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Brooks Wilson's Economics Blog: January 2009

Saturday, January 31, 2009

Outrageous Use of Funds?

I have a slightly different take on the Obama administration's jawboning, which lead Citibank to cancel its purchase of a new corporate jet, than our friend Don Boudreaux at Cafe Hayek. He writes,

Does no one see the sick hypocrisy here? A man who flies in a private jet paid for exclusively with taxpayer funds (Air Force One) scolds other persons for flying in private jets paid for only in part with taxpayer funds.

For a little background, the AP reported Wednesday, January 28, 2009, in an article titled, "Citigroup won't accept new jet," reported that

An official in President Obama's administration contacted Citigroup on Monday to reiterate Obama's position that such jets aren't "the best use of money at this point," and are "an outrageous use of funds" for a company getting taxpayer dollars, said a White House official who spoke on the condition of anonymity.

The jet, a Dassault Falcon 7X costing $50 was ordered in 2005, and was to be one of five corporate jets owned by the company. Citi plans to cut its fleet from five to two jets.

The outrageousness of the purchase is dependent on the return on investment. My guess is that Citi made such a calculation, and the Obama administration did not, relying rather on the appearance of conspicuous impropriety.

If the return on investment was adequate, then the administration made Citibank less profitable, increased the cost of the bailout, and cost jobs of jet construction workers as well as pilots and mechanics at Citi.

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The United Kingdom Is Not A Socialist Country

Driving yesterday, I heard Sean Hannity refer to the United Kingdom (U.K.) as a socialist country. He fears that, under President Obama's leadership, the United States (U.S.) will adopt some form of nationalized medicine, and more social democratic policies of Europe, increasing the size and scope of government. He could have picked a better example from Europe than the U.K. According to the Heritage Foundation's ranking of economic freedom, the U.K. finishes as the tenth freest economy in the world, compared to our finish at sixth. It is the fourth freest of forty three countries in the Europe region. Of the British economy, Heritage writes,

The U.K. has long benefited from openness to global trade and investment. It scores extraordinarily well in investment freedom, financial freedom, property rights, business freedom, freedom from corruption, labor freedom, and trade freedom. The average tariff rate is low, and regulation is efficient. Monetary stability is well maintained. There are few restrictions on foreign investment. The financial system is well developed, and credit is allocated on market terms. The judiciary is independent and highly capable of enforcing contracts and intellectual property rights.

The U.K. scores below the world average only in fiscal freedom and government size. Both the income tax rate and the overall tax burden are high. Government spending has risen steadily.

The Fraser Institute also keeps a ranking of economic freedom, and the U.K. does even better, finishing as the fifth freest economy in the world, four places above the U.S. The U.K. is simply not a socialist country.

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Friday, January 30, 2009

The Salt have Lost His Savour

It is thenceforth good for nothing except to be cast out on streets after snow storms, and to be trodden under foot of men who won't slip. As salt trucks rolled across New York City, Marcia Kramer of reports that Mayor Michael Bloomberg is pressuring restaurants and food manufacturers to reduce the salt content in their products by 50% over ten years ("Mayor Bloomberg Declares War On ... Salt").

I wish that city officials had claimed market failure for their actions. They could have said they were bargaining for citizens who could not mobilize at a reasonable cost to bargain for themselves, but they added more evidence that government officials believes that New Yorkers are stupid. Kramer reports that,

City officials said that people don't realize the salt content of the things they buy in the supermarket.

Reason's Jacob Sullum provides evidence that Mayor Bloomberg's concern may be unwarranted ("Can a New York Bureaucrat Put the Whole Country on a Low-Salt Diet?," January 29, 2009).

In a 2002 review of the research, Alderman, a past president of the American Society of Hypertension, concluded that "existing evidence provides no support for the highly unlikely proposition that a single dietary sodium intake is an appropriate or desirable goal for the entire population." Despite the weakness of the evidence, Alderman noted, the dogma of less salt is still "preached with a fervour usually associated with religious zealotry."

Mayor Bloomberg cares a great deal about his citizens' health. He has previously banned work place smoking and trans fats, and forced restaurants to post the caloric content of their foods. Commenting on the work place smoking ban, Bloomberg said (Justine Blau, "NYC Smoking Ban Debuts," March 30, 2003),

Fundamentally, people just don't want the guy next to them smoking.

The Mayor is an former smoker, and we all know how they are. In the past, when I was in a work environment with smokers, I always asked the former smokers to confront the smokers. They are zealots. I helped. I nodded in the back with others in timid agreement.

The mayor demonstrates no trust in individuals to solve problems on their own. He must be awfully smart. But he is not alone. Government officials at all levels are willing to micro manage other people telling them what televisions they can buy, what carbonated beverages they should drink, and how properly to measure their vegetables. It could be that Bloomberg and his ilk in government are like Mary Poppins, "nearly perfect in every way," but recent evidence suggests otherwise.

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Wednesday, January 28, 2009

President Obama and CAFE Standards

President Obama campaigned as a post-partisan politician who could work with Republicans as well as Democrats, and make decisions based on empirics rather than politics. His directive to ensure that the U.S. auto fleet (the cars we choose to drive) averages 35 miles per gallon by 2020 is not a good example of empirical based decisions.

Bryan Walsh of Time (Jan. 26, 2009) reports in "Obama's Move on Fuel Efficiency: A Clean Win for Greens,"

President Barack Obama made the first big green move of his Administration by simply getting out of the way. Speaking from the White House, the President on Monday announced that he was directing the Environmental Protection Agency (EPA) to reconsider an application by California and 13 other states to set stricter limits on greenhouse-gas emissions from cars and trucks, opening the way for tighter fuel efficiency standards nationwide. Obama is also directing the Department of Transportation to issue guidelines that will ensure the U.S. auto fleet reaches an average fuel economy of 35 miles per gallon (m.p.g.) by 2020 at the latest. Together the directives — the first official memorandums issued by the new President — signal Obama's willingness to take on America's disastrous auto sector, which is bleeding money even as it contributes heavily to climate change and the country's addiction to foreign oil. "The days of Washington dragging its heels are over," he said. "It will be the policy of my Administration to reverse our dependence on foreign oil while building a new energy economy that will create millions of jobs."

Mr. Obama's policy shift is a "clean win for greens," but it is not a clean win for the environment. Corporate Average Fuel Standards (CAFE standards) have many flaws.

They impose an unnecessary burden on the auto industry at a time that Congress has used taxpayer dollars to prop up GM and Chrysler. Improving fuel efficiency of the cars that we choose to drive, comes with a price. There is no hidden technology that automakers can roll out that dramatically improves fuel efficiency. Profit incentives would have compelled automakers to use it in Europe and Japan were gas prices and demand for fuel efficient cars is higher. Automakers will meet new CAFE standards by reducing vehicle weight, slowing acceleration, employing new technology as it becomes available, and decreasing the price of fuel efficient cars while increasing the cost of less fuel efficient cars.

Ronald Bailey of reasononline in "Obama's Fuel Economy Follies, "quotes Mary Nichols, California Air Resources Board Chair, who claims that the state's new CAFE standards would add about $400 per car, and Bob Lutz, General Motors Vice Chairman, who claims the new standards would add about $6,000.

Bailey makes a more telling point, Americans prefer to drive less efficient vehicles.

In 2007, the Pew Campaign For Fuel Efficiency released a poll in which 89 percent of respondents said that it was important for Congress to pass higher automobile fuel efficiency standards. Whatever Americans might tell pollsters, they voted quite differently with their pocketbooks. For example, CAFE standards on passenger vehicles had a big unintended consequence—the rise of sport utility vehicles (SUVs). Mileage standards for light trucks were set lower at 20.7 mpg and SUVs and minivans qualified as light trucks. In 1975, only 20 percent of vehicles sold were light trucks, but by 2002, that had risen to more than 50 percent of vehicles. In 2002, the San Francisco Chronicle reported that the EPA's 10 most fuel efficient models constituted less than 2 percent of auto sales. As recently as 2007, none of the top 10 vehicles chosen by consumers voting at the popular website had an average gas mileage that met current federal CAFE standards

Although CAFE standards increase the cost of a vehicle, they lower the marginal cost of driving by increasing fuel efficiency. We will drive more because we will spend less at the pump, but not as much as we would have driven in absence of the increase in the CAFE standards.

