Economist's View

"The Canary in the Mine?"

I just can't picture Larry Summers as a canary:

Is Larry Summers the canary in the mine?, by By Devesh Kapur, Pratap Mehta and Arvind Subramanian, Commentary, Financial Times: Is a liberal international economic order losing intellectual support? Should developing economies be worried? If Larry Summers is the canary in the intellectual mine, his two columns in the Financial Times suggest that the answers to both questions are yes.

The liberal economic order of the last several decades was premised on two assumptions. First, that the proliferation of prosperity across countries was a good thing. Second, there would be winners and losers but, on balance, a majority of people in both developing and developed countries would benefit. Mr Summers now appears to be questioning both assumptions ..., his columns ... suggest that globalisation creates competition for America.

This is an obvious fact. For the first time since the 17th century the west’s economic pre-eminence is being seriously challenged. But he goes on to draw the disturbing conclusion that the process of globalisation should be attenuated, precisely because it poses potential threats to the US. In doing so he, perhaps unwittingly, presents the rise of the poorer parts of the world ... more as a threat than an opportunity to the US. In effect, globalisation is justified only when it serves American interests.

This apparently nationalist argument is couched in appealing distributional terms. The losers in the process are US workers. The structure of globalisation is such that their bargaining power is considerably weakened, while mobile capital reaps all the benefits.

Mr Summers is right to worry that US workers have not benefited as much from globalisation... He is also right to assert that globalisation requires democratic legitimation.

But the ... terms of what constitutes just globalisation cannot be determined unilaterally from the standpoint of the gains and losses within the US. It has to be determined co-operatively, involving discussions over the costs and benefits to all, especially those least able to defend their interests in both rich and poor countries. ...

That globalisation needs appropriate regulation is hardly in doubt. But blaming globalisation preponderantly for the ills of American workers runs the risk of providing an alibi for the sins of omission in domestic policy that have had a much bigger impact.

It is undeniable that the best line of defence for protecting workers has to be overwhelmingly domestic – through progressive taxation, improving education, strengthening the bargaining position of labour and improving the safety nets. Since the Ronald Reagan years, the headlong embrace of market solutions has systematically undermined each of these policy responses.

One reading is that Mr Summers’ angst about globalisation is motivated by desire to maintain the environment for the continuing spread of prosperity: a need to tweak the rules – through regulatory harmonisation – to bolster the fraying consensus among the US middle class in favour of globalisation.

But the manner in which his position is framed, the inconsistencies of the arguments across time, the inappropriate transferring of the burden of any response from domestic actions to international ones, and the susceptibility of the proposed remedies to protectionist misuse point to a more alarming prospect for developing countries. The ground is shifting under their feet. They would do well to take notice.

The Fed's Blank Check

Steve Waldman responds:

Capabilities, constraints, and confidence, by Steve Waldman: Mark Thoma offers a very thoughtful rejoinder to my post on whether the Fed should be given authority to pay interest on deposits. Mark's comments range from specific, technical points to broad questions about governance. What follows is a quick response to some of the issues he raises. Do read his piece, The Fed Already Has a Blank Check.

My bottom line remains the same. Although the central bank does have the capability to unilaterally expand its balance sheet, it is subject to a variety of constraints that restrain it in practice. I am opposed to relieving the Fed of those constraints unless hard limits are placed upon the scale of its direct investment in the financial system, both to protect taxpayers from absorbing losses, and to support the long-term ability of financial markets to allocate real economic capital well.

I address some of Mark's points specifically below.

• Mark suggests that "the Fed already has a blank check", because it could increase reserve requirements, rather than borrow funds, to sterilize the inflationary effect of printing cash. This is true in theory, but I think it would be very difficult in practice for the US central bank. The Fed has not used reserve requirements as an active instrument of monetary policy for a long time, and has allowed (encouraged) them to atrophy, with an eye towards eliminating them entirely. (See here and here.) Reserve requirements could be reinvigorated, of course, but not easily or quickly. They would have to be restored over time and in careful consultation with banks, whose enthusiasm for the project would be less than overwhelming.
• You'll hear no argument from me when Mark suggests that the Fed already has the power to do great harm. Poor monetary policy can lead to unnecessary recessions, or to credit and mis-investment booms that leave the economy structurally crippled. That an institution already has great and terrible power is no argument for handing it yet another means of mischief-making.
• While central banking has always entailed risk, customary and statutory constraints usually reduce the likelihood of harm. Any asset can lose value, but restricting Fed purchases to short maturity Treasury securities limits the risk of capital losses, and importantly, distributes gains from seignorage to all taxpayers. Purchasing or lending against more speculative assets provides a subsidy to particular sectors and institutions (undermining legitimacy), puts taxpayer funds at risk, and privatizes the gains of seignorage in the event of nonperformance. (Central bank cash that otherwise would have retired public debt are instead distributed to private parties and never returned.) Fair allocation of seignorage gains is one of the prime virtues of fiat money central banking. Lending against questionable collateral imperils that advance.
• Mark correctly points out that the potential upside of the Fed's bank investments is not merely, as I suggested, "about what [taxpayers] would have earned investing in safe government bonds". The purpose of the central bank's activism is to prevent harms to the public that might result from turmoil in the financial sector, and these foregone harms should be included in our calculus. But if we include nonfinancial benefits, we must also consider nonfinacial costs, such as the long-term effects of the "moral hazard", a loss of information in asset prices (assets must be valued as complex bundles of economic claims and options on potential government support), and impaired political legitimacy of the central bank and the financial system as a whole. We must weigh these costs and benefits against alternative policies, not only a straw-man scenario under which all government agencies stand completely aside and watch helplessly as the world falls apart. Of course, in "real time", the Fed did not have the luxury of reflection. But we do have it now. Mark and I would come to very different judgments about the nonfinancial costs and benefits of Fed policies. I assure you that, in general, Mark's judgment is much better than mine. Nevertheless, cranks like me will aver that the long-term costs due to moral-hazard and information loss are inestimably large, that questions of legitimacy and favoritism will haunt financial capitalism for a generation, and that it would be possible (even now!) to adopt uniform procedures for managing the collapse and reorganization of institutions that could not survive without life support from the Fed. Who should be empowered to decide these issues? Ben Bernanke? Hank Paulson? I vote for the people that I voted for, warts and all.

I want to make clear that I don't actually disagree with Mark on the technical question of whether an interest rate corridor is a good idea. So long as the Fed restricts itself to traditional monetary policy — that is, so long as it buys only Treasury debt with borrowed funds — I would support this change (mostly because an interest rate corridor is easier for non-experts to understand than open market operations).

Unfortunately, not only has the Fed resorted to unorthodox tools during an acute emergency, but all indications are that the central bank plans to expand its innovative practices and continue them indefinitely. The "unusual and exigent circumstances" under which the Fed's extraordinary actions have been justified specifies duration about as precisely as the "global war on terror". Mark has great confidence in the Federal Reserve, and sees little hazard in granting it more freedom to maneuver. I view the central bank as prone to catastrophic error, and wish to see its capabilities clipped, not enlarged. I think the consequences of centralizing private sector risk on public sector balance sheets will turn out be grave, and must oppose any tool that would make it easier for the Fed to continue to do so.

Finally, Mark writes regarding the occasional need for fast action in a crisis:

This is an old problem — how much authority should be centralized thereby allowing quick and immediate response during a crisis, and how much should be retained in slower, deliberative bodies like the House and Senate? The War Powers Act reflects this compromise — we want the ability to respond quickly to an attack or other military developments, but we worry about the concentration of power in the hands of a single individual. Centralization has the benefit of allowing a quick response to a crisis, but it risks being out of step with the democratic process. In the case of financial market emergencies, however, I have more faith in the Fed than in congress to act quickly and correctly. That's partly because I have little faith in the ability of congress to quickly comprehend what the problem is and attack it directly and effectively — many of them admit to not having a clue about economics, and more worrisome are the ones who think they have a clue but don't — but congress should not give up its oversight role.

I have little faith in Congress, and even less faith in the Fed. (That's not, by the way, a reflection of the individuals running the place. Ben Bernanke is quite brilliant. But culture and ideology saddle the Fed with both blind spots and hubris.) I like Mark's idea, though. I'd support a financial "War Powers Act" that would authorize emergency extensions of secured credit by the Fed to private actors deemed systemically important. But here's my deal-breaker: That support would have to be withdrawn within 180 days, and would not be renewable. Six months is long enough for solvent institutions to counter a "liquidity panic" with full disclosure, for modestly troubled institutions to secure new capital, and for regulators to arrange an orderly unwinding of firms that cannot be made solvent and liquid within the statutory timeframe. Whaddaya say?

By the way, we'll have our six-month anniversary of the first $40B in TAF financing in June.

Specific details aside, I think something along those lines - a compromise of our positions - is worth considering. I do, however, believe that the Fed needs to update its toolbox to be consistent with today's financial market structure, and that as we think about these extensions, trust in the Fed is warranted.

