We reward subjects based on the number of mazes they can solve, and the number of solved mazes is lowest when payments are independent of the participants' performance; rises to a maximum at a medium level of inequality; then falls at the highest level of inequality. ...

Thus, it is not at all clear that moving from high to moderate levels of inequality reduces economic incentives and economic growth.

Update: The Economist blog, Free Exchange, follows up on whether Venezuela's economic policies have stifled economic growth.

Globalization and Declining Policy Effectiveness

This was suggested in a email (thanks). It's by Michael Mandel of BusinessWeek and it discusses the change in the effectiveness of economic policy due to globalization, an important issue. Economists do not yet fully understand how traditional monetary and fiscal policies, supply-side policies, etc. have changed due to globalization and that has made it difficult propose effective policy responses when economic conditions change within our borders:

Can Anyone Steer This Economy?, by Michael Mandel, BusinessWeek Online: ...This will come as a rude shock to ... newly enfranchised leaders in the Democratic Party. Sure, they're likely to have the power to pass legislation, including boosting the minimum wage. But ... [t]he broad-based drop in incomes is being driven more by the ... intensification of global competition. And there is little Democrats can do to reverse these trends. ... Globalization has overwhelmed Washington's ability to control the economy. ...[L]evers of economic policy just don't work as well as they once did.

As recently as 10 years ago, the U.S. economy was still relatively self-contained. Then-Federal Reserve Chairman Alan Greenspan ... could be sure that the U.S. economic machine would eventually respond when he called for higher or lower rates. Tax and spending decisions made in Washington could set the course for growth, while economic events in the rest of the world ... were felt as minor bumps.

That has changed. ...[T]he U.S. is more open to the global economy than ever before... Greenspan and his successor, Ben S. Bernanke, have found this out the hard way. To restrain economic growth and cool the housing market, the two Fed heads have raised short-term interest rates 17 times since 2004... But even as the Fed tightened up on the domestic money supply, foreign investors made up the difference.

As a result, the interest rate on 10-year government bonds today is 4.6%, exactly where it was in 2004, when the Fed started raising rates. Good news for home buyers who want mortgages. Not so good news for the policymakers trying for a soft landing.

President Bush encountered a similar problem. His huge tax cuts poured hundreds of billions into the economy... [T]he fiscal stimulus generated far fewer jobs than anyone expected, as more and more production headed overseas. "Traditional macro policies are less effective than they used to be," says Robert S. Shapiro, a top economic adviser to President Bill Clinton who now runs a Washington economic consulting firm. "We don't know how to ensure strong job creation and strong wage growth anymore." ...

What's McCain Thinking?

Interesting analysis from Robert Reich:

John McCain's Real Plan for Iraq, by Robert Reich: I talked with John McCain Sunday morning in the green room just before “This Week.” I asked him why he continued to call for more troops for Iraq when he must know it's a political non-starter. He said he thought it important for the morale of the troops.

McCain gives every impression of meaning what he says, which is one of his greatest assets. But I simply can’t believe this one. What’s most important for the morale of the troops is knowing they’ll be coming home soon, not hearing some politician say we need more troops when there’s no possible chance of that happening.

I think McCain knows Iraq is out of our hands – it’s disintegrating into civil war, and by 2008 will be a bloodbath. He also knows American troops will be withdrawn. The most important political fact he knows is he has to keep a big distance between himself and Bush in order to avoid being tainted by this horrifying failure. Arguing that we need more troops effectively covers his ass. It will allow him to say, “if the President did what I urged him to do, none of this would have happened.”

McCain is smarter on this score than Dems who intend to engage in post-Baker Commission “what we must do now” bipartisanship. It may make Dems feel relevant and important, but it will also make them complicit in the impending failure. ... HRC will be drawn in, as will Barak Obama and all other Dem notables who will feel it necessary to participate in a “plan.”

In the end, McCain alone will be able to escape blame. At least, that’s what I think he’s thinking.

Pin the failure on the donkey. How should Democrats respond? Assuming prominent Democrats insist on supporting the "plan," they should assert strongly that because of bad policy up to this point by the administration, policy implemented with the full support of people like McCain, the "plan," though likely to fail, is the best option we have according to the consensus in both parties (as opposed to a few neocons behind closed doors and their enablers like McCain). That is, in response to:

“if the President did what I urged him to do, none of this would have happened.”