Increasing CAFE standards only results in increased fuel efficiency of new cars that meet higher standards. It does nothing to increase the efficiency of cars we already drive. Furthermore, to the extent that drivers resist buying efficient cars as they have in the past, the higher CAFE standards will result in an older U.S. fleet. Crandall (1992),[1] estimates that the full impact of the higher standards would not be realized for eight years after implementation.

An increase in the gasoline tax would decrease the impact on automakers compared with increasing CAFE standards. People would drive less, reducing the demand for new vehicles. Demand would shift from less fuel efficient vehicles to more efficient vehicles. More subtle market signals for increased efficiency would replace heavy handed mandates.

All drivers, including those with older vehicles, face incentives to drive less with an increase in the gasoline tax. Gone is the adverse impact of the CAFE standards which incentives people to drive more by reducing the marginal cost of driving. Less driving also lowers pollution and congestion.

Crandall concludes that

The existing empirical literature suggests that CAFE costs about 7 to 10 times as much as a petroleum tax that would induce comparable reductions in oil consumption, because CAFE fails to equate the marginal costs of reducing fuel consumption across all uses, including usage of older vehicles and nonvehicular consumption.

CAFE is an even less efficient mechanism to reduce greenhouse gases. To reduce CO2 emissions, a carbon tax is much more efficient than a petroleum tax, which in turn is decidedly more efficient than CAFE standards. The empirical evidence suggests that CAFE would cost the economy at least 8.5 times as a carbon tax with equivalent effects on carbon emissions.

Why might President Obama prefer CAFE standards to an increase in the gasoline tax? It might be an example of politics as usual. CAFE standards are popular, even if people that support them fail to buy high efficiency vehicles. The costs are also more difficult to spot. Increase the gas tax, and every voter knows about it the next time they fill up. Increase CAFE standards, and voters may never trace back the increase in vehicle costs to the standards. If President Obama is concerned about energy independence and carbon emission, I recommend that he join Mankiw's Pigou Club.

[1] Crandall, Robert W. Journal of Economic Perspectives, "Policy Watch: Corporate Average Fuel Economy Standards," Vol. 6, Num. 2, Spring 1992.


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Monday, January 26, 2009

James Hamilton On Improving Bailouts

James Hamilton of Econbrowser writes "Bailouts should be no fun." The trust of his argument is that bankruptcy proceedings are slow, freezing assets and lowering economic activity, exerting substantial spillovers or externalities on otherwise health pockets of the economy. A representative of taxpayers' could speed negotiations and lower externality costs by demanding concessions from owners, creditors, management, and workers in return for bailout funds. Taxpayers would benefit if the bailout funds were less than the avoided externality costs. Hamilton concludes,

If properly implemented, the taxpayers should leave the negotiating table pleased with the deal they achieved, and everybody else should leave battered, comforted only by the knowledge that, had they not made those concessions, things would have been even worse.

On the other hand, if everybody and their grandmother is lining up for a bailout, and pulling political make sure they get it, I read that as prima facie evidence that the taxpayers' interests are not being properly represented.

It appears that everybody and their grandmother is lining up. In a previous post, I named three banks, automotive firms, and a couple of pornographers. Cities, states, insurance companies, credit card companies and others can be added to the list. Hamilton's proposal might be a good way to shorten the line.

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The Obama Inauguration

Ashley Cruseturner writes my first guest as a post as a witness to President Obama's inauguration. Ashley teaches government (well) for my employer, McLennan Community College. The subject matter is a departure from economics, but I thought that it would be of general interest. Ashley writes,

I have much to say about my trip to the Federal City. But, first, let me begin with an overview.

January 20, 2009. High Noon. There I was, standing with 1.8 million of my fellow Americans, wedged on the Mall between the Monument and the Memorial, with the Capitol as a backdrop, watching the 56th quadrennial American Inauguration of the 44th President of the United States.

My journey had been long and circuitous.

My pilgrimage began the day before in a parking lot on the campus of McLennan Community College in Waco, Texas. From there, eighteen of us flew 1200 miles from Austin to Baltimore-Washington International Airport, staying the night in College Park, Maryland, riding the Metro Green Line into the District the following morning, forced by overflow crowds to abandon the subway several stops short of our destination, walking west then north, then west then north again--and again, bellying around closed-off streets, eventually finding a clear artery onto the Mall.

There we stood, finally, on "America's front yard." But that famous pet name for the National Mall falls short of expressing the full power of the place, for the long stretch between Capitol Hill and the Potomac is not just a massive shared lawn--it is consecrated ground. We had arrived at the outer courtyard of the great temples of American democracy, independence, and our conception of justice, sprinkled throughout with shrines and tabernacles to our national accomplishments, sacrifices, heroes, and ideals.

We are suddenly quiet--even in the midst of the din of a million voices. Now we are ready to celebrate the most sacred rite in our political culture: the constitutionally prescribed installment of a popularly elected Chief Magistrate of the United States of America.

For all the rhetoric of bipartisanship, the crowd was primarily Democrats--not surprising and not necessarily unfitting. When Jimmy Carter appeared on the screen, they erupted with excitement and approval. When the Clintons came into focus, the boisterous multitudes screamed with glee. Bush-41 and Barbara: silence. Bush-43: snarling enmity. For the vast majority of these pilgrims, this is not a day to forgive easily or indiscriminately hail presidents in general. They had arrived with a palpable malice toward at least one. Perhaps one day they will feel more charitable toward Forty-Three--but this is not that moment. Again, no real surprise--and no offense taken.

The intermittent chant: O-bam-a. O-bam-a. O-bam-a.

An Aside: there is something unsettling about this brand of personal adulation. If this were a Republican crowd, it would be U-S-A, U-S-A, U-S-A, but let us judge not, that we be not judged.

Rick Warren's invocation is long--but not offensive to the throng. The moment passes without comment.

Joe Biden becomes vice president. His voice is loud and clear, almost startling over the massive public address system.

There is a moment of high art. Yo-Yo Ma, Itzhak Perlman, and other musical luminaries play a stringed ditty to sooth the savage beast and prolong the moment of anticipation. Is it live? Or is it Memorex? Memorex, as it turns out.

Then there is Aretha--and her hat, which is somehow perfectly befitting in the great collage.

Then the Oath (including the "stumble"). The new President is nothing if not a gracious man--in the big picture, this is very good news for the nation and carries a whole host of positive ramifications.

We are packed in--tighter and tighter as the climactic moment of transfer draws near. By the time Obama raises his hand we are pressed together snugly, straining to see through the smaller and smaller cracks in the wall of humanity. Every time Dianne Feinstein, master of ceremonies, gives permission for the audience to "sit down," the mob on the Mall roars with laughter and Bronx cheers.

Then the address: it is wonderfully traditional, subtlety stressing continuity over change. Inaugurations, of course, were not intended as victory parties; rather, they provide an institutional moment for renewal and re-dedication to the principles of the Revolution and the hard realities of constitutional governance. The lofty rhetoric of the address is properly replete with echoes of FDR and JFK and a host of other former chief executives and ancient Greeks and Romans. The newly remastered words roll over the crowd, plucking "mystic chords of memory connecting every living heart with every patriot's grave," perfectly tailored for ceremonial re-absorption into the collective American canon.

Early on in the speech, I am aware of a man in front of me. He is about my age. He is above-average height, with a relatively athletic build, and white. He is with his wife. They both carry themselves with a confidence that leads me to guess that they are comfortable professionals. I imagine both of them to be alumni of some prestigious institution of higher learning. By the end of the address, they will both be crying--and happily taking digital photographs of their tear-stained faces. But before that, the man is holding a small American flag above his head. Following a few early Obama oratorical high points, the man smiles down at his wife and observes, with great irony, "look at me; I am now a flag-waving American."

A flag-waving American? Who would have believed it--I think I hear him saying. Prior to this moment, the patriotic pose had been for simpletons--the last refuge of a scoundrel. Clearly, this man was much too sophisticated to "wave the flag." Men and women of great intellect had taught him long ago that the emotional exhortations to nationalism were ill-intentioned broad-axes designed to manipulate ignoramuses in Kansas and other backward parts of Red-State America.