The Evolution of the "Economic Web"

One of the editors at Scientific American brought this to my attention, and he is hoping to receive feedback. This is part of their "Edit This" series. The idea is that they post a draft of an article they plan to print in a future edition of the magazine, then incorporate feedback into the the print version:

Tell us your reactions to the arguments made in this piece. Your feedback will be incorporated into a version of this article that will appear in a future print issue of Scientific American.

The article itself, "which is sure to raise the hackles of some members of the economic community," argues that economists cannot explain the relationship between innovation and growth, and proposes a "grammar model" as an alternative to traditional growth models:

The Evolving Web of Future Wealth, by Stuart Kauffman, Stefan Thurner, and Rudolf Hanel, SciAm: ...Perhaps the most stunning feature of the economy over time is the explosion of goods and services. Yet contemporary economics has no adequate theory to understand this explosion or its importance for economic growth and the evolution of future wealth.

My first reaction was that we do have models of variety and growth:

Optimal Product Variety, Scale Effects, and Growth, by Henri L.F. de Groot and Richard Nahuis: ...Product variety is an important determinant of economic welfare. Following the seminal work by Dixit and Stiglitz (1977), and Spence (1976) the welfare effects of variety have been analyzed from various angles.[1] ... With the presence of economies of scale in production, producing a small variety saves resources that can be used to extend the production volume. Hence a trade-off arises... It turns out that the market supports too low product diversity. Subsequent studies addressed the optimality question in the presence of growth. In a dynamic context, reduced variety not only saves resources that can be used for extending the produced quantity, but potentially also to increase the rate of growth. Grossman and Helpman (1991, chapter 3) analyze welfare in a model of endogenous growth. In their analysis, there is (continuous) growth in product variety resulting from investment in R&D. The more labour an economy allocates in the R&D sector, the less labour remains for producing consumption goods. The question here is one of growth in variety versus volume of consumption goods. The optimal trajectory entails more rapid growth of variety than the market equilibrium sustains, as firms ignore the contribution of their knowledge creation to a common ’knowledge pool’. Grossman and Helpman (1991) also analyze a quality ladder model. ... Here innovative effort aimed at quality improvement might be suboptimal high or low, depending on the size of the quality step. Van de Klundert and Smulders (1997) develop an endogenous growth model in which, contrary to Grossman and Helpman (1991), R&D is an in-house activity aimed at improving quality. Besides quality growth, variety is also determined endogenously. ...

The studies discussed so far assume that variety has a direct effect on consumers’ welfare as consumers have a love for variety. Another branch of literature looks at the productivity effects of increased product variety...

And as footnote 1 notes, "In the overview..., we have no pretension of being exhaustive," so this is by no means all of the work on this topic. But these models don't, as far as I know, explain how new innovations and variety arise, and that is one of the things the Scientific American article is trying to do (though I'm not sure it is fully successful, the model produces broad statistical relationships that predict how frequently innovations ought to occur, but is not precise about the types of innovations that will arise). Back to the article:

Economic growth theory is highly sophisticated about the roles of capital, labor, human capital, knowledge, interest rates, saving rates and investment in existing economic opportunities, or investment of savings in research to find novel goods and services. Yet the major conceptual frameworks that undergird contemporary economics (competitive general equilibrium, rational expectations and game theory) share a crucial failing. They assume that all the goods and services (as well as the relations between them) and all the strategies for engaging with them in a local or global economy can be "pre-stated"—that is, known in advance. In reality, novel goods and services may constantly enter markets, thereby requiring economic actors to develop ever more novel strategies: all the relevant variables cannot be pre-stated.

Thus standard growth theory misses an essential feature of this "economic web" of goods and services. Even more important, as we shall explain, it ignores the role that the structure of the economic web itself plays in driving the creation of novelty and the evolution of future wealth. ...

The ways goods and services come to be used together in the real economy may not be describable in advance... Because it is impossible to identify all the preadaptations and potential economic uses for goods and services, it is impossible to finitely prestate all the possibilities for them. This conclusion has profound significance: it means that predicting future innovations is fundamentally incalculable, even on the basis of probability because no probability distribution can be assessed without knowing the range of possible outcomes. (And beyond economics, this principle may have equally radical consequences for much of the rest of science [see sidebar].)

Decision theory—the tool of management that suggests making optimal choices by summing discounted future values over the probability distribution of all possible outcomes—is of limited usefulness, as are businesses' five-year plans. ... Business, like life in general, is an art wherein we must use reason, intuition, emotion, metaphors, models, case studies and more to guide ourselves. Business is not a calculus. Thus, economics can only partially be a calculus, and a much broader conceptual framework is needed.

The Economic Web A screw and a screwdriver are complements, used together to create value by, say, fastening two boards. A screw and a nail are largely substitutes: loosely speaking we can use one where we use the other. Now imagine all 10 billion or more distinct goods in the contemporary global economy as points in a large three-dimensional space. Join complements by green lines and substitutes by red lines.

This network is the economic web. We do not know its structure, but it exists. It evolves over time, although we know little about how. Do statistical laws govern its evolution? Are firms located near the center of the web (say, automobiles or computers) in a strategic situation different from those on the periphery, such as hula hoops?

The web of complements to a good forms a mutually self-reinforcing and cross-reinforcing subnetwork that enhances its own economic growth. For example, with the car came its complements, among them gasoline, paved roads, motels, fast food restaurants and suburbia. In turn suburbia gave rise to an enormous number of consumers of automobiles, gasoline, paved roads and so on. We might call such mutual cross-enhancement "collectively autocatalytic,"... In economic terms, we might call them collective webs of mutually positive "externalities" between complementary technologies. ...

In contrast, consider the hula hoop, which appears to have few complements. It may have made money for its producers, but it sparked no lightning in the form of complementary technologies or products that collectively drove an explosion of wealth. The hula hoop could come and go with little effect on the economy.

The preceding observations show why we must come to understand the structure, evolution and roles of the economic web. Of course, it is people who invent novel goods and services, but the structure of the web itself singles out where invention and investment are likely to yield a profit and drive growth.

Two further features of the web make us suspect that the diversity of the economic web drives its own growth autocatalytically. First,.... The more goods and services that exist in the economy, the more recombinations among them are possible. ...

Second, new goods and services typically enter the economy as complements or substitutes for existing goods and services. Call the set of goods and services that are complements or substitutes to a given good or service its economic niche. As the web grows, does it create new niches faster than it creates new goods and services? The general answer is not known, but the very large number of complements to the automobile and computer noted above, with their mutually cross enhancing externalities, suggest that the average number of new adjacent complements and services created per new good or service is greater than 1.0.

If so, then the growth of economic niches is indeed autocatalytic. The more goods and services that exist, the higher the diversity of the economic web and the faster the creation of new economic niches. Thus the very diversity of the economic web is almost certainly a major factor in creating the conditions for its own further expansion.

We do not yet know whether that is so, nor whether the average number of novel niches created per new good has changed since 50,000 years ago. Economic historians can discover the truth. But in the meantime, we note that these issues are not yet part of economic theory, and may be major, largely overlooked factors. If so, they may have practical implications and deserve detailed examination.

An Algorithmic Model There are profound reasons that the structure and growth of the economic web is not part of current economic theory... What algorithmic model can describe unforeseeable Darwinian preadaptations in the economy? There may be none.

The hope of finding a mathematics that could describe and predict how novel goods and services unfold as the economy evolves into its adjacent possible thus seems precluded, at least at present. But even if the growth of the economy is not algorithmic, an algorithmic approach may still be of use in finding statistical features of model economies for comparison to the real one. Crucial here is the enlargement of the current framework: a concept is needed to mathematically tame the "adjacent possible."

One such approach is a "grammar model" that represents goods and services with binary symbol strings... Within our model, the number and diversity of the strings can stand for renewable resources, appearing each year. Symbol strings can act on one another to create new symbol strings. ... A "grammar table" lists all the pair rules for these transformations. This arrangement can simulate a simple economic production function.

Intuitively, one sees that if the starting (and renewable) number of strings is small, that their diversity is low and that the grammar table has few pair rules, symbol strings will probably not be able to act on one another and few novel symbol strings will be created. We call such behavior subcritical. A subcritical economy cannot generate a growing diversity of goods and services. On the other hand, studies show that as the number of pair rules, resource strings or both increases, the system can abruptly transit into a supercritical domain where a large—perhaps unending—diversity of symbols strings may be generated. We call this explosion of goods and services supracritical. ...[...continue reading...]

Quick reactions are dangerous, but I'm going to do it anyway. It's not hard to believe that when there are a lot of complementary objects in close proximity, they can be combined in many, many ways, some of which will be highly valued. It's also believable that what can be produced from novel combinations depends upon what already exists, i.e. there is path dependence to use the term from economics for this. That there is a critical number of connections required for innovative activity also seems reasonable.

