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Brooks Wilson's Economics Blog: January 2010

Sunday, January 31, 2010

4th Quarter GDP Growth

The Drudge Report headline read "NOW FOR SOME GOOD NEWS: 5.7% GDP!," but linked to a Yahoo Finance article by an AP writer with a less enthusiastic headline, "4th quarter's fast economic pace likely to wane."  James Hamilton explains the schizophrenic view of the same Bureau of Economic Analysis report ("Strong GDP growth with weak fundamentals," Econbrowser) after a quick review for some and preview for others of national income accounting.

Gross Domestic product (GDP) is the statistic that attempts to measure the market value of all final goods and services produced within a country over a specified time period, usually one year.  The economy is growing when we produce more and 5.7% growth is good.  To better understand the causes of growth, GDP is broken into four components: consumption, investment, government purchases, and net exports (exports less imports) and the sum of these four components equals GDP.  Those components are further broken into subcomponents.  To understand why the economy grew so rapidly in the fourth quarter, it is necessary to understand how inventories are treated.  As Mankiw explains ("Principles of Macroeconomics: Fifth Edition," Chapter 10: Measuring a Nation's Income," 
...the treatment of inventory accumulation is noteworthy.  When Dell produces a computer and, instead of selling it, adds it to its inventory, Dell is assumed to have "purchased" the computer for itself.  That is, the national income accountants treat the computer as part of Dell's inventory investment spending.  (If Dell later sells the computer out of inventory, Dell's inventory investment will then be negative, offsetting the positive expenditure of the buyer.)  Inventories are treated this way because one aim of GDP is to measure the value of the economy's production, and goods added to inventory are part of that period's production.
Hamilton explains why changes in inventory played such a big part in the BEA report.
Three-fifths of that Q4 GDP growth came from the fact that businesses were drawing down inventories more slowly than they had the quarter before. Firms sold $8.5 billion more goods (at a quarterly rate) in 2009:Q4 than they produced, and met those sales by drawing down inventories by $8.5 billion. This reduction in inventories counts as negative investment spending of -$8.5 billion at a quarterly rate (or -$34 B at the annual rate these numbers are typically reported) for purposes of calculating fourth-quarter GDP. Firms sold $34.8 billion more than they produced in 2009:Q3, which amounted to negative inventory investment of -$139 billion at an annual rate for Q3. Since this component of investment spending went from -139 to -34, it counts as positive growth [-34-(-139)] when you compare Q3 GDP with Q4 GDP. This mechanism alone contributed 3.4 percentage points to the 5.7% growth rate for real GDP reported for Q4.

To put it another way, if consumers, businesses, foreigners, and the government had all purchased exactly the same quantity of real goods and services in 2009:Q4 as they had in 2009:Q3, more of those sales would have come out of inventory drawdown in Q3 than in Q4, so even without any gain in final sales we would have had to produce more stuff in Q4 than Q3, specifically, 3.4% more stuff at an annual rate. In fact real final sales to consumers, businesses, foreigners, and the government were not stagnant, but grew at a 2.3% annual rate during the fourth quarter, and the two effects combined give us the 5.7% reported GDP growth.

Just because the production gains can be accounted for in terms of slower inventory drawdown doesn't mean they aren't real, and doesn't mean they can't continue. I noted in July that we might expect inventory restocking to add 1.6% to the annual GDP growth rate for each of the first four quarters of the economic recovery, and we haven't even yet begun that inventory restocking process. The question, though, is what we'll see for the other components of GDP. Exports grew more than imports in Q4, with the result that net exports contributed 0.5 percentage points to that 2.3% growth in real final sales. That's certainly a very welcome development and a critical step for correcting the imbalances that have been very troubling over the last decade.
Those who project a slow rebound note that growth from slower inventory drawdown cannot continue forever because firms will run out of inventory, and fear that consumer spending will remain sluggish, limiting future hiring.

As a reminder not to read too much into a story, the growth in GDP should not be viewed as evidence that the Obama administration's stimulus package was successful any more than growing unemployment over the past year should be viewed as evidence that the stimulus failed.  A researcher would need to construct a model specifically designed to measure actual economic activity against the projected activity in the absence of a stimulus or measure how different government policies affected economic activity over time and across countries.  Menzie Chinn of Econbrowser has several posts on this topic here.

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Friday, January 29, 2010

A Trade Peccadillo?

Ninety-three percent of economists agree with the statement that "tariffs and quotas usually reduce general economic welfare" (Richard Alston, J. R. Kearl, and Michael Vaughn, "Is There Consensus among Economists in the 1990s?," American Economic Review, May 1992 or Dan Fuller Geide-stevenson, "Consensus Among Economists: Revisited," Journal of Economic Education, Fall, 2003).  Yet, protectionist trade policies remain popular in the general population and in many political circles in Washington.  A Reuters article, "US slaps duties on electric blankets from China," describes the most recent efforts in Washington to limit trade.

WASHINGTON, Jan 27 (Reuters) - The United States has set preliminary anti-dumping duties ranging from 90 to nearly 175 percent on about $30 million worth of electric blankets from China, the U.S. Commerce Department said on Wednesday.
The ruling is a victory for Jarden Consumer Solutions, a Florida-based subsidiary of consumer products company Jarden Corp (JAH.N). It filed a petition earlier this year asking for protection against its Chinese competitors.

The relatively small case is of one several ongoing U.S. investigations into charges that Chinese companies are selling their goods in the United States at unfairly low prices and benefit from unfair government subsidies.

The products covered by the probe include finished, semi-finished, and unassembled woven electric blankets of all sizes and fabric types, whether made of man-made fiber, natural fiber or a blend of both...

Commerce will make its final decision on duty levels in June, setting the stage for the U.S. International Trade Commission to cast a final vote in July or early August on whether to allow the duties.
The government is attempting to cover its peccadillo with the sackcloth of winning a more balance playing field for our producers.  Would it be good if the subsidies were eliminated? Yes, but these types of policies are often used to disguise protectionist policies.

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Thursday, January 28, 2010

Fear the Boom and Bust

The video is educational and entertaining.

In "The General Theory of Employment, Interest Money" John Maynard Keynes wrote “The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist."

Watch the video and see if you can hear the voices of Keynes and Hayek, two defunct economists, reflected through politicians who support the stimulus (Keynes) and those who oppose it (Hayek).

I love Hayek's quote at the end of the video, "The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design." It neatly summarizes the views of Austrian economists and others who they have influenced.

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An Item for the Tea Party Agenda

Seismic economic events have shaken Washington.  Republicans, who were largely blamed for the crisis, were flattened in a political quake.  The victorious Democrats acted on their mandate of change but the change they enacted or proposed deepened huge deficits and did not restore full employment demanded by an angry electorate.  The Tea Party Revolt rose from the rubble to shock both parties and it is building political pressure along fault lines that may result in as big as a political quake in November 2012 as hit Washington in 2010.  The remarkable success of the spontaneously generated Tea Party has led many to suggest a course of action that they should follow.  This is my unsolicited advice. 

The Tea Party might cause Washington to sway toward fiscal responsibility, but it will not permanently alter spending habits which are firmly built on long standing foundational incentives between voters and their representatives.  One of the footings is that constituents like taxes raised in other districts spent in theirs and every politician knows it.  Using the House of Representatives as an example, nearly all the benefits of a government funded project in a district are enjoyed by those living in it while the taxes raised to fund the project are distributed more evenly between all 435 districts.  So long as a project has $1 dollar of benefit locally to $435 of cost nationally, a congressman will support it.  The story in the Senate is only slightly better where a senator has incentive to vote for a project if it has $1 of benefit in her state to $50 of cost nationally.  Stevens' bridge to nowhere and Murtha's airport to the same location illustrate the problem.  Voter support for these perverse incentives is summarized in the oft heard comment, "I don't agree with many of my congressman's positions but he really brings home the bacon”?  We love pork in our districts but we hate it in other's. 