But there this man stands, inches away from me, waving his American flag, and wiping away the tears of joy streaming down his face. God Bless America? Could this really be the land of the free? Could it be possible that the creed is NOT merely a lie manufactured and promulgated by rich white men to obscure the issues of exploitation, racism, sexism, and corporate greed.

My most optimistic hope: this really is a new day.

For all the hackneyed talk of "history in real time," this time and place presents Barack Obama with a truly unique opportunity. His presidency has the potential to usher in a watershed moment in our modern national life. Might this be the dawning of a new era in which the several generations of citizens hyper skeptical of the "mythic" American narrative reconnect with a less antagonistic view of the American past?

It is a heavy burden--much too much to ask any one man to carry in our current milieu of ironic detachment. Nevertheless, I choose to believe this President sees the danger of our collective loss of faith and plans on pursuing a rigorous agenda of renewal.

What the cynics fail to understand is that the ground has shifted beneath them — that the stale political arguments that have consumed us for so long no longer apply.

Are we on the cusp of a New American Patriotism?

"Fondly do we hope, fervently do we pray...."

My Prayer for US. My prayer for this President:

"With firmness in the right, as God gives us to see the right, let us strive on to finish the work we are in."

May God Bless this President. May God Bless America.

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Saturday, January 24, 2009

The Views of Economists and Non Economists On The Economy

In a previous post, “Economists as Experts,” I stated that economists deserve respect as experts on economics, and that common accusations about their objectivity were wrong. In this post, I describe how the views of economists differ systematically from non economists. As in my previous post, I rely heavily on Bryan Caplan’s book, The Myth of the Rational Voter: Why Democracies Choose Bad Policies. His work is based on a survey on 1,510 randomly selected Americans and 250 Ph.D. economists that was conducted by the Washington Post, Kaiser Family Foundation, and Harvard University in 1996. The survey had thirty seven questions about the state of the economy and how it functioned.

Claiming that economists are nonbiased experts and that their opinions are the best representation of reality, Caplan compares their views to the public’s, and finds that they differ in four areas that he calls public biases. The first, antimarket bias, is the tendency to underestimate the effectiveness and benefits of the market mechanism. Caplan writes,

Economists across the political spectrum criticize anitmarket bias. Liberal Democratic economists echo and amplify Schumpeter’s theme. Charles Schultze, head of Jimmy Carter’s Council of Economic Advisors, proclaims, ‘Harnessing the ‘base’ motive of material self-interest to promote the common good is perhaps the most important social invention mankind has yet achieved.’ But politicians and voters fail to appreciate this invention.

Schultze is not the first economist who supported liberal political agendas to speak to the strengths of markets. In fact, I have difficulty using the political term liberal to define economists and do so with some caution. In this post, I will only call an economist liberal if he or she is a self proclaimed liberal, or supported Obama over McCain in the last election. One such economist is Nobel Laureate (1970) Paul Samuelson who penned these words in a SpiegelOnline article titled, “The Dynamic Moving Center,”

Based on my observations of economic history, both short run and long run, I believe that there is no satisfactory alternative to market systems as a way of organizing both economically poor and economically rich populations.

Also for SpiegelOnline, Edmund Phelps, a Nobel Laureate (2006) writes in a article titled, “What Has Gone Wrong Up Until Now,”

It is preposterous to speak, as some Europeans have, of the "end of capitalism." A good life requires a rewarding workplace -- one of change and challenge -- and that requires some sort of well-functioning capitalism.

Economists recognize greater strengths in markets than does the public in general.[1]

The public also expresses antiforeign bias, a tendency to underestimate the benefits of economic interchange with foreigners. As examples of the differences between economists and the public at large, economists express less concern about outsourcing of jobs and immigration. They also overwhelmingly support policies that lower restrictions on trade.

The general public is also more likely to underestimate the benefits of conserving labor, what Caplan calls the make-work bias. Economists generally favor the introduction of labor saving technology. It allows more of a good to be produced with the same amount of labor, freeing that labor to produce other things. Technological advance in agriculture freed 17 million workers as yields per acre increased. Displaced workers retrained, found new jobs, and produced other things. It might have been difficult to see how the displaced farmers and farm workers would benefit from increasing agricultural productivity, but most did, and certainly the country prospered. Economists measure progress within an industry and in the country by increasing productivity, not by employment numbers. Job creation tends to expand to cover all who wish to work, and flows to areas in which it is most highly valued.

Finally, Caplan argues that non economists suffer from pessimistic bias, the tendency to overestimate the severity of economic problems and underestimate the past, present, and probable future performance of the economy. As a demonstration of the optimism of economists, Brad DeLong writes in the abstract of his paper, “Cornucopia: Increasing Wealth in the Twentieth Century,”

There is one central fact about the economic history of the twentieth century: above all, the century just past has been the century of increasing material wealth and economic productivity. No previous era and no previous economy has seen material wealth and productive potential grow at such a pace. The bulk of America’s population today achieves standards of material comfort and capabilities that were beyond the reach of even the richest of previous centuries. Even lower middle-class households in relatively poor countries have today material standards of living that would make them, in many respects, the envy of the powerful and lordly of past centuries.

As experts in economics, economists have studied economic progress, see its incredible advance over the last century, understand some of its causes, and extrapolate that success into the future.[2]

[1] To be sure, “liberal” economists will speak more about the limits of markets because of imperfections such as asymmetry of information, externalities, public goods, or market power than “libertarian” economists like Milton Friedman, just follow the link on Samuelson’s article as an example, but they both recognize the same flaws as well as the same strengths.

[2] At the risk of repeating a common theme of other posts, one of the disconcerting features of the debate about the current recession is the level of pessimism expressed about the outlook for the U.S. economy in the near term.

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Friday, January 23, 2009

Economists as Experts

Economists have a chip on their shoulder, or at least I do. Nobody argues gravity with a physicist, or covalent bonding with a chemist, but they do argue supply and demand with an economist. Nobody ever asks if a physicist or a chemist is biased, but people make these claims all the time about economists. Like Rodney Dangerfield, economists, "don't get no respect."

In his book, The Myth of the Rational Voter: Why Democracies Choose Bad Policies, Bryan Caplan describes two common biases that many think economists possess. They are self-serving bias and ideological bias.

Self-serving bias is based on a literature that suggests that people form beliefs that are comfortable and support their financial interests. As an expression of self-serving bias, Lincoln said of slaveholder,

The effect on the minds of the owners is to persuade them that there is no wrong in it. The slaveholder does not like to be considered a mean fellow, for holding that species of property, and hence he has to struggle within himself and sets about arguing himself into the belief that Slavery is right. The property influences his mind. [1]

The argument implies that economists are on average well-to-do, and have job security and therefore support policies that help the rich through markets. Caplan's statistical analysis suggests that self-serving bias does not explain economists' views. If economists had the same level of income and job security as the average person, their opinion on policy would still mirror those of other economists.

Ideological bias suggests that economists beliefs were shaped by their free market mentors. If Republicans are more conservative than Democrats, implying that they are more likely to support free market policies, the accusation does not fit. Economists are more likely to be Democrats than Republicans. Daniel Klein and Charlotta Stern (How Politically Diverse Are the Social Sciences and Humanities? Survey Evidence from Six Fields) surveyed six social science disciplines. The overall response rate of 30.9% and the small number of academic economists responding (96) suggests that results should be interpreted with caution. Academic economists were defined as those working at four year colleges or above. They found that three times as many economists vote regularly for Democrats as compared to Republicans.

The (Examining the candidates) surveyed 683 research economists at the National Bureau of Economic Research, and found similar results to Klein and Stern.

A total of 142 responded, of whom 46% identified themselves as Democrats, 10% as Republicans and 44% as neither. This skewed party breakdown may reflect academia’s Democratic tilt, or possibly Democrats’ greater propensity to respond. Still, even if we exclude respondents with a party identification, Mr Obama retains a strong edge—though the McCain campaign should be buoyed by the fact that 530 economists have signed a statement endorsing his plans.

