Murphy on Inequality and Economic Growth

(HT Mankiw). Kevin Murphy of the University of Chicago was interviewed by Douglas Clement, the editor of The Region, which is published by the Federal Reserve Bank of Minneapolis. The interview is divided into about ten sections. I will probably post on several. Clement first describes Murphy's qualifications.

Murphy is one of the world's finest economists. In 1997, he received the John Bates Clark medal, awarded to the most promising economist under the age of 40. A year later he was elected to the American Academy of Arts & Sciences, rare for an economist so young.

In 2005, the MacArthur Foundation gave Murphy one of its so-called genius grants in recognition of his research on "seemingly intractable economic questions, placing them on a sound empirical and theoretical footing." And in 2007, he won the prestigious Kenneth J. Arrow award for work on the economic value of health and longevity. "He's brilliant, very brilliant, and I don't use that term often," said Nobel laureate Gary Becker in 2006. "He is at the top ranks in economics."

The first topic is inequality and economic growth. As many have noted, inequality has grown over the last thirty years. Murphy explains that the return on education has increase, resulting in increased inequality.

First, you have to think about the growth of inequality and where it’s come from, and probably the easiest place to start is education and the return that people get on their education. Over the decade of the 1980s and continuing though the 1990s, we saw growth in the premium for going to college. This can be seen best by comparing the average amount earned by college graduates to the average amount earned by high school graduates. In the late 1970s, the ratio of the two averages was about 1.35, saying that college graduates earned on average about 35 percent more than high school graduates.

By the time we get to the late 1990s, that number is more like 1.7, meaning that by the late 1990s, the average college graduate earned 70 percent more than the average high school graduate. Thus, between the late ’70s and the late ’90s, the return to going to college roughly doubled. If you look at the return to going to graduate school compared to stopping after high school, that gap increased even more.

On the one hand, you could say, well, that means there’s more inequality. College graduates used to earn more than high school graduates. Now the gap is even bigger than before. That’s sort of the downside, and I think that’s one of the first reactions people have.

Of course, the other side of the equation is that the return to going to college—that is, the return on your investment, if you invest the time, money and effort to go to college—is higher today than it’s probably been in half a century. That’s a good thing. When we say we have a higher return on investment, whether you earn more on your stock market investment or on your college investment, we think that that’s a good thing. It means there’s greater opportunity out there for individuals and society as a whole to increase our incomes by increasing our investment in people, by investing more in their education.

Many people believe that increasing inequality within society is bad and that the "rich" should be taxed at a higher rate to pay for government services to be given to the "poor."  I put rich and poor in quotation marks because few ever define where poor ends and rich begins.  Knowing that much of the increase in inequality is a result of a better return to education, do you believe that the economic system is flawed, or that the better educated (the rich) should be taxed at a higher rate to pay for services for the uneducated (the poor)?
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James Hamilton Defends Ben Bernanke

James Hamilton of Econbrowser ably and appropriately defends Federal Reserve Chairman Ben Bernanke who was browbeaten by members of the House Committee on Oversight and Government Reform ("On grilling the Fed Chair," June 27, 2009). Hamilton writes,

It is one thing to have different views from those of the Fed Chair on particular decisions that have been made-- I certainly have plenty of areas of disagreement of my own. But it is another matter to question Bernanke's intellect or personal integrity. As someone who's known him for 25 years, I would place him above 99.9% of those recently in power in Washington on the integrity dimension, not to mention IQ. His actions over the past two years have been guided by one and only one motive, that being to minimize the harm caused to ordinary people by the financial turmoil. Whether you agree or disagree with all the steps he's taken, let's start with an understanding that that's been his overriding goal.

These interrogations reveal more about those doing the grilling than they reveal about Bernanke. I see this as pure political theater, and I don't like it.

If Congress wants to explore more usefully the wisdom and motives behind some of the decisions that have been made, it might want to investigate why some legislators are now pushing for Fannie and Freddie to guarantee a riskier category of mortgage condo loans.

Occasionally a bit technical for readers with limited background in economics, Econbrowser is one of the best blogs on economics. James Hamilton and Menzie Chinn are excellent economists and writers.

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The Nanny State and Light Bulbs

Liz Sidoti, an AP reporter writing for the Washington Post in "White House announces new lighting standards," dated June 29,2009 reports that,

Aiming to keep the focus on climate change legislation, President Barack Obama put a plug in for administration efforts to make lamps and lighting equipment use less energy.

"I know light bulbs may not seem sexy, but this simple action holds enormous promise because 7 percent of all the energy consumed in America is used to light our homes and businesses," the president said, standing alongside Energy Secretary Steven Chu at the White House.

Obama said the new efficiency standards he was announcing for lamps would result in substantial savings between 2012 and 2042, saving consumers up to $4 billion annually, conserving enough energy to power every U.S. home for 10 months, reducing emissions equal to the amount produced by 166 million cars a year, and eliminating the need for as many as 14 coal-fired power plants.

Does anything escape the notice of this president?  He opened our garage doors and learned we were buying the wrong kinds of cars and mandated that we drive cars that on average get 35 miles per gallon, saving us $520 per year.  He opened our mail and learned that we are not smart enough to shop for the best terms for credit cards and, with Congress, ordered that banks alter terms and conditions to favor consumers.  Unfortunately, the banks will cut credit to customers with weaker credit histories, but this is OK because President Obama said that many Americans are irresponsible with their debt.  Now he peeks through the windows of our homes and sees that we are using the wrong kind of bulbs and mandates that we use cost saving bulbs. 

Mr. President, I am smart enough to buy my own car, shop for credit cards and pick light bulbs.  Leave me alone!
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Cap-and-Trade Advocates Who Oppose Waxman-Markey

I have selected three articles that point to a rift between environmental groups and the Obama administration over the Waxman-Markey cap-and-trade legislation. The writers do not oppose cap-and-trade legislation in general, but his version of it. Josh Harkinson of Mother Jones gives a good summary of the debate within and between environmental groups about the Waxman-Markey legislation in "The War Over Waxman-Markey," dated June 22, 2009.

A long-awaited vote on the Waxman-Markey climate bill, expected this week or early next month, has environmentalists teetering at the edge of existential crisis. Some believe the bill is so deeply flawed it might actually make matters worse...

The split encompasses more than predictable ideological divides. Debate over the relative merits of a carbon tax versus this bill's cap-and-trade model has mostly given way to concerns about whether the legislation, sponsored by representatives Henry Waxman (D-Calif.) and Edward Markey (D-Mass.), lines the pockets of polluters with little to show for it. The most it would cut carbon emissions by 2020 is 17 percent below 1990 levels, nowhere near the 25 to 40 percent reduction sought by scientists and international climate negotiators. The Sierra Club has withheld its endorsement in hopes of improving the bill before a final vote—it wants to prevent polluters from receiving tradable emissions permits for free, preserve the EPA’s authority to independently regulate carbon, and better fund energy efficiency and clean energy—but Fahn and other environmentalists are skeptical that lawmakers will listen. “From my perspective,” he says, “the prospects of strengthening it to where we’d want to support the ultimate version are growing slim.”

Greenpeace's USA Deputy Campaigns Director, Carroll Muffett issued the following statement in "Greenpeace Opposes Waxman-Markey," dated June 25, 2009.

"Since the Waxman-Markey bill left the Energy and Commerce committee, yet another fleet of industry lobbysists has weakened the bill even more, and further widened the gap between what Waxman-Markey does and what science demands. As a result, Greenpeace opposes this bill in its current form. We are calling upon Congress to vote against this bill unless substantial measures are taken to strengthen it. Despite President Obama’s assurance that he would enact strong, science-based legislation, we are now watching him put his full support behind a bill that chooses politics over science, elevates industry interests over national interest, and shows the significant limitations of what this Congress believes is possible.

“As it comes to the floor, the Waxman-Markey bill sets emission reduction targets far lower than science demands, then undermines even those targets with massive offsets. The giveaways and preferences in the bill will actually spur a new generation of nuclear and coal-fired power plants to the detriment of real energy solutions. To support such a bill is to abandon the real leadership that is called for at this pivotal moment in history. We simply no longer have the time for legislation this weak.

“With many others in the environmental, faith and consumer rights communities, Greenpeace has expressed tremendous concern about the role of offsets in this legislation. Unless strictly controlled, the abuse of offsets could prevent real emission reductions for more than a decade. The decision to move authority over offsets from EPA to the Department of Agriculture further reduces the likelihood that such controls will be maintained and increases the likelihood they will undermine real reductions.

