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Tuesday, October 20, 2009

"Will Economic Inequality Lead to Terrorism?"

Bruce Judson with a description of a "chilling call" that occurred while he "was a guest on OnPoint which is distributed nationally by NPR." As he notes in an email, "the post raises an important issue. All of the discussion of economic inequality essentially presumes that people continue to view the existing economic system as legitimate. As foreclosure rise, jobs disappear, and the divide between the have's and have not's increases, our ability to take this for granted becomes less clear":

Will Economic Inequality Lead to Terrorism? A Chilling Moment on NPR, by Bruce Judson: Last week, It Could Happen Here was the subject of a 45-minute segment of Tom Asbrook’s OnPoint, which airs nationally on NPR. To demonstrate, how inequality can divide a nation, It Could Happen Here, which is a nonfiction book, opens with a fictional scenario involving American terrorists who threaten the nation with dirty bombs demanding an end to foreclosures by “vulture banks,” and free access to healthcare and higher education for all. Tom Ashbrook asked hard questions about this scenario. I said to him think of a laid off engineer who works with radioactivity to create medical devices…

Here’s the transcript of the discussion:

BRUCE JUDSON: First off, here’s a flash point for you. In the scenario, in the fictional scenario, I talk about…It is very easy to imagine that an engineer, or someone else with the necessary knowledge who works on, let’s say, medical devices and has used radioactivity to create a better world…. to save lives, is laid off. You can imagine that he suddenly is facing foreclosure. He’s an educated person unable to put his kids through college.

A few minutes later the show took calls. The show received a chilling call from an out of work nuclear engineer–who had helped to build 13 nuclear power plants but had not worked in two years. You can read the transcript of his call below, or click to listen to his call here.

Click player below to listen to out of work Nuclear Engineer:

TOM ASHBROOK: Certainly inequality’s a big issue. Let me get a call right here from New London, Connecticut. And

Don. Hi, Don. You’re on the air.

CALLER: Hi.

TOM ASHBROOK: Hi.

CALLER: I think you should be listening to this guy, Judson. I’m an unemployed nuclear engineer. I’ve worked on 13 nuclear power plants. Making a dirty bomb is not a big deal. I’m not going to go out and tell everybody now to do it, but I’m just saying things like that can happen. And it sounds like you’re just being dismissive of all his ideas and what he’s saying. Because there’s a lot of anger out here, and there are a lot of people who feel that the American Dream is slipping away from them, they don’t have a chance. And the only entrepreneurial opportunity for them is to sell drugs and to be an outlaw. It’s happening.

TOM ASHBROOK: [OVERLAPPING] I hear you, [PH] Don. We’ve got Bruce on for an hour. So, I can’t say we’re not listening to him. But let me ask you, you’ve got a lot of expertise in your field, nuclear engineering. But does that mean you’re unhappy if you’re unemployed? Do you really feel like the country’s ready to revolt?

CALLER: I’m not an expert in revolution, and I don’t really know how they happen. All I know is I’m 60 years old. There’s not a lot of people who want to hire a nuclear engineer who’s 60 years old. And there are a lot of people out there like me who are out there who, you know, once you have so much gray hair, you’re out of here. And there’s just a lot of people that are just not happy with the way that the country’s going right now. And I don’t know…where it’s going to take it, or what’s going to be its spark, or what’s going to be the event. But people feel like there’s just no way to climb out of the hole. Like there’s just nothing that’s going to get them out. This attitude, that I’ve seen, over 60 years, I’ve never seen anything like it. It scares me.

TOM ASHBROOK: Up against it. And with an education, a particular education. Don, thank you for your call.

You can listen to the full OnPoint segment by clicking the player below:

In ... today’s New York Times column Safety Nets for the Rich, Bob Herbert, details our emerging have and have not society, where two-thirds of  the entire income gains of the nation between 2002 and 2007 went to the top 1% of Americans. Herbert writes:

And we still don’t seem to have learned the proper lessons. We’ve allowed so many people to fall into the terrible abyss of unemployment that no one — not the Obama administration, not the labor unions and most certainly no one in the Republican Party — has a clue about how to put them back to work.

Meanwhile, Wall Street is living it up. I’m amazed at how passive the population has remained in the face of this sustained outrage.

Unfortunately if we do not change course, Herbert’s amazement may end in circumstances that we do not want to contemplate.  We are witnessing the unfolding of a chain of dangerous events associated with our collapsing middle class and increasingly two-tier economy. Sadly, the dynamics outlined in It Could Happen Here that lead to political instability are occurring  with increasing ferocity. More on this in my next post...

    Posted by on Tuesday, October 20, 2009 at 05:04 PM in Economics, Income Distribution | Permalink  TrackBack (0)  Comments (80) 


    "Is The American Dream A Myth?"

    We've known for some time that the degree of social mobility in the US is much less than people believe. But given how widespread the mobility myth is -- the false perception that there is equal (enough) opportunity allows us to be more accepting of unequal outcomes than we would be if we knew how stagnant social outcomes actually are -- the evidence that rebuts this belief is worth repeating:

    Is The American Dream A Myth?, by Ronald Brownstein, National Journal: One tenet that separates the United States from other countries is our belief in upward mobility. A study of attitudes in 27 countries found that Americans, more than people elsewhere, tend to believe that intelligence, skill, and effort will be rewarded with success. This faith is vibrant even among groups to which opportunity has often been denied:... African-Americans and Hispanics were more likely than whites to believe that children of all races had adequate chances to succeed in America.
    But as Brookings Institution scholars Ron Haskins and Isabel Sawhill demonstrate in a compelling new book, America's record doesn't entirely justify this optimism. ... In the generation after World War II, the median income roughly doubled, increasing faster for those on the lower rungs of the ladder than for those at the top. Since 1979, the median income has advanced much more slowly overall, and it has grown much faster for the affluent than for those below them. Today,... family incomes are higher than in the 1970s almost entirely because women are working...; men in their 30s today earn less than their fathers did at the same age. In this environment, upward mobility becomes tougher. ...
    More than 60 percent of Americans whose parents scaled the top fifth of the income ladder have reached the top two-fifths themselves, Haskins and Sawhill found. By contrast, 65 percent of Americans with parents from the lowest fifth of earners remain stuck in the bottom two-fifths. Though we venerate the American Dream, studies show that children born to low-income parents in the United States are more likely to remain trapped near the bottom than their counterparts in Europe...
    Many factors constrain upward mobility in America, including the decline of the two-parent family and bad personal decisions... But another reason the escalator is slowing ... is that income is now so dependent on education. Today, four-year college graduates earn about 80 percent more than workers with high school degrees. That's more than double the gap in the 1960s.
    Young people who begin with the most advantages are considerably more likely than the less well-off to add the advantage of advanced education. Sawhill and Haskins report that children of parents in the top fifth of income are now more than twice as likely to attend college, and nearly five times as likely to graduate, as are children of parents in the bottom fifth. Separate research from Thomas Mortenson ... shows that this income gap in college completion has widened substantially since the 1970s. ...
    These are deeply unhealthy, even destabilizing, patterns. If advanced education is the key to economic success, it's dangerous to reserve it primarily for those who start out on top. Such ossification is a recipe for class and racial conflict...
    He and Sawhill see several keys to expanding college access. Although affordability remains a challenge, they say that enough financial aid is available for needy students that money is not the principal obstacle. ...
    The two believe that less progress has been made in developing programs that effectively prepare lower-income students to apply to college or help them succeed once they arrive. Most important, too few public schools in poor neighborhoods academically equip students to handle college work.
    There is no simple answer to these challenges. But the nation is inviting conflict if it apportions opportunity primarily to the children with the good sense to be born where it is already within reach.

      Posted by on Tuesday, October 20, 2009 at 12:36 PM in Economics, Income Distribution | Permalink  TrackBack (0)  Comments (75) 


      FRBSF: The Economic Outlook

      Glenn Rudebusch of the SF Fed:

      Five key questions are often asked about current economic and financial conditions: Has the financial crisis ended? Is the recession over? Will the economy return to full employment and normal conditions anytime soon? Is inflation going to jump too high? Does the Federal Reserve have an "exit strategy" to undo its extraordinary policy actions of the past two years? The answers, respectively, are: Mostly, Almost certainly, No, No, and Yes.

       Gap

      He also notes the poor outlook for jobs:

      Although growth has returned, the economy will remain in a deep hole with high unemployment and underutilized productive resources for some time. So, even though the recession is over, production, income, sales, and employment will persist at subpar levels. A large amount of unemployed or underutilized labor and capital remains in the economy, and it will take a sustained period of growth for the economy to return to its normal or potential level.

      And, unless something is done about it (hint, hint), the problems are likely to persist for a considerable time period:

      A rough benchmark for calibrating the stance of monetary policy explains the level of the funds rate in terms of inflation and unemployment. Currently, this simple rule of thumb, which has captured the broad contours of policy over the past two decades, suggests that the funds rate will be near its zero lower bound for several years.

      More here.

        Posted by on Tuesday, October 20, 2009 at 01:42 AM in Economics | Permalink  TrackBack (0)  Comments (12) 


        "Safety Nets for the Rich"

        The administration must be aware of the impact that continuing weakness in labor markets will have on Democrat's political fortunes:

        Safety Nets for the Rich, by Bob Herbert, Commentary, NY Times: ...We’ve spent the last few decades shoveling money at the rich like there was no tomorrow. We abandoned the poor, put an economic stranglehold on the middle class and all but bankrupted the federal government — while giving the banks and megacorporations and the rest of the swells at the top of the economic pyramid just about everything they’ve wanted.
        And we still don’t seem to have learned the proper lessons. We’ve allowed so many people to fall into the terrible abyss of unemployment that no one — not the Obama administration, not the labor unions and most certainly no one in the Republican Party — has a clue about how to put them back to work.
        Meanwhile, Wall Street is living it up. I’m amazed at how passive the population has remained in the face of this sustained outrage.
        Even as tens of millions of working Americans are struggling to hang onto their jobs and keep a roof over their families’ heads, the wise guys of Wall Street are licking their fat-cat chops over yet another round of obscene multibillion-dollar bonuses — this time thanks to the bailout billions that were sent their way by Uncle Sam, with very little in the way of strings attached. ...
        We need to make some fundamental changes in the way we do things in this country. The gamblers and con artists of the financial sector, the very same clowns who did so much to bring the economy down in the first place, are howling self-righteously over the prospect of regulations aimed at curbing the worst aspects of their excessively risky behavior and preventing them from causing yet another economic meltdown.
        We should be going even further. We’ve institutionalized the idea that there are firms that are too big to fail and, therefore, “we, the people” are obliged to see that they don’t — even if that means bankrupting the national treasury and undermining the living standards of ordinary people. What sense does that make? If some company is too big to fail, then it’s too big to exist. Break it up.
        Why should the general public have to constantly worry that a misstep by the high-wire artists at Goldman Sachs (to take the most obvious example) would put the entire economy in peril? ...
        Enough! Goldman Sachs is thriving while the combined rates of unemployment and underemployment are creeping toward a mind-boggling 20 percent. Two-thirds of all the income gains from the years 2002 to 2007 — two-thirds! — went to the top 1 percent of Americans.
        We cannot continue transferring the nation’s wealth to those at the apex of the economic pyramid ... while hoping that someday, maybe, the benefits of that transfer will trickle down in the form of steady employment and improved living standards for the many millions of families struggling to make it from day to day.

        That money is never going to trickle down. It’s a fairy tale. We’re crazy to continue believing it.

        If you had the authority to change economic policy, what would you do to create jobs? I'd start and the state and local level, make sure that governments are expanding to absorb unemployed resources rather than contracting and adding to the problem, and work upward from there. The creation of new employment opportunities would be the primary focus of the policy initiatives.

          Posted by on Tuesday, October 20, 2009 at 01:41 AM in Economics, Unemployment | Permalink  TrackBack (0)  Comments (113) 


          Monday, October 19, 2009

          links for 2009-10-19

            Posted by on Monday, October 19, 2009 at 11:03 PM in Economics, Links | Permalink  TrackBack (0)  Comments (11) 


            The Health Care Status Quo is Not Stable

            The recession is accelerating the movement away from employer based health insurance:

            How the Recession is Killing Private Social Insurance, by Noam Scheiber: The Wall Street Journal has a terrific piece today about how the recession is accelerating the fraying the post-World War II compact between workers and employers (which has, of course, been fraying for several decades now). Key nugget:

            Two-thirds of big companies that cut health-care benefits don't plan to restore them to pre-recession levels, they recently told consulting firm Watson Wyatt. When the firm asked companies that have trimmed retirement benefits when they expect to restore them, fewer than half said they would do so within a year, and 8% said they didn't expect to ever.

            Overall, the story really just affirms the president's central mantra on health care reform--that is, a rejection of the idea that the health care status quo is stable (if less than ideal). In fact, as Obama has stressed, the status quo gets significantly worse every year. From the Journal story:

            Employers that offer health insurance spend an average of $6,700 per employee on it this year, nearly twice as much as in 2001, according to consulting firm Hewitt Associates. ...
            The percentage of employers offering health-care benefits is 60% this year, down from 63% in 2008 and 69% in 2000, according to the Kaiser Family Foundation.
            In a survey by Hewitt last winter, 19% of large employers said they planned to move away from directly sponsoring health-care benefits over the next five years.
            In the meantime, workers' share of health costs is headed up. For next year, 63% of employers that offer health coverage plan to increase employees' share of the expense, according to a survey ... by another consulting firm, Mercer.

            For what it's worth, the pension portions of the piece are pretty interesting, too.

            If the government doesn't step in with an effective reform package, a lot of people who thought their health insurance would be there when they need it are in for a surprise.

              Posted by on Monday, October 19, 2009 at 07:55 PM in Economics, Health Care | Permalink  TrackBack (0)  Comments (23) 


              "Fed Chief Cites Trade Imbalances’ Role in Crisis"

              Ben Bernanke:

              Fed Chief Cites Trade Imbalances’ Role in Crisis, by Edmund Andrews, NY Times: Ben S. Bernanke, the chairman of the Federal Reserve, said on Monday that global trade imbalances played a central role in the global economic crisis and warned that the both the United States and fast-growing Asian nations needed to do more to prevent them from recurring.
              “We were smug,” Mr. Bernanke said of the United States, saying the American financial regulatory system was “inadequate” at managing the immense inflows of cheap money from China and other countries that had huge trade surpluses.
              Though the Fed chairman acknowledged that trade imbalances have declined sharply as a result of the crisis, mainly because trade itself plunged, he warned that American foreign indebtedness will aggravate the imbalances once again unless the United States reduces its soaring federal budget deficit.
              “The United States must increase its national saving rate,” he said. “The most effective way to accomplish this goal is by establishing a sustainable fiscal trajectory, anchored by a clear commitment to substantially reduce federal deficits over time.” ...
              By the same token, he said, Asian countries needed to rely less on exports and more on their consumption at home for their economic growth. One way to increase Asian household consumption, he said, would be for countries like China to increase social insurance programs and reduced the uncertainty that currently hangs over many consumers. ...
              With the Asian economy expanding at an annualized rate of 9 percent in the second quarter of this year, and China’s economy expanding at rates of more than 10 percent, Mr. Bernanke said, “Asia appears to be leading the global recovery.”
              But the Fed chairman warned that the United States-led crisis was fueled in large part by huge inflows of cheap money to the United States from countries like China that were trying to recycle dollars from their huge trade surpluses.
              The Fed chairman noted that global trade and financial imbalances have narrowed considerably since the crisis began... But he cautioned that the imbalances could widen out again as economic growth revives. While the United States has to tighten its belt by saving more and consuming less, China and other Asian countries need to increase their consumer spending in order to promote faster domestic economic growth.
              Mr. Bernanke avoided what was in many ways the elephant in the room: the value of the United States dollar. The dollar has dropped sharply in recent weeks against the euro and the Japanese yen, which has helped increase American exports by making them cheaper in some foreign markets. But the dollar has not budged in more than a year against China’s renmimbi...

              There were three important factors in the crisis, global imbalances (Bernanke's savings glut), low interest rate policy by the Fed, and the failure of markets and regulators to provide the checks and balances necessary to prevent the crisis from occurring. The global imbalances combined with the Fed's low interest rate policy led to the massive build up of global liquidity looking for a safe, high return home, and the market and regulatory failures allowed the extra liquidity and the false promise of high, safe returns to concentrate risk in the mortgage markets.

              Bernanke focuses on two of these causes of the crisis, global imbalances and regulatory problems (market failures get less attention), but he does not focus on the Fed's role in the crisis at all. So let me say that I hope the Fed is more willing to consider popping bubbles as they inflate than it has been in the past. But that is not the main point I want to make.

              The crisis, according to Bernanke, occurred when the excess global liquidity overwhelmed financial markets -- it was too much for either regulators and markets to handle. Think of a hurricane hitting a city that is so strong and powerful that it overwhelms levees and other flood/damage control mechanisms. That's essentially Bernanke's explanation, the shock was too big for the mechanisms we had in place to control the damage. One solution to the hurricane problem is to hope that such large shocks don't happen again and simply rebuild the same defenses as before, and another response is to recognize that such shocks will occur every so often and to build the stronger defensive measures needed to get ready.

              Bernanke acknowledges that the defenses, i.e. the regulation of financial markets, need to be strengthened, but he seems to place a lot of emphasis on reducing the size of future shocks (reduce the budget deficit, have Asian countries consume more to reduce imbalances, etc.). I think that is fine, we should reduce the danger as much as we can, but we need to accept that global imbalances are possible, that a shock of this magnitude could and probably will happen again at some point in the future, and we need to make sure that markets don't fail like they did this time (i.e. we need to fix the bad incentives in these markets). But more importantly, we need to strengthen our regulatory defenses in anticipation of the next big shock. If it's fair to blame the government for not having levees, etc. ready for Katrina, if we insist that the defenses need to be strengthened going forward, then the same argument can be made in financial markets. Despite our best efforts to reduce the chances that a large shock will occur through deficit reduction and higher domestic saving rates, we should expect that global imbalances will rear their head again at some point, and the system cannot be overwhelmed again like it was this time.

