Economist's View

"John Stuart Mill as a Social Science Founder"

Daniel Little discusses John Stuart Mill's significant contributions to the creation of a positivist science of society:

John Stuart Mill as a social science founder, by Daniel Little: John Stuart Mill was Britain's leading thinker when it came to issues having to do with logic and scientific knowledge in the mid-nineteenth century. His System of Logic was first published in 1843 and was reprinted in numerous editions, and it constituted a comprehensive treatment of scientific knowledge and inference within the empiricist tradition. 

The book devoted an entire section to the logic of what Mill referred to as the "moral sciences" (Book VI, published separately as The Logic of the Moral Sciences). He defined the moral sciences as those areas of study having to do with human dispositions, character, and action, extending from psychology to social science. The conception of social science knowledge that he presents has had a deep impact on subsequent thinking about "scientific" social analysis and is worth examining again. (Here is a link to the Gutenberg etext edition of the System of Logic.)

Mill developed a general vision of science that was derived from the best current examples of progress in the natural sciences, and he then applied this vision to the effort to understand human and social phenomena scientifically. Putting his vision simply, science consists of the discovery of general causal laws based on systematic empirical observation. It lays the framework for a positivist conception of social science, and it prepares a charge of "Not scientific!" to social scientists who deviate from these central positivist tenets.

"The Savings Rate Has Recovered…if You Ignore the Bottom 99%"

Yves Smith suggested this. I don't know if it's correct or not, as noted below most of the numbers are speculative due to data limitations, but the question of how recent changes in saving vary with income does seem like a question worth asking:

Guest Post: The Savings Rate Has Recovered…if You Ignore the Bottom 99%, by By Andrew Kaplan, a hedge fund manager: It has become fashionable among equities managers of the bullish persuasion to argue that a strong recovery in GDP will occur in 2010 because the “structural adjustment period” of moving back to a more normal savings rate has been completed. We’ve gone from a savings rate of barely 1% in 2008 up to 4.2% in July (ok, so the argument sounded better when the number was 6.2% in May, but still…).

The story goes something like, “consumers took a little time to recognize that their home equity had disappeared, but now they’ve adjusted their savings rates toward the desired level to reflect the fact that they need to save a larger proportion of income for retirement…so this effect will no longer be a drag on growth in coming quarters.”

This is the kind of conventional wisdom which could only emerge among folks in the 99^th income percentile who spend their time primarily with other folks in the 99^th income percentile. You don’t have to look at the data (mortgage delinquencies, foreclosures, credit card defaults, bankruptcies) all that hard to see a very different picture. In fact, it is almost certainly true that the savings rate for 99% of the US population is negative. These people (a/k/a “all of us”) are drowning. And to the extent that our savings rate is less negative than it was one or two years ago, that simply reflects the reality of reduced home equity and unsecured credit lines rather than any conscious effort to reach a “desired level” of savings.

Paul Krugman: Missing Richard Nixon

If we're lucky, we might get health care reform that is almost as good as what Richard Nixon offered in the early 1970s:

Missing Richard Nixon, by Paul Krugman, Commentary, NY Times: Many of the retrospectives on Ted Kennedy’s life mention his regret that he didn’t accept Richard Nixon’s offer of a bipartisan health care deal. The moral some commentators take from that regret is that today’s health care reformers should do what Mr. Kennedy balked at doing back then, and reach out to the other side.

But it’s a bad analogy, because today’s political scene is nothing like ... the early 1970s. In fact, surveying current politics, I find myself missing Richard Nixon.

No, I haven’t lost my mind. Nixon was surely the worst person other than Dick Cheney ever to control the executive branch.

But the Nixon era was a time in which leading figures in both parties were capable of speaking rationally about policy..., our political system’s ability to deal with real problems has been degraded to such an extent that I sometimes wonder whether the country is still governable.

As many people have pointed out, Nixon’s proposal for health care reform looks a lot like Democratic proposals today. In fact, in some ways it was stronger. ... Nixon proposed requiring that all employers, not just large companies, offer insurance.

Nixon also embraced tighter regulation of insurers, calling on states to “approve specific plans, oversee rates, ensure adequate disclosure, require an annual audit and take other appropriate measures.” No illusions there about how the magic of the marketplace solves all problems.

So what happened to the days when a Republican president could sound so nonideological, and offer such a reasonable proposal?

Part of the answer is that the right-wing fringe, which has always been around ... has now, in effect, taken over one of our two major parties. Moderate Republicans, the sort of people with whom one might have been able to negotiate..., have either been driven out of the party or intimidated into silence. Whom are Democrats supposed to reach out to, when Senator Chuck Grassley..., who was supposed to be the linchpin of any deal, helped feed the “death panel” lies?

But there’s another reason health care reform is much harder now...: the vast expansion of corporate influence.

We tend to think of ... a huge army of lobbyists permanently camped in the corridors of power, with corporations prepared to unleash misleading ads and organize fake grass-roots protests against any legislation that threatens their bottom line, as the way it always was. But our corporate-cash-dominated system is a relatively recent creation, dating mainly from the late 1970s.

And now that this system exists, reform of any kind has become extremely difficult. That’s especially true for health care... The health insurance industry ... has become a political behemoth, one that is currently spending $1.4 million a day lobbying Congress. ...

Given the combination of G.O.P. extremism and corporate power, it’s now doubtful whether health reform,... if we get it ..., will be anywhere near as good as Nixon’s proposal, even though Democrats control the White House and have a large Congressional majority.

And what about other challenges? Every desperately needed reform I can think of, from controlling greenhouse gases to restoring fiscal balance, will have to run the same gantlet of lobbying and lies.

I’m not saying that reformers should give up. They do, however, have to realize what they’re up against. There was a lot of talk last year about how Barack Obama would be a “transformational” president — but true transformation, it turns out, requires a lot more than electing one telegenic leader. Actually turning this country around is going to take years of siege warfare against deeply entrenched interests, defending a deeply dysfunctional political system.

"An Interview with Barney Frank"

 

links for 2009-08-31

• New evidence on international trade and US wages - voxeu.org
• Triple time-inconsistent policies - voxeu.org - Calvo
• What property right? - Stumbling and Mumbling
• “Heterodox” Economists and the Crisis - Open Economics
• When Money Was New - Economic Principals
• In which I don’t care about genocides - Easterly
• Hydraulic Macro: A Fable - Arnold Kling
• A Public-Option Compromise - Jonah Gelbach
• Bonus Guarantees Can Fuel Risky Moves - Lucian Bebchuk
• Frank Said to Back Broader Fed Audits - WSJ.com

"An Echo Chamber of Boom and Bust"

Robert Shiller says the global recovery in economic confidence is being driven by a social epidemic, the contagion of ideas, and huge feedback loops:

An Echo Chamber of Boom and Bust, by Robert Shiller, Commentary, NY Times: The global signs of a recovery in economic confidence seem puzzling.

It is a large and diverse world, after all, so why should confidence have rebounded so quickly in so many places? ... Economic analysts often turn to indicators like employment, housing starts or retail sales as causes of a recovery, when in fact they are merely symptoms. For a fuller explanation, look beyond the traditional economic links and think of the world economy as driven by social epidemics, contagion of ideas and huge feedback loops that gradually change world views. These social epidemics can travel as swiftly as swine flu: both spread from person to person and can reach every corner of the world in short order. ...

"Why Doesn’t This Generation’s Intellectuals Fight This Generation’s Wars?"

If the premise is correct, then what's the answer?:

Cowards, every single one of us?, by Chris Blattman: Early in the 20th century, the West’s intellectual elites rushed to fight the Spanish civil war. The same could be said of World War II. It’s hard to imagine the same today. What happened...: why doesn’t this generation’s intellectuals fight this generation’s wars?

Cowards, every single one of us? Possibly, but I see a few other explanations.

The economist in me says it could be comparative advantage at work. Technology has played an increasingly important role in war. A sensible government would direct its best educated patriots to engineering and intelligence.

The armed forces also face more competition for idealistic talent. We’ve seen 10,000% growth in the number of international NGOs in the last 60 years. Those who want to fight injustice have many more options.

There is also the perception, probably real, that the army is no longer a friendly place for intellectuals. A consequence of competition and comparative advantage?

Three generations have also witnessed the examples of Gandhi and Dr. King, and the gospel of non-violent action. ...

But the answer that appeals most to me: today’s battles are not drawn along intellectual lines, but religious ones. The Spanish Civil War was the left’s stand against fascism and the subjugation of the European working class, and the way the West would be run. There is a battle for hearts and minds, but not within our own society.

Thoughts...?

The Vietnam war was not a religious battle, it was portrayed as an ideological battle against communism, yet the intellectual elites did not rush to join the battle, so I'm not sure the last answer explains the change. But I don't have anything better to offer, so I'll leave it to all of you to resolve whether the premise is correct and, if so, why this change has occurred.

links for 2009-08-30

• Health Care Fit for Animals - NYTimes.com
• A Less-is-More Growth Strategy for Africa - Project Syndicate
• Good and bad discussions of financial innovation - Economics of Contempt
• Of Ideologues and Ranters - Econbrowser
• Apologies to Menzie Chinn - Arnold Kling
• Disgraced former FEMA director to speak at conference - McClatchy
• A Map of FDR’s Vacation - Strange Maps
• Obama’s Mixed Messages - NYTimes.com
• Financing Health Care Reform: 2009 vs. 2003 - Economix

Stiglitz: Thanks to the Deficit, the Buck Stops Here

Joseph Stiglitz repeats a warning that he and others have made in the past that, like it or not, the dollar's days as a reserve currency are numbered. Thus, instead of resisting this change -- as we have -- "it's better for us to participate in the construction of a new system than have it happen without us":

Thanks to the Deficit, the Buck Stops Here, by Joseph E. Stiglitz, Commentary, Washington Post: Beware of deficit fetishism. Last week we learned that the national debt is likely to grow by more than $9 billion. That's not great news -- no one likes a big deficit -- but President Obama inherited an economic mess from the Bush administration, and the cleanup comes with an inevitably high price tag. We're paying it now. ...

There are ... consequences, however, that we're missing in the debate over all this red ink. Our budget deficit, as well as the Federal Reserve's ballooning lending programs and other financial obligations, will accelerate a process already well underway -- a changing role for the U.S. dollar in the global economy.

The domino effect is straightforward: Higher deficits spark market concerns over future inflation; concerns of inflation contribute to a weaker dollar; and both come together to undermine the greenback's role as a reliable store of value around the world. ...

Hoover's "Pro-Labor Stance" Did Not Help to Cause the Great Depression

In a new paper, Lee Ohanion claims that Herbert Hoover's call for "business leaders to be gentle to their workers" helped to cause the Great Depression. Brad DeLong explains why this claim does not hold up to closer scrutiny:

Herbert Hoover: A Working Class Hero Is Something to Be, by Brad DeLong: Oh Noes! Andrew Leonard reads Lee Ohanian:

Herbert Hoover: The working man's hero - How the World Works - Salon.com: I did not need a cup of coffee to wake up this morning -- I just checked my e-mail, and saw the subject header: "Hoover's pro-labor stance helped cause Great Depression, UCLA economist says."

Without reading the message, I knew instantly who the economist must be -- Lee Ohanian.... Last we saw of Ohanian... he was arguing that FDR's New Deal policies extended the Great Depression and resulted in "less work than average" for American workers. Which might be true, if you don't count anyone who got a job through "the Works Progress Administration (WPA) or Civilian Conservation Corps (CCC), or any other of Roosevelt's popular New Deal workfare programs." Makes sense -- if you don't count Roosevelt's pro-labor programs, he doesn't end up very pro-labor!

So now we have "What -- or Who -- Started the Great Depression?," a 68-page paper Ohanian has been working on for four years that is sure to become a never-to-be-extinguished talking point for New Deal haters, union-busters, and opponents of all kinds of government intervention in the economy. Here are some key points, taken from the press release pushed out by UCLA.

Pro-labor policies pushed by President Herbert Hoover after the stock market crash of 1929 accounted for close to two-thirds of the drop in the nation's gross domestic product over the two years that followed, causing what might otherwise have been a bad recession to slip into the Great Depression, a UCLA economist concludes in a new study. "These findings suggest that the recession was three times worse -- at a minimum -- than it would otherwise have been, because of Hoover," said Lee E. Ohanian, a UCLA professor of economics.

According to Ohanian, these pro-labor policies including pressure for job-sharing and propping up wages handcuffed industry's ability to respond flexibly to the post-crash economic contraction.

"When Carbon is Priced, Who Ultimately Pays?"

Who pays the costs of a cap and trade system for carbon emissions? This analysis of who pays based upon the legislation passed by the House in June suggests that "the distributional consequences have been addressed fairly effectively," and that "Strong opposition to the legislation will probably be based more on ideological grounds than distributional concerns":

When carbon is priced, who ultimately pays?, by Corbett Grainger and Charles Kolstad, Vox EU: Climate change legislation is winding its way through the US Congress. In June (2009), the House passed complex legislation involving, among other things, a cap and trade system for carbon emissions in the US. The legislation passed by the slimmest of majorities – 219 to 212 with 3 not voting. Although most Republicans opposed the legislation, a significant number of Democrats, primarily those from coal-rich or rural districts, also voted no. Politics is local, even for global warming.

The Senate will consider similar legislation in September, and its passage is likely to be even more difficult. Several issues are at the core of the opposition:

1. The competitive effect on industry. Will higher costs cause US industry to lose market share to foreign producers? In order to win over skeptics, legislators mandated import tariffs on goods from countries without climate legislation (such as China). President Obama has subsequently condemned such mandatory trade barriers.
2. The burden of increased energy prices on lower-income individuals. The poor often drive older cars, commute further to work, and in other respects consume goods and services differently than wealthier members of society. Furthermore, to the extent that energy is a necessity, one would expect price increases to hit the poor particularly hard. In other words, carbon regulation may be regressive.
3. The burden of higher prices for consumers in states heavily reliant on coal-based electricity. Coal has the largest carbon emissions per unit of heat energy of any of the fossil fuels (by a wide margin) and thus will be hit hard by any legislation.