Clive Cook, writing for the Financial Times in "Obama is choosing to be weak," dated June 28, 2009 states that,

The cap-and-trade bill is a travesty. Its net effect on short- to medium-term carbon emissions will be small to none. This is by design: a law that really made a difference would make energy dearer, hurt consumers and force an economic restructuring that would be painful for many industries and their workers. Congress cannot contemplate those effects. So the Waxman-Markey bill, while going through the complex motions of creating a carbon abatement regime, takes care to neutralise itself.

It proposes safety valves that will ease the cap if it threatens to have a noticeable effect on energy prices. It relies heavily on offsets – theoretical carbon reductions bought from other countries or other industries – so that big US emitters will not need to try so hard. It gives emission permits away, and tells utilities to rebate the windfall to consumers, so their electricity bills do not go up. It creates a vastly complicated apparatus, a playground for special interests and rent-seekers, a minefield of unintended consequences – and the bottom line for all that is business as usual.

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Stavins On Cap-and-Trade

Greg Mankiw linked without comment to an excellent article by Robert Stavins titled "The Wonderful Politics of Cap-and-Trade: A Closer Look at Waxman-Markey," and published May 27, 2009. He defends cap-and-trade as a method to reduce pollution in general and its specific application to reducing carbon emissions through the Waxman-Markey bill. I do not know if he would support the bill in its final form. Stavins makes several points about the efficiency of cap-and-trade that he (and I) believe are not well understood. Perhaps the most important point to remember is that a cap-and-trade system efficiently reduces emissions regardless of the allocation of initial permits.

Generally speaking, the choice between auctioning and freely allocating allowances does not influence firms’ production and emission reduction decisions. Firms face the same emissions cost regardless of the allocation method. When using an allowance, whether it was received for free or purchased, a firm loses the opportunity to sell that allowance, and thereby recognizes this “opportunity cost” in deciding whether to use the allowance. Consequently, the allocation choice will not influence a cap’s overall costs.

Stavins believes that

...the political process of states, districts, sectors, firms, and interest groups fighting for their share of the pie (free allowance allocations) serves as the mechanism whereby a political constituency in support of the system is developed, but without detrimental effects to the system’s environmental or economic performance. That’s the good news, and it should never be forgotten.

I believe that he is largely correct in stressing that the political allocation does not affect cap-and-trade's environmental impact, but I disagree that it is a health process. Stavins implicitly assumes that the bill is necessary and that building a constituency for it is a political necessity. Politicians can bribe carbon emitting special interest groups with allowances if they support the bill or extort support from them with the threat of higher taxes if they don't. Bjorn Lomborg refers to the alliance of politicians and pocket lining businessmen as the "climate industrial complex."

I will illustrate the point with an example. Representative G. W. Green has two carbon emitting producers in his district, Coal Inc. and Dairy Farms. Each will suffer net losses of $100 if the bill passes. Green informs them that the first to announce their support of his vote for the bill will receive allowances valued at $120 paid for by taxes on the other emitter. Dairy Farms caves first, and earns a net profit of $20. Coal Inc. stands on principles and pays the cost of $220. Its not difficult to envision bills passing that are bad for the country but are vociferously supported by special interests who have been paid off. Let me emphasize that Stavins carefully explains how the allowances were allocated as of the publication date and that consumers were the primary beneficiary. My normative value is that $1 of allowances allocated to a consumer is of no more value to society than $1 of allowances allocated to any other group. I suspect that I am of the minority position yet again.

Finally, Stavins lists his concerns of which I mention two. He seems to prefer an auction to free distribution of allowances.

First, auction revenue may be used in ways that reduce the costs of the existing tax system or fund other socially beneficial policies. Free allocations to the private sector forego such opportunities. Below I will estimate the actual share of allowance value that accrues to the private sector.

I agree that auction revenue might be wisely used, but that there is a high probability that it will not.

Stavins and I share a concern about the impact of cap-and-trade on the competitiveness of the United States in international markets. He is optimistic about potential solutions; I am not. He writes,

The only real solution to the competitiveness issue is to bring non-participating countries within an international climate regime in meaningful ways. (On this, please see the work of the Harvard Project on International Climate Agreements.)

As a skeptic of anthropogenic global warming theories and particularly catastrophic predictions of death and destruction, I recommend that those interested in global warming and possible solutions read Stavin's original article and the links in his quotes. Given the assumption that global warming is largely a man-made problem, he gives good analysis of possible solutions.
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Initial Unemployment Claims for June 26, 2009

As I have mentioned in previous posts, Robert J. Gordon did research looking at the relationship between the 4 week moving average of initial unemployment claims and found that recessions often bottom out shortly after the 4-week moving average of initial unemployment claims peaks. The average may have peaked at 658,750 for the week ended April 4, 2009. On June 26, 2009 the Department of Labor released the most recent data on initial unemployment claims for the week ended June 20, 2009 in "Unemployment Insurance Weekly Claims Report." Seasonally adjusted initial claims was 627,000, up 15,000 from a revised estimate of initial claims of 612,000 for the week ended June 13, 2009. The 4 Week moving average increased 500 to 617,250. The average is down 41,500 from its peak, signaling a possible peak for this business cycle. Even though the average has declined, initial claims are still very high.

Using National Bureau of Economic Research estimates on the beginning and ending dates of recessions, I have also included a graph that compares the recession that began in March 2001 with the current recession which began in December 2007. Both graphs are measured over 92 weeks, beginning eight weeks before the recessions began. The horizontal axes begins in October 2007, and the data for the 2001 recession is superimposed on those dates. The graph gives some insight into why economists, politicians and others have expressed so much concern about the current recession. As time permits, I will add data from other recessions to the graph.

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Markets Have Few Friends in Politics

It's often hard to devine how a politician's public pronouncements will affect policy when he or she assumes office. Both President Obama and former President Bush praised our nation's reliance on markets. In Audacity of Hope (2006) President Obama wrote,

Our Constitution places the ownership of private property at the very heart of our system of liberty.... The result of this business culture has been a prosperity that's unmatched in human history...The result of this business culture has been a prosperity that’s unmatched in human history. It takes a trip overseas to fully appreciate just how good Americans have it; even our poor take for granted goods and services – electricity, clean water, indoor plumbing, telephones, televisions, and household appliances – that are still unattainable for most of the world. Our greatest asset has been our system of social organization, a system that for generations has encouraged constant innovation, individual initiative and the efficient allocation of resources.

President Bush expressed faith in markets during a CNN interview held June 18, 2009 in Eire, Pennsylvania, when he criticized President Obama's reliance on government rather than markets to solve the nation's problems.

Concerning the economy, Bush told the 104th annual Manufacturer and Business he knows "it's going to be the private sector that leads this country out of the current economic times we're in. You can spend your money better than the government can spend your money."

Bush remained optimistic about the country's future, pressing for free trade, open markets and the free enterprise system, the Times reported.

"We'll come out of this better than before," he said.

He was less sanguine bout Obama's plan to overhaul the U.S. healthcare system.

"There are a lot of ways to remedy the situation without nationalizing healthcare," Bush said. "I worry about encouraging the government to replace the private sector when it comes to providing insurance for healthcare."

Also in the Audacity of Hope, President Obama emphasizes the role of government in correcting perceived imperfections of markets.

Aside from making needed investments that private enterprise can't or won't make on its own, an active national government has also been indispensable in dealing with market failures...But it was during the stock market crash of 1929 and the subsequent Depression that the government's vital role in regulating the marketplace became fully apparent. With investor confidence shattered, bank runs threatening the collapse of the financial system, and a downward spiral in consumer demand and business investment, FDR engineered a series of government interventions that arrested further economic contraction.

At best, President Obama's actions indicate that prior to his administration there was a huge imbalance in our economy incorrectly favoring markets that required a vigorous government to correct. At worst, he gave lip service to markets that he described as the "very heart of our system of liberty."

The second quote shows that President Obama also exhibits a distressing view of the positive influence of government during the Great Depression, our longest and most severe economic crisis. The government made the recession much worse than it would have been if it had not intervened. The Federal Reserve contracted the money supply when it should have been expanded. The Congress and President Hoover promoted protectionism when they should have defended trade. Both the Hoover and Roosevelt administrations used a variety of policies to freeze wages and prices that should have remained flexible. If government policy helped, it was by accident, not well thought out coordinated policy.

President Bush said that he supported markets, but when the financial crisis hit and push came to shove his administration overrode bankruptcy law and passed the biggest bailout in American history. President Bush was famously quoted as stating that, "I've abandoned free-market principles to save the free-market system." At best, President Bush feared to trust market institutions he extolled when the economy under stress. At worst, his support of markets was feigned and as Don Boudreaux writes,

The man who never cheats on his wife because no other woman will have him is not particularly principled - but he proudly fancies himself that way. So the first bimbo he sniffs who'll do him the honor will prompt him to "abandon his principles" with as much alacrity as a hungry dog will attack a ham. Such are the principles of our "leaders."