A modification to the tax code would break this perverse incentive.  It is based on the benefit principle of taxation, the idea that those receiving the benefits of expenditures should pick up the tab. The income tax code should be modified to reflect expenditures in each congressional district with the exception of those for defense and university research. The modification should change tax rates evenly through all brackets making the tax structure less progressive in districts with high expenditure to taxes paid ratios and more progressive in districts with low ratios.  If a congresswoman brings home twice the average level of expenditures, her constituents’ tax rates should be twice the national average. A natural constituency opposing wasteful spending within each district would quickly materialize because the constituents would now pay for the pork.

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Tuesday, January 26, 2010

Climategate: Mostly a Repost

Last November, an important story referred to as "Climategate," or alternatively as "The CRUTape Letters," broke over the Internet.  A hacker or whistle blower has posted over 1,000 e-mails and 2,000 other documents from the University of East Anglia Climate Research Unit to a server in Russia (Watts Up With That, "Breaking News Story: CRU has apparently been hacked – hundreds of files released).  Steve McIntyre of Climate Audit provides a timeline of events related to the story ("The Mosher Timeline").  The information in the documents speaks ill of many of the scientist mentioned (at least eight), and more importantly, of their abuse of the scientific method and peer review process.  The scandal also shouts of the dangers of mixing science and politics.  

How does an economist become interested in climate change?  Our interests intersect in at least three areas.  Economists devise methods to minimize the cost to the economy of environmental protection and cleanup.  Economics and climatology have similar methodological problems.  Few questions we investigate can be answered through controlled experimentation.  Both disciplines establish control through complex mathematical models verified with equally complex statistical testing.  If lack of controlled experimentation were not enough, we generally have bad data.  Finally, all scientists have an interest in the integrity of science, and I fear that science may take a hit from politicized and bad science.[1]

Before I proceed, I do not claim to know a great deal about climate science.  The scientists involved were important contributors in their fields and on the IPCC, but how important I don't know.  Some of the involved scientists managed important databases, but I do not know the percentage of the scientific literature that made use of it.

In class, I place a great deal of emphasis on the scientific process.  The purpose of scientific training is to help practitioners think clearly and free of biases which tie conclusions to prior beliefs, eliminating the need to conduct research.  The scientists involved in this scientific scandal violated the process at almost every step.  An early step of scientific enquiry involves a search of the relevant literature, which they appeared to do, and incorporation of that literature into the formulation of models, and possibly into hypotheses, steps they did not take.  They were aware of criticism of their own work and ignored it, and worse, they attempted to keep opposing opinions from seeing the peer-reviewed light of day.

Another important part of the scientific process involves testing hypotheses, and again, it appears these scientists behaved badly.  At the least, they manipulated data used to produce graphs explaining their findings to the general public.  They withheld data and statistical techniques that they used from scientists that were skeptical of their work.  While this is a very human thing to do, it is not the scientific thing to do.  The released data also suggests that one of the four great databases showing long-term temperature change was not as sound as the Climate Research Unit at UEA claimed.  Lower quality data lowers the strength of conclusions.

The peer review process is, or at least should be, the gold standard of scientific research.  It is supposed to be anonymous, meaning that the scientists who wrote the paper do not know those who review it, and those who review it do not know the authors.  Reputation should not influence the scientific judgement of what is published.  The released e-mails clearly demonstrate efforts to control scientific discourse without regard to merit.[2] 

[1]  Daniel Botkin, one of the first ecologists to explore the impact of global warming, expressed similar concerns in a EconTalk podcast, "Botkin on Nature, the Environment and Global Warming," November 26, 2007).  Botkin demonstrates wonderful scientific restraint in not exceeding the bounds of his expertise. 

[2]  Megan McArdle suggests that I might have an idealized view of the scientific process.  She is probably correct.  She writes ("ClimateGate," The Atlantic: Asymmetrical Information, November 24, 2009). 
A few of you have asked what I think about ClimateGate.  Mostly I concur with Tyler Cowen and Robin Hanson:  I have so far seen no evidence of the kind of grand conspiracy that some critics have charged.  Rather, to my mind this is about how real science (unfortunately) does sometimes get done. 
Scientists are human beings.  They react to pressure to "clean up" their graphs and data for publication, and they gang up on other people who they dislike.  Sometimes they're right--there's a "conspiracy" to keep people who believe in N-rays from publishing in physics journals, but that's a good thing.  But sometimes they're wrong, and a powerful figure or group of people can block progress in science.

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Solow on Markets and Their Failures

In Pirates of the Caribbean: The Curse of the Black Pearl," Jack Sparrow describes Will Turner's father as a "good man and a pirate," a seeming paradox.  Outside of economics, many argue that conservatives trust markets to allocate resources and liberals do not, making it impossible for a  to see fundamental value in markets.  Robert Solow is a politically liberal economist and sees value in markets.  Saying that he is a politically liberal economist does not describe his contribution to economics, which can be summarized by noting that he was awarded the Nobel Prize in Economics in 1987 for his work on economic growth theory.  Because many incorrectly believe that a liberal could recognize the value of markets I will first establish his liberal bona fides and then provide a few quotes from his New Republic book review, "Hedging Markets," to demonstrate that he values markets but notes their failures.

A Wall Street Journal article notes that Solow has long advised Democratic presidential candidates and is an Obama backer.
Robert Solow, the Nobel Prize winning economist who long has counseled Democrats, said Barack Obama should roll back the Bush tax cuts for the rich but shouldn’t use the proceeds to cut taxes for the middle class, as the Democratic presidential candidate has proposed...

Instead, he would use the money “both for urgent needs now and for future deficit reduction,” he said. “The government needs that money and ought not to be using it to promote consumption [consumer spending.]”...

Mr. Solow was quick to add: “I understand this” — backtracking on a promised middle-class tax cut — “is not a politically easy thing to do.” He remains an Obama backer.
In "Hedging Markets," Solow gives an introductory lesson on markets and their failures.
My late colleague Evsey Domar, who was, among other things, a student of the Soviet economy, told us how the planning bureau began by setting production quotas for paper factories in tons per year. The result was paper so thick that it could not fit in a Soviet typewriter or anywhere else. So the clever planning bureau changed to setting quotas in terms of square meters per year. The result was paper so thin that even a member of the planning bureau could see right through it. The lesson is that it is so much simpler and more effective to tell paper producers that they have to compete to sell their paper to notebook manufacturers (who are also competing with each other), and live off the proceeds.

If this is how more or less free, more or less competitive markets can deal with something as simple as a spiral notebook, how much more remarkable it is that they can do the same for something as complicated as a computer or a refrigerator. But there seems to be no other practical way to run a modern economy efficiently. That is what Adam Smith understood: a competitive market economy, motivated primarily by individual pecuniary self-interest, can produce coordination where one might expect only chaos.

He invented for that process the memorable image of the Invisible Hand. In the following two centuries and more, an army of economists has spent an enormous amount of time and intellectual effort refining and elaborating Smith’s initial insight, teasing out exactly how far that logic can be carried, how the hand operates, investigating when and how it breaks down, and elucidating odd or complex special cases such as professional team sports, or Internet services, or health care...

Today, of course, no one is against markets. The only legitimate questions are: What are their limitations? Can they go wrong? If so, how can we distinguish the ones that do from the ones that don’t? What can be done to fix the ones that do go wrong? When is some regulation needed, how much, and what kind? More broadly: how to protect the economy and society against specified tendencies to market failure without losing much of either the capacity of a market system to coordinate economic activity efficiently or its ability to stimulate and reward technological and other innovations that lead to economic progress?Today, of course, no one is against markets. The only legitimate questions are: What are their limitations? Can they go wrong? If so, how can we distinguish the ones that do from the ones that don’t? What can be done to fix the ones that do go wrong? When is some regulation needed, how much, and what kind? More broadly: how to protect the economy and society against specified tendencies to market failure without losing much of either the capacity of a market system to coordinate economic activity efficiently or its ability to stimulate and reward technological and other innovations that lead to economic progress?