Measuring the burden of a carbon price

It is important to distinguish between a tax’s statutory incidence (i.e., who writes the check to the government) and its ultimate burden (who ends up paying the cost of the tax). A cap-and-trade system is not a tax in the normal sense, but it does induce a tax-like carbon price change. Raising the price of carbon increases the costs of doing business, and those costs may be passed on to consumers, workers, or owners.

links for 2009-08-29

• Posner, Redux - Justin Wolfers
• Cowards, every single one of us? - Chris Blattman
• Job Losses Are Not the Problem - Andy Harless
• Is the output gap showing? - macroblog
• Company size: Big is back - The Economist
• A case for (even) more transparency in the OTC markets - voxeu.org
• US trade’s transmission of the global recession - voxeu.org
• Fear of appreciation in emerging economies - voxeu.org
• Low-Frequency Robust Cointegration Testing - NBER - Muller and Watson
• The very model of a modern central banker - The Economist
• IMF needs to co-ordinate reform of global system - Barry Eichengreen
• Oregon land fraud and the Republican nomination of 1912 - Eric Rauchway
• The Hoover pro-labor thesis: "Completely wrong" - Andrew Leonard
• Reality check on business and the internet in developing countries - PSD Blog
• Greg Mankiw Hearts Genetic Determinism - The Monkey Cage
• Household Debt, Monetary Policy and Financial Stability - SSRN - BIS
• Communication of Monetary Policy Decisions by Central Banks - SSRN - BIS

Bernanke and Regulation of the Financial Sector

Economics of Contempt says I gave in too easily:

Bernanke's Reappointment, by Economics of Contempt: Bernanke's reappointment seems to be the topic of the day, so I suppose I'll weigh in as well. I think Bernanke absolutely deserves a second term. He reacted early and aggressively when strains in the funding markets first appeared back in the fall of 2007, after the two Bear Stearns hedge funds failed and the ABCP market shut down, and he's kept his foot on the gas ever since.

Everyone seems to be praising Bernanke for his "creativity" in responding to the financial crisis. While the Fed's various liquidity facilities have indeed been creative, they were almost certainly designed by the New York Fed's markets desk, not Bernanke. What Bernanke deserves credit for is his willingness to use these new and decidedly non-traditional facilities without hesitation. Like Paul Krugman said, a different Fed chairman might well have balked at these new facilities. Bernanke's willingness to approve the AMLF—the most creative of the new lending facilities—probably saved the entire prime money market fund sector, which was experiencing a full-blown bank run. (The Fed pumped $122 billion into money market funds in the first 7 days of the AMLF—and bear in mind that only money funds that were experiencing specified redemption pressures were even eligible for the AMLF in the first place.)

People who, like Kevin Drum, oppose Bernanke based on his regulatory views, simply haven't been paying attention. Drum claims that Bernanke "inherited and then perpetuated weak regulation of consumer loan products, something that aggravated the housing bubble." It's true that Bernanke inherited weak regulation of mortgages, but it's simply not true that he perpetuated that weak regulation. That sounds more like what Drum thinks Bernanke probably did (if he had to guess, and without looking at the record). In reality, the Fed adopted new regulations on subprime mortgages over a year ago, and there was nothing "light touch" about them. The Fed started the process of adopting new regulations on subprime mortgages way back in 2006, and the explicit focus from the beginning was on curbing the abuses of 2004/2005.

But a Fed chairman can't just wave his magic wand and have new regulations appear in Federal Register—the rulemaking process takes time. And when it comes to something like Reg Z, which is both controversial and complex, it often takes even longer than normal. Bernanke can't be blamed for sweeping the regulatory effort under the rug either. He devoted the bulk of his semiannual Humphrey-Hawkins testimony—the most high-profile testimony a Fed chairman gives—to the need for more regulation of subprime mortgages in July 2007. (He made the case for subprime mortgage regulation again a few months later, in even longer testimony.) The Board of Governors approved the final rule in July 2008.

Mark Thoma, who previously argued that Bernanke will be an effective regulator, actually concedes Drum's point, saying that his argument is probably "based more on hope than on evidence." Don't give up so easily, Professor Thoma! If anything, Thoma's argument is the one based on evidence, while Drum's seems to be based on a flawed memory.

[Read Barry Ritholz's post on disingenuous Bernanke bashing as well.]

Did Heterodox Economists Get it Right?

After feeling like I overstated the case, I invited Barkley Rosser (or anyone else) to respond to my claim that "heterodox economists did not do a better job of "calling" the recent crashes and crises than did mainstream or conventional economists." I don't think the list below of people who called the crisis is particularly well defined, e.g. how do you leave off people like Raghuram Rajan, should Krugman be on it, and so forth, and the definition of what it means to have called it can be questioned. But I was the one who first invoked the list (I got it from Steven Keen's site), and I agree that the list as formulated is slanted toward non-conventional economists. I also agree with Barkley's response to my invitation to respond:

Mark,

I do not think this is going to be easy to determine. It involves not only identifying "who called it," (preferably publicly) and who did not, as well as this sticky wicket of "who is heterodox" and who is not (having just pointed out that it is unclear whether I count or not, and I called a lot of it, and there is question about whether Dean Baker is heterodox, who certainly called a lot of it and very early).

What certainly is clear that the clearly orthodox, and here I would say those who accepted (and many still accept) rational expectations and some sort of equilibrium associated with that, have been very wrong, with basically none of them "calling it." ...

Here's the counterargument:

Did Heterodox Economists Do Better At "Calling It" Than Mainstream Ones?, by Barkley Rosser: In a posting and comments yesterday, Mark Thoma at economists view, , argued that heterodox economists did not do a better job of "calling" the recent crashes and crises than did mainstream or conventional economists. Of course, part of the issue here involves both who one counts as "calling it," and also how one labels economists. In the comments, a list provided by Steve Keen of 11 who "called it," was invoked, with Thoma, at least, claiming that it did not show any preponderance of the heterodox. The list is as follows:

Dean Baker,US
Wynne Godley, UK
Fred Harrison, UK
Michael Hudson, US
Eric Janszen, US
Stephen Keen, Australia
Jakob Brochner Madsen and Jens Kjaer Sorenson, Denmark
Kurt Richebacher, US
Nouriel Roubini, US
Peter Schiff, US
Robert Shiller, US.

Keen categorizes these as follows in a private communication with me: 5 as Post Keynesian (Baker, Godley, Hudson, Keen, Sorenson), 2 as Austrian (Richebacher, Schiff), 2 as "from neoclassical backgrounds," but "mavericks" (Roubini, Shiller), one sort of a combination of Austrian and Post Keynesian (Janszen), and one unclear (Harrison). This looks about right to me to the extent I know about these people, although I note that Thoma claims that Baker is not "heterodox." I have not asked Dean, and he may not wish to comment, although he was once-upon-a-time a co-blogger on the predecessor to this blog, maxspeak, prior to starting his own punchy blog, Beat the Press. About four of these people I know nothing about.

I also note that there are quite a few others who can make the claim of having "called it" (I like to include myself in that gang, at least to some degree), and I also know that some of those are conventional, more or less, such as Andrew Lo of MIT, although he is now pushing a non-conventional theory about evolutionary financial dynamics. In any case, I think that the heterodox have the edge here, even if it is not clear what constitutes being in that category.

Update: I forgot about this older post of an interview with Daniel Kahneman ("There were Exactly Five People Who Foresaw This Crisis"):

"It was possible to foresee, and some people did. ... I have a colleague at Princeton who says there were exactly five people who foresaw this crisis... One of them is Prof. Robert Shiller, who also predicted the previous bubble. The problem is there were other economists who predicted this crisis, like Nouriel Roubini, but he also predicted some crises that never came to be."

He was one of those who predicted 10 crises out of three.

"Ten out of three is a pretty good record, relatively. But I conclude from the fact that only five people predicted the current crisis that it was impossible to predict it. In hindsight, it all seems obvious: Everyone seemed to be blind, only these five appeared to be smart. But there were a lot of smart people who looked at the situation and knew all the facts, and they did not predict the crisis." ...

The interesting psychological problem is why economists believe in their theory, but this is the problem with the theory, any theory. It leads to a certain blindness. It's difficult to see anything that deviates from it."

We only look for information that supports the theory and ignore the rest. "Correct..." ...

"Beware Authoritative 'Inside Washington' Sources"

Robert Reich says incremental reform of health care won't work, and he gives an example to illustrate why incremental reform isn't always the best way to proceed:

Beware Authoritative "Inside Washington" Sources Who Say The Public Option is Dead, by Robert Reich: ...Years ago, as the story goes, Britain's Parliament faced a difficult choice. On the European continent drivers use the right lanes, while the English remained on the left. But tunnels and fast ferries were bringing cars and drivers back and forth ever more frequently. Liberals in Parliament thought it time to change lanes. Conservatives resisted; after all, Brits had been driving on the left since William the Conquerer's chariot. Parliament's compromise was to move from the left to right lanes -- but incrementally, on a voluntary basis. Truckers first.

But his main point is to be careful of reports of authoritative voices saying that "the public option is dead, that the President won't be able to get a comprehensive health care bill, and that the White House and congressional leadership already know the best they'll be able to do now is move incrementally":

 Washington, D.C. is an echo chamber in which anyone who sounds authoritative repeats the conventional authoritative wisdom about the "consensus" of inside opinion, which they've heard from someone else who sounds equally authoritative, who of course has heard it from another authoritative source. Follow the trail to its start and you often find an obscure congressional or White House staffer who has seen some half-assed poll number or briefing memo, but seeking to feel important hypes it a media personality or lobbyist who, desperate to sound authoritative, pronounces it as truth. In any other place on the planet it would be called rumor, gossip, or drivel. In our nation's capital it's called "inside information." The process would be harmless except that it creates self-fulfilling prophesies. Since most of our elected representatives would rather not stick their necks out lest they lose their heads, they tend to rush toward whatever consensus seems to be emerging -- which, of course, is based on authoritative reports about the emerging consensus.

In the last few days authoritative sources have repeatedly told me that the public option is dead, that the President won't be able to get a comprehensive health care bill, and that the White House and congressional leadership already know the best they'll be able to do now is move incrementally... The rightwing media fearmongers and demagogues have won.

Don't believe it. The other thing about Washington is how quickly conventional authoritative wisdom changes, especially when the public is still in flux over some large matter. Rightwing fearmongers and demagogues thrive only to the extent the mainstream media believes they're thriving. Although polls continue to show that while most Americans like the health care they're getting, they also dislike their insurance companies, worry that they or their families will be denied coverage, and are anxious about the increasing co-payments, deductibles, and premiums they're facing. Most are still eager for reform.

In addition, we've come to the point where health-care incrementalism won't work. [explains why, and also explains the need for a public option]... When you go through the logic, it starts to look a lot like comprehensive reform. ...

So forget the authoritative sources. Mobilize and organize. We can get comprehensive, meaningful health care reform if we push hard enough. And we must.

Health Care Reform and Entreprenuership

I've also argued that if we don't reform health care, people who think they will be able to keep their current health coverage will find out otherwise, and that health care reform will have a positive effect on entrepreneurship:

Fixing Health Care Is Good for Business, by Gary Locke, Commentary, WSJ: ...There has been a lot of talk about the 47 million Americans who do not have health insurance. But health-care reform is just as important to the majority of Americans who have health insurance now. Absent reform, the price of an average family's insurance will nearly double over the next decade—to $25,000 from $13,000.

No less troubling are the stories I hear from CEOs, entrepreneurs and workers. Rising health-care costs are crushing American companies—particularly small businesses that are the source of much of our economic vitality. ...

The pernicious price of runaway health-care costs also has a dampening effect on entrepreneurship.

How many aspiring owners of businesses are locked in jobs they don't like for fear that striking out on their own would cause them to lose their health insurance? The Small Business Majority, a national advocacy group, estimates there are as many as 1.6 million. ...

The bills working through Congress are moving in the right direction... We must keep moving forward. ...

Because insurance costs are obscured by the employer based system that we rely upon for much of our health insurance, most people don't realize how much they pay for insurance now, let alone the costs they will face in the future. This lack of transparency about the actual insurance costs faced by a typical family creates unnecessary confusion and fear. When, for example, people hear that reform means they might have to pay, say, $8,000 for insurance coverage, they balk at the figure even though it actually saves money and would result in their receiving higher wages (research suggests that the total wage plus insurance bill that firms pay is relatively stable so that a fall in the cost of insurance translates into higher wages). And even if people know how much the insurance costs, the belief may be that the employer is actually paying for the insurance, or at least a significant portion of it, but that is not what research on the incidence of the insurance costs suggests.

Paul Krugman: Till Debt Does Its Part

Should you be worried about the national debt, or the politicians in charge of it?:

Till Debt Does Its Part, by Paul Krugman, Commentary, NY Times: So new budget projections show a cumulative deficit of $9 trillion over the next decade. According to many commentators, that’s a terrifying number, requiring drastic action — in particular, of course, canceling efforts to boost the economy and calling off health care reform.

The truth is more complicated and less frightening. Right now deficits are actually helping the economy. In fact, deficits here and in other major economies saved the world from a much deeper slump. The longer-term outlook is worrying, but it’s not catastrophic.

The only real reason for concern is political. The United States can deal with its debts if politicians of both parties are, in the end, willing to show at least a bit of maturity. Need I say more?

Let’s start with the effects of this year’s deficit. ... Consider what would have happened if the U.S. government and its counterparts around the world had tried to balance their budgets as they did in the early 1930s. It’s a scary thought. If governments had raised taxes or slashed spending in the face of the slump, if they had refused to rescue distressed financial institutions, we could all too easily have seen a full replay of the Great Depression.

As I said, deficits saved the world.

In fact,... the ... White House forecast shows a nation stuck in purgatory for a prolonged period, with high unemployment persisting for years. If that’s at all correct — and I fear that it will be — we should be doing more, not less, to support the economy.

But what about all that debt we’re incurring? That’s a bad thing, but it’s important to have some perspective. ...

Here’s one way to look at it: We’re looking at a rise in the debt/G.D.P. ratio of about 40 percentage points. The real interest on that additional debt (you want to subtract off inflation) will probably be around 1 percent of G.D.P., or 5 percent of federal revenue. That doesn’t sound like an overwhelming burden.