In one case, we have a president who secretly waits for a crisis to eagerly replace market institutions with government, and on the other, a president who fears trusting markets to solve economic upheaval once it occurs. Neither was a friend of markets.
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Epstein on Bankruptcy and Bailouts

Richard Epstein was interviewed by Peter Robinson of Uncommon Knowledge with Peter Robinson on a wide range of subjects involving law and economics. The interview is divided into five segments; a transcript is also provided. I will be quoting from the third segment in which Robinson asks Epstein about the impact of government bailouts of firms outside of bankruptcy courts.

Peter: During the final months of the Bush administration...the fed and treasury cooperated in overseeing a fire sale of Bear Stearns, the effective nationalization of Freddie Mac, Fannie May and AIG and in bailing out GM and Chrysler President George W. Bush on January 12th, 2009, "I readily can see that I chucked aside some of my free-market principles." Did Bush and his administration do right?

Richard: Not really. Let me sort of indicate what I think first the proper approach is structurally and then how to treat it...the first and kind of difficult situation was the Bear Stearns situation in 2008. And I had actually looked at the terms of that transaction and it looked like a pretty standard bankruptcy situation in which the priority rules apply so that the debtors got money before the shareholders got money and when all the shareholders at Bear Stearns claimed that they had been given a haircut that was a good not necessarily a bad sum.

Peter: You're saying that Bernanke and then Treasury Secretary Paulson handled it reasonably well? They achieve a close facsimile of actually bankruptcy?

Richard: But the steak was that they did it and it would have been much better to have a bankruptcy clause do this.

Peter: The original sin in all this was letting Bear Stearns go not letting Lieman [assumed spelling][the correct spelling is Lehman] go down later it was letting Bear -- it was saving Bear in the first place?

Richard: Well it was saving Bear through political means through the treasury...bankruptcy has is two forms it has liquidation and it has reorganization...If a concern has going concern value that is it continues to work in a sensible way...you'll keep it alive in the reorganization thing, sell off useful units and rationalize the rest of the structure and it'll be free of political complications and the shareholders may come out with a little and they may come out with a lot. The reason why I give them pretty good marks is that when they try to do this through the Treasury Department in the Federal Reserve they were trying to do what a bankruptcy judge did and they were left relatively free of political interference. The danger is when you start getting to Lieman [Lehman] and everybody else and now you're keeping it out of bankruptcy if it's in the political arena you're gonna save some, you're not gonna save others, you're gonna get a lot lobbying to see what you get to save and why. In addition to that you're not gonna be able to keep it off of congress' desk so if you go back and you look in the October transformation the first of the bills which was designed to deal with the AIG problem and so forth was about 3 pages it was a kind of standard bail-out bill. The republicans vetoed it because it was a giveaway, they had a point right? By the time you got it past a week later that bill was 150 pages and my favorite portion of the bail-out program is the Paul Wellstone [assumed spelling] mental health and addiction provisions which were designed to establish parody in health care markets in the treatment that's afforded to mental illness and addiction treatment with physical injuries, somehow or other that had to be part of the bail-out right? And so at this particular point you're having regulatory chaos come into place because everybody says oh you want my vote on this bail-out you got to do my favorite things and measures that could never pass while standing alone get passed when bundled up with everything else...

Peter: You know what -- can I just -- one of the common threads here in your comments about the Bush administration and the Obama administration is that they don't know enough about bankruptcy law, they don't understand -- it sounds to me as though they're permitting themselves to be spooked like an ordinary layman to think that bankruptcy equals...death and destruction...it's a relatively orderly process, we have legal, this law is well known, there are bankruptcy judges who know how to do it, right?

Richard: Yeah what we do is we take it away from experts and give it to a collection of congressional individuals who are charitably called clowns, I mean it really makes no sense whatsoever to do it in this particular fashion. And as I look this over time and time again I'm always struck about how it is when you bring things to congress it becomes politicized and politicized decisions become destructive decisions.

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China and Trade Restrictions

Despite a great economic awakening, the Chinese government controls imports, hindering future growth.  The U.S. and the European Union have both filed complaints with the World Trade Organization over the Chinese government's trade policy.  (HT Drudge) A June 23, 2009 AP story titled, "US files WTO case against China over exports," reads,

The United States has filed its first trade case against China with the World Trade Organization, accusing the Asian power of restricting exports of certain raw materials to give Chinese manufacturers "unfair advantages."

Trade Representative Ron Kirk says the U.S. is "deeply troubled at what appears to be a conscious policy to create unfair advantages for Chinese industries" by restricting exports of raw ingredients used in steel, aluminum and chemicals.

Kirk said Tuesday dialogue was the preferred method to settle the dispute, but that China has not changed its policies despite the U.S. raising the issue repeatedly.

The European Union also requested formal WTO action with China on the issue.

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Hazlett and Subsidies of High-Speed Data Networks

Thomas Hazlett and Richard Epstein write periodically in the "New Technology Policy Forum" in the "Technology" section of the Financial Times.  Anyone interested in telecommunications should keep up with their work.  As part of the stimulus bill, formally known as the American Recovery and Investment Act, the Congress allocated $7.2 billion to subsidize the spread of high-speed data networks in unserved and underserved areas.  Hazlett explains why this program as passed by the Congress will not stimulate economic activity ("Shovel-ready broadband stimulus," May 1, 2009).  It is illustrative of perverse incentives created by government programs to improve private economic activities through subsidies.

Plagued with the sharpest economic downturn in a generation, US policy makers scrolled through a series of emergency deficit-enhancement measures in 2008-09. The third and final such effort was enacted in February. At $800bn, it set a new standard for government red ink: 12 per cent of 2009 GDP – twice the previous post-World War II high.

The theory is that, by sweeping unemployed resources into the marketplace, society not only gets a bargain, it bucks up consumers and investors, instilling confidence. And don’t forget this stimulation: emergency spending projects are to Congress what free beer is to a college fraternity party.

Markets are yet to feel the buzz, but what society will be getting is, in some instances, already visible. Consider the $7.2bn subsidy spread across the Broadband Technology Opportunities Act (Department of Commerce) and the American Recovery and Investment Act (Department of Agriculture), monies to fund up to 80 per cent of the cost of building private high-speed data networks in “unserved” and “underserved” areas.

As much as it hurts me to say this about programs with such well-polled names, neither program will achieve what it advertises for the US economy. They do offer real hope, however, that the recession will soon be over for communications lawyers and shareholders of ridiculously inefficient rural telephone companies.

In macro-economic terms, meanwhile, the “broadband stimulus” may be perverse: firms that had been building rural broadband networks have reportedly halted operations, circling back to Washington. In March, industry consultant Joseph Upton noted that rural phone carriers were “paralysed,” unsure how to play the subsidy game. “One CEO told me that she had six previous quarters of 25 per cent growth in a company that had been on the skids,” wrote Upton, “but the minute the stimulus word came out, all business just stopped.”

In an unquoted section of the article, Hazlett explains that a reverse auction, which is supported by 71 economists including two Nobel Laureates and Hazlett, might solve some of the problems inherent in the bill and why the Congress will not support a more efficient method of allocating funds.
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Candis on Health Care Reform

Candis made an excellent comment to my post, "Samuelson and Health Care Reform."  She mentions that the supply curve for doctors' services is inelastic and that the demand from medical services will increase as more people are covered.  I wish to address several points she makes.  I quote Candis.

Universal healthcare would cause an upward shift in demand for healthcare. In the short term, 8 years or more, the supply of doctors would be more inelastic than the demand for them since training to be a doctor is such a long time consuming process. This will result in physicians valuing their time more highly and increasing the cost of a doctor visit in accordance with what is demanded of them. Some thought needs to be given to building up the infrastructure of the healthcare system to accommodate the 45 million now uninsured who would be accessing healthcare if universal healthcare is enacted.

The short run supply of doctors services should be inelastic, and demand should increase are points understood by those who helped design the Obama administration's health care reform plan.  David Cutler, a Harvard University professor, one of the nation's leading economic scholars on the economics of health care, and an election advisor to candidate Obama, outlines the international history of health care reform ("Equality, Efficiency, and Market Fundamentals: The Dynamics of International Medical-Care Reform," Journal of Economic Literature, Vol. XL, September 2002).  Cutler addressed one aspect of the supply of medical services, physicians' salaries.  European governments have been successful at limiting the income of physicians over time but not other health care workers.  Cutler writes,

When there are quasi-rents [producer surplus] in medical-care provision, as there are in the return to past investments by physicians, price reductions need not be accompanied by reduced supply.