The subtitle of John Cassidy’s book illustrates the problem. Most market failures--they occur every day--are not even nearly calamities. They start with the existence of partial monopoly power in this or that industry, with the result that the market price is “too high” and the rate of production “too low” in the precise sense that everyone could be made better off if that error were corrected. They extend to cases [of  externalities] where the market does not impose the full costs of their actions on certain producers and consumers, with the result that economic activity is misdirected: the consequences may be minor (a small amount of pollution) or major (fish stocks collapse from overfishing) or potentially catastrophic (climate change from excessive unpenalized emission of greenhouse gases). And what are we to make of the stock-market collapse of October 1987, the largest one-day fall ever on the New York Stock Exchange? It was in one sense a calamity, but it left essentially no trace in the “real” economy of production, employment, consumption, and everyday life. Evidently being for or against “free markets” does not come close to being an adequate response to the problems that arise in a complex modern economy.
To be sure, Solow would tend to find more instances of market failure severe enough to justify government intervention than I, but we are generally viewing problems within the same economic framework.

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Monday, January 25, 2010

Ideas to Reduce the Deficit

David Rogers writes that the Obama administration will attempt to join deficit hawks (David Rogers, "Obama endorses deficit commission plan," Politico, Jan. 23, 2010).
...President Barack Obama formally endorsed legislation Saturday creating an independent commission with the power to force Congress to vote on major deficit reduction steps this year, after the November elections.
Although I applaud efforts to reduce the deficit, I can't resist the cheap shot that the votes will be scheduled for after the election.  Apparently, most members who support reducing deficits believe that it will be unpopular with constituents.  If our elected officials are correct, and there is evidence to suggest that they are, it is our fault and not theirs.  Here are just a few ideas that the independent commission might consider that I believe will reduce the deficit and/or increase the dynamic efficiency of the economy.
1.  Do away with the Selective Service System (SSS).  I know that this is small fry but their is no need for ongoing registration of young men when we have an effective volunteer army and no prospects for a war that would require a draft.  If we were ever endangered, the SSS could be reestablished quickly.  Besides, I am tired of hearing commercials telling young men of the governmental benefits that they would lose if they don't register. 

2.  Sell the TV band spectrum, raising between $40 and $60 billion and creating consumer benefits in excess of $50 billion annually.  The sale of this spectrum would have the additional benefit of unleashing innovation of a creative sector of the economy (Thomas Hazlett "A letter to the new FCC chair, Mr Julius Genachowski," Financial Times, June 2, 2009).

3.  End all ethanol subsides including the forced use of ethanol as a gasoline additive saving taxpayers an estimated $5 billion annually.  Consumers would benefit from lower cost fuel and a cleaner environment (John Stossel, "The Many Myths of Ethanol," Real Clear Politics, May 23, 2007 and Jeff St. John, "Corn Ethanol's Subsidy Glut," greentechmedia, Jan. 9, 2009).  While we are at it, we should end all price subsidies to farmers. 

4.  Repeal Sarbanes Oxley.  The bill was passed as emergency legislation in response to a couple of giant accounting sandals.  Compliance costs are high, particularly for small firms that are more likely to be innovative, and benefits are low.  Ivy Xiying Zhang estimates that the bill lowered stock market values by $1.4 trillion ("Economic Consequences of the Sarbanes-Oxley Act of 2002," Feb. 2005).  Roberta Romano suggests that, "The paper's conclusion is that SOX's corporate governance provisions should be stripped of their mandatory force and rendered optional."  ("The Sarbanes-Oxley Act and the Making of Quack Corporate Governance," Yale Law Journal, Vol. 114, 2005).

5.  Repeal corporate average fuel economy (CAFE) standards.  They are an expensive way to promote vehicle fuel efficiency.  If the country desires a more efficient fleet, raise taxes on gasoline (Robert Crandall, "Don't Drink the CAFE Kool-Aid," Brookings, Jan. 25, 2010).
My list is just a start not even touching on non discretionary policy.  Feel free to disagree with my list or add items of your own.

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Sunday, January 24, 2010

The NCAA and Social Networking

In an earlier post, "The NCAA Blind Sides Poor Athletes," I suggested that NCAA rules were too restrictive.  Looking for a little more information, I found an article,"NCAA rules place limits on fan enthusiasm," by that describes limits on students' recruiting that I find grotesquely restrictive and completely unnecessary.
What may seem like an innocuous post on a social media forum may be an NCAA recruiting violation, according to what Kansas Athletics is telling fans.

Even though average KU fans may not think of themselves as boosters in the traditional sense, Jim Marchiony, associate athletics director at KU, said they become boosters when they do things that could be considered an effort to attract high school athletes to KU.
The set of rules governing recruiting is sufficiently convoluted and complex to make a Pharisee blush.  Steve Yanda of the Washington Post writes in "Fans' Recruiting Pitches Are Catching On," that

Current students cannot serve as representatives of their schools' athletic interests and thus are not allowed to contact recruits, according to Stacey Osburn, the NCAA's associate director of public and media relations. In fact, NCAA rules state that any individual who is known or should have been known by a member of a school's athletic administration to be "assisting in the recruitment of prospective student-athletes" qualifies as a representative of that institution's athletic interests. Therefore, any fan with a social networking account could possibly cause a violation, not merely those currently enrolled at a school.

"If a school found out this was going on, it would have to self-report it," Osburn said. "The NCAA then would look at the situation within reason." She added that reports of major violations concerning this subject have yet to surface...

Osburn said that if a school were to report a violation regarding fan usage of social networks to contact recruits, the NCAA would try to answer two questions: Did the university in question have a system in place to monitor this type of activity, and was the university responsible in any way for encouraging the students to contact recruits?

Because there have been no reported instances of major NCAA violations regarding social network recruiting, Osburn said the NCAA has established no penalty guidelines for such cases. She said it was likely that secondary violations have occurred but she did not have access to such information.

Let me sum up this mess.  It is against NCAA rules for students and other fans to "recruit" athletes, and their actions are impossible to monitor.  Despite the difficulty of the task, athletic departments must demonstrate that they have a program in place to track and inform fans that their actions are violations of NCAA rules, and being reasonable, the NCAA will not hit the schools with sanctions.

Here's an idea.  Dump the unenforceable restrictions on students and fans that add a new layer of expense to college athletics.  It is clearly a violation of their free speech rights, and, and from a view of economics, it is unnecessary.  Sufficient competition exists between colleges and universities that all schools would be able to compete and if they could not, that probably tells high school athletes something important about the recruiting schools. 

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Friday, January 22, 2010

Wilson on Citizens United v. the Federal Election Commission

Yesterday, the Supreme Court announced its 5-4 decision in Citizens United v. the Federal Election Commission.  The ruling reestablishes the rights of people to voice political speech through corporations and labor unions.  As might be expected with a politically divided Supreme Court and nation, the decision has resulted in both celebration ("A Free Speech Landmark" Wall Street Journal, Jan. 22, 2010) and weeping, wailing and gnashing of teeth.  David Kirkpatrick of the New York Times succinctly summarizes the fears of many ("Lobbyists Get Potent Weapon in Campaign Finance Ruling," Jan. 22, 2010).
WASHINGTON — The Supreme Court has handed lobbyists a new weapon. A lobbyist can now tell any elected official: if you vote wrong, my company, labor union or interest group will spend unlimited sums explicitly advertising against your re-election.

“We have got a million we can spend advertising for you or against you — whichever one you want,’ ” a lobbyist can tell lawmakers, said Lawrence M. Noble, a lawyer at Skadden Arps in Washington and former general counsel of the Federal Election Commission.
The fear that money buys votes, distorting elections, is overblown for a number of reasons.  First, Steven Levitt and Stephen Dubner explain in "Freakonomics," Levitt's research on the impact of campaign contributions and political victory.  Comparing results in which the same candidates ran against each other in consecutive elections, Levitt found that spending had little impact.  A winning candidate can cut spending in half and only lose about 1% of the vote; good candidates attract money and not money buys elections.