Now, this assumes that the U.S. government’s credit will remain good so that it’s able to borrow at relatively low interest rates. So far, that’s still true. Despite the prospect of big deficits, the government is able to borrow money long-term at ... less than 3.5 percent, which is low by historical standards. People making bets with real money don’t seem to be worried about U.S. solvency. ...

So is there anything to worry about? Yes, but the dangers are political, not economic.

As I’ve said, those 10-year projections aren’t as bad as you may have heard. Over the really long term, however, the U.S. government will have big problems unless it makes some major changes. In particular, it has to rein in the growth of Medicare and Medicaid spending.

That shouldn’t be hard in the context of overall health care reform. After all, America spends far more on health care than other advanced countries, without better results, so we should be able to make our system more cost-efficient.

But that won’t happen, of course, if even the most modest attempts to improve the system are successfully demagogued — by conservatives! — as efforts to “pull the plug on grandma.”

So don’t fret about this year’s deficit; we actually need to run up federal debt right now and need to keep doing it until the economy is on a solid path to recovery. And the extra debt should be manageable. If we face a potential problem, it’s not because the economy can’t handle the extra debt. Instead, it’s the politics, stupid.

Update: A response to Jim Hamilton:

The burden of debt. by Paul Krugman: I respect Jim Hamilton a lot, so I take his criticism seriously — and he raises questions that others raise too about my relatively sanguine assessment of the debt situation. Yet I think that he and others are quite wrong, on several counts.

First off: the assertion that the post-World War II debt was sui generis, that it offers no guidance on what we can afford. It’s true that right after the war it was possible to get a drastic reduction in spending easily, since we didn’t have to fight the Axis any more. But let’s take a slightly later start date: in 1950, federal debt in the hands of the public was 80 percent of GDP, which is in the ballpark of what we’re looking at for 2019. By 1960 it was down to 46 percent — and I haven’t heard that anyone considered America a debt-crippled nation when JFK took office.

So how was that possible? Was it through drastic cuts in defense spending? On the contrary: we’re talking about the height of the Cold War (with a hot war in Korea along the way), and federal spending actually rose as a share of GDP. So yes, it wasn’t entitlement programs, but it wasn’t exactly discretionary either.

How, then, did America pay down its debt? Actually, it didn’t: federal debt rose from $219 billion in 1950 to $237 billion in 1960. But the economy grew, so the ratio of debt to GDP fell, and everything worked out fiscally.

Which brings me to a question a number of people have raised: maybe we can pay the interest, but what about repaying the principal? Jim gets scary numbers about the debt burden by assuming that we’ll have to pay off the debt in 10 years. But why would we have to do that? Again, the lesson of the 1950s — or, if you like, the lesson of Belgium and Italy, which brought their debt-GDP ratios down from early 90s levels — is that you need to stabilize debt, not pay it off; economic growth will do the rest. In fact, I’d argue, all you really need to do is stabilize debt in real terms.

So where Jim Hamilton has us paying $1 trillion a year to service $9 trillion in debt, I have us paying $225 billion — 2.5% real interest on that sum.

Now, how does that compare with the tax base? Hamilton rather mysteriously compares debt service only with current personal income taxes. If we use the overall tax take, and talk about what that tax take will be a decade from now, things look much less severe.

So: in 2008, with revenues already depressed by the recession and housing bust, the federal government took in $2.5 trillion in revenues. If we assume 2.5% real growth* and 2% inflation, by 2019 that would rise to $4 trillion. So debt service costs due to the next decade’s deficits would be less than 6 percent of revenue under current law.

So, to review: to make the debt look scary, you have to dismiss the post-World -War II experience, even though it turns out that the 50s offer a quite good lesson; assume that in the future the federal government will have to amortize debt over a quite short period, even though it never had to in the past; compare this inflated debt burden with a narrow piece of the federal tax base; and ignore the likely growth in the tax base over the next decade.

I’m not convinced.

*Contrary to what some think, we’d actually expect growth over the next decade to be somewhat above trend, as the economy picks up some of the current slack. That’s what the historical record tells us actually happens.

links for 2009-08-28

• I Am Even More Confused Now... - Econbrowser
• Are women better loan officers? - voxeu.org
• U.S. Report Suggests Fed Profits Turning Higher - Real Time Economics
• Honest Ben - The Big Picture
• We should put sand in the wheels of the market - Avinash Persaud
• Nonlinear Temperature Effects and Crop Yields - Michael Roberts
• Losing his deregulation religion - Andrew Leonard
• Scientists find 'great Pacific Ocean garbage patch' - EurekAlert
• Finance: Before the Next Meltdown - Simon Johnson and James Kwak
• Heads I win, tails I don't lose - Andrew Gelman
• Good and bad financial innovation - Felix Salmon
• Positive, Normative, and … ? - Donald Marron
• Health Care Fit for Animals - NYTimes.com
• Macroeconomic Causes of the Great Recession - Thomas palley
• Could ‘Tobin tax’ reshape financial sector DNA? - GillianTett
• The FDIC is not bust, ok? - FT Alphaville
• What good is finance? - Free exchange
• Oil speculators dominate open interest in oil futures - EurekAlert
• Iceland shows the dangers ahead for us all - FT.com
• Featured Reading Lists - Google Reader

"Obama Lucky to Have Bernanke"

Brad DeLong explains why presidents are willing to reappoint Fed chairs that are members of opposing political parties:

Obama lucky to have Bernanke, by J. Bradford DeLong, Commentary, Project Syndicate: William McChesney Martin, a Democrat, was twice reappointed chairman of the ... Federal Reserve by Republican President Dwight D. Eisenhower.

Paul Volcker, a Democrat, was reappointed once by the Reagan administration (but not twice: there are persistent rumors that Reagan's treasury secretary, James Baker, thought Volcker too invested in monetary stability and not in producing strong economies to elect Republicans).

Alan Greenspan, a Republican, was reappointed twice by Bill Clinton. And now Barack Obama has announced his intention to renominate Republican appointee Ben Bernanke...

The reason American presidents are so willing to reappoint Fed chairmen from the opposite party is closely linked to ... confidence of financial markets that the Fed will pursue non-inflationary policies.

If financial markets lose that confidence - if they conclude that the Fed is too much under the president's thumb to wage the good fight against inflation, or if they conclude that the chairman does not wish to control inflation - then the economic news is almost certain to be bad.

Capital flight, interest-rate spikes, declining private investment, and a collapse in the value of the dollar - all of these are likely should financial markets lose confidence in a Fed chairman.

And if they occur, the chances of success for a president seeking re-election - or for a vice president seeking to succeed him - are very low. By reappointing a Fed chairman chosen by someone else, a president can appear to guarantee to financial markets that the Fed is not too much under his thumb. ...

It may or may not be true, especially these days, that what is good for General Motors is good for America and vice versa, but certainly what is good economically for America is good politically for the president.

It is here that Obama has lucked out. Ben Bernanke is a very good choice for Fed chairman because he is intelligent, honest, pragmatic and clear-sighted in his vision of the economy. He has already guided the Fed through two very tumultuous years with only one major mistake - the bankruptcy of Lehman Brothers.

This probably helped with Obama's willingness to reappoint Bernanke:

For years, some of his closest friends did not know that Ben S. Bernanke was a Republican. ... "If you read anything he's written, you can't figure out which political party he's associated with," said Mark L. Gertler, a professor of economics at New York University who has written more than a dozen papers with Mr. Bernanke. Mr. Gertler, who said he did not know his close friend's political affiliation until relatively recently, added: "He's not ideological. I could imagine Ben working with economists in the Clinton administration." Alan S. Blinder, a longtime colleague at Princeton who has advised numerous Democratic presidential candidates, also said he had worked alongside Mr. Bernanke for years without having any sense of his political views. "We wrote articles together and sat at the same lunch table thousands of times before I knew he was a Republican," Mr. Blinder recalled. "We never talked politics." ...

The Size of the Bush Tax Cuts vs. the Cost of Health Care Reform

Via Economix:

Trillion Dollar Health Reform, $3 Trillion in Tax Cuts, by Howard Gleckman, Tax Policy Center: It is interesting, and perhaps worth noting, that while political opposition seems to be hardening against the $1 trillion, ten-year cost of the early versions of health reform, barely a peep of concern has been raised about the $3 trillion price tag for President Obama’s plan to extend most of the Bush-era tax cuts.

The message seems pretty clear: The President, congressional Democrats, and nearly all Republicans are fine with busting the budget to cut taxes for nearly everyone, notwithstanding a cumulative deficit over the next decade of $9 trillion. They are, by contrast, unwilling to spend one-third as much to provide medical insurance for those who cannot afford it. I’ve always felt that health reform is as much an ethical choice as an economic one. We appear to be making ours.

Yes, priorities. Tax cuts for the wealthy come before health care for the uninsured.

"Would Growth in the U.S. Debt be Inflationary?"

David Andolfatto explains why a worldwide shortage of safe, liquid assets may help the U.S. to avoid the inflationary consequences of high debt levels:

Why the Growing Level of U.S. Debt May Not be Inflationary, by David Andolfatto: History shows that high levels of government debt are frequently associated with inflation. The reason for this seems clear enough. At some point, maturing debt needs to paid back. At high enough levels of debt, rolling the debt over is no longer feasible. Cutting back government spending and raising taxes is politically difficult. The easy way out is simply to print new money. As the money supply expands, inflation results.

Let us consider the U.S. Unlike most other economies, there appears to be a huge worldwide demand for U.S. Treasuries and U.S. dollars (which can be thought of as zero-interest Treasuries). A large scale increase in the supply of these government debt instruments need not lead to a depreciation in their value if there is a correspondingly large scale increase in the worldwide demand for these objects. What is the evidence that this may be happening?

Foreigners Snap Up Treasuries Even as US Debt Keeps Rising

But why should this be so? What accounts for what appears to be an insatiable demand for US debt, especially in the wake of the recent financial crisis?

Ricardo Caballero of MIT offers some hints in a very interesting piece entitled: On the Macroeconomics of Asset Shortages. After reading this paper, I started thinking in the following way. Tell me what you think.

There is a high and growing demand for low-risk assets, both as a store of value, and as collateral objects in payment systems (e.g., repo and credit derivatives markets). This growth has exploded over the last 20 years or so; and stems from the demand from emerging economies and innovations in the financial sector. There is a worldwide "shortage" of good quality (low-risk) assets, like U.S. Treasuries (which explains their relatively low yield). Indeed, many of the innovations in the financial sector can be interpreted as the private sector's response to this shortage: the creation of "low-risk" tranches of MBSs allowing these objects to substitute for U.S. Treasuries as collateral in the rapidly expanding repo market. ...

If this is more or less true, then the implication is this: The massive increase in the supply U.S. Treasury debt may very be "socially optimal" in the sense that the U.S. government is simply supplying the world with an asset that is in very high demand (which, in turn, means that the demanders obviously find some value in the existence of such an asset). To the extent that this "new demand regime" remains stable, the added supply of U.S. Treasuries will impose no financial burden on the U.S. (indeed, they make off like bandits, as the Treasuries are ultimately purchased by exporting goods and services to the U.S.).

The million dollar question, of course, is whether the high world demand for U.S. debt will persist long into the future (and whether the U.S. government will "overissue" debt beyond what is called for by this new high-demand regime). Who knows what will happen. But it appears to me that IF the U.S. government plays its cards right, it may very well enjoy its higher debt levels without the prospect of inflation. U.S. citizens will benefit (from the sales of Treasuries for goods) and the world will be grateful to hold a stable asset.

Well, maybe. But that was a big IF. What could possibly go wrong?

The future level of the debt in the U.S. is not a worry if we get effective health care reform (rising health care costs are the major source of projected future deficits). But if a debt problem does exist, I'm not sure the main risk is inflation since I expect the Fed to hold the line on debt monetization. If so, if the Fed does hold the line, then the pressure would be on government spending and taxes. If congress cannot solve the debt problem by cutting spending and/or raising taxes, the result would likely be high interest rates that crowd out private investment. In any case, what this says to me is that to the extent that this demand for safe assets exists, debt levels can be carried at a lower interest rate than otherwise, and this reduces concerns about crowding out (perhaps this is one of the reasons why long-term interest rates have remained relatively low, financial markets recognize this demand exists, believe the demand is large enough to matter, and believe it will continue for some time into the future).

"Tell me what you think."

*****

[On the relationship between debt and inflation, much of the evidence comes from developing countries. Here's one story about why debt and inflation might be related. Often a developing country will decide to run a government deficit to, say, build new roads, bridges, dams, etc. They are trying to build up the infrastructure. The idea is that the future growth that will come from this spending will allow the debt to be paid off. It's an investment in the future of the country -- borrow now, invest the money in needed infrastructure projects, and then use the resulting increase in future economic output to pay for spending (though much less noble motives for increasing debt exist as well).

How can this debt be paid for in the interim, i.e. during the time period when the projects are being built and before the expected growth is realized? The alternatives are to increase taxes, print the money, or borrow the money.

The countries can't increase taxes, these are developing countries and the tax base is insufficient. The whole point of the infrastructure projects is to begin to change that through economic growth.

If they can't tax, then can they borrow the money? Probably not domestically since, again, they are a developing country with little wealth. The necessary funds aren't available domestically. So that leaves borrowing from foreigners. Is that possible? Not if they have defaulted in the past. If they have defaulted, nobody may be willing to take the risk of lending them money, and if the money comes from international agencies such as the IMF, it may come with so many restrictions that it does no good. And even if the money can be borrowed, at some point it must be paid off, and if the promised growth does not materialize (and overly optimistic promises make this likely), investors will be unwilling to allow the debt to be rolled over. The point is that, for developing countries, supporting government spending through taxes or borrowing may not be feasible. This leaves only two choices, giving up on the spending projects, or printing money to pay for them. Printing money - and the inflationary consequences that follow - is often the choice that is made.

Developed countries are not so constrained. They have much more latitude to borrow from their own citizens or from foreigners, they have the ability to raise substantial sums through taxation, and often their infrastructure and other needs aren't as dire. In addition, they can generally count on future growth to help to pay for the borrowing. For all these reasons, developing countries aren't necessarily forced to pay for spending by printing new money and creating inflation.]