Empirical evidence shows that regulation affected both prices and quantities of care provided.  Providers earn less in regulated systems than they do in unconstrained systems.  Real earnings of physicians in the United States increased by 35 percent between 1970 and 1990.  In countries with expenditure limits, by contrast, real earnings were flat.  As a result, doctors in the United States now earn twice what their counterparts earn in other countries...

There may be savings in other factor payments from cost controls, but these will be smaller.  The opportunities for nurses, orderlies, and other personnel to move to other industries prevents a large income reduction for these groups.  Physicians, in contrast, have much more profession-specific human capital.

As a technical note, quasi-rents and producer surplus are the same.  They are pure profit, the repayment of fixed costs, or both.  The Obama plan would deal with the inelastic supply of doctors' services by extracting quasi-rents or producer surplus from doctors by using the government's position as a large supplier of medical coverage to lower payments to doctors.  Economists refer to this type of action as holdup.  Holdup occurs when one party to a contract alters it to his or her advantage after the other party has taken an irreversible action called for by the contract; it reduces producer surplus.  My argument is that doctors have an implicit contact through markets.  If a person completes the grueling process required to become a physician, they will earn a good salary.  I do not like the idea of using holdup to change the agreement between the government and existing physicians for normative and positive reasons.  Normatively, changing agreements after they have been formed is wrong as the term holdup implies.  Positively, holdup will reduce the quality or quantity of care at some time in the future, a point I believe that Cutler glosses over when he writes,

Price reductions are, in the short term, a transfer from medical-care providers to consumers.  There may be long-term effects on the quantity or quality of medical-care personnel, but these effects will not occur for some time. 

Becoming a physician is expensive, time consuming and grueling.  I believe that compassion for suffering of their fellow beings motivates most who enter medical school, but so does future income.  Stagnating income will drive away many potential physicians and increase the cost of medical care in the long run.

To limit the demand of medical services, the Obama administration will attempt to pass more costs onto the consumer, introduce competition through a government plan, and ration medical care by using information technology to identify valuable and non-valuable procedures.  Passing costs onto consumers violates the notion that the Obama administration supports of medical care being a right and not a traditional service like haircuts.  Furthermore, the goal of passing costs onto consumers can be achieved at lower costs by modifying tax laws to make all medical payments tax deductible, or by taxing all medical payments.  Currently, private markets produce thousands of private insurance plans.  Introduction of a government plan would not be as effective as reducing state level restrictions on the provision of health insurance at introducing new competition.  Finally, I support increased use of information technology in health care, but I don't understand why some argue that the government is needed.  Compare Google, Inc. to your state's department of transportation, or UPS to the US Postal Service and ask yourself who is more technologically efficient. 
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Big Ayatollah and Big Brother vs. Google

Economists generally assume that firms maximize profits, not just in the current period, but overtime.  Maintaining this assumption, The people at Google seem to have adopted very different strategies for dealing with the Iranian and Chinese governments perhaps suggesting that Google's owners and management (Google) believe the Chinese government will survive and the Iranian government will not. 

(HT Drudge)  An unnamed Breitbart.com author writes in "Google vows to fight porn in China after govt rebuke," dated June19, 2009 that,

Internet giant Google promised Friday to work harder to eliminate pornography from its Chinese Web pages as state media reported authorities had shut down some of its search services.

"Google has continually taken measures against vulgar content, particularly material that is harmful to children, on the Internet in China," a statement by the company said.

"Google is currently stepping up its efforts in this regard."

...China has vowed to crack down on Internet content that it deems unhealthy, including pornography and information critical of authorities.

While Google reluctantly submits to Chinese government officials, their response in Iran has been to support consumers.  Alexei Oreskovic of Reuters writes in "Google translation tool aims to improve Iran info access," on June 19, 2009 that Google has improved its product for the Iranian market.

SAN FRANCISCO (Reuters) - Google Inc released a tool that translates Internet blogs, news articles and text messages from English to Persian, and vice-versa, in a move the firm said will "improve access to information" amid the turmoil and media restrictions following Iran's disputed election.

The move is the latest example of the growing role that consumer Internet technology is playing in the wake of Iran's most serious political unrest since the Islamic revolution 30 years ago.

Google Principal Scientist Franz Och, who heads Google's translation group, said in an interview with Reuters that given the recent events in Iran it was a "natural idea" to help people get access to information and to communicate.

"This tool will improve access to information for people inside and outside", Iran, said Och.

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ABC Is a Watchdog?

The media often refers to itself as the fourth estate, whose purpose "is to act as a guardian of the public interest and as a watchdog on the activities of government."  In a Drudge Report article titled, "ABC TURNS PROGRAMMING OVER TO OBAMA; NEWS TO BE ANCHORED FROM INSIDE WHITE HOUSE," dated June 16, 2009, the author reports that ABC joins the first estate, the executive branch, on June 24.

On the night of June 24, the media and government become one, when ABC turns its programming over to President Obama and White House officials to push government run health care -- a move that has ignited an ethical firestorm! Highlights on the agenda:

ABCNEWS anchor Charlie Gibson will deliver WORLD NEWS from the Blue Room of the White House.

The network plans a primetime special -- 'Prescription for America' -- originating from the East Room, exclude opposing voices on the debate. 

The Director of communications at the White House Office of Health Reform is Linda Douglass, who worked as a reporter for ABC News from 1998-2006.

Late Monday night, Republican National Committee Chief of Staff Ken McKay fired off a complaint to the head of ABCNEWS:

Dear Mr. Westin: >

As the national debate on health care reform intensifies, I am deeply concerned and disappointed with ABC's astonishing decision to exclude opposing voices on this critical issue on June 24, 2009. Next Wednesday, ABC News will air a primetime health care reform ?town hall? at the White House with President Barack Obama. In addition, according to an ABC News report, GOOD MORNING AMERICA, WORLD NEWS, NIGHTLINE and ABC?s web news ?will all feature special programming on the president?s health care agenda.? This does not include the promotion, over the next 9 days, the president?s health care agenda will receive on ABC News programming.

Today, the Republican National Committee requested an opportunity to add our Party's views to those of the President's to ensure that all sides of the health care reform debate are presented. Our request was rejected. I believe that the President should have the ability to speak directly to the America people. However, I find it outrageous that ABC would prohibit our Party's opposing thoughts and ideas from this national debate, which affects millions of ABC viewers.

In the absence of opposition, I am concerned this event will become a glorified infomercial to promote the Democrat agenda. If that is the case, this primetime infomercial should be paid for out of the DNC coffers. President Obama does not hold a monopoly on health care reform ideas or on free airtime. The President has stated time and time again that he wants a bipartisan debate. Therefore, the Republican Party should be included in this primetime event, or the DNC should pay for your airtime.

Respectfully,
Ken McKay
Republican National Committee
Chief of Staff

MORE

ABCNEWS Senior Vice President Kerry Smith on Tuesday responded to the RNC complaint, saying it contained 'false premises':

ABCNEWS prides itself on covering all sides of important issues and asking direct questions of all newsmakers -- of all political persuasions -- even when others have taken a more partisan approach and even in the face of criticism from extremes on both ends of the political spectrum. ABCNEWS is looking for the most thoughtful and diverse voices on this issue.

ABCNEWS alone will select those who will be in the audience asking questions of the president. Like any programs we broadcast, ABC News will have complete editorial control. To suggest otherwise is quite unfair to both our journalists and our audience.

One day later, the Drudge Report updated the original article in, " UPDATE: ABC REFUSES OPPOSITION ADS DURING WHITE HOUSE SPECIAL," dated June 17, 2009, the author reports that,

ABC is refusing to air paid ads during its White House health care presentation, the DRUDGE REPORT has learned, including a paid-for alternative viewpoint!

The development comes a day after the network denied a request by the Republican National Committee to feature a representative of the party's views during the Obama special.

Conservatives for Patients Rights requested the rates to buy a 60-second spot immediately preceding 'Prescription for America'.

Some watchdog.
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Samuelson and Health Care Reform

Robert Samuelson does not like health care reform as proposed by the Obama administration.  In a Washington Post op-ed, "Wrong Way on Health 'Reform'," dated June 15, 2009, Samuelson opines,

It's hard to know whether President Obama's health care "reform" is naive, hypocritical or simply dishonest. Probably all three. The president keeps saying it's imperative to control runaway health spending. He's right. The trouble is that what's being promoted as health care "reform" almost certainly won't suppress spending and, quite probably, will do the opposite.

He agrees with the president's Council of Economic Advisers that controlling health costs is important, describes what he believes is the real problem and rebuffs the administration's proposal as cosmetic.