More importantly, corporations and labor unions are organized interests that represent groups of individuals and these individuals may have legitimate political interests.  They are self-interested but not monolithic.  Steel makers may lobby for higher steel prices but they will be opposed by automakers and others that use steel as an input.  Unions will support their industry's interests.  Unions will campaign for favorable organizing laws but they will be opposed by unionized and non unionized corporate interests and probably by non unionized labor.  In short, free speech is an American value set forth in the First Amendment and should be defended.

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Thursday, January 21, 2010

Sowell on Interventionist Policy

Thomas Sowell is a great writer and one of my favorite economists. His latest book is "Intellectuals and Society." In "Massive Government Intervention Drove U.S. Deeper Into Depression," an Investors Business Daily editorial, he offers the hypothesis that government intervention may deepen and lengthen economic downturns. He presents historical evidence to support his position comparing the stock market crashes of 1929 and 1987. His hypothesis is similar to Higgs' "Regime Uncertainty" (see "The Crisis Paradox). Key sections of Sowell's article articulating the conventional wisdom concerning Roosevelt's interventions and Sowell's dissent read
Many saw in the Great Depression the failure of free market capitalism as an economic system and a reason for seeking a radically different kind of economy — for some Communism, for some Fascism and for some the New Deal policies of Franklin D. Roosevelt's administration.

Whatever the particular alternative favored by particular individuals, what was widely believed then and later was that the stock market crash of 1929 was a failure of the free market and the cause of the massive unemployment that persisted for years during the 1930s.

Given the two most striking features of that era — the stock market crash and a widespread government intervention in the economy — it is not immediately obvious which was more responsible for the dire economic conditions. But remarkably little effort has been made by most of the intelligentsia to try to sort out the cause or causes. It has been largely a foregone conclusion that the market was the cause and government intervention was the saving grace.

While unemployment went up in the wake of the stock market crash, it never went as high as 10% for any month during the 12 months following that crash in October 1929. But the unemployment rate in the wake of subsequent government interventions in the economy never fell below 20% for any month over a period of 35 consecutive months.

In short, though the stock market crash has been conceived of as the "problem" and government intervention as the "solution," in reality the unemployment rate following the economic problem was less than half of the unemployment rate following the political solution.
He enumerates how bad monetary policy, protectionist trade policy, doubling taxes on high income earners, and price fixing stifled economic recovery.

Next, Sowell describes Reagan's benign response to the 1987 stock market crash, the media's harsh criticism and the ensuing economic recovery.
There is of course no way to rerun the stock market crash of 1929 and have the federal government let the market adjust on its own to see how that experiment would turn out. The closest thing to such an experiment was the 1987 stock market crash, similar in size but not in duration to the 1929 collapse. The Reagan administration did nothing, despite outrage in the media at the government's failure to act.

"What will it take to wake up the White House?" the New York Times asked, declaring that "the president abdicates leadership and courts disaster." Washington Post columnist Mary McGrory said that Reagan "has been singularly indifferent" to the country's "current pain and confusion." The Financial Times of London said that President Reagan "appears to lack the capacity to handle adversity" and "nobody seems to be in charge."

A former official of the Carter administration criticized President Reagan's "silence and inaction" following the 1987 stock market crash and compared him unfavorably to President Franklin D. Roosevelt, whose "personal style and bold commands would be a tonic" in the current crisis.

The irony in this was that FDR presided over an economy with seven consecutive years of double-digit unemployment, while Reagan's policy of letting the market recover on its own, far from leading to another Great Depression, led instead to one of the country's longest periods of sustained economic growth, low unemployment and low inflation, lasting 20 years.

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Feldstein on Obama Administration's Economic Policy

(HT Mankiw) Martin Feldstein was a chairman of the Council of Economic Advisors under President Reagan and is a professor of economics at Harvard.  In "Missing the Target," a Wall Street Journal opinion article, he agrees with the Obama administration's conclusions that government intervention was needed but thinks that the interventions were ill designed.  He describes the impact of the interventions as follows
...despite the talented team of economists in the administration, most of the president's economic policies have done little to help the problem. And indeed, many of these policies have created even more problems than they solved.
He enumerates several interventions a specific problems with their design.
...the president allowed congressional Democrats to design the $787 billion stimulus package. The result was an unnecessarily large increase in the national debt for a very modest rise in gross domestic product, with too much emphasis on redistributing income and preserving public-sector jobs and not enough on raising economic activity. Only about one-fourth of the nearly $800 billion will be used for government spending that adds directly to GDP. In contrast, the funds given to households will be largely saved or used to pay down existing debts. And the dollars that went to state governments relieved pressure to use their "rainy day" funds or levy temporary tax increases.

The flaw in the stimulus package wasn't, as some say, that it was too small. It was that it was poorly targeted. Instead, Congress and the president could have gotten more stimulus from accelerating the repairing and replacing of equipment in the civilian and defense sectors. Long-term reductions in marginal tax rates of the type used by Presidents Kennedy and Reagan would also have been better than temporary tax cuts that have no positive incentive effects.

Other programs by the administration have had similar failings. "Cash for clunkers," for instance, was successful in raising auto buying and gave a temporary boost to GDP, since two-thirds of the third-quarter GDP rise was motor-vehicle production. The credit for first-time home buyers also gave a temporary boost to the housing market. But both programs just borrowed demand from the future...

Local banks around the country have cut back business lending because they fear future losses on existing real-estate loans. The administration's plan to prevent mortgage defaults by helping millions of homeowners reduce their monthly mortgage payments fizzled down to helping just a few hundred thousand. Moreover, nothing was done to reduce the incentive to default among the 15 million homeowners whose mortgages now exceed the value of their homes. And nothing has been done to deal with the $1.5 trillion of distressed commercial real-estate loans that will have to be rolled over during the next five years.

The administration's plan to induce local banks to sell impaired loans to nonbank investors so that they could start lending again was well intentioned. But it failed, despite generous proposed subsidies, because banks don't want to reduce their accounting capital.

Although solving the banking and real-estate problem is key to recovery, the president's focus on his health legislation and the public's concern about future deficits appears to have stopped him from dealing with these problems...
Feldstein ends by expressing concern over the administration's "legacy of debt:" both larger deficits and national debt.

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The 4-Week Moving Average of Initial Unemployment Claims Increases

The data released today in the "Unemployment and Insurance Weekly Claims Report" was not good.  The report states that
In the week ending Jan. 16, the advance figure for seasonally adjusted initial claims was 482,000, an increase of 36,000 from the previous week's revised figure of 446,000. The 4-week moving average was 448,250, an increase of 7,000 from the previous week's revised average of 441,250.
Robert J. Gordon researched the relationship between the 4 week moving averages of initial unemployment claims and economic activity and found that recessions often bottom out shortly after the 4-week moving average of initial unemployment claims peaks. Barring a deep double dip recession, the average peaked at 658,750 for the week ended April 4, 2009.
Comparing the movement in the 4-week moving average during this recession to the previous three shows that the averages seem to be converging and yet the unemployment rate during the earlier three were either much lower or declining.  This suggest that something else is happening.  In "Decline in the Labor-force Participation Rate," I compared the labor-force participation rate of the past four recessions and found that the rate has declined more precipitously during the current recession. 

The 4-week moving average of initial claims, unemployment rate, and labor-force participation rate are probably tied to an omitted variable in the simple graphical presentations.  Two economists offer different explanations for the current slow recovery.  Martin Feldstein suggests that intervention was necessary, but that the interventions were flawed in "Missing the Target."  In "Massive Government Intervention Drove U.S. Deeper Into Depression," Thomas Sowell goes one step further and concludes that government interventions lengthen and deepen economic declines.  