Their nonscientific results find that Democrats outnumber Republicans 4.6 to 1, an even stronger result.

Caplan compares the political beliefs and policy views of 250 Ph.D. economists and concludes,

Compared to the general public, the typical economist is left of center. Furthermore, contrary to critics of the economics profession, economists do not reliably hold right-wing positions. They accept a mix of 'far right' and 'far left' views.

Economists may have biases, but they are not self-serving bias or ideological bias as often claimed.

[1] Miller, William Lee. Lincoln's Virtues: An Ethical Biography, Alfred A. Knopf, New York , 2002, page 388.

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Wednesday, January 21, 2009

Chavez and Peron

Latin American strong men, with the possible exception of Chile's Pinochet, have often promised sweeping economic reform, and failed to deliver growth, efficiency or equity. It doesn't seem to matter whether they are from the right or the left, popularly elected, or rise to power in a coup; their empty promises of reform litter the Latin American landscape.[1]

Juan Peron is the prototypical Latin American strongman. He gained national prominence through his political machinations while in the military, and won the presidency in quasi-democratic elections. He campaigned on economic reform promising to free Argentina of foreign influence, and went so far as to nationalize foreign owned companies including British railroads, and ITT. In part, the purchases were financed by windfall revenues Argentina earned during the WWII, supplying foodstuffs to England. The price paid by the Argentine government seemed high as noted by contemporary critics (Crawly (1984), A House Divided: Argentina 1880-1980, C. Hurst & Company, London).

...Miranda returned to the negotiating table, and after much tough talking emerged in January 1947 with a new deal, this time for the outright purchase of the railways. The cost of the acquisition, originally calculated at 1,000 million pesos, first doubled to 2,000 million ('for sentimental reasons and debts of gratitude with England,' Miranda said), and was finally fixed at 2,700 million, as the Argentine government took over the legal and administrative costs of the operation and the debts the railways still owed the pension funds and the workers. The Socialists sneered in a clandestine publication: 'Italy paid 325 million dollars as the sum total of war reparations, while we have paid a 375 million dollar surplus only for sentimental reasons.

The Peron administration purchased Union Telefonica from ITT for 319 million peso (95 million dollars). The government granted ITT a ten year monopoly for the supply of materials and technical assistance as part of the purchase price. Again, critics noted the high purchase price.

Venezuela, under Hugo Chavez, has similarly undertaken a program of nationalizations financed in part by oil revenues, but oil production is falling as are oil prices. Chavez must decide how to hold onto his socialist reforms in a rough economic environment. It's not that Venezuela lacks reserves, the Orinoco Field has an estimated 235 billion recoverable barrels; it is that the Western oil companies understand developing oil fields better than their competitors. Simon Romero of the International Herald Tribune reported on January 15, 2009 that

In recent years, Chávez has preferred partnerships with national oil companies from countries like Iran, China and Belarus. But these ventures failed to reverse Venezuela's declining oil output. State-controlled oil companies from other nations have also been invited to bid this time, but the large private companies are seen as having an advantage, given their expertise in building complex projects in Venezuela and elsewhere in years past.

Hugo Chavez was quietly asking foreign oil companies like Chevron, Royal Dutch/Shell and Total of France to bid on new projects to open new oil fields to gain their expertise, which he had assumed was inconsequential. Like the Peron regime in Argentina sixty years before, the Chavez regime will need to pay a premium to gain the needed expertise. In Chavez’ case, the premium will be for the property rights risk that he created. The Venezuelan people will pay that price.

[1] To be fair, democratically elected regimes have not had much more success.

[2] Under Chavez' regime, both political freedom and civil rights in Venezuela have fallen according to Freedom House, leaving the countries status as partially free rather than free. During the same period, Venezuela's economic freedom has fallen from 56.1 to 29.9 according to the Heritage Foundation.

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Tuesday, January 20, 2009

Monday, January 19, 2009

Being Good Vs Being Popular

Over the course of time, Russ Roberts, the host of EconTalk, has interviewed three Nobel Laureates in Economics whose work was not immediately accepted. The economists are Milton Friedman, Gary Becker, and Vernon Smith. You can listen to the interviews by following the links inserted on their names. All sciences have an established body of work, and these economists challenged the prior beliefs of their professions embody by that work. It is proper and fitting that great effort should be necessary to move the center of economic belief. It is also proper and fitting that their ideas, given empirical support eventually won out, and their contributions are now widely recognized.

In short, Friedman opposed what was then the dominant economic belief that markets were unstable, and that government intervention was needed in the form of fiscal policy to stabilize markets. He argued that markets were inherently stable, and that through sound monetary policy involving a rule, a constant rate of growth in the money supply, government could best maintain economic growth. He was a Monetarist in a Keynesian world. Much of his work is now incorporated into the two dominant schools of Macroeconomics that followed his academic career, New Classical and New Keynesian economics.

Gary Becker extended economic research into nontraditional areas began in 1955 with the economics of discrimination, and followed by human capital, the allocation of time, crime, and the family. Other economists, particularly older ones, tended not to notice Becker’s contributions because they were nontraditional. He missed job opportunities, and the recognition that lesser economists received. By the middle of the 1970s Becker noticed that young economists greatly admired his work, and furthered his research.

Vernon Smith introduced experimental economics to the profession. In 1955, with a new Ph.D. from Harvard he began to teach at Perdue University. He soon realized that he did not understand the connection between how people operated in markets and the theory of supply and demand. The conventional stories did not explain how market reached equilibrium.

He began experimenting on students, and gained great insight into how markets reached equilibrium. His work demonstrated that markets were more efficient than traditional models demonstrated--economic agents did not need perfect information, and the number of agents did not need to be large. He attempted to publish his work in the Journal of Political Economy, a journal that was generally pro-market. His paper work was not accepted for publication.

In his interview on EconTalk, Smith quips,

Why did I send it to the JPE? Why that's a University of Chicago journal, and I thought, what have I shown? I've shown that markets really work quite well, better than I anticipated, and better than the...conventional wisdom as we taught it in economics. So I said, I'll send it to the JPE because those guys in Chicago have a reputation for believing in markets so they'll like this. Well that was wrong. I think it became evident why it was wrong. If you believe in markets you don't necessarily need evidence.

Smith describes in some detail his travails in publishing his work. He submitted his paper twice, and both times the referees rejected the paper. Eventually, Harry Johnson took over as new editor and asked Smith to submit yet another revised version. Ultimately the paper was published and Smith quotes Johnson as saying,

I haven't been at this job very long and I've learned a lot. I've discovered that you have to keep evaluating everybody, including yourself. I have to confess that I was one of the original referees (that was negative on the paper), but you've convinced me.

Good work, hard work paid off, and acclaim followed.

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Steven Levitt Does Standup At Princeton

Steven Levitt, coauthor of the controversial book, Freakonomics: A Rogue Economist Explores the Hidden Side of Everything, spoke at Princeton on September 27, 2006. You will need to search and scroll a little to find the lecture on the permanent links, but you can view it here, or listen to it here. Levitt is truly funny, and you might listen to him only for that reason, but he also discusses interesting economics.

Beginning at 33 minutes and 50 seconds into the lecture, Levitt describes economists' research exploring altruism, which they historically doom to oblivion assuming self-interest. Much of the research centers on the dictator game in which two people are brought into a lab. They never see each other. One person, the dictator, is given $10 and the option of keeping all of the money or giving all to part of it to the other person. On average, the dictator gives $3 of the $10 to the other person, leading economists to conclude that people are innately altruistic.

In a discussion with a friend, John List, Levitt observes that no one ever came up to him on a bus and said, "I have $10, take $3." List reworked the experiment so that the dictator retained the option of keeping the awarded $10, or giving all or part of it away, but could now take up to $10 from the other participant. Now on average, the dictator took $3 rather than giving $3, so much for altruism.

But List was not done. He modified the experiment so that both the dictator and the other participant had to stuff envelopes for an hour, and then performed the same experiment. In this case, on average, the dictator neither gave money nor took it from the other participant.

Levitt concluded that the early experiments only captured the dictators' desire to please the person conducting the test by being generous rather than measuring altruism.