"Revisiting Popper"

Is it true that "History and society are not law-governed systems for which we might eventually hope to find exact and comprehensive theories"?:

Revisiting Popper, by Daniel Little: Karl Popper's most commonly cited contribution to philosophy and the philosophy of science is his theory of falsifiability (The Logic of Scientific Discovery, Conjectures and Refutations: The Growth of Scientific Knowledge). (Stephen Thornton has a very nice essay on Popper's philosophy in the Stanford Encyclopedia of Philosophy.) In its essence, this theory is an alternative to "confirmation theory." Contrary to positivist philosophy of science, Popper doesn't think that scientific theories can be confirmed by more and more positive empirical evidence. Instead, he argues that the logic of scientific research is a critical method in which scientists do their best to "falsify" their hypotheses and theories. And we are rationally justified in accepting theories that have been severely tested through an effort to show they are false -- rather than accepting theories for which we have accumulated a body of corroborative evidence. Basically, he argues that scientists are in the business of asking this question: what is the most unlikely consequence of this hypothesis? How can I find evidence in nature that would demonstrate that the hypothesis is false? Popper criticizes theorists like Marx and Freud who attempt to accumulate evidence that corroborates their theories (historical materialism, ego transference) and praises theorists like Einstein who honestly confront the unlikely consequences their theories appear to have (perihelion of Mars).

At bottom, I think many philosophers of science have drawn their own conclusions about both falsifiability and confirmation theory: there is no recipe for measuring the empirical credibility of a given scientific theory, and there is no codifiable "inductive logic" that might replace the forms of empirical reasoning that we find throughout the history of science. Instead, we need to look in greater detail at the epistemic practices of real research communities in order to see the nuanced forms of empirical reasoning that are brought forward for the evaluation of scientific theories. Popper's student, Imre Lakatos, makes one effort at this (Methodology of Scientific Research Programmes; Criticism and the Growth of Knowledge); so does William Newton-Smith (The Rationality of Science), and much of the philosophy of science that has proceeded under the rubrics of philosophy of physics, biology, or economics is equally attentive to the specific epistemic practices of real working scientific traditions. So "falsifiability" doesn't seem to have a lot to add to a theory of scientific rationality at this point in the philosophy of science. In particular, Popper's grand critique of Marx's social science on the grounds that it is "unfalsifiable" just seems to miss the point; surely Marx, Durkheim, Weber, Simmel, or Tocqueville have important social science insights that can't be refuted by deriding them as "unfalsifiable". And Popper's impatience with Marxism makes one doubt his objectivity as a sympathetic reader of Marx's work.

"Should We be Excited about the July New Home Sales Number?"

Richard Green:

Should we be excited about the July new home sales number?: The short answer is no. The July number was the worst July number since 1982; it just wasn't as bad as the June number, which wasn't as bad as the May number.

Everybody wants to know if we have hit bottom. There are three indicators suggesting we have--and three suggesting not. The good: prices in many markets have fallen below replacement cost (which is a pretty robust fundamental in the absence of population declines). Morris Davis at Wisconsin has shown that rent to price ratios have returned to be more in line with long term ratios, and given how low mortgage rates are, this is comforting. And resale inventories in California have dropped to under 4 months.

On the down side, we may have a lot of foreclosed houses coming at us in the next year. The employment picture is still atrocious. And if rents keep falling, prices will follow.

I would also guess that the first-time homebuyer tax credit is time-shifting sales, rather than raising them for the long term, but we shall see. On the other hand, the nature of investor sales is actually a positive indicator: investors are buying with cash and renting out units at decent rates of return. This is very different from the borrow, buy and flip model from the earlier part of this decade.

FWIW, I would assign a subjective probability of .7 that we are at bottom. On the other hand, around 2005, I assigned a .35 probability that we were about to face serious trouble.

Hope or Evidence?

I think this is a fair response to my contention that Bernanke will be effective at pushing for new regulation of the banking industry. Thinking about it more, it's probably true that it is based more on hope than on evidence:

Ben's Second Term, by  Kevin Drum: What do we have to look forward to from Ben Bernanke's second term as chairman of the Fed?  The New York Times asked a bunch of economists for their predictions. Here's Mark Thoma:

My worry is that as time passes, we’ll forget how bad things were and the desire to impose necessary new regulation will fade. Here’s where I think Mr. Bernanke’s experience will be crucial. He was there at every step in the development of the Fed’s response to the crisis and he will not soon forget the problems he faced (nor repeat his mistakes), making it more likely that he’ll be a forceful and passionate advocate for new regulation before Congress. [Italics mine.]

Boy, do I hope this is true.  But it strikes me as woefully wishful thinking. One of the reasons I opposed reappointing Bernanke is that I'd like to have someone running the Fed who's serious about reregulating the financial industry, both at a macro and a consumer level. ...

Still, I remain hopeful.

Update: Free Exchange also responds:

What will Ben Bernanke do?, Free Exchange: Kevin Drum is collecting predictions about Ben Bernanke's second term. Here's Mark Thoma, for instance:

He was there at every step in the development of the Fed’s response to the crisis and he will not soon forget the problems he faced (nor repeat his mistakes), making it more likely that he’ll be a forceful and passionate advocate for new regulation before Congress. ...

Now, no Fed chairman (or potential Fed chairman) can or will pre-commit themselves to specific policy actions before they're nominated (nor should we want them to, given the importance of Fed independence). At the same time, nomination is the one time that political actors get some kind of say over what they want in a Fed chairperson. It therefore seems like it might be a good idea to ask what a nominee's priorities are ahead of time. ...

In other words, it shouldn't be unclear whether Mr Bernanke is going to forcefully advocate for needed regulatory changes. And maybe it isn't unclear to the president. But there's not necessarily any reason we ought to be flying blind with respect to the chairman's views on issues that will be hugely important during his second term. ...

Update: Tim Duy emails:

Bernanke will run away from financial reform if it means the risk of exposing the Fed to enhanced GAO oversight.  And maybe he should.

[End updates]

Here's Thomas Palley's view of Bernanke's reappointment. Thomas is, you will recall, a "heterodox economist" so it's not surprising that most of his criticism is directed at the profession itself rather than at Bernanke (much of which is in the full version of the article). Unfortunately, heterodox economists didn't do any better than mainstream economists at foreseeing and warning about the crisis. Thus, while I agree that new thinking and change is needed to prevent problems in the future, it's not clear that his call to open the Fed to "alternative economic views" would have done anything to help to prevent the problems we are having:

One Hand Clapping for Bernanke, by Thomas I. Palley, Commentary, Project Syndicate: President Barack Obama's nomination of Ben Bernanke to a second term as chairman of the U.S. Federal Reserve represents a sensible and pragmatic decision, but it is nothing to celebrate.

Instead, it should be an occasion for reflection on the role of ideological groupthink among economists, including Bernanke, in contributing to the global economic and financial crisis.

The decision to nominate Bernanke is sensible on two counts. First, the U.S. and global economies remain mired in recession. Though the crisis may be over in the sense that outright collapse has been avoided, the economy remains vulnerable. As such, it makes sense not to risk a shock to confidence that could trigger a renewed downturn.

Second, Bernanke is the best among his peers. He did eventually come to understand the nature and severity of the crisis, and then took decisive steps that contributed to halting the economic freefall.

That record, combined with doubts that any of his peers would have done better, means replacing him with another mainstream candidate makes little sense.

These two factors justify Bernanke's reappointment, but the faintness of praise is indicative of the deeper problems that his leadership has exposed. Those problems concern the state of economics and economic policy advice.

One such problem is Wall Street's implicit veto over the Fed. After all, a major reason for reappointing Bernanke is to avoid rocking financial markets. ...

In effect, financial markets have established an implicit veto over much of economic policy and the people who can hold top policymaking positions, and it is time to think how we can escape that hold.

A second problem concerns the state of economics. Though Bernanke may be the best in his peer group, the fact is that the economic crisis decisively proved him and his peers to have been wrong. ...

Though circumstances dictate that Bernanke is the best candidate and should be reappointed, the real challenge is to ensure a thorough intellectual housecleaning at the Fed in order to open space for alternative economic views.

The great danger is that reappointing Bernanke will be interpreted as a green flag for a flawed status quo.

That is where public debate and Bernanke's Senate confirmation hearings enter the picture. Those hearings should be an occasion for critical examination of what went wrong, and why.

If that happens, Bernanke's reappointment can serve as a trigger for constructive change rather than an endorsement of a discredited paradigm.

links for 2009-08-27

• Markets and values: Competition builds trust - voxeu.org
• UK regulator seeks to deflate financial sector with global tax - FT
• William Poole on Ben Bernanke - MacroMania
• Taylor Rule Change Will Hurt Fed’s Inflation Fight - John Taylor
• Post-Macroeconomics - SSRN - Célestin Monga
• Ben's Second Term - Kevin Drum
• French Bank’s Parent to Guarantee Toxic Assets - NYTimes.com
• Why Ben Bernanke was (and should have been) reappointed - Richard Green
• The Bank Lending Channel Reconsidered - SSRN - Alistair Milne, Geoffrey Wood
• Critically Assessing Bernanke's Record - Macro and Other Market Musings
• The U.S. Economy and the Employment Challenge - Dennis P. Lockhart
• Cabbies & record companies - Stumbling and Mumbling
• Advance Durable Goods Orders - spencer

Do the Costs of Our Financial System Exceed the Benefits?

Does the total cost of our financial system exceed the total benefits at the current scale of operation? Like Benjamin Friedman, I wish I knew the answer, though I suspect that much of the recent innovation would be difficult to justify on the margin:

Overmighty finance levies a tithe on growth, by Benjamin Friedman, Commentary, Financial Times: ...The crucial role of the financial system in a mostly free-enterprise economy is to allocate capital investment towards the most productive applications. The energetic growth and technological advance of the western economies suggest that our financial system has done this job pretty well over long periods. ... The financially triggered Great Recession of 2008-? blemishes this record but does not wipe it away.

Aside from the recession, it is important to ask what this once-admired mechanism costs to run. If a new fertilizer offers ... a higher crop yield but its price and the cost of transporting and spreading it exceeds what the additional produce will bring at market, it is a bad deal for the farmer. A financial system, which allocates scarce investment capital, is no different.

The discussion of the costs associated with our financial system has mostly focused on the paper value of its recent mistakes and what taxpayers have had to put up to supply first aid. ... The misused resources and the output foregone due to the recession are ... part of the calculation of how (in)efficient our financial system is. What has somehow escaped attention is the cost of running the system. ...

One part of that cost is ... much of the best young talent in the western world [going] to private financial firms. ... At the individual level, no one can blame these graduates. But at the level of the aggregate economy, we are wasting one of our most precious resources..., much of their activity adds no economic value.

In the US, both the share of all wages and salaries paid by the financial firms and those firms’ share of all profits earned have risen sharply in recent decades. In the early 1950s, the “finance” sector (not counting insurance and real estate) accounted for 3 per cent of all US wages and salaries; in the current decade that share is 7 per cent. From the 1950s to the 1980s, the finance sector accounted for 10 per cent of all profits earned by US corporations; in the first half of this decade it reached 34 per cent.

These wages and profits – and the office rents, utility bills, advertising and travel expenses – are all parts of the cost of running the mechanism that allocates our economy’s capital. To recall, what makes a new fertilizer a good deal for the farmer is not just that it delivers greater production per acre but that the added production is sufficient to buy the fertilizer and increase the farmer’s own return.

What makes a more efficient financial system worthwhile is not just that it allows us to achieve greater production and economic growth, but that the rest of the economy benefits. The more the financial system costs to run, the higher the hurdle. Does the increased efficiency our investment allocation system delivers meet that hurdle? We simply do not know.

Economic decisions are supposed to turn on weighing costs and benefits. It is time for some serious discussion of what our financial system is actually delivering to our economy and what it costs to do that.

"The Dangers Ahead for Bernanke"

At the Room for Debate, we were asked "What’s the biggest challenge Mr. Bernanke faces in his second term?" Here are the answers:

James K. Galbraith
Tyler Cowen
Brad DeLong
Mark Thoma
Added: Vincent R. Reinhart

My response:

One important challenge Mr. Bernanke will face is to keep the financial sector recovery on track by not raising interest rates too soon, while avoiding inflation by not raising interest rates too late. It will be a difficult balancing act, particularly with the complications that a large budget deficit adds. I’m quite confident Mr. Bernanke is up to the task.

But the most important challenge is how to restructure the financial sector to reduce its vulnerability to a collapse like the one we just experienced. That’s a task that will require both institutional and regulatory change.

Some of this the Fed can do on its own, but other parts require Congressional approval. As the financial sector has started to show signs of life, we are already hearing protests against regulation. The most prominent objection is that regulation will stifle new financial innovation (never mind that it was this innovation that helped to cause the predicament we are in).

My worry is that as time passes, we’ll forget how bad things were and the desire to impose necessary new regulation will fade. Here’s where I think Mr. Bernanke’s experience will be crucial. He was there at every step in the development of the Fed’s response to the crisis and he will not soon forget the problems he faced (nor repeat his mistakes), making it more likely that he’ll be a forceful and passionate advocate for new regulation before Congress.

For example, the Fed needs the authority to dismantle “too big to fail” financial firms, authority it lacked but very much needed during the crisis. Mr. Bernanke knows first hand how hard it was to manage the crisis without this authority. He’s also seen the consequences of an unregulated shadow banking sector, and he knows how bad incentives and poor market structures created problems that could have been avoided.

There are two other factors working in Mr. Bernanke’s favor. If the financial recovery goes as I expect, his reputation will grow, giving him the authority he needs to persuade Congress to make needed regulatory changes. And just as important, unlike some past Fed chairmen, he’s been able to articulate complex ideas in ways that legislators seem to understand.

Update: This is from Barry Ritholtz. It addresses the view held by many that Bernanke should not have been reappointed because he helped to create the housing bubble (which implicitly assumes the Fed is responsible for the bubble - I think the low interest rate policy after the dot.com crash was one source of the liquidity that fueled the housing boom, but not the only source, the global savings glut also played a role, and there were other failures, i.e. false promises of high returns with low risk, that caused the funds to flow into mortgage markets and related securities rather than into other investments):

I am less critical ... regarding the Bernanke renomination [and] his 3 year term as Governor. Let’s not forget that Greenspan was known as the Maestro back then. Congress, which is now pillorying Bernanke every appearance, was adoring of Easy Al’s visage and garbled Greenspeak each and every appearance. AG ran the Fed as an unchallenged stronghold, a fiefdom where he was the central-banker-in-chief as rock star. No one challenged him directly.