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Wednesday, January 20, 2010

Baumol, Cost Disease, and Health Care

Greg Mankiw (Baumol's Cost Disease) links to a New York Times interview of William Baumol by David Herszenhorn and calls it a "nice discussion."   I agree.  Even the title is a good and provides an accurate synopsis: "For Ailing Health System, a Diagnosis but No Cure," (January 17, 2010).  Baumol delivers his prior beliefs.
Let me say first of all that I am a strong supporter of the general notion of the president’s health care proposals.
Baumol is concerned that political supporters of reform have exaggerated its benefits and explains why "cost disease" will cause health care costs to rise faster than the rate of inflation.  Baumol speaks through Herszenhorn. 
Dr. Baumol and a colleague, William G. Bowen, described the cost disease in a 1966 book on the economics of the performing arts. Their point was that some sectors of the economy are burdened by an inexorable rise in labor costs because they tend not to benefit from increased efficiency. As an example, they used a Mozart string quintet composed in 1787: 223 years later, it still requires five musicians and the same amount of time to play.

Despite all sorts of technological advances, health care, like the performing arts, suffers from the cost disease. So do other public services like education, police work and garbage collection. While some industries enjoy sharp increases in productivity (cars can be built faster than ever, retail inventory can be managed better), endeavors like health care are as labor-intensive as ever.

And yet, wages in health care grow to match wage increases in the broader economy. (Imagine trying to pay today’s violinist the same as a counterpart in 1787.)

All of this happens invisibly, but the proof is in the budget ledgers of local, state and federal governments. Cost disease helps explain why low-income Americans can now afford flat-screen televisions that were out of reach a decade ago, but health insurance that was unaffordable in January 2000 remains unaffordable in January 2010.
I am not sure that I like the example of hiring string quintet now as compared to hiring them in 1787 compared to today.  Sure in would cost more to hire live performers today, but I could also purchase a CD produced by the best quintet in the world and for a small price. 

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An Indirect Comment from Royal Caribbean

I received this comment from Kimberly who names her link to Royal Caribbean and thought it important enough to highlight by posting it to the main page.  She appropriately links to the donation page of Food for the Poor. 
This is Kimmy from M80, a marketing agency working with Royal Caribbean. In light of Tuesday’s earthquake in Haiti, Royal Caribbean is providing various relief efforts to the region. They have teamed up with Food For The Poor, a relief organization that provides direct assistance throughout Latin America and the Caribbean. Anyone interested in assisting can make a donation, Food for the Poor.  For regular updates on Royal Caribbean’s humanitarian relief efforts, you can visit President and CEO, Adam Goldstein’s blog: Why Not?.  Thank you.
In part, Goldstein writes,
My view is this — it isn’t better to replace a visit to Labadee (or for that matter, to stay on the ship while it’s docked in Labadee) with a visit to another destination for a vacation. Why? Because being on the island and generating economic activity for the straw market vendors, the hair-braiders and our 230 employees helps with relief while being somewhere else does not help. These 500 people are going to need to support a much larger network of family and friends, including many who are in (or are missing in) the earthquake zone. Also, the north is going to bear a good part of the burden of the agony of the south, and the more economic support there is to the north, the better able the north will be to bear this burden. People enjoying themselves is what we do. People enjoying themselves in Labadee helps with relief. We support our guests who choose to help in this way which is consistent with our nearly 30 year history in Haiti.
Goldstein has good economic insights. 
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Tuesday, January 19, 2010

A Reader Challenges the Premise of The Blind Side

A reader, TLC '80, challenged the premise of The Blind Side, that the NCAA placed onerous burdens on poor students.  The writer played a year of college football and has insights that a wannabe athlete with neither physical talent nor skills would not possess.  I did take a tour of USC as part of a baseball camp and learned that the athletics department spends $1 million annually on tutors.  They also send an employee to each class in which a student is enrolled to verify that the student is attending.  This is not proof that the departments or athletes value education but it is proof that compliance is expensive.  TLC '80 writes
I'm not sure I buy this premise. It may be designed to sell more books and promote a movie, rather than reflect reality. I played high school football in Dallas in the 70's, and went on to play at Texas Lutheran (for 1 year - injuries forced me to quit).

I had high school friends who played at the big schools -- A&M, Oklahoma, Texas, etc. These guys got paid by the backers (can you say Barry Switzer?). Some of my friends at the large schools got free cars, cash, and no-show "jobs" that allowed them to stay in school. This was all known and winked at throughout the old Southwest Conference. I'm sure it was just as bad in the other conferences.
We had the same problem then -- we played with middle-class white kids, and poor black kids. TLC (now TLU) won the NAIA Div III national title a few times -- and none of our players went on to the NFL. And I don't think any of them had any expectation that they would.

Now, I'm an old fart, and things have changed in 30 years (SMU death penalty, etc). But one of the problems that the NCAA faces (and some high school teams in TX with UIL do, too) is kids moving from school to school in search of scholarship money -- any money -- just to stay in school. And they'll treat the rules just like we treat taxes -- ("Anyone may arrange his affairs..." -- Learned Hand). Why should we be surprised when family and big-money (typically white) athletic supporters encourage all players to get right up to the line and push the edge of the rules, just as they do in their business and personal lives?

It has always been my position that college players should be paid a stipend (ok, salary) in order to remove some of the incentives to cheat. In my case, I never got any money from boosters (I wasn't very good), but I worked real jobs for real money, and there were no limits to what I could earn. I had a union job in the summer that paid $12 per hour (big money in the 70's) and that paid for my college.

Now in my day, we had no illusions that we would play pro ball. We wanted to earn that National Title ring, and then brag about it until our grand kids were bored of hearing about it.

I'm sure it's changed - there's a lot more money sloshing around - but this line that there are players who are "sustained by the hope" that they'll be pros is a stretch. We have schools who don't require them to show up for class, and the 60's "social promotion" is still going on in college. How in the world can we grant a college degree to someone who is functionally illiterate, and hasn't been to class in a semester or so? This is a problem at the teaching level (and the athletic program bringing in the big bucks). Why in the hell do we have tenured teachers if they won't stand up to the coach and the school and say "no" to giving passing grades to players who don't really pass?

Perhaps if we saw fewer "ganstas" like Michael Irvin sporting 10 carat diamond earrings, and a little better roll-models on the part of white and black players (active pro and retired), along with stipends, we could put a dent in this so-called problem.

But college is about education for life, and the athletics is secondary. THIS is the message that must be the basic premise of college admission counselors, coaches, and backers. I think a stipend for the players will slow down the use of big-name college programs as farm teams for the NFL. Let's get Jerry Jones to put a few of those millions to work at SMU or at Baylor instead of building billion-dollar stadiums.

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Royal Caribbean in Haiti

(HT Drudge Report)  The reports in "Cruise ships still find a Haitian berth" that
Sixty miles from Haiti's devastated earthquake zone, luxury liners dock at private beaches where passengers enjoy jetski rides, parasailing and rum cocktails delivered to their hammocks.

The 4,370-berth Independence of the Seas, owned by Royal Caribbean International, disembarked at the heavily guarded resort of Labadee on the north coast on Friday; a second cruise ship, the 3,100-passenger Navigator of the Seas is due to dock.

The Florida cruise company leases a picturesque wooded peninsula and its five pristine beaches from the government for passengers to "cut loose" with watersports, barbecues, and shopping for trinkets at a craft market before returning on board before dusk. Safety is guaranteed by armed guards at the gate.

Some passengers expressed feelings ranging from squeamish to outrage at the Royal Caribbean's decision...
The decision to go ahead with the visit has divided passengers. The ships carry some food aid, and the cruise line has pledged to donate all proceeds from the visit to help stricken Haitians. But many passengers will stay aboard when they dock; one said he was "sickened".

"I just can't see myself sunning on the beach, playing in the water, eating a barbecue, and enjoying a cocktail while [in Port-au-Prince] there are tens of thousands of dead people being piled up on the streets, with the survivors stunned and looking for food and water," one passenger wrote on the Cruise Critic internet forum.