The central cause of runaway health spending is clear. Hospitals and doctors are paid mostly on a fee-for-service basis and reimbursed by insurance, either private or governmental. The open-ended payment system encourages doctors and hospitals to provide more services -- and patients to expect them. It also favors new medical technologies, which are made profitable by heavy use. Unfortunately, what pleases providers and patients individually hurts the nation as a whole.

That's the crux of the health care dilemma, and Obama hasn't confronted it. His emphasis on controlling costs is cosmetic. The main aim of health care "reform" now being fashioned in Congress is to provide insurance to most of the 46 million uncovered Americans. This is popular and seems the moral thing to do. After all, hardly anyone wants to be without insurance. But the extra coverage might actually worsen the spending problem.

Let me describe the problem through an example.  You have group insurance that has a fixed cost, say $500 per month, and a copayment of $20 per visit.  You think you have a cold, but know that there is some chance that it is a sinus infection.  The bill for a visit to the doctor is $100.  The visit is worth $75 to you, but will cost you $20.  The doctor will bill the insurance company for the difference of $80.  During the visit, your doctor checks your nose and says that there is a 95% chance that you have a cold, but that you can know with a 99% certainty that you do not have a sinus infection by taking an additional test costing $50.  Your insurance company picks up the tab, not you.  Your doctor informs you that the test indicates that you do not have a sinus infection, but you are still worried.  He suggests that you can take an antibiotic that will cost you $10 and your insurance company $50 to ease your fear.  You agree to this course of action.  Your bill is $30, well under the $75 value that you put on the visit.  Your doctor is happy because he gave you honest advice, letting you pick between alternatives.  Suppliers (the doctor and pharmaceutical company) billed your insurance company $180 for a visit that you value at $75.  Because there is not a direct connection between the cost of the insurance and the cost of a visit to the doctor, many insured will overuse medical services.  This puts upward pressure on the price of insurance, but because the insurance policy is based on the actions of a group, your actions have virtually no impact on the insurance price and you continue to overuse the service.

Many economists believe that the government can effectively reduce costs by rationing care.  As an example, suppose your doctor proposes a test that he will bill at $85 and that you value at $120, but the government values at $60.  The test will not be approved; your care has been rationed.  Suppose that your position and the government's is reversed.  You value the service at $60 and the government at $120.  You will purchase the test, creating the same type of inefficiency that exists within the current system. 

Dividing the country into two groups, those that were insured before reform and those who were not, who will have their care rationed?  The previously uninsured will get more services implying that rationing will reduce health care services to the previously insured.  The rationed care still does not place a link between your valuation of the medical service and its cost so it is not efficient economically. 

Samuelson does not believe rationing will occur, asserting that expanded coverage will increase costs, and that the cost reducing measures proposed by the administration will be ineffective as have been past "scattershot" reforms that have failed to address the real problem, and that the administration should begin reform with Medicare. 

The one certain consequence of expanding insurance coverage is that it would raise spending. When people have insurance, they use more health services. That's one reason why Obama's campaign proposal was estimated to cost $1.2 trillion over a decade (the other reason is that the federal government would pick up some costs now paid by others). Indeed, the higher demand for health care might raise costs across the board, increasing both government spending and private premiums.

No doubt the health program that Congress fashions will counter this reality by including some provisions intended to cut costs ("bundled payments" to hospitals, "evidence-based guidelines," electronic record keeping). In the past, scattershot measures have barely affected health spending. What's needed is a fundamental remaking of the health care sector -- a sweeping "restructuring"-- that would overhaul fee-for-service payment and reduce the fragmentation of care.

The place to start would be costly Medicare, the nation's largest insurance program serving 45 million elderly and disabled. Of course, this would be unpopular, because it would disrupt delivery patterns and reimbursement practices. It's easier to pretend to be curbing health spending while expanding coverage and spending. Presidents have done that for decades, and it's why most health industries see "reform" as a good deal.

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The Living City?

Tom Leonard has written an interesting article, "US cities may have to be bulldozed in order to survive," for the Telegraph.co.uk in which he or the people he interviews anthropomorphizes American cities like Flint (HT Drudge). 

"Places like Flint have hit rock bottom. They're at the point where it's better to start knocking a lot of buildings down," she said [Karina Pallagst, director of the Shrinking Cities in a Global Perspective program at the University of California, Berkeley]...

If the city didn't downsize it will eventually go bankrupt, he added [Dan Kildee, the treasurer of Genesee County, which includes Flint]...

The city is buying up houses in more affluent areas to offer people in neighbourhoods it wants to demolish. Nobody will be forced to move, said Mr Kildee.

A city is not a living being with a heart, soul and brain, and we should remember that.  It is a political organization formed by citizens to establish rules that will allow people to interact socially and economically.  I understand the difficulty in continually referring to the relevant people involved in government or market actions, but it is a useful exercise.  When Karina Pallagst said that, "Places like Flint have hit rock bottom," she must be referring to the remaining citizens, the property owners, or the citizens that comprise the local government.  Dan Kildee's perspective seems clearer; he is referring to the people that run the city and the financial difficulties they face in providing services to citizens.  The article only condescendingly refers to the citizens served.

When net migration is negative, the remaining population, through their political representatives must decide how to cut back on services.  Kildee suggests that city officials have and should continue to buy property in "good" neighborhoods and offer it in exchange for property in "bad" neighborhoods.  The city officials would demolish homes in the "bad" neighborhoods and return them to a natural state.  This may be a good way for city officials to deal with a declining population if exchange is conducted at market prices but the article suggests that the purchases of homes may not be conducted at market prices.

Flint's recovery efforts have been helped by a new state law passed a few years ago which allowed local governments to buy up empty properties very cheaply.

Without more information, I am doing a little guess work, but it seems that the owners of abandoned homes are the big losers.  If I am a city official wishing to retain employment and needing someone to tax, who better to tax than those who have left the jurisdiction and no longer capable of voting.  Force the owners of abandon properties in the neighborhoods to be preserved to sell at below the market prices and offer it to voters at discounted prices.  Then force owners of abandoned properties in neighborhoods to be demolished to sell at cheap prices and create green zones for remaining citizens.  What a racket!
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Carbon Subsidies?

I do not know if the use of carbon based fuels is causing anthropogenic global warming (AGW), but my readers know that I am skeptical of the doomsday conclusions of many AGW adherents.  Some scientists believe that the earth will grow cooler based on the relationship between solar cycles and weather, and that the cooler climate will adversely impact agriculture, decreasing the supply of some crops and by extension, forcing up prices ("Canada and USA agricultural weather issues and changes in our solar cycles," Watts Up With That, June 15, 2009). 

If the earth is growing cooler, and cooler is bad, and using carbon based fuels combats global cooling, is it time to subsidize their use because they produce a positive externality?Replace this text with...
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Prosperity Without Wealth

I previously suggested that the Obama administration might use the campaign slogan, "No Citizen Gets Ahead."  I have a suggestion for a campaign slogan for Congressmen on the House Financial Services Committee, "Prosperity Without Wealth."  Jim Kuhnhenn, an AP reporter who wrote, "US government seeks to rein in executive pay," explains that Congressmen

...on the House Financial Services Committee said Thursday the administration's efforts to hector the private sector into reining in executive pay might not go far enough.

The administration contends that excessive compensation contributed to the U.S. financial crisis, but rejects direct intervention in corporate pay decisions.

Instead, the administration plans to seek legislation that would try to rein in compensation at publicly traded companies through nonbinding shareholder votes and less management influence on pay decisions.

"I do differ with the administration in that hope springs eternal and their position seems to be that if we strengthen the compensation committees we will do better," said the committee chairman, Rep. Barney Frank...

Rep. Brad Sherman...said that instead of giving shareholders a nonbinding voice on pay, their votes should be binding on boards of directors.

[these Congressmen] and administration officials agreed that companies across the private sector need to adjust compensation practices to avoid damaging the economy.

Please note, as did Barney Frank, that the administration's rhetoric is stronger than the brief description of the legislative proposal.  The administration claims without evidence that excessive compensation contributed to the financial crisis, but rather than limit executive compensation, the administration proposes nonbinding shareholder votes and less management influence on pay decisions.  The new rules might increase executive compensation.  Michael Jensen and Kevin J. Murphy (CEO Incentives--It's Not How Much You Pay, But How," Harvard Business Review, May-June 1990, No. 3) make just this

Paying top executives "better" would eventually mean paying them more...There are serious problems with CEO compensation, but excessive pay is not the biggest issue. The relentless focus on how much CEOs are paid diverts public attention from the real problem--how CEOs are paid.