But the web does not form exogenously, and the underlying economics has a big impact on its evolution. For example, agglomeration economies induce firms with complementary goods to locate close to each other - when a manufacturer comes to town, a company that produces packing materials for shipping the good may open nearby, and these decisions, when made by many firms, concentrate human and physical capital in close proximity, and this can set the stage for further innovation. (People with substitutes will also locate strategically, usually far apart but not always). What seems to be missing from this from my quick reading of it is the main topic of the research - the economics - and how price and expected profit signals determine how the web is organized, which innovations are pursued, etc. The decisions of agents, where to locate, what goods to buy, which ideas to pursue, determine the structure of the web. It is not an exogenous process that can be imposed upon the economic system, and the endogenous evolution of the web seems to me to be the important - and unanswered - question.

In a way we mathematically benefit from our profound ignorance of the real economic web's detailed structure because it forces us to model the catalytic network as basically random.

But is it "basically random"? That's where my questions begin.

How Do Search Engines Price Ads?

Hal Varian explains how Google uses auctions to set ad prices:

How auctions set ad prices, by Hal Varian, Google: All of the major search engines use auctions to price ads. The reason is simple: there are millions of keywords that need to be priced and it would be impossible to set all those prices by hand.

Using an auction removes the burden of having to do this: the prices are determined by the auction participants. These auctions run every time a user enters a query, so they always reflect the current values that advertisers place on keywords.

The outcome of the ad auction is efficient in the sense that the available ad slots are awarded to those who value them mostly highly. The outcome is also equitable in that the price an advertiser has to pay is determined by the other advertisers -- those with whom it has to compete for slots.

But how do they actually work? There are several steps in the process.

1) Each advertiser enters a list of keywords, ads, and bids.

2) When a user enters a query, Google compiles a list of all the ads whose keywords match that query.

3) The list of ads is then ordered based on the bids and the Ad Quality Scores, which measure the relevance of the ad to the user.

4) The highest ranked ad is displayed in the most prominent position, the second highest ranked ad gets the second most prominent position, and so on.

5) If the user clicks on an ad, the advertiser is charged a price that depends on the bid and Quality Score of the advertiser below it. The price charged is the minimum necessary to retain the advertiser's position in the list.

A simple example is when all ads have the same Quality Score. In this case, the ads will be ranked by bids and the price an advertiser pays per click will just be the bid of advertiser below it in the ranking. Hence the amount that advertisers pay is no more than what they bid and typically less.

In the general case, where ad qualities differ, the price an advertiser pays for a click will depend on its Quality Score relative to the quality of the ad below it in the auction. Roughly speaking, an ad that has twice the quality of another ad will tend to get about twice as many clicks, and will only have to pay half as much per click as the competing ad.

Where does this Ad Quality Score come from? It was originally determined by historical click through rates but has been refined over the years using sophisticated statistical models. Using ad quality as a factor in ranking ads provides strong incentives to advertisers to make sure that they provide relevant ads to end users.

There are many additional tweaks on top of this basic design. For example, Google actually runs two auctions: one for ads at the top of the page, and one for ads on the side of the page. Only ads with particularly high quality are eligible to compete in the top-ad auction. Ads that have particularly low quality may be disabled, and not shown at all. Advertisers also can set and adjust their daily and monthly budget so as to cap their maximum spend.

But the essential structure is that outlined above: advertisers bid for position and pay just enough to beat their runner-up. Prices for keywords are, ultimately, determined by the advertisers.

Bombs Away

Here's what I wish we would have done. Loaded up the bombers until they couldn't carry any more, have a second wave ready, a third, and a put a continuous rotation in place ready to keep it up until the job is done. Then, get them in the air along with escorts that say "just try and stop us" and just bombed the hell out of Burma with food, clothes, and medicine until the job is done. Blast our way in if necessary, and drop crate after crate full of supplies, one drop after another, and keep it up until the mission is complete.

Permission to give aid? We don't need no stinking permission...

What Have the Romans Ever Done for Us?

The Declining High School Graduation Rate in the US

If we want to reduce inequality, increasing the high school graduation rate - it's around 75% -  is a good place to start:

The Declining American High School Graduation Rate: Evidence, Sources, And Consequences, by James J. Heckman and Paul A. LaFontaine, NBER Reporter: Research Summary 2008 Number 1: The high school graduation rate is a barometer of the health of American society and the skill level of its future workforce. Throughout the first half of the twentieth century, each new cohort of Americans was more likely to graduate from high school than the preceding one. This upward trend in secondary education increased worker productivity and fueled American economic growth .[1]

In the past 25 years, growing wage differentials between high school graduates and dropouts increased the economic incentives for high school graduation. The real wages of high school dropouts have declined since the early 1970s while those of more skilled workers have risen sharply.[2] Heckman, Lochner, and Todd[3] show that in recent decades, the internal rate of return to graduating from high school versus dropping out has increased dramatically and is now above 50 percent. Therefore, it is surprising and disturbing that, at a time when the premium for skills has increased and the return to high school graduation has risen, the high school dropout rate in America is increasing. America is becoming a polarized society. Proportionately more American youth are going to college and graduating than ever before. At the same time, proportionately more are failing to complete high school.

One graduation measure issued by the National Center for Educational Statistics (NCES), the status completion rate[4] - widely regarded by the research community as the official rate- shows that U.S. students responded to the increasing demand for skill by completing high school at increasingly higher rates. By this measure, U.S. schools now graduate nearly 88 percent of students and black graduation rates have converged to those of non-Hispanic whites over the past four decades.

A number of recent studies have questioned the validity of the status completion rate and other graduation rate estimators. They have attempted to develop more accurate estimators of high school graduation rates.[5] Heated debates about the levels and trends in the true high school graduation rate have appeared in the popular press.[6] Depending on the data sources, definitions, and methods used, the U.S. graduation rate has been estimated to be anywhere from 66 to 88 percent in recent years-an astonishingly wide range for such a basic statistic. The range of estimated minority rates is even greater-from 50 to 85 percent.

In an NBER Working Paper published in 2007[7], we demonstrate why such different conclusions have been reached in previous studies. We use cleaner data, better methods, and a wide variety of data sources to estimate U.S. graduation rates. When comparable measures are used on comparable samples, a consensus can be reached across all data sources. After adjusting for multiple sources of bias and differences in sample construction, we establish that: 1) the U.S. high school graduation rate peaked at around 80 percent in the late 1960s and then declined by 4-5 percentage points; 2) the actual high school graduation rate is substantially lower than the 88 percent estimate; 3) about 65 percent of blacks and Hispanics leave school with a high school diploma, and minority graduation rates are still substantially below the rates for non-Hispanic whites. Contrary to estimates based on the status completion rate, we find no evidence of convergence in minority-majority graduation rate Exclusion of incarcerated populations from some measures greatly biases the reported high school graduation rate for blacks.

These trends are for persons born in the United States and exclude immigrants. The recent growth in unskilled migration to the United States further increases the proportion of unskilled Americans in the workforce, apart from the growth attributable to a rising high school dropout rate.

Why Did the EPA Fire a Respected Toxicologist?

Herbert Needleman speaks out:

Why did the EPA fire a respected toxicologist?, EurekAlert: In March, the US House Energy and Commerce Committee launched an investigation into potential conflicts of interest in scientific panels that advise the Environmental Protection Agency on the human health effects of toxic chemicals. The committee identified eight scientists that served as consultants or members of EPA science advisory panels while getting research support from the chemical industry to study the chemicals under review. Two scientists were actually employed by companies that made or worked with manufacturers of the chemicals under review.

Such conflicts, Chairman John Dingell (D-Mich.) noted, stand in stark contrast to the agency’s dismissal last summer of highly respected public health scientist Deborah Rice, an expert in toxicology, from a panel examining the health impacts of the flame retardant deca. The EPA fired Rice after the chemical industry’s trade group, the American Chemistry Council, complained that was could not provide an objective scientific review because she had spoken out about the health hazards posed by deca.

This trend is neither new nor unique, argues legendary lead researcher Herbert Needleman, a pediatrician and child psychiatrist, in a new article published this week in the open-access journal PLoS Biology. With his groundbreaking research on the cognitive effects of lead on children, Needleman laid the foundation for one of the greatest environmental health successes of modern times—five-fold reduction in the prevalence of lead poisoning in American children.

In “The Case of Deborah Rice: Who is the Environmental Protection Agency Protecting"” Needleman points out that the EPA summarily fired Rice even though it had honored her just a few years before with one of its most prestigious scientific awards for “exceptionally high-quality research into lead’s toxicity.” Why" Because the American Chemistry Council asked the agency to fire her.

“EPA, without examining or contesting the charge of bias, complied,” Needleman write. “Rice was fired. The next formal act of the EPA was to remove all of her comments from the written report completely erase her name from the text of the review. There is now no evidence that she ever participated in the EPA proceedings, or was even in the room.” Needleman is confident that Rice, who is “widely admired by her colleagues for her intelligence, integrity and moral compass,” will “withstand this insult and continue to contribute to the public welfare.”