"It was hard enough to sit and eat a picnic lunch at Labadee before the quake, knowing how many Haitians were starving," said another. "I can't imagine having to choke down a burger there now.''

Some booked on ships scheduled to stop at Labadee are afraid that desperate people might breach the resort's 12ft high fences to get food and drink, but others seemed determined to enjoy their holiday."I'll be there on Tuesday and I plan on enjoying my zip line excursion as well as the time on the beach," said one.

The company said the question of whether to "deliver a vacation experience so close to the epicentre of an earthquake" had been subject to considerable internal debate before it decided to include Haiti in its itineraries for the coming weeks.
I understand discomfort of these customers, but I believe I believe that Royal Caribbean made the morally and economically right decision in resuming normal operations.
"In the end, Labadee is critical to Haiti's recovery; hundreds of people rely on Labadee for their livelihood," said John Weis, vice-president. "In our conversations with the UN special envoy of the government of Haiti, Leslie Voltaire, he notes that Haiti will benefit from the revenues that are generated from each call …

"We also have tremendous opportunities to use our ships as transport vessels for relief supplies and personnel to Haiti. Simply put, we cannot abandon Haiti now that they need us most."

"Friday's call in Labadee went well," said Royal Caribbean. "Everything was open, as usual. The guests were very happy to hear that 100% of the proceeds from the call at Labadee would be donated to the relief effort."

Forty pallets of rice, beans, powdered milk, water, and canned foods were delivered on Friday, and a further 80 are due and 16 on two subsequent ships. When supplies arrive in Labadee, they are distributed by Food for the Poor, a longtime partner of Royal Caribbean in Haiti.

Royal Caribbean has also pledged $1m to the relief effort and will spend part of that helping 200 Haitian crew members.

The company recently spent $55m updating Labadee. It employs 230 Haitians and the firm estimates 300 more benefit from the market. The development has been regarded as a beacon of private investment in Haiti; Bill Clinton visited in October. Some Haitians have decried the leasing of the peninsula as effective privatisation of part of the republic's coastline.
Maintaining some degree of normalcy during the crisis is valuable not to mention keeping 530 Haitians employed and demonstrating that private foreign investors can find profit in Haiti.

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Monday, January 18, 2010

Haiti Before the Quake

Laura Freschi writes a short introduction to Anne Hasting's narrated slide show about Haiti (Aid Watch, "Haiti’s recent troubled past," January 15, 2010).  Freschi provides a link to the slide show that I encourage readers to view.  I agree with Freschi's description as "eerily prescient."  It is enough to make you weep.
This is Anne Hasting, director of Fonkoze, alternative bank of the poor, in fall of 2008, speaking to reporter Ruxandra Guidi about the damage from the latest hurricanes to hit Haiti. That year, four hurricanes and tropical storms hit Haiti in quick succession, causing mudslides and floods that wiped out the coastal town of Gonaives, killing some 800 people and displacing millions.

Take a moment to watch the narrated slide show, produced by journalist Ruxandra Guidi with photographs by Roberto Guerra and a haunting soundtrack by Luis Guerra.

In these next few days, we turn from our initial horror at Haiti’s new catastrophe to the dizzying, widening view of a human disaster that will take years to recover from. This eerily prescient video is now an artifact of Haiti’s immediate past, when Port-au-Prince, with its houses and markets, slums and palaces, churches and hospitals, was still standing.

Thanks go to reader Luke Seidl for the tip.

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Aiding Haiti's Earthquake Victims and Growth

I was sent via e-mail a copy of an article by Brian Concannon writing for Counter Punch in "Working with the Haitian Government." Concannon is a human rights lawyer working in Haiti, a laudable career and I wish him well, but I believe that he has made several errors that have characterized developmental aid in the past that we should avoid in the future.  He writes 
Haiti’s lack of infrastructure and history of corruption should be considered in shaping the international response to Tuesday’s earthquake. But these factors should be a reason for investing in infrastructure and good governance, not for bypassing Haiti’s government.
Arnold and Schulz (From Poverty to Prosperity) use the "resource curse" to explain why it might be bad to funnel foreign aid through a government.
Economists have coined the phrase "the resource curse" to describe countries whose wealth consists primarily of diamonds or oil.  The problem is that resource wealth is more characteristically stolen than earned.  Natural resources do not reward work, capital accumulation, or innovation.  They reward those who can establish and maintain control over the resource.

Some economists believe that foreign aid, because it is unearned, can be a similar curse.  When aid is channeled through the recipient government, it gives the leaders an incentive to remain in power, in order to control the wealth represented by the aid.  Just as the owner of a diamond mine tries to hang on his franchise, the leader of an aid-dependent nation tries to exclude others from power.

Thus, unearned income serves to undermine the work of ethic and the public service ethic.  Resources and government aid offer rewards to those skilled at taking things rather than those skilled at creating or improving things.  Unearned income makes corruption relatively easy and profitable.  

Concannon continues
Haiti’s devastation exposed the disadvantages of an extremely limited government. The earthquake itself was a natural phenomenon, but its horrible toll was largely the product of manmade factors like the failure to prevent shoddy construction on precarious slopes (or provide safer housing) and a health care system already stretched to the breaking point. Sixteen months ago, and five years ago, similar factors produced high death tolls from tropical storms that hit neighboring countries harder but less lethally.
As a defender of limited government, I would substitute "ineffective" for "limited" in the above paragraph.  Nor is the prevention of shoddy construction simple a function of government regulations or a strained health care system the result of governmental neglect.  Markets have something to do with the provision of goods and services.  Rather than blame shoddy construction for damage, I would blame extreme poverty.  People working through markets recognize Haitian poverty and produce a market driven construction code.  Imagine the rise in building expenses and homelessness if the government could effectively impose Los Angeles' building code on Haiti.  How many Haitians could afford our health care or even Mexico's health care?  The issue is how to bring economic growth not how to provide better goods and services which are a byproduct of growth.

Concannon concludes
An effective international response to the earthquake will minimize the damage of the next stress in Haiti, by including both short- and long-term measures to develop the government’s capacity to provide basic, honest services to its citizens.
Accepting Concannon's belief that is the role of the international community to "develop the government's capacity to provide basic, honest services to its citizens" I would ask if this is the right goal and do we have the capacity to achieve it?  Substitute "Haitian's" for "government's" in the above paragraph and you might be headed in a better direction for growth.  As North, Wallis, and Weingast point out in Violence and Social Orders countries that advance in wealth and prosperity do so by developing more private and local governmental organizations.  The authors suggest that this growth is organic.  Perhaps foreign efforts to encourage the growth of organizations outside the federal level will fail as have past efforts to work through them. As William Easterly observes ("Interview with William Easterly," in From Poverty to Prosperity)
There's been $2.3 trillion spent over the last fifty years in foreign aid.  And that's in today's dollars. And really, there's surprisingly little to show for it.  The main objective of foreign aid, of course was the permanent reduction of poverty; the main objective was to promote economic growth.  And unfortunately, there's no connection at all between aid and economic growth according to the empirical evidence that we have. 

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Sunday, January 17, 2010

The NCAA Blind Sides Poor Athletes

The Blind Side is a heat warming movie about Michael Oher, a black boy without family or home who is befriended and ultimately adopted by a wealthy white family.  The makers of the movie make several important claims, that nurture is more important than nature, love is colorblind, and that religion and athletics are two of the few bridges between white and black America.  A minor point is that the NCAA thought that a white family befriending an athletic black boy might be an NCAA violation.  In a wonderful interview by Robert Birnbaum (RB), Michael Lewis (ML), the author the book, The Blind Side, delves into the role of the NCAA in restricting the access of the poorest of black athletes from a ladder of upward mobility through college education (identity, "Michael Lewis 2.0").
ML: I didn’t feel outraged by it watching it [subversion of NCAA rules] up close. Because...while it’s outrageous in theory that this happens—that people can go and subvert the rules of the NCAA—the rules themselves seem to me to be a little screwy. First, the rules that kid lived by his whole life...what basically the NCAA is saying to this kid is, “Society completely cheated you for the first sixteen years of your life. Failed you in every possible way. No family, no love, no upbringing, no structure, no schooling. Nothing! And so we are going to make sure that that sticks.”...