Levitt also discusses the relative importance to graduate students of having deep economic insight versus good mathematical ability, his experience consulting businesses, and the economics of prostitution.

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Friday, January 16, 2009

Kobe and Reverse Causality

Critics of Kobe Bryant often claim that he is a selfish player. They note with glee that the Lakers lose a higher percentage of their games when he takes more than thirty shots than when he shoots less. The same thing was said about Michael Jordan. Reporters claimed that he scored a lot of points before he learned to be a team player, then he won championships.

I offer this hypothesis for your consideration; I believe that have reversed causality. Bryant and Jordan took a more shoots when their teammates couldn't score, and fewer when they could. Their games did not improve, their teammates did.

Reverse causality is a problem that plagues economists. Kevin Grier gives a good example in the Concise Encyclopedia of Economics, in "Empirics of Economic Growth," and writes,

[W]e are seldom sure whether the variables expected to cause growth actually do so or are themselves caused by growth. For example, some economists claim that financial development helps growth, but others argue that economic growth itself causes financial development.

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Friedman on Businesses and Markets

Many have noted an apparent paradox of businesses that demand freedom from government taxation, regulation, social engineering are begging for government bailouts. Today, we read that Bank of America will bet an additional $20 billion in taxpayer money on their bold investments (HT Drudge). Does anyone smell a moral hazard? In an episode of porn gone wild, Larry Flynt and Joe Francis are asking for a $5 billion bailout of the porn industry. It seems like the demand for porn is more elastic (responsive to changes in price) than porn executives believed and anti-porn leaders had feared. And who will forget the specter of auto executives driving to DC and eventually winning a $17.4 billion bailout.

In an EconTalk podcast of Milton Friedman hosted by Russ Roberts, Friedman explains that there is no paradox in business behavior. They are doing what's best for them.

[I]t's always been true that business is not a friend of a free market...It's in the self-interest of the business community to get government on its side. It's in the self-interest of a particular business...But the real puzzle—puzzle isn't quite the right word—the real problem here is where do you find the support for free markets? If free markets weren't so damn efficient, they could never have survived because they have so many enemies and so few friends. People think of capitalism or free markets as something that obviously is supported by business. People think that if a business party is a party in politics, it will promote free market. But that's wrong. It will be in the self-interest of individual businesses to promote a tariff here and a tariff there…

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Wednesday, January 14, 2009

Posner, Becker and the Stimulus

As always, Posner and Becker offer insightful comments in this weeks posts, "The Obama "Stimulus" (Deficit Spending) Plan--Posner" and "On the Obama Stimulus Plan-Becker." 

Posner begins using the "D" word.

I suspect that we have entered a depression. There is no widely agreed definition of the word, but I would define it as a steep reduction in output that causes or threatens to cause deflation and creates widespread public anxiety and a sense of crisis.

Both Posner and Becker note a dramatic rise in economists calling for a Keynesian stimulus.  Posner writes,

Almost the entire economics profession converted--virtually overnight--from being Milton Friedman monetarists (Friedman believed that only bad monetary policy could turn a recession into a depression) to being John Maynard Keynes deficit spenders. I'll assume they're right, and move on to the question of structure.

Becker responds,

As Posner and others have indicated, there appears to have been a huge conversion of economists toward Keynesian deficit spenders, but the evidence that produced such a "conversion" is not apparent (although maybe most economists were closet Keynesians all along).

After building a Keynesian economic case for a fiscal stimulus, Posner expresses doubts about the effectiveness of tax cuts and transfer payments, while supporting the soundness of infrastructure projects .  He concludes,

Properly structured, a Keynesian program can help to check a downward economic spiral. With monetary policy apparently inadequate to avert a downward spiral big enough to trigger deflation, there may be no good alternative to such a program.

Becker stresses several problems.  The first is government spending crowding out private.  For example, if the government builds new public schools financed through borrowing, interest rates would rise, increasing the cost of private investment.  The higher cost of borrowing crowds out private investment that is no longer profitable at the higher cost.  He  then notes the lack of empirical support for fiscal policy, and finally expresses doubts about the size of the multipliers that Romer and Bernstein use to estimate the impact of the Obama stimulus package on the economy.  Multipliers are the ripple effects that the economy receives from the fiscal stimulus.  For instance, if you receive a tax cut, and spend those funds buying electronics, the owner of the electronics store gains benefit above the benefit that you received from the tax cut.  If she spends the money at the pet store buying dog toys, the pet store owner benefits as well.  The larger the multiplier, the greater the justification of a fiscal stimulus.  Becker ends predicting, 

Time will tell whether I am right that a spending and tax package of the type analyzed by Romer and Bernstein may stimulate the economy as measured by GDP and employment, but that the stimulus will be smaller then they estimate, and its value to consumers and taxpayers could be even smaller.

Like the Glaeser article analyzed (by me) here, Posner's post is a little scary.  With no new empirical support, another economist well aware of the limitations of fiscal policy supports it.  It gives me some solace hoping that, as Becker quips, "maybe most [of these] economists were closet Keynesians all along," and it may be true that some were just waiting in the bushes to jump at the next opportunity to show their true Keynesian stripes.   But that solace does not ease my fear that many well trained, reasonable economists support policy that six months ago they would have opposed. 

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Tuesday, January 13, 2009

Plasma TVs: CO2 Emitting Demons or Stimulative Saints?


First, England prosecutes the Metric Martyrs, for selling veggies by the pound, then the state of New York considers a tax on sugar- laced sodas aiming to protect citizens against obesity wether they want to be thin or not, and now the EU will ban certain types of energy hogging, CO2 emitting  plasma televisions.  Fiona Macrae of Mail Online writes in an article titled, "Energy-guzzling plasma TVs will be banned in Brussels eco blitz,"

Giant energy-guzzling flatscreens are expected to be banned under legislation due to be agreed by the EU this spring.

Plasma screens have been nicknamed the '4x4s' of the living room because they use up to four times as much electricity and are responsible for up to four times as much carbon dioxide as traditional cathode ray tube sets.

The most energy intensive will be phased out under the new EU standards for minimum energy performance...

The remaining TVs of all types will have to carry energy rating labels designed to make it easy to distinguish between the best and worst performers.

The moves are part of an effort to tackle climate change by stemming the spiralling electricity consumption in households...

Families have nearly three times as many electrical appliances and gadgets as a generation ago and the amount of electricity used to power them has doubled.

The government's economic justification is that the three named activities create negative externalities in which your private transactions affect third parties, and sometimes all of mankind!  Sell veggies by the pound, and your neighbors might not ever figure out the kilo.  Drink sugary sodas, and New York taxpayers may have to pick up some of your medical costs.  And worst of all, watch a plasma television and cause the polar ice caps to melt, polar bears to drown, sea levels to rise, and perhaps eliminate humans from our planet.

Maybe, some of the externalities are real.  Maybe anthropogenic global warming does threaten to impose large costs on society, but please, don't ban plasma televisions, or any other device. 

I confess that I have more electric gadgets than I did when I was a child, and I further confess that I like them all: my leaf blower, iPod, multiple televisions, microwave, cell phone, and believe me I could go on.  In the future, I hope to have more gadgets, not less.  Just tax electricity at a little higher rate like New York is doing with sodas, and let consumers decide how best to reduce their electrical consumption. 

Let me offer an alternative theory.  Plasma televisions are not  devils, but angels, offering a much needed stimulus to the world economy.  Electricity is a complementary good, and the more plasma TVs, the more windmills, nuclear power plants, and other green forms of energy.  Jobs will be created, the economy will expand, and full employment restored.  Maybe, just maybe, we can also drink more sugary sodas, which will induce us to buy more treadmills, stationary bicycles, continuing this virtuous cycle of job creating consumption. 

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Monday, January 12, 2009

Edward Glaeser and the Stimulus

Edward Glaeser wrote an interesting and a little scary column titled, "Who should get the federal stimulus funds," for  There is both acknowledgement of the failure of traditional tools to stabilize the economy, and resignation to a fiscal stimulus despite manifest problems in implementation when he writes,

Until last year, the economic consensus was that monetary policy could smooth the business cycle with greater speed and less waste than countercyclical taxes or spending. Fiscal policy has made a comeback, not because its flaws have disappeared, but because the alternatives don't seem to be working.