              For that reason, I'm a bit disappointed in Bernanke's willingness to point fingers at external causes and say other countries must change their consumption habits, or to blame budget deficits, at a time when financial regulation is coming onto the legislative agenda (though he didn't say anything about the exchange rate). Those are important problems and I don't mean to dismiss them, but right now financial regulation is being considered by congress, and it's essential that we get the regulations in place that can withstand the next big shock. Blaming external forces for the crisis will make it easier for opponents of regulation to blame China and other countries, and that gives legislators an excuse to give in to pressure (e.g. campaign contributions) from the financial industry to go soft on regulatory changes.

              Update: Paul Krugman comments on Bernanke's remarks: America’s Chinese disease (not quite what you think).

                Posted by on Monday, October 19, 2009 at 11:43 AM in China, Economics, Financial System, International Finance, Monetary Policy | Permalink  Comments (32) 


                Paul Krugman: The Banks Are Not Alright

                The failure to pursue the best strategy for cleaning up the financial system, temporary nationalization and a large injection of capital, is slowing down the recovery, particularly for "the part of banking that really matters — lending, which fuels investment and job creation":

                The Banks Are Not Alright, by Paul Krugman, Commentary, NY Times: ...[Many people] reacted with fury to the spectacle of Goldman Sachs making record profits and paying huge bonuses even as the rest of America, the victim of a slump made on Wall Street, continues to bleed jobs. ...

                Ask the people at Goldman, and they’ll tell you that it’s nobody’s business but their own how much they earn. But as one critic recently put it: “There is no financial institution that exists today that is not the direct or indirect beneficiary of trillions of dollars of taxpayer support for the financial system.” Indeed: Goldman has made a lot of money..., but .... only ... thanks to policies that put vast amounts of public money at risk...

                So who was this thundering bank critic? None other than Lawrence Summers... Administration officials are furious at the way the financial industry, just months after receiving a gigantic taxpayer bailout, is lobbying fiercely against serious reform. But you have to wonder what they expected to happen. They followed a softly, softly policy, providing aid with few strings, back when all of Wall Street was on the ropes; this left them with very little leverage over firms like Goldman that are now, once again, making a lot of money.

                But there’s an even bigger problem: while the wheeler-dealer side of the financial industry,... trading operations, is highly profitable again, the part of banking that really matters — lending, which fuels investment and job creation — is not. Key banks remain financially weak, and their weakness is hurting the economy as a whole.

                You may recall that earlier this year there was a big debate about how to get the banks lending again. Some analysts, myself included, argued that at least some major banks needed a large injection of capital from taxpayers, and that the only way to do this was to temporarily nationalize the most troubled banks. The debate faded out, however, after Citigroup and Bank of America, the banking system’s weakest links, announced surprise profits. All was well, we were told, now that the banks were profitable again.

                But a funny thing happened on the way back to a sound banking system: last week both Citi and BofA announced losses in the third quarter. What happened?

                Part of the answer is that those earlier profits were in part a figment of the accountants’ imaginations. More broadly,... economic distress, especially persistent high unemployment, is leading to big losses on mortgage loans and credit cards.

                And here’s the thing: The continuing weakness of many banks is helping to perpetuate that economic distress. Banks remain reluctant to lend, and tight credit, especially for small businesses, stands in the way of the strong recovery we need.

                So now what? Mr. Summers still insists that the administration did the right thing: more government provision of capital, he says, would not “have been an availing strategy for solving problems.” Whatever. In any case, as a political matter the moment for radical action on banks has clearly passed.

                The main thing for the time being is probably to do as much as possible to support job growth. With luck, this will produce a virtuous circle in which an improving economy strengthens the banks, which then become more willing to lend.

                Beyond that, we desperately need to pass effective financial reform. For if we don’t, bankers will soon be taking even bigger risks than they did in the run-up to this crisis. After all, the lesson from the last few months has been very clear: When bankers gamble with other people’s money, it’s heads they win, tails the rest of us lose.

                  Posted by on Monday, October 19, 2009 at 12:54 AM in Economics, Financial System, Policy | Permalink  Comments (87) 


                  "How Moody's Sold its Ratings -- and Sold Out Investors"

                  Robert Waldmann says "This McClatchy article by Kevin G Hall seems important to me." It does seem like there was "market failure in everything" when it comes to mortgage markets, from the incentives faced by the homeowner (non-recourse loans) and real estate agent ( maximize commission income) at the very first point of contact, through other points in the system such as appraisers, mortgage brokers, and bank managers.

                  Maybe fixing the incentive problems at each of these steps would have stopped the problem, or at least made it much less severe, but maybe not. In any case, it's clear that markets failed to self regulate at many key points, and that there are problems that need to be fixed covering the entire spectrum from the sale of higher priced, higher profit mortgage contracts to unwary homeowners when better options were available to the incentives bank managers had to maximize short-run profits and accumulate too much risk.

                  But the flow of toxic paper upward through the system should have had a gatekeeper of last resort, or at least a thorough checkpoint, and that was the ratings agencies. I don't think the failure of the ratings agencies, by itself, caused the financial crisis, but it was an important contributor and it's one of the things that needs to be fixed:

                  How Moody's sold its ratings -- and sold out investors, by Kevin G. Hall, McClatchy Newspapers: As the housing market collapsed in late 2007, Moody's Investors Service, whose investment ratings were widely trusted, responded by purging analysts and executives who warned of trouble and promoting those who helped Wall Street plunge the country into its worst financial crisis since the Great Depression.
                  A McClatchy investigation has found that Moody's punished executives who questioned why the company was risking its reputation by putting its profits ahead of providing trustworthy ratings for investment offerings.
                  Instead, Moody's promoted executives who headed its "structured finance" division, which assisted Wall Street in packaging loans into securities for sale to investors. It also stacked its compliance department with the people who awarded the highest ratings to pools of mortgages that soon were downgraded to junk. Such products have another name now: "toxic assets."
                  As Congress tackles the broadest proposed overhaul of financial regulation since the 1930s, however, lawmakers still aren't fully aware of what went wrong at the bond rating agencies, and so they may fail to address misaligned incentives...
                  The Securities and Exchange Commission issued a blistering report on how profit motives had undermined the integrity of ratings at Moody's and its main competitors, Fitch Ratings and Standard & Poor's,... but the full extent of Moody's internal strife never has been publicly revealed.
                  Moody's ... disputes every allegation against it. "Moody's has rigorous standards in place to protect the integrity of ratings from commercial considerations," said Michael Adler, Moody's vice president for corporate communications... Insiders, however, say that wasn't true before the financial meltdown.
                  To promote competition, in the 1970s ratings agencies were allowed to switch from having investors pay for ratings to having the issuers of debt pay for them. That led the ratings agencies to compete for business by currying favor with investment banks that would pay handsomely for the ratings they wanted.
                  Wall Street paid as much as $1 million for some ratings, and ratings agency profits soared. This new revenue stream swamped earnings from ordinary ratings. ... Ratings agencies thrived on the profits that came from giving the investment banks what they wanted, and investors worldwide gorged themselves on bonds backed by U.S. car loans, credit card debt, student loans and, especially, mortgages. ...
                  Nobody cared about due diligence so long as the money kept pouring in during the housing boom. ...
                  One Moody's executive who soared through the ranks during the boom years was Brian Clarkson, the guru of structured finance. He was promoted to company president just as the bottom fell out of the housing market. Several former Moody's executives said he made subordinates fear they'd be fired if they didn't issue ratings that matched competitors' and helped preserve Moody's market share. ...
                  Clarkson rose to the top in August 2007, just as the subprime crisis was claiming its first victims. Soon afterward, a number of analysts and compliance officials who'd raised concerns about the soundness of the ratings process were purged and replaced with people from structured finance. ...
                  Another mid-level Moody's executive ... recalls being horrified by the purge. "It is just something unthinkable, putting business people in the compliance department. It's not acceptable. I was very upset, frustrated," the executive said. "I think they corrupted the compliance department." ...
                  Others who worked at Moody's at the time described a culture of willful ignorance in which executives knew how far lending standards had fallen and that they were giving top ratings to risky products.
                  "I could see it coming at the tail end of 2006, but it was too late. You knew it was just insane," said one former Moody's manager. "They certainly weren't going to do anything to mess with the revenue machine." ...[...more...]...

                    Posted by on Monday, October 19, 2009 at 12:42 AM in Animation, Economics, Financial System, Market Failure, Regulation | Permalink  Comments (6) 


                    Sunday, October 18, 2009

                    links for 2009-10-18

                      Posted by on Sunday, October 18, 2009 at 11:05 PM in Economics, Links | Permalink  Comments (18) 


                      Global Warming in SuperFreakonomics: A Reply to Critics

                      Stephen Dubner replies to critics. Paul Krugman replies briefly to Dubner in the process of a "broader analysis of what it all means."

                        Posted by on Sunday, October 18, 2009 at 02:50 PM in Economics, Environment | Permalink  Comments (59) 


                        The Pundit's Dilemma

                        Mark Liberman at Language Log says the game theory can explain why pundits "best move always seems to be to take the low road":

                        ...Overall, the promotion of interesting stories in preference to accurate ones is always in the immediate economic self-interest of the promoter. It's interesting stories, not accurate ones, that pump up ratings for Beck and Limbaugh. But it's also interesting stories that bring readers to The Huffington Post and to Maureen Dowd's column, and it's interesting stories that sell copies of Freakonomics and Super Freakonomics. In this respect, Levitt and Dubner are exactly like Beck and Limbaugh.

                        We might call this the Pundit's Dilemma — a game, like the Prisoner's Dilemma, in which the player's best move always seems to be to take the low road, and in which the aggregate welfare of the community always seems fated to fall. And this isn't just a game for pundits. Scientists face similar choices every day, in deciding whether to over-sell their results, or for that matter to manufacture results for optimal appeal.

                        In the end, scientists usually over-interpret only a little, and rarely cheat, because the penalties for being caught are extreme. As a result, in an iterated version of the game, it's generally better to play it fairly straight. Pundits (and regular journalists) also play an iterated version of this game — but empirical observation suggests that the penalties for many forms of bad behavior are too small and uncertain to have much effect. Certainly, the reputational effects of mere sensationalism and exaggeration seem to be negligible. ...

                        I think it's correct that the penalties pundits face for "many forms of bad behavior are too small and uncertain to have much effect," but I'm not sure that was always true to the extent it's true today. So the question to me is why the tolerance for this behavior has changed over time (has it changed?).

                        I'm not sure I know the answer to that, but I suspect it has something to do with increased competition among media companies for eyeballs and ears combined with profit incentives that cause information organizations to maximize something other than the output of credible information (maximizing profit may not be the same as maximizing the output of factual, useful information).

                        Though this type of behavior was always present in the media, it seems to have gotten much worse with the proliferation of cable channels and other media as information technology developed beyond the old fashioned antennas on roofs receiving analog signals. I don't want to go back to the days where we had an oligopolistic structure for the provision of news (especially on network TV), competitive markets are much better, but there seems to be a divergence between what is optimal for the firm and what is socially optimal.

                        Some people have argued that there are big externalities to good and bad reporting, and therefore that "some kind of tax credit scheme for non-entertainment news reporting might enhance societal efficiency and welfare." That might help to change incentives, but I'm not sure it solves the fundamental problem. There must be reputation effects that matter to the firm, some way of making the firms pay a cost for bad pundit behavior. But that is up to the public at large, people must reward good behavior and penalize bad, it is not something the government can control. I suppose we could try something like British libel laws to partially address this, but looking at the UK press does not convince me that this solves the problem.

                        So I don't know what the answer is. It drives me crazy that, for example, people invited to appear on CNN will say something that is an outright lie, and the person saying it clearly knows it is a lie or misrepresentation, but yet they get invited back anyway due to their entertainment value. Why isn't the rule that if you lie once on the air, you can never come back again? No matter what they say or how accurate they are, the line-up on the news, op-ed pages, etc., etc., is pretty much the same tired old group of people who have proven they will say controversial things that draw ratings. And that is what matters, never mind the accuracy.

                        The distressing part is that there doesn't seem to be a good way to change these incentives so long as the public continues to lend their eyeballs and ears to those who play this game.

                        Is there a solution?

                          Posted by on Sunday, October 18, 2009 at 11:15 AM in Economics, Press | Permalink  Comments (45) 


                          Saturday, October 17, 2009

                          links for 2009-10-17

                            Posted by on Saturday, October 17, 2009 at 11:05 PM in Economics, Links | Permalink  Comments (6) 


                            "An Obama Report Card"

                            Alan Blinder grades the administration's accomplishments on macroeconomic and banking issues:

                            Comedy Aside, an Obama Report Card, by Alan Blinder, Commentary, NY Times: First, “Saturday Night Live” parodies President Obama’s “achievements.” Then Mr. Obama wins the Nobel Peace Prize, bringing yet more head-scratching. Clearly, the nation’s attention is focused squarely on a question few presidents want to answer just nine months into their term: What has your administration accomplished?
                            I’ll leave foreign and military affairs to the Oslo Five and concentrate on domestic economics. ...
                            Stopping the Slide Let’s remember that the new president was dealt a dreadful hand on Inauguration Day — including a shattered financial system and a national economy teetering on the brink of disaster. The administration’s chief accomplishment to date surely is devising and executing — with huge assists from the Federal Reserve — a comprehensive program to pull us back from the abyss. ... Thus Job No. 1 — stopping the train wreck — appears to have been done rather well.
                            Enacting the Stimulus Package The much-maligned fiscal stimulus has been criticized from both the left (as too small) and from the right (as too big, especially the spending parts). My own judgment is that both its magnitude and composition were reasonable, though not perfect. But ... speed of enactment merits substantial weight in the overall grade. By that standard, the stimulus package scores well — especially considering that Republican obstructionism... Give it a B or B+.
                            Rescuing Banks ...[T]he Treasury secretary ... wisely resisted the siren songs coming from both the left (“nationalize the banks”) and the right (“let ’em fail”), opting instead for the high-risk “stress tests” of 19 big financial institutions. Today, all 19 are alive and breathing. None have been nationalized. ... Most are not just showing a pulse but also actually have pink in their cheeks. ... (In fairness, the Fed and other regulators deserve great credit for executing this delicate task so skillfully.)
                            So give the bank rescue plan an A–. The minus comes from being too soft on many banks and bankers, who failed us and then benefited from public largess.
                            Reducing Foreclosures Mr. Obama’s efforts to mitigate foreclosures have been more modest — and less successful. ... Give them a C.
                            Trying for Regulatory Reform While it is still only a set of proposals,... the Treasury worked at breakneck speed ... to produce an intelligent and comprehensive set of financial regulatory reforms after just five months in office. The ... proposals ... are not perfect. ... And I continue to be distressed that the president, having overloaded his plate, has been unable to devote enough time and effort to pushing the proposals through Congress — leaving the lobbyists far too much running room.
                            At this point, we can’t even guess what may pass. So give this policy an “incomplete,” noting, however, that the first draft shows promise.
                            Etc. In addition to these efforts on the macroeconomic and financial fronts, the president appears to be making some headway on health care reform... By contrast, the betting is against getting through Congress a cap-and-trade system for reducing carbon emissions.
                            On balance, then, this assessment leads to a Nobel-like verdict in the areas of financial regulation, health care and energy: the ideas have great merit, but any real achievements are hopes for the future. They don’t award prizes for that in Washington, even if they do so in Oslo.
                            Yet on the crucial macroeconomic and banking issues,... Mr. Obama’s accomplishments in just nine months are palpable and were very much needed. ...

                            Let me add one more category, how the benefits from the stimulus package and the bank bailout package have been distributed. With so many of the benefits of the financial bailout accruing to the same people and institutions that helped to cause the problems, with employment still lagging, and with social insurance programs to help those who cannot find employment coming under increased budgetary pressures, particularly at the state and local levels, it seems evident that the distribution could have been much better without compromising (and perhaps even enhancing) the speed of recovery.

                              Posted by on Saturday, October 17, 2009 at 10:17 PM in Economics, Politics | Permalink  Comments (41) 


                              "Something is Wrong with Wall Street"

                              One element in the creation of  bubble is people's willingness to believe that this time is different. In the present case, this time was different because of financial innovation, better monetary policy, better technology to manage shocks (e.g. digital technology reducing supply bottlenecks), and so on leading to a (supposed) reduction in overall financial risk without a corresponding reduction in returns.

                              But this time wasn't different, it was in many ways a rerun of the dot.com bubble, and Shane Greenstein says people are finally starting to notice. In fact, according to the argument below, the effort to address problems on Wall Street has passed the "Russ Roberts test":

                              This just in, something is wrong with Wall Street, by Shane Greenstein [Note: original post replaced with an updated version at the author's request]:

                              Please forgive the irony in the title. But I just felt like expressing sarcasm because – Ha! — many professional economists have begun to notice something is wrong with Wall Street.

                              Better late than never, I guess.

                              This recent essay/podcast from Russell Roberts is a good indication that just about everyone has noticed that Wall Street has a tin ear for its public standing, which has sunk quite low due to self-serving behavior.

                              In case you have not noticed what Roberts has noticed, then let me remind you. Just recently the management at Goldman Sachs announced that the firm had a very profitable quarter, which, of course, resulted in very high pay for their executives.

                              That is where it gets interesting. Roberts points out (correctly, IMHO) that had the government not stepped in at AIG, etc., Goldman would have gone down with everyone else. Ergo, their executives should recognize that they have a connection to taxpayer money as much as any other firm, and they should, therefore, eschew blatantly selfish and observable behavior, such as paying themselves high salaries.

                              Russ Roberts is normally a free market economist, but in his essay he sounds like an old fashioned populist. When a firm does something to turn Russell Roberts into a populist then — perhaps — something is actually amiss with attitudes on Wall Street.

                              Alright, then, so what? Well, take this observation another step or two…

                              What Roberts did not say

                              Here is what Roberts did not say, so I will. Goldman displayed a tin ear by not making any gesture at the same time they announced their profitable earnings.

                              What do I mean by tin ear? Here is an example. They did not announce the hiring of many (otherwise) laid off workers — as sort of a political gesture to address the need to do something about the high unemployment rate around the country.

                              Here is another idea. Why stop with hiring a few more employees? How about making an unusually big (I mean VERY BIG) donation to a soup kitchen — once again, as a gesture to suffering of others in these hard time.

                              Hmmm, here is another idea. How about doing anything mildly publicly-spirited, like buying a new fire truck for the New York city Fire Department, because the whole city is having a bad budget year? Why the New York city Fire Department? Because nobody ever has anything bad to say about firefighters in most cities, and certainly not in New York City after their sacrifice during 9/11.