ML: It’s a corrupt regulatory system—it's worse than you know. What happens is that there is a career to be had as an NCAA investigator, and what you do is go to work for the NCAA—like a career with the Securities Exchange Commission: you go to work being the cop, and then you get hired for a fancy salary working for the school interpreting the rules written by the cops. And so it becomes this little incestuous world that justifies itself in all sorts of ways. And its main purpose is to serve as a figleaf for what has become professionalized college athletics. The tutors at Ole Miss were very blunt about this. They watched the regime that the football players were in; they said that they give them a speech when they arrive: “You are employees of a corporation. You are not college students. You are employees of a corporation. You are just not paid.” [laughs] I think the harm that is done by the hypocrisy is greater than the harm that would be done just by throwing open the doors and saying this is the way it is. People have so obsessed with football at the college level, and it is such a money maker—it’s not just a money maker for these universities: in some cases the school would have trouble surviving without the football team. So let’s just acknowledge this. Let’s acknowledge it in the way we acknowledge professional baseball players were once indentured servants and they shouldn’t have been—these people have a market value. They are poor people who desperately are in need of realizing their market value—let’s be fair and honest about it.

RB: Right, they are all not going to the NFL.

ML: The vast majority will not go to the NFL. These are the numbers—there are a million high school football players in the country, roughly fifty-five thousand of them will play college football. And a thousand of those will have some kind of professional contract, of whom just a couple hundred will make enough money to have careers. So you are talking about a winnowing process that’s brutal. However, the whole system is premised—not the million to fifty-five thousand—but of those fifty-five thousand college football players, there is some large number of them who are sustained by the hope that they are going to be professional football players and are not making other provisions for themselves.
Michael Lewis believes that college athletics will eventually evolve into an organization that gives more to its employees. 
RB: So even in those years when they are in college, they could get some vocational guidance, and get some compensation—

ML: —and it will all work out. I think what will happen is someone will come along who won’t buckle under the pressure and will say, “Okay, we’re going to get a good lawyer and take care of them and break the system.” Because it’s outrageous. It is outrageous. Essentially what you have now is thousands upon thousands of poor black kids coming from the most horrendous kind of destitution, exploited briefly for three or four years and led to believe that they might actually make a career playing football and then thrown back on the street with absolutely nothing to show for it. And the flip side of that is what an opportunity to at least make a dent in the social problem. There are not very many points of contact between white America and black America. Here can be cynical about sports, about football, but you can’t argue that white people aren’t interested in those black people playing on the field when they are playing football. Why not use that for some greater purpose? Instead of forbidding the rich white boosters for so much as taking the black football players to lunch, why not insist that they not only take them to lunch but they give them an internship and pay them well in the off season and teach them about their business? The minute those kids cease to be football players, they are of no interest whatsoever to those white people anymore. That relationship should be cultivated rather than denied.

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Friday, January 15, 2010

McGwire and Bradbury, the Sports Economist

For the third straight year, allegations of steroid use kept Mark McGwire from election into the Baseball Hall of Fame gathering only 23.7% of the vote in 2010.  This week, he acknowledged steroid use in a tearful apology.  As a preface to my remarks, I admit to liking McGwire.  He appeared more likable than many athletes.  In his rookie year, he hit 49 home runs, but forewent the opportunity to hit 50, sitting out two games to witness the birth of his first child.  When negotiating a contract, he signed with St. Louis Cardinals when other teams were offering more because he liked the cities and franchise's baseball tradition.  He gave a million a year to a charity helping abused children.  Joel Stein of Time provides a good biography in "Mark McGwire: Mark of Excellence."  It was written in 1998, before the steroid's scandal broke.  Is steroid use the only viable explanation for McGwire's performance?

J. C. Bradbury's book, "The Baseball Economist" is a must read for students who like baseball, economics and statistics.  He offers the hypothesis that baseball expansion is another explanation for the spike in home runs between 1998 and 2001 than steroids use.  Roger Maris hit 61 home runs in 1961 when the Los Angeles Angels and Washington Senators joined the American League.  His second highest home run total was 39.  Baseball expanded prior to the spike in 1993 and 1998.  The causal relationship is that as the league expands, talent becomes more dispersed.  On average, the best hitters face worse pitching, and vice versa.  Bradbury writes,
What does this say about the current ear of baseball history, especially given the intense public focus on steroids as the cause of the increased number of home runs?  Pitching talent is more dispersed than it has ever been, while hitting talent is still quite concentrated.  It means there are plenty of batters out there who are able to take advantage of bad pitchers.  A more dispersed pitching talent pool gives the best hitters greater opportunities against weaker talent, which ought to lead them to perform extreme feats...

Also, if low-quality pitchers are hitting more batters, shouldn't better pitchers benefit from facing more bad hitters as hitting talent has become less compressed since the 1980s?  In fact, they do, as pitchers increased their strikeout rates over the same span....
Bradbury concludes,
The fact that talent dilution may be part of the cause for the great performances of players does not mean that steroids have not influenced the game.  However, it's certainly incorrect to say that steroids, or other performance-enhancing drugs, are the only explanation. 

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The Government, Computes and Reverse Causality

Peter Orszag, Director of the Office of Management and Budget, has committed the error of reverse causality arguing that the government is inefficient and ineffective because it has a technology gap with the private sector.  The gap exists because government is inefficient and ineffective relative to the private sector.  Ian Swanson writes in the Hill's technology blog, Hillicon Valley ("White House budget director blames old computers for ineffective government") that Peter Orszag believes that a technology gap is responsible for ineffective and inefficient government.
The public is getting a bad return on its tax dollars because government workers are operating with outdated technologies, Orszag said in a statement that kicked off a summit between Obama and dozens of corporate CEOs.

“Twenty years ago, people who came to work in the federal government had better technology at work than at home,” said Orszag, director of the Office of Management and Budget. “Now that’s no longer the case.

“The American people deserve better service from their government, and better return for their tax dollars.”

The White House release that included Orszag’s comments said one “specific source” of ineffective and inefficient government is the huge technology gap between the public and private sectors that results in billions of dollars in waste, slow and inadequate customer service and a lack of transparency about how dollars are spent.
For those old enough to remember interacting with the government twenty years ago, were they more efficient and ineffective relative to the private sector? 
The private sector has been and remains more efficient than the government because it generally has superior incentives, most importantly profits.  If a business believes that a new technology will increase profits, they employ it or risk adaptation by a competitor that will cannibalize their profits and market share.  The government has no such incentive.  They may know that a new technology will improve efficiency but there is no profit motive to encourage adaptation.  They may or may not make the investment.  If they don't make it we get the same service.

Orszag wants to improve government, a laudable goal.  A first step is to recognize government's shortcomings and limit its scope to areas in which the private sector has poor incentives relative to the public sector.  The government should provide national defense, a judicial system to protect people and property, city roads, and perhaps a few other services.  Policy makers can improve the effectiveness and efficiency of the government by turning over functions to the private sector.

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Thursday, January 14, 2010

Decline in the Labor-force Participation Rate

The economy has improved; growth has resumed, albeit slow growth, but little if any of the improvement seems to have reached labor markets.  The most encouraging news is that the 4-week moving average was 440,750, a decrease of 9,000 from the previous week's revised average of 449,750.  This average has been declining for nine months, and in the past, its decline has signaled an economic rebound.  As we all know, "Past performance is not necessarily indicative of future results."  The unemployment rate remains at 10 percent and the labor-force participation rate has been falling like a rock.  Christopher S. Rugaber, an AP writer, observes in "Economy 101: Dropouts Hold Down Unemployment Rate," (abc News/Money) that
Nearly 2 million Americans have dropped out of the work force since last May — and if they hadn't, the unemployment rate would have risen a lot more dramatically over the last several months.