Why not say the president has already done what you and others told him to do and this is where we ended up? Are we supposed to believe you suddenly got wiser? When he talks now about increasing troop levels, ask him why he wasn't calling for more troops when it would have mattered, at a time when a true leader would have spoken up and said the administration's policy will not work. There were plenty of people saying that troop levels were inadequate from the onset of the war, where was he? Why didn't we hear from McCain then?

We didn't hear from him because he supported the president's policies. The current situation in Iraq is due to policies McCain supported and Democrats cannot let him avoid responsibility for where we are now, and for whatever happens next as a consequence.

"How the Poor Die"

I stumbled across this essay by George Orwell. It was written in 1946 and it's about his experiences as a non-paying patient in a ward of a hospital in France in 1929. At this time, "If you are seriously ill and if you are too poor to be treated in your own home, then you must go into [a] hospital." The essay explains why "The dread of hospitals probably still survives among the very poor, and in all of us it has only recently disappeared." There isn't much in the way of explicit economics, but for those who are interested it's a fairly descriptive look at health care for the poor in this particular hospital at this time in history.

There are economic implications however. For example, making the poor paying customers through national health insurance improves the quality of care:

Moreover, the national health insurance has partly done away with the idea that a working-class patient is a pauper who deserves little consideration. Well into this century it was usual for ‘free’ patients at the big hospitals to have their teeth extracted with no anaesthetic. They didn't pay, so why should they have an anaesthetic — that was the attitude. That too has changed.

Here's the essay:

How the Poor Die, by George Orwell, 1946: In the year 1929 I spent several weeks in the Hôpital X, in the fifteenth arrondissement of Paris. The clerks put me through the usual third-degree at the reception desk, and indeed I was kept answering questions for some twenty minutes before they would let me in. If you have ever had to fill up forms in a Latin country you will know the kind of questions I mean. For some days past I had been unequal to translating Reaumur into Fahrenheit, but I know that my temperature was round about 103, and by the end of the interview I had some difficulty in standing on my feet. ...

Fed Remains Undecided about Explicit Inflation Targeting

John Berry says the Fed remains undecided on the issue of explicit inflation targets:

Fed Far From Inflation-Target Policy, by John M. Berry, Bloomberg: After much study and discussion, Federal Reserve officials are far from adopting inflation targeting as part of the monetary policymaking process. And even though Fed Chairman Ben S. Bernanke favors having some sort of explicit target, the outcome of the comprehensive review of the concept he set in motion remains unclear.

A substantial portion of the Oct. 24-25 meeting of the Federal Open Market Committee was devoted to communications issues and discussion of ''the advantages and disadvantages of quantifying an inflation objective,'' minutes of the meeting ... said. ... The officials will pick up where they left off at the committee's next two-day meeting in late January. ...

How Should Poverty Be Measured?

There are both income and consumption based measures of poverty, and they give different pictures of how much poverty exists and how it is changing over time. Which measure is better? The Minneapolis Fed takes a look at this question:

Poor by what standard?, by Ronald A. Wirtz, Editor, Fedgazette: ...Official poverty guidelines were first developed in 1963 by economist Mollie Orshansky (working at the Social Security Administration) and formally adopted two years later ... for President Lyndon Johnson's War on Poverty. Although changes have been made, in essence today's poverty yardstick still reflects Orshansky's original definition of poverty based mostly on household food consumption and minimally adequate diets.

Most economists, sociologists and other researchers agree that this definition -- called the “money-income” approach ...-- is far too simplistic a measure... Numerous alternative methodologies have been drawn up... Many studies indicate that poverty is higher than official estimates; others say it's lower.

A growing body of research ... argues that a better, more direct way to assess household need and hardship is to look at consumption rather than income. Unlike most alternative measures of poverty, ... consumption-based research suggests that poverty has lessened.

Has Job Security Declined? (Update)

[Updates at the end]

The Economist blog, Free Exchange, says outsourcing and technological change have not impacted job security - it's all a myth:

Unstable?, Free Exchange: Last month, unemployment hit 4.1% in America, the lowest ... in thirty years. Yet at the same time, Democrats are vowing to protect American jobs from foreign competition... If globalisation is sending jobs abroad, how is it that unemployment is so low?