The administration's proposal as presented by Kuhnhenn aims to change how CEO's are paid and many economists see problems with the corporate incentive structure that determines pay.  Lucian Bebchuk and Jesse Fried ("Executive Compensation as an Agency Problem," Journal of Economic Perspectives, Vol. 17, No. 3, 2003) describe list several reasons why corporate directors may overpay executives: directors generally like to stay on boards, and CEO's play a big role in nominating directors for the board; directors typically have a small equity interest in the firms they serve; market forces are not sufficiently well defined as to guarantee optimal contracts.  They recommend a solution that does not involve government action.

The conclusion that managerial power and rent extraction play an important role in executive compensation has significant implications for corporate governance, which we explore in our forthcoming book (Bebchuk and Fried, 2004). It is important to note, however, that this is an area in which widespread recognition of the problem might contribute to alleviating it. The extent to which managerial influence can move compensation arrangements away from optimal contracting outcomes depends on the extent to which market participants, especially institutional investors, recognize the problems we have discussed. Financial economists can thus make an important contribution to improving compensation arrangements by analyzing how current practices deviate from those suggested by optimal contracting. We hope that future studies of executive compensation will devote to the role of managerial power as much attention as the optimal contracting model has received.

Bebchuk also explains how government action may create perverse incentives (Cari Tuna and Joann Lublin, "Risk vs. Executive Reward," Wall Street Journal, June 15, 2009). 

Mr. Bebchuk, who directs Harvard's corporate-governance program, worries that federal officials are pushing banks to adopt practices, such as granting restricted stock and giving shareholders an advisory vote on executive pay, that may make the problem worse. That is because many banks' share prices are now so low that shareholders, with little to lose, may support executives' taking big risks.

When markets are self correcting, and government action could damage market performance, government officials should opt for the wise policy option of doing nothing. 
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Nynaeve al'Meara on Taxation

While rereading Robert Jordan's "The Wheel of Time Series," in preparation for the release of the final books of the series, I ran across a passage describing Nynaeve al'Meara's opinion about the government taking from the rich to aid the poor.  While waiting to be reintroduced to Masema, who has become the powerful ruler in a large region, Nynaeve witnesses him telling a rich woman that she has too much gold.  The rich women removes her rings, bracelet and necklace and drops them into a bag.  Nynaeve's escorts convincingly inform her that every penny will be used for the poor.  Masema lives in humble home, and even his meals, which are plain, come as gifts.  Jordan gives his character life, describing her feelings.

Nynaeve shook her head.  She supposed it was one way to find money for the poor.  Simply rob anyone who was not poor.  Of course, that would just make everyone poor in the end, but it might work for a time...People who claimed they were collecting money to help others often had a way of letting a good bit stick in their own pockets, or else they liked the power that spreading it about gave them, liked it far too much.  She had better feeling for the man who freely gave one copper from his own purse than for the fellow who wrested a gold crown from someone else's.  And less for fools who abandoned their farms and shops to follow this...this Prophet, with no idea where their next meal would come from.

There are of course similarities with today's political drama.  The biggest difference is that Masema is fictional and President Obama is not.  Other differences should be mentioned.  Masema is insane, President Obama clearly is not.  Masema is an ascetic, a man who would take his wife out for a night on Broadway clearly is not.  Both are willing to take money from the wealthy to aid the poor.
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The AMA and Obama Care

Robert Pear of the New York Times, reports in "Doctors’ Group Opposes Public Insurance Plan," (June 10, 2009) that the American Medical Association (AMA) opposes a government sponsored health insurance plan that candidate Obama claimed would keep private providers honest. 

As the health care debate heats up, the American Medical Association is letting Congress know that it will oppose creation of a government-sponsored insurance plan, which President Obama and many other Democrats see as an essential element of legislation to remake the health care system...

While committed to the goal of affordable health insurance for all, the association had said in a general statement of principles that health services should be “provided through private markets, as they are currently.” It is now reacting, for the first time, to specific legislative proposals being drafted by Congress.

In the presidential campaign last year and in a letter to Congress last week, Mr. Obama called for a new “public health insurance option,” which he said would compete with private insurers and keep them honest.

But in comments submitted to the Senate Finance Committee, the American Medical Association said: “The A.M.A. does not believe that creating a public health insurance option for non-disabled individuals under age 65 is the best way to expand health insurance coverage and lower costs. The introduction of a new public plan threatens to restrict patient choice by driving out private insurers, which currently provide coverage for nearly 70 percent of Americans.”

If private insurers are pushed out of the market, the group said, “the corresponding surge in public plan participation would likely lead to an explosion of costs that would need to be absorbed by taxpayers.”

On his blog, in "What's the point of a public option," Greg Mankiw explains why there is no need for a public health insurance option and why it would not keep private providers honest.

It seems to me that this passage, like most discussion of the issue, leaves out the answer to the key question: Would the public plan have access to taxpayer funds unavailable to private plans?

If the answer is yes, then the public plan would not offer honest competition to private plans. The taxpayer subsidies would tilt the playing field in favor of the public plan. In this case, the whole idea of a public option seems to be a disingenuous route toward a single-payer system, which many on the left favor but recognize is a political nonstarter.

If the answer is no, then the public plan would need to stand on its own financially and, in essence, would be a private nonprofit plan. But then what's the point? If advocates of a public plan want to start a nonprofit company offering health insurance on better terms than existing insurance companies, nothing is stopping them from doing so right now. There is free entry into the market for health insurance. If a public plan without taxpayer support would succeed, so would a nonprofit insurance company. The fundamental viability of the enterprise does not depend on whether the employees are called "nonprofit administrators" or "civil servants."

The bottom line: If the goal is honest competition in the provision of health insurance, the public option cannot do much good but can potentially do much harm.

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Treasury to Bank of America: You've Got Mail

In December 2008, Merrill Lynch & Co. (ML) was on the verge of bankruptcy.  Bank of America (BA) was the Treasury's last remaining viable buyer.  As the negotiations to acquire ML proceeded, additional information about Merrill's potential losses spooked BA CEO Kenneth Lewis, who suggested to Secretary of Treasury Paulson that they were going to exercise a material adverse clause in the merger agreement to end negotiations.  Paulson and Federal Reserve Chairman Bernanke pressured Lewis to go forward with the deal and he capitulated.  Craig Torres and Scott Lanman of Bloomberg tell the story more fully in, "Fed Memo Said Aid for Bank of America Would ‘Come at a Price’" (June 11, 2009).

Jessica Pressler a New Yorker writer gives sage advise in "Fed Flamed Bank of America CEO in E-mails, Threatened to Have Him Fired" (June 11, 2009).

See, this is why we always say that if you're going to threaten someone you should do it in person, in an area that has been swept clean of recording devices. What is even the point of working for the United States government if you cannot take advantage of the CIA's infrastructure for this stuff? The full e-mails have not been released yet, but we imagine when Bernanke's whole "Don't you know who I AM? You and me, we’re f*****’ DONE professionally" rant hits the Internet he's going to be mighty embarrassed.

The Bush administration professed love for markets until the financial meltdown began in September, 2008, when President Bush proclaimed "I've abandoned free-market principles to save the free-market system."[1]  The negotiations between the Treasury and BA illustrate that the Bush administration was willing to run roughshod over private property rights to obtain its objectives. Motivation for Bernanke's actions may be found in his American Economic Review paper, "Bankruptcy, Liquidity, and Recession, (Vol. 71, No. 2, May 1981).  Bernanke begins his paper,

This paper examines the possibility that the economy-wide level of bankruptcy risk plays a structural role in the propagation of recessions.  The argument is as follows: Bankruptcy imposes net social costs, so that all agents have an interest in avoiding it.  Consumers and firms do this by being careful to retain sufficient liquid assets to meet fixed expenses; banks and other lenders, by being selective in choosing borrowers and limiting the size of loans.  The onset of recession strains the system by reducing the flow of income available to meet current obligations and by increasing uncertainty about future liquidity needs.  There is a general attempt to insure solvency which leads to a reduced demand for consumer and producer durables--which may in turn generate further income reductions. 

Bernanke's confidence in this model as Fed chairman exceeds his confidence as a researcher.  Near the end of the paper, he describes evidence supporting his model.

At present the empirical evidence relevant to the story I have told is limited and does not permit firm conclusions. 

The coerced purchase of ML by BA illustrates the sad nature of political commitment to markets.  Republicans often profess their love of markets in good times, but abandon them as soon as a crisis occurs with little or no evidence that the government will perform better.  Democrats are generally more skeptical of markets, but lack political support for increased intervention in good times.  But when a crisis comes, with religious fervor, Democrats "never let a serious crisis go to waste."  The result is that crisis often results in more government regardless of the party in power as Robert Higgs hypothesized in "Crisis and Leviathan,"   (Oxford University Press 1987).[2]

If anything, the Obama administration has less respect for private decision making than the Bush administration.