                              Heck, once you start thinking this way, it is quite easy to find a way to spend a half billion dollars in unexpectedly large profits. But if you have a tin ear for this sort of non-selfish gesture, then the thought might never have surfaced.

                              And now to the point of this rant…

                              For those of us who live in the land of high tech, these type of observations are nothing new. The self-serving and otherwise destructive behavior of some Wall Street managers is well known…

                              Look, I have been around the block enough to understand that sometimes financial managers have something useful to say to high tech firms. But there is also something wrong. For example, the short-termism of Wall Street managers is legendary among high tech managers who have a long term vision for their firm but are asked to deliver revenue tomorrow. The self-serving decision making of managers who give IPOs to friends is another well known behavior (and most young firms and VCs would love to eliminate it). Another common complaint concerns the unwillingness of IPO managers to change the system if it meant a loss of control. For example, remember this? Wall Street was unwilling to conduct any IPO as an auction until Google insisted — insisted! — that the old system would not apply to them.

                              Enough is enough. Even guys like Roberts can see that something is amiss.

                              Remember the dot com madness?

                              It is really nothing new. Really.

                              Back in the late 1990s — more than a decade ago — Wall Street cheered on one of the goofiest investment bubbles I have ever seen in my lifetime (and hopefully I ever will see). It was called the dot-com boom, and, frankly, it was nuts from any rational perspective.

                              Yes, there are lots of explanations for the boom. There was a social dimension: Plenty of observers tried to say it was nuts. They were drowned out by crazy evangelists who ignored basic finance and who argued that price earnings ratios could be way out of whack. And it sold copy: the business media loves of a sensational story, and that did not help.

                              But that is why adult supervision is required in high tech. The financial professionals and auditors of this country had a professional obligation to say sober things, to ask — perhaps, insist! — that revenues align with expenses, and advise investors when such alignment has little chance of appearing. And in the late 1990s, what did the professionals do? Well, it is complicated, but, suffice to say, few of them said no to the nuttiness.

                              Why not? Here is a good clue in an essay by Henry Blodget.

                              You may recall that Blodget was a wunderkindt cheer leader for dot coms. How did he get there? Basically, he made a bold call, got himself some attention, and kept making more bold calls. His bosses saw an opportunity and replaced someone else who had the good sense to point out that the promises had considerably risk. Blodgett instead went full steam ahead because — he fully admits it — he was hired to do just that.

                              I do not know this fellow, nor have we ever met. I have read some of his writing. As best I can tell, Blodgett actually has a pretty smart head on his shoulders. He writes well and has the capacity to make some intelligent and deep observations.

                              Anyway, Blodgett eventually got himself into trouble. While I understand how someone with those sort of smarts can delude themselves enough to tempt fate for a short while — he is human, after all — nonetheless, it is beyond my capacity as a psychologist to explain how someone can do it for a long time.  And he did. For several years. Until the dot com crashed, and a scandal broke, and he got banned.

                              There is a deeper question behind that run of several years. How did his bosses allow Blodgett to ply this trade for so long even though the wiser adults among them surely must have suspected/concluded/known that much of it was a financial charade?

                              The answer, of course is quite simple: they made so much money during that time. Blodgett’s bosses had no reason to change anything.

                              Many years later Blodgett wrote about his time in this essay. He finds many reasons for explaining his own behavior. Blodget says he did it because if he did not others would.  He did it because his bosses wanted him to do it. He did because everyone was making huge amounts of money from focusing on the short term benefits to their firm. All in all, he did it because it seemed like a good idea at the time.

                              In economics-speak, all those explanations add up to the following. Henry and his bosses simply ignored the consequences for the prudent investor or for the country as a whole — even though it had occurred to them that there was a chance that something might have gone wrong.

                              Let’s say this in general terms. Wall Street firms had no reason to internalize the issues with systemic risk — that is, they each ignored the downside to the entire system from all of them taking on too much risk, because each of them only contributed a small amount to it. Instead, each of them pursued their own selfish interests, and made out well in the short run, sacrificing system-wide long run stability.

                              Summing up

                              Those of us who live in high tech land noticed the odd behavior of Wall Street a while ago. Finally, it seems, the macroeconomics policy crowd has started to notice the same issues, and has started to argue that — perhaps — it is time to reign this in a bit. When a free market guy like Roberts notices, you know that the sensible people are finally thinking this one through.

                              Like I said, better late than never.

                              Now, on to the serious conversation: what to do about it….I am not sure what the right answers are, but limits on executive bonuses seems like a band-aid for a systemic issue. It is too much to ask a manager who makes several million dollars a year to stop gaming the system, but it might be reasonable to ask for better auditing, more transparency for investors, tighter capital requirements for firms taking risky actions, and a few others unpleasant measures that might help us all avoid these system-wide problems.

                              Oh yes… until then, the executives at Goldman might consider a public spirited gesture or two, such as — I dunno’ — donating a fraction of their recent profits to the New York Fire Department.

                              "Even guys like Roberts can see that something is amiss." So this time is different?

                              I want to believe that, I really do.

                                Posted by on Saturday, October 17, 2009 at 11:07 AM in Economics, Financial System, Regulation | Permalink  Comments (45) 


                                "Superfreakonomics on Climate"

                                Paul Krugman:

                                Superfreakonomics on climate, part 1, by Paul Krugman: OK, I’m working my way through the climate chapter — and the first five pages, by themselves, are enough to discredit the whole thing. Why? Because they grossly misrepresent other peoples’ research, in both climate science and economics.
                                The chapter opens with the “global cooling” story — the claim that 30 years ago there was a scientific consensus that the planet was cooling, comparable to the current consensus that it’s warming.
                                Um, no. Real Climate has the takedown. What you had in the 70s was a few scientists advancing the cooling hypothesis, and a few popular media stories hyping their suggestions. To the extent that there was a consensus, it was that there wasn’t much evidence for anything, and more research was needed.
                                What you have today is a massive research program involving thousands of scientists and many peer-reviewed publications, with all major international bodies agreeing that man-made global warming is real. You can, if you insist, dismiss it all as a gigantic hoax or whatever — but it’s nothing like the isolated 70s speculations about cooling.
                                And then we come to a bit of economics. The book asks
                                Do the future benefits from cutting emissions outweigh the costs of doing so? Or are we better off waiting to cut emissions later — or even, perhaps, polluting at will and just learning to live in a hotter world?
                                The economist Martin Weitzman analyzed the best available climate models and concluded that the future holds a 5 percent chance of a terrible-case scenario ..
                                Yikes. I read Weitzman’s paper, and have corresponded with him on the subject — and it’s making exactly the opposite of the point they’re implying it makes. Weitzman’s argument is that uncertainty about the extent of global warming makes the case for drastic action stronger, not weaker. And here’s what he says about the timing of action:
                                The conventional economic advice of spending modestly on abatement now but gradually ramping up expenditures over time is an extreme lower bound on what is reasonable rather than a best estimate of what is reasonable.
                                Again, we’re not even getting into substance — just the basic issue of representing correctly what other people said.
                                Administrative note: I’m going to block comments here, because I know it will be overwhelmed.

                                Robert Waldmann defends the book (here too).

                                I haven't read the book, and can't, at least not yet.

                                Brad DeLong:

                                Correspondence on Global Warming and Superfreakonomics, by Brad DeLong: Steve Dubner writes:
                                Brad,
                                It is amazing to see how quickly and thoroughly Romm's extremely misleading attack has spread, to the point where even independent thinkers like you accept it on face value. His attack is full of deception and outright lies. He makes it sound as if we somehow twisted and abused Caldeira's research; nothing could be further from the truth. We will have to clear this up publicly, although as you suggest it will be hard to put out this fire no matter how wrongfully set. This is politics that's being played now, nothing else. Also: yes, Romm posted a PDF of the chapter on his website, which the publisher, in its routine effort to pull pirated copies of its copyrighted material off the web, asked him to take down. As far as I know, it was never on Amazon; there's been no censoring; we are talking about a book that hasn't yet been published (when it is, I assume Amazon will post the searchable pages, as is typical), but Romm has done a great job of getting people to believe that a book they haven't read is full of errors.
                                I reply:
                                Brad DeLong to Stephen
                                Re: "It is amazing to see how quickly and thoroughly Romm's extremely misleading attack has spread, to the point where even independent thinkers like you accept it on face value..."
                                As I said, I can't read your chapter--by your publisher's choice.
                                That's very bad for you: Romm's posting your chapter and a link to it is a way for him to establish credibility--"see for yourself"; your publisher's pulling it down is a way to diminish yours.
                                Over this weekend, people's views are gelling--Paul Krugman's, for example--while your voice isn't being heard, and once people's views are gelled, it takes a huge amount of evidence and the right kinds of psychological pressure to ungell them.
                                Thus, for example, I would love to believe in Myrhvold and in cheap geoengineering solutions. But I come from Berkeley, where Richard Muller is the dominant public-intellectual voice on geoengineering, and he is very knowledgeable and very skeptical. My second cousin Tom Kalil does solar panels and so forth for a living at OSTP. The reaction of the climate people I know to Myrhvold on solar panels, whom Romm says you quote:
                                "A lot of the things that people say would be good things probably aren’t,” Myrhvold says. As an example he points to solar power. “The problem with solar cells is that they’re black, because they are designed to absorb light from the sun. But only about 12% gets turned into electricity, and the rest is reradiated as heat — which contributed to global warming..."
                                is simply unprintable--that it's like claiming that curve balls curve because of photon pressure from the stadium lights.
                                So given what is flowing past my computer screen at the moment, it looks very much to me as though you were simply hornswoggled by Myrhvold and company, who have formed their own tight self-reinforcing intellectual community reinforcing each other's beliefs up there in Seattle. There is nothing I can see contradicting that interpretation, and a bunch of things from Romm and others confirming it.
                                The place where I would concentrate, if I were you, would be Stanford's Ken Caldeira. Romm claims:
                                "[Caldeira] writes me: 'If you talk all day, and somebody picks a half dozen quotes without providing context because they want to make a provocative and controversial chapter, there is not much you can do.' One sentence about Caldeira in particular is the exact opposite of what he believes (page 184): 'Yet his research tells him that carbon dioxide is not the right villain in this fight.' Levitt and Dubner didn’t run this quote by Caldeira, and when he saw a version from Myrhvold, he objected to it. But Levitt and Dubner apparently wanted to keep it very badly — it even makes the SuperFreakonomics Table of Contents in the Chapter Five summary “Is carbon dioxide the wrong villain?...”
                                If your principal experts truly do repudiate the interpretation you place on their work, that's very bad for you...

                                Comments are open.

                                Update: Steven Levitt:

                                The Rumors of Our Global-Warming Denial Are Greatly Exaggerated, by Steven D. Levitt: SuperFreakonomics isn’t even on sale yet, and the attacks on our chapter about global warming are already underway.
                                A prominent environmental blogger has attacked us. A well-known environmental-advocacy group pressured NPR into reading a statement critical of the book at the end of an interview I had given on Scott Simon’s Weekend Edition show. Even Paul Krugman and Brad DeLong got in on the action before they’d even read the book.
                                We are working on a thorough response to these critics, which we hope to post on the blog in the next day or two. The bottom line is that the foundation of these attacks is essentially fraudulent, as we’ll spell out in detail. In the meantime, let us just say the following.
                                Like those who are criticizing us, we believe that rising global temperatures are a man-made phenomenon and that global warming is an important issue to solve. Where we differ from the critics is in our view of the most effective solutions to this problem. Meaningfully reducing global carbon emissions has proven to be difficult, if not impossible. This isn’t likely to change, for the reasons we discuss in the book. Consequently, other approaches represent a more promising path to lowering the Earth’s temperature. , so obviously that’s not the case.
                                The statements being circulated create the false impression that our analysis of the global-warming crisis is ideological and unscientific. Nothing could be further from the truth.

                                I don't get the complaint in the very first sentence. They send the book out early to people hoping for reviews, then complain when people actually review the book? I realize it's not what they hoped for, but what's the complaint here? The people leading the attacks have read the book. If their reviews had been positive, would they still be telling people that the reviewers they chose to send the book to are liars who are not credibly reporting what's in it, and dismissing those who echo what the reviewers wrote? Putting this another way, if they people they chose to send the book to are writing unfavorable things, what would those they suspected would not like the book (and hence were not sent a copy) say?

                                Finally, it seems to me that they are misstating the objections ("The critics are implying that we dismiss any threats from global warming; but the entire point of our chapter is to discuss global-warming solutions"). The complaint isn't that they are global warming deniers, it's that they misstated the science associated with proposed solutions to the problem.

                                Update: While they are not global warming deniers, Mathew Yglesias says the book does make the claim that the climate change threat is being overstated by environmentalists, and that the book supports this view by inaccurately representing the views of the scientific community:

                                ...Go here and read for yourself pages 184, 185, and the beginning of page 186 of Suprefreakonomics. The point, quite clearly, is to lead you to believe that “hard-charging environment activist and all-around peacenik” Ken Caldeira share the Levitt/Dubner view that (a) environmentalists are overstating the extent of the climate change problem, (b) curbing carbon dioxide emissions should not be our main tool in combatting climate change, and (c) that it’s useful to disparagingly analogize advocates of CO2 emissions curbs to those driven by religious faith rather than scientific expertise. Caldeira is called onto the floor to speak as a voice of sober-minded science against the misguided CO2-limiters. ... Of course it’s possible that ... Ken Caldeira is mistaken about some things. But it’s not possible that Levitt and Dubner are correctly representing the views of Caldeira or climate scientists in general...

                                Update: More from Paul Krugman. A snippet:

                                Levitt now says that the chapter wasn’t meant to lend credibility to global warming denial — but when you open your chapter by giving major play to the false claim that scientists used to predict global cooling, you have in effect taken the denier side. The only way I can reconcile what Levitt says now with that reality is that he and Dubner didn’t do their homework — not only that they didn’t check out the global cooling stuff, the stuff about solar panels, and all the other errors people have been pointing out, but that they didn’t even look into the debate sufficiently to realize what company they were placing themselves in.

                                And that’s not acceptable. This is a serious issue. We’re not talking about the ethics of sumo wrestling here; we’re talking, quite possibly, about the fate of civilization. It’s not a place to play snarky, contrarian games.

                                Update: And more from Brad DeLong: Six Questions for Levitt and Dubner.

                                Update: Stephen Dubner replies to critics. Paul Krugman replies briefly to Dubner in the process of a "broader analysis of what it all means."

                                  Posted by on Saturday, October 17, 2009 at 09:33 AM in Economics, Environment | Permalink  Comments (33) 


                                  Friday, October 16, 2009

                                  links for 2009-10-16

                                    Posted by on Friday, October 16, 2009 at 11:04 PM in Economics, Links | Permalink  Comments (32) 


                                    "Myth of Rising Protectionism"

                                    Dani Rodrik says that fears that the economic crisis would protectionist measures have largely gone unrealized, and that "much of the credit must go the social programs that conservatives and market fundamentalists would like to see scrapped":

                                    Myth of Rising Protectionism, by Dani Rodrik, Commentary, Project Syndicate: There was a dog that didn't bark during the financial crisis: protectionism. Despite much hue and cry about it, governments have in fact imposed remarkably few trade barriers on imports. Indeed, the world economy remains as open as it was before the crisis struck.
                                    Protectionism normally thrives in times of economic peril. Confronted by economic decline and rising unemployment, governments are much more likely to pay attention to domestic pressure groups than to upholding their international obligations.
                                    As John Maynard Keynes recognized, trade restrictions can protect or generate employment during economic recessions. But what may be desirable under extreme conditions for a single country can be highly detrimental to the world economy.
                                    When everyone raises trade barriers, the volume of trade collapses. No one wins. That is why the disastrous free-for-all in trade policy during the 1930s greatly aggravated the Great Depression.
                                    Many complain that something similar, if less grand in scope, is taking place today. An outfit called the Global Trade Alert (GTA) has been at the forefront, raising alarm bells..." ... with China as the most common target. ...
                                    The reality is that the international trade regime has passed its greatest test since the Great Depression with flying colors. Trade economists who complain about minor instances of protectionism sound like a child whining about a damaged toy in the wake of an earthquake that killed thousands.
                                    Three things explain this remarkable resilience: ideas, politics, and institutions.
                                    Economists have been extraordinarily successful in conveying their message to policymakers ― even if ordinary people still regard imports with considerable suspicion. Nothing reflects this better than how "protection" and "protectionists" have become terms of derision.
                                    After all, governments are generally expected to provide protection to its citizens. But if you say that you favor protection from imports, you are painted into a corner with Reed Smoot and Willis C. Hawley, authors of the infamous 1930 U.S. tariff bill.
                                    But economists' ideas would not have gone very far without significant changes in the underlying configuration of political interests in favor of open trade. For every worker and firm affected adversely by import competition, there is one or more worker and firm expecting to reap the benefits of access to markets abroad. The latter have become increasingly vocal and powerful, often represented by large multinational corporations. ...
                                    But the relative docility of rank-and-file workers on trade issues must ultimately be attributed to something else altogether: the safety nets erected by the welfare state. Modern industrial societies now have a wide array of social protections ― unemployment compensation, adjustment assistance, and other labor-market tools, as well as health insurance and family support ― that mitigate demand for cruder forms of protection.
                                    The welfare state is the flip side of the open economy. If the world has not fallen off the protectionist precipice during the crisis, as it did during the 1930s, much of the credit must go the social programs that conservatives and market fundamentalists would like to see scrapped.
                                    The battle against trade protection has been won ― so far. But, before we relax, let's remember that we still have not addressed the central challenge the world economy will face as the crisis eases: the inevitable clash between China's need to produce an ever-growing quantity of manufactured goods and America's need to maintain a smaller current-account deficit.

                                    Unfortunately, there is little to suggest that policymakers are yet ready to confront this genuine threat.

                                    I don't think we should draw the conclusion that because social insurance helped to avoid destructive protectionism, the amount of social protection we provide is adequate. In many areas, e.g. adjustment insurance and health care, it isn't.