The full article from full article from Plos Biology:

The Case of Deborah Rice: Who Is the Environmental Protection Agency Protecting?, by Herbert Needleman: For researchers who operate at the intersection of basic biology and toxicology, following the data where they take you—as any good scientist would—carries the risk that you will be publicly attacked as a crank, charged with scientific misconduct, or removed from a government scientific review panel. Such a fate may seem unthinkable to those involved in primary research, but it has increasingly become the norm for toxicologists and environmental investigators. If you find evidence that a compound worth billions of dollars to its manufacturer poses a public health risk, you will almost certainly find yourself in the middle of a contentious battle that has little to do with scientific truth (see Box 1).

"Why Legal Barriers are Not Critical to Deterring Immigrants"

Fences or not, most people choose not to immigrate:

Why legal barriers are not critical to deterring immigrants, by Drew Keeling, Vox EU: Policymakers addressing immigration frequently concentrate on using laws and regulations to influence the selection of immigrants and deter unwanted arrivals. But policymakers and scholars may be overemphasising legal mechanisms at the expensive of economic fundamentals.

Consider an historical period when legal mechanisms played little role in determining the volume of immigration flows. Despite minimal legal restrictions, annual migration rates across the North Atlantic in the nineteenth and early twentieth century rarely exceeded 1-2% of the population. This is not much higher than rates of international migration today.

For decades, scholars have believed that transportation costs severely limited long distance movement during the earlier open-border era. With international travel much cheaper today, strict legal barriers have thus been regarded as essential in keeping migration from rising far above already controversially high levels. But in recent research, I find that the great transatlantic migration of Europeans a century ago was not strongly constrained by the costs of travel.[1] Most people, most of the time, simply prefer to stay put rather than relocate abroad.

The cost of immigration a century ago Globalisation one hundred years ago bears many similarities to globalisation today. Then, as now, a disproportionate volume of the world’s economic activity occurred within the relatively more developed North Atlantic region.[2]

Free trade and free movement of goods, services, finance and information helped economic growth and international convergence persist for many decades until the outbreak of the First World War. One salient difference between that world and ours is that, a century ago, borders were also widely open to mass movements of labour.[3]

The ability to observe more closely the underlying processes of mass migration, unobscured by visa requirements, quotas, and work permit restrictions, has made the “Great Migration” of a century ago a favourite of migration scholars. Until recently, however, there has been very little systematic examination of the travel industry, which brought millions of Europeans overseas to foreign entry stations such as New York’s Ellis Island.

In my research, I develop a continuous long-term record of transatlantic passenger fares between 1885-1914, using shipping records from the Cunard Line’s Liverpool to New York route. During this time, North Atlantic migration volumes tended to fall when fares dropped. This happened during economic recessions in North America when migration declined markedly and shipping companies found it difficult to maintain fare levels.

Did the "Barr" for McCain Just Get Higher?

This adds in interesting twist to the race:

Barr announces Libertarian White House bid, by Ben Evans, AP: Former Republican Rep. Bob Barr launched a Libertarian Party presidential bid Monday, saying voters are hungry for an alternative to the status quo who would dramatically cut the federal government.

His candidacy throws a wild card into the White House race that many believe could peel away votes from Republican Sen. John McCain given the candidates' similar positions on fiscal policy.

Barr, who has hired Ross Perot's former campaign manager, acknowledged that some Republicans have tried to discourage him from running. But he said he's getting in the race to win, not to play spoiler or to make a point. ...

Barr first must win the Libertarian nomination at the party's national convention that begins May 22. Party officials consider him a front-runner...

If he wins the White House, he said he would immediately freeze discretionary spending in Washington. He also would begin withdrawing troops from Iraq and consider slashing spending at federal agencies such as the departments of education and commerce _ as well as at overseas military bases.

The former U.S. attorney also said he would strictly enforce immigration laws. ...

Barr, 59, quit the Republican Party two years ago, saying he had grown disillusioned with its failure to shrink government and its willingness to scale back civil liberties in fighting terrorism. He has been particularly critical of President Bush over the war in Iraq and says the administration is ignoring constitutional protections on due process and privacy.

While in Congress, he was a persistent critic of President Clinton and was among the first to press for impeaching the former president. He helped manage House Republicans' impeachment case before the Senate. ...

Above: "many believe [Barr] could peel away votes from Republican Sen. John McCain given the candidates' similar positions on fiscal policy." Similar positions? McCain's plan makes no sense. Then again, I guess the two plans are similar...

I'm not counting on this, but in addition to the potential to help Democrats, there's another possible positive. If Barr's entry into the race does anything at all to force other candidates to adopt positions that reduce the "willingness to scale back civil liberties" and the government's "ignoring constitutional protections on due process and privacy," that will be a step in the right direction.

The Fed Already Has a Blank Check

In the interest of continuing the conversation, I want to argue a contrary position and push back a bit on Steve Waldman's post about allowing the Fed to pay interest on reserves, and his worry that this change will allow the Fed to put excessive amounts of public money at risk:

Let's not write the Fed a blank check, by Steve Waldman: Last week, the Fed decided to ask Congress for the right to pay interest on bank reserves. (Hat tip Barry Ritholtz, see also William Polley, Mark Thoma, Brad DeLong) This is a very big deal.

Don't be misled into thinking that the Fed's proposal is just some arcane, technocratic change. The Federal Reserve is asking taxpayers for a big pile of signed, blank checks. That's far too much power to put in the hands of a quasipublic organization with little democratic accountability. This authority should not be granted without some strong strings attached. ...

First, some background. There is a trend among central banks to move from old-fashioned, fractional-reserve banking to a system whereby interest rates are managed via a "channel" or "corridor", and under which fixed reserve requirements might be dispensed with entirely. The basic idea is simple. The Fed ... choose two interest rates, a "floor rate" at which the Fed would stand ready to borrow funds, and a "ceiling rate" at which the Fed would stand ready to lend. As long as there is no stigma attached to transacting with the Fed, banks would never lend for less than the floor rate or borrow for more than the ceiling rate. The interbank interest rate would necessarily lie within a "corridor" defined by these two interest rates. ...

A corridor system would represent a meaty change to how central banking is done in the US, but the approach seems to work okay in other countries. ...

As long as the Fed is conducting ordinary monetary policy, switching to a channel system offers modest benefits at a modest cost to taxpayers. But the Fed's monetary policy has not been ordinary at all lately. In fact, it's been quite extraordinary. It is in the context of this extraordinary policy that the Fed has asked Congress to accelerate its authority to implement a channel system...

The core of the Fed's new exuberance is a willingness to enter into asset swaps with banks. The Fed lends safe Treasury securities to banks, and accepts as collateral assets that private markets consider dodgy or difficult to value. (This is the direct effect of the Fed's TSLF program, and the net effect of TAF and other lending arrangements that the Fed sterilizes in order to hold its interest rate target.) In doing so, the Fed puts taxpayer funds at risk. If a bank that has borrowed from the Fed runs into trouble, the Fed would face an unappetizing choice: Orchestrate a bail-out, or permit a failure and accept collateral of questionable value instead of repayment. Either way, taxpayers are left holding the bag. ...

In December, the Fed had $775 worth of Treasury securities. That stock will soon have dwindled to $300B, give or take. The difference, about $475B, represents an investment by the central bank in risky assets of the US financial sector.

$475B is an extraordinary sum of money. It is as if the Fed borrowed more than $1500 from every man, woman, and child in the United States, and invested that money on our behalf in Wall Street banks that private financiers were afraid to touch. For bearing all this risk, if things work out well, taxpayers will earn about what they would have earned investing in safe government bonds. If things don't work out well, the scale of the losses is hard to predict. ...

If the Fed were to blow through the rest of its current stock of Treasuries, it would have invested more than $2500 for every man, woman, and child in America. Public investment in the financial sector would have exceeded the direct costs to date of the Iraq War by a wide margin. Would that that be enough? If not, how much more? Just how large a risk should taxpayers endure on behalf of companies that arguably deserve to fail, to prevent "collateral damage"? Have we considered other approaches to containing damage, approaches that shift costs and risks towards those who benefited from bad practices, rather onto the shoulders of taxpayers and nominal-dollar wage earners? Does this sort of policy choice belong within the purview of an independent central bank?

Now I don't actually mean to be too harsh. Putting aside the years of preventable foolishness that got us here, ... a crisis emerged that had to be managed and the Fed was the only organization capable of stepping up to the plate. I don't love the decisions that were made, but decisions did have to be made, and there weren't very good options. But now we have a moment to reflect. If the credit crisis flares hot and bright again, how much more citizen wealth should be put at risk before other policy options are considered? That's not a rhetorical question: We need to choose a number, a figure in dollars. My answer would be something north of zero, but not more than the roughly $300B stock of Treasuries that remains on the Fed's balance sheet. But this is a decision that Congress needs to make.