Either way, joblessness is quite high. The Labor Department said Friday the unemployment rate remained at 10 percent last month, the same as in November and just below the 10.1 percent rate reached in October. The October figure, which was revised down from 10.2 percent, was the highest in 26 years.
Rugaber mentioned the unemployment rate, which is calculated by dividing the unemployed by the labor-force and, to convert a decimal to a percentage, multiplying by 100 (unemployed/labor-force*100).  If there is a one-to-one decline in unemployment and the labor-force, a drop in both results in a decrease in the unemployment rate.  He did not mention the labor-force participation rate, which is calculated by dividing the labor-force by the adult population and multiplying by 100 (labor-force/adult population*100).  It is one of the statistics used by labor economists to take the pulse of labor markets which are weak if workers exited because they became discouraged by bad job prospects.  CalculatedRisk estimates that
If the participation rate was at the same level as in July, the unemployment rate would probably be around 10.8%.

I have included a couple of graphs.  The first shows the labor-force participation rate during the last four recessions.  The second shows the deviation of the labor-force participation rate from its average during the recessions and perhaps adds more emphasis to changes in the rate.  The data in the graphs began three months before the National Bureau of Economic Research concluded that the recessions began and is denoted in both graphs with a red vertical line.  The three recessions preceding the current had ended in the time frame included in the graph and is denoted with two black vertical lines. 

The only obvious conclusion is that the labor-force participation rate has fallen more during the current recession than the previous three.  Three of the four recessions experienced a decline in the labor-force participation rate.  The 1981-82 recession did not suggesting that other factors may have a larger impact on the rate than the strength of the economy.  The age of the labor-force is also an important factor and, as CalculatedRisk noted, was declining prior to the recession.  Although I do not believe that it is likely, perhaps the recession has hastened retirement.   

My next post on the topic will graph the relationship between the labor-force participation and unemployment rates. 

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Monday, January 11, 2010

Washington, the Catholic Church and Hold-up

With deference to Steven Levitt and Stephen Dunbar, you shouldn't mix apples and oranges and that is exactly what the Catholic Church and Washington D.C.'s city government have done when they became partners in distributing aid to the poor and needy.  Emily Esfahani Smith explains that the partnership benefits the District and the needy within it ("Washington, Gay Marriage and the Catholic Church," the Wall Street Journal, January 9, 2010).
...the District outsources many of its social services to Catholic Charities, which runs the charitable services of the archdiocese. These charities provide a variety of services—including shelters for the homeless and food for the hungry—to about 124,000 needy residents in the region (which also includes a portion of Maryland). The archdiocese also oversees St. Ann's Infant and Maternity Home, a care center for foster children, and it administers adoptions for the District. For this work, Catholic Charities receives approximately $20 million in contracts, grants and licenses from the city. It bolsters these funds with $10 million of its own money and a network of 3,000 volunteers.
Let me begin with a disclaimer.  The opinions I am about to express apply not only to Catholics, but agnostics, atheists, Baptists, Jews, Mormons, Muslims and other religious group.  Nor am I addressing the issue of gay marriage.  I don't like mixing church and state through charities because I like bright distinctions between them and I believe that society is best served when those distinctions are maintained.  I don't want avenues of influence to develop through the tangled webs of contractual arrangements.  I don't want those lines of influence used to change the policy of the other.  In this instance, the city government is engaged the practice that economists call hold-up.[1]  It is changing the terms of a contract after the Catholic Church has made an irreversible commitment to aid the poor in part with government funding in order to pressure the Archdiocese to change its stance on gay marriage.  Smith writes,
By passing gay marriage, the City Council has put the Catholic Church, or more accurately, the Archdiocese of Washington, in an awkward position. Either the church will have to recognize gay marriage or it will be forced to abandon a large portion of its charitable programs...

If same-sex marriages are legalized, which seems inevitable, Archbishop Donald Wuerl of Washington points out that the church will find itself in violation of the new law if it continues its city-sponsored social services programs. Why? Because city contractors are required to abide by all of the District's laws and there are provisions in the bill requiring the church to acknowledge gay marriage by offering employment benefits to same-sex couples and by placing children with gay adoptive couples.
The poor and the needy are the baby the City government and the Catholic Church are about to split and using the wisdom of Solomon, the organization that seems most willing to compromise seems to have the best interest of the poor in mind.  The City Council could add a religious exemption to its bill as most governments at all levels have done, but they won't.  They are playing hardball with the welfare of the poor.  As Smith notes,
The archdiocese isn't willing to play hardball with the city. Susan Gibbs, a spokeswoman for the archdiocese, told me that her organization is committed to serving the poor, regardless of what the laws are in the District, and that it is now looking "to find a way to enable Catholic Charities to keep working in partnership with the city."

So either the archdiocese will drop benefits for all employees—if it doesn't provide benefits to married couples, it won't have to offer them to same-sex couples—or it will follow in the footsteps of Georgetown University, the District's largest Catholic organization. There, an employee, whether gay or straight, married or not, receives full benefits for himself plus one legally domiciled member of his or her household. This would allow the archdiocese to save face by pretending it isn't knowingly recognizing gay marriages.

Either accommodation would allow the archdiocese to continue to run its charities. Yet both require a change within the archdiocese. The first would force the archdiocese to drop benefits it had provided in support of traditionally married couples, while the latter would entail a dishonest dodge from an institution built on sincere faith.
It is evident that the Catholic Church is more concerned about the poor than the D.C. City Council.

[1]  Economists believe that hold-up results in less contracting than is socially desirable, or in this case, less aid to the poor.  I offered the opinion that no contracting between the two is desirable based on the unsupported hypothesis that the contracting will mute the desirable characteristics of church and state. 

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Friday, January 8, 2010

Harkin on the Relationship of Men and Government

When I was in my early twenties and still a liberal Democrat I read "Capitalism and Freedom" by Milton Friedman and hated it.  On the first page he dissected President John Kennedy's statement, "Ask not what your country can do for you--ask what you can do for your country."  My friend and mentor Del Gardner, who had traveled with Milton Friedman as a graduate student at Chicago asked me the source of my disdain.  I said that Friedman had read too much into a plea for patriotism. 

Yesterday, I read a statement by Senator Thomas Harkin of Iowa ( Christina Crippes, "Harkin favors taxing stock transactions," The Hawk Eye, or Ryan J. Donmoyer, "Wall Street Transaction Tax Proposed by Democrats (Update4)," Bloomberg, December 3, 2009) who attempted to justify a tax on each transaction of stock, futures, options and swaps, by saying,
Let me put it bluntly, we need this revenue, which would amount to as much as $100 billion or more annually. We need it to reduce the deficit as well as to pay for new legislation to create jobs and put people back to work.  We need a shift of priorities to this: Ask not what America can do for Wall Street. Ask what Wall Street can do for America.
A flood of memories poured through my thoughts.  It has been a long while since I have been a liberal Democrat and almost as long since I began to enjoy Friedman's quote, but the accuracy of Friedman's vision again struck me.  Friedman wrote of Kennedy's statement,

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, an instrumentality, neither a grantor of favors and gifts, nor a master or god to be blindly worshipped and served. 

Can it be any clearer that Harkin views investors as servants or votary and the government as the master or deity?

Harkin seems to have as bad an understanding of the economics of the proposal as of the relationship between man and government stating a historical precedence for the tax rather than an economic justification.
Until 1966, the United States taxed all stock transactions and transfers. Indeed, Congress doubled the transaction tax rate during the Great Depression in order to finance economic recovery initiatives.
Someone might ask Senator Harkin why he wishes to emulate a policy enacted during the longest period of high unemployment in our nation's history.  He should know that if you want less of something you tax it.  To repeat a theme of an earlier post (The Crisis Paradox), Robert Higgs  wrote that regime uncertainty created by less secure property rights, higher taxes, and other measures is an explanation of the Depression's duration (Higgs, Robert, "Regime Uncