Economist's View

'Global Warming Has a Fairly Simple and Cheap Technical Solution'

Robert Frank:

Carbon Tax Silence, Overtaken by Events, by Robert Frank, Commentary, NY Times: ...Mitt Romney ... has been equivocal about whether rising temperatures are caused by human action. But he has been adamant that uncertainty about climate change rules out policy intervention. ...

Climatologists are the first to acknowledge that theirs is a highly uncertain science. The future might be better than they think. Then again, it might be much worse. Given that risk, policy makers must weigh the potential cost of action against the potential cost of inaction. And even a cursory look at the numbers makes a compelling case for action. ...

The good news is that we could insulate ourselves from catastrophic risk at relatively modest cost by enacting a steep carbon tax. ... A carbon tax would also serve two other goals. First, it would help balance future budgets. ... If new taxes are unavoidable, why not adopt ones that ... make the economy more efficient? By reducing harmful emissions, a carbon tax fits that description.

A second benefit would occur if a carbon tax were ... phased in gradually, only after the economy had returned to full employment. High unemployment persists in part because businesses, sitting on mountains of cash, aren’t investing it... News that a carbon tax was coming would create a stampede to develop energy-saving technologies. ...

Some people argue that a carbon tax would do little good unless it were also adopted by China and other big polluters. It’s a fair point. But access to the American market is a potent bargaining chip. The United States could ... tax imported goods in proportion to their carbon dioxide emissions if exporting countries failed to enact carbon taxes at home.

In short, global warming has a fairly simple and cheap technical solution. ...

Update: I didn't do a very good job of highlighting Robert Frank's point that we shouldn't "expect to hear much about climate change at the Republican and Democratic conventions," but "Many climate scientists ... are now pointing to evidence linking rising global temperatures to the extreme weather we’re seeing around the planet." Thus, "Extreme weather is already creating enormous human suffering, and "If the recent meteorological chaos drives home the threat of climate change and prompts action, it may ultimately be a blessing in disguise."

'The Latest Tory Idiocy'

Chris Dillow:

"Nothing to fear"?, by Chris Dillow: Here's the latest Tory idiocy. Dominic Raab says the "talented and hard-working have nothing to fear" from a scrapping of "excessive protections" for workers.

Let's ignore the fact that the UK has some of the weakest job protection laws in the world. Let's also ignore the fact that there's no evidence that scrapping employment protection would create new jobs. And let's also ignore the fact that employment protection is of only marginal concern to small businesses, and that even a former director-general of the CBI has mocked the idea of abolishing the few protections workers have.

Is Raab right that the best workers have nothing to fear?

No. ...[explains why]... I'm pretty sure, then, that Raab is talking rot. What I'm not so sure about is why. One possibility is that he's so blinded by free market ideology and by romantic ideas about entrepreneurs and managers that he just cannot see that some free market reforms are of negligible benefit and that some bosses are less than heroic.

But you'd have thought that the experience of the crisis - which has seen bankers get multi-million bonuses whilst good workers lose their jobs - would have disabused anyone of the just world theory that capitalism rewards talent and effort. There's comes a point when a cognitive bias shades into a psychiatric disorder.

This leaves another possibility. It's that Raab is simply taking sides in a class war. He wants to further empower bosses to bully workers, even if this has no macroeconomic benefit.

Outsourcing Government: What Is Mitt Romney Talking About?

Brad DeLong is very puzzled:

Department of "Huh!?": What Is Mitt Romney Talking About?: An interview with Mitt Romney:

QUESTION: One thing that distinguishes this recovery is that public sector jobs, government jobs, have already fallen by 650,000. Given the conservative goal of shrinking government, is this a positive development or a negative one?

MITT ROMNEY: Well, clearly you don’t like to hear [about] anyone losing a job. At the same time, government is the least productive—the federal government is the least productive of our economic sectors. The most productive is the private sector. The next most productive is the not-for-profit sector, then comes state and local governments, and finally the federal government. And so moving responsibilities from the federal government to the states or to the private sector will increase productivity. And higher productivity means higher wages for the American worker. All right? America is the highest productivity nation of major nations in the world, and that results in our having, for instance, an average compensation about 30 percent higher than the average compensation in Europe. A government that becomes more productive, that does more with less, is good for the earnings of the American worker, and ultimately it will mean that our taxes don’t have to go up, that small businesses will find it easier to start and grow, and we will be able to add more private sector jobs. Don’t forget! It’s the private sector jobs that pay for government workers. So if you have fewer government workers doing work more and more productively, that means private sector work will grow.

Nobody can figure out what Mitt Romney is talking about here. He seems to be referring to some aggregate assessment of "productivity" across the four major sectors--private, non-profit, state and local government, and federal government. But nobody can figure out what he is talking about.

Does he really think that we should outsource the army to Blackwater? Or the NIH to Merck? Or the Marine Corps to Marriott? Or the Social Security Administration to Bain Capital?

Certainly our experience with for-profit hospitals and for-profit universities does not support the hypothesis that productivity inevitably goes up when we shift things over to the private sector.

Where is this coming from?

No reason to be puzzled -- Paul Krugman explained "the real motives for turning government functions over to private companies" several years ago (and it wasn't the first time):

Outsourcer in Chief, by Paul Krugman, Commentary, NY Times, December 11, 2006: According to U.S. News & World Report, President Bush has told aides that he won’t respond in detail to the Iraq Study Group’s report because he doesn’t want to “outsource” the role of commander in chief.

That’s pretty ironic. You see, outsourcing of the government’s responsibilities — not to panels of supposed wise men, but to private companies with the right connections — has been one of the hallmarks of his administration. And privatization through outsourcing is one reason the administration has failed on so many fronts.

For example, an article in Saturday’s New York Times describes how the Coast Guard has run a $17 billion modernization program: “Instead of managing the project itself, the Coast Guard hired Lockheed Martin and Northrop Grumman, two of the nation’s largest military contractors, to plan, supervise and deliver the new vessels and helicopters.”

The result? Expensive ships that aren’t seaworthy. The Coast Guard ignored “repeated warnings from its own engineers that the boats and ships were poorly designed and perhaps unsafe,” while “the contractors failed to fulfill their obligation to make sure the government got the best price, frequently steering work to their subsidiaries or business partners instead of competitors.”

In Afghanistan, the job of training a new police force was outsourced to DynCorp International, a private contractor, under very loose supervision: when conducting a recent review, auditors couldn’t even find a copy of DynCorp’s contract to see what it called for. And $1.1 billion later, Afghanistan still doesn’t have an effective police training program.

In July 2004, Government Executive magazine published an article titled “Outsourcing Iraq,” documenting how the U.S. occupation authorities had transferred responsibility for reconstruction to private contractors, with hardly any oversight. “The only plan,” it said, “appears to have been to let the private sector manage nation-building, mostly on their own.” We all know how that turned out.

On the home front, the Bush administration outsourced many responsibilities of the Federal Emergency Management Agency. For example, the job of evacuating people from disaster areas was given to a trucking logistics firm, Landstar Express America. When Hurricane Katrina struck, Landstar didn’t even know where to get buses. According to Carey Limousine, which was eventually hired, Landstar “found us on the Web site.”

It’s now clear that there’s a fundamental error in the antigovernment ideology embraced by today’s conservative movement. Conservatives look at the virtues of market competition and leap to the conclusion that private ownership, in itself, is some kind of magic elixir. But there’s no reason to assume that a private company hired to perform a public service will do better than people employed directly by the government.

In fact, the private company will almost surely do a worse job if its political connections insulate it from accountability — which has, of course, consistently been the case under Mr. Bush. The inspectors’ report on Afghanistan’s police conspicuously avoided assessing DynCorp’s performance; even as government auditors found fault with Landstar, the company received a plaque from the Department of Transportation honoring its hurricane relief efforts.

Underlying this lack of accountability are the real motives for turning government functions over to private companies, which have little to do with efficiency. To say the obvious: when you see a story about failed outsourcing, you can be sure that the company in question is a major contributor to the Republican Party, is run by people with strong G.O.P. connections, or both. ...

Going back to Romney's claims about productivity, we seem to be forgetting that there are some goods that the private sector won't produce at all due to market failures (e.g., the classic example is national defense). In those cases, the government is clearly more efficient than the private sector. The government may not be maximally efficient -- and there may be ways to improve upon that -- but it's certainly better than relying upon a private sector that won't produce the goods in anywhere near sufficient quantities, if they get produced at all.

Here's an interesting example from Shane Greenstein:

...with the benefit of ideological blinders, and a dose of lack of detail, several commentators — most notably, the Wall Street Journal editorial page (which David Warsh nicely summarizes) — recently have begun to argue that government’s investment in the Internet was not essential to its growth. That conclusion arises due from the (again, frightfully) unstated assumption that the Internet would have turned out the same way without government sponsorship at the outset.

Look, somebody can only say such things if they do not know the history of the Internet, and they make a concerted effort not to know the facts. (If you are neophyte, there are many places to start online, but I recommend starting here). There actually were attempts to make networking investments with private firms, and there were privately funded packet switching firms too. Those did not catch on widely, and they remained a niche service. I repeat: Attempts to build a private national packet switching network of the scale and size of the Internet failed to catch on. And it is very clear why it failed: because they were restricted to proprietary interconnection, with restricted rights to users and other firms. Nobody interconnected with anyone else.

But everyone would interconnect with the government sponsored Internet. It came out of universities, who took over funding for network development from the Department of Defense (who originally got into the business because DOD needed better computing for their own purposes). The standards coming from universities were not proprietary. That is actually why it worked.

Look, take the blinders off. Government sponsorship also was not perfect. That setting truncated application development. Private markets were great for exploring new uses, once the network was up and running. ...

There are lots and lots of things that government has no business doing. The private sector, appropriately regulated to ensure competitiveness, can take care of the provision of these goods and services. But there are other things that government must do if they are to be done at all. Sometimes the lines are fuzzy, and there can be legitimate debates about what should and shouldn't be in government hands. I suspect some people will still object to the claim above about the internet, for example. But there are also clear cases on both sides of the fuzzy line, something we seem to have forgotten.

Shiller: Bubbles without Markets

Robert Shiller argues that reining in markets is not the answer to bubbles:

Bubbles without Markets, by Robert Shiller, Commentary, Project Syndicate: A speculative bubble is a social epidemic whose contagion is mediated by price movements. News of price increase enriches the early investors, creating word-of-mouth stories about their successes... The excitement then lures more and more people into the market ... in successive feedback loops as the bubble grows. After the bubble bursts, the same contagion fuels a precipitous collapse, as falling prices cause more and more people to exit the market, and to magnify negative stories about the economy.

But, before we conclude that we should now, after the crisis, pursue policies to rein in the markets, we need to consider the alternative. In fact, speculative bubbles are just one example of social epidemics, which can be even worse in the absence of financial markets. In a speculative bubble, the contagion is amplified by people’s reaction to price movements, but social epidemics do not need markets or prices to get public attention and spread quickly.

Some examples of social epidemics unsupported by any speculative markets can be found in Charles MacKay’s 1841 best seller Memoirs of Extraordinary Popular Delusions and the Madness of Crowds.The book made some historical bubbles famous: the Mississippi bubble 1719-20, the South Sea Company Bubble 1711-20, and the tulip mania of the 1630’s. But the book contained other, non-market, examples as well.

MacKay gave examples, over the centuries, of social epidemics involving belief in alchemists, prophets of Judgment Day, fortune tellers, astrologers, physicians employing magnets, witch hunters, and crusaders. Some of these epidemics had profound economic consequences. The Crusades from the eleventh to the thirteenth century, for example... Between one and three million people died in the Crusades.

There was no way, of course, for anyone either to invest in or to bet against the success of any of the activities promoted by the social epidemics – no professional opinion or outlet for analysts’ reports on these activities. So there was nothing to stop these social epidemics from attaining ridiculous proportions. ...

The recent and ongoing world financial crisis pales in comparison with these events. And it is important to appreciate why. Modern economies have free markets, along with business analysts with their recommendations, ratings agencies with their classifications of securities, and accountants with their balance sheets and income statements. And then, too, there are auditors, lawyers and regulators.

All of these groups have their respective professional associations, which hold regular meetings and establish certification standards that keep the information up-to-date and the practitioners ethical in their work. The full development of these institutions renders really serious economic catastrophes – the kind that dwarf the 2008 crisis – virtually impossible.

Setting aside the extent to which these are really bubbles as commonly understood, nobody is talking about eliminating markets entirely. The push from those of us who want to "rein in the markets" is to regulate them so they function better than they did prior to the crisis. I don't see how these examples of so called non-market bubbles argue against regulating markets to make them work better. Modern economies may have something like the "free markets" Shiller talks about, but unregulated markets do not always function in the public's best interest and regulations that rein them in and make them more competitive, less subject to catastrophic failure, etc. can improve their social value. The question isn't about markets versus non-markets, the question is how to make our existing insitutions perform better and none of the above helps much with that question. How, for example, can we make business analysts, ratings agencies, accountants, lawyers, and regulators that Shiller lauds -- all of whom fell down on the job to some extent prior to the crisis -- do a better job next time?

Finally, I can't help asking: What is his definition of "really serious catastrophe"? How many millions of unemployed does it take? I'd hate to see a crisis that "dwarfs" this one, but this was no walk in the park. Perhaps the crowd Shiller hangs around in didn't think it was all that serious, but for many, many people it was quite catastrophic.

Update: I should have also added that the fact that this recession, while severe, didn't reach the depths of the Great Depression has more to do with improved social insurance, better automatic stabilizers, better policy (though far from perfect), and a higher initial level of wealth than it does the presence of free markets, business analysts, ratings agencies, accountants, auditors, lawyers, and regulators.