To emphasize that monetary policy is, perhaps was, generally considered more effective than fiscal policy, consider two quotes.  The first is from the abstract in Christina Romer's NBER Working Paper  3829, titled, "What Ended The Great Depression?  it reads,

A simple calculation indicates that nearly all of the observed recovery of the U.S. economy prior to 1942 was due to monetary expansion. Huge gold inflows in the mid- and late-1930s swelled the U.S. money stock and appear to have stimulated the economy by lowering real interest rates and encouraging investment spending and purchases of durable goods. The finding that monetary developments were crucial to the recovery implies that self-correction played little role in the growth of real output between 1933 and 1942.

Similarly, Brad DeLong writes in the Journal of Economic Perspectives, "The Triumph of Monetarism?"

Under normal circumstances, monetary policy is a more potent and useful tool for stabilization than is fiscal policy...Any sound approach to stabilization must recognize the limits of stabilization policy, including the long lags and low multipliers associated with fiscal policy...

If these are not normal circumstances, and the economy is not self-correcting, or government can speed self-correction through sound policy, what should a fiscal stimulus look like?  Glaeser provides some insights

The country needs to invest steadily and wisely on infrastructure, not rush hundreds of billions of dollars out the door. Really expensive projects, like the Big Dig, can take many years to plan, permit, and build...The country should take infrastructure investment seriously, but infrastructure spending is unlikely to be sound stimulus...

The best way to make sure that a vast stimulus package doesn't turn into a federal boondoggle bonanza is for that money to go directly to private citizens and local governments. Reducing payroll taxes for middle- and lower-income people harkens back to the Jacksonian idea of small-government egalitarianism. Shoring up the balance sheets of state and local governments would help ensure that those governments don't make the downturn worse by cutting spending during a recession.

According to Glaeser, even if the tax cut portion of the stimulus does not ease the recession, it might ease its burden on the poor, and, I might add, increase the progressiveness of the tax code, a policy Mr. Obama endorsed in the campaign. 

For other economists, their doubt about the wisdom of a fiscal stimulus still outweighs their desire to act, particularly in support a policy based on weak empirical evidence.  Perhaps there is little that we can do collectively through the government.   

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Market Self-Correction?


You can see more of Jeff Stahler's work here.

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Sunday, January 11, 2009

The Everyday Economist

I have added The Everyday Economist to my blog role. Over the weekend, I was surfing the Internet in search of articles in which prominent economists give their opinions on the proposed Obama stimulus package, and I ran across this blog. It is maintained by Josh Hendrickson who is a lecturer in economics at Wayne State University.

The blog is well organized and elegant in appearance. Better yet, the writing is good and informative. I read several post and enjoyed them all. If you are interested, you might start with, "Macroeconomic Theory, Policy, and the Crisis," or "Taylor on the Crisis."

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Saturday, January 10, 2009

Finn Kydland and the Stimulus

In a December 9, 2008, Andina article titled, "Infrastructure investment, best way to face financial crisis", says Nobel in Economics" Finn Kydland gives what sounds like guarded advice on dealing with the international financial crisis. The article reads

Infrastructure investment is one of the best ways to face the international financial crisis due to its long term positive effects on the productivity of the country, Nobel Prize in Economics for 2004, Finn Kydland, stated Tuesday.

"I do not trust too much on measures addressed to aliviate situations in the short term since, usually, these measures are likely to have negative effects in the long term, and long term is what really matters”, señaló.

For example, he said, a fiscal policy such a temporal reduction of taxes has little effect, so that infrastructure investment is better to face financial crisis.

“When the economy grows and the highways do not progress accordingly, the economy becomes ineffective, hence, investing in transport is a good idea", he stated.
He said infrastructure investment is one of the most recommended measures by the
Copenhagen Consensus (2004) for Latin America, and is also mentioned in the Consulta de San José en Costa Rica (2007).

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China Humbles Google and Others

In a previous post, "Big Brother Vs Big Porn," I describe how China and Britain are attempting to regulate the porn industry. I suggest that the task will be difficult, posing Stigler's question, "What can regulators regulate?"

A Yahoo News Canada article (HT Drudge) titled, "Internet portals targeted by Chinese crackdown apologise," describes a no-holds-barred smackdown by the Chinese government,

Google and other major Internet sites apologised on Wednesday after the Chinese government accused them of failing to police links on their web pages that could lead to pornographic material. Google said it had deleted all links to vulgar material from its search indexes, "which may have had a negative effect on web users", in an apology posted in the company blog on its Chinese site...Baidu and other targeted sites posted similarly worded apologies.

Not having technical expertise, I do not know if this means the Chinese government has won the war, but it must have won an important battle, mustn't it?

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Friday, January 9, 2009

The WABAC Machine

Hand pained limited edition for sale (and not by me).

Mr. Peabody, AKA the Wolf of Wall Street, and Sherman are sitting in Peabody's penthouse, when Sherman asks, "Where are we going today, Mr. Peabody?"

Peabody responds, "June 1997, to Washington."

Why, Mr. Peabody?

“The Asian Financial Crisis will break out in early July, raising fears of a worldwide economic meltdown and we have to stop it.”

His curiosity aroused, Sherman demands, “Tell me more, Mr. Peabody.”

Peabody explains, (quote from Wikipedia) “The crisis started in Thailand with the financial collapse of the Thai baht [Thai currency] caused by the decision of the Thai government to float the baht, cutting its peg to the USD [U.S. dollar], after exhaustive efforts to support it in the face of a severe financial overextension that was in part real estate driven. At the time, Thailand had acquired a burden of foreign debt that made the country effectively bankrupt even before the collapse of its currency. As the crisis spread, most of Southeast Asia and Japan saw slumping currencies, devalued stock markets and other asset prices, and a precipitous rise in private debt.”

“What are we going to do about it, Mr. Peabody?”

Holding a browned copy of the September 25, 1998 Wall Street Journal, and pointing to an article titled, "Would-Be-Keyneses Vie Over How to Fight Globe's Financial Woes" and Peabody reads, "President Clinton asks, ‘Is there a modern John Maynard Keynes to show us the path back to prosperity?’” Flipping to the back page to continue the article, he knowingly points to the pictures of Paul Krugman, Jeffrey Sachs, and Joseph Stilitz, and calmly declares, “Yes Sherman, and I know who they are!”

“Why didn't anyone listen to them?”

Peabody continues reading about Keynes from the WSJ, "[ Keynes], who died in 1946, fell from grace in the late 1970s and early 1980s as his followers in governments around the world couldn't easily understand or cure inflation. But the current talk of deflation, global overcapacity and irrational financial markets harks back to the Depression-era issues he confronted."

Sherman, surfing the Internet, lands on The Financial Times Economists' Forum, and eyes an article by Peter Clarke titled, "In the Long run we are all dependent on Keynes", and reads to himself, "It was US president Richard Nixon who declared: ‘We are all Keynesians now.’ Well, times change. Myths become vulnerable to debunking – and, if you wait long enough, to rebunking too. The Keynesian era came to grief in the 1970s. For about 30 years Keynes’s reputation languished. Then, in about 30 days, it has apparently been restored.’” Sherman responds, “Gee that sounds familiar Mr. Peabody.”

Peabody, glaring at Sherman, explains, “We are going to perform a natural experiment. We will try the Keynesian solution, and if they don’t work, we will try the New Classical solutions proposed by Robert Lucas, Thomas Sargent, and Edward Prescott. Doing something about a problem that has not happened yet just might work. If that doesn’t work, we’ll try New Keynesian solutions proposed by Greg Mankiw, David Romer, and Olivier Blanchard.”

“And we’ll try plans until one works?” Sherman asks innocently, and then he grasps the genius of Peabody’s plan, “Everybody will wake up and the Asian Financial Crisis will never have happened?”

“Yes, and maybe the American Financial Crisis will be history as well if policy makers learn from past success.” Peabody declares, and then thoughtfully observes, “Another possibilities exist: People might wake up and find that nothing has changed. This means that we none of the policies worked, or that policy makers did not listen to hard advice from good economists.”