And what does all this have to do with the question that will soon be put before the Congress, whether the Fed should be permitted to pay interest on deposits?

Paul Krugman: The Oil Nonbubble

Is the high price of oil price due to fundamentals or speculation?:

The Oil Nonbubble, by Paul Krugman, Commentary, NY Times: “The Oil Bubble: Set to Burst?” That was the headline of an October 2004 article in National Review, which argued that oil prices, then $50 a barrel, would soon collapse.

Ten months later, oil was selling for $70 a barrel. “It’s a huge bubble,” declared Steve Forbes...

All through oil’s five-year price surge, which has taken it from $25 a barrel to last week’s close above $125, there have been many voices declaring that it’s all a bubble, unsupported by the fundamentals of supply and demand.

So here are two questions: Are speculators mainly, or even largely, responsible for high oil prices? And if they aren’t, why have so many commentators insisted, year after year, that there’s an oil bubble? ...

Imagine what would happen if the oil market were humming along, with supply and demand balanced at a price of $25 a barrel, and a bunch of speculators came in and drove the price up to $100. ...

Faced with higher prices, drivers would cut back on their driving; homeowners would turn down their thermostats; owners of marginal oil wells would put them back into production.

As a result, the initial balance between supply and demand would be broken, replaced with a situation in which supply exceeded demand. This excess supply would, in turn, drive prices back down again — unless someone were willing to buy up the excess and take it off the market.

The only way speculation can have a persistent effect on oil prices, then, is if it leads to physical hoarding...But ... inventories have remained at more or less normal levels. This tells us that the rise in oil prices isn’t the result of runaway speculation; it’s the result of fundamental factors, mainly the growing difficulty of finding oil and the rapid growth of emerging economies like China. The rise in oil prices ... had to happen to keep demand growth from exceeding supply growth.

Saying that high-priced oil isn’t a bubble doesn’t mean that oil prices will never decline. ... But it does mean that speculators aren’t at the heart of the story.

Why, then, do we keep hearing assertions that they are?

Part of the answer may be ... that many people are now investing in oil futures — which feeds suspicion that speculators are running the show... But there’s also a political component.

Traditionally, denunciations of speculators come from the left of the political spectrum. In the case of oil prices, however, the most vociferous proponents of the view that it’s all the speculators’ fault have been conservatives — people who you wouldn’t normally expect to see warning about the nefarious activities of investment banks and hedge funds.

The explanation of this seeming paradox is that wishful thinking has trumped pro-market ideology.

After all, a realistic view of what’s happened over the past few years suggests that we’re heading into an era of increasingly scarce, costly oil.

The ... odds are that we’re looking at a future in which energy conservation becomes increasingly important, in which many people may even — gasp — take public transit to work.

I don’t find that vision particularly abhorrent, but a lot of people, especially on the right, do. And so they want to believe that if only Goldman Sachs would stop having such a negative attitude, we’d quickly return to the good old days of abundant oil.

Again, I wouldn’t be shocked if oil prices dip in the near future — although I also take seriously Goldman’s recent warning that the price could go to $200. But let’s drop all the talk about an oil bubble.

"McCain's Economist Supporters vs. Facts"

Jonah Gelbach is puzzled by "prominent, right-leaning economists" who have endorsed John McCain's economic proposals:

McCain's Economist Supporters vs. Facts, by Jonah Gelbach: Over at MarginalRevolution, Tyler Cowen has posted the text of an email he received recently. It seems a number of prominent, right-leaning economists have endorsed John McCain's stated economic proposals. The list includes many of the usuals (e.g., Becker, Hassett, McCain chief economic adviser Doug Holtz-Eakin, Taylor, Harvey Rosen, Meltzer, etc.); the list is chock full of prominent economists who have earned their academic reputations. Here's the text that Cowen excerpted in his main post (the rest of the letter is posted in his comments section):

We enthusiastically support John McCain's economic plan. It is a comprehensive, pro-growth, reform agenda. The reform focuses on the real economic problems Americans face today and will face in the future. And it builds on the core economic principles that have made America great.

His plan would control government spending by vetoing every bill with earmarks, implementing a constitutionally valid line-item veto, pausing non-military discretionary government spending programs for one year to stop their explosive growth and place accountability on federal government agencies.

I've previously discussed the enormous increase in deficits that would be caused by McCain's tax proposals, as scored by Len Burman and Greg Leiserson of the Tax Policy Center. So let me focus on the second paragraph above, which is uniformly contradicted by both facts and experience:

1. His plan would control government spending by vetoing every bill with earmarks, Well, this one has already been repudiated by....John McCain's chief economic adviser, Doug Holtz-Eakin. I've already posted on this issue:

    

   • McCain has already had to change his "definition" of those nasty earmarks he'll eliminate (somehow, without a line-item veto). According to this story by the Politico's Ben Smith, Holtz-Eakin initially claimed that there were $100 billion in earmarks in the current budget... After a former senior Democratic staffer, Scott Lilly, pointed out that many of these earmarks included stuff McCain supports, like money for Israel, Egypt and U.S. military construction, Holtz-Eakin stated that in fact the real amount of money associated with earmarks ... was only $16-18 billion.

    

2. implementing a constitutionally valid line-item veto... Clearly, this one is there to allow them to respond to criticisms ... based on the fact that under current law, the President has no capacity to pick and choose which items to fund. President McCain will have to sign or veto actual statutes, not their components. Back in the first Clinton Administration, Congress enacted and President Clinton signed the Line Item Veto Act (LIVA) to change all this. Lawsuits ensued... In Clinton v. City of New York, the Court struck down LIVA as a violation of the Constitution's Presentment clause. ... I am not a constitutional lawyer, but given my understanding of the Court's language in Justice Stevens's opinion for the Court, I find it very difficult to imagine that McCain and his lawyers (much less his economists) will be capable of "implementing a constitutionally valid line-item veto".
   
3. pausing non-military discretionary government spending programs for one year to stop their explosive growth... Gee, I hardly know where to begin on this one. First off, a one-year pause would do nothing to stop "explosive growth". It would reduce the level of spending, to be sure, but then that "explosive growth" would go right on happening. This is a mathematical principle of which each of the economist-letter's signatories no doubt is aware.

   That said, this post over at CBPP is worth a look [Update: I see that Mark Thoma posted much of the CBPP post, which I should have noted was written by Richard Kogan, back in March]. It shows the following:
   

   1. Domestic discretionary spending fell from 18.4% of all non-interest federal spending in 2001 to (an estimated) 14.7% in 2008. By comparison, defense and security spending (in which the CBPP includes DHS and Veterans' spending) rose from 21.7% to 29.2%.
   2. The real, i.e., inflation-adjusted, growth rate of domestic discretionary spending over this period was 1.3%. That's hardly an "explosive growth" path; by comparison, defense/security increased 9.1%, while SS/Medicare/Medicaid increased 3.8%.
   3. As a share of GDP, domestic discretionary spending actually fell, from 3.1% to 2.8%. That means that this category of spending has been becoming less, not more, burdensome. Defense/security rose from 3.6% to 5.6% of GDP over this period, while SS/M/M rose from 7.7% to 8.4%.

   I am frankly baffled as to what my colleagues on the right are talking about when they discuss "explosive growth" in "nonmilitary discretionary government spending". The real money on the spending side is in the military and entitlement categories. ...

   It is inconceivable that McCain will cut military spending substantially... Moreover, even after we "win" or leave Iraq, one legacy of the wars in Iraq and Afghanistan will be substantial future expenditures to care for wounded and disabled Veterans.

   Perhaps McCain does intend to broadly slash future entitlement spending; the economists' letter refers to "plans to address entitlement programs--especially Social Security, Medicare and other government health care programs". But apart from the Part D income-testing he has proposed, neither McCain nor these economists have said how or how much he will "address" entitlement programs. No one covering this race should grant a pass either to McCain or to his economist fans concerning this issue. ...

4. That leaves "place accountability on federal government agencies." Frankly, I have no idea what this means, or how it would save any money at all, much less the hundreds of billions of dollars needed to make up for McCain's extension of the Bush tax cuts.

Politics is tough arena for economists. Few of us, myself included, have ever seen a candidate whose policies all comport with our professional judgments, much less our personal preferences. I certainly won't claim that I agree with absolutely every economic policy proposal that Obama has made, and I dislike gratuitous accusations of either incompetence or dishonesty.

But it is difficult for me to believe that people who promote John McCain's economic policies on the basis of the second paragraph of the letter above can simultaneously be aware of the facts and providing honest assessments. Perhaps I am wrong. I hope so.

How Will You Use Your Wish?

I was going to ask this yesterday, but I found I had a hard time answering it myself, and I figured I ought to be able to answer my own question. I still can't come up with a decent response. Can you?:

You have just been tapped on the head by the Calvo fairy's magic wand and granted one wish. The wish can be used to make one specific change in policy, institutions, etc., anything at all, and your goal is to make the largest possible improvement in the economic system in the US with a single, narrowly focused change. It is up to you to decide what "improvement" means. What change do you want to make?

Numbers Racket?

The argument in this piece is that over time, a series of "opportunistic" changes in the statistics describing the economy have led to a biased and overly rosy view of the health of our economic system. You can read it for yourself, there's a link to the article below along with a brief passage, but my take is a bit different.

There are answers to each of the claims in the article - none are new - but let me take a more general approach. The economists in the agencies that prepare our national economic statistics are dedicated individuals whose only goal is to make the statistics as accurate as possible. They are not political hacks willing to distort the picture of the economy to help the administration. Far from it. Their goal is to provide the most accurate statistics possible and there are always improvements they would like to see made. But due to factors such as data compatibility and the cost of redefining and recalculating a measurement, statistics are not generally adjusted until it is believed the improvement is large enough to justify the change (though sometimes the statistics can be adjusted backward or spliced together in a way that preserves data compatibility).

However, even when it is clear that the measurements could be improved, and the improvements are substantial, the political process may prevent definitional changes. When are we most likely to see desired changes implemented? At some points in time, the changes may work against the administration in power, in others the changes may be helpful, and it is unlikely that the administration in power would approve of a chance unless it was helpful.

This means that changes in the definitions of statistics will, looking back, generally appear to have been put into place to help the administration in power, i.e. it will appear that they were manipulated for political purposes since the changes almost always make the economy look better. But that's not the motivation - the reason for the change is to improve the measurements - and the politics surrounding such changes dictate that they will occur most often when the changes are politically favorable.

This does impart a bias, but it is not a bias in the measurements themselves, it is a bias in the types of improvements that can be made. All of the changes improve the measurements, they don't distort the picture of the economy they make it more accurate, at least that's the intent, but the changes do not generally occur unless they are politically favorable. (Let me acknowledge that there could be some bias toward a better than true picture if this is how it works. If the politics only allow definitional changes that make the economy look better, then there could be some changes that are known to be needed, but left undone because they would make the economy look worse. This would make the reported statistics biased toward a healthier looking economy, and this is why the agencies that measure the economy should be as free as possible from political influence, so they can adjust the measurements in either direction as needed.):

Numbers Racket: Why the economy is worse than we know, by Kevin Phillips, Harper's Magazine v.316, n.1896 1may2008: If Washington's harping on weapons of mass destruction was essential to buoy public support for the invasion of Iraq, the use of deceptive statistics has played its own vital role in convincing many Americans that the U.S. economy is stronger, fairer, more productive, more dominant, and richer with opportunity than it actually is.

The corruption has tainted the very measures that most shape public perception of the economy—the monthly Consumer Price Index (CPI), which serves as the chief bellwether of inflation; the quarterly Gross Domestic Product (GDP), which tracks the U.S. economy's overall growth; and the monthly unemployment figure, which for the general public is perhaps the most vivid indicator of economic health or infirmity. Not only do governments, businesses, and individuals use these yardsticks in their decision-making but minor revisions in the data can mean major changes in household circumstances—inflation measurements help determine interest rates, federal interest payments on the national debt, and cost-of-living increases for wages, pensions, and Social Security benefits. And, of course, our statistics have political consequences too. An administration is helped when it can mouth banalities about price levels being "anchored" as food and energy costs begin to soar.

The truth, though it would not exactly set Americans free, would at least open a window to wider economic and political understanding. Readers should ask themselves how much angrier the electorate might be if the media, over the past five years, had been citing 8 percent unemployment (instead of 5 percent), 5 percent inflation (instead of 2 percent), and average annual growth in the 1 percent range (instead of the 3–4 percent range). We might ponder as well who profits from a low-growth U.S. economy hidden under statistical camouflage. Might it be Washington politicos and affluent elites, anxious to mislead voters, coddle the financial markets, and tamp down expensive cost-of-living increases for wages and pensions?

Let me stipulate: the deception arose gradually, at no stage stemming from any concerted or cynical scheme. There was no grand conspiracy, just accumulating opportunisms. As we will see, the political blame for the slow, piecemeal distortion is bipartisan—both Democratic and Republican administrations had a hand in the abetting of political dishonesty, reckless debt, and a casino-like financial sector. To see how, we must revisit forty years of economic and statistical dissembling. ...

The U.S. Economy Ex-Distortion

The real numbers, to most economically minded Americans, would be a face full of cold water. Based on the criteria in place a quarter century ago, today's U.S. unemployment rate is somewhere between 9 percent and 12 percent; the inflation rate is as high as 7 or even 10 percent; economic growth since the recession of 2001 has been mediocre, despite a huge surge in the wealth and incomes of the superrich, and we are falling back into recession. ...

The question is which gives the more distorted picture, the old definitions from 25 or 30 years ago, or the newer definitions. I'm sticking with the newer definitions, though sometimes it doesn't matter much, e.g. take the unemployment rate figure. The figure above is simply the broadest definition that the BLS measures (U6 in Table A12), and this measure adds several percentage points to the standard measure (it's available every month - there's no secret here). But the difference is fairly constant over time so that while the number is higher, the relative picture doesn't change much in terms of when unemployment was lower or higher, i.e. when things were better or worse for labor market participants.

Or take core inflation, one of the things criticized in the article. As explained here many times, there are theoretical reasons for preferring the core measure, and some of the discussions criticizing the Fed's use of core inflation don't seem to realize that the "alpha-trimming" is symmetric, i.e. both large increases and large decreases in prices are excluded from the preferred inflation measures used for policy (that's not true of CPI les food and energy, but that's not what the Fed uses for policy). Nor do they realize that the Fed is not trying to measure the cost of living. (Just to say this once more, one use of a price index is to measure the cost of living, but another is to determine the course of monetary policy, and it turns out the best price index for the Fed to use for policy excludes highly volatile prices. The Fed is not trying to measure the cost of living, it is trying to find the best signal for the course of monetary policy - see here). The CPI less food and energy measures of prices reported in the news  aren't the best measures of "core inflation," and I'd prefer that the headline number be the symmetrically trimmed PCE figure, but the two measures aren't that far apart, generally, and making such a change would likely create as much confusion and suspicion (see above) as it would improvement in communication about economic conditions. As for how to measure prices, the old way which gives the higher inflation figure in the last paragraph (does the author really want the Fed to increase the federal funds rate that much?), or the new way, again, I prefer the new way.

"Controversies about the Rise of American Inequality: A Survey"

Robert Gordon and Ian Dew-Becker survey "seven aspects of rising inequality":

Controversies about the Rise of American Inequality: A Survey, by Robert J. Gordon and Ian Dew-Becker,  NBER WP 13982, April 2008 [Open Link to Paper]: Abstract This paper provides a comprehensive survey of seven aspects of rising inequality that are usually discussed separately: changes in labor's share of income; inequality at the bottom of the income distribution, including labor mobility; skill-biased technical change; inequality among high incomes; consumption inequality; geographical inequality; and international differences in the income distribution, particularly at the top. We conclude that changes in labor's share play no role in rising inequality of labor income; by one measure labor's income share was almost the same in 2007 as in 1950. Within the bottom 90 percent as documented by CPS data, movements in the 50-10 ratio are consistent with a role of decreased union density for men and of a decrease in the real minimum wage for women, particularly in 1980-86. There is little evidence on the effects of imports, and an ambiguous literature on immigration which implies a small overall impact on the wages of the average native American, a significant downward effect on high-school dropouts, and potentially a large impact on previous immigrants working in occupations in which immigrants specialize. The literature on skill-biased technical change (SBTC) has been valuably enriched by a finer grid of skills, switching from a two-dimension to a three- or five-dimensional breakdown of skills. We endorse the three-way "polarization" hypothesis that seems a plausible way of explaining differentials in wage changes and also in outsourcing. To explain increased skewness at the top, we introduce a three-way distinction between market-driven superstars where audience magnification allows a performance to reach one or ten million people, a second market-driven segment consisting of occupations like lawyers and investment bankers, and a third segment consisting of top corporate officers. Our review of the CEO debate places equal emphasis on the market in showering capital gains through stock options and an arbitrary management power hypothesis based on numerous non-market aspects of executive pay. Data on consumption inequality are too fragile to reach firm conclusions. We introduce two new issues, disparities in the growth of price indexes and also of life expectancy between the rich and the poor. We conclude with a perspective on international differences that blends institutional and market-driven explanations. ...

9. Conclusion ...We argued in section 2 that there have been no interesting changes in labor’s share of national income over the last two decades, once a consistent cyclical chronology is applied. Over the full period 1950–2006 labor’s share has risen, not fallen, but once the labor portion of proprietor’s income is added in, labor’s share has been almost exactly flat for more than 50 years. Further, we point out that labor’s share in national income is not related to the current debate about increased inequality. If the labor income of the highest-paid workers increased enough, we could observe simultaneously an increase in labor’s share and a decline in the real income of the median worker.

Section 3 documents the evolution since the late 1970s of the 90-50-10 ratios from CPS data for men, for women, and for both together. Our most important finding is that all discussions of income by percentile below the 90th must distinguish carefully between men and women. We were surprised to learn that the 90-10 income ratio for women has increased by fully double the increase for men. While the 90-50 ratio for both men and women increased slowly and steadily from 1979 to 2005, the 50-10 ratio showed a sharp jump in 1979–86 that was twice as large for women as for men. Then the 50-10 ratio remained on a high plateau for women about 20 percent above its 1979 value, while for men the 50-10 ratio gradually slipped back to its 1979 value.

In examining causes for these changes, we focus in section 4 on five elements, the decline of unionization, the increase of trade, the increase of immigration, the decline in the real minimum wage, and the drop in top-bracket income tax rates.

Pain Inequality and the Social Security Retirement Age

Should we raise the Social Security retirement age?:

Pain and inequality, Crooked Timber: The results of this new study on pain assessment by Princeton’s Alan Krueger and SUNY Stony Brook’s Arthur Stone are for the most part not particularly surprising. As it turns out, ... even physical pain is unequally shared. For example, the Krueger/Stone study found that respondents with low socio-economic status experienced “significantly higher pain occurrences and severity.”...

Occupational status seems to play an important role, given that

the average pain rating for blue collar workers is 1.00 during work and 0.84 during nonwork, and for white collar workers it is 0.61 during both work and non-work episodes.

And in an interview, Krueger said, “Those with higher incomes welcome pain almost by choice, usually through exercise,” he says. “At lower incomes, pain comes as the result of work.”

It’s a pretty decent study; though the response rate was low enough (37%) to be worrying, the sample was weighted to reflect the composition of the general population. It’s also an improvement on earlier surveys...

The results aren’t exactly news; other studies have shown that pain and socioeconomic status tend to be inversely related. But Krueger said the relationship between pain and socioeconomic status was “stronger” than he expected.

What are the policy implications? Well, for one thing, the authors say:

The strong association between self-reported disability status and pain is notable given concerns by economists and some policymakers that able-bodied individuals may seek benefits from the Disability Insurance system.

So maybe, just maybe, all those people applying for disability aren’t just a bunch of perfectly able-bodied fakers and whiners after all?

Also, one expert says the results demonstrate “the need for pain preventing measures [in the workplace] such as better ergonomics.” Well maybe, but it’s hard to see how even the most high-quality ergonomic devices are going to make life much easier for people who make a living by scrubbing floors all day, or lifting heavy boxes. And sure, a health care system that provided universal access and did a better job at pain management would help things, too.

Given that pain is higher among blue collar workers than among white collar workers, and given that pain tends to increase with age, retirement has got to look to very different to blue collar workers who have done physical labor all their life, than it does to their more sedentary white collar counterparts. Conservatives and other Social Security crisis-mongerers love to scream about how if we don’t raise the retirement age the Social Security fund will go bankrupt. The more honest ones don’t claim Social Security is going to go under any time soon, but they do say that, given increased life expectancy, increasing the retirement age only makes sense.

In fact, I once heard a University of Chicago economics professor make that very argument. It was a lecture so I couldn’t interrupt, but it was exasperating to listen to. Easy for you to say, Mr. Economics Professor! You can do your job until you’re 100, or until senility sets in, at least.

But what about the people who scrub toilets for a living? Or health care workers who spend much of their work day manually lifting patients? Asking people to do highly physically demanding jobs like those until they’re 65 is already asking quite a lot. There’s a reason why the classic union steelworker contract had a “30 and out” pension provision. After 30 years on the job, a lot of those guys’ bodies had taken so much that they weren’t physically capable of doing physical labor anymore.

So please, let’s not hear anything more about raising the Social Security retirement age... (H/T: Shakesville)

What do conservatives say about people who want to raise taxes? That nothing is stopping them from sending the government more money voluntarily, or something like that? I suppose we could say the same thing here - if you think people should work longer, nothing is stopping you from doing so - except, perhaps, your health. We could make people with physically demanding jobs get a new job somewhere else, probably a much lower paying job than they are used to given the difficulty finding employment as age advances, just to be sure they have done their part for society. After all, doing physical labor day in and day out, and in some cases giving up their bodies and their health to produce stuff for the rest of us isn't enough, we need more than that before we give them a few years in peace.

[See also: The Costs and Benefits of Raising the Retirement Age, and Indexing for Longevity.]

Should Policymakers Try to Stabilize the Economy?

Peter Bernstein:

When Should the Fed Crash the Party?, by Peter L. Bernstein, Commentary, NY Times: In  the darkest days of the Depression, Treasury Secretary Andrew W. Mellon, one of the richest men in the United States, opposed any government action to stem the tide of plunging business activity and soaring unemployment. Instead, he urged a policy of supreme indifference.

“Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate,” he said. “It will purge the rottenness out of the system,” he added, and values “will be adjusted, and enterprising people will pick up the wrecks from less competent people.”

John Maynard Keynes, for one, thought that prescriptions like Mellon’s were preposterous. The economist called those who held such views “austere and puritanical souls”...

Keynes won the argument, and government intervention to overcome rising unemployment and falling profits has been standard operating procedure forever after. Nevertheless, the debate over intervention ... replays in today’s headlines.

As the world economy wrestles with the credit crisis and a shattered housing sector, there are those who grumble that too much prosperity caused the excesses that became the root cause of all our troubles. Now, they fear, aggressive countercyclical policies will lead to inflation and threaten a run on the dollar. In some ways, this view derives from Mellon’s dark advice.

Just recently, William Fleckenstein, a successful investment manager in Seattle, said: “Part of me keeps hoping we’ll just let financial gravity take over and have this brutal crack-up. We’d have a decent foundation instead of the balsa wood structure we had coming out of the last bubble.”

This school holds Alan Greenspan responsible for current problems. Critics ... contend that he pressed the panic button as the year-over-year inflation rate plunged from 3.6 percent year over year in May 2001 to only 1 percent just 13 months later. ...

Now, Mr. Greenspan’s critics contend, his determined creation of excess liquidity has left his successor, Ben S. Bernanke, with a mess. In this view, Mr. Bernanke is making matters only worse by carrying out extreme interventions. ...

Did Mr. Greenspan’s Fed make the right decisions? ... It is important to remember that deflation is devilishly hard to deal with. When people expect prices to decline, they tend to hold back from spending, which only makes prices fall further. ...

A profound issue is at stake here. ... Prosperity does not manage itself. William McChesney Martin Jr., the Fed chairman in the 1950s and ’60s, famously declared that the Fed’s role was “to take away the punch bowl just when the party gets going.” If we could refrain from squeezing out the last drop of punch on the upside — a temptation that Mr. Greenspan could not resist during the high-tech boom of the 1990s — fewer maladjustments would develop, and the downside would be less ominous and easier to control.

In the real world, however, managing prosperity is just as complex as managing recessions. How does anyone know precisely when the party gets too good? Mr. Martin’s timing with the punch bowl was less neat than he would have liked. Real G.D.P. declined by an average of 2.5 percent during the three recessions that followed his removal of the punch bowl. During Mr. Greenspan’s tenure, ... G.D.P. declined by an average of only 0.7 percent over two recessions.

In any case, those who echo Mellon’s view about letting downturns run their course are inconsistent in their arguments. This school favors government intervention on the upside, but wants no part of government action when trouble develops. Like Mr. Martin, it believes that government should deal with prosperity by cutting it short, before the party really gets good. But when the economy slips into recession, let ’er rip! ...

The onset of the credit crisis last summer could have led to a replay of many features of the Depression. Was it worth the risk of taking no action, and the resulting social and political consequences, in order to clean house and start fresh?

I have no doubt that today’s authorities are taking risks and are going to make mistakes in managing the complex fallout from the speculative fevers of recent years. Nevertheless, I would still reject Mellon’s advice and those who echo it, because the consequences would be unthinkable.

There are two issues here concerning whether policymakers ought to intervene to stabilize the economy. One is the idea that as the economy goes into a recession the government shouldn't interfere with the process of cleaning out the inefficient, poorly managed firms. Those who hold this "creative destruction" view believe that if it does, it not only interferes with this necessary liquidation process, it also has the potential to create moral hazard problems in the future further undermining the economy's ability to be dynamic, flexible, and innovative.

The other issue concerns the practical problems with intervention. Since the "creative destruction" idea gets plenty of ink, and since I don't agree with it, let me offer a few thoughts on some of the difficulties policymakers face in trying to stabilize output and employment.

Suppose we have an output gap:

That is, output is less than the natural rate of output (the level of output consistent with full employment). Suppose also that either monetary or fiscal policy is an effective policy tool, i.e. one or the other (or both) can move output up or down as desired (not everyone agrees this is a good assumption). Should we intervene to move output to its full employment level?

It depends. The first problem is that the value of the natural rate of output, Y*, is unknown and has to be estimated. We can think of this in terms of output or employment, so this is the same as asking what the unemployment rate target should be. Is it 4%? Is it 6%? Is it 5%? If the current unemployment rate is 5%, the answer matters. If we think full employment is 4% when it's really 6%, then we will implement the wrong policy and try to stimulate the economy to lower the 5% unemployment rate rather than taking the punch bowl away. That is likely to be inflationary.

But it's worse than this for policymakers because policy impacts output fully only after a considerable lag - it can be as long as one to three years - so they have to forecast what the full employment level of output or employment will be in the future, and the target varies over time:

So, policymakers are shooting at a moving target with very slow bullets, and the movements in the target aren't always easy to predict. So you can see why policymakers might have a difficult time.

But it's even worse than this. Not only does the target move, output moves on its own as well. Even if there is no policy intervention at all, eventually output would recover (equal the natural rate again):

The fact that output recovers on its own brings up a couple of considerations. First, suppose that the automatic adjustment of the economy is very fast, e.g. the economy can fix itself independent of policy in three months. In addition, suppose that policy takes six months to have any discernible effect on output. Then by the time the policy intervention hits output, it will already have recovered. In such a case, when policy impacts output after the six month lag, it will knock output away from, not closer to the natural rate and this is precisely the opposite of what we want policy to do. So if policy is relatively slow as compared to the self-healing process, then policy is likely to do more harm than good. This is why we devote so much energy to trying to find out how much time it takes for policy to impact the economy, and to determining how fast the economy can overcome frictions that prevent it from staying at full employment continuously.

Second, suppose that the automatic recovery process is very slow, slower than the effects of a policy intervention. In this case, policy can help, but because output is moving on its own (as is the target), the exact size of the policy intervention is difficult to determine. We don't know for sure how fast the economy will recover when hit by a particular shock, nor do we know for sure how fast policy impacts the economy, the exact size of the impact when it does hit, and the target is not known for sure either. But all of these pieces of information are needed to determine how large the policy shock should be. Give the economy too much of a policy shock and you overshoot causing inflation, too little and output will be too low leaving people unemployed. Further, it's hard to readjust and fine tune as you move forward due to the lags and moving targets, and this often results in a fairly conservative intervention, one that attempts to avoid making big mistakes.

For these and other reasons, policymakers should be humble about their ability to stabilize the economy, and some people believe it is so difficult that they ought not try at all since when they do they are just as likely - or more likely - to make things worse as they are to make things better. This, minimally, increases the variance of output over time. But I don't share that view. Yes, it's hard, but it's not impossible and I think that policymakers do much more to help than they do to hurt. They don't always get it right, part of the problem in the 1970s was that the Fed believed the natural rate of unemployment was much lower than it actually was, but for the most part the interventions have been helpful. We would be much worse off right now had we pursued a hands off approach in response to our current troubles either because we believe in the creative destruction approach, or because we believe the practical problems of policy intervention are too difficult to allow an effective response.

James Galbraith vs. Paul Krugman

A dialogue:

From: James K. Galbraith
To: Paul Krugman
Posted: Tuesday, November 5, 1996, at 4:30 p.m. PT

Jacques Derrida
Ain't no wrida
Then again, ain't no reada
Eida.

MIT, at the pinnacle of professional prominence, has an ideological flavor ... and also a stronger team orientation than most places. The problem is not conditions at the pinnacle but the inferior results when lesser places try to replicate the coverage without the people. And when good people in niches cannot find steady employment because second- and third-rate departments lack the courage to hire them.

Evidently Krugman ain't no reada, eida.

Krugman's main point is that he represents the "nerds" of economics, whereas I and the distinguished writer Robert Kuttner are "literati," who would like the profession to be less mathematical than it is. Leaving Kuttner to speak for himself, this view also totally misrepresents not only my position but also Paul Krugman's own professional one.

This may come as a surprise to outsiders, but Krugman is not a mathematical theorist (and I have heard him admit this, to a knowing audience). Krugman's mathematics are not deep, and he has no interest in complicated manipulations of data. He owes his fame, instead, to an exceptional grace and lucidity of formal presentation. With these gifts, Paul has expanded the range of neoclassical economics in several notable directions, especially international trade theory. Krugman's professional work is mathematically literate, of course. The point is that it is also literate, and, for many economists, that is its appeal.

My own work is mathematical when it needs to be. In recent years it has become very much so, in papers that are just beginning to appear (one came out this year) and working documents that I or co-authors have presented recently at Harvard, Berkeley, and to the physics department (of all places) at Texas. I have nothing against math, and when my topic (inequality, in this case) is mathematical, then so am I.

So if the issues between Krugman and myself are neither hermeneutic nor mathematic, what are they? The actual issues are philosophical and theoretical.

Paul's worldview rests on the belief that useful implications for important questions of public policy can be derived, essentially from first principles, with the help of a well-structured logic. Well-structured deduction from metaphysical first principles is the Krugman forte.

I don't accept that much of use can be learned about policy in this way. When the world deviates from the principles, as it usually does, the simple lessons go astray. This is not a complaint against math. It is a complaint against indiscriminate application of the deductive method, sometimes called the Ricardian vice, to problems of human action. Mine is an old gripe against much of what professional economists do; not against science but against scientism, against the pretense of science. To combat it, I spend my research time wrestling with real-world data, and I spend much of my writing time warring against the policy ideas of aggressive, ahistorical deductivists.

Within economic theory, our differences can be stated even more simply, for those who know the jargon. Paul is a moderately liberal neoclassical economist, formed at MIT. I am an unreconstructed and very thoroughgoing Cambridge Keynesian. Paul's main mentors are, I would judge, Paul Samuelson and Robert Solow. Mine were probably Nicholas Kaldor and Joan Robinson, not to mention the influence of my own father. This accounts for many differences between Krugman and myself, on issues ranging from the role of the market to the role of the state, differences that are rooted in deep disagreements over economic ideas.

In the final analysis, Krugman's argument is that there is a simple distinction between the "serious" economists--who agree with him--and the "critics," who are, by definition, not serious. It is true, of course, that economic-policy discussions are magnets for cranks. But from this it does not follow, and is not in fact true, that all "serious" economists hold to some single position. It is even more absurd to suppose that one gains access to this wisdom by passing an exam in algebra. In this respect, Krugman's argument is so shallow, so actually illogical (a fallacy of induction, in this case), that it is evidently aimed at rubes. I hope not many will be taken in.

(Many of my articles, including the original target of Krugman's critique, "What Is to Be Done [About Economics?]" are accessible online. Also available, a paper entitled: "Linear Decomposition of Time-Series" [for anyone interested in checking out my linear algebra ...].)

From: Paul Krugman
To: James K. Galbraith
Posted: Tuesday, November 5, 1996, at 4:30 p.m. PT

I am grateful to James Galbraith for two things: the relative civility of his letter, and the link to his article on doing economics. That way we need not throw quotations at each other--readers can go look at his piece and see if I have gotten the spirit of it right.

When you try to talk about the importance of a mathematical sensibility in doing economics, there are two misunderstandings that you must immediately confront. The first is that the math must be fancy--that I must be talking about pages and pages full of squiggles. The second is the charge that if you think that algebra is important, you must believe that everything about the world can be deduced from equations, and be uninterested in checking your equations against reality.

What I actually have in mind is something much more prosaic. Economics is at least partly about quantities and their relationships; so you can't make sense of it unless you are willing to do some arithmetic and even some algebra to make sure that the stories you tell hang together--and that they are consistent with the evidence. This doesn't sound like much, but experience shows that there are many influential intellectuals who are prepared to make sweeping pronouncements on economics without doing the arithmetic. And by the way, throwing around lots of statistics is not the point: It's a question of thinking hard about how the statistics fit together.

Maybe the only way to explain what I am talking about is to give an example. It involves Michael Lind of The New Yorker, against whom I have no particular grudge--in fact, part of the point is that he is, undoubtedly, a very smart guy. That is what makes this particular example so revealing: It shows what happens when someone who is very bright but does not understand the role of arithmetic in economic analysis tries to make pronouncements on the subject.

Two years ago, Lind wrote the following in Harper's:

Many advocates of free trade claim that higher productivity growth in the United States will offset any downward pressure on wages caused by the global sweatshop economy, but the appealing theory falls victim to an unpleasant fact. Productivity has been going up, without resulting wage gains for American workers. Between 1977 and 1992, the average productivity of American workers increased by more than 30 percent, while the average real wage fell by 13 percent. The logic is inescapable. No matter how much productivity increases, wages will fall if there is an abundance of workers competing for a scarcity of jobs--an abundance of the sort created by the globalization of the