"An Important Property of Cap-and-Trade"

Another quick one while I wait for a connection at the SF airport --- Robert Stavins explains the independence property for cap-and-trade systems. This property "allows equity and efficiency concerns to be separated. In particular, a government can set an overall cap of pollutant emissions (a pollution reduction goal) and leave it up to a legislature to construct a constituency in support of the program by allocating shares of the allowances to various interests, such as sectors and geographic regions, without affecting either the environmental performance of the system or its aggregate social costs":

Two Notable Events Prompt Examination of an Important Property of Cap-and-Trade, by Robert Stavins: ...In our just-published article, “The Effect of Allowance Allocations on Cap-and-Trade System Performance,” [Robert] Hahn and I ... focused on an idea that is closely related to the Coase theorem, namely, that the market equilibrium in a cap-and-trade system will be cost-effective and independent of the initial allocation of tradable rights (typically referred to as permits or allowances). That is, the overall cost of achieving a given emission reduction will be minimized, and the final allocation of permits will be independent of the initial allocation, under certain conditions (conditional upon the permits being allocated freely, i.e., not auctioned). We call this the independence property. It is closely related to a core principle of general equilibrium theory (Arrow and Debreu 1954), namely, that when markets are complete, outcomes remain efficient even after lump-sum transfers among agents.

The Practical Political Importance of the Independence Property

We were interested in the independence property because of its great political importance.  The reason why this property is of such great relevance to the practical development of public policy is that it allows equity and efficiency concerns to be separated. In particular, a government can set an overall cap of pollutant emissions (a pollution reduction goal) and leave it up to a legislature to construct a constituency in support of the program by allocating shares of the allowances to various interests, such as sectors and geographic regions, without affecting either the environmental performance of the system or its aggregate social costs.  Indeed, this property is a key reason why cap-and-trade systems have been employed and have evolved as the preferred instrument in a variety of environmental policy settings.

In Theory, Does the Property Always Hold?

Because of the importance of this property, we examined the conditions under which it is more or less likely to hold — both in theory and in practice.  In short, we found that in theory, a number of factors can lead to the independence property being violated. These are particular types of transaction costs in cap-and-trade markets; significant market power in the allowance market; uncertainty regarding the future price of allowances; conditional allowance allocations, such as output-based updating-allocation mechanisms; non-cost-minimizing behavior by firms; and specific kinds of regulatory treatment of participants in a cap-and-trade market.

In Reality, Has the Property Held?

Of course, the fact that these factors can lead to the violation of the independence property does not mean that in practice they do so in quantitatively significant ways.  Therefore, Hahn and I also carried out an empirical assessment of the independence property in past and current cap-and-trade systems: lead trading; chlorofluorocarbons (CFCs) under the Montreal Protocol; the sulfur dioxide (SO₂) allowance trading program; the Regional Clean Air Incentives Market (RECLAIM) in Southern California; eastern nitrogen oxides (NO_X) markets; the European Union Emission Trading Scheme (EU ETS); and Article 17 of the Kyoto Protocol.

I encourage you to read our article, but, a quick summary of our assessment is that we found modest support for the independence property in the seven cases we examined (but also recognized that it would surely be useful to have more empirical research in this realm).

Politicians Have Had it Right

That the independence property appears to be broadly validated provides support for the efficacy of past political judgments regarding constituency building through legislatures’ allowance allocations in cap-and-trade systems. Governments have repeatedly set the overall emissions cap and then left it up to the political process to allocate the available number of allowances among sources to build support for an initiative without reducing the system’s environmental performance or driving up its cost.

This success with environmental cap-and-trade systems should be contrasted with many other public policy proposals for which the normal course of events is that the political bargaining that is necessary to develop support reduces the effectiveness of the policy or drives up its overall cost.  So, the independence property of well-designed and implemented cap-and-trade systems is hardly something to be taken for granted.  It is of real political importance and remarkable social value.

The Role of Government

A recent column:

The Role of Government, by Mark Thoma: The upcoming presidential election gives voters a choice between two very different philosophies of government. For Democrats, an activist government is necessary to keep markets functioning, and to smooth economic fluctuations. Without government oversight, markets would be captured by monopoly power, consumers would be at the mercy of unscrupulous producers, there would be distortions from adverse selection, information asymmetries, moral hazard problems, and so on. In addition, if government does not take action when a recession hits, the downturn will be much worse and much longer than necessary.

For Republicans, however, activism is exactly the wrong approach to take. They believe that the key to making markets work and smoothing economic fluctuations is for the government to get out of the way and let the private sector work its magic. In general, markets react faster, incorporate more information, and regulate commercial behavior better than humans will ever be able to do.

What is behind the stark difference in views about the role of government? Activists believe that market failures have large negative consequences, that these problems won't necessarily fix themselves, and that government is an effective way of overcoming these problems. Government isn't perfect, but neither is the private sector (see the bulldozed waste from the housing bubble), and on net it’s helpful for the government to take action when relatively severe market failures are present. Traditionally, those who take a more hands off approach do not deny that all markets fail to some degree – no market is perfectly competitive. But for the most part they do not see these failures as having large consequences, and even when they do government intervention is rarely the solution. In many, if not most cases, that just makes things worse.

In the modern Republican Party, these views have been taken to the extreme so that government is rarely, if ever, supported. But there are some areas where private sector will not provide goods and services by itself, public goods for example, and even when the goods are provided market failures distort the outcome. Who will build bridges, provide sewage systems, national defense, roads, airports, water systems, and so on if not the government? Who will force internalization of all costs of production if not the government? Who else can overcome adverse selection, information, and moral hazard problems in health and retirement markets? Conservatives can come up with stories about how the private sector will overcome these problems and provide goods in each case, but historically these goods simply haven't been provided, at least not at the scale and breadth needed. That's why government stepped in to begin with. To think it will somehow be different this time if government stepped out of the way is highly wishful thinking.

We cannot function economically without supporting infrastructure, we are already falling behind where ought to be and that will prove costly over time, and we cannot allow externalities, particularly those associated with global warming, to run rampant. Conservatives used to understand that government had an important role to play in these areas, and opposition to government was based upon coherent reasoning rather than a knee-jerk rejection of government.

This extremism within the Republican Party is hurting the economy. In the short-run, it makes it much harder to do anything about the recession. Even if you believe spending more on infrastructure will do nothing to help employment, letting infrastructure crumble will hurt our long-run growth, and presently the construction of infrastructure is about as cheap as it gets. Infrastructure is inherently a supply-side policy with attractive demand side effects in a recession, and the refusal of Republicans to support such spending looks far more like a political ploy than a well-reasoned position.

But that may pale in comparison to the long run consequences of failing to deal with global warming. Here we have a party that purports to be all about letting markets work their magic confronted with a clear market failure with considerable potential consequences, a problem that the private sector will not fix by itself. So what do they do? They know that there's no solution except government intervention if they admit to a consequential market failure, so they deny that a problem even exists.

There was a time when extremists were not the main voice of the Republican Party, a time when we had some chance of dealing with important issues. There were arguments about the precise location of the line separating when the government should and shouldn't step in, and there were debates about command and control versus market based mechanisms to solve problems. But both sides understood that the lines existed, and when both lines were crossed there was at least a chance the two sides would come together to solve our problems.

Unfortunately, those days are long gone, and if Republicans win big in November it will be a long time before we see them again.

Bigger is Not Always Better

Robert Reich is pleased to see the Justice Department crackdown on "Big Pharma," but doesn't think think the government is doing anywhere near enough to solve the problem:

How Not to Get Big Pharma to Change Its Ways, by Robert Reich: Earlier this week the Justice Department announced a $3 billion settlement of criminal and civil charges against pharma giant GlaxoSmithKline — the largest pharmaceutical settlement in history — for improper marketing prescription drugs in the late 1990s to the mid-2000s.

The charges are deadly serious. Among other things, Glaxo was charged with promoting to kids under 18 an antidepressant approved only for adults; pushing two other antidepressants for unapproved purposes,... and, to further boost sales of prescription drugs, showering doctors with gifts, consulting contracts, speaking fees, even tickets to sporting events.

$3 billion may sound like a lot of money, but during these years Glaxo made $27.5 billion on these three antidepressants alone,... so the penalty could almost be considered a cost of doing business. 

Besides, to the extent the penalty affects Glaxo’s profits and its share price, the wrong people will be feeling the financial pain. ... Not a single executive has been charged — even though some charges against the company are criminal. ...

The Glaxo case is the latest and biggest in a series of Justice Department prosecutions of Big Pharma for illegal marketing prescription drugs. ... The Department says the prosecutions are well worth the effort. By one estimate it’s recovered more than $15 for every $1 it’s spent.

But what’s the point if the fines are small relative to the profits, if the wrong people are feeling the financial pinch, and if no executive is held accountable? 

The only way to get big companies like these to change their behavior is to make the individuals responsible feel the heat.

An even more basic issue is why the advertising and marketing of prescription drugs is allowed at all, when consumers can’t buy them and shouldn’t be influencing doctor’s decisions anyway. Before 1997, the Food and Drug Administration banned such advertising on TV and radio. That ban should be resurrected.

Finally, there’s no good reason why doctors should be allowed to accept any perks at all from [drug] companies... It’s an inherent conflict of interest. Codes of ethics that are supposed to limit such gifts obviously don’t work. All perks should be banned, and doctors that accept them should be subject to potential loss of their license to practice.  

Simon Johnson, summarizing Dennis Kelleher of the blog Better Markets, says banks have the same problem:

... Global megabanks have an incentive to deceive customers, including both individuals and nonfinancial corporations. Their size confers both market power and the political power needed to conceal the extent to which they engage in economic fraud. The lack of transparency in derivatives markets provides them with an opportunity to cheat, but the abuses are much wider – as the Libor scandal demonstrates. The ripoff is not just of retail investors. ...

This has motivated Samuel Brittan of the Financial Times to rethink his view of competitive markets. Sort of:

As one of the few commentators to have always favored competitive market capitalism I have had to ask myself a few questions. Apart from scandals such as the Libor rate fixing, we have had the behavior of banks before the great recession; a trend to much greater concentration of income and wealth, squeezing the living standards of ordinary citizens; and one could go on.

So, after asking himself these questions, what does he propose?:

Yet if anyone expects me to issue a clarion call for more state ownership and control, they will be disappointed. ... What then has gone wrong? ... Few of us like competition; and the tendency to form closely knit groups to keep outsiders at bay is probably as old as the human race. For pre-capitalist examples one has only to think of the medieval guilds, whether of craftsmen or Master Singers. More subtle are the practices of bankers, as they come disguised as services for customers. In summary, success has depended more on whom you know than what you know. Hence the catchphrase “crony capitalism”. ...

The biggest obstacle to reform is that insiders can devote time and energy to maintaining their position. For ordinary citizens, political reform is a sideshow that hardly repays such efforts. The protests in financial canters are a well-meant but ill-focused attempt to offset this bias.

Yet nil desperandum. The UK corn laws were repealed and the US antitrust acts were passed; and in time both the financiers and the Eurocrats will be brought down.

So, no cause for despair? Not so sure about that (the changes he describes did not come easily). It feels a bit like the Libor scandal has produced a turning point, but the power hold on politicians is still as strong as ever. We've seen how some Democrats react if Obama so much as points a finger in the direction of the financial industry, and if Romney is elected does anyone think the government will get tougher with big banks, big pharma, or big anything else?

'Giving Health Care a Chance to Evolve'

Robert Frank discusses market failures in health insurance markets, and how the president's health care plan helps to overcome them:

Giving Health Care a Chance to Evolve, by Robert Frank, Commentary, NY Times: ...Nearly every economic analysis of the health care industry rests on the observation that individually purchased private insurance is not a viable business model...

The fundamental problem is that ... people ... with serious pre-existing conditions ... are likely to need expensive care. Any company that issued policies to such people at affordable rates would be driven into bankruptcy, its most profitable customers lured away by competitors offering lower rates made possible by selling only to healthy people.

Economists call this the adverse-selection problem. Because of it, unregulated private markets for individual insurance cannot accommodate the least healthy — those who most desperately need health insurance.

Many countries solve this problem by having the government provide health insurance for all. In some, like Britain, the government employs the care providers. Others, like France, reimburse private practitioners — as does the Medicare program for older Americans. ...

Modeled after proposals advanced by the Heritage Foundation, the American Enterprise Institute and other conservative research organizations in the 1990s, the main provisions of the president’s health care law were intended to eliminate the most salient problems associated with the current system. ...

It isn’t that people should buy health insurance because it would be good for them. Rather, failure to do so would cause significant harm to others. Society will always step in to provide care — though in much more costly and often delayed and ineffective forms — to the uninsured who fall ill. To claim the right not to buy health insurance is thus to assert a right to impose enormous costs on others. Many legal scholars insist that the Constitution guarantees no such right. ...

What’s important now is how ... the law will ... extend coverage to tens of millions who now lack it. In addition, new insurance exchanges will provide a broader array of care options. ... The point worth celebrating is that last week’s ruling will at last enable our distinctly dysfunctional health care system to evolve into something better.

[More on market failures in health insurance markets here and here.]

More on the Economics of the Mandate

In my discussion of the economics underlying the reason for the mandate (and the penalties needed to enforce it), I talked about the adverse selection problem, but I wish I would have talked about moral hazard as well since that is also part of the problem.

Under adverse selection, relatively healthy people drop out of insurance pools because they expect their health costs to be less than they would have to pay for insurance. As the relatively healthy people drop out, it raises the average cost of covering people (since the relatively healthy are no longer in the pool), which causes more people to drop out (the ones with expected costs that are now less than the higher premiums), which raises the price again, which causes more people to drop out, and so on until the market breaks down entirely.