That seems to be lost in a lot of the revisionism now taking place. Roach writes “While America’s head central banker deserves credit for being creative and courageous in orchestrating an unusually aggressive monetary easing programme, it is important to remember that his pre-crisis actions played an equally critical role in setting the stage for the most wrenching recession since the 1930s.”

Not exactly. It was Greenspan’s Fed. Under his leadership, the FOMC and its governors were all second bananas to the Wolrd’s most famous banker. In Bailout Nation, I criticize this deference: “The Federal Open Market Committee (FOMC) must take responsibility for following [Greenspan] so obsequiously, especially in the latter years of his reign.”

However much I blame the FOMC, I have a hard time holding them to the same level of accountability as I do Greenspan. He was the master architect, the maestro conducting the monetary policy orchestra.

Second bananas cannot should the blame for what the head of the bunch does. Once they become banana-in-chief, the standards and level of accountability all go up accordingly.

Blogger's Conference Video: Entrepreneurship and the U.S. Economy

I can't watch videos that I am in, so I have no idea what is on this video or what I said. The WSJ's Real Time Economics offers:

The “econoblogosphere” is taking the world by storm, it seems. The latest to draw attention to these bloggers is the Kauffman Foundation, with a new 20-minute video featuring bloggers including Tyler Cowen and Mark Thoma and their thoughts on entrepreneurship and the U.S. economy. “The people that are blogging are part journalist, part economist, part agitator, and we’re seeing a whole new art form, if you will, develop right before our very eyes,” says Robert E. Litan, the foundation’s vice president of research and policy.

links for 2009-08-26

• Bernanke’s four point ‘to-do’ list - FT Alphaville
• Don't Succumb to Deficit Hysteria - Robert Reich
• Subprime Lenders Getting U.S. Subsidies, Report Says - washingtonpost.com
• The timing of fiscal interventions - voxeu.org
• Earthquake Science - Arnold Kling
• U.S. deaths in Afghanistan headed for another record - McClatchy
• Considering a Financial Product Safety Commission - The Tobin Project
• How Insurers Do, and Don’t, Compete - Economix
• Don't Want a Public Plan? What Do You Think of Medicare? - Johnson and Kwak
• Lost cause purgatory - The Reality-Based Community
• Should Journals Have To Compete For Papers? - EconoSpeak
• Economics Bloggers Video - Growthology
• The case against Bernanke - FT.com
• Financial pay shouldn’t be left to the market - Lucian Bebchuk
• Maybe pigs can fly - Richard Green
• Rating agencies vs. investment banks: Who’s minding the shop? - FT
• To Opponents Of The Stimulus - Bruce Bartlett
• Bernanke Reappointment Is ‘Good News’ - Real Time Economics

Are Macroeconomic Models Useful?

There has been no shortage of effort devoted to predicting earthquakes, yet we still can't see them coming far enough in advance to move people to safety. When a big earthquake hits, it is a surprise. We may be able to look at the data after the fact and see that certain stresses were building, so it looks like we should have known an earthquake was going to occur at any moment, but these sorts of retrospective analyses have not allowed us to predict the next one. The exact timing and location is always a surprise.

Does that mean that science has failed? Should we criticize the models as useless?

No. There are two uses of models. One is to understand how the world works, another is to make predictions about the future. We may never be able to predict earthquakes far enough in advance and with enough specificity to allow us time to move to safety before they occur, but that doesn't prevent us from understanding the science underlying earthquakes. Perhaps as our understanding increases prediction will be possible, and for that reason scientists shouldn't give up trying to improve their models, but for now we simply cannot predict the arrival of earthquakes.

However, even though earthquakes cannot be predicted, at least not yet, it would be wrong to conclude that science has nothing to offer. First, understanding how earthquakes occur can help us design buildings and make other changes to limit the damage even if we don't know exactly when an earthquake will occur. Second, if an earthquake happens and, despite our best efforts to insulate against it there are still substantial consequences, science can help us to offset and limit the damage. To name just one example, the science surrounding disease transmission helps use to avoid contaminated water supplies after a disaster, something that often compounds tragedy when this science is not available. But there are lots of other things we can do as well, including using the models to determine where help is most needed.

So even if we cannot predict earthquakes, and we can't, the models are still useful for understanding how earthquakes happen. This understanding is valuable because it helps us to prepare for disasters in advance, and to determine policies that will minimize their impact after they happen.

All of this can be applied to macroeconomics. Whether or not we should have predicted the financial earthquake is a question that has been debated extensively, so I am going to set that aside. One side says financial market price changes, like earthquakes, are inherently unpredictable -- we will never predict them no matter how good our models get (the efficient markets types). The other side says the stresses that were building were obvious. Like the stresses that build when tectonic plates moving in opposite directions rub against each other, it was only a question of when, not if. (But even when increasing stress between two plates is observable, scientists cannot tell you for sure if a series of small earthquakes will relieve the stress and do little harm, or if there will be one big adjustment that relieves the stress all at once. With respect to the financial crisis, economists expected lots of little, small harm causing adjustments, instead we got the "big one," and the "buildings and other structures" we thought could withstand the shock all came crumbling down. On prediction in economics, perhaps someday improved models will allow us to do better than we have so far at predicting the exact timing of crises, and I think that earthquakes provide some guidance here. You have to ask first if stress is building in a particular sector, and then ask if action needs to be taken because the stress has reached dangerous levels, levels that might result in a big crash rather than a series of small stress relieving adjustments. I don't think our models are very good at detecting accumulating stress, in large part because when we are not at the long-run equilibrium, we model the short-run as though every market clears at every point in time. This means that there are no stresses continuously building in these models, the adjustments always relieve the stress and move us back toward long-run equilibrium. We have to do a better job of allowing for the build up of stress within our models, and then using these models to guide the measurement and monitoring of "stress levels" in particular markets, particularly asset markets, so we can take action when the levels are too high.)

Whether the financial crisis should have been predicted or not, the fact that it wasn't predicted does not mean that macroeconomic models are useless any more than the failure to predict earthquakes implies that earthquake science is useless. As with earthquakes, even when prediction is not possible (or missed), the models can still help us to understand how these shocks occur. That understanding is useful for getting ready for the next shock, or even preventing it, and for minimizing the consequences of shocks that do occur. 

But we have done much better at dealing with the consequences of unexpected shocks ex-post than we have at getting ready for these a priori. Our equivalent of getting buildings ready for an earthquake before it happens is to use changes in institutions and regulations to insulate the financial sector and the larger economy from the negative consequences of financial and other shocks. Here I think economists made mistakes - our "buildings" were not strong enough to withstand the earthquake that hit. We could argue that the shock was so big that no amount of reasonable advance preparation would have stopped the "building" from collapsing, but I think it's more the case that enough time has passed since the last big financial earthquake that we forgot what we needed to do. We allowed new buildings to be constructed without the proper safeguards.

However, that doesn't mean the models themselves were useless. The models were there and could have provided guidance, but the implied "building codes" were ignored. Greenspan and others assumed no private builder would ever construct a building that couldn't withstand an earthquake, the market would force them to take this into consideration. But they were wrong about that, and even Greenspan now admits that government building codes are necessary. It wasn't the models, it was how they were used (or rather not used) that prevented us from putting safeguards into place.

We haven't failed at this entirely though. For example, we have had some success at putting safeguards into place before shocks occur, automatic stabilizers have done a lot to insulate against the negative consequences of the recession (though they could have been larger to stop the building from swaying as much as it has). So it's not proper to say that our models have not helped us to prepare in advance at all, the insulation social insurance programs provide is extremely important to recognize. But it is the case that we could have and should have done better at preparing before the shock hit.

I'd argue that our most successful use of models has been in cleaning up after shocks rather than predicting, preventing, or insulating against them through pre-crisis preparation. When despite our best effort to prevent it or to minimize its impact a priori, we get a recession anyway, we can use our models as a guide to monetary, fiscal, and other policies that help to reduce the consequences of the shock (this is the equivalent of, after a disaster hits, making sure that the water is safe to drink, people have food to eat, there is a plan for rebuilding quickly and efficiently, etc.). As noted above, we haven't done a very good job at predicting big crises, and we could have done a much better job at implementing regulatory and institutional changes that prevent or limit the impact of shocks. But we do a pretty good job of stepping in with policy actions that minimize the impact of shocks after they occur. This recession was bad, but it wasn't another Great Depression like it might have been without policy intervention.

Whether or not we will ever be able to predict recessions reliably, it's important to recognize that our models still provide considerable guidance for actions we can take before and after large shocks that minimize their impact and maybe even prevent them altogether (though we will have to do a better job of listening to what the models have to say). Prediction is important, but it's not the only use of models.

What Happened to Chicago's "Life of the Mind"?

Via email:

For someone with close ties to the place, the changes in the economics department at the University of Chicago are incredibly sad.

Steve Levitt, the future of the Friedman/Stigler/Becker tradition of microeconomics is turning his Freakonomics blog in to a carny side-show, most recently with a smirking post about breast implants and a gruesome murder. Meanwhile, Richard Posner tries to make a principled stand in favor of serious intellectual discourse on macroeconomic policy, but is so out of touch that he ends up channeling Steven Colbert. It's hard to recall any instance in which an author so publicly and completely undercut his own argument.

Milton Friedman used to speak with nostalgia about the things that made Chicago unique. When he arrived, it was far away from both the corridors of power and from the east-coast bastions of accepted wisdom. It was the kind of place where as a young academic he could make claims that no one else believed: The data from the great depression actually showed that monetary policy was extraordinarily powerful. Exchange rates trade in open market; traders at the commodities exchanges could even write futures contracts on exchange rates. The government could finance public education without being the provider.

These ideas, all widely accepted now, were heresy when Friedman proposed them. But Chicago was the kind of place where you could take an unusual stand. Your colleagues would take your ideas seriously, challenge them, probe them, help you decide if they were right. 

Over time, the willingness to challenge the prevailing consensus that characterized the Chicago School has devolved into smug willingness to shock. Friedman's colleagues held him accountable. Where are the colleagues who could keep Levitt and Posner from flying off the rails? The debates that the department was once so proud of, the ones that constituted "the life of the mind," have been replaced by blog posts. 

Posner, of course, made his career by pushing the limits, famously with his 1978 paper on adoption. In retrospect, the tone then had already begun to change. He had a serious point to make, but he was just a little bit too eager to be the bad boy and get attention. Friedman could have given the same analysis, but is hard to believe that he would casually dropped in a reference to the "the baby market."

Steve's post about the brutal murder of the young woman certainly got attention, including a comment that starts, "He he." What his point could possibly be, other than getting attention, is hard to imagine. Read the post and the comments that follow if you ever have trouble remembering why so many people hate economists.

In truth, Friedman did also pioneer the role of economist as celebrity. He balanced the conflicts this raises remarkably well, but in the end it is not a healthy mix. If Levitt and Posner are the role models that the next generation at Chicago look up to, the future is grim.

links for 2009-08-25

• Why have Canadian banks been more resilient? - voxeu.org
• Economists React: Bernanke Reappointment Is ‘Good News’ - RTE
• Existing Home Sales Far Worse Than Advertised - The Big Picture
• Get Ready for Interest Rate Shocks - David Beckworth
• The GOP embraces the big lie - Salon.com
• Why Does the New York Times Publish Casey Mulligan? - Brad DeLong
• Fiscal Policy and Recoveries in Various Large Countries - pgl
• Obama to Nominate Bernanke to Lead Fed for Second Term - NYTimes.com
• Q: Where do too-big-to-fails come from? A: Reaganomics - New Deal 2.0
• Magic and the myth of the rational market - FT
• Cash for Clunkers helped car dealers. But... - Daniel Gross
• The Stash - links
• The Big Picture - links
• Abnormal Returns - links
• Credit Writedowns - links
• Bill Easterly - links
• Free Exchange - links
• naked capitalism - links
• FT Alphaville - links
• Marginal Revolution - links
• Brad DeLong - links

"Why This New Crisis Needs a New Paradigm of Economic Thought"

[More Side of the road blogging - stopped for a moment at the Great Salt Lake.] When I talked to the senate's COP panel, one of many things that I emphasized was the need to develop plans in advance to deal with various contingencies. Without such plans policy actions - even justifiable ones - appear ad hoc and also face resistance that delays their implementation or prevents them from being put into place altogether.

For example, we need a plan on the shelf and ready to go for dismantling large banks that have failed, something that has received a lot of attention. It has received much less attention, but I also think we need a plan for disposing troubled financial assets when the need arises. I still believe that the crisis would have been much less severe if very early, prior to Lehman for sure, the government had moved aggressively to buy bad assets from bank balance sheets. it took far too long, and when they finally decided to do this (i.e. the original Paulson plan), they had no idea how to value the assets, there was considerable political resistance because nobody knew how the program would work (allowing lots of false information to enter the debate), and so on, and this program never really got off the ground. The assets are still there waiting for the miracle of rising asset prices to restore their value.

Having a plan ready in advance that specifies how assets will be valued, how taxpayers will be protected if the government overpays (overpaying can help with recapitalization, but it shouldn't be a gift), and so on, a plan that has been approved in advance by legislators (at least implicitly) so as to reduce political resistance, will overcome many of the technical problems and objections that prevented the bad asset removal programs from being used effectively in this crisis.

Keiichiro Kobayashi believes these toxic assets, many of which are still hidden on bank balance sheets, are still a problem and could result in a Japan style lost decade if the government does not remove them, and he calls for a new macroeconomic paradigm that puts these issues front and center (On his main point about whether financial sector recovery is necessary before the real economy can recover, I think we will recover either way, but agree that recovery would be faster if these assets were removed once and for all - but I should get back on the road...):

Why this new crisis needs a new paradigm of economic thought, by Keiichiro Kobayashi, Commentary, Vox EU: The policies being debated in the US and Europe today are almost identical to those that played out in Japan a decade or so ago. Japan experienced the collapse of its colossal property bubble in 1990 and then a series of crises as major banks and securities companies were overwhelmed by rapidly rising non-performing debts. The conventional wisdom among economists and politicians throughout the 1990s was that massive public expenditure and extraordinary monetary easing would give the necessary boost to market sentiments and prompt an economic recovery. Public opinion in the US and Europe today seems to be the same.