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Thursday, January 8, 2009

Jeffrey Sachs and Root Causes

In a March 21, 2008 column titled, "The Roots of Crisis," published in the, Jeffrey Sachs concludes that the roots of the financial crisis had its foundation

in 2001 at the end of the Internet boom and the shock of the September 11 terrorist attacks. It was at that point that the Fed turned on the monetary spigots to try to combat an economic slowdown. The Fed pumped money into the US economy and slashed its main interest rate - the Federal Funds rate - from 3.5% in August 2001 to a mere 1% by mid-2003. The Fed held this rate too low for too long.

The next part of Sachs' story sounds familiar. Monetary expansion lowers borrowing costs, weakens the dollar, and increases inflation. New borrowing was concentrated in housing where commercial and investment banks created new types of collateralized securities which expanded lending to borrowers with little creditworthiness, and through feedback loops, the bubble inflates.

Sachs believes that much of the blame for today's financial crisis

rests with "the Fed, helped by wishful thinking of the Bush administration.

It was the Fed that maintained an easy money policy, and declined to regulate "dubious" lending practices. Of course, Alan Greenspan, who has gone from hero to zero, was the chairman at the time but Ben Bernanke does not escape with a free pass. Sachs notes,

At a crucial moment in 2005, while he was a governor but not yet Fed Chairman, Bernanke described the housing boom as reflecting a prudent and well-regulated financial system, not a dangerous bubble. He argued that vast amounts of foreign capital flowed through US banks to the housing sector because international investors appreciated "the depth and sophistication of the country's financial markets.

Seven months later, in a Financial Times Economists Forum article titled, "The best recipe for avoiding a global recession," Sachs presents his plan for solving our current economic difficulties. It is global in nature:

(1) Western central banks should extend swap lines to countries with emerging markets.

(2) the International Monetary fund should extend low-conditionality loans to all countries that request it.

(3) Western central bankers should pressure banks not to withdraw credit from foreign operations.

(4) China, Japan and South Korea should take coordinated macroeconomic expansion.

(5) Middle Eastern countries should invest in emerging and low income countries,

(6) The U.S. and Europe should expand export credits to low and middle-income countries, and finally,

(7) The U.S. and Europe should follow expansionary fiscal policy aimed at infrastructure and transfers to cash-strapped states, and no tax cuts.

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Wednesday, January 7, 2009

Confirmation Bias

As classes begin, I urge my students to avoid confirmation bias. Robert T. Carroll of the Skeptic's Dictionary describes confirmation bias as

a type of selective thinking whereby one tends to notice and to look for what confirms one's beliefs, and to ignore, not look for, or undervalue the relevance of what contradicts one's beliefs.

Expose yourself to new ideas. Students tend to think of economics in terms of the Democrat and Republican debate. Although economists are often partisans, their debates frequently turn on a different axis. For example, economists might debate the relative effectiveness of monetary policy and fiscal policy in achieving full employment. Both a Democrat and a Republican might favor stimulative fiscal policy but differ on who gets tax cuts. Many of the economists who believe that fiscal policy is effective may not like the tax cut plans of either party.

Greg Mankiw recently posted a letter from the "perfect" student in A Question about Learning Economics, or at least that's how I think the student. The student reads books by economists with very different perspectives, and respectfully engages professors in discussions. The student mentions having a professor who was a Friedman disciple and another who was New Keynesian. Mankiw's reply is sold. In part, he writes,

You are lucky that you have professors with different viewpoints. Your job, as a budding economist, is to learn from all of them. Ideally, at the end of the day, you should be able to understand and appreciate (although not necessarily agree with) each point of view. You should try to construct in your mind a debate between your Friedmanite professor and your Keynesian professor. What points would each raise, and how would the other respond?

In a valuable EconTalk, Ian Ayers suggests that listeners attempt to name things that they have learned but that they don't like. If you can't think of any, you are a biased consumer of education.

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Tuesday, January 6, 2009

Big Brother Vs Big Porn

We are back to a familiar question, what can regulators regulate? Two recent articles (HT Drudge for both), related how two governments, the Chinese and British, are concerned with the impact of pornography on minors.

According to a MyWay article,

China launched a major crackdown on Internet pornography Monday targeting popular online portals and major search engines such as Google.

Seven government agencies will work together on the campaign to "purify the Internet's cultural environment and protect the healthy development of minors," said a statement by the information office of the State Council, China's Cabinet.

Pornography is banned in China, though the government's Internet police struggle to block Web sites based abroad.

Britain is attempting to control access to porn and for much the same reason. Robert Winnett of the writes,

In an interview with The Daily Telegraph, Andy Burnham [Culture Secretary] says he believes that new standards of decency need to be applied to the web. He is planning to negotiate with Barack Obama’s incoming American administration to draw up new international rules for English language websites.

The Cabinet minister describes the internet as “quite a dangerous place” and says he wants internet-service providers (ISPs) to offer parents “child-safe” web services.

Very few people would like kids to have access to porn, and I do not want to know those few let alone grant them any access to my kids. Some could reasonably argue that it is the parent’s and not the government’s job to filter Internet.

We are back to a familiar question, what can regulators regulate? My guess is that regulators will have their hands full, but I have zero technical expertise, zip, nada. I would love readers with technical expertise to answer a few questions: Can the Big Brother effectively take on Big Porn? If parents would demand "child-safe" web services, why don't they already exist?

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Monday, January 5, 2009

Experts Vs Partisans

I love college football; my favorite team is Southern Cal and it has been since I was ten. I love tailgating before the game, and walking into the stadium in a wave of cardinal. Then the game starts. USC defers to the second half. Ray Maualuga smacks a back for a five yard loss and the band plays Conquest. Mark Sanchez hits Patrick Turner on a slant up the middle for a thirty yard gain and the band plays Conquest. The band plays Conquest a lot. After the game, the players, the band, and the fans gather at one end of the stadium to chant traditional cheers, often led by players. I love being a fan and surrounded by other fans.

If I had money on the game, I would not listen to my fellow fans; I wouldn’t even trust my own opinion. As a fan, I have too much skin in the game. With money on the line, I would look at a computer model, or read what an expert or experts say. I would also try to get a consensus opinion of experts by looking at the Las Vegas betting line, or prediction markets. Experts and aggregations of experts somehow stay above the fray and remain objective.

There is a similar relationship between economists, politicians, and citizens; economists are the experts and politicians are the players, the media, the band, and voters, the fans. Politicians and voters are partisans, allegiance to the team comes before objectivity. Politicians enact policy through law, and economists study the impact of policy and advise politicians. Politicians need good positive economics to achieve their normative goals. But if I were a politician, I would like to know my advisors had my back, and would not hire an advisor unwilling to show allegiance to me.

Economists advising politicians walk a fine line between holding to their science and remaining objective, or becoming partisans. Occasionally, a good advisor might contradict the politicians they advise as did Greg Mankiw when he said,

Romney has had to distance himself from his top economics adviser after Mankiw _ a Princeton-trained economist now teaching at Harvard _ voiced his support for an immigration bill Romney strongly opposes [1].

At some point, an economist must become a partisan, or at least bit his tongue when his team supports policy that contradicts good science as Greg Mankiw did when he supported tax cuts that important Bush administration officials said would raise tax revenues. Mankiw is on the record as stating that tax cuts don’t increase tax revenue. He took incoming fire from fellow economists for his silence, but defended himself by parsing words, noting that, “Being opposed to a tax cut as a policy and being critical of an argument for tax cuts are two different things. [2]” In response to Mankiw’s relative silence and awkward position on the revenue impact of the tax cut, Brad DeLong noted,

Mankiw was indeed correct in thinking that he personally could do more good for the country and the world working inside than if he were to march up to Dick Cheney, tell him "you have to stop saying that tax cuts raise revenues," and so get fired. But the Bush administration did frequently argue that tax cuts raised revenue. And there is the much harder question: is it worth the sacrifice of the economics profession's outside credibility and the further confusion of the public that is entailed when good economists defend bad policies on the outside that they are working to change on the inside? I don't know the answer to that.