                                      Posted by on Friday, October 16, 2009 at 11:41 AM in Economics, International Finance, International Trade, Social Insurance | Permalink  Comments (16) 


                                      Paul Krugman: A Hatchet Job So Bad It’s Good

                                      The health insurance industry's recent "hatchet job" attacking health care reform may have actually done health care reform a favor:

                                      A Hatchet Job So Bad It’s Good, by Paul Krugman, Commentary, NY Times: In the past, the insurance industry’s power has been a major barrier to health-care reform. Most notably, the industry paid for the infamous “Harry and Louise” ads that helped kill the Clinton plan. But times have changed.
                                      Last weekend, the lobbying organization America’s Health Insurance Plans, or AHIP, released a report attacking the reform plan just passed by the Senate Finance Committee. Some news organizations gave the report prominent, uncritical coverage. But health-care experts quickly, and correctly, dismissed it as a hatchet job. And the end result of AHIP’s blunder may be a better bill than we would otherwise have had.
                                      For 2009, it turns out, is not 1993. Once again, Republicans have tried to kill reform with smears and scare stories. But all they seem to have killed with their cries of “socialism” and warnings about “death panels” is their own credibility. Some form of health-care reform is highly likely to pass.
                                      So it’s a different game than it was 16 years ago. And it’s a game that the insurance industry apparently doesn’t know how to play.
                                      The motivation for the AHIP report seems to have been the decision by the Finance Committee to weaken the penalties for individuals who don’t sign up for insurance, even as it retains regulations requiring that insurers offer the same policies to everyone, regardless of medical history. The industry worries that some people will game the system, remaining uninsured as long as they’re healthy, then signing up when they get sick.
                                      This is, believe it or not, a valid concern. Many health-care economists believe that a strong individual mandate, requiring that almost everyone sign up, will be needed to make health reform work. And the Finance Committee probably did weaken the mandate too much.
                                      But AHIP, apparently unable to help itself, didn’t stop there. Instead, the report threw every anti-reform argument the authors could think of at the wall, hoping that something would stick. ...
                                      Which brings us to the ways in which AHIP may have done health reform a favor.
                                      As I said, the individual mandate probably should be stronger than it is in the Finance Committee’s bill. But there’s a reason the mandate was weakened: fear that too many people would balk at the cost of insurance, even with the subsidies provided to lower-income individuals and families. So why not address that cost?
                                      Aside from making the subsidies larger, which they should be, there are at least two changes to the legislation that would help limit costs. First, health exchanges — special, regulated markets in which individuals and small businesses can buy insurance — can be made stronger, in effect giving small buyers a better bargaining position. Second, the public option — missing from the Finance Committee’s bill — can be brought back in, giving private insurers some real competition.
                                      The insurance industry won’t like these changes, but that matters less than it did a week ago.
                                      There’s also another point, which House Speaker Nancy Pelosi has stressed. Part of the opposition to a strong individual mandate comes from the sense that Americans will be forced to buy policies from a greedy insurance industry. Giving people, literally, another option — the right to buy into a public plan instead — would defuse that opposition.
                                      Even with stronger exchanges and a public option, health reform would probably increase, not reduce, insurance industry profits. But the insurers wanted it all. The good news is that by overreaching, they may have ensured that they won’t get it.

                                        Posted by on Friday, October 16, 2009 at 12:42 AM in Economics, Health Care, Politics | Permalink  Comments (146) 


                                        "Public Trust has Economic Consequences"

                                        Howard Davies says we need to rebuild trust in financial markets:

                                        Public trust has economic consequences, by Howard Davies, Commentary, Project Syndicate: Public trust in financial institutions, and in the authorities that are supposed to regulate them, was an early casualty of the financial crisis. That is hardly surprising, as previously revered firms revealed that they did not fully understand the very instruments they dealt in or the risks they assumed. ... But ... if this loss of trust persists, it could be costly for us all.
                                        As Ralph Waldo Emerson remarked, “Our distrust is very expensive.” The Nobel laureate Kenneth Arrow made the point in economic terms almost 40 years ago: “It can be plausibly argued that much of the economic backwardness in the world can be explained by the lack of mutual confidence.”
                                        Indeed, much economic research has demonstrated a powerful relationship between the level of trust in a community and its aggregate economic performance. Without mutual trust, economic activity is severely constrained. ...
                                        So if it is true that trust in financial institutions – and in the governments that oversee them – has been damaged by the crisis, we should care a lot, and we should be devising responses which seek to rebuild that trust. ...
                                        In the United States,... a ... systematic, independent survey promoted by economists at the University of Chicago Booth School of Business ... did show a sharp fall in trust in late 2008 and early 2009, following the collapse of Lehman Brothers.
                                        That fall in confidence affected banks, the stock market, and the government and its regulators. Furthermore, the survey showed that ... if your trust in the market and in the way it is regulated fell sharply, you were less likely to deposit money in banks or invest in stocks.
                                        So falling trust had real economic consequences. Fortunately, the latest survey, published in July this year, shows that trust in banks and bankers has begun to recover, and quite sharply. This has been positive for the stock market.
                                        There is also a little more confidence in the government’s response and in financial regulation than there was at the end of last year. The latter point, which no doubt reflects the Obama administration’s attempts to reform the dysfunctional system it inherited, is particularly important, as the sharpest declines in investment intentions were among those who had lost confidence in the government’s ability to regulate.
                                        It would seem that rebuilding confidence in the Federal Reserve and the Securities and Exchange Commission is economically more important than rebuilding trust in Citibank or AIG. Continuing disputes in Congress about the precise details of reform could, therefore, have an economic cost if a perception that the system will not be overhauled gains ground. ...
                                        Researchers at the European University Institute in Florence and UCLA recently demonstrated that there is a relationship between trust and individuals’ income. ...
                                        The data show, intriguingly, that ... if you diverge markedly from society’s average level of trust, you are likely to lose out, either because you are so distrustful of others that you miss out on opportunities for investment and mutually beneficial exchange, or because you are so trusting that you leave yourself open to being cheated and abused. ...
                                        Maybe we should trust each other more – but not too much.

                                        Deviating from society's average level of trust is costly only of the average level of trust is correct. Prior to the financial crisis, the level of trust was too high and more distrust than average would have been helpful in avoiding losses. Also, because the level of trust was too high, restoring trust to the blind faith level it was at before the crisis would be unwise. There wasn't enough fear and mistrust in financial markets as the bubble was inflating, and more skepticism and doubt than is appropriate. We need to rebuild trust, but even with an optimal regulatory response, we shouldn't go back to the same level of trust in complex financial products, ratings agencies, etc. that we had before.

                                          Posted by on Friday, October 16, 2009 at 12:24 AM in Economics | Permalink  Comments (24) 


                                          Thursday, October 15, 2009

                                          links for 2009-10-15

                                            Posted by on Thursday, October 15, 2009 at 11:03 PM in Economics, Links | Permalink  Comments (3) 


                                            "The Chamber of Commerce Has It Backwards"

                                            Simon Johnson:

                                            The Chamber of Commerce Has It Backwards, by Simon Johnson: The US Chamber of Commerce is opposing the administration’s proposed Consumer Financial Protection Agency, on the grounds that it would hurt small business.  Their argument is that this agency will extend the dead hand of government into every small business.
                                            For the Chamber of Commerce, government is the enemy of small business and should always and everywhere be fought to a standstill.  Chamber Senior Vice President (and former Fred Thompson campaign manager) Tom Collamore sees this as “advocacy on behalf of small businesses, job creators, and entrepreneurs”...
                                            Somewhere, the Chamber’s senior leadership missed the plot.  What brought on the greatest financial crisis since the 1930s?  What has hurt, directly and indirectly, small business of all kinds to an unprecedented degree over the past 12 months?  What is killing small and medium-sized banks at a rate not seen in nearly 80 years?
                                            It’s the behavior of the financial sector, particularly big banks and their close allies – by consistently mistreating consumers.  And the letter and spirit of the regulatory regime let them get away with it. ...
                                            The state of knowledge regarding how to persuade people to buy stuff is impressive, the degree of potential manipulation for consumer preferences is simply stunning, and the “innovations” in this area are not slowing down.
                                            The scope for taking advantage of consumers in subtle ways, or outright duping them, is probably higher for finance than for any other sector.  For fairly obvious reasons, people are more likely to misunderstand credit than, say, furniture. ...
                                            Unscrupulous Finance has brought us down and will do it again.  Those most damaged now and in the future include small and medium-sized business owners who are trying to treat customers fairly.
                                            The Chamber of Commerce ... small business membership should wake up to the current reality and press the Chamber hard to change its position before it is too late. ...  The Chamber of Commerce is arguing that unfettered finance is good for small business.  They are wrong.

                                            Another case of mixing up the difference between "free markets" and markets that behave optimally:

                                            Markets are Not Magic, by Mark Thoma: To listen to some commentators is to believe that markets are the solution to all of our problems. Health care not working? Bring in the private sector. Need to rebuild a war-torn country? Send in the private contractors. Emergency relief after earthquakes, hurricanes, and tornadoes? Wal-Mart with a contract is the answer.

                                            Whatever the problem, the private sector - markets and their magic - beats government every time. Or so we are told. But this is misplaced faith in markets. There is nothing special about markets per se - they can perform very badly in some circumstances. It is competitive markets that are magic, though even then we have to remember that markets have no concern whatsoever with equity, only efficiency, and sometimes equity can be an overriding concern.

                                            In order to work their magical efficiency, markets need very special conditions to be present. There must be full information available to all participants. Product quality, locations and prices of alternative suppliers, every relevant piece of information must be known. Not quite sure if the wine is good or not? That's an information problem. Not sure if the used car has problems? Don't know where any gas stations are except the ones beside the freeway in a strange town? No way to monitor the quality of the building built in Iraq with U.S. aid? No way to be sure if consultants are worth the amount they are being paid? Information problems are common and they can cause substantial departures from the perfectly competitive, ideal outcome.

                                            There also must be numerous buyers and sellers, enough so that no single buyer or seller's decisions can affect the market price. For example, if a firm can affect the market price by threatening to limit supply, the market does not satisfy this condition. If, as some claim, CEOs are in such short supply that they can individually negotiate their compensation, then the market is not producing an efficient outcome. Whenever there are a small number of participants on either side of the market - suppliers or demanders - this is potentially problematic.

                                            In order for markets to work their magic, the product must be homogeneous. That is, the product or input to production sold by all firms in the market must be perfectly substitutable so that as far as the buyer is concerned, one is as good as the other. If some buyers favor one brand over another, if CEOs are perceived to have different and unique talents, if government favors one contractor over another due to political contributions, this condition does not hold. In many cases the variety may be worth the inefficiency, not many of us would want just one style and color of shirt to be available in stores, but the inefficiency is there nonetheless.

                                            In order for markets to work their magic there must be free entry and exit. Most people understand free entry, but free exit is sometimes less evident, so let me try to give an example. Starting a blog on Blogger or TypePad is easy. Entry is a snap and you can be up and running in no time at all. It's easy to join the competition and start supplying posts. But suppose that later you decide you want to switch to, say, TypePad from Blogger (or the other way around). That is not so easy. There is no way, at least no simple and convenient way, to export all of your old posts from Blogger and import them into TypePad, a significant barrier to exit if a large number of posts must be moved. Whenever barriers exist in markets that prevent free movement into and out of the marketplace or between firms within a market (on either side - there are sometimes barriers to purchasing as well), markets will underperform.

                                            The list goes on and on. In order for markets to work their magic, there can be no externalities, no public goods, no false market signals, no moral hazard, no principle agent problems, and, importantly, property rights must be well-defined (and I probably missed a few). In general, the incentives that the market provides must be consistent with perfect competition, or nearly so in practical applications. When the incentives present in the marketplace are inconsistent with a competitive outcome, there is no reason to expect the private sector to be efficient.

                                            Markets don't work just because we get out of the way. When government contracts are moved to the private sector without ensuring the proper incentives are in place, there will be problems - waste, inefficiency, higher prices than needed, etc. There is nothing special about markets that guarantees that managers or owners of companies will have an incentive to use public funds in a way that maximizes the public rather than their own personal interests. It is only when market incentives direct choices to coincide with the public interest that the two sets of interests are aligned.

                                            If there is no competition, or insufficient competition in the provision of government services by private sector firms, there is no reason to expect the market to deliver an efficient outcome, an outcome free of waste and inefficiency. Why would we think that giving a private sector firm a monopoly in the provision of a public service would yield an efficient outcome? If the projects are of sufficient scale, or require specialized knowledge so that only one or a few private sector firms are large enough or specialized enough to do the job, why would we expect an ideal outcome just because the private sector is involved? If cronyism limits the participants in the marketplace, why would we expect an outcome that maximizes the public interest?

                                            There is nothing inherent in markets that guarantees a desirable outcome. A market can be a monopoly, a market can be perfectly competitive, a market can be lots of things. Markets with bad incentives produce bad outcomes, markets with good incentives do better.

                                            I believe in markets as much as anyone. But the expression free markets is often misinterpreted to mean that unregulated markets are all that is required for markets to work their wonders and achieve efficient outcomes. But unregulated is not enough, there are many, many other conditions that must be present. Deregulation or privatization may even move the outcome further from the ideal competitive benchmark rather than closer to it, it depends upon the characteristics of the market in question.

                                            For government goods and services, when incentives consistent with a competitive outcome are present, we should get government out of the way and privatize, and there are lots of circumstances where this will be appropriate. There is no reason at all for the government to produce its own pencils and pens, buying them from the private sector is more efficient so long as the bids are competitive.

                                            When competitive conditions are not met but can be regulated, the regulations should be put in place and the private sector left to do its thing (e.g.  mandating that sellers disclose problems with a house to prevent asymmetric information or mandating that government funded projects be subject to competitive bidding and monitoring to ensure contract terms are met). There's no reason for government to do anything except ensure that the incentives to motivate competitive behavior are in place and enforced.

                                            But rampant privatization based upon some misguided notion that markets are always best, privatization that does not proceed by first ensuring that market incentives are consistent with the public interest, doesn't do us any good. There are lots of free market advocates out there and I am with them so long as we understand that free does not mean the absence of government intervention, regulation, or oversight, even libertarians agree that governments must intervene to ensure basics like private property rights. Free means that the conditions for perfect competition are approximated as much as possible and sometimes that means the presence - rather than the absence - of government is required.

                                            [Update: I should have added that perhaps the Chamber fully understands the difference between free markets and competitive markets, and simply wants to preserve the "freedom" to take advantage of customers.]

                                              Posted by on Thursday, October 15, 2009 at 12:40 PM in Economics, Financial System, Regulation | Permalink  Comments (73) 


                                              "Finding a Job Right Now is Extremely Difficult"

                                              The ratio of the number of unemployed to the number of job openings suggests that the current weakness in labor markets is likely to persist:

                                              A look at another job market number, Macroblog: ...At the end of August there were estimated to be fewer than 2.4 million job openings, equal to only 1.8 percent of the total filled and unfilled positions—a new record low. This is an especially significant issue given the large number of people who are looking for work. The ratio of the number of unemployed to the number of job openings was greater than 6 in August. In contrast, that ratio was under 1.5 in 2007 and previously peaked at 2.8 in mid-2003, suggesting that finding a job right now is extremely difficult...

                                              Unemp-to-openings

                                              The quit rate moved back down to its record low of 1.3 percent, as relatively few people want to leave a job voluntarily in the face of such a weak labor market. At the same time, the rate of involuntary separations moved up from 1.6 percent to 1.8 percent, not far below the peak of 1.9 percent in April.

                                              The low probability of finding a job has also caused the average amount of time spent unemployed to rise substantially. ...

                                              Labor markets need more help.

                                                Posted by on Thursday, October 15, 2009 at 12:51 AM in Economics, Unemployment | Permalink  Comments (54) 


                                                Can Better Logistics Ease Harsh Labor Market Conditions in Developing Countires?

                                                This argues that better workflow logistics can be an effective means of alleviating harsh working conditions:

                                                Saving labor, by Peter Dizikes, MIT News Office: The existence of harsh labor conditions in factories around the world is a pressing moral issue. But to improve those conditions, we should regard it as a logistical issue, too.
                                                Consider the case of ABC, a giant clothing manufacturer whose products are made in more than 30 countries, and the subject of a new study led by Richard Locke ... of the MIT Sloan School of Management. After being accused of poor labor practices in the early 1990s, Locke notes, ABC became a leader among corporations in addressing labor conditions. The firm adopted a code of conduct for all factories providing it with goods, including those owned and run by local suppliers. ABC developed a system to monitor labor conditions, and hired a large compliance staff to enforce its policies world-wide.
                                                And yet for all of its efforts, just 24 percent of the roughly 200 factories in ABC's global supply chain met its own labor standards in 2006, as Locke and some colleagues reveal in a recently published paper based on a study of the firm's own audit data and practices. Garment workers at plants supplying ABC in the Dominican Republic were exposed to noxious chemicals and forced to work in overheated conditions, according to Locke and his co-authors; as they detail it, other laborers, from Honduras to India, were asked to work overtime shifts in excess of ABC's own established limits.
                                                The traditional system of setting labor standards and attempting to enforce them, through periodic checks by corporate compliance officers, has not worked well enough, Locke and his colleagues conclude. ... "My original view was that the compliance system could make conditions better, if it were just better-designed or better-funded," says Locke. "In the process of research, I realized that just checking on factories and threatening them doesn't work." In this view, multinational firms cannot just diagnose factory problems and expect them to vanish, but must take the lead in changing them. ...
                                                Basic policing of factories has "yet to deliver on its promise of sustained improvement in labor rights," the authors say, while by contrast, factory monitors who take a problem-solving approach, have created "sustained improvements in working conditions and labor rights" around the world.
                                                The authors were able to conduct the study because ABC (a pseudonym chosen to protect its identity) allowed them to study its data on labor conditions, and granted the researchers access to numerous factories where ABC's suppliers actually make its clothes.
                                                While evaluating the firm, Locke, Amengual, and Mangla saw with their own eyes evidence that a pragmatic, trouble-shooting mode of enforcement has rapid effects. To solve the problems of exposure to fumes overheating in the Dominican Republic, for instance, compliance officers suggested moving the relevant equipment to the edge of the building space. Ventilation improved and the problem diminished significantly.
                                                To help the factory in Honduras, ABC persuaded its management to re-orient its machinery and workers' schedules, to better handle the short-term "rapid replenishment" orders that had led to excess overtime. The improved logistics cost the factory little financially and let it comply with ABC's standards. The MIT researchers found a similar result at a factory supplying ABC in Bangalore, India, where better workflow logistics also eliminated an overtime problem.
                                                "We know from years of research that when you implement certain kinds of systems in the advanced industrial countries, you get better results," says Locke. But the managers of factories supplying ABC, he notes, often lack "real training or understanding of production techniques and high-performance systems."
                                                Labor-rights advocates applaud Locke's ideas. "People have looked to codes and auditing as a way to force accountability," says Chris Jochnick, director of Private Sector Development at Oxfam America. "But Rick was one of the first people to see that the way improvement happens is probably a lot more nuanced. His work is a valuable way of looking at the problem."
                                                As Locke notes, this logistics-based approach to factory violations is just one piece of a still larger problem; the demands global brands put on local factories must be addressed as well. And as he readily acknowledges, some practical solutions could be expensive for factories, making managers reluctant to implement them. In those cases, a hard-line approach may yet be useful. "Sometimes you do need a bit of a threat," he says. "It's that blend that seems to matter." ...
                                                Later this month, Locke will host a conference of executives both from non-governmental organizations and athletic-wear firms — including Nike, Adidas, New Balance, Puma and Asics — to discuss ways to use this problem-solving approach. ...