But even healthy people have some chance of catastrophic illness, illness that could be deathly for example, so why wouldn't they purchase insurance in case this happens?

People know we are a compassionate society, and if they come down with a life threatening disease we will take care of them even if they don't have insurance, i.e. even if moral hazard causes them to shirk the personal responsibility conservatives hold so dear. Thus, relatively healthy people can take a chance and go without insurance secure in the knowledge that they will be treated if something awful happens. Broken bones, catastrophic illness and so on will be covered. But covered by whom? In many cases, the individual will not have sufficient resources to pay for the medical care, it would bankrupt them, so there is no choice but for all of the rest of us to pick up the bill.

A mandate stops this from happening. It forces those who would take a chance and go without care, those who are relying on all of the rest of us to insure them against large, unavoidable medical costs, to insure themselves against this. That is, it stops this moral hazard behavior. (Essentially, adverse selection is about the average or mean cost, moral hazard is about the variance -- loss of life, for example, can be viewed as a very bad draw that occurs with some probability and imposes very large, perhaps infinite costs.)

Adverse selection and moral hazard are not mutually exclusive. As you can see, they work together -- people with expected costs lower than premiums drop out knowing they are covered by the rest of us against a bad draw. A mandate, or its equivalent, helps to overcome both of these problems.

"Reviving Real Estate Requires Collective Action"

Robert Shiller:

Reviving Real Estate Requires Collective Action, by Robert Shiller, Commentary, NY Times: Imagine that you are watching an outdoor theater production while sitting on the grass. You have difficulty seeing, so you prop yourself up on your knees. Soon everyone behind you does the same. Eventually, most people are kneeling or standing, yet they are less comfortable than they were before and have no better view. Everyone should sit down, and everyone knows it, but no one does.

This is a collective action problem, a phenomenon that is, unfortunately, all too common. At the moment, the trouble in our real estate markets and the drag these markets are placing on our entire economy may be understood as a collective action problem. In a nutshell, mortgage lenders need to write down the amounts owed by individual homeowners — that is, let everyone sit down and relax — but the different stakeholders have been unable to reach an agreement, even if it is in their common interest. ...

If such mortgage principal reductions could be applied on a large scale, there could be large neighborhood effects, raising a sense of optimism among homeowners and bolstering the value of all homes and, ultimately, the whole economy. But mortgage lenders in all their different forms lack a group strategy. ...

He goes on to suggest several solutions to this problem.

A Back Door to the Public Option?

Robert Reich says there's still hope even if the Supreme Court strikes down the individual mandate in the Affordable Care Act:

A Back Door to the Public Option, by Robert Reich: Any day now the Supreme Court will issue its opinion on the constitutionality of the Accountable Care Act, which even the White House now calls Obamacare.

Most high-court observers think it will strike down the individual mandate in the Act that requires almost everyone to buy health insurance,... but will leave the rest of the new healthcare law intact.

But the individual mandate is so essential to spreading the ... cost of health care over the whole population, including younger and healthier people, that some analysts believe a Court decision that nixes the mandate will effectively spell the end of the Act anyway.

Yet it could have exactly the opposite effect. If the Court strikes down the individual mandate, health insurance company lobbyists and executives will swarm Capitol Hill seeking to have the Act amended to remove the requirement that they insure people with pre-existing medical conditions. They’ll argue that without the mandate they can’t afford to cover pre-existing conditions.

But the requirement to cover pre-existing conditions has proven to be so popular with the public that Congress will be reluctant to scrap it. This opens the way to a political bargain. Insurers might be let off the hook, for example, only if they support allowing every American, including those with pre-existing conditions, to choose ... something very much like Medicare. In effect, what was known during the debate over the bill as the “public option.” ...

The fact is, there’s enough the public likes about Obamacare that if the Court strikes down the individual mandate that won’t be the end. It will just be the end of the first round.

I'd like to think he's right, but hard for me to see this happening. [Here's an old post explaining why an individual mandate is needed.]

Why Zingales Now Endorses Glass-Steagall

Luigi Zingales has changed his mind about Glass-Steagall:

Why I was won over by Glass-Steagall, by Luigi Zingales, Commentary, FT: I have to admit that I was not a big fan of the forced separation between investment banking and commercial banking along the lines of the Glass-Steagall Act in the US. I do not like restrictions to contractual freedom, unless I see a compelling argument that the free market gets it wrong. Nor did I buy the argument that the removal of Glass-Steagall contributed to the 2008 financial crisis. The banks that were at the forefront of the crisis – Bear Stearns, Lehman Brothers, Washington Mutual, Countrywide – were either pure investment banks or pure commercial banks. The ability to merge the two types was crucial in mounting swift rescues to stabilize the system – such as the acquisition of Bear Stearns by JP Morgan and of Merrill Lynch by Bank of America.

Over the last couple of years, however, I have revised my views and I have become convinced of the case for a mandatory separation.

There are certainly better ways to deal with excessive risk-taking behavior by banks, but we must not allow the perfect to become the enemy of the good. In the absence of these better mechanisms, it makes perfect economic sense to restrict commercial banks’ investments in very risky activities, because their deposits are insured. Short of removing that insurance – and I doubt commercial banks are ready for that – restricting the set of activities they undertake is the simplest way to cope with the burden that banks can impose on taxpayers. ...

I was initially swayed by Dean Baker's argument that the banks that caused the most trouble were "either pure investment banks or pure commercial banks" as noted above, and thus that reestablishing a forced separation between the two types of institutions would not do much to insulate us from crises in the future. By my view on this has also evolved along the same lines, e.g. that "With the repeal of Glass-Steagall, investment banks exploded in size and so did their market power" leading to "an opaque over-the-counter market populated by a few powerful dealers," that "The separation between investment and commercial banking also helps make the financial system more resilient," and that, importantly, "Glass-Steagall helped restrain the political power of banks." This should not be the only thing we do to try to make the financial system more stable, there is much,much more that needs to be done. But it is an important part of the effort. (One more note on this -- I also think that there were additional vulnerabilities created by the removal of Glass Steagall. Even if those additional vulnerabilities didn't cause trouble this time around, that doesn't mean they never can. Re-imposing the separation between investment banking and commercial banking eliminates some of these potential problems.)

"Adam Smith and the Myth of Laissez Faire"

Gavin Kennedy continues to fight against cartoonish mis-representations of what Adam Smith actually said and believed:

Adam Smith and the Myth of Laissez Faire, by Gavin Kennedy: ...Let us be clear: Adam Smith did not use the words “Laissez-faire” in anything that he wrote, published in his lifetime or posthumous, or in any student notes that have so far been found, or in any reports of his lectures by those who attended them (John Millar, James Woodrow, Lord Buchan, John Stuart, etc.,) or by those who knew him intimately (such as Dugald Stewart, whose father was a student at Glasgow with Smith). ...

We know that Smith knew of the use and meaning of laissez-faire from his close association with the Physiocratic circle around Quesnay during his visits to Paris (1764-67). The fact is that laissez-faire never entered his vocabulary. Nor did an English translation. This has not prevented many commentators from seeking to use Smith’s use of Natural Liberty as a synonym for laissez-faire. It was not the same thing.

Natural Liberty was a philosophical concept based on Natural Law theories as expressed by Grotius and Pufendorf... The originator of laissez-faire was a ‘plain spoken’ French merchant, M. le Gendre, a deputy of commerce, who responded to the question put to them by Colbert, the French minister, what he could do for them at a meeting that Colbert convened: “lassez nous faire’ le Gendre replied in 1690. Those who quote the phrase today often miss these details. Note that it was a merchant who favoured laissez faire. Consumers were not asked but are supposed to be the main beneficiaries of laissez-faire. Smith remained suspicious of merchants who from Elizabethan times had monopolised who could practise their trade and where, in the infamous Town Guilds. “People of the same trade seldom meet together, even for merriment and diversion, but the conversation sends in a conspiracy against the public, or in some contrivance to raise prices” (WN I.x.c.27: 145). Laissez-faire was of dubious benefit, given its claimants hence Smith never advocated it.

He believed that consumption was the sole end of production and competition was the antidote to open and secret monopolies. Far from leaving merchants alone, he wanted them under the pressure of free competition of consumer choice. Colbert typified state regulations of trade and France was a prime example where government regulations abounded, with numerous officious Inspectors of French street markets and fairs inspecting every detail, not to ensure open competition, but to ensure the State’s passion for order. Absent these regulated orders, enforced by the Inspectors ,the merchants would have imposed their own orders, and their likely behaviours, if free to do so, would not have worked for the best interests of their captive customers. Trade guilds, legal or unofficial, under the cloak of laissez-faire worked for the interests of merchants, not consumers.

So where did cries by merchants and manufacturers for ‘laissez faire come from throughout the 19th century? Two French economists, Say and Bastiat, were prominent in cries for laissez-faire, using Adam Smith’s name as cover for its popularity among politicians and merchant campaigners against the ‘Corn Laws’ and the newly passed but limited Factory Acts. ...

This is a point I've made in another context. Free, unregulated markets -- those absent government oversight of any kind -- are not the same as the ideal competitive markets found in textbooks, those that produce optimal outcomes. In a free market, producers are free to organize, for example, "in some contrivance to raise prices," and this takes us away from the optimal outcome free market enthusiasts are trying to defend. Government oversight and regulation are needed to stop producers from engaging in behavior that is harmful to consumers, excessive market power and the associated political power that come with it are both problematic, a point Smith's so-called disciples ought to take to heart.

Climate Change and Political Polarization

Robert Stavins has always seemed optimistic about the potential for action on climate change, but there seems to be a shift toward a more pessimistic posture. After making the case for a market-based regulatory approach (as opposed to, for example, mandates), which is worth reading too, he says:

Can Market Forces Really be Employed to Address Climate Change?, by Robert Stavins: ...The U.S. political response to possible market-based approaches to climate policy has been and will continue to be largely a function of issues and structural factors that transcend the scope of environmental and climate policy. Because a truly meaningful climate policy – whether market-based or conventional in design – will have significant impacts on economic activity in a wide variety of sectors and in every region of the country, it is not surprising that proposals for such policies bring forth significant opposition, particularly during difficult economic times.

In addition, U.S. political polarization – which began some four decades ago and accelerated during the economic downturn – has decimated what had long been the key political constituency in Congress for environmental (and energy) action: namely, the middle, including both moderate Republicans and moderate Democrats. Whereas congressional debates about environmental and energy policy have long featured regional politics, they are now largely partisan. In this political maelstrom, the failure of cap-and-trade climate policy in the Senate in 2010 was collateral damage in a much larger political war.

Better economic times may reduce the pace – if not the direction – of political polarization. And the ongoing challenge of large federal budgetary deficits may at some point increase the political feasibility of new sources of revenue. When and if this happens, consumption taxes – as opposed to traditional taxes on income and investment – could receive heightened attention; primary among these might be energy taxes, which, depending on their design, can function as significant climate policy instruments.

Many environmental advocates would respond that a mobilizing event will surely precipitate U.S. climate policy action.  But the nature of the climate change problem itself helps explain much of the relative apathy among the U.S. public and suggests that any such mobilizing events may come “too late.”

Nearly all our major environmental laws have been passed in the wake of highly publicized environmental events or “disasters,” including the spontaneous combustion of the Cuyahoga River in Cleveland, Ohio, in 1969, and the discovery of toxic substances at Love Canal in Niagara Falls, New York, in the mid-1970s. But note that the day after the Cuyahoga River caught on fire, no article in The Cleveland Plain Dealer commented that the cause was uncertain, that rivers periodically catch on fire from natural causes. On the contrary, it was immediately apparent that the cause was waste dumped into the river by adjacent industries. A direct consequence of the observed “disaster” was, of course, the Clean Water Act of 1972.

But climate change is distinctly different. Unlike the environmental threats addressed successfully in past U.S. legislation, climate change is essentially unobservable to the general population. We observe the weather, not the climate. Until there is an obvious and sudden event – such as a loss of part of the Antarctic ice sheet leading to a dramatic sea-level rise – it is unlikely that public opinion in the United States will provide the bottom-up demand for action that inspired previous congressional action on the environment over the past forty years.

But then some of the optimism returns:

Despite this rather bleak assessment of the politics of climate change policy in the United States, it is really much too soon to speculate on what the future will hold for the use of market-based policy instruments, whether for climate change or other environmental problems.

On the one hand, it is conceivable that two decades (1988–2008) of high receptivity in U.S. politics to cap-and-trade and offset mechanisms will turn out to be no more than a relatively brief departure from a long-term trend of reliance on conventional means of regulation.

On the other hand, it is also possible that the recent tarnishing of cap-and-trade in national political dialogue will itself turn out to be a temporary departure from a long-term trend of increasing reliance on market-based environmental policy instruments. Perhaps the ongoing interest in these policy mechanisms in California (Assembly Bill 32), the Northeast (Regional Greenhouse Gas Initiative), Europe, and other countries will eventually provide a bridge to a changed political climate in Washington.

To me, one of the most frustrating elements of this is so-called market defenders in the GOP standing in the way of policies that would internalize externalities and improve how these markets function. Despite what Republican "market defenders" say, in the end distribution -- who gets what -- is more important than efficiency for this group. They talk about efficiency, growth, blah, blah, blah, but in the end protecting the ability of supporters to earn high profits in finance, energy -- wherever -- carries the day over regulations that could make these markets work better.

Break Them Up

This was unexpected:

Federal Reserve Bank of St. Louis President James Bullard said Thursday that banks deemed “too big to fail” should be split up. “We do not need these companies to be as big as they are,” Bullard said. His remarks come a week after J.P. Morgan Chase & Co. disclosed a $2 billion trading loss. “We should say we want smaller institutions so that they can safely fail if they need to fail,” he said...

I don't like excessively large banks because of the economic and political power that they have. For me, that is the main reason to break them up (especially since I have yet to see convincing evidence that we need banks this large in order to exploit economies of scope and scale).

But when it comes to stabilizing the financial system, it's not so clear. If we break a big bank into smaller banks, and a systemic shock hits that threatens to cause all of the small banks to fail, it may be harder to shore up the system and prevent a domino-style collapse than it would be if there was just one large bank to deal with. The Great Depression, for example, was characterized by the failure of many, many smaller banks rather than the toppling of a few large, systemically important institutions.

But that is not an insurmountable problem. A coordinated policy across the smaller banks can be equivalent to policy at a single, large institution, and we simply have to be ready to implement the appropriate policies when trouble threatens. So although it may be somewhat easier to deal with one bank rather than, say, 10 or 20, that's not a reason to allow banks to be so large. So I'm glad to see Bullard's comments.

However, Tim Duy is less pleased with his views on inflation:

Don't Let the Data Get in the Way of Your Story, by Tim Duy: St. Louis Federal Reserve President James Bullard:

The main risk lies in potentially overcommitting to the ultra-easy monetary policy, reigniting the global inflation debacle of the 1970s.

Ten-year inflation expectations via the Cleveland Federal Reserve:

Bullard is obviously a Serious Central Banker, because Serious Central Bankers only see inflation everywhere.

Undue fear of inflation generally among FOMC memebers is holding policy back. There are those who favor more aggressive policy, but not enough to make a difference.

The Slippery Slope for Health Care's Slippery Slope Opposition

Richard Thaler:

Slippery-Slope Logic, Applied to Health Care, by Richard Thaler, Commentary, NY Times: There are lots of important things to worry about these day... So it is important that we limit our worries to real as opposed to imaginary risks.

One pernicious category of imaginary risks involves ... dreaded “slippery slope” arguments. Such arguments are dangerous because they are popular, versatile and often convincing, yet completely fallacious. Worse, they are creeping into ... the Supreme Court ... deliberations on health care reform.

There is a DirecTV ad that humorously illustrates the basic form of the slippery-slope argument. A foreboding announcer intones a list of syllogisms that are enacted on screen: “When your cable company puts you on hold, you get angry. When you get angry, you go blow off steam. When you go blow off steam, accidents happen.” Later, we reach the finale: “You wake up in a roadside ditch. Don’t wake up in a roadside ditch.” ... The idea is that while Policy X may be acceptable, it will inevitably lead to the terrible Outcome Y... The problem is that such arguments are often made without any evidence that doing X makes Y more likely, much less inevitable. ...

Given how flimsy slippery-slope arguments can be, it is downright scary that they might play an important role in the Supreme Court decision on ... whether it is constitutional for the federal government to penalize people who fail to buy health insurance. ...

Consider these now-famous comments about broccoli from Justice Antonin G. Scalia during the oral arguments. “Everybody has to buy food sooner or later, so you define the market as food,” he said. “Therefore, everybody is in the market. Therefore, you can make people buy broccoli.” Showing remarkable restraint, he did not mention anything about ending up in a roadside ditch. ...

Please stop! The very fact that a slippery slope is being cited as grounds for declaring the law unconstitutional ... tells you all that you need to know about the argument’s validity. Can anyone imagine Congress passing a broccoli mandate law, much less the court allowing it to take effect? ... Surely, the justices have the conceptual resources to draw a distinction between the health care market and the market for broccoli. And even if they don’t, then all the briefs, the zillions of blog posts and a generation’s worth of economic literature can help them.

More generally, we would be better off as a society if we could collectively agree to ignore all slippery-slope arguments that aren’t accompanied by evidence that said slope exists. ...

"Game Over for the Climate"

I think it would be faid to say that James Hanson is not a tar sands advocate:

Game Over for the Climate, by James Hansen, Commentary, New York Times: Global warming isn’t a prediction. It is happening. That is why I was so troubled to read a recent interview with President Obama ... in which he said that Canada would exploit the oil in its vast tar sands reserves “regardless of what we do.”

If Canada proceeds, and we do nothing, it will be game over for the climate..., concentrations of carbon dioxide in the atmosphere eventually would reach levels higher than in the Pliocene era, more than 2.5 million years ago, when sea level was at least 50 feet higher than it is now. ... Sea levels would rise and destroy coastal cities. Global temperatures would become intolerable. Twenty to 50 percent of the planet’s species would be driven to extinction. Civilization would be at risk.

That is the long-term outlook. But near-term, things will be bad enough. Over the next several decades, the Western United States and the semi-arid region from North Dakota to Texas will develop semi-permanent drought... Economic losses would be incalculable. ...

If this sounds apocalyptic, it is. This is why we need to reduce emissions dramatically. President Obama has the power not only to deny tar sands oil additional access to Gulf Coast refining,... but also to encourage economic incentives to leave tar sands and other dirty fuels in the ground. ...

We should impose a gradually rising carbon fee,... then distribute 100 percent of the collections to all Americans ... every month. The government would not get a penny. ... Not only that, the reduction in oil use resulting from the carbon price would be nearly six times as great as the oil supply from the proposed pipeline from Canada, rendering the pipeline superfluous...

But instead..., the world’s governments are forcing the public to subsidize fossil fuels with hundreds of billions of dollars per year. ...

President Obama speaks of a “planet in peril,” but he does not provide the leadership needed to change the world’s course. ... The science of the situation is clear — it’s time for the politics to follow. ... Every major national science academy in the world has reported that global warming is real, caused mostly by humans, and requires urgent action. The cost of acting goes far higher the longer we wait — we can’t wait any longer to avoid the worst and be judged immoral by coming generations.

The Clean Water Act Worked

Pollution levels off the California coast have dropped significantly since the passage of the Clean Water Act (i.e., contra Repulicans, government is not always the problem):

First evaluation of the Clean Water Act's effects on coastal waters reveals major successes, EurekAlert: Landmark legislation helped clean up LA's coastal waters over the past 40 years, study indicates

Levels of copper, cadmium, lead and other metals in Southern California's coastal waters have plummeted over the past four decades, according to new research from USC.

Samples taken off the coast reveal that the waters have seen a 100-fold decrease in lead and a 400-fold decrease in copper and cadmium. Concentrations of metals in the surface waters off Los Angeles are now comparable to levels found in surface waters along a remote stretch of Mexico's Baja Peninsula.

Sergio Sañudo-Wilhelmy, who led the research team, attributed the cleaner water to sewage treatment regulations that were part of the Clean Water Act of 1972 and to the phase-out of leaded gasoline in the 1970s and 1980s. ...

Lower Growth Can Be Better Than Higher Growth

Whenever the subject of carbon taxes is raised, the inevitable response from the political right is that such a tax would lower economic growth and employment, and therefore we shouldn't do this (the "it will kill growth and jobs" objection is a standard reply to policies the right doesn't like). Lower growth is, of course, worse than higher growth.

But that's not necessarily true. If firms are allowed to pass some of the costs of production to others in the form of externalities, then it's likely that firms will grow faster than is optimal when all costs are internalized. If we force these firms to internalize the costs of production -- to pay the full costs of production, including in pollution/environmental costs -- then instead of moving away from the optimal growth path to a lower, suboptimal path, we would be moving from higher than optimal growth toward the optimum. More is not better when more depends upon being able to pass environmental costs costs off to others.

"Why Gas Prices Are Out of Any President’s Control"

One more quick one from the airport -- Richard Thaler attempts to nudge people away from the idea that the president can control gas prices (and he calls for an increase in the gas tax):

Why Gas Prices Are Out of Any President’s Control, by Richard Thaler, Commentary, NY Times: Everyone knows it’s dangerous to ingest gasoline or to inhale its fumes. But I am starting to believe that merely thinking about the price of gasoline can damage cognitive processing. Thus I may be risking some of my precious few remaining brain cells by writing about that topic.

Here is a one-item test to see whether you are guilty of cloudy thinking about gas prices: Do you believe that they are something a president can control? Many Americans believe that the answer is yes, but any respectable economist will tell you that the answer is no.

Consider a recent poll of a panel of economists conducted by the University of Chicago Booth School of Business, where I teach. ... The 41 panel members were asked whether they agreed with the following statement: “Changes in U.S. gasoline prices over the past 10 years have predominantly been due to market factors rather than U.S. federal economic or energy policies.”

Not a single member of the panel disagreed with the statement.

Here is why: Oil is a global market in which America is a big consumer but a small supplier. ...[continue reading]...

Paul Krugman: Broccoli and Bad Faith

The Supreme Court is undermining the public's confidence in its ability to stand above politics:

Broccoli and Bad Faith, by Paul Krugman, Commentary, NY Times: Nobody knows what the Supreme Court will decide with regard to the Affordable Care Act. But ... it seems quite possible that the court will strike down the “mandate” — the requirement that individuals purchase health insurance — and maybe the whole law. Removing the mandate would make the law much less workable, while striking down the whole thing would mean denying health coverage to 30 million or more Americans.

Given the stakes, one might have expected all the court’s members to be very careful... In reality, however,... antireform justices appeared to embrace any argument, no matter how flimsy, that they could use to kill reform.

Let’s start with the already famous exchange in which Justice Antonin Scalia compared the purchase of health insurance to the purchase of broccoli... That comparison horrified health care experts ... because health insurance is nothing like broccoli.

Why? When people choose not to buy broccoli, they don’t make broccoli unavailable to those who want it. But when people don’t buy health insurance until they get sick — which is what happens in the absence of a mandate — the resulting worsening of the risk pool makes insurance more expensive, and often unaffordable, for those who remain. As a result, unregulated health insurance basically doesn’t work, and never has.

There are at least two ways to address this reality... One is to tax everyone ... and use the money raised to provide health coverage. That’s what Medicare and Medicaid do. The other is to require that everyone buy insurance, while aiding those for whom this is a financial hardship.

Are these fundamentally different approaches? ... Here’s what Charles Fried — who was Ronald Reagan’s solicitor general — said..: “I’ve never understood why regulating by making people go buy something is somehow more intrusive than regulating by making them pay taxes and then giving it to them.” ... (By the way, another pet conservative project — private accounts to replace Social Security — relies on, yes, mandatory contributions from individuals.)

So has there been a real change in legal thinking here? Mr. Fried thinks that it’s just politics — and other discussions in the hearings strongly support that perception. ...

As I said, we don’t know how this will go. But it’s hard not to feel a sense of foreboding — and to worry that the nation’s already badly damaged faith in the Supreme Court’s ability to stand above politics is about to take another severe hit.

Moral Hazard and the Health Insurance Mandate

I want to return to the argument about the need for an individual mandate. A post earlier today talks about adverse selection problems in the health insurance market. These problems are driven by the fact that individuals know more about their health status than insurance companies. But there is another reason for insurance mandate as well, moral hazard (and avoiding externalities).

We are, I hope, a compassionate society, one that would not let an individual suffer severe health problems, perhaps even death, if treatment is available. In an emergency, we generally give the care that is needed and ask questions later.

This allows relatively healthy people to go without health insurance secure in the knowledge that if they get hit with a truly catastrophic and expensive to treat illness, society will take care of them. If we could make people pay the full cost of this wager that they won't need insurance, i.e. if society could turn it's back and say you made your choice, now live (or die) with it, a mandate wouldn't be needed. ut we can't (and I wouldn't want to live in a societ that could).

When it comes to Social Security we recognize that people can game the system in this way -- contribute nothing during their lives and rely on the fact that society will provide for them when they are old -- and we force them to contribute. That way, they build up their own retirement funds with a long series of small contributions and, at least in part, pay their own way. They have no choice but to do so. If this didn't happen, other members of society would have to pay this portion of the bill.

I don't see anything wrong with asking people to pay the expected value of their health care -- a mandate to get insurance to cover the catastrophic things that society would cover in any case -- to avoid this type of gaming of the system. Yes, it's true that many healthy people will pay, remain healthy, and seem to get nothing. But that's the wrong way to look at it. They have insurance whether they pay for it or not. Society will not let them die of a standard, treatable illness so insurance services are present. In fact, it's the knowledge that society is providing these services that motivates many people to take a chance and go without. So people are getting something, insurance services, in any case and those services are present whether or not you get sick. Just like fire insurance, the presence of insurance coverage has value to households even if they never use it. All society is doing with a mandate is asking people to pay for the health insurance services they receive rather than relying on others to pay the bill for them.

"JK Rowling Blows Up the eBookstore Business"

Standing up to market power can work if you have significant market power of your own:

JK Rowling blows up the eBookstore business, by Joshua Gans: ...Today, JK Rowling finally joined the eBook party on her own Pottermore website. ... I want to concentrate on what all this means for eBook publishing.

First, some facts. (i) You can only purchase Harry Potter books from Pottermore. Go to Amazon ... and you are directed to the Pottermore site. You then go through a process of linking your Amazon account but then can download the book straight on to your device.

(ii) You purchase once and you can get the book on any device. And I mean any. Kindle, iPad (through iBooks), Google Play (whatever that is) and Sony who appear to have provided the technical grunt to get this working. There is no other major book that is available this way. Actually, probably no other paid book available this way.

(iii) What about DRM? That is hard to parse. Here is what I know. I ... downloaded ... direct to my computer (in ePub format) and it appears that with that version I can put it on as many readers as I like. The site says I am limited to 8 downloads but once I have that ePub version there does not seem to be any limits.