The world has need for both experts and partisans, and it is difficult to do both simultaneously. Anyone who reads my blog for any period of time will note that I do not like economists surrendering their science for partisanship. I believe that most economists share my sentiments. I hope that I can be fair. Best wishes to the Obama economics team that now must walk that fine line.

[1] Glen Johnson, “Romney Finds Advisors Both Help And Hurt,” The Washington Post, June 19, 2007.

[2] Nathan Strauss, “Mankiw Defends Tax Cut Stance, Faces Online Flak,” The Harvard Crimson, July 13, 2007.

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Sunday, January 4, 2009

Economics and Religion

On October 9, 2006, Russ Roberts interviewed Larry Iannaccone, pictured above, on the economics of religion for EconTalk. All of the discussion is worthwhile, but I want to focus on the impact of state regulation on religion.

Beginning at 11:25 minutes, Iannccone explained that intellectuals at the time that English colonies were established believed that religion was important for society, creating positive externalities which are benefits that society receives from individual membership in a church. They also believed that people would not attend religious services if membership was not mandated. To order society so that individuals and society as a whole received the benefits of religion, colonial rulers established state religions. The state mandated that citizens be members of the state church, and set up barriers to entry, making it difficult to impossible to participate in a non-state sponsored religion.

The Constitution of the United States began the first experiment with free market religion and strengthened the Great Awakening. As people could choose their religion freely, state churches declined, and upstart religions like the Methodists and Baptists grew rapidly. As competition among churches increased, the overall proportion of people that attended increased.

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Saturday, January 3, 2009

Michael Spence and Root Causes

Michael Spence is a Nobel Prize winner in economics for his analysis of markets with asymmetric information. In a Financial Times Economist Forum titles, "Balance sheets and income statements: breaking the downward spiral" he gives his opinion about the causes of the current financial crisis and recommendations on how to solve it.

I recommend this article. For those who do not wish to read it, here is a quick synopsis. The financial crisis which is international in scope was due to extreme leverage, an underestimation of risk, and the growing correlation of risk between assets. As an example of the correlation of risks between assets, the risk that housing prices in Atlanta would fall at the same time that housing prices in Las Vegas fell increased. The falling housing values were also linked to the default rate on mortgages. Assets and liabilities are found on balance sheets and the correlations were not limited to housing.

Developed economies have to deleverage, lower asset values, and temporarily reduce consumption, but the process may be going too far. Investment, consumption and employment, all part of our national income statement have entered a feedback loop with the balance sheet that is creating a sort of negative bubble. Asset values are being reduced too much, and this in turn results in too great a reduction in investment, consumption and employment. The loop then passes through the loop again.

Spence recommends a large stimulus package, hopefully international in nature, as well as announced in advance. He notes that addressing asset deflation is crucial and very difficult. He also recommends that governments buy assets. He notes that under current conditions, governments will make many mistakes, opening themselves to critics. He ends by noting that it is fortunate that the government's deeds will be done before the critics pens have cooled.

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Treasury Secretary Hank Paulson Blames...

Krishna Guha of the Financial Times reports that is a valedictory interview, Mr. Paulson said that

in the years leading up to the crisis, super-abundant savings from fast-growing emerging nations such as China and oil exporters – at a time of low inflation and booming trade and capital flows – put downward pressure on yields and risk spreads everywhere...Excesses...built up for a long time, [with] investors looking for yield, mis-pricing risk. It could take different forms. For some of the European banks it was eastern Europe. Spain and the UK were much more like the US with housing being the biggest bubble. With Japan it may be banks continuing to invest in equities.

Mr. Paulson said the solution was better global macroeconomic cooperation, better regulation and risk pricing.

I have briefly looked for a transcript of the interview and could not find it. Perhaps in the full text he stated how a need for better regulation springs from the root causes he names, certainly regulators erred in pricing risk as did investors. Hazarding another guess, from a U.S. perspective, perhaps by global macroeconomic cooperation, he means pegging Asian exchange rates differently so as to generate fewer imports, more exports, and less net capital inflows.

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Friday, January 2, 2009

A Cautionary Tale of Bailing Out Equity

This post is dated; it should have been written in September or early October. On October 1, Paul Krugman made a prescient remark on the government bailout,

My view, which I think is now shared by many economists, is that Paulson grabbed hold of the wrong end of the stick — he should have been seeking to expand bank capital, taking an ownership share in compensation, rather than trying to push up the value of toxic paper. In the end, that’s what we’ll probably do.

Later, Krugman criticized the Bush administration for taking equity but not protecting taxpayers by voting rights or negotiating other concessions from banks and investment banks.

On October 5, Don the swing voter from the Daily Kos succinctly stated his plan,

Nationalize. Then privatize. That is a proven approach.

I am in a fortunate position. I can sit back and criticize without making a decision. I do agree with Don, if you are going to buy equity, nationalizing or partially nationalizing, get in and out as quickly as possible. Long ago, in economic circumstances far, far away, Boarding and Vining studied the performance of private firms, state-owned enterprises, and mixed firms. Mixed firms have both private and government ownership. They found that

The results provide evidence that after controlling for a wide variety of factors, large industrial mixed enterprises and state-owned enterprises perform substantially worse than similar private companies.

While banks, investment banks, and insurance companies are not industrial companies, the incentives faced by private companies, nationalized companies and partially nationalized companies differ. Private companies will try to maximize profits while minimizing costs.

State-owned companies may try to increase employment, increase worker pay, introduce what they consider socially beneficial products, or not introduce innovative products.

Many mixed firms have the worst characteristics of both private firms and state-owned firms. Like Fannie and Freddie, profits may be private and losses paid by taxpayers, or they maintain inefficient social policies to satisfy government overseers.

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Thursday, January 1, 2009

Israel, Hamas, War and Peace

Warning. I do not pretend to have expertise on political events in the Middle East. I attempt to illustrate how an economic model developed by Jack Hirshleifer can be used to discuss them.

War continues between Israel and Hamas, with both sides rejecting international calls for a cease-fire. I can understand the Israeli position; if Canada or Mexico were firing missiles into the U.S. I would expect the government to react. I do not understand the Palestinian position if Hamas represents it. Why lob missiles into a country that is wealthier, has more military might, and in the past has shown a willingness to use it?

Jack Hirshleifer wrote a paper titled "Appeasement: Can It Work" that was published in the American Economic Review. I link to his UCLA working paper with the same title here. The paper uses game theory and preference theory to examine decisions made by the western powers (Britain and France) and Hitler's Germany.

Hirshleifer begins by using game theory to compare strategies for the western powers under four different models of Hitler's preferences: peace-loving, aggressive, aggressive but appeasable, and peace-loving but bluffing aggression. The correct response by the western powers, with one exception, was to oppose Hitler.

The exception was the aggressive but appeasable Germany. Hirshleifer introduces preferences to further evaluate this alternative, considering a reduction in western standing measured in income as a superior good and then as an inferior good to Germany. Consumption of a superior good increases as wealth increases, implying that a wealthier Germany would devote more resources to diminishing western income. Consumption of an inferior good decreases as wealth increases, implying that a wealthier Germany would devote fewer resources to decreasing western income.

To summarize his conclusions, Hirshleifer offers the following proposition,

If the opponent's preferences are hostile and non-appeasable, the best strategy is to keep her so poor that she cannot afford to engage in deprivation. If the opponent is hostile but appeasable, the best strategy is to make her so affluent that she will no longer desire to exercise her deprivation option.

To quote Dr. Emmitt Brown, "back to the future." Through Palestinian blundering or Israeli policy, Palestine is about as poor as can be imagined. According to our model, Palestinians should not be able to threaten Israel, but outside interests seem to play a big role.

Iran is using Hamas to fight a proxy war with Israel. I can see no benefit to Palestinians in general but a benefit to Hamas leadership whose hate or lust for power is so great that they would sacrifice the welfare of their people.

The modern western powers seem to be operating under the premise that hostility is an inferior good to Palestinians, and that they can buy peace for Israel by making Palestinians wealthier. In this case, the wealth may be through national pride gained through land and other concessions by Israel.

Despite enormous simplifications made in this model, the conflict between Israel and the Palestinians seems very complex. My guess is that hostilities between Israel and the Palestinians will not end until the Palestinians are freed from Iranian influence.

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