                                                Firms must have the desire to set a code of conduct that they are serious about enforcing (as opposed to using the code to gain positive publicity with no real intent of forcing firms to comply), and they must also have the means to enforce compliance. This focuses on the ability to enforce or induce compliance, but the incentive to establish the code and then make a serious attempt to change things when suppliers are in violation of the rules is another important aspect of the problem.

                                                In a competitive marketplace where buyers do not consider the labor market conditions of suppliers when purchasing a good, and where there are no regulations preventing firms from transacting with suppliers who are in violation of minimal standards (something that would be difficult to monitor), firms will have no incentive beyond their own moral values to enforce labor market standards.

                                                I'm sympathetic to the argument that low wage jobs in many developing countries provide opportunities that wouldn't exist otherwise, but there are bounds that shouldn't be crossed.

                                                  Posted by on Thursday, October 15, 2009 at 12:42 AM in Development, Economics, Regulation | Permalink  Comments (6) 


                                                  Wednesday, October 14, 2009

                                                  links for 2009-10-14

                                                    Posted by on Wednesday, October 14, 2009 at 11:05 PM in Economics, Links | Permalink  Comments (11) 


                                                    "Is Consumption the Grail for Inequality Skeptics?"

                                                    Lane Kenworthy responds to Will Wilkinson's Cato Unbound essay on inequality:

                                                    Is Consumption the Grail for Inequality Skeptics?, by Lane Kenworthy: ...Over [the 1979 to 2006 time] period the share of total income going to the top 1% of households jumped from 7% to 16%, while the share for the bottom three quintiles fell from 36% to 28%.[2] This is a substantial rise in income inequality. Very few social scientists deny its existence. The debate among them focuses on its characteristics, timing, magnitude, and causes.[3]
                                                    But there is far less consensus about whether, and if so to what extent, we should worry about this development. Inequality skeptics have offered a number of reasons for downplaying its significance: inequality is the product of free choices, what really matters is equality of opportunity, measures of income inequality ignore upward mobility, higher inequality boosts economic growth, focusing on a single country fetishizes national borders, and others.
                                                    Will Wilkinson emphasizes the distinction between income and consumption:
                                                    As far as I can tell, when most people are worried about economic inequality, they’re usually worried about inequalities in ... the real material conditions of life. . . An individual’s or household’s standard of living is determined rather more directly by the level of consumption than by the level of income. . . Different datasets and analytical methods produce somewhat different results, but most stories of consumption inequality are stories of stability or a relatively mild rise.
                                                    Wilkinson makes other arguments in his piece, and additional ones in his earlier Cato essay. But I want to focus on this point. I don’t find it compelling.

                                                    Continue reading ""Is Consumption the Grail for Inequality Skeptics?"" »

                                                      Posted by on Wednesday, October 14, 2009 at 02:54 PM in Economics, Income Distribution | Permalink  Comments (93) 


                                                      "How the Servant Became a Predator: Finance’s Five Fatal Flaws"

                                                      I am not as negative about banking and financial intermediation as William Black, I think intermediaries perform essential functions that, for example, pools risk across individuals, pools deposits over time (i.e. allows long-term loans with short-term deposits), pools small deposits to allow large loans, they help to overcome adverse selection and moral hazard problems by providing monitoring of loans and expertise on the ability of buyers to repay loans that individuals do not have. By providing pooling functions, solving asymmetric information problems, and so on, financial intermediaries allow productive activity to take place that wouldn't occur otherwise, and we are better off because of it.

                                                      So, for instance, on point one below that "The financial sector harms the real economy," I would state it differently. I would say that the net effect of the financial sector is unambiguously positive, without it there would be far fewer loans and a corresponding reduction in output and employment, but some parts of it have detracted from the overall good (significantly recently), and those parts do need to be fixed. But I cannot sign on to a general statement that the financial sector is harmful. Even given the large problems it has caused recently and in the past, we would not be better off if it didn't exist at all. I think this is implicit in the points made below, e.g. there is a call to return to the simple banking of the past, but we differ on the value of developments since that time. I don't see all complex financial products as bad or harmful, some provide essential functions. The trick is to weed out the bad parts, the bad incentives, etc., but save the good, and there are a lot of good parts to the system. I have been one of the stronger proponents of regulating the financial system and reining in the excesses, but it is possible to go too far:

                                                      How the Servant Became a Predator: Finance’s Five Fatal Flaws, by Bill Black: What exactly is the function of the financial sector in our society? Simply this: Its sole function is supplying capital efficiently to aid the real economy. The financial sector is a tool to help those that make real tools, not an end in itself. But five fatal flaws in the financial sector’s current structure have created a monster that drains the real economy, promotes fraud and corruption, threatens democracy, and causes recurrent, intensifying crises.
                                                      1. The financial sector harms the real economy.
                                                      Even when not in crisis, the financial sector harms the real economy. First, it is vastly too large. The finance sector is an intermediary — essentially a “middleman”. Like all middlemen, it should be as small as possible, while still being capable of accomplishing its mission. Otherwise it is inherently parasitical. Unfortunately, it is now vastly larger than necessary, dwarfing the real economy it is supposed to serve. Forty years ago, our real economy grew better with a financial sector that received one-twentieth as large a percentage of total profits (2%) than does the current financial sector (40%). The minimum measure of how much damage the bloated, grossly over-compensated finance sector causes to the real economy is this massive increase in the share of total national income wasted through the finance sector’s parasitism.
                                                      Second, the finance sector is worse than parasitic. In the title of his recent book, The Predator State, James Galbraith aptly names the problem. The financial sector functions as the sharp canines that the predator state uses to rend the nation. In addition to siphoning off capital for its own benefit, the finance sector misallocates the remaining capital in ways that harm the real economy in order to reward already-rich financial elites harming the nation. The facts are alarming:

                                                      Continue reading ""How the Servant Became a Predator: Finance’s Five Fatal Flaws"" »

                                                        Posted by on Wednesday, October 14, 2009 at 10:22 AM in Economics, Financial System, Regulation | Permalink  Comments (51) 


                                                        "Reviewing the Recession: Was Monetary Policy to Blame?"

                                                        David Altig says "it is yet far from clear that the financial crisis can be explained by a misstep in the setting of the federal funds rate" due to a failure to base monetary policy rules on models that include a well developed credit channel:

                                                        Reviewing the recession: Was monetary policy to blame?, by David Altig: In a recent speech given at the University of South Alabama, Federal Reserve Bank of Atlanta President Dennis Lockhart added his voice to what is now the general consensus: "I agree with all who are declaring that a technical recovery is under way."
                                                        There is still much work to be done, of course, not least the continuing examination of just what led to the recession and how a repeat performance can be avoided. One theme of this examination appeared in last week's Financial Times:
                                                        "It is certainly true that the most recent bubble, its bursting and the Fed's actions in the aftermath have inspired existing critics and recruited new ones. The first charge is that interest rates under Alan Greenspan, [current Fed Chairman Ben] Bernanke's predecessor, were kept too low for too long, contributing to a bubble of easy credit."
                                                        Here is an exercise that that I find intriguing. Suppose we try to estimate, as closely as we can, the actual interest rate decisions of the Federal Open Market Committee (FOMC) over the period spanning the beginning of Greenspan's tenure to the present. It turns out that by using an approach based not only on measures of inflation and actual output relative to potential but also on the lagged fed funds rate, you can actually get pretty darn close to statistically describing what the FOMC did:
                                                        I'm going to resist the temptation to call this approach a "Taylor rule." The estimating "rule" used here does in fact include realizations of inflation and a measure of the output gap (that is, a measure of how different gross domestic product is from its potential). These are the essential ingredients of the Taylor rule, but not the source of the close fit evident in the chart above. Over the period covered by the chart, you could have done a pretty good job mimicking the actual federal funds rate outcomes in any given month using knowledge of the previous month's rate. (If you are interested in the details of the estimating rule, you can find them here.)
                                                        The interpretation of the tendency for today's federal funds rate to generally follow yesterday's rate—sometimes referred to as interest rate smoothing—is controversial. Glenn Rudebusch (from the Federal Reserve Bank of San Francisco) explains:
                                                        "Many interpret estimated monetary policy rules as suggesting that central banks conduct very sluggish partial adjustment of short-term policy interest rates. In contrast, others argue that this appearance of policy inertia is an illusion and simply reflects the spurious omission of important persistent influences on the actual setting of policy."
                                                        Rudebusch is decidedly in the second camp, but for our purposes here the exact interpretation may not be that important. Though I am glossing over some not insignificant caveats—such as the difference between final data and the information the FOMC had to react to in real time—the chart above suggests that whatever the underlying structure of policy decisions, after the fact the FOMC appears to have behaved in an extraordinarily consistent way over the period extending from the late 1980s. This observation, in turn, suggests to me that there was nothing all that unusual about monetary policy in 2003 once you account for the state of the economy.
                                                        Which leads me to my main point on the chart above: If you are of the opinion that interest rate policy was good through the late 1980s and 1990s, then there seems to be a good case the FOMC was just sticking with "proven" success as it set interest rates through the dawning of the new millennium.
                                                        There is, of course, the possibility that the pattern of the funds rate depicted in the chart above was incomplete all along in the sense that whatever variables are explicit and implicit in the estimated rule, they did not include information to which the FOMC should have responded. In calmer times, the story would go, not including potentially pertinent information was not much of a problem. Eventually the missing-data chickens could come home to roost. The prime omitted variable suspect would, of course, be some sort of asset prices.
                                                        Scratch any gathering of macroeconomists these days and out will bleed a steady stream directed at incorporating credit and financial market activity into thinking about the aggregate economy. The necessity of proceeding with that work was emphasized by no less an authority than Don Kohn, vice chairman of the Federal Reserve Board of Governors, speaking at just such a gathering of macroeconomists last week:
                                                        "It is fair to say, however, that the core macroeconomic modeling framework used at the Federal Reserve and other central banks around the world has included, at best, only a limited role for the balance sheets of households and firms, credit provision, and financial intermediation. The features suggested by the literature on the role of credit in the transmission of policy have not yet become prominent ingredients in models used at central banks or in much academic research."
                                                        I will admit that economists were not exactly ahead of the curve with this agenda, but prior to 2007 it was not at all clear that detailed descriptions of how funds moved from lenders to borrowers or how short-term interest rates are transmitted to longer-term interest rates and capital accumulation decisions were crucial to getting monetary policy right. Models without such detail tended to deliver policy decisions not far from the sort depicted above, and, as I noted, they seemed to be working quite well in terms of macroeconomic outcomes.
                                                        Thus far, one of the lessons from models in which financial intermediation is taken seriously is that interest rate spreads or stock prices or other asset prices do become part of the policy rate recipe. Your response might well be something along the lines of "duh." You are entitled to that opinion, and I won't push back too hard. But it is yet far from clear that the financial crisis can be explained by a misstep in the setting of the federal funds rate caused by the failure to make whatever adjustments might have been indicated by the inclusion of pertinent financial variables in implicit rate-setting rules of thumb. Furthermore, early versions of research I have seen that combines capital regulation policy and interest rate policy suggest that the macroeconomic consequences of getting the former wrong may be much greater than the consequences of getting the latter wrong. To me, that conclusion has the ring of truth.

                                                        I have advocated targeting a price index that includes asset prices as part of the policy rule, but I share the view that this likely would not have been enough by itself to stop the crisis from occurring. Targeting a broader price index might have tempered the downturn some, or even quite a bit -- it sounds like I am more optimistic than David along about how well this might work -- but changes in regulation must be an essential component of reform if we are going to prevent problems from reoccurring in the future.

                                                        However, I think that not having models with detailed descriptions of the credit transmission mechanism was costly. The New Keynesian model that is used to inform monetary policy decisions relies upon wage and price rigidities to explain how changes in monetary policy and/or financial market conditions are transmitted to the broader economy. Thus, the price/wage rigidity transmission channels must serve as a proxy for the effects that work through credit (or other) channels, and it is not evident to me that they are adequate proxies for this task (e.g. what would a government spending multiplier look like within a model that had a richer set of connections between financial markets and the real economy?). Whether or not having such models would have prevented the crisis is an open question, and I won't push back too hard against David's view of this, but not having such models once this crisis hit did, I think, make it more difficult for us to evaluate the appropriate policy response. Not having the models we needed led to uncertainty from policymakers that showed up in the seemingly, if not actual ad hoc and trial and error nature of many of the policy responses.

                                                          Posted by on Wednesday, October 14, 2009 at 12:36 AM in Economics, Financial System, Monetary Policy | Permalink  Comments (86) 


                                                          "Transaction Cost Economics"

                                                          Why do firms exist? Why is it sometimes beneficial to, say, produce a part needed in the production process yourself, and why is it better to contract with an outside firm at other times? Where are the boundaries between what will be performed internally, and what will be performed externally? How should firms be organized? Robert Salomon explains the contributions of Oliver Williamson to the field of Transaction Cost Economics, and he reacts to some of the reactions to the announcement of the award:

                                                          Oliver Williamson, Nobel Honoree, by Robert Salomon: I was delighted to hear that Oliver Williamson was awarded the Nobel Prize in Economics (shared with Elinor Ostrom). Oliver Williamson is recognized for his contribution to the field of Transaction Cost Economics, building on the path-breaking work of scholars like Ronald Coase.
                                                          Transaction Cost Economics is a central theory in the field of Strategy. It addresses questions about why firms exist in the first place (i.e., to minimize transaction costs), how firms define their boundaries, and how they ought to govern operations.
                                                          In Transaction Cost Economics, the starting point is the individual transaction (the synapse between the buyer and the seller). The question then becomes: Why are some transactions performed within firms rather than in the market, as the neoclassical view prescribes.
                                                          The answer, not surprisingly, is because markets break down.
                                                          As a consequence of human cognitive limitations, coupled with the costs associated with transacting, the basic assumptions associated with efficient markets (e.g., anonymous actors, atomistic actors, rational actors, perfect information, homogeneous goods, the absence of liquidity constraints) fail to hold. For these reasons it is often more advantageous to structure transactions within firms. And this is why firms are not just ubiquitous in our society, but also worthy of study in their own right. This contrasts with the typical view of firms in neoclassical economic theory as, at worst, a market aberration that ought not exist, and at best, a black box production function.
                                                          Williamson’s contributions to the field of Transaction Cost Economics complement, and extend, those of Coase. First, Williamson started with an explicitly behavioral assumption of human behavior (bounded rationality). Second, he recognized that transacting parties sometimes behave opportunistically and take advantage of their counterparties. Finally, he identified features of transactions (e.g., specificity, uncertainty, frequency) that cause markets to fail; and hence, are likely to lead certain transactions to be organized within firms (hierarchies) rather than markets.
                                                          I was pleased to see Oliver Williamson recognized not just because of my inherent intellectual bias — my research has drawn on, and contributed to, the field of Transaction Cost Economics and I have worked with students of Williamson (see my research page for details) — but also because of what his selection implies for the broader field of economics. It implies that the field is moving in the direction of greater inclusion of economic perspectives that are based more on behavioral theories (see Krugman on the Future of Economics).
                                                          It was also fun to watch establishment economists make sense of the selection (see the Economists View post for some perspective). For example, Steven Leavitt writes:
                                                          When I was a graduate student at MIT back in the early 1990’s, there was a Nobel Prize betting pool every year. Three years in a row, Oliver Williamson was my choice. At the time, his research was viewed as a hip, iconoclastic contribution to economics — something that was talked about by economists, but that students were not actually trying to emulate (and probably would have been actively discouraged from had they tried to do so). What’s interesting is that in the ensuing 15 years, it seems to me that economists have talked less and less about Williamson’s research, at least in the circles in which I run.
                                                          My comment: I think Leavitt underestimates the impact of Williamson’s work because he is neither a Strategy scholar, nor is he in a Strategy or Management department. Go to any Strategy or Management department and you will find oodles of researchers (and doctoral students) working on Transaction Cost problems. It is a dominant paradigm.
                                                          Paul Krugman (in his post An Institutional Economics Prize) writes:
                                                          The way to think about this prize is that it’s an award for institutional economics, or maybe more specifically New Institutional Economics.
                                                          Neoclassical economics basically assumes that the units of economic decision-making are a given, and focuses on how they interact in markets. It’s not much good at explaining the creation of these units — at explaining, in particular, why some activities are carried out by large corporations, while others aren’t. That’s obviously an interesting question, and in many cases an important one.
                                                          …Oliver Williamson’s work underlies a tremendous amount of modern economic thinking; I know it because of the attempts to model multinational corporations, almost all of which rely to some degree on his ideas.
                                                          My comment: Krugman gets it partially right, but he does a lot of handwaving with respect to Williamson’s specific contributions. But with all due respect, he certainly makes no claim to be a Strategy scholar. He is right in the sense that the award speaks volumes about New Institutional Economics, broadly defined. However, in the case of Williamson, the specific contribution is to the field of Transaction Cost Economics. Moreover, the contributions of Williamson’s work extend far beyond the field of international business (or international strategy), but I agree that Transaction Cost Economics has been influential in those fields as well.
                                                          Nevertheless, my congratulations to Oliver Williamson, and to his students (many of whom I know well), who have long carried the torch for this important, yet underappreciated, branch of economics.