So what does this mean? The whole concern over eBooks was potential device lock-in. We are worried about being tied to Amazon or Apple or what have you forever. This same thing is preventing entry or inroads by others such as Sony. The Rowling initiative breaks through all of that. It is device independent for the first time in this industry. One can only imagine the negotiations that occurred that allowed that to be possible — particularly with Amazon. Also, I can’t imagine that Amazon or Apple are getting their 30% cuts in this deal but let’s wait and see on that.

The point is that once one author ... can prove all this possible, there is the potential for floodgates to be opened. It will be interesting to see where this leads.

"Markets or Shareholders?"

Where do crony capitalists get their training?:

Markets or shareholders?, by Niraj Dawar, INSEAD: There is a fine line between professing free-market capitalism and teaching the subversion of those markets that is crossed in business-school classrooms every day. ...

We like to believe in the ideal of free markets because competition, we are convinced, is good for the economy. Competition forces sellers to keep the interests of the buyers at the heart of what they do; competition marginalizes and eliminates inefficient players; and competition for customers and resources spurs innovation... In short, these ideal markets lead to an efficient allocation of the economy’s resources, making us all better off in the long term.

If there is one principle that informs business school curricula, it is the belief in the efficiency and inherent goodness of free markets.

But there is another principle that contends for the title, and that is the belief that the goal of a business organization is the maximization of shareholder value. ... This is a worthy goal... Businesses that aim to maximize shareholder value in competitive markets will use the economy’s resources efficiently.

In a real economy – one that is not your textbook picture-perfect market – the maximization of shareholder value is most efficiently achieved by exploiting market imperfections..., companies get into the business of creating and maintaining regulatory wrinkles so that they can continue to exploit them... Firms that push for government protection in the form of trade barriers, longer patent life, or more global application of patents are attempting to keep competitors out. This type of lobbying for protection and favorable regulation undermines markets in many industries in many countries, including telecoms, banking, airlines, energy, infrastructure, pharmaceuticals, etc. ...

And business schools often end up supporting the erection of regulatory barriers to entry. In other words, at the same time as we profess a reverence for the markets, we’re teaching the subversion of freer markets. ...

Restoring society’s eroding faith in capitalism is not something that will happen overnight. Alleviating popular skepticism of business schools and their graduates may take even longer. But a good place for business schools to start is with some soul searching about where their allegiance resides: with efficient markets in the service of society, or with the creation of market inefficiencies in the service of oligopolies?

(Amusing as it may be to watch, the theater of having MBAs take oaths and participate in ring ceremonies is not going to restore society’s faith in business schools).

This problem won't be solved from within, i.e. by hoping that businesses will suddenly drop behaviors that lead to increased profits. It's the institutions surrounding markets that must adjust.

The Benefits of a Gas Tax

MIT energy economist Christopher Knittel says a gas tax would pay for itself, or nearly so, with the benefits the tax would bring:

Fuel for thought, by Peter Dizikes, MIT News Office: ...Christopher Knittel ... is the William Barton Rogers Professor of Energy Economics at the MIT Sloan School of Management...

Knittel’s research addresses a clutch of practical and linked questions: How much progress have automakers made on fuel efficiency? (More than you might think.) How do car owners respond when fuel prices rise? (They really do ditch their gas-guzzlers.) How large are the collateral health benefits of removing dirty vehicles from the nation’s fleet? (Very large.) ...

One of his papers, “Automobiles on Steroids,” recently published in the American Economic Review, examines technological progress in the auto industry. From 1980 through 2006, the fuel efficiency of America’s vehicles has increased by just 15 percent — at first glance, a lethargic rate of improvement. But as Knittel points out, cars’ average horsepower has roughly doubled since then, and average curb weight of those vehicles rose 26 percent... Adjusting for these changes, fuel economy has actually increased by 60 percent since 1980, but as Knittel observes, “most of that technological progress has gone into [compensating for] weight and horsepower.”

On the stagnation of overall fuel efficiency since 1980, Knittel adds, “It’s no fault of the manufacturers and consumers. Firms are going to give consumers what they want, and if gas prices are low, consumers are going to want big, fast cars. If you’re going to blame anyone, it’s the policymakers for not creating the incentive structure for putting that technological progress into fuel economy.”

Pain at the pump

Cars and light trucks produce about 15 percent of U.S. greenhouse gases. The best policy for reducing energy consumption from those sources, Knittel believes, would be higher fuel prices. “That would incentivize all the things we want,” Knittel says. “When gas prices go up, people shift to more fuel-efficient cars, they drive fewer miles, and insofar as there are lower-carbon-intensive fuels out there, people shift to them. They get rid of their clunkers faster.”

That’s not just an assumption; Knittel has studied the responses of auto owners nationwide to rising gas prices from 1999 to 2008 in another research paper, “Pain at the Pump,” co-authored with Meghan Busse and Florian Zettelmeyer of Northwestern University. The researchers found that with each $1 rise in the price of gas, purchases of highly fuel-efficient autos increase 21 percent, while purchases of gas-guzzling vehicles drop 27 percent.

A shift to newer, more fuel-efficient vehicles would actually help people in another way, besides releasing fewer greenhouse gases: It would reduce the amount of harmful local pollution in the air, as Knittel detailed in a paper written with Ryan Sandler of U.C. Davis, based on a study of California from 1998 to 2008. “When gas prices go up, you’re getting bigger mileage reductions from cars that are worse in terms of these pollutants,” Knittel observes.

That produces significant health benefits beyond the problems associated with climate change. “We’re talking about asthma attacks and respiratory problems,” he adds. “This isn’t just a matter of helping the world two generations from now. You can point to this and say, ‘Here is a more immediate, salient reason for a gas tax.’” According to Knittel and Sandler, 70 percent of the costs of a gas tax of $1 per gallon could be recouped by immediate health benefits from reduced pollution. Other possible benefits from the tax — reductions in climate change, traffic congestion and accidents — could make it a net winner for people in economic terms alone.

But will politicians ever impose higher gas prices on a financially stretched public? A variety of powerful lobbying interests in Washington oppose such a move — and Knittel knows hardball when he sees it. Indeed, Knittel is examining the financial rewards industries reap from their lobbying efforts in some of his current research. Still, he does retain a sense of optimism. “The idealistic academic in me says that the more you broadcast the truth, the more likely it will be to win out,” Knittel says. “But we’ll see.”

See also Ryan Avent who comments on related research.

Eichengreen: Europe’s Tobin Tax Distraction

Barry Eichengreen is not a big fan of the Tobin tax, at least not for the purposes leaders in Europe have given when arguing for the policy:

Europe’s Tobin Tax Distraction, by Barry Eichengreen, Commentary, Project Syndicate: At last, European leaders have revealed their top-secret plan for solving the euro’s crisis. And it is – drum roll – a version of the “Tobin tax,” a levy on financial transactions first suggested in 1972 by the Nobel laureate economist James Tobin. ...

But how, exactly, a tax on financial transactions would help to cure Europe’s ills is unclear. According to the European Commission’s own estimates, it would raise only about €50 billion ($65.7 billion) a year, even if imposed throughout the European Union. This is a pittance compared to the eurozone’s debts and deficits, and would fall far short of funding Europe’s permanent rescue facility... Moreover, the Commission’s €50 billion estimate surely overstates the prospective receipts. ...

If the aim is to augment revenues, a Tobin tax is the wrong tool. Indeed, Tobin designed it to solve an entirely different problem: excessive volatility in currency markets. ...Tobin’s proposal sought to promote exchange-rate stability by preventing national currencies from coming under speculative attack. The irony, of course, is that eurozone members have no national currencies to attack. ...

Forgive my naiveté, but I have begun to think that politics rather than economics explains European leaders’ enthusiasm for a Tobin tax. Sarkozy can preempt a long-standing proposal of the Socialists in the run-up to this spring’s presidential election. By supporting Sarkozy, Merkel can get in return what she really wants: French support for stronger fiscal rules. And EU leaders can claim that the financial sector is being made to contribute to the costs of Europe’s financial cleanup. ...

Though no one can say for sure what Tobin would have thought of Europe’s crisis, his priority was always the pursuit of full employment. One suspects that he would have urged European policymakers to dispense with their silly fixation on a financial transactions tax and instead repair their broken banking systems and use all monetary and fiscal means at their disposal to jump-start economic growth.

I've supported this tax mainly because it helps to overcome a market failure. If it produces revenue at the same time, so much the better.

Romer: Do Manufacturers Need Special Treatment?

Christina Romer says the case for promoting manufacturing is less than fully convincing:

Do Manufacturers Need Special Treatment?, by Christina Romer, Commentary, NY Times: Everyone seems to be talking about a crisis in manufacturing. Workers, business leaders and politicians lament the decline of this traditionally central part of the American economy. President Obama, in his State of the Union address, singled out manufacturing for special tax breaks and support. Many go further, by urging trade restrictions or direct government investment in promising industries.

A successful argument for a government manufacturing policy has to go beyond the feeling that it’s better to produce “real things” than services. American consumers value health care and haircuts as much as washing machines and hair dryers. And our earnings from exporting architectural plans for a building in Shanghai are as real as those from exporting cars to Canada.

The economic rationales for a policy aimed specifically at shoring up manufacturing largely fall into three categories. None are completely convincing: Market Failures ..., Jobs ..., Income Distribution ...

As an economic historian, I appreciate what manufacturing has contributed to the United States. It was the engine of growth that allowed us to win two world wars and provided millions of families with a ticket to the middle class. But public policy needs to go beyond sentiment and history. It should be based on hard evidence of market failures, and reliable data on the proposals’ impact on jobs and income inequality. So far, a persuasive case for a manufacturing policy remains to be made...

[I probably should have noted that I said something similar in my last column, i.e. "Manufacturing ... is not the only path to a better future. We need a strategy that creates the conditions for new, innovative firms of all sorts rather than focusing too much on any one area."]

Rogoff: Coronary Capitalism

Ken Rogoff on the need for government to intervene and overcome important market failures:

Coronary Capitalism, by Kenneth Rogoff, Commentary, Project Syndicate: A systematic and broad failure of regulation is the elephant in the room when it comes to reforming today’s Western capitalism. ... But is the problem unique to the financial industry...?

Consider the food industry... Obesity rates are soaring around the entire world... Of course,... there are numerous other examples, across a wide variety of goods and services, where one could find similar issues. Here, though, I want to focus on the food industry’s link to broader problems with contemporary capitalism...

True, market forces have spurred innovation, which has continually driven down the price of processed food, even as the price of plain old fruits and vegetables has gone up. That is a fair point, but it overlooks the huge market failure here.

Consumers are provided with precious little information through schools, libraries, or health campaigns; instead, they are swamped with disinformation through advertising. Conditions for children are particularly alarming..., children are co-opted by channels paid for by advertisements...

If our only problems were the food industry causing physical heart attacks and the financial industry facilitating their economic equivalent, that would be bad enough. But the pathological regulatory-political-economic dynamic that characterizes these industries is far broader. We need to develop new and much better institutions to protect society’s long-run interests.

Of course, the balance between consumer sovereignty and paternalism is always delicate. But we could certainly begin to strike a healthier balance than the one we have by giving the public far better information across a range of platforms, so that people could begin to make more informed consumption choices and political decisions.

I appreciate the sentiment, I've been a long-time advocate of more aggressive intervention to solve market failure problems myself, but was less excited about the particular example. Then, by chance, one of the next things I read was this:

Societal control of sugar essential to ease public health burden, EurekAlert: Sugar should be controlled like alcohol and tobacco to protect public health, according to a team of UCSF researchers, who maintain in a new report that sugar is fueling a global obesity pandemic, contributing to 35 million deaths annually worldwide from non-communicable diseases like diabetes, heart disease and cancer.

Non-communicable diseases now pose a greater health burden worldwide than infectious diseases... In the United States, 75 percent of health care dollars are spent treating these diseases and their associated disabilities.

In the Feb. 2 issue of Nature, Robert Lustig MD, Laura Schmidt PhD, MSW, MPH, and Claire Brindis, DPH, colleagues at the University of California, San Francisco (UCSF), argue that sugar ... is far from just "empty calories" that make people fat. At the levels consumed by most Americans, sugar changes metabolism, raises blood pressure, critically alters the signaling of hormones and causes significant damage to the liver – the least understood of sugar's damages. These health hazards largely mirror the effects of drinking too much alcohol, which ... is the distillation of sugar.

Worldwide consumption of sugar has tripled during the past 50 years and is viewed as a key cause of the obesity epidemic. But obesity ... may just be a marker for the damage caused by the toxic effects of too much sugar. This would help explain why 40 percent of people with metabolic syndrome—the key metabolic changes that lead to diabetes, heart disease and cancer—are not clinically obese.

"As long as the public thinks that sugar is just 'empty calories,' we have no chance in solving this," said Lustig, a professor of pediatrics,... and director of the Weight Assessment for Teen and Child Health (WATCH) Program at UCSF.

"There are good calories and bad calories...," Lustig said. "But sugar is toxic beyond its calories."

Limiting the consumption of sugar has challenges beyond educating people about its potential toxicity. "We recognize that there are cultural and celebratory aspects of sugar," said Brindis, director of UCSF's Philip R. Lee Institute for Health Policy Studies. "Changing these patterns is very complicated"

According to Brindis, effective interventions can't rely solely on individual change, but instead on environmental and community-wide solutions, similar to what has occurred with alcohol and tobacco, that increase the likelihood of success.

The authors argue for society to shift away from high sugar consumption, the public must be better informed about the emerging science on sugar.

"There is an enormous gap between what we know from science and what we practice in reality," said Schmidt, professor of health policy at UCSF...

Many of the interventions that have reduced alcohol and tobacco consumption can be models for addressing the sugar problem, such as levying special sales taxes, controlling access, and tightening licensing requirements on vending machines and snack bars that sell high sugar products in schools and workplaces.

"We're not talking prohibition," Schmidt said. "We're not advocating a major imposition of the government into people's lives. We're talking about gentle ways to make sugar consumption slightly less convenient, thereby moving people away from the concentrated dose. What we want is to actually increase people's choices by making foods that aren't loaded with sugar comparatively easier and cheaper to get."

Some of this was news to me (e.g. "significant liver damage"), so maybe there's more to the market failure in the food industry due to informational asymmetries claim than I thought.

Greenspan's Faith in Markets

Antonio Fatás:

A matter of faith (in markets), by Antonio Fatás: Alan Greenspan contributed yesterday to the Financial Times debate about Capitalism in Crisis. The title of his article was "Meddle with the market at your peril". Not surprisignly Greenspan presents a strong defense of capitalism and market economies by comparing its success to the failures of other systems (such as planned economies).

I do not think that many disagree with that conclusion. But where the article surprised me is when he talks about the potential failure of markets:

Anti-capitalist virulence appears strongest from those who confuse “crony capitalism” with free markets. Crony capitalism abounds when government leaders, usually in exchange for political support, routinely bestow favours on private-sector individuals or businesses. That is not capitalism. It is called corruption.

This is the only sentence in the article where Greenspan admits that there could be some failure in a market economy. But that failure is driven by bad government behavior! Other than that, markets work fine. I hope his views are not really that extreme and that he is willing to accept some of the market failures that economists have identified in the past and that are taken care of by different forms of regulation. This is to me the interesting debate, the one that identifies market failures and then tries to address them via intervention or regulation. In that debate we might find that government intervention is not always possible or efficient. And I am sure we will find disagreement on the domains where government intervention is necessary or optimal. The other debate, the one that compares "capitalism" with the economic system of the former Soviet Union does not sound too interesting or useful at this stage. And it only leads to statements like the one above that seem to be driven by faith in one of the two systems.

For awhile, Greenspan seemed to recognize that his excessive faith in markets blinded him to the dangers of the housing bubble -- his famous mea culpa. But lately he seems to be backing away from that recognition in an effort to defend his reputation and his record as Fed Chair.

"How the Big Three Forgot Accounting 101"

The accountant's view:

How the Big Three forgot Accounting 101, EurekAlert: The Big Three were so driven by short-term profits that they forgot – or ignored – basic accounting practices that could have helped guard against production decisions with long-term damage, according to an award-winning study by Michigan State University and Maastricht University in the Netherlands.

Essentially, the domestic automakers built far more vehicles than they needed while failing to appropriately account for the costs of excess capacity or the damage the overproduction would have on their reputations. ...

Karen Sedatole, MSU associate professor of accounting ... co-authored the study with Ranjani Krishnan, MSU professor of accounting, and Alexander Bruggen, associate professor at Maastricht.

From 2005 to 2006 – several years before the auto bailouts – the researchers did field interviews with managers from one of the domestic automakers and collected a wealth of production data on the entire North American auto industry.

What they found was a culture of emphasizing short-term gain over long-term brand stability at General Motors Co., Ford Motor Co. and Chrysler Group LLC.

By building more cars than the market demanded, domestic automakers could better compete with their foreign counterparts on the hours-per-vehicle metric used in the influential Harbour Report and widely considered an indicator of automotive efficiency. Increasing production also allowed them to keep significant and rising costs of excess capacity off the Income Statement and on the Balance Sheet in the form of inventory. This practice, although acceptable for financial reporting purposes, is contrary to good accounting practices from a management decision-making perspective.

By doing this, the automakers made it appear as though their costs-per-vehicle were lower and their profits higher. Such behaviors are not uncommon for firms facing pressure from stockholders to boost operating profit and pressure from the public to justify large bonuses to executives. Sedatole characterized all these factors coming together as the "perfect storm."

Krishnan said the problem was worsened by high turnover in the management ranks. "The fact is, five years from now a certain manager may not be working here, so he needs to make his production numbers today so his analysts are happy, his investors are happy, his customers are happy and he makes his bonus," Krishnan said.

In the field interviews, many managers indicated they knew the short-term strategy would hurt their company's brand image, or reputation, in the long-term, but could not alter the culture. ...

As a result, the automakers were left with an excess supply of vehicles they had to sell by offering huge incentives to consumers, a costly endeavor that also exacerbated the decline in brand image.

Since the industry crisis of 2008-2010, which led to the bailouts, the automakers have reduced some excess capacity, the researchers said. But as long as the automakers still can exceed market demand for short-term gain, Krishnan believes they will continue to do so. ...

"Mind over Market"

Michael Spence surprises me by making many of the points about markets I've been trying to emphasize lately (and help making these points is more than welcome), in particular that markets are not very good at addressing stability, distributional equity, and sustainability issues:

Mind over Market, by Michael Spence, Commentary, Project Syndicate: In the 66 years since World War II ended, virtually all centrally planned economies have disappeared, largely as a result of inefficiency and low growth. Nowadays, markets, price signals, decentralization, incentives, and return-driven investment characterize resource allocation almost everywhere.

This is not because markets are morally superior... Markets are tools that, relative to the alternatives, happen to have great strengths with respect to incentives, efficiency, and innovation. But they are not perfect; they underperform in the presence of externalities (the un-priced consequences – for example, air pollution – of individual actions), informational gaps and asymmetries, and coordination problems when there are multiple equilibria, some superior to others.

But markets have more fundamental weaknesses. Or, rather, most societies have important economic and social objectives that markets and competition are not designed to achieve. In today’s rapidly globalizing world, the most important of these objectives – expressed in various ways through the political and policymaking process in a wide range of countries – are stability, distributional equity, and sustainability. ... Stability, equity, and sustainability challenges have become crucially important, and the role of the state in relation to markets may need re-thinking as a result. ...[continue reading]...

Democrats are Not Anti-Market

A recent column (on the claim that Democrat are anti-market, socialists, see here too):

Democrats are Not Anti-Market, by Mark Thoma: Republican hopefuls are attempting to portray the coming presidential election as a battle between people who believe in free markets and those who want to turn the U.S. into a socialist state. Michele Bachmann has been quite explicit  with this charge, and Mitt Romney,  Newt Gingrich, and the other leading Republican candidates have made similar claims.

There are certainly those on the left who call for radical change, including the elimination of the market system, just as there are those on the right who have extreme views on a variety of topics. But the Democratic Party is not calling for the overthrow of capitalism, and the claim that Democrats prefer a socialist state is false. Democrats support markets too. The disagreement is about the best way to bring about a well-functioning market system, and whether that system produces an equitable distribution of income and opportunity.

Conservatives believe that markets work best when government involvement is minimal or absent altogether. They don’t deny that individual markets can fail for a variety of reasons, and they acknowledge that the aggregate economy is subject to cyclical swings that bring periods of high unemployment. However, with patience markets and the macroeconomy will fix themselves. If the government steps in and tries to help, on net it will make things worse, not better. Thus it’s almost always best to wait for the economy to heal itself, even if the wait is a long one.

Democrats have different ideas about what it takes for markets to fully realize their potential. They believe that individual markets work best when government takes an active role to prevent market failures. They also believe that monetary and fiscal policies are useful tools to offset cyclical swings in the aggregate economy.

Democrats also differ from Republicans on the need for government to redistribute income. Republicans believe that redistributing income reduces the incentive to pursue economic gains, and this lowers long- run economic growth. Democrats believe that a more equitable distribution of income is desirable in some instances, and that worries about the impact redistribution will have on economic growth are overstated. Democrats also believe there are significant concentrations of political power and market failures that distort the distribution of income, and these distortions should be corrected through government action.

Which of these two visions is correct? Republicans have tried to blame the financial crisis on the government, in particular government programs to support housing for low-income households, but the evidence overwhelmingly refutes this claim.  The problem wasn’t too much government, it was that government did not do enough.

We would be much better off today if government had ignored Alan Greenspan and other advocates of deregulation who argued that financial markets are self-policing, and had instead provided strong regulatory oversight of both the traditional and shadow banking sectors. We would also be better off if the Fed had intervened and popped the housing bubble as it was inflating rather than denying there was a bubble and arguing it could always clean up the mess quickly and neatly in any case.

And in assessing the two views, it’s important to note that the things the government did do were helpful. Though the design of the Bush administration’s bailout of the financial sector left much to be desired, it prevented a much worse outcome. There’s also little doubt that the fiscal stimulus put in place during the Obama administration helped the economy. Things would be better today if we had resisted the austerity minded and done even more to stimulate output and job creation.

In the coming year, we will have to choose between these competing views of the government’s proper role in the economy. The Republican view is that the economy can take care of itself. There’s no need for government to intervene, and the distribution of income – no matter how skewed – should also be left alone.

We’ve already tried Republican policies in recent decades and the promised economic growth, stability, and widely shared prosperity did not materialize. Instead we had a Great Recession, inequality widened substantially, and market and political power became more and more concentrated.

In addition, the recent recession challenges the GOP’s “markets are magic” point of view. During the time when the housing bubble was inflating, markets misdirected resources and too much of our intellectual talent, labor, and raw materials were drawn into housing and finance. Markets also failed to optimally hedge against risks, they have been very slow to self-correct – labor markets in particular – and the fact that the extraordinarily high profits in the financial sector have not been eroded away through new entry is a sign of excessive and persistent market imperfections.

The other view, that of Democrats, speaks directly to these problems. It embraces active oversight of markets to ensure they are operating to maximize social good, it encourages the use of countercyclical monetary and fiscal policies to stabilize output and employment, and it advocates correcting the inevitable inequities in income and opportunity that arise in imperfect, real world market systems.

Thus, contrary to the charge from Republicans that Democrats are anti-market, there’s a strong argument to be made that it’s the policies of Democrats rather than Republicans that do the best job of allowing markets to reach their full potential.

"The Decline of the Public Good"

Robert Reich discusses the reasons for the decline of public institutions (I tried to get at this same notion in a recent column -- the decline in support for public goods due to an increasingly divided society -- but the focus was narrower):

The Decline of the Public Good, by Robert Reich: ...Public institutions are supported by all taxpayers, and are available to all. If the tax system is progressive, those who better off (and who, presumably, have benefited from many of these same public institutions) help pay for everyone else. ...

Much of what’s called “public” is increasingly a private good paid for by users — ever-higher tolls on public highways and public bridges, higher tuitions at so-called public universities, higher admission fees at public parks and public museums.  

Much of the rest of what’s considered “public” has become so shoddy that those who can afford to find private alternatives. As public schools deteriorate, the upper-middle class and wealthy send their kids to private ones. As public pools and playgrounds decay, they buy memberships in private tennis and swimming clubs. As public hospitals decline, they pay premium rates for private care....

Why the decline of public institutions? The financial squeeze on government ... since 2008 explains only part of it. The slide really started more than three decades ago with so-called “tax revolts” by a middle class whose earnings had stopped advancing even though the economy continued to grow. ...

Beyond all this is the reality that America no longer values public goods as we did before. 

The great expansion of public institutions ... began in the early years of 20th century when progressive reformers championed the idea that we all benefit from public goods. Excellent schools, roads, parks, playgrounds, and transit systems would knit the new industrial society together, create better citizens, and generate widespread prosperity. Education, for example, was less a personal investment than a public good — improving the entire community and ultimately the nation. 

In subsequent decades ... this logic was expanded upon. Strong public institutions were seen as bulwarks against, in turn, mass poverty, fascism, and then communism. ...

But in a post-Cold War America distended by global capital, distorted by concentrated income and wealth, undermined by unlimited campaign donations, and rocked by a wave of new immigrants easily cast by demagogues as “them,” the notion of the public good has faded. Not even Democrats any longer use the phrase “the public good.” Public goods are now, at best, “public investments.” Public institutions have morphed into “public-private partnerships;” or, for Republicans, simply “vouchers.” ...

[T]otal public spending on education, infrastructure, and basic research has dropped from 12 percent of GDP in the 1970s to less than 3 percent by 2011. ... We’re losing public goods available to all, supported by the tax payments of all and especially the better off. ...

Contrary to Republican Claims, Democrats are Not Anti-Market

New column: Republicans charge Democrats with advocating socialist, anti-market policies, but Democrats would do a better job of allowing markets to reach their full potential than Republicans:

GOP Throws Low Blows at Dems over Free Markets

Markets work best when government adopts an active rather than a passive stance.

Brad DeLong: America’s Financial Leviathan

Brad DeLong:

America’s Financial Leviathan, by J. Bradford DeLong, Commentary, Project Syndicate: In 1950, finance and insurance in the United States accounted for 2.8% of GDP... Today, it is 8.4% of GDP, and it is not shrinking. The Wall Street Journal’s Justin Lahart reports that the 2010 share was higher than the previous peak share in 2006.

Lahart goes on to say that growth in the finance-and-insurance share of the economy has “not, by and large, been a bad thing....Deploying capital to the places where it can be best used helps the economy grow...”

But ... the extra 5.6% of GDP that it is now spending on finance and insurance ... is a good bargain only if it boosts overall annual economic growth by ... 6% per 25-year generation. ... But it is not obvious that the US economy today would be 6% less productive if it had had the finance-insurance system of 1950 rather than the one that prevailed during the past 20 years.

There are five ways that an economy gains from a well-functioning finance-insurance system. ...[discussion of each]...

Overall, however, it remains disturbing that we do not see the obvious large benefits, at either the micro or macro level, in the US economy’s efficiency that would justify spending an extra 5.6% of GDP every year on finance and insurance. ...

Why has the devotion of a great deal of skill and enterprise to finance and insurance sector not paid obvious economic dividends? There are two sustainable ways to make money in finance: find people with risks that need to be carried and match them with people with unused risk-bearing capacity, or find people with such risks and match them with people who are clueless but who have money. Are we sure that most of the growth in finance stems from a rising share of financial professionals who undertake the former rather than the latter?

The ratings agencies are supposed to solve this problem, i.e. provide the clueless the information about risks that they need to avoid getting taken to the cleaners. We know how well that worked out.

Paul Krugman: Springtime for Toxics

The EPA's new rules on mercury and other airborne toxics should produce large benefits -- if they can survive opposition from the GOP:

Springtime for Toxics, by Paul Krugman, Commentary, NY Times: Here’s what I wanted for Christmas: something that would make us both healthier and richer. And since I was just making a wish, why not ask that Americans get smarter, too?

Surprise: I got my wish, in the form of new Environmental Protection Agency standards on mercury and air toxics for power plants. ...

As far as I can tell, even opponents of environmental regulation admit that mercury is nasty stuff. It’s a potent neurotoxicant... The E.P.A. explains: “Methylmercury exposure is a particular concern for women of childbearing age, unborn babies and young children, because studies have linked high levels of methylmercury to damage to the developing nervous system, which can impair children’s ability to think and learn.”

That sort of sounds like something we should regulate, doesn’t it?

The new rules would also have the effect of reducing fine particle pollution, which is a known source of many health problems... The ... payoff to the new rules is huge: up to $90 billion a year in benefits compared with around $10 billion a year of costs in the form of slightly higher electricity prices. ...

And it’s a deal Republicans very much want to kill.

With everything else that has been going on in U.S. politics recently, the G.O.P.’s radical anti-environmental turn hasn’t gotten the attention it deserves. ... And I’m not exaggerating: during the fight over the debt ceiling, Republicans tried to attach riders that ... would essentially have blocked the E.P.A. and the Interior Department from doing their jobs. ...

More generally, whenever you hear dire predictions about the effects of pollution regulation, you should know that special interests always make such predictions, and are always wrong. For example, power companies claimed that rules on acid rain would disrupt electricity supply and lead to soaring rates; none of that happened, and the acid rain program has become a shining example of how environmentalism and economic growth can go hand in hand.

But again, never mind: mindless opposition to “job killing” regulations is now part of what it means to be a Republican. And I have to admit that this puts something of a damper on my mood: the E.P.A. has just done a very good thing, but if a Republican — any Republican — wins next year’s election, he or she will surely try to undo this good work.

Still, for now at least, those who care about the health of their fellow citizens, and especially of the nation’s children, have something to celebrate.

The Great Economic Divide Makes Everyone Poorer

I have a new column:

The Great Economic Divide Makes Everyone Poorer

A divided society is a poorer society.

"The Darwin Economy"

I am hosting a discussion of Robert Frank's The Darwin Economy at FDL (2-4 PST). The introductory post is here, and you are, of course, welcome to join in.

One theme in the book is that the debate between libertarians and progressives over government intervention in the economy is a false one. Robert Frank argues that libertarians ought to support government intervention to stop the "arms race" for positional goods since the race wastes resources without providing any benefit to those engaged in the contest. But the ideas are presented as correcting both libertarian and progressive views. One thing I want to ask is why he sees his ideas as standing in opposition to traditional ideas about market failure that many progressives use to justify government intervention rather than enhancing and complementing them.

Kenneth Arrow: Economics and Inequality

I've written recently on several occasions about the mal-distribution of income over the last several decades, i.e. the fact that wages have lagged behind increases in labor productivity. Why has this happened? Kenneth Arrow explains how the fact that "the bulk of the gains from increased productivity went to a small group of upper-income recipients" is related to market failure in the finance industry, in particular the presence of asymmetric information (he also highlights additional explanations for rising inequality such as the "steady attack on the use of the tax system as a means of equalizing income"):

Economics and Inequality, by Kenneth Arrow , Boston Review: The specific problems of the current United States economy—the drastic increase in unemployment and sluggish increase in output—overlay a tendency of much longer duration, a drastic and rapid increase in the inequality of income. ... Profits from the finance sector, which historically have been about 10 percent of all profits, have risen to an extraordinary 40 percent. ...

The notion of a well-running market is applicable to manufactured goods; different items are produced to be alike and can be evaluated by consumers. But the products of ... finance ... are ... complex. The consumer cannot seriously evaluate them—a situation that economists call “asymmetric information.”

This casts light on the claim that the problem is one of personal ethics, of “greed.” After all, the search for improvement in technology, and consequently in the general standards of living, is motivated by greed. When the market system works properly, greed is tempered by competition. Hence, most of the gains from innovation and good service cannot be retained by the providers.

But in situations of asymmetric information, the forces of competition are weakened. The individual .. client of a financial firm does not have access to all the relevant information. Indeed, when the information is sufficiently complex, it may be impossible to provide adequate information.

In these circumstances, the concept of “greed” becomes more relevant. There arises an obligation to present the relevant information as fully as possible, an obligation that has been violated in the financial industry. ... A proper sense of responsibility has to be enforced by legislation... There has been some erosion in the law, for example under the Clinton administration, and in enforcement. The Dodd-Frank law is a step in the right direction, but the influence of the financial industry watered it down and created unnecessary complications.

It is, of course, not superfluous to argue that steepening the income tax progression, removing a number of blatant loopholes, such as the special treatment of capital gains, and reducing the exemption level for estates would add considerably to post-tax equality.

Self-Referral Increases Medical Costs

This isn't a surprise -- we've known about this problem for a long time -- the question is why we haven't done something about it:

Self-referral leads to more negative exams for patients, EurekAlert: Physicians who have a financial interest in imaging equipment are more likely to refer their patients for potentially unnecessary imaging exams...

"Self-referral," whereby a non-radiologist physician orders imaging exams and directs patients to imaging services in which that physician has a financial interest, is a concerning trend in medicine and a significant driver of healthcare costs. "Self-referred medical imaging has been shown to be an important contributor to escalating medical costs," said Ben E. Paxton, M.D., radiology resident at Duke University Medical Center in Durham, N.C. ...

Between 2000 and 2005, ownership or leasing of MRI equipment by non-radiologists grew by 254 percent, compared to 83 percent among radiologists. The U.S. Government Accountability Office (GAO) reported that the proportion of non-radiologists billing for in-office imaging more than doubled from 2000 to 2006. During that same time period, private office imaging utilization rates by non-radiologists who control patient referral grew by 71 percent.

For the study, the researchers set out to determine if utilization of lumbar spine MRI differs, depending on the financial interest of the physician ordering the exam. They reviewed 500 consecutive diagnostic lumbar spine MRI exams ordered by two orthopedic physician groups serving the same community. The first group had financial interest in the MRI equipment used (FI group), and the second had no financial interest in the equipment (NFI group). ...

"Orthopedic surgeons with financial interest in the equipment had a much higher rate of negative lumbar spine MRIs," Dr. Paxton said. "In addition, they were much more likely to order MRI exams on younger patients. This suggests that there is a different clinical threshold for ordering MRI exams in the setting of financial incentivization."

Dr. Paxton added that increased imaging utilization due to self-referral may not yield medically useful information and may place the patient at risk for potential adverse consequences.

"It is important for patients to be aware of the problem of self-referral and to understand the conflict of interest that exists when their doctor orders an imaging exam and then collects money on that imaging exam," he said.

Ideological Bias and Antitrust Law

Apparently some judges refuse to enforce antritrust law because "Such judges just do not like antitrust laws for ideological reasons." That attitude -- which is not confined to judges -- explains a lot about detrimental the rise of economic and political power in recent decades. This is Shane Greenstein discussing the proposed merger between AT&T and T-Mobile:

Lawyers invariably ... launch into comments about the uncertain state of antitrust law in the United States, observing that many judges today do not think there is any valid reason to enforce any antitrust law, irrespective of the facts of the case. Such judges just do not like antitrust laws for ideological reasons. Recently such friends have gotten more specific, commenting on the odds of getting past the particular judge assigned to hear the from Department of Justice, as it tries to block the merger.

Political analysts, in contrast,... invariably launch into comments about AT&T’s enormous powerful presence in Washington, observing that AT&T has gotten whatever it has wanted from the Obama and Bush administrations. Recently such friends have gotten very specific, about which representatives and senators were most likely to act on AT&T’s behalf.

The point he is making, however, is that in this particular instance economics did seem to matter:

To make a long story short, there was not much evidence of benefits. To make efficiency gains AT&T would have to fire quite a few people, but to get the merger past its unions AT&T’s management had to promise to preserve jobs. To buy political support AT&T had to promise to build broadband in under-served areas, but independent analysis showed that far cheaper ways to build such broadband than through a thirty billion dollar merger. The economic benefits did not exist. To use an old expression, there was no there there.

And therefore:

The FCC recently announced it would move to have a hearing about the AT&T and T-Mobile merger. In response, AT&T withdrew its application from the FCC, delaying the hearing indefinitely (or until AT&T resubmits the application).

But the fact that the police catch the bad people when (and seemingly only when) the facts are really, really obvious isn't all that comforting. Big banks, for example, appear to be far larger than the size required to take advantage of economies of scale/scope, etc., and the additional size enhances their political clout and the chances of regulatory capture without any clear economic benefits. There are potential costs, large ones -- see the recession. But it's hard to find a solid analysis demonstrating that there's any reason banks need to be so large that they are able to dominate particular markets. However, prior to the crisis instead of looking at these banks with an eye toward reining in their market power, we were told how wonderful such large institutions were -- how necessary firms with so much power are in a global economy. Even now we still hear arguments about how much these firms are needed (and it's still hard to get people to care about this issue).

Anyway, I could go on with this rant -- the problem of large, powerful firms is by no means confined to the financial industry -- but I've made these points many times in the past (starting before the crisis hit) and hopefully the point is clear. To me, the rise of economic power among the few is one of the strongest and clearest indications of how thoroughly economic and political power has shifted to the rich and powerful in recent decades.

Joshua Gans: Entrepreneurship and Inequality

Do you agree with this?:

Entrepreneurship and inequality, by Joshua Gans: So I was reading Felix Salmon’s account of a debate here in Toronto between Paul Krugman and Larry Summers. ... I was struck by this passage.

Summers also tried to defend inequality, at least in part, by saying that “suppose the United States had 30 more people like Steve Jobs” — that, he said, would be a good thing even as it increased inequality. “So we do need to recognize that a component of this inequality is the other side of successful entrepreneurship; that is surely something we want to encourage.”

Now there is nothing new in this view. It is an argument for inequality that reminds me of Ted Baxter (from the Mary Tyler Moore Show) who intended to have six children in the hope that one of them grows up to solve the population problem. The inequality version is that we accept inequality in the hopes of getting the fruits of entrepreneurship.

So no one disagrees with encouraging entrepreneurship. ... But when we link it to inequality in this way we are asking ... whether the poor (or middle class) are happy outsourcing knowledge creation and are each willing to pay a bit to see that happen.

Seen in this light, the problem of inequality is a design problem. This is something that Jean Tirole and Glen Weyl have recently investigated. They ask a related question: when is it a good idea to confer entrepreneurs with market power (as a reward)? The answer turns out to be, when the government does not know much about the nature of demand for innovative products. In this world, by exposing entrepreneurial rewards to what they can get through monopoly pricing, we screen for innovations that maximize the gap between innovative benefits and innovative costs. The implication here is that if we outsourced innovation to creative geniuses, we would do it in a way that allows them to charge high prices.

But does that carry over when there is real inequality? Let’s face it, the actual products Steve Jobs produced were not priced for the poor. The best we can say is that when they were imitated the poor received some benefits (which may also be arguable). So is it really the case that poorer people would be willing to be taxed more (by government or through monopoly pricing) in order to bring out more people like Steve Jobs? Instead, the Steve Jobs argument is surely one for a lateral wealth transfer from those with wealth — innovators or not — to be more concentrated amongst those who innovate. It is inequality in talent and skill and its mismatch to wealth that drives the argument not inequality in wealth.

It takes a village to make an iPad.

Paul Krugman: Vouchers for Veterans

Why is the Veteran's Health Administration "in the crosshairs" of Republicans? Is it because it's an example of socialized medicine that works?:

Vouchers for Veterans, by Paul Krugman, Commentary, NY Times: American health care is remarkably diverse. In terms of how care is paid for and delivered, many of us effectively live in Canada, some live in Switzerland, some live in Britain, and some live in the unregulated market of conservative dreams. One result of this diversity is that we have plenty of home-grown evidence about what works and what doesn’t. ...

And that brings me to Mitt Romney’s latest really bad idea, unveiled on Veterans Day: to partially privatize the Veterans Health Administration (V.H.A.). What Mr. Romney and everyone else should know is that the V.H.A. is a huge policy success story, which offers important lessons for future health reform. ... Multiple surveys have found the V.H.A. providing better care than most Americans receive, even as the agency has held cost increases well below those facing Medicare and private insurers. Furthermore, the V.H.A. has led the way in cost-saving innovation...

And yes, this is “socialized medicine” — although some private systems, like Kaiser Permanente, share many of the V.H.A.’s virtues. But it works — and suggests what it will take to solve the troubles of U.S. health care more broadly.

Yet Mr. Romney believes that giving veterans vouchers to spend on private insurance would somehow yield better results. Why? Well, Republicans have a thing about vouchers. ... The claim, always, is ... that “private sector competition” would lower costs.

But we have a lot of evidence about how private-sector competition in health insurance works, and it’s not favorable. The individual insurance market ... has huge administrative costs and has no demonstrated ability to reduce other costs. ... And the international evidence accords with U.S. experience. ...

So what lies behind the Republican obsession with privatization and voucherization? Ideology, of course. It’s literally a fundamental article of faith in the G.O.P. that the private sector is always better than the government, and no amount of evidence can shake that credo.

In fact, it’s hard to avoid the sense that Republicans are especially eager to dismantle government programs that act as living demonstrations that their ideology is wrong. Bloated military budgets don’t bother them much — Mr. Romney has pledged to reverse President Obama’s defense cuts, despite the fact that no such cuts have actually taken place. But successful programs like veterans’ health, Social Security and Medicare are in the crosshairs.

Which brings me to a final thought: maybe all this amounts to a case for Rick Perry. Any Republican would, if elected president, set out to undermine precisely those government programs that work best. But Mr. Perry might not remember which programs he was supposed to destroy.

Why We Need an Individual Mandate for Health Insurance

Relative to the health care ruling today -- I wrote this awhile back, and just reposted it CBS News:

Why we need an individual mandate for health insurance

The Concentration of Economic Power

I am going to have to plead not guilty to the charge that "mainstream and left-wing economists" should be criticized "for their lack of attention to monopoly power." I've also wondered many times why this issue doesn't get more attention and, more importantly, why the increasing concentration of power doesn't draw more action from regulators:

Who Rules the Global Economy?, by Nancy Folbre, Commentary, NY Times: ...Three Swiss experts on complex network analysis have recently examined the architecture of international ownership, analyzing a large database of transnational corporations. They concluded that a large portion of control resides with a relatively small core of financial institutions, with about 147 tightly knit companies controlling about 40 percent of the total wealth in the network. ... An article in the British magazine New Scientist describes the research as evidence of a global financial oligarchy. ...

A recent article in the socialist journal Monthly Review, by John Bellamy Foster, Robert W. McChesney and R. Jamil Janna, criticizes both mainstream and left-wing economists for their lack of attention to monopoly power.

Focusing on the United States, they note that the percentage of manufacturing industries in which the largest four companies account for at least 50 percent of shipping value has increased to almost 40 percent, up from about 25 percent in 1987.

Even more striking is the increase in retail consolidation, largely reflecting a “Wal-Mart effect.” In 1992, the top four companies accounted for about 47 percent of all general merchandise sales. By 2007, their share had reached 73.2 percent.

Banking, however, takes the cake. Citing my fellow Economix blogger Simon Johnson, the Monthly Review article notes that in 1995, the six largest bank-holding companies (JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs and Morgan Stanley) had assets equal to 17 percent of gross domestic product in the United States. By the third quarter of 2010, this had risen to 64 percent. ...

Public concerns about economic concentration are stoked by hard times. Congress authorized a full-scale investigation of the topic back in days of the Great Depression. Seems like the time has come for a fully international update.

Rodrik: Milton Friedman’s Magical Thinking

Dani Rodrik argues that Milton Friedman leaves "an ambiguous and puzzling legacy":

Milton Friedman’s Magical Thinking, by Dani Rodik, Commentary, Project Syndicate: Next year will mark the 100th anniversary of Milton Friedman’s birth. Friedman ... will be remembered primarily as the visionary who provided the intellectual firepower for free-market enthusiasts..., and as the éminence grise behind the dramatic shift in the economic policies that took place after 1980.

At a time when skepticism about markets ran rampant, Friedman explained in clear, accessible language that private enterprise is the foundation of economic prosperity. ... He railed against government regulations that encumber entrepreneurship and restrict markets. ...

Inspired by Friedman’s ideas, Ronald Reagan, Margaret Thatcher, and many other government leaders began to dismantle the government restrictions and regulations that had been built up over the preceding decades. China moved away from central planning and allowed markets to flourish... Latin America sharply reduced its trade barriers and privatized its state-owned firms. When the Berlin Wall fell in 1990, there was no doubt as to which direction the former command economies would take: towards free markets.

But Friedman also produced a less felicitous legacy. ... In effect, he presented government as the enemy of the market. He therefore blinded us to the evident reality that all successful economies are, in fact, mixed...

The Friedmanite perspective greatly underestimates the institutional prerequisites of markets. Let the government simply enforce property rights and contracts, and – presto! – markets can work their magic. In fact,... markets ... are not self-creating, self-regulating, self-stabilizing, or self-legitimizing. Governments must invest in transport and communication networks; counteract asymmetric information, externalities, and unequal bargaining power; moderate financial panics and recessions; and respond to popular demands for safety nets and social insurance. ... [And] Given China’s economic success, it is hard to deny the contribution made by the government’s industrialization policies.

Free-market enthusiasts’ place in the history of economic thought will remain secure. But thinkers like Friedman leave an ambiguous and puzzling legacy, because it is the interventionists who have succeeded in economic history, where it really matters.

Glasner: Barro on Keynesian Economics vs. Regular Economics

"I am sure that Professor Barro, very, very clever fellow that he is, will clear all this up":

Barro on Keynesian Economics vs. Regular Economics, by David Glasner: Readers ... may have guessed by now that I am not a fan of The Wall Street Journal editorial page. ... But I have to admit that even I was not quite prepared for Robert Barro’s offering in today’s Journal. You don’t have to be a Keynesian economist – and I have never counted myself as one – to find Barro’s piece, well, let’s just say, strange....

Barro ... draws the contrast ... between Keynesian economics and regular economics. Regular economics is the economics of scarcity and tradeoffs in which there is no such thing as a free lunch, in which to get something you have to give up something else. Keynesian economics on the other hand is the economics of the multiplier in which government spending not only doesn’t come at the expense of private sector spending, amazingly it increases private sector spending. Barro throws up his hands in astonishment:

If [the Keynesian multiplier were] valid, this result would be truly miraculous. The recipients of food stamps get, say, $1 billion but they are not the only ones who benefit. Another $1 billion appears that can make the rest of society better off. Unlike the trade-off in regular economics, that extra $1 billion is the ultimate free lunch.

Quickly composing himself, Barro continues:

How can it be right? Where was the market failure that allowed the government to improve things just by borrowing money and giving it to people? Keynes in his “General Theory” (1936), was not so good at explaining why this worked, and subsequent generations of Keynesian economists (including my own youthful efforts) have not been more successful.

Nice rhetorical touch, that bit of faux self-deprecation, referring to his own fruitless youthful efforts. But the real message is: “I’m older and wiser now, so trust me, the multiplier is a scam.”

But wait a second. What does Barro mean by his query: “Where was the market failure that allowed the government to improve things just by borrowing money and giving it to people?” Where is the market failure? Hello. Real GDP is at least 10% below its long-run growth trend, the unemployment rate has been hovering between 9 and 10% for over two years, and Professor Barro can’t identify any market failure? Or does Professor Barro, like many real-business cycle theorists (say, Charles Plosser, for instance?), believe that fluctuations in output and employment are optimal adjustments to productivity shocks involving intertemporal substitution of leisure for labor during periods of relatively low productivity?

Perhaps that is what Barro thinks now,... but about two and a half years ago, writing another op-ed piece for the Journal, Barro had a slightly different take on what is going on during a depression.

[A] simple Keynesian macroeconomic model implicitly assumes that the government is better than the private market at marshalling idle resources to produce useful stuff. Unemployed labor and capital can be utilized at essentially zero social cost, but the private market is somehow unable to figure any of this out. In other words, there is something wrong with the price system.

John Maynard Keynes thought that the problem lay with wages and prices that were stuck at excessive levels. But this problem could be readily fixed by expansionary monetary policy, enough of which will mean that wages and prices do not have to fall.

So in January 2009, Barro was at least willing to entertain the possibility that some kind of obstacle to necessary price and wage reductions might be responsible for the failure of markets to generate a spontaneous recovery from a recession, so that a sufficient monetary expansion could provide a cure for this problem by making wage-and-price reductions unnecessary. But ... it would be interesting to know if he thinks that monetary expansion ... is not somehow inconsistent with his conception of regular economics. I mean you print up worthless pieces of paper and, poof, all of a sudden all that output that private markets couldn’t produce gets produced, and all those workers that private markets couldn’t employ get employed. In Professor Barro’s own words, How can that be right? ...

Well,... if restoring full employment by printing money does not contradict regular economics, I have trouble seeing why restoring full employment by borrowing and government spending does contradict regular economics. But I am sure that Professor Barro, very, very clever fellow that he is, will clear all this up for us in due course...

[In a part I left out, he explains the similarity between the two types of policy in more detail.]

Merkel and Sarkozy are Right about a Tobin Tax

Here are a few comments at Reuters on the news that Nicolas Sarkozy and Angela Merkel may propose a financial transactions tax in September:

Merkel and Sarkozy are right about a Tobin tax

The Not Smart Enough Grid

Via Scientific American, one more quick post before another day on the road:

The too-smart-for-its-own-good grid, MIT News: In the last few years, electrical utilities have begun equipping their customers’ homes with new meters that have Internet connections and increased computational capacity. One envisioned application of these “smart meters” is to give customers real-time information about fluctuations in the price of electricity, which might encourage them to defer some energy-intensive tasks until supply is high or demand is low. Less of the energy produced from erratic renewable sources such as wind and solar would thus be wasted, and utilities would less frequently fire up backup generators, which are not only more expensive to operate but tend to be more polluting, too.

Recent work by researchers in MIT’s Laboratory for Information and Decision Systems, however, shows that this policy could backfire. If too many people set appliances to turn on, or devices to recharge, when the price of electricity crosses the same threshold, it could cause a huge spike in demand; in the worst case, that could bring down the power grid. Fortunately, in a paper presented at the last IEEE Conference on Decision and Control, the researchers also show that some relatively simple types of price controls could prevent huge swings in demand. ...

Research scientist Mardavij Roozbehani and professors Sanjoy Mitter and Munther Dahleh assumed that every consumer has a “utility function” describing how inconvenient it is for him or her to defer electricity usage. While that function will vary from person to person, individual utility functions can be pooled into a single collective function for an entire population. The researchers assumed that on average, consumers will ... try to get as much convenience for as little money as possible.

What they found was that if consumer response to price fluctuation is large enough to significantly alter patterns of energy use — and if it’s not, there’s no point in installing smart meters — then price variations well within the normal range can cause dangerous oscillations in demand. “For the system to work, supply and demand must match almost perfectly at each instant of time,” Roozbehani says. “The generators have what are called ramp constraints: They cannot ramp up their production arbitrarily fast, and they cannot ramp it down arbitrarily fast. If these oscillations become very wild, they’ll have a hard time keeping track of the demand. And that’s bad for everyone.” ...

But minimizing the risks of giving consumers real-time pricing information also diminishes the benefits. “Possibly, when you need an aggressive response from the consumers — say the wind drops — you’re not going to get it,” Roozbehani says.

One way to improve that trade-off, Roozbehani explains, would be for customers to actually give utilities information about how they would respond to different prices at different times. Utilities could then tune the prices that they pass to consumers much more precisely, to maximize responsiveness to fluctuations in the market while minimizing the risk of instability. Collecting that information would be difficult, but Roozbehani’s hunch is that the benefits would outweigh the costs. He’s currently working on expanding his model so that it factors in the value of information, to see if his hunch is right.

As noted, it shouldn't be too hard to develop a pricing system that takes care of this problem. On the last point, getting information about demand elasticities, they have the data at hand -- over time they can see how people respond to these incentives and alter prices accordingly -- so I don't see why this is a such a big stumbling block.

The S&P Downgrade: Is the Sky Falling?

Paul Krugman on the S&P downgrade:

S&P and the USA, by Paul Krugman: OK, so Standard and Poors has gone ahead with the threatened downgrade. It’s a strange situation.

On one hand, there is a case to be made that the madness of the right has made America a fundamentally unsound nation. And yes, it is the madness of the right: if not for the extremism of anti-tax Republicans, we would have no trouble reaching an agreement that would ensure long-run solvency.

On the other hand, it’s hard to think of anyone less qualified to pass judgment on America than the rating agencies. The people who rated subprime-backed securities are now declaring that they are the judges of fiscal policy? Really?

Just to make it perfect, it turns out that S&P got the math wrong by $2 trillion, and after much discussion conceded the point — then went ahead with the downgrade.

More than that, everything I’ve heard about S&P’s demands suggests that it’s talking nonsense about the US fiscal situation. ... In short, S&P is just making stuff up — and after the mortgage debacle, they really don’t have that right.

So this is an outrage — not because America is A-OK, but because these people are in no position to pass judgment.

S&P is not worried about ability to pay, it is worried that the US political system does not have the necessary willingness. The worry is that we must cut spending and raise taxes to get the debt under control, both will be needed, but as the recent negotiations over the debt ceiling made clear, the GOP is unwilling to allow the necessary tax increases.

S&P may also be covering itself after doing so poorly prior to the financial meltdown. If S&P leaves the outlook at AAA and problems emerge down the road, it's credibility will be even more shot than it is already and likely irreparable. Missing another big problem is essentially a death sentence. But if it downgrades the debt and nothing happens, it can claim its warnings and the downgrade were key factors in persuading people in both the public and private sectors to take steps to avoid disaster. It's Chicken Little claiming that his warnings stopped the sky from falling.

The point I'm making is that because of its damaged reputation, the risks S&P faces are not symmetric, and the lack of symmetry will bias the ratings it issues toward ensuring it doesn't miss another problem. The upshot is that false positives, as I believe this is, will be much more likely.