[1] Don Boudreaux of Cafe Hayek wrote the "Politicians Principles,"

I wrote the following lines in a private letter to friends back in December when George W. Bush, then still president of the executive branch of the U.S. national government, announced that he was abandoning his free-market principles.  The truth of these lines, however, transcends time and political party.

The man who never cheats on his wife because no other woman will have him is not particularly principled - but he proudly fancies himself that way. So the first bimbo he sniffs who'll do him the honor will prompt him to "abandon his principles" with as much alacrity as a hungry dog will attack a ham. Such are the principles of our "leaders."

(P.S. One cannot abandon what one never possessed.)

[2]  Beginning in the late 1970's and continuing until the 1990's economic crisis induced government officials to deregulate and privatize.  Perhaps Higgs' hypothesis should be amended to read that "crisis causes government action." 
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Obama Like Putin? Not!

Laurie Kellman, an AP writer, reports in "No. 2 House Republican compares Obama to Putin," that

The No. 2 Republican in the House on Thursday compared President Barack Obama's plans for the auto industry to the policies of Russian Prime Minister Vladimir Putin, saying the White House has stripped credit holders of rights and given them to Democratic allies.

"They said, 'Set aside the rule of law, let's strip secured creditors, bondholders, of their rights. Take them away outside of the bankruptcy process and give them to the political cronies and the auto workers' unions," Rep. Eric Cantor, R-Va., said in an interview with The Associated Press.

"It's almost like looking at Putin's Russia," added Canton [sic], the GOP's House whip. "You want to reward your political friends at the expense of the certainty of law?"

While I do not like President Obama's policies named by Rep. Cantor, they are a order of magnitude better than Prime Minister Putin's.  According to the Heritage Foundation's "Index of Economic Freedom World Rankings," the United States ranked 6th best in the world prior to the Obama presidency.  Russian ranked 146th.  While the Obama administration's policies will take us in the wrong direction for economic freedom, they will be significantly above Russia's.  Freedom House ranks political rights and civil liberties on a scale from a best of 1 to a worst of 7.  In 2008, the United States earned a 1 in political rights and civil liberties.  I don't believe that those scores will change during the Obama presidency.  Russian earned 6 in political rights and a 5 in civil liberties.  Let's keep the debate real.

Permanent Link
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U.S. Negotiations with China to Reduce Carbon Emissions

nilateral action by the United States to reduce carbon emissions will do little to reduce global carbon emissions and will impose significant costs to households. (HT Mankiw) Martin Feldstein, a professor of economics at Harvard University, makes the point in, "Cap-and-Trade: All Cost, No Benefit," Washington Post, June 1, 2009.

The Obama administration and congressional Democrats have proposed a major cap-and-trade system aimed at reducing carbon dioxide emissions. Scientists agree that CO2 emissions around the world could lead to rising temperatures with serious long-term environmental consequences. But that is not a reason to enact a U.S. cap-and-trade system until there is a global agreement on CO2 reduction. The proposed legislation would have a trivially small effect on global warming while imposing substantial costs on all American households. And to get political support in key states, the legislation would abandon the auctioning of permits in favor of giving permits to selected corporations...

The Congressional Budget Office recently estimated that the resulting increases in consumer prices needed to achieve a 15 percent CO2 reduction -- slightly less than the Waxman-Markey target -- would raise the cost of living of a typical household by $1,600 a year. Some expert studies estimate that the cost to households could be substantially higher. The future cost to the typical household would rise significantly as the government reduces the total allowable amount of CO2.

Americans should ask themselves whether this annual tax of $1,600-plus per family is justified by the very small resulting decline in global CO2. Since the U.S. share of global CO2 production is now less than 25 percent (and is projected to decline as China and other developing nations grow), a 15 percent fall in U.S. CO2 output would lower global CO2 output by less than 4 percent. Its impact on global warming would be virtually unnoticeable. The U.S. should wait until there is a global agreement on CO2 that includes China and India before committing to costly reductions in the United States.

I made a similar point here, arguing that negotiation would be very difficult and costly for a variety of reasons. I missed an important reason a country might want to use carbon based fuels, the main reason: they are a cheap way to provide the energy for economic growth. Kathrin Hille of the Financial Times describes the difficulty the U.S. has encountered in negotiations with China to reduce carbon emissions in both countries ("Biggest emitters fail to show the way forward," June 11, 2009).

China and the US failed to achieve a breakthrough at their latest round of climate talks on Wednesday, raising the stakes in the global effort to fight global climate change.

The two countries responsible for almost half of the world’s greenhouse gas emissions ended three days of negotiations in Beijing...

Chinese officials maintained that the two countries should have a “common but differentiated approach” – code for Beijing’s reluctance to adopt a formal domestic mandate to reduce its carbon emissions. The US Congress is considering a bill that would reduce US emissions to 83 per cent of 2005 levels by 2020. China wants the US to cut its emissions to 40 per cent below 1990 levels by 2020 – a different order of magnitude. It also wants the US to pledge up to 1 per cent of its gross domestic product to pay for clean technology in China and elsewhere.

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Who's Running GM?

President Obama said his administration does not want to run the day-to-day operations of GM.  Neil King Jr., Jeffrey McCracken and Mike Spector describe the administration's position ("Potential Conflicts Abound in Government Role," Wall Street Journal, June 1, 2009). 

Once helping a company such as GM restructure, the government would manage its stake "in a hands-off, commercial manner" and not get involved in issuing day-to-day directives to GM, the guidelines said.

Currently, the Treasury plan is to hold its GM ownership stake in a blind trust, say people briefed on the situation, and draw up so-called trust documents that lay out how that trust and its government-appointed trustees will manage the government's majority stake in GM.

The selection of Edward Whitacre Jr. as the new chairman of GM illustrates what the government means by "helping" a company restructure.  Amy Thomson and Katie Merx of Bloomberg describe how Whitacre was selected ("Whitacre Vows to ‘Learn About Cars’ as GM Chairman (Update1)," June 10, 2009)(HT Drudge).  Nowhere does the article mention discussions with the existing GM management or anyone that has had experience in the auto industry. 

“What was required was somebody with savvy, big-business experience that could take a company, change its management culture, make some of those tough decisions to put it on that path toward viability,” Press Secretary Robert Gibbs told reporters at a briefing today.

The U.S. Treasury, which is backing GM’s restructuring with about $65 billion, reached out “some weeks ago,” Whitacre said, enticing him out of retirement to help oversee a company that has lost almost $88 billion since 2004.

“Lots of conversations” followed with Steven Rattner, the Wall Street dealmaker running President Barack Obama’s car task force, said Whitacre, adding that Treasury’s message was: “We need your help. It’s a great company. You could be a lot of assistance to GM.”

Why does the administration need to run the day-to-day operations when it has already decided the basic product and the management team to produce it?  Does anyone really believe the administration can't flex its ownership control anytime that it wishes?  Even if the executive branch manages to turn (10%) control of the company to other owners, the Canadian government (12%), the UAW (17.5%) and former bondholders, could the new owners keep Congress out of business decisions?  King et al write,

Congress also is sure to exert its muscle over GM's affairs, as it did in recent weeks. Key lawmakers rebelled in May when word got out that GM, post-bankruptcy, planned to boost its imports of cars made at GM factories in China.

With pressure building on Capitol Hill, GM agreed as part of its talks with the United Auto Workers to reopen an idled factory in the U.S. for smaller models not now produced domestically.

King, et al also note potential conflicts of interest between regulators and the government owned company.

Some experts already are asking what will happen within the Office of Management and Budget when regulations are promoted on fuel-efficiency standards or safety standards, for instance, that will prove costly to GM, and thus also to the federal government.

"Once the federal government is not simply a regulator, but is all of a sudden also on the receiving end of regulations, that fundamentally alters the politics of how the government interacts with the car industry," said John Graham, an auto safety expert who served as President George W. Bush's regulatory czar within the OMB.

That neutrality issue will be particularly pointed when it comes to Ford Motor Co., which alone among the Big Three has not received federal assistance. Mr. Graham and others worry that the government could find itself tilting key regulatory or purchasing decisions in favor of GM or Chrysler because of its interest in those companies.