                                                            Posted by on Wednesday, October 14, 2009 at 12:27 AM in Economics, Market Failure | Permalink  Comments (9) 


                                                            Tuesday, October 13, 2009

                                                            links for 2009-10-13

                                                              Posted by on Tuesday, October 13, 2009 at 11:03 PM in Economics, Links | Permalink  Comments (8) 


                                                              "Supply-Side Economics, R.I.P."?

                                                              Bruce Bartlett says supply-side economics should "should declare victory and then go out of existence.":

                                                              Supply-Side Economics, R.I.P., by Today is the official publication date of my latest book, The New American Economy. In this post I'd like to explain a little bit about why I wrote it and how I arrived at my present state of mind, which seems to be confusing to many of my friends.
                                                              The book grew out of an op-ed I had in the New York Times back in 2007. In it I argued that supply-side economics (SSE) should declare victory and then go out of existence. Everything that was true about it had by then been fully incorporated into mainstream economic thinking and all that was left was a caricature. Continuing to maintain a separate identity for SSE only created unnecessary conflict with mainstream economists, I argued.
                                                              As a member of Jack Kemp's congressional staff back in the late 1970s, I had a front-row seat to the creation of SSE. ... I was the person on Kemp's staff whose job it was to actually draft and promote the Kemp-Roth tax bill, which was adopted by Ronald Reagan during the 1980 campaign and enacted into law in August 1981. It brought the top marginal income tax rate down from 70 percent to 50 percent, among other things. ...
                                                              I continue to believe that what the supply-siders did was good for the economy, good for the country and good for the advancement of economic science. The best economists in the country were pretty clueless about our economic problems during the Carter years. It was widely asserted that the money supply had no meaningful effect on inflation, that marginal tax rates had no incentive effects, and that it would take decades or another Great Depression to break the back of inflation.
                                                              As all economists now know, these ideas were wrong. All economists today accept the importance of the money supply--perhaps too much; during the recent crisis many asserted that fiscal stimulus was unnecessary because an increase in the money supply was the only thing necessary to restore growth. (How this would have been accomplished when interest rates were close to zero was never explained.) All economists now accept the importance of marginal tax rates to economic decisionmaking...
                                                              During the George W. Bush years, however, I think SSE became distorted into something that is, frankly, nuts--the ideas that there is no economic problem that cannot be cured with more and bigger tax cuts, that all tax cuts are equally beneficial, and that all tax cuts raise revenue.
                                                              These incorrect ideas led to the enactment of many tax cuts that had no meaningful effect on economic performance. Many were just give-aways to favored Republican constituencies, little different, substantively, from government spending. What, after all, is the difference between a direct spending program and a refundable tax credit? Nothing, really, except that Republicans oppose the first because it represents Big Government while they support the latter because it is a "tax cut." I think these sorts of semantic differences cloud economic decisionmaking rather than contributing to it. As a consequence, we now have a tax code riddled with ... schemes of dubious merit...
                                                              The supply-siders are to a large extent responsible for this mess, myself included. We opened Pandora's Box when we got the Republican Party to abandon the balanced budget as its signature economic policy and adopt tax cuts as its raison d'être. In particular, the idea that tax cuts will "starve the beast" and automatically shrink the size of government is extremely pernicious.
                                                              Indeed, by destroying the balanced budget constraint, starve-the-beast theory actually opened the flood gates of spending. ...[I]f, as Republicans now maintain, taxes must never be increased at any time for any reason then there is never any political cost to raising spending and cutting taxes at the same time, as the Bush 43 administration and a Republican Congress did year after year.
                                                              My book is an effort to close Pandora's Box and explain to people why I believe that SSE should go out of business--or declare victory and go home, if that makes the idea easier to accept. To the extent that it has any valid insights left to inform policymaking they should be used to design a tax system capable of raising considerably more revenue at the least possible economic cost. Going forward, I believe that financing an aging society and a permanent welfare state is the biggest economic problem we face. ...
                                                              As I thought about the cycle that SSE had gone through from a response to the failure of Keynesian economics in the 1970s to triumph in the 1980s to caricature in the 2000s, it occurred to me that SSE and Keynesian economics had a lot in common. Each had been developed in response to serious economic problems that the existing orthodoxy was incapable of dealing with, both struggled for acceptance but were ultimately implemented to great success, both were then misapplied in inappropriate circumstances, thus leading to them becoming discredited.
                                                              So basically the book is about the rise and fall of Keynesian economics followed by the rise and fall of SSE. Although the Keynesian part of the book was originally intended to flesh out my model of the rise and fall of economic theories, it turned out to have very valuable lessons for today. Indeed, the circle appears to have come around to where Keynesian theories are now the best ones we have for dealing with today's economic crisis. ...
                                                              The General Theory, I think, was really just Keynes' way of making some relatively simple ideas look scientific in order to make them more acceptable to policymakers. The first idea is that deflation was the central economic problem. Second is that it was impractical to cut money wages to reduce unemployment and restore equilibrium. And third is that monetary policy was impotent because the economy was in a liquidity trap. ...
                                                              Economist Irving Fisher added an additional component ... by showing that the zero-bound problem is a very serious impediment to monetary policy... Fisher also explained that deflation magnified the real value of debt, which became a crushing burden on both households and businesses that reduced spending and growth.
                                                              What both Keynes and Fisher said was that when the economy is in a deflationary depression the collapse of private spending had to be compensated for by public spending, because that was the only way to get money circulating and make monetary policy effective. While monetary policy would drive the recovery it needed fiscal policy in order to work.
                                                              When the economic crisis hit in the fall of last year, I was very grateful for having studied the Great Depression and absorbed the work of great thinkers like Keynes and Fisher because, as Yogi Berra might have said, it was déjà vu all over again.
                                                              It seemed obvious to me right from the beginning that there was a close parallel between the causes of the Great Depression and the current crisis. The principal difference is that the former was caused by a collapse of the money supply resulting from the closure of many banks and the disappearance of their deposits, while the latter was caused by a fall in velocity resulting from a sharp decline in consumer spending following bursting of the housing bubble. (Because GDP equals the money supply times velocity, a decline in velocity has exactly the same effect as a decline in the money supply--nominal GDP must shrink, which causes both prices and output to fall.) ...
                                                              [M]y ... analysis led me to support a large fiscal stimulus. Without public spending on goods and services I didn't see any way for monetary policy to be effective... I was disappointed that so little of the February stimulus package went to the purchase of goods and services, which drives spending, and so much into economically ineffective transfers, which don't. But I understood that time was of the essence and that taking the time to design a better package would have required even more effort to overcome the economy's inertia, not to mention the political obstacles.
                                                              In researching my book I saw many points early in the Great Depression when a little bit of the right monetary and fiscal stimulus might have turned things around and made it just a run-of-the-mill recession. But as effective action was delayed year after year, more and more effort was needed to get the economy off a dead stop. It was only when all constraints on spending and money growth were cast aside during World War II that the Great Depression really ended.
                                                              I believe that relatively modest action early last year could have forestalled the current crisis or at least mitigated it substantially. I think the tax rebate was wrongheaded and a complete waste of money, and that the money would have been better spent cleaning up the housing mess. ...[B]ut the Bush administration's obsession with tax cuts as the sole cure for every economic problem--even when they involved nothing more than mailing out government checks--blinded it to alternative policies that might have nipped the housing problem in the bud and prevented the banking system from imploding.
                                                              By September, it was obvious to me that substantial government funds would be necessary to bail-out the financial system and prevent a systemic collapse that would have cost vastly more and imposed vastly greater economic hardship. I thought this argument was pretty straightforward and been well accepted by economists ever since the time of Walter Bagehot in the late 18th century. ...
                                                              I remain incredulous that serious economists not only opposed TARP, but also argued that tax cuts were the only fiscal stimulus the government should have engaged in--if it did anything at all. ... I really don't understand how tax cuts would have done the slightest bit of good when millions of people had no income because they were unemployed, when businesses had no profits to tax, and investors had huge capital losses that will offset all of their gains for years to come. Given such economic conditions--resulting from a lack of demand, not supply--it's nonsensical to think that tax cuts would have helped. Indeed, one can make a case that the tax cuts included in the stimulus bill were its least effective element.
                                                              Many of my friends believe I have abandoned supply side economics and become a Keynesian. ... But as I try to explain in my book, my views haven't changed at all; it's circumstances that have changed. I believe that my friends are still stuck in the 1970s when tax rates were considerably higher and excessive demand (i.e., inflation) was our biggest economic problem. Today, tax rates are much lower and a lack of demand (i.e., deflation) is the central problem. I really don't understand why conservatives insist on a one-size-fits-all economic policy consisting of more and bigger tax cuts no matter what the economic circumstances are; it's simply become dogma totally disconnected from reality.
                                                              Nor do I understand the conservative antipathy for Keynes, who was in fact deeply conservative. He developed his theories primarily for the purpose of saving capitalism from some form of socialism. Same goes for Franklin D. Roosevelt, whose biggest economic mistake, I believe, was not that he ran big budget deficits, as all conservatives believe, but that he didn't run deficits nearly large enough until the war forced his hand. ... People can judge for themselves if I prove my case. ...

                                                              I'm between classes so I don't have time to add much, but the op-ed linked above that Bartlett says motivated him to write the book sparked a long, detailed, and intense discussion here when it was first published among Bruce Bartlett, Paul Krugman, Brad DeLong, Jamie Galbraith, and Lawrence White among others (I weigh in too, but I would not write it the same way today). See:

                                                                Posted by on Tuesday, October 13, 2009 at 12:45 PM in Economics, Fiscal Policy, Macroeconomics, Taxes | Permalink  Comments (34) 


                                                                The Bank Lending Channel

                                                                Many economists, Ben Bernanke foremost among them, have argued that monetary policy has effects that are independent of the traditional interest rate channel (where an increase in the money supply lowers the real interest rate and induces more investment and consumption spending). The alternative models include a "credit channel" for monetary policy, which is often further divided into financial accelerator models and bank lending channel models.

                                                                One class of models within the bank lending channel branch relies upon a difference in the availability of credit for large and small firms. If smaller businesses have fewer sources of credit than large firms (who can issue bonds, stocks, commercial paper, etc.), then a credit shock induced by policy or some other factor will have an asymmetric negative effect on the activity of large and small firms. Since smaller firms have trouble getting credit from non-bank sources, a disruption in bank credit can cause them to contract their activities much more than large firms. (If all firms have perfect substitutes for bank credit, e.g. borrowing from foreigners on the same terms, then monetary policy cannot affect real output through the bank lending channel. The point of this research is that some firms do not have close substitutes for bank credit, and therefore monetary policy can have real effects.) According to this, there's some evidence that these effects are operable:

                                                                Credit Tightens for Small Businesses, NY Times: Many small and midsize American businesses are still struggling to secure bank loans, impeding their expansion plans and constraining overall economic growth...
                                                                Bankers worry about the extent of losses on credit card businesses as high unemployment sends cardholders into trouble. They are also reckoning with anticipated failures in commercial real estate. Until the scope of these losses is known, many lenders are inclined to hang on to their dollars rather than risk them on loans to businesses in a weak economy...
                                                                Bankers acknowledge that loans are harder to secure than in years past, but they say this attests to the weakness of many borrowers rather than a reluctance to lend.
                                                                “Banks want to lend money,” said Raymond P. Davis, chief executive of Umpqua Bank, a regional lender based in Portland, Ore. “The problem is the effect that the recession is still having on us. Some of these businesses are still trying to come out of it. For them to go to a bank, if they are showing weak performance, it is harder to borrow.”
                                                                As the financial crisis has largely eased in recent months, big companies have found credit increasingly abundant, with bond issues sharply higher.
                                                                But for ... many smaller companies,... borrowing remains tough. ...

                                                                Recall this graph posted here not too long ago (discussed further at the source):

                                                                Job.loss

                                                                It may be hard to see at first glance, but the graph shows the "disproportionate effect the recession has had on very small businesses." In 2001, only 9% of the job losses came from small businesses, while in the current recession - where credit problems are a much larger factor - small business accounts for 45% of lost jobs. Part of the discussion of the graph notes this comment from William Dudley, the president of the Federal Reserve Bank of New York:

                                                                In a speech yesterday,... he said:

                                                                "For small business borrowers, there are three problems. First, the fundamentals of their businesses have often deteriorated because of the length and severity of the recession—making many less creditworthy. Second, some sources of funding for small businesses—credit card borrowing and home equity loans—have dried up as banks have responded to rising credit losses in these areas by tightening credit standards. Third, small businesses have few alternative sources of funds. They are too small to borrow in the capital markets and the Small Business Administration programs are not large enough to accommodate more than a small fraction of the demand from this sector."

                                                                It will take more careful analysis to make the case that the bank lending channel has been important in this recession, but it is suggestive.

                                                                  Posted by on Tuesday, October 13, 2009 at 01:08 AM in Economics, Financial System, Monetary Policy | Permalink  Comments (32) 


                                                                  "Skyhooks versus Cranes: The Nobel Prize for Elinor Ostrom"

                                                                  Paul Romer wants to make sure that we understand the importance of Elinor Ostrom's "work on one of the deepest issues in economics":

                                                                  Skyhooks versus Cranes: The Nobel Prize for Elinor Ostrom. by Paul Romer: Most economists think that they are building cranes that suspend important theoretical structures from a base that is firmly grounded in first principles. In fact, they almost always invoke a skyhook, some unexplained result without which the entire structure collapses. Elinor Ostrom won the Nobel Prize in Economics because she works from the ground up, building a crane that can support the full range of economic behavior.
                                                                  When I started studying economics in graduate school, the standard operating procedure was to introduce both technology and rules as skyhooks. If we assumed a particular set of rules and technologies,... then we economists could describe what people would do. Sometimes we compared different sets of rules that a “social planner” might impose... Crucially, we never even bothered to check that people would actually follow the rules we imposed.
                                                                  A typical conclusion was that rules that assign property rights and rules that let people trade lead to good outcomes. What’s the skyhook? That people will follow the rules. Why would they respect the property rights of someone else? ... We might have had in mind something like this: police officers will arrest people who don’t follow the rules. But this is just another skyhook. Who are these police officers? Why do they follow rules? ... Elinor showed that there are lots of important cases where people follow rules about ownership without police officers. One of the central challenges in understanding failures of economic development is that in many places, police officers don’t follow the rules they are meant to enforce.
                                                                  Elinor’s fieldwork, followed up by her experimental work, pointed us in exactly the right direction. To understand BOTH why we don’t need police officers in some cases AND why police officers don’t follow the rules in other cases, we have to expand models of human preferences to include a contingent taste for punishing others. In reaching this conclusion, she ... spelled out the program that economists should follow. To make the rules ... emerge as an equilibrium outcome instead of a skyhook, economists must extend our models of preferences and gather field and experimental evidence on the nature of these preferences.
                                                                  Economists who have become addicted to skyhooks ... think that they are doing deep theory but are really just assuming their conclusions... If we fail to explore rules in greater depth, economists will have little to say about the most pressing issues facing humans today – how to improve the quality of bad rules that cause needless waste, harm, and suffering.

                                                                  Cheers to the Nobel committee for recognizing work on one of the deepest issues in economics. Bravo to the political scientist who showed that she was a better economist than the economic imperialists who can’t tell the difference between assuming and understanding.

                                                                  Regulators attempting, and failing to impose the correct rules and how that helped to cause the financial crisis comes to mind. Seems like more focus on work like this might have helped.

                                                                    Posted by on Tuesday, October 13, 2009 at 12:42 AM in Economics, Methodology | Permalink  Comments (36) 


                                                                    Monday, October 12, 2009

                                                                    links for 2009-10-12

                                                                      Posted by on Monday, October 12, 2009 at 11:07 PM in Economics, Links | Permalink  Comments (14) 


                                                                      Should Health Care be a Human Right?

                                                                      William Easterly says defining health care as a human right "has made global healthcare more unequal":

                                                                      Human rights are the wrong basis for healthcare, by William Easterly, Commentary, Financial Times: The agonizing US healthcare debate has taken on a new moral tone. President Barack Obama recently held a conference call with religious leaders in which he called healthcare “a core ethical and moral obligation”. Even Sarah Palin felt obliged to concede: “Each of us knows that we have an obligation to care for the old, the young and the sick.”
                                                                      This moral turn echoes an international debate about the “right to health”. Yet the global campaign to equalize access to healthcare has had a surprising result: it has made global healthcare more unequal.
                                                                      The notion of a “right to health” has its origins in the United Nations’ Universal Declaration of Human Rights in 1948. But in the decades that followed, foreign aid’s most successful efforts in health – such as the World Health Organization and Unicef campaigns on vaccines and antibiotics – were based on a more limited goal: obtaining the largest possible health benefits for the poor from finite foreign aid budgets.
                                                                      The moral argument made a big comeback in the new millennium. One of its most eloquent advocates is Dr Paul Farmer, who earned fame with heroic efforts to give people access even to complex medical treatment amid extreme poverty in Haiti and Rwanda, saying that healthcare was “a fundamental human right, which should be available free”. The WHO shifted from pragmatic improvement of health outcomes towards “the universal realization of the right to health”. Even Amnesty International ... added a new section to its human rights report in 2009 on the “right to health”.
                                                                      So what is the problem? It is impossible for everyone immediately to attain the “highest attainable standard” of health... So which “rights to health” are realized is a political battle. Political reality is that such a “right” is a trump card to get more resources – and it is rarely the poor who play it most effectively.
                                                                      The biggest victory of the “right to health” movement has been the provision of aid-financed antiretroviral treatment for African Aids patients, who include the upper and middle classes. ...
                                                                      Saving lives in this way is a great cause – except to the extent that it takes resources away from other diseases. Alas, many observers fear that is exactly what it did.
                                                                      An evaluation by the World Bank in 2009 faulted the bank for allowing Aids treatment to drive out many other programs. Global deaths due to either tuberculosis or malaria stood at 2m in 2008, around the same as those from Aids. Yet Aids accounted for 57 per cent of World Bank projects on communicable diseases from 1997 to 2006, compared with 3 per cent for malaria and 2 per cent for TB. Other big killers of the poor – such as pneumonia, measles and diarrheal diseases, which together accounted for more than 5m deaths in 2008 – received even less attention. ...
                                                                      The lesson is that, while we can never be certain, the “right to health” may have cost more lives than it saved. The pragmatic approach – directing public resources to where they have the most health benefits for a given cost – historically achieved far more than the moral approach.
                                                                      In the US and other rich countries, a “right to health” is a claim on funds that has no natural limit, since any of us could get healthier with more care. We should learn from the international experience that this “right” skews public resources towards the most politically effective advocates, who will seldom be the neediest.

                                                                      This is not my area, but I do wonder if the problem is the designation of the right, or something more systemic within these countries. That is, the implicit assumption is that with a different goal - a "pragmatic approach" of directing resources where they will have the most benefits - the poor would have fared better, but are we sure that's the case? Who decides what defines "the most benefits"? My guess is that the same people who diverted resources before would manage to do so again by defining the benefits appropriately, i.e. in a way that benefits the same groups of people as before. If so, then the problem is not the designation of a right to health care.

                                                                        Posted by on Monday, October 12, 2009 at 03:37 PM in Development, Economics, Health Care | Permalink  Comments (94) 


                                                                        "Will Stimulating Nominal Aggregate Demand Solve our Problems?"

                                                                        There has been a bit of a pushback, both implicit and explicit, to calls to implement policies to accelerate hiring. For example, Jim Hamilton recently noted an old theory of his where some types of unemployment cannot be overcome through standard stimulative policies (this was in response to a question about whether Arnold Kling's recalculation model can explain asymmetric adjustment, but I am focusing on the technological and physical constraints present in both Hamilton and Kling's model, not whether the asymmetries can be explained):

                                                                        Will stimulating nominal aggregate demand solve our problems?, by Jim Hamilton: ...[I]n 1988 ... I presented a model in which unemployment arises from a drop in the demand for the output of a particular sector. The unemployed workers could consider trying to retrain or relocate, or might instead decide to wait it out in hopes that the demand for their specialized skills will come back. ...[T]he key kind of unemployment that I think this sort of model describes-- waiting for an opening in the particular area in which you've specialized-- is caused by drops in demand...
                                                                        Insofar as the frictions in that model are of a physical, technological nature, increasing the money supply would simply cause inflation and not do anything to get people back to work. I should emphasize that I built that monetary neutrality into the model not because I think it is the best description of reality, but in order to illustrate more clearly that there is a type of cyclical unemployment that stimulating nominal aggregate nominal demand is useless for preventing.
                                                                        My personal view is that real-world unemployment arises from the interaction of sectoral imbalances with frictions in the wage and price structure of the sort documented by Truman Bewley and Alan Blinder. The key empirical test, in my opinion, is at what point inflationary pressures begin to pick up. If Krugman is correct, we could have much bigger monetary and fiscal stimulus without seeing any increase in inflation. If the sectoral imbalances story is correct, it would be possible for inflation to accelerate even while unemployment remains quite high. ...
                                                                        Thus, according to this view, some part of the sectoral imblances in of a "physical, technological nature," and standard demand side policy does not help. Policy may be able to induce people to stop sticking around for jobs that will never materialize and move on, but those typically aren't the kinds of policies typically associated with stimulating employment, e.g. tax credits to encourage hiring.

                                                                        A new colleague of mine, Nick Sly, emails that it is not always optimal, from a long-run economic growth point of view, to provide incentives for firms to hire workers, how those incentives are structured is crucial:

                                                                        There is a paper on my website called Intraindustry Trade and the Composition of Labor Market Turnover. (It is a heavily revised version with more of a trade focus.) The highlights of the paper are:
                                                                        1. Because of constant turnover in labor markets, hiring costs are persistent for all firms.
                                                                        2. Turnover and Hiring occur both because firms update their workforce (job creation costs) and to replace workers who leave for reasons unrelated to the firm (worker hiring costs). These phenomena are distinct 3. (KEY) I show (theoretically and confirm empirically) that each source of turnover has the opposite effect on the incentives of firms to adopt state-of-the-art production techniques. As a consequence industries with different compositions of labor mobility have varying degrees of engagement of foreign markets.

                                                                        The relevance:

                                                                        The act of hiring workers could be the result of demand side (firms creating new jobs) or supply side (workers need to be replaced) incentives. We may not want to jump to quickly to put people back to work if it means employing less productive production methods. The short term gains can be lost as poor matching of workers and adoption of weak production methods alter the recovery path.

                                                                        I believe that the timing of the hiring tax credits, and the sort of hiring it promotes (i.e. creating new vacancies versus filling previously existing positions), will determine the long-run consequences of such a policy.

                                                                        Let me try to express the main point a different way. When firms hire workers, as they are constantly doing, they have a choice between using old or new technology, and the way in which hiring incentives are structured can affect this choice. As we think about putting programs to induce firms to hire workers in place, we need to be sure that we are not giving firms the incentive to use old rather than new technology so that economic growth is maximized, and we also need to be sure that we don't distort the choice firms make toward labor intensive rather than growth maximizing change.

                                                                        Our economy faces lots of adjustments as it recovers from the recession, far more than in some past recessions when we could return, pretty much, to what we were doing before the shock hit. But not this time. We have adjustments in the auto, finance, and housing sectors just for openers, and there are other underlying adjustments that are in progress as well (e.g. in the manufacturing sector). As these adjustments occur, it's important that we don't impede the necessary change, or induce firms to make suboptimal choices as we attempt to induce them to hire more workers.

                                                                        But if we give firms the time they need to make the changes that are needed, there will be excess labor during these adjustment periods, both from sectoral reallocations and from technological change. The question is what we are going to do to help people who lose their jobs or are otherwise negatively affected by these transitions.

                                                                        One choice is to induce firms to house the excess labor during this time period through tax or other inducements, but the danger is that in doing so you distort the choices of firms away from the optimal trajectory. Another choice is for the public sector to absorb much of the burden by providing jobs to the unemployed and providing the aid needed to carry workers through the adjustment period (and we can also provide incentives for workers to relocate in areas where they have a better chance of finding employment).

                                                                        Even better, though, is to structure the incentives so that the technological change is encouraged by the hiring of new workers. For example, Nick Sly suggests that the hiring credit be only for "new" jobs offered by firms, somehow defined, because this gives firms an incentive to both hire new workers and to employ the latest technology. Thus, the best choice of all is to provide incentives to employ workers that have, as a byproduct, and inducement to maximize technology and economic growth, and then use public employment (e.g. infrastructure) or aid to help those who remain unemployed.

                                                                        No matter what we do, however, there will be those who cannot find employment during these time periods, and we need to do a better job than we do in helping those who, through no fault of their own, are caught up in the tumultuous change that sometimes occurs in modern economies.

                                                                          Posted by on Monday, October 12, 2009 at 02:59 PM in Economics, Productivity, Taxes, Technology, Unemployment | Permalink  Comments (72) 


                                                                          Oliver Williamson and Elinor Ostrom Awarded Nobel in Economics

                                                                          I would not have predicted this (links to other comments are given below):

                                                                          Two Americans Share Nobel in Economics, by Louis Uchitelle, NY Times: In a departure from prevailing economic theory, the Nobel Memorial Prize in Economic Science was awarded Monday to two social scientists for their work in demonstrating that business people, including competitors, often develop implicit relationships that supplement and resolve problems that arise from free-market competition.
                                                                          The prize committee cited Elinor Ostrom of Indiana University “for her analysis of economic governance, especially the commons,” and Oliver E. Williamson of the University of California, Berkeley, “for his analysis of economic governance, especially the boundaries of the firm.”
                                                                          Ms. Ostrom becomes the first woman to win the prize for economics. Her background is in political science, not economics.
                                                                          “It is part of the merging of the social sciences,” Robert Shiller, an economist at Yale, said of Monday’s awards. “Economics has been too isolated and these awards today are a sign of the greater enlightenment going around. We were too stuck on efficient markets and it was derailing our thinking.” ...

                                                                          Continue reading "Oliver Williamson and Elinor Ostrom Awarded Nobel in Economics" »

                                                                            Posted by on Monday, October 12, 2009 at 09:28 AM Permalink  Comments (23) 


                                                                            Paul Krugman: Misguided Monetary Mentalities

                                                                            We need to avoid thinking and acting in ways that got us into trouble in the past:

                                                                            Misguided Monetary Mentalities, by Paul Krugman, Commentary, NY Times: One lesson from the Great Depression is that you should never underestimate the destructive power of bad ideas. And some of the bad ideas that helped cause the Depression have, alas, proved all too durable: in modified form, they continue to influence economic debate today.
                                                                            What ideas am I talking about? The economic historian Peter Temin has argued that a key cause of the Depression was ... the “gold-standard mentality.” By this he means not just belief in the sacred importance of maintaining the gold value of one’s currency, but a set of associated attitudes: obsessive fear of inflation even in the face of deflation; opposition to easy credit, even when the economy desperately needs it, on the grounds that it would be somehow corrupting; assertions that even if the government can create jobs it shouldn’t, because this would only be an “artificial” recovery.
                                                                            In the early 1930s this mentality led governments to raise interest rates and slash spending, despite mass unemployment, in an attempt to defend their gold reserves. And even when countries went off gold, the prevailing mentality made them reluctant to cut rates and create jobs.
                                                                            But we’re past all that now. Or are we? ...[A] modern version of the gold standard mentality ... could undermine our chances for full recovery.
                                                                            Consider first the current uproar over the declining international value of the dollar. The truth is that the falling dollar is good news. For one thing, it’s mainly the result of rising confidence: the dollar rose ... as panicked investors sought safe haven in America, and it’s falling again now that the fear is subsiding. And a lower dollar is good for U.S. exporters...
                                                                            But if you get your opinions from, say, The Wall Street Journal’s editorial page, you’re told that the falling dollar is a ... sign that the world is losing faith in America (and especially, of course, in President Obama). ...
                                                                            And ... there are worrying signs of a misguided monetary mentality within the Federal Reserve system itself. In recent weeks there have been a number of ... Fed officials ... calling for an early return to tighter money... What’s ... extraordinary ... is the idea that raising rates would make sense any time soon. After all, the unemployment rate is a horrifying 9.8 percent and still rising, while inflation is running well below the Fed’s long-term target. This suggests that the Fed should be in no hurry to tighten — in fact, standard policy rules ... suggest that interest rates should be left on hold for the next two years or more, or until the unemployment rate has fallen to around 7 percent.
                                                                            Yet some Fed officials want to pull the trigger on rates much sooner. To avoid a “Great Inflation,” says Charles Plosser of the Philadelphia Fed, “we will need to act well before unemployment rates and other measures of resource utilization have returned to acceptable levels.” Jeffrey Lacker of the Richmond Fed says that rates may need to rise even if “the unemployment rate hasn’t started falling yet.”
                                                                            I don’t know what analysis lies behind these itchy trigger fingers. But it probably isn’t about analysis, anyway — it’s about mentality, the sense that central banks are supposed to act tough, not provide easy credit.
                                                                            And it’s crucial that we don’t let this mentality guide policy. We do seem to have avoided a second Great Depression. But giving in to a modern version of our grandfathers’ prejudices would be a very good way to ensure the next worst thing: a prolonged era of sluggish growth and very high unemployment.

                                                                              Posted by on Monday, October 12, 2009 at 12:33 AM in Economics, Inflation, Monetary Policy | Permalink  Comments (98) 


                                                                              Sunday, October 11, 2009

                                                                              "A Second Great Depression is Still Possible"

                                                                              Let's hope Thomas Palley, who says "a second Great Depression remains a real possibility," is wrong. My best guess is that he is (though I don't expect a quick recovery, particularly for labor). But I suppose I "should never underestimate the destructive power of bad ideas":

                                                                              A second Great Depression is still possible, by Thomas Palley, Commentary, Economists' Forum: Over the past year the global economy has experienced a massive contraction, the deepest since the Great Depression of the 1930s. But this spring, economists started talking of “green shoots” of recovery and that optimistic assessment quickly spread to Wall Street. More recently, on the anniversary of the Lehman Brothers crash, Ben Bernanke, Federal Reserve chairman, officially blessed this consensus by declaring the recession is “very likely over”.
                                                                              The future is fundamentally uncertain, which always makes prediction a rash enterprise. That said there is a good chance the new consensus is wrong. Instead, there are solid grounds for believing the US economy will experience a second dip followed by extended stagnation that will qualify as the second Great Depression. ...

                                                                              Continue reading ""A Second Great Depression is Still Possible"" »

                                                                                Posted by on Sunday, October 11, 2009 at 11:07 PM in Economics | Permalink  Comments (58) 


                                                                                links for 2009-10-11

                                                                                  Posted by on Sunday, October 11, 2009 at 11:05 PM in Economics, Links | Permalink  Comments (7) 


                                                                                  Labor Markets Need More Help

                                                                                  Brad DeLong:

                                                                                  Washington Post Crashed-and-Burned-and-Smoking Watch: ...[The Washington Posts's] Fred Hiatt this morning:

                                                                                  Re-Stimulating. Unemployment is bad. More fiscal debt might be worse: At 9.8 percent, the unemployment rate is higher than it has been since it hit 10.1 percent in June 1983. Since the recession began 21 months ago, the economy has shed nearly 7 million jobs. Whole industries -- cars, housing, finance -- have been devastated and may never recover fully. Nevertheless, White House economists reported in September that "employment is estimated to be between 600,000 and 1.1 million higher than it would otherwise have been" because of the Obama administration's stimulus plan and other government policies, especially the Fed's monetary expansion. While no one can prove or disprove that -- much less apportion credit between fiscal and monetary policy -- basic economics suggests that things might have been even worse if the government had done nothing...

                                                                                  It does not necessarily follow, however, that the economy needs more stimulus now. Government has managed to blunt the recession, but at a cost -- a higher national debt burden, which future Americans must pay off by working harder and saving more than they otherwise would have...

                                                                                  Ummm...

                                                                                  So far the stimulus spendout has been some $160 billion. The midpoint estimate by Christy Romer and company is that GDP is now 1% higher than it would have been otherwise. That higher level of production and employment than we would have seen otherwise is going to lead to the collection of an extra $80 billion in tax revenues. That means that the net effect of the $160 billion we have pushed out the door has been to raise the national debt by $80 billion. The Treasury can now borrow through its TIPS program for 20 years at an interest rate of 2% plus inflation. That means that taxes in the future have to be higher by $1.6 billion per year--by $5 per person per year.

                                                                                  Thus the stimulus package so far:

                                                                                  • Incur an extra forward-looking tax burden per person of 1.3 cents per day...
                                                                                  • Get an extra 800,000 people productively at work--and get all the stuff they make and do--this year...

                                                                                  That looks like a very good deal: buying an extra productive job for an American today at a cost of $2000 per year in higher taxes looking forward--particularly when you think that some of those extra jobs build up our productive capacity to make us richer in the future as well.

                                                                                  The stimulus arithmetic suggests we should be doing more of it. The benefit-cost ratio at current stimulus spending levels is very good...

                                                                                  But nobody on Fred Hiatt's staff realized this. For nobody on Fred Hiatt's staff thinks that doing any arithmetic is part of their job description. Indeed, nobody on Fred Hiatt's staff is capable of doing any arithmetic at all.

                                                                                  They blather on:

                                                                                  The real question is whether the benefits of pumping even more government fuel into America's engine outweigh the risks. We see several reasons to doubt it. The first is the sheer immensity of stimulus policies already in place.... A second reason for skepticism is the intellectual poverty of some policy proposals.... [B]orrowing new money to move demand from the future to the present -- whether it's demand for houses, cars, or workers -- is a dubious proposition.

                                                                                  Let's set ourselves a national goal: close down the Washington Post down by July 2012.

                                                                                  Shaving peaks (e.g. tempering a housing boom so it doesn't crash and burn) and filling troughs is demand shifting, and that's exactly what you want to do to stabilize the economy across business cycles. It's a bonus if the extra spending today gives you higher economic growth in the future, but that is not necessary for stabilization policy to be successful.

                                                                                  We are constrained in what we can do to stimulate the economy due to the artificial rule imposed by Republicans that any stimulus spending must increase economic growth in the future or it is not worth doing. That ties your hands in ways that makes it harder to implement anything but large scale public infrastructure projects (roads, bridges, etc.). Nothing wrong with those, they should be part of the mix, but those projects take time to put into place and may not be the best way to give an immediate boost to employment.

                                                                                  Under this definition of what type of stimulus is allowable, hiring someone to pick up trash in a public park is "wasteful" even though the community might place a high value on such activities, and it has an immediate impact on employment. I think Brad falls into the trap of being limited by this constraint in his calculations and discussions which emphasize future productivity. If you read between the lines he allows for other types of benefits ("some of those extra jobs build up our productive capacity to make us richer in the future as well"), but the discussion does seem to be framed within the "it must help with growth" terms that the right has set down (Republicans will, of course, accept growth enhancing tax cuts as an alternative).

                                                                                  We need to do something about the employment problem, and I don't understand why the left has allowed its hands to be tied be the GOP's framing of the stimulus issue. Of course it's a political non-starter if you don't fight back and present alternative arguments. There are benefits to stabilizing the economy by shifting demand from the good times to the bad times even if it doesn't affect future economic growth (one could even argue that slightly lower growth is an acceptable trade off for enhanced stability, but that too is a political non-starter). People need jobs, and we need to put the policies in place - whatever those are - that can provide them.

                                                                                  On the "burden to future generations" point, please see "Bogus Arguments about the Burden of the Debt".