And indeed, throughout the 1990s, Japan did introduce major public works projects and tax cuts, yet the economy failed to stabilise, asset prices continued to fall, and the volume of non-performing debts continued to climb. Far from being dispelled, the sense of insecurity that had permeated the markets actually increased throughout the 1990s, ultimately leading to the collapse of several major financial institutions in 1997 and sparking an outbreak of panic.

Even after this, recovery efforts continued to be channelled through large-scale public expenditure, while the disposal of non-performing debts became bogged down. Only around 2001 did Japanese public opinion finally turn away from the belief that reductions in bad debt and financial system stability would follow an economy recovery. The public came to understand that the financial system had to be stabilised and market insecurity dispelled before any recovery could occur. Special inspections were conducted repeatedly by financial regulators and Japanese megabanks were forced to accept massive capital increases and a new round of mergers. Meanwhile, the Resolution and Collection Corporation and the Industrial Revitalisation Corporation of Japan restructured companies that had collapsed under enormous debt burdens and finally broke the back of the non-performing debt problem. This sparked a recovery of market confidence, and Japan enjoyed a period of economic expansion from 2002 to 2007.

Paul Krugman: All the President’s Zombies

The age of Reaganism should be over, but it isn't:

All the President’s Zombies, by Paul Krugman, Commentary, NY Times: The debate over the “public option” in health care has been dismaying in many ways. Perhaps the most depressing aspect for progressives, however, has been the extent to which opponents of greater choice in health care have gained traction — in Congress, if not with the broader public — simply by repeating, over and over again, that the public option would be, horrors, a government program.

Washington, it seems, is still ruled by Reaganism — by an ideology that says government intervention is always bad, and leaving the private sector to its own devices is always good.

Call me naïve, but I actually hoped that the failure of Reaganism in practice would kill it. It turns out, however, to be a zombie doctrine: even though it should be dead, it keeps on coming.

Let’s talk for a moment about why the age of Reagan should be over.

First of all, even before the current crisis Reaganomics had failed to deliver what it promised. Remember how lower taxes on high incomes and deregulation that unleashed the “magic of the marketplace” were supposed to lead to dramatically better outcomes for everyone? Well, it didn’t happen. ...

President George W. Bush, who had the distinction of ... presiding over the first administration since Herbert Hoover in which the typical family failed to see any significant income gains.

And then there’s the small matter of the worst recession since the 1930s. There’s a lot to be said about the financial disaster..., but the short version is simple: politicians in the thrall of Reaganite ideology dismantled the New Deal regulations that had prevented banking crises for half a century, believing that financial markets could take care of themselves. The effect was to make the financial system vulnerable to a 1930s-style crisis — and the crisis came.

“We have always known that heedless self-interest was bad morals,” said Franklin Delano Roosevelt in 1937. “We know now that it is bad economics.” And last year we learned that lesson all over again.

Or did we? The astonishing thing about the current political scene is the extent to which nothing has changed.

The debate over the public option has, as I said, been depressing in its inanity. ... But it’s much the same on other fronts. Efforts to strengthen bank regulation appear to be losing steam, as opponents of reform declare that more regulation would lead to less financial innovation — this just months after the wonders of innovation brought our financial system to the edge of collapse...

So why won’t these zombie ideas die?

Part of the answer is that there’s a lot of money behind them. ... In particular, vast amounts of insurance industry money have been flowing to obstructionist Democrats like Mr. Nelson and Senator Max Baucus, whose Gang of Six negotiations have been a crucial roadblock to legislation.

But some of the blame also must rest with President Obama, who famously praised Reagan during the Democratic primary, and hasn’t used the bully pulpit to confront government-is-bad fundamentalism. That’s ironic, in a way, since a large part of what made Reagan so effective, for better or for worse, was the fact that he sought to change America’s thinking as well as its tax code.

How will this all work out? I don’t know. But it’s hard to avoid the sense that a crucial opportunity is being missed, that we’re at what should be a turning point but are failing to make the turn.

Many people - people who make up key voting blocks - are happy with the health care coverage they have now (employer based or Medicare for the most part) and they do not want it to change. Thus, if they can be convinced that they will have to give up some of their own health care (and/or pay much higher taxes) in order to expand coverage to the uninsured, then they will be unlikely to support reform. The government death panel lie plays into people's fear of losing what they have now by implying that choices will be much more limited if reform is enacted, and worse, that someone else will make the choices for you. It promotes the general fear that government involvement means less options than are available now, and that many of the choices will be mandated.

Democrats made a mistake, I think, by not emphasizing that just the opposite is true. It is the failure to reform health care that will limit future choices, perhaps severely if cost projections are realized. Government is the best hope of maintaining the choices that are available now, and of expanding the choices available to those who currently have no health insurance. In light of this, the message from reform supporters has emphasized the need for both cost control and expanded coverage.

The problem with the message is that cutting costs and expanding coverage sounds like it's a tradeoff. That is, it sounds like the intent is to cut costs - partly by limiting choices for those who now have coverage - in order to expand coverage to those who are currently uninsured. Because of this, people who have adequate coverage are afraid of losing options and control over their care. Democrats need to explain that universal coverage and cost control are not tradeoffs in this sense, but rather both of these are elements of an overall strategy to do the best we can to maintain the choices that people now have. It's not one of the other, both are part of a system-wide approach to reform. The same is true with other elements of the plan such as the public option. This doesn't take away the choice of health care plans, it adds one and if people don't like it, they don't have to use it.

The point that Democrats must make clear is that doing nothing puts people's existing health care coverage at substantial risk. People should be very afraid if reform fails, especially people who have good coverage now since they're the ones with the most to lose. So while I wholeheartedly agree that Democrats need to confront "government-is-bad fundamentalism," they also need to make clear how government can do good. System-wide reform of health care is the best chance people have for a health care system that meets their needs at least as well as what they have now, and the necessary reform cannot be accomplished without government's help.

links for 2009-08-24

• Status-Quo Anxiety - The New Yorker
• Claiming the Social Security Benefits Will Fall - pgl
• The risk of a double-dip recession is rising - Nouriel Roubini
• The market-perceived monetary policy rule - Econbrowser
• Job Guarantee - Randall Wray
• A Low-Tech Appratus for Horizon-Scanning - Economic Principals
• EconTech - links
• Credit Writedowns - links
• Abnormal Returns - links
• Naked Capitalism - links
• FT Alphaville - links
• Brad DeLong - links

"Fictional Sovereignties"

More side of the road blogging (still traveling):

Fictional Sovereignties, by Robert Skidelsky, Commentary, Project Syndicate: ...The world's population is about six billion. Suppose it was divided into independent political units of two million people each. That would mean 3,000 micro-states, each refusing to accept any sovereignty superior to its own. Of course, this would be a recipe for global anarchy.

Yet the trend over the past century has been toward a continuous increase in the number of small states, mainly owing to nationalist revolts against multinational empires: the latest bout of state creation followed the disintegration of the USSR.

Even long-established states like the United Kingdom now have strong separatist movements. In its political life, the world has been regressing to a form of tribalism, even as its economic life has become increasingly globalized.

The equation of state with nation is the arch-heresy of our time. A "nation" is, at root, an ethno-linguistic ― occasionally religious ― entity, and because it is through language and liturgy that culture is transmitted, each nation will have its own distinctive cultural history, available for use and misuse, invention and discovery.

The state, however, is a political construction, designed to keep the peace in an economically viable territory. There are simply too many "nations," actual or potential, to form the basis of a world system of states, not least because so many of them, having been jumbled up for centuries, cannot now be disentangled.

Micro-states can never be made small enough to satisfy their advocates' exalted standards of cultural integrity. So the unraveling of multinational states is a false path.

The way forward lies in democratic forms of federalism, which can preserve sufficient central authority for the purposes of statehood, while respecting local and regional cultures.

Today's upsurge of micro-nationalism is not just a consequence of the revolt against empires: it is also a revolt against globalization.

There is widespread resistance to the idea that the chief function of modern states is to slot their peoples into a global market dominated by the imperatives of efficiency and cheapness, heedless of the damage to non-economic activities.

This feeling is strengthened when the global economy turns out to be a global casino. National assertion is a way of combating impersonal forces and remote authorities.

Globalization promises too much in terms of welfare gains, particularly to developing countries, to be abandoned.

But the lesson from the current crisis is that we will have to develop styles of global economic governance to manage, regulate, and mitigate the creative, but often disruptive forces unleashed by the global market.

In the absence of an actual world government, this can be done only through cooperation among states. The fewer "sovereigns" there are, the easier it will be to secure the necessary cooperation.

The Bretton Woods Agreement of 1944, which laid the institutional foundation for the postwar World War II economy, was made possible because the United States and Britain called the shots.

When objections were raised to Cuba being put on the drafting committee, Harry Dexter White, the American representative, remarked that Cuba's function was to provide cigars.

Such a cavalier attitude to the demands of lesser powers to be heard is no longer possible. But all this means is that the facades will have to be more subtle and the fictions more elaborate.

Provided we do not deceive ourselves about where real power lies, let presidents and parliaments be three a penny if that is what makes people feel good about themselves.

I agree that we shouldn't deceive ourselves about where the real power lies, but we also need to recognize that as other economies around the world develop, the distribution of power will shift, something that global institutions must begin to incorporate into their governance structures (the power shift is already happening, even more so after the war in Iraq and the financial crisis undermined the authority of the U.S.).

"Don’t Let the Stimulus Lose Its Spark"

Robert Frank makes two points. First, state and local governments facing budget problems due to the recession need more help from the federal government. Second, those who object to federal help for states, or to government spending to stimulate the economy more generally, "have not offered persuasive arguments":

Don’t Let the Stimulus Lose Its Spark, by Robert Frank, Commentary, NY Times: Encouraging economic news has been reanimating the critics of President Obama’s stimulus program. But heeding their admonition to end the program would be a grave mistake. We need more stimulus now, not less.

Even if the economy is improving, it is still very weak. Another quarter-million jobs were lost last month... Now we face an ominous new threat to recovery from sharp cuts in state and local government spending. ... These cuts were mandated by laws meant to stop politicians from spending beyond their means. While such measures may be beneficial on balance, sharply reduced government spending is exactly what the economy doesn’t need right now.

Through its legal authority to run deficits to stabilize the economy, the federal government can keep recovery on track by transferring revenue to states and cities. Of course, opponents of the original economic stimulus program have no desire to see it extended this way. Yet they haven’t made a persuasive case. The flaws in their arguments don’t rise to the absurd heights seen in recent town hall meetings on health care reform. But it is a difference in degree, not kind. ...

In a recent column in Forbes magazine, the economist Lee Ohanian of the University of California, Los Angeles, a stimulus opponent, explained why he believes that increased government spending wouldn’t help... The problem, he says, is that “the higher taxes on incomes or expenditures that ultimately accompany higher spending depress economic activity.” ...

His argument, and that of stimulus opponents generally,... boils down to this striking contention: As the government spends borrowed funds, consumers will start to realize that the resulting debt spells higher taxes in the future, which will lead them to curtail their current spending. Those cuts will offset increased government spending, leaving no net stimulus.

Although there may be people who would actually spend less now to hedge against uncertain future tax bills, it’s unlikely that you know any of them. As behavioral economists have been saying for decades, that’s just not the way most people act. Hardly any consumers even know how ... the national debt ... will affect future taxes.

More important, there are good reasons for believing that stimulus spending will make people’s future tax payments lower, not higher. Yes, government borrowing adds to the national debt. But if the stimulus also hastens the downturn’s end, it will accelerate the growth of future incomes and tax revenue. In that case, the net effect would be to reduce future taxes, compared with what they would have been without the stimulus. ...

The recent state and local spending cuts are a major setback to the stimulus program, which many economists have argued was much too small to begin with. A small minority disagrees but has not offered persuasive arguments.

The downturn threatens every goal we care about. Doing everything possible to limit state and local spending cuts will help end it faster.

Helping states is a good idea, and more help is needed. But that's not enough by itself to bring aggregate demand up to the necessary level, other types of spending are also needed  (think of it this way - saving every state and local job that would be cut without federal aid is not enough to solve the employment problem).

However, a state that knows the federal government will step in and help if it gets into trouble may be unwilling to take steps to smooth the state's business cycle such as creating a rainy day fund (i.e., build the fund during boom times bringing output closer to its long-run trend, and spend the fund during the bad times also bringing output closer to its long-run trend). Because of this, if the federal government stands ready to backfill state budgets during recessions, we may want to require that states meet certain restrictions (such as having a rainy day fund of a particular size) before they can receive help.

Allowing state government to contract during a recession makes things worse, and I believe this recession will teach us that the federal government needs to provide much more help than it did this time around. But if the federal government does explicitly take on the responsibility to prevent state governments from contracting when the economy turns downward, then the obligations of local, state, and federal governments need to be clarified. We also need to make sure, as much as possible, that the states cannot game the system to their advantage.

Update: Brad DeLong adds, in reference to Lee Ohania's argument:

This is, as I say every day, simply wrong as a matter of very basic economic theory. Increased nominal government spending financed by future taxes is crowded out by a reduction in nominal private consumption spending if and ony if what the government spends money on is a perfect substitute for what private consumers spend money on. That just is not the case.

"Five Myths about Health Care around the World"

An attempt to "dispel a few myths about health care abroad":

5 Myths About Health Care Around the World, by By T.R. Reid, Commentary, Washington Post: ...I've traveled the world ... to see how other developed democracies provide health care. Instead of dismissing these models as "socialist," we could adapt their solutions to fix our problems. To do that, we first have to dispel a few myths about health care abroad:

1. It's all socialized medicine out there. Not so. ... In some ways, health care is less "socialized" overseas than in the United States. Almost all Americans sign up for government insurance (Medicare) at age 65. In Germany, Switzerland and the Netherlands, seniors stick with private insurance plans for life. Meanwhile, the U.S. Department of Veterans Affairs is one of the planet's purest examples of government-run health care....

2. Overseas, care is rationed through limited choices or long lines. Generally, no. Germans can sign up for any of the nation's 200 private health insurance plans -- a broader choice than any American has. ... The Swiss, too, can choose any insurance plan in the country.

In France and Japan, you ... can go to any doctor, any hospital, any traditional healer. There are no U.S.-style limits such as "in-network" lists of doctors or "pre-authorization" for surgery. You pick any doctor, you get treatment -- and insurance has to pay. ...

As for those notorious waiting lists, some countries are indeed plagued by them. Canada makes patients wait weeks or months for nonemergency care, as a way to keep costs down. But ... many nations -- Germany, Britain, Austria -- outperform the United States on measures such as waiting times for appointments and for elective surgeries. In Japan, waiting times are so short that most patients don't bother to make an appointment. ...

3. Foreign health-care systems are inefficient, bloated bureaucracies. Much less so than here. ...

4. Cost controls stifle innovation. False. The United States is home to groundbreaking medical research, but so are other countries... Any American who's had a hip or knee replacement is standing on French innovation. ... Many of the wonder drugs promoted endlessly on American television, including Viagra, come from British, Swiss or Japanese labs. Overseas, strict cost controls actually drive innovation. ...

5. Health insurance has to be cruel. Not really. American health insurance companies routinely reject applicants with a "preexisting condition"... They employ armies of adjusters to deny claims. If a customer ... faces big medical bills, the insurer's "rescission department" digs through the records looking for grounds to cancel the policy... Foreign health insurance companies, in contrast, must accept all applicants, and they can't cancel as long as you pay your premiums. ...

In many ways, foreign health-care models are not really "foreign" to America, because our ... system uses elements of all of them. For Native Americans or veterans, we're Britain: The government provides health care, funding it through general taxes, and patients get no bills. For people who get insurance through their jobs, we're Germany: Premiums are split between workers and employers, and private insurance plans pay private doctors and hospitals. For people over 65, we're Canada: Everyone pays premiums for an insurance plan run by the government, and the public plan pays private doctors and hospitals according to a set fee schedule. And for the tens of millions without insurance coverage, we're Burundi or Burma: In the world's poor nations, sick people pay out of pocket for medical care...

This fragmentation is another reason that we spend more than anybody else and still leave millions without coverage. All the other developed countries have settled on one model for health-care delivery and finance; we've blended them all into a costly, confusing bureaucratic mess.

Which, in turn, punctures the most persistent myth of all: that America has "the finest health care" in the world. We don't. In terms of results, almost all advanced countries have better national health statistics than the United States... In terms of finance, we force 700,000 Americans into bankruptcy each year because of medical bills. In France, the number of medical bankruptcies is zero. Britain: zero. Japan: zero. Germany: zero.

Given our remarkable medical assets -- the best-educated doctors and nurses, the most advanced hospitals, world-class research -- the United States ... should be the best in the world. To get there, though, we have to be willing to learn some lessons about health-care ... from the other industrialized democracies.

There are, of course, groups that have a strong interest in perpetuating these myths as part of their attempt to block health care reform.

"Why Sleep?"

Is sleep our power saving mode?:

Why sleep?, EurekAlert: ...Humans ... spend roughly one-third of their lives asleep, but sleep researchers still don't know why. ... Theories range from brain "maintenance" — including memory consolidation and pruning — to reversing damage from oxidative stress suffered while awake, to promoting longevity. ...

Now, a new analysis by Jerome Siegel, UCLA professor of psychiatry ... has concluded that sleep's primary function is to increase animals' efficiency and minimize their risk by regulating the duration and timing of their behavior. The research appears in the current online edition of the journal Nature Reviews Neuroscience.

"Sleep has normally been viewed as something negative for survival because sleeping animals may be vulnerable to predation and they can't perform the behaviors that ensure survival," Siegel said. These behaviors include eating, procreating, caring for family members, monitoring the environment for danger and scouting for prey.

"So it's been thought that sleep must serve some as-yet unidentified physiological or neural function that can't be accomplished when animals are awake," he said.

Siegel's lab conducted a new survey of the sleep times of a broad range of animals, examining everything from the platypus and the walrus to the echidna, a small, burrowing, egg-laying mammal covered in spines. The researchers concluded that sleep itself is highly adaptive, much like the inactive states seen in a wide range of species, starting with plants and simple microorganisms; these species have dormant states — as opposed to sleep — even though in many cases they do not have nervous systems. That challenges the idea that sleep is for the brain, said Siegel.

links for 2009-08-23

• Leakage from Carbon Offsets - Michael Roberts
• The global financial crisis one year after - Jeffrey D Sachs
• Who's the best at targeting inflation? - News N Economics
• Five Myths About Health Care in the Rest of the World - washingtonpost.com
• A Public Option That Works - NYTimes.com
• Is It A Smart Signal To Submit Papers To Econ Journals With Incorrect Reference Formats? - EconoSpeak
• Patient safety -- Canada and France - UnderstandingSociety
• Did the administration tweak its position on derivatives regulation? - Economics of Contempt
• How the world likely views arguments among academics - Richard Green

"Why the Gang of Six is Deciding Health Care"

Why does the "gang of six" have so much power over health care reform?:

Why the Gang of Six is Deciding Health Care for Three Hundred Million of Us, by Robert Reich: Last night, the so-called "gang of six" -- three Republican and three Democratic senators on the Senate Finance Committee -- met by conference call and, according to Senator Max Baucus, the committee's chair, reaffirmed their commitment "toward a bipartisan health-care reform bill" (read: less coverage and no public insurance option). The Washington Post reports that the senators shared tales from their home states, where some have been besieged by protesters angry about a potential government takeover of the nation's health care system. ...

But who, exactly, anointed these six to decide the fate of the nation's health care?

I don't get it. Of the three Republicans in the gang, the senior senator is Charles Grassley. In recent weeks Grassley has refused to debunk the rumor that the House's health-care bill will spawn "death panels"... Grassley called the President and Speaker Nancy Pelosi "intellectually dishonest" for claiming the opposite. On Thursday Grassley told the Washington Post that Congress should scale back its efforts to overhaul health care in the wake of intense anger at town hall meetings. But -- wait -- the anger is largely about distortions such as the "death panels" that Grassley refuses to debunk.

This week on Fox News Grassley termed the House bill "the Pelosi Bill," and called it "a government takeover of heath care, exploding the deficit because it's not paid for and it's got high taxes in it."

I really don't get it. We have a Democratic president in the White House. Democrats control sixty votes in the Senate, enough to overcome a filibuster. It is possible to pass health care legislation through the Senate with 51 votes (that's what George W. Bush did with his tax cut plan). Democrats control the House. The Speaker of the House, Nancy Pelosi, is a tough lady. She has said there will be no health care reform bill without a public option.

So why does the fate of health care rest in Grassley's hands?

It's not even as if the gang represents America. The three Dems on the gang are from Montana, New Mexico, and North Dakota -- states that together account for just over 1 percent of Americans. The three Republicans are from Maine, Wyoming, and Iowa, which together account for 1.6 percent of the American population.

So, I repeat: Why has it come down to these six? Who anointed them? Apparently, the White House. At least that's what I'm repeatedly being told by sources both on the Hill and in the Administration. "The Finance Committee is where the action is. They'll tee-up the final bill," says someone who should know.

links for 2009-08-22

• Sour sixteen - Paul Krugman
• Bernanke’s Speech: The Quick Version - Real Time Economics
• Why the Gang of Six is Deciding Health Care for Three Hundred Million of Us - Robert Reich
• What Fraction of Richard Posner's Arguments Are Off by a Factor of Sixteen? - Brad DeLong
• Thanks to Ben Bernanke, Ben Bernanke Doesn't Need to be Reappointed as Fed Chair - Tom Bozzo
• Richard Posner Misunderstands Numbers, Yet Again - Econbrowser
• The roots of the "clean up after bubbles" approach - Free Exchange
• Across three Augusts - Free Exchange

Paul Krugman: Obama’s Trust Problem

The fight over the public plan is about more than just health care policy:

Obama’s Trust Problem, by Paul Krugman, Commentary, NY Times: According to news reports, the Obama administration — which seemed, over the weekend, to be backing away from the “public option” for health insurance — is shocked and surprised at the furious reaction from progressives.

Well, I’m shocked and surprised at their shock and surprise.

A backlash in the progressive base — which pushed President Obama over the top in the ...election... has been building for months. The fight over the public option involves real policy substance, but it’s also a proxy for broader questions about the president’s priorities and overall approach. ...

One purpose of the public option is to save money. Experience with Medicare suggests that a government-run plan would have lower costs than private insurers; in addition, it would introduce more competition and keep premiums down.

And let’s be clear: the supposed alternative, nonprofit co-ops, is a sham. That’s not just my opinion; it’s what the market says: stocks of health insurance companies soared on news that the Gang of Six senators trying to negotiate a bipartisan approach to health reform were dropping the public plan. Clearly, investors believe that co-ops would offer little real competition to private insurers.

Also, and importantly, the public option offered a way to reconcile differing views among Democrats. Until the idea of the public option came along, a significant faction ... rejected anything short of true single-payer, Medicare-for-all reform... The public option ... settled some of those qualms.

That said, it’s possible to have universal coverage without a public option — several European nations do it — and some who want a public option might be willing to forgo it if they had confidence in the overall health care strategy. Unfortunately, the president’s behavior in office has undermined that confidence.

On the issue of health care itself, the inspiring figure progressives thought they had elected comes across, far too often, as a dry technocrat... Mr. Obama’s explanations of his plan have gotten clearer, but he still seems unable to settle on a simple, pithy formula...

Meanwhile, on such fraught questions as torture and indefinite detention, the president has dismayed progressives with his reluctance to challenge or change Bush administration policy.

And then there’s the matter of the banks.

I don’t know if administration officials realize just how much damage they’ve done themselves with their kid-gloves treatment of the financial industry...

So there’s a growing sense among progressives that they have, as my colleague Frank Rich suggests, been punked. And that’s why the mixed signals on the public option created such an uproar.

Now,... Mr. Obama was never going to get everything his supporters wanted.

But there’s a point at which realism shades over into weakness, and progressives increasingly feel that the administration is on the wrong side of that line. It seems as if there is nothing Republicans can do that will draw an administration rebuke: Senator Charles E. Grassley feeds the death panel smear, warning that reform will “pull the plug on grandma,” and two days later the White House declares that it’s still committed to working with him.

It’s hard to avoid the sense that Mr. Obama has wasted months trying to appease people who can’t be appeased, and who take every concession as a sign that he can be rolled.

Indeed, no sooner were there reports that the administration might accept co-ops as an alternative to the public option than G.O.P. leaders announced that co-ops, too, were unacceptable.

So progressives are now in revolt. Mr. Obama took their trust for granted, and in the process lost it. And now he needs to win it back.

"Public Auction Option Shouldn't be a Deal Breaker"

Tim Duy recommends this piece on public-private competition. The argument, based upon the outcome of public-private competition in electrical power and worker's compensation insurance, is that there is no reason to fear a public option for health care:

Public option shouldn’t be deal breaker for reform, by Jack Roberts, Guest Viewpoint, Register Guard: Recent reports that the Obama administration may (or may not) be backing away from a public option for health care reform are likely to raise the decibel level of the debate even higher. Unfortunately, the result may be to reduce further the chances of getting health care reform passed at all. ...

To a great extent, this is reminiscent of the great debate in the 1930s over public vs. private power... Nowhere was this debate more contentious than in Oregon.

Public power advocates believed that private utilities were strangling the economy and robbing ratepayers, while opponents insisted that public power was a sure route to socialism. Sound familiar? The only thing both sides seem to agree on was that one system or the other must prevail and that public and private power could not coexist.

Jump ahead 70 years. Here in Lane County, most people receive their electrical power from municipal utilities, cooperatives or a people’s utility district. Private utilities such as Portland General Electric and Pacific Power serve most of the rest of the state.

Today, we may use euphemisms such as “consumer-owned” and “investor-owned” utilities, but it is still the same public vs. private power distinction. ...[T]here is actually little difference in the way public and private utilities operate. The reason is that both public and private utilities are funded by their ratepayers. Public utilities are not subsidized by general tax dollars, as private power advocates once feared. ...

There is little reason to believe that a public health insurance option would operate much differently from private health insurance companies, either. Already there are nonprofit health insurance companies that operate more or less like their for-profit competitors. Their incentive to hold down costs ... is no less than a for-profit company’s. After all, their top management still wants to keep its jobs and be compensated for good performance, too.

Probably the best example of how a public health insurance option could operate is Oregon’s experience with a quasi-public worker’s compensation insurance company, the State Accident Insurance Fund...

True, its principal private sector competitor, Liberty Northwest, complains about unfair competition... Yet in a state that requires businesses to carry worker’s compensation insurance, SAIF serves as a critical provider of affordable workers’ comp coverage for thousands of Oregon companies, large and small. ...[M]ost Oregonians don’t regard SAIF as representing a government takeover of workers’ compensation, much less a harbinger of socialism. ...

Yet Oregon’s workers’ comp system is not so clearly better than the 25 states that have no equivalent to SAIF as to render their mandatory workers’ compensation laws worthless or unworkable. The fact is that mandatory workers’ compensation laws were a major step forward..., with or without a public option for providing worker’s comp insurance.

Adopting universal health care coverage will be equally revolutionary in its effect on our society, whether it initially includes a mandatory public option, and whatever the precise form that option originally takes.

The real key to health insurance reform is to prevent insurance companies from excluding people from coverage or charging higher premiums based on a person’s pre-existing health condition, and then to mandate coverage for everyone. ...

Pop Keynesianism

In response to the posts about Judge Richard Posner playing economist and getting the basics wrong, Tim Duy reminds me of Paul Krugman's "Pop Internationalism" and sends along links to Stephen Gordon and Google books (I am out of town this week, and I appreciate Tim's suggestions as I have a long, long drive ahead of me):

The anatomy of anti-economics, by Stephen Gordon: I recently had occasion to re-read Paul Krugman's "Pop Internationalism", and this passage from 'The illusion of conflict in international trade' jumped out at me. His point of reference is international economics, but in my experience it also applies to other fields as well:

As far as I can tell, the attitude of policy-minded intellectuals to economics is pretty much unique. Many people have opinions about legal matters or about defense policy; but they generally accept that a fair amount of specialized knowledge is necessary to discuss these matters intelligently. Thus a law degree is expected of a commentator on legal affairs, a professional military career or a record of study of military matters is expected of a commentator on defense, and so on.

When it comes to economics, however, and especially international trade, it seems to be generally accepted that there is no specialized knowledge to master. Lawyers, political scientists, historians cheerfully offer their views on the subject, and often seem quite sure that whatever it is that professors have to say – something they are fairly blurry about – is naïve and wrong…

[T]he attitude … that international economics requires no special knowledge, and that the theories of the academics, whatever they are, are obviously silly … is extremely common…

[W]hy is this attitude so prevalent? At this point, I am in the awkward position of having to defend economic professionalism by playing amateur sociologist, but let me offer the following five-part hypothesis.

First, economics is a subject that touches so many real-world concerns that there is a great incentive to claim expertise. This is especially true of international economics, in which the romance and allure of anything to which to word “global” is attached adds to the attraction of the enterprise. As a result, a large number of people inevitably propound views about international economics without much background in the subject.

Second, ignorance finds strength in numbers. Since so many lawyers, political experts, etc. feel free to opine on economics, others considering such a role do not hesitate over their lack of formal qualifications or knowledge of the field.

Third, economics written by non-economists often sounds more persuasive than the real thing. This is not just a matter of jargon: no matter how well explained, serious economic analysis is often intrinsically difficult…

Fourth, there is a lot of bad-mouthing of economists. This is understandable. After all, suppose you are, say, a military expert who has decided that he is an economic expert too. You write an article or even a book on the subject; then an academic economist tells you that all of your ingenious arguments are familiar fallacies covered in an undergraduate textbook, and that your basic thesis involves a contradiction because you do not understand national accounts. You might decide that you really should go back and read a basic textbook; more likely, you begin denigrating economists as pompous types who actually don’t know anything.

And finally, the bad-mouthing of economists, by people who typically have rapport with their audience because they share that audience’s misconceptions, reinforces the perception that economists have nothing to offer – which encourages more non-economists to declare themselves experts, enter the fray, and reinforces the cycle.

In short, there is a circular process by which bad ideas drive out good. As far as the public discourse on international trade is concerned, this process is essentially complete: not only sophisticated theories, but comparative advantage and even S – I = X – M have been driven out of the discussion.

Here's the original from Google books. Begin with "The Anatomy of Anti-Economics at the bottom of page 78. The missing piece at the end is in the post above.

And for even more on this, see Justin Wolfers and Menzie Chinn.

links for 2009-08-21

• Institutions are the secret to development, if only we knew what they were - Easterly
• Emerging market debts: Why don’t investment banks pay attention? - voxeu.org
• Basic Math for the Math Challenged - Econbrowser
• The Fed’s independence is at risk - FT
• Anti-Public Intellectuals, or Public Anti-Intellectuals? - Freakonomics
• Why sleep? - EurekAlert
• Derivatives Proposal Is Too Soft, Regulator Says - washingtonpost.com
• Employer-sponsored health insurance premiums projected to double by 2020 - EurekAlert
• City dwellers bear disproportionate federal tax burden - EurekAlert
• Washington Thinktanks in the Twenty-First Century: A Modest Proposal - Brad DeLong
• Bank Exposure to Commercial Real Estate - Federal Reserve Bank of Cleveland
• Rethinking Macroeconomics, Continued - Arnold Kling
• New Claims Day -  Modeled Behavior

Recession 101

I am driving through the Nevada desert today. Just outside of Fernley, Nevada there is a billboard that says:

Recession 101

Chill
(Hysteria causes recessions)

That was it as far as I remember. Just lettering on a white background. I wonder who thought that sign would be worth the cost?

"The Rationing Canard"

Free Exchange responds to a WSJ editorial by Martin Feldstein charging that "rationing health care is central to President Barack Obama's health plan":

The rationing canard, Free Exchange: Many, many people have already weighed in on whether or not the health care plan making its way through Congress will involve "rationing", and it was inevitable, I suppose, that Martin Feldstein would eventually decide that it's his turn. Here he is:

...The Obama strategy is to reduce health costs by rationing the services that we and future generations of patients will receive.

The White House Council of Economic Advisers issued a report in June explaining the Obama administration's goal of reducing projected health spending by 30% over the next two decades. That reduction would be achieved by eliminating "high cost, low-value treatments," by "implementing a set of performance measures that all providers would adopt," and by "directly targeting individual providers . . . (and other) high-end outliers."

The president has emphasized the importance of limiting services to "health care that works." To identify such care, he provided more than $1 billion in the fiscal stimulus package to jump-start Comparative Effectiveness Research (CER)... Comparative effectiveness could become the vehicle for deciding whether each method of treatment provides enough of an improvement in health care to justify its cost. ...

...The deployment of scare quotes would seem to suggest that Mr Feldstein has a problem with the government limiting high cost, low-value treatments, even though they're costly and not very valuable. In his third paragraph he says that Comparative Effectiveness Research—that is, research to determine whether treatments are effective or not—could lead to a cost-control mechanism which could become the vehicle for deciding whether a treatment's effectiveness justifies its cost. And then he says something about a system that in no way resembles the one America would have if the current reform package passed. Left unaddressed is whether it counts as rationing if you're still allowed to pay for additional services out of pocket.

It's fair for Mr Feldstein to recommend certain changes in the tax code, as he then proceeds to do, as a useful policy step. But why the long and dishonest preamble?

The bigger problem with the argument by rationing is that it seems to ignore how resources are allocated in a perfectly free market—by willingness or ability to pay. Mr Feldstein writes:

But unlike reductions in care achieved by government rationing, individuals with different preferences about health and about risk could buy the care that best suits their preferences. While we all want better health, the different choices that people make about such things as smoking, weight and exercise show that there are substantial differences in the priority that different people attach to health.

Certainly, preferences regarding the level of health insurance to carry vary, as do preferences for overall healthiness, as revealed by choices about things like smoking and diet. But to what extent are lifesaving treatments had or not had on the basis of preference? What about costly but effective therapies for chronic conditions?

The nub of the matter is this—government can afford to provide basic coverage to everyone, but it can't afford to provide every treatment everyone may want to everyone who wants it. It must therefore decide how to limit its expenses, and it can leave open the option of using a private practitioner to those who are denied care based on a cost-benefit analysis. Or government can provide coverage to no one, and those who cannot afford a treatment—effective or not—will go without. Those people will be just as fine as they'd be with treatment in some cases, they'll suffer in others, and occasionally they'll die because they couldn't afford coverage.

That's the nub of it, really. Faced with the prospect of a plan that provides effective treatments to everyone but forces people who want relatively ineffective treatments to pay for them on the private market, Mr Feldstein says he'd prefer a system where people who are unable to afford effective treatments don't get them, calling concern for those unable to pay for treatments "misplaced egalitarianism".

It's all well and good to let the market allocate televisions. Many people live happy lives without televisions, and lack of a television hasn't ever killed anyone. Attempting to provide a basic level of access to television to every American would be misplaced egalitarianism. I would have thought Mr Feldstein could understand the ways in which the market for televisions is different from that for health insurance.

I've discussed rationing via price and other mechanisms previously, (e.g. here), so let me instead try to characterize the political debate on this topic with an overly simplified example. We can, very roughly, break down medical costs as:

total medical costs = (cost per person)*(number of people covered)

The cost per person can be broken into two components:

cost per person = (number of procedures per person)*(cost per procedure)

The number of procedures per person is intended as a rough proxy for the level of care each person receives (i.e. the quality of care, and it includes all aspects of a particular procedure, including prescription drugs). Putting these together gives:

total medical costs = (cost per procedure)*(procedures per person)*(number of people covered)

The Republican attacks are, essentially:

Democrats intend or will be forced to reduce costs by reducing the number of people covered (perhaps focusing on the elderly) and by reducing procedures per person (i.e. a lower level of care on average). Dramatic tax increases may be needed as well.

The Democrat's response runs along the following lines:

That's a fabrication. There's no intent to reduce the number of people covered or to reduce the level/quality of care. In fact, the number of people covered must rise to achieve universal coverage, and procedures per person, i.e. the level of care, will only fall to the extent that procedures with little or no benefit are eliminated. The number of procedures (i.e. the quality  of care) will, if anything, go up.

To achieve the goal of universal coverage while controlling costs, it is necessary that costs per person fall. However, this will not be achieved through rationing care. Instead, costs per person will be reduced by lowering the cost per procedure (through lower administrative costs, increased competition, lower drug costs, etc.) and by eliminating unnecessary procedures. Additional revenue may also be used to broaden coverage. Cross-country studies indicate that the reduction in costs per person needed to provide universal coverage without reducing the level of care is achievable.

The goal of Democrats is to lower costs without sacrificing the quality of care (which will allow coverage to be expanded). Whether that's achievable or not is a legitimate point to debate, I think the experience in other countries suggests there's quite a bit of excess in the system that can be removed without affecting the quality of care people receive, but accusing Democrats of intending to cut the quality of care or to ration care within particular segments of the population (or overall) mischaracterizes what they are trying to achieve.

"Honesty, Dishonesty and Competence"

Since Richard Posner has decided to continue his attack on economists as public intellectuals, this time directed at Brad DeLong (see here plus the update at the end if you are unfamiliar with how this started), let me note Menzie Chinn's response to Posner's initial critique (the full version of Menzie's post explains the points below in more detail):

Honesty, Dishonesty and Competence: Comments on Posner's Critique, by Menzie Chinn: Richard Posner has a critique of public intellectuals who work in the public sphere (with special reference to Christina Romer), either in government service, or in journalistic fora. Mark Thoma and Brad Delong have already made clear the (many) points at which Mr. Posner has gone astray. Parenthetically, I'll add that I wonder about the analytical abilities of anybody who lumps Phillip Glass (!) and Elliott Carter together into the highbrow music category (see page 18 in his tome Public Intellectuals: A Study of Decline (1991)). More substantively, I have a few of additional observations...

First, I agree with Mark Thoma that Mr. Posner apparently has little understanding of macroeconomics...

Second, I would not pass a student out of intermediate macro who ... is confusing a financial investment with physical investment in a NIPA sense. ...

Third, before he pontificates on what economists who work in the government should or should not be doing, I think Mr. Posner should read Martin Feldstein's discussion of how the CEA works... CEA members ... do not "leave behind their academic scruples" when they move from academia to government service. ..

Fourth, I think any blog post (let alone paper) should be internally consistent. ... [Posner's isn't.]

Fifth, ...As someone who had to "fact-check" numbers going into White House policy documents and speeches on occasion, I can say that the numbers are verifiable... But the more substantive question is whether the math is so nonsensical. As I showed quite clearly in this post, the number Dr. Romer obtained was easily calculated and plausible.

Sixth, my impression is that former CEA staffers and members that have become bloggers are pretty careful with the numbers and analytics -- certainly more so than Mr. Posner. These include Jeff Frankel, Paul Krugman (notwithstanding Mr. Posner's barbs), Andy Samwick, Diane Lim Rogers, and Nouriel Roubini. (see this post for former gov't/Fed economists who became bloggers.)

"Social Mobility"

The U.S. does not have as much social mobility as Horatio Alger would have you believe. Equal opportunity is an important social goal, at least it is to me, and to the extent that this indicates unequal opportunity, it is of concern. Why is social mobility within the U.S. lower than in many other countries?:

Social mobility, by Daniel Little?: We often think of the United States as a place with a lot of social mobility. What exactly does this mean? And is it true? Ironically, the answer appears to be a fairly decisive "no." In fact, here's a graph from a 2005 New York Times series on income mobility that shows that the United States ranks second to last among Great Britain, US, France, Canada, and Denmark when it comes to the rate of income improvement over four generations for poor families. And here are two very interesting recent studies that come to similar conclusions -- a report on social mobility by the Center for American Progress and a 2007 academic study by researchers at Kent State, Wisconsin and Syracuse. Here is how Professor Kathryn Wilson, associate professor of economics at Kent State University, summarizes the main finding of the latter study: “People like to think of America as the land of opportunities. The irony is that our country actually has less social mobility and more inequality than most developed countries” (link).

Basically social mobility refers to the likelihood that a child will grow up into adulthood and attain a higher level of economic and social wellbeing than his/her family of origin. Is there a correlation between the socioeconomic status (SES) of an adult and his/her family of origin? Do poor people tend to have poor parents? And do poor parents tend to have children who end up as poor adults later in life? Does low SES in the parents' circumstances at a certain time in life -- say, the age of 30 -- serve to predict the SES of the child at the same age?

The fact of social mobility is closely tied to facts about social inequality and facts about social class. In a highly egalitarian society there would be little need for social mobility. And in a society with a fairly persistent class structure there is also relatively little social mobility -- because there is some set of mechanisms that limit entry and exit into the various classes. In the simplest terms, a social class is a sub-population within a society in which parents and their adult children tend to share similar occupations and economic circumstances of life. It is possible for a society to have substantial inequalities but also a substantial degree of social mobility. But there are good sociological reasons to suspect that this is a fairly unstable situation; groups with a significant degree of wealth and power are also likely to be in a position to arrange social institutions in such a way that privilege is transmitted across generations. (Here are several earlier postings on class; post, post, post.)

A crucial question to pose as we think about class and social mobility, is the issue of the social mechanisms through which children are launched into careers and economic positions in society. A pure meritocracy is a society in which specific social mechanisms distinguish between high-achieving and low-achieving individuals, assigning high-achieving individuals to desirable positions in society. A pure plutocracy is a society in which holders of wealth provide advantages to their children, ensuring that their adult children become the wealth-holders of the next generation. A caste system assigns children and young adults to occupations based on their ascriptive status. In each case there are fairly visible social mechanisms through which children from specific social environments are tracked into specific groups of roles in society. The sociological question is how these mechanisms work; in other words, we want to know about the "microfoundations" of the system of economic and social placement across generations.