What a mess.
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A Brief History of the "Buy American" Provision of The Stimulus

I have written several posts (here, here, here) about the buy American provision of the stimulus bill (The American Recovery and Reinvestment Act of 2009) that continues to rankle our trading partners.  This post presents a brief history of the provision.  The original bill required that all public projects use iron, steel, and manufactured goods produced in the United States.  Representatives of foreign governments, including Canadian prime minister, Stephan Harper, became concerned about the sections protectionist nature.  As the debate over the stimulus raged in Congress, President Obama was preparing to meet with Harper in Canada.  Roger Runningen and Hans Nichols write for Bloomberg in  "Obama Will Review Buy American Provision in Stimulus (Update1)," (January 30, 2009) that,

The administration “will review that particular provision,” Gibbs [President Obama's press sectretary] said today at his regular briefing. The president’s advisers understand “all of the concerns that have been heard, not only in this room, but in newspapers produced both up north and down south.”

He refused to say whether the administration supported or opposed keeping that part of the legislation intact. Nor did he say what the president would do if the provision remains once the bill clears the House and the Senate.

The issue may cloud Obama’s trip to Canada on Feb. 19, his first journey outside U.S. borders as president. Officials in Canada, the top U.S. trade partner, are criticizing a part of legislation that passed the U.S. House of Representatives Jan. 28 that requires the use of U.S.-made iron and steel in infrastructure projects.

On February 4, 2009, Sheldon Alberts of Canada.com reports in "U.S. Senate votes to soften 'Buy American' clause," that

American lawmakers on Wednesday voted to soften the controversial "Buy American" provisions in the proposed U.S. economic stimulus package over fears they could spark a trade war.

The change gives Canada, among other major trading partners, some comfort it would be exempted from a strict requirement in the $819-billion bill, which passed the House last week, that only U.S.-produced steel and iron be used in projects launched with funds from the economic stimulus.

The amendment, approved by the Senate, requires the Buy American provisions be "applied in a manner consistent with U.S. obligations under international agreements."

Senate Democrats had earlier in the evening voted down an amendment, proposed by Senator John McCain, that would totally strip the Buy American provisions.

The "Buy American" section  as passed by the Congress and signed by President Obama reads,

Sec. 1605. Use of American Iron, Steel, and Manufactured Goods. (a) None of the funds appropriated or otherwise made available by this Act may be used for a project for the construction, alteration, maintenance, or repair of a public building or public work unless all of the iron, steel, and manufactured goods used in the project are produced in the United States.

(b) Subsection (a) shall not apply in any case or category of cases in which the head of the Federal department or agency involved finds that--

(1) applying subsection (a) would be inconsistent with the public interest;

(2) iron, steel, and the relevant manufactured goods are not produced in the United States in sufficient and reasonably available quantities and of a satisfactory quality; or

(3) inclusion of iron, steel, and manufactured goods produced in the United States will increase the cost of the overall project by more than 25 percent.

(c) If the head of a Federal department or agency determines that it is necessary to waive the application of subsection (a) based on a finding under subsection (b), the head of the department or agency shall publish in the Federal Register a detailed written justification as to why the provision is being waived.

(d) This section shall be applied in a manner consistent with United States obligations under international agreements.

While meeting with the Canadian prime minister, President Obama promised U.S. compliance with international trade obligations and related his hope that trade would continue to expand ("PM, Obama talk trade, Afghanistan, pledge 'clean energy dialogue'," CBCnews.ca, February 19, 2009.

On the controversial "Buy American" provision included in the U.S. stimulus package, Obama said he made clear that those measures will be consistent with Washington's obligations under the World Trade Organization and the North American Free Trade Act.

"I provided Prime Minister Harper an assurance that I want to grow trade, not contract it," Obama said.

Harper said those agreements do allow domestic purchasing preferences, but pointed out they are not allowed without limits.

"We have agreed in the G-20 countries to stimulate the global economy, not just benefit ourselves. If we choose to benefit ourselves at the expense of others, we will deepen the global economic crisis," Harper said.

Apparently, there is a lot of wiggle room in international agreements that allows nation to restrict trade when spending on government funded projects.  The provision is being applied and our trading partners are considering retaliation.  President Obama's supporters promised an empirical president.  Protectionism is a knee jerk reaction, that is not based on empirical evidence. 
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No Citizen Gets Ahead

Under the banner, "No Child Left Behind," President Bush attempted to improve educational standards, particularly for underachievers.  President Obama has unfurled a new banner, "No Citizen Gets Ahead," in his attempt to improve the welfare of the poor.  He plans to raise the top income tax rate to 40%, cut deductions--even charitable deductions, remove the cap on social security taxes, and now foist the cost of health care for the poor onto the rich.  Laura Litvan and Ryan Donmoyer of Bloomberg write ("Democrats Weigh Health Mandate as Obama Urges Taxing Wealthy," June 7, 2009),

President Barack Obama wants Congress to consider taxing the wealthy instead of workers to pay for a health-care overhaul, as House Democrats discuss a plan to require health insurance for most Americans...

The president is trying to avoid broad-based levies such as a Senate proposal to tax some employer-provided health benefits Axelrod said. Instead he is urging lawmakers to reconsider limiting all tax deductions for Americans in the highest tax brackets.

“He made a very strong case for the proposal that he put on the table, which was to cap deductions for high-income Americans, and he urged them to go back and look at that,” Axelrod said on the CNN’s “State of the Union.” Goolsbee, appearing on “Fox News Sunday,” said Obama is “mindful” about how “ordinary Americans are able to foot the bills” and never proposed taxing employee benefits.

Apparently, some of his top campaign donors (the wealthy) misread candidate Obama's populist rhetoric for demagoguery, which is OK (Leonard Doyle, "Barack Obama's rich supporters fear his tax plans show he's a class warrior," Telegraph.co.uk, May 9, 2009).

Wealthy Wall Street financiers and other business figures provided crucial support for Mr Obama during the election, backing him over the Republican candidate John McCain as the right leader to rescue the collapsing US economy.

But it is now dawning on many among them that Mr Obama was serious about his campaign trail promises to bring root and branch reform to corporate America - and that they were more than just election rhetoric.

A top Obama fundraiser and hedge fund manager said: "I'm appalled at the anti-Wall Street rhetoric. It was OK on the campaign but now it's the real world. I'm surprised that Obama is turning out to be so left-wing. He's a real class warrior."

Chris Edwards of the Cato Institute, a free enterprise think tank, said Democrats in Congress were unnerved by the president's latest plan to raise $210 billion over 10 years from multinational corporations.

Although I disagree with many of the administration's policies, taken individually, they are well within America's historical bounds of policy debates.  I understand the reasoning behind raising the top income tax rate to 40%.  It was that high under Clinton.  I understand the distorting effects of tax deductions.  I understand the need to increasing revenues for Social Security, and the desire to help the poor gain better access to medical care.  I don't understand the economic reasoning behind the administration's attempt to raise taxes on U.S. based multinationals.  But taken as a whole, they are a radical departure from past policy debates that constitute an assault on the freedom of all Americans who are economically successful.  President Kennedy said, "Ask not what your country can do for you--ask what you can do for your country."  The Obama administration has bent those words to, "Ask asks not what we can do for our country, but what the wealthy can do for us."  Milton Friedman's opening words in "Capitalism and Freedom" are as prescient now as they were in 1962 when they were penned. 

In a much quoted passage in his inaugural address, President Kennedy said, “Ask not what your country can do for you—ask what you can do for your country.” It is a striking sign of the temper of our times that the controversy about this passage centered on its origin and not on its content. Neither half of the statement expresses a relation between the citizen and his government that is worthy of the ideals of free men in a free society. The paternalistic “what your country can do for you” implies that government is the patron, the citizen the ward, a view that is at odds with the free man’s belief in his own responsibility for his own destiny. The organismic, “what you can do for your country” implies that government is the master or the deity, the citizen, the servant or the votary. To the free man, the country is the collection of individuals who compose it, not something over and above them. He is proud of a common heritage and loyal to common traditions. But he regards government as a means, and instrumentality, neither a grantor of favors and gifts, nor a master or god to be blindly worshipped and served. He recognizes no national goal except as it is the consensus of the purposes for which the citizens severally strive.

The free man will ask neither what his country can do for him nor what he can do for his country. He will ask rather “What can I and my compatriots do through government” to help us discharge our individual responsibilities, to achieve our several goals and purposes, and above all, to protect our freedom? And he will accompany this question with another: How can we keep the government we create from becoming a Frankenstein that will destroy the very freedom we establish it to protect? Freedom is a rare and delicate plant. Our minds tell us, and history confirms that the great threat to freedom is the concentration of power. Government is necessary to preserve our freedom, it is an instrument through which we can exercise our freedom; yet by concentrating power in political hands, it is also a threat to freedom. Even though the men who wield this power initially be of good will and even though they be not corrupted by the power they exercise, the power will both attract and form men of a different stamp.

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