                                                                                  Update: Dean Baker also weighs in and makes some of the arguments in the "Bogus Arguments" link above (where he is quoted), along with a few additional points:

                                                                                  More Bad Math/Bad Economics at the Post, by Dean Baker: Given the quality of the economics reporting, parents would be well-advised to prohibit their children from reading the Washington Post so that they don't get confused on basic arithmetic concepts. The Post doesn't want more stimulus and is willing to say anything to push its case.
                                                                                  The lead editorial tells readers that: "government has managed to blunt the recession, but at a cost -- a higher national debt burden, which future Americans must pay off by working harder and saving more than they otherwise would have." Actually, future Americans will own the debt that will be paid off. This is not a generational issue, it can be a distributional one.
                                                                                  There is a point that some of the debt is held by foreigners. This will be a burden on the country, but the issue here is the trade deficit, not the budget deficit. If we had no government debt, but foreigners bought up $4 trillion of private capital in the United States, it would pose the same burden on future generations as if foreigners bought up $4 trillion of government debt. Remarkably, the Post is not concerned about the trade deficit and the burden it poses on future generations and actually does not want the cause of the deficit -- the over-valued dollar-- to be fixed.
                                                                                  The Post also gives the bizarre argument that we should wait on further stimulus because "the government still hasn't run through half of the $787 billion in tax cuts and spending increases enacted this year." Of course, for those of us who passed our third grade arithmetic class this argument is just plain silly.
                                                                                  The stimulus is already being disbursed at its maximum rate and therefore having its full impact on the economy. The additional spending will provide no further boost.
                                                                                  To see this point, imagine my rich uncle promises to give me $2,400 over two years in installments of $100 a month. I may originally be slow to change my consumption, but after 3 or 4 months I will likely have fully adjusted my spending in accordance with this monthly gift of $100. Once I have reached the 8th month, I will almost certainly be at my maximum spending rate, even though two thirds of the gift is yet to come.
                                                                                  This is where we stand right now. We have spent close to 40 percent of the stimulus with more than 60 percent yet to come, however the rate of spending will not be increasing from this point forward. Therefore, it will provide no further net boost to the economy. People who write editorials for major newspapers should understand this fact.
                                                                                  It is worth noting that the Congressional Budget Office (CBO) projections showing a 10.2 percent unemployment rate for 2010 and a 9.1 percent rate for 2011 include the impact of the stimulus. Perhaps the Post's editors know something that CBO doesn't, in which case they should share this information with their readers.

                                                                                    Posted by on Sunday, October 11, 2009 at 10:01 AM in Economics, Fiscal Policy | Permalink  Comments (98) 


                                                                                    Saturday, October 10, 2009

                                                                                    links for 2009-10-10

                                                                                      Posted by on Saturday, October 10, 2009 at 11:04 PM in Economics, Links | Permalink  Comments (15) 


                                                                                      "Global Imbalances and the Financial Crisis: Products of Common Causes"

                                                                                      Maurice Obstfeld and Kenneth Rogoff attempt to sort out the role that global imbalances played in the financial crisis. This is the introduction to their paper:

                                                                                      Global Imbalances and the Financial Crisis: Products of Common Causes, by Maurice Obstfeld and Kenneth Rogoff, October 2009 (Conference Draft): In my view … it is impossible to understand this crisis without reference to the global imbalances in trade and capital flows that began in the latter half of the 1990s. --Ben S. Bernanke1
                                                                                      Introduction Until the outbreak of financial crisis in August 2007, the mid-2000s was a period of strong economic performance throughout the world. Economic growth was generally robust; inflation generally low; international trade and especially financial flows expanded; and the emerging and developing world experienced widespread progress and a notable absence of crises.
                                                                                      This apparently favorable equilibrium was underpinned, however, by three trends that appeared increasingly unsustainable as time went by. First, real estate values were rising at a high rate in many countries, including the world’s largest economy, the United States. Second, a number of countries were simultaneously running high and rising current account deficits, including the world’s largest economy, the United States. Third, leverage had built up to extraordinary levels in many sectors across the globe, notably among consumers in the United States and Europe and financial entities in many countries. Indeed, we ourselves began pointing to the potential risks of the “global imbalances” in a series of papers beginning in 2001.2 As we will argue, the global imbalances did not cause the leverage and housing bubbles, but they were a critically important codeterminant.
                                                                                      In addition to being the world’s largest economy, the United States had the world’s highest rate of private homeownership and the world’s deepest, most dynamic financial markets. And those markets, having been progressively deregulated since the 1970s, were confronted by a particularly fragmented and ineffective system of government prudential oversight. This mix of ingredients, as we now know, was deadly.
                                                                                      Controversy remains about the precise connection between global imbalances and the global financial meltdown. Some commentators argue that external imbalances had little or nothing to do with the crisis, which instead was the result of financial regulatory failures and policy errors, mainly on the part of the U.S. Others put forward various mechanisms through which global imbalances are claimed to have played a prime role in causing the financial collapse. Former U.S. Treasury Secretary Henry Paulson argued, for example, that the high savings of China, oil exporters, and other surplus countries depressed global real interest rates, leading investors to scramble for yield and underprice risk.3
                                                                                      We too believe that the global imbalances and the financial crisis are intimately connected, but we take a more nuanced stance on the nature of the connections. In our view, both of these phenomena have their origins primarily in economic policies followed in a number of countries in the 2000s (including the United States) and in distortions that influenced the transmission of these policies through financial markets. The United States’ ability to finance macroeconomic imbalances through easy foreign borrowing allowed it to postpone tough policy choices (something that was of course true in many other deficit countries as well). Not only was the U.S. able to borrow in dollars at nominal interest rates kept low by a loose monetary policy. Also, until around the autumn of 2008, exchange-rate and other asset-price movements kept U.S. net foreign liabilities growing at a rate far below the cumulative U.S. current account deficit. On the lending side, China’s ability to sterilize the immense reserve purchases it placed in U.S. markets allowed it to maintain an undervalued currency and postpone rebalancing its own economy. Had seemingly easy postponement options not been available, the subsequent crisis might well have been mitigated, if not contained.4
                                                                                      We certainly do not agree with the many commentators and scholars who argued that the global imbalances were an essentially benign phenomenon, a natural and inevitable corollary of backward financial development in emerging markets. These commentators, including Cooper (2007) and Dooley, Folkerts-Landau, and Garber (2005), as well as Caballero, Farhi, and Gourinchas (2008) and Mendoza, Quadrini, and Rios-Rull (2007), advanced frameworks in which the global imbalances were essentially a “win-win” phenomenon, with developing countries’ residents (including governments) enjoying safety and liquidity for their savings, while rich countries (especially the dollarissuing United States) benefited from easier borrowing terms. The fundamental flaw in these analyses, of course, was the assumption that advanced-country capital markets, especially those of the United States, were fundamentally perfect, and so able to take on ever-increasing leverage risklessly. In our 2001 paper we ourselves underscored this point, identifying the rapid evolution of financial markets as posing new, untested hazards that might be triggered by a rapid change in the underlying equilibrium.5
                                                                                      Bini Smaghi’s (2008) assessment thus seems exactly right to us:
                                                                                      [E]xternal imbalances are often a reflection, and even a prediction, of internal imbalances. [E]conomic policies … should not ignore external imbalances and just assume that they will sort themselves out.6
                                                                                      In this paper we describe our view of how the global imbalances of the 2000s both reflected and magnified the ultimate causal factors behind the recent financial crisis. At the end, we identify policy lessons learned. In effect, the global imbalances posed stress tests for weaknesses in the United States, British, and other advanced-country financial and political systems – tests that those countries did not pass. ...

                                                                                      See also: Why are we in a recession? The Financial Crisis is the Symptom not the Disease! [open link]. The paper argues that the huge increase in the labor supply available to developed countries is the primary force behind our current troubles. Here are parts of the introduction and conclusion:

                                                                                      The impact of globalization is a sharp increase in the developed world’s labor supply. Labor in developing countries – countries with vast pool of grossly underemployed people – can now compete with labor in the developed world without having to relocate in ways not possible earlier. ... [W]e argue that this huge and rapid increase in developed world’s labor supply, triggered by geo-political events and technological innovations, is the major underlying force that is affecting world events today.2 The inability of existing financial and legal institutions in the US and abroad to cope with the events set off by this force is the reason for the current great recession: The inability of emerging economies to absorb savings through domestic investment and consumption caused by inadequate national financial markets and difficulties in enforcing financial contracts through the legal system; the currency controls motivated by immediate national objectives; the inability of the US economy to adjust to the perverse incentives caused by huge moneys inflow leading to a break down of checks and balances at various financial institutions, set the stage for the great recession. The financial crisis was the first symptom. ...

                                                                                      10 The Way Forward The common wisdom is that cheap money and lax supervision of financial institutions led to this financial crisis, and solving that crisis will take us out of the recession. In our view, the financial crisis is just the symptom. The fundamental cause of the crisis is the huge labor supply shock the world has experienced, not the glut in liquidity in money supply.

                                                                                      Recovery will only occur when structural imbalances in global capital flows are corrected, in part through higher saving in developed nations and in part through greater capital flows into developing nations. ...

                                                                                      It may be tempting for those in power to close the door to outsourcing of manufacturing and other activities. While that may provide some immediate relief, it will accentuate other problems...

                                                                                      When millions of World War II soldiers returned home that increased the US labor force of about 60 million workers by almost 25% within a very short period of time. At that time the Department of labor, which certainly had no cause to accentuate the negative, predicted that 12 to 15 million workers would be unemployed.28 That did not happen! We managed that problem well leading to prosperity instead of doom, thanks in no small part to the GI Bill and other governmental fiscal intervention. We can manage this one as well. For that to happen, the first step is to recognize the problem for what it is. A solution may well require actions similar in scope to the GI Bill and require a national debate.

                                                                                      While there is plenty of blame to go around for mistakes, the macro forces triggered by the labor shock is like a tidal wave that needed to wash ashore no matter what. History might have taken an entirely different path with better risk management controls in place in the US but then again, financial innovation might just have found a different way of getting highly leveraged deals done off-shore or through creative accounting.29 The root cause of the excess liquidity in the global financial system must be addressed, otherwise we are just squeezing the proverbial balloon only to see it bulge out somewhere else. However, this does not negate the need for the development of improved risk management in the broadest sense in order to ensure financial stability and prosperity going forward.

                                                                                      China and India will continue to need to bring tens of millions of rural laborers into the productive workforce in the coming decades and the world economy must find a sustainable way of dealing with this influx. Clearly China’s export led growth strategy of the past cannot continue indefinitely and domestic consumption must be allowed to grow as a share of GDP. At the same time, Western economies must adjust to a new equilibrium in which commodities are scarcer and households will face stiffer competition for jobs.

                                                                                        Posted by on Saturday, October 10, 2009 at 02:25 AM in China, Economics, Financial System, International Finance | Permalink  Comments (39) 


                                                                                        Friday, October 09, 2009

                                                                                        links for 2009-10-09

                                                                                          Posted by on Friday, October 9, 2009 at 11:05 PM in Economics, Links | Permalink  Comments (47) 


                                                                                          "Optimism Amid Uncertainty"

                                                                                          Max Lichtenstein and Jessica Renier of the Dallas Fed give their view of the outlook for the national economy:

                                                                                          Optimism Amid Uncertainty, by Max Lichtenstein and Jessica Renier, FRB Dallas: As we enter the final quarter of 2009, a number of important indicators are beginning to show expansion, suggesting that the trough of the current contraction may have come in the second quarter of this year. However, not all incoming information has been positive. Some data suggest that any optimism should be tempered, that this fledgling recovery has a long way to go before the economy achieves stability, and that the key word moving forward is “uncertainty.”

                                                                                          Manufacturing Up, but Job Losses Give Reason for Pause
                                                                                          An example of recent growth is the Institute for Supply Management’s Purchasing Managers Index for Manufacturing. In August, this indicator crossed the critical threshold of 50 for the first time since January 2008. And it remained above 50 during September with a value of 52.6. This typically signals expansion in the manufacturing sector. The ISM’s nonmanufacturing indicator also rose into expansion territory for the first time in a year, to a value of 50.9 (Chart 1).

                                                                                          Chart 1 ISM manufacturing and nonmanufacturing indexes in expansion territory

                                                                                          Conversely, the job picture in September is no cause for excitement. During the month, the economy shed 263,000 jobs, and the unemployment rate rose to 9.8 percent (Chart 2). The story becomes somewhat more worrisome when looking at only private-sector jobs. As of September, the number of nongovernment jobs was just below that seen in June 1999, leaving the impression that 10 years of private sector progress has been lost through 21 months of labor market downturn.

                                                                                          Chart 2 Job losses still give reason for worry

                                                                                          There is some optimism to be found in the job market, however. Job losses in housing-related industries are now tapering off at about the same pace as in nonhousing-related activities, suggesting that the structural adjustment that this sector has been undergoing since roughly 2005 may be coming to an end.

                                                                                          Continue reading ""Optimism Amid Uncertainty"" »

                                                                                            Posted by on Friday, October 9, 2009 at 10:03 PM in Economics | Permalink  Comments (1) 


                                                                                            T Pain Obama Auto-Tune

                                                                                              Posted by on Friday, October 9, 2009 at 06:19 PM in Economics, Health Care, Video | Permalink  Comments (3) 


                                                                                              The "Big Brother Database"

                                                                                              We need to update our privacy rules for the digital age so that the "cyber warriors" know where the boundaries are, and we also need to ensure that the boundaries are respected:

                                                                                              Who's in Big Brother's Database?, by James Bamford, NYRB: On a remote edge of Utah's dry and arid high desert, where temperatures often zoom past 100 degrees, hard-hatted construction workers with top-secret clearances are preparing to build what may become America's equivalent of Jorge Luis Borges's "Library of Babel," a place where the collection of information is both infinite and at the same time monstrous, where the entire world's knowledge is stored, but not a single word is understood. At a million square feet, the mammoth $2 billion structure will be one-third larger than the US Capitol and will use the same amount of energy as every house in Salt Lake City combined.
                                                                                              Unlike Borges's "labyrinth of letters," this library expects few visitors. It's being built by the ultra-secret National Security Agency—which is primarily responsible for "signals intelligence," the collection and analysis of various forms of communication—to house trillions of phone calls, e-mail messages, and data trails: Web searches, parking receipts, bookstore visits, and other digital "pocket litter." Lacking adequate space and power at its city-sized Fort Meade, Maryland, headquarters, the NSA is also completing work on another data archive, this one in San Antonio, Texas, which will be nearly the size of the Alamodome. ...
                                                                                              Once vacuumed up and stored in these near-infinite "libraries," the data are then analyzed by powerful infoweapons, supercomputers running complex algorithmic programs, to determine who among us may be—or may one day become—a terrorist. In the NSA's world of automated surveillance on steroids, every bit has a history and every keystroke tells a story. ...[...continue reading...]...

                                                                                                Posted by on Friday, October 9, 2009 at 03:01 PM in Economics, Terrorism | Permalink  Comments (21) 


                                                                                                "Skewed Rewards for Bankers"

                                                                                                Joseph Stiglitz remembers another Nobel:

                                                                                                Skewed rewards for bankers, Joseph Stiglitz, Project Syndicate:  -- The recent death of Norman Borlaug provides an opportune moment to reflect on basic values and on our economic system. Borlaug received the Nobel Peace Prize for his work in bringing about the "green revolution," which saved hundreds of millions from hunger and changed the global economic landscape. ...

                                                                                                Continue reading ""Skewed Rewards for Bankers"" »

                                                                                                  Posted by on Friday, October 9, 2009 at 12:55 PM in Economics, Financial System, Market Failure | Permalink  Comments (9) 


                                                                                                  Obama's Nobel

                                                                                                  In case you want to talk about it:

                                                                                                  Obama Says He’s ‘Surprised and Humbled’ by Nobel Prize

                                                                                                  Here's the response from the White House:

                                                                                                  Remarks by the President on Winning the Nobel Peace Prize

                                                                                                    Posted by on Friday, October 9, 2009 at 09:14 AM in Economics, Politics | Permalink  Comments (91) 


                                                                                                    Paul Krugman: The Uneducated American

                                                                                                    The crisis in education is "about to get much worse":

                                                                                                    The Uneducated American, by Paul Krugman, Commentary, NY Times: If you had to explain America’s economic success with one word, that word would be “education.” In the 19th century, America led the way in universal basic education. Then, as other nations followed suit, the “high school revolution” of the early 20th century took us to a whole new level. And in the years after World War II, America established a commanding position in higher education.
                                                                                                    But that was then. The rise of American education was, overwhelmingly, the rise of public education — and for the past 30 years our political scene has been dominated by the view that any and all government spending is a waste of taxpayer dollars. Education, as one of the largest components of public spending, has inevitably suffered.
                                                                                                    Until now, the results of educational neglect have been gradual — a slow-motion erosion of America’s relative position. But things are about to get much worse, as the economic crisis — its effects exacerbated by the penny-wise, pound-foolish behavior that passes for “fiscal responsibility” in Washington — deals a severe blow to education across the board.
                                                                                                    About that erosion:... Most people, I suspect, still have ... an image of America as ... unique in the extent to which higher learning is offered to the population at large. That image used to correspond to reality. But these days ... we have a college graduation rate that’s slightly below the average across all advanced economies.
                                                                                                    Even without ... the current crisis, there would be every reason to expect us to fall further in these rankings, if only because we make it so hard for those with limited financial means to stay in school [compared to] their counterparts in, say, France. ... But the crisis has placed huge additional stress on our creaking educational system.
                                                                                                    According to the Bureau of Labor Statistics,... lost jobs ... in state and local education .... over the past five months [totalled] 143,000. That may not sound like much, but education ... should, and normally does, keep growing even during a recession. Markets may be troubled, but that’s no reason to stop teaching our children. Yet that’s exactly what we’re doing.
                                                                                                    There’s no mystery about what’s going on: education is mainly the responsibility of state and local governments, which are in dire fiscal straits. Adequate federal aid could have made a big difference. But ... back in February centrist senators insisted on stripping much of that aid from the ... stimulus bill.
                                                                                                    As a result, education is on the chopping block. And laid-off teachers are only part of the story. Even more important is the way that we’re shutting off opportunities.
                                                                                                    For example,... generations [of] talented students from less affluent families have used [California’s community] colleges as a stepping stone to the state’s public universities. But in the face of the state’s budget crisis those universities have been forced to slam the door on this year’s potential transfer students. One result, almost surely, will be lifetime damage to many students’ prospects — and a large, gratuitous waste of human potential.
                                                                                                    So what should be done?
                                                                                                    First of all, Congress needs to undo the sins of February, and approve another big round of aid to state governments. We don’t have to call it a stimulus, but it would be a very effective way to create or save thousands of jobs. And it would, at the same time, be an investment in our future.
                                                                                                    Beyond that, we need to wake up and realize that one of the keys to our nation’s historic success is now a wasting asset. Education made America great; neglect of education can reverse the process.

                                                                                                      Posted by on Friday, October 9, 2009 at 12:48 AM in Economics, Universities | Permalink  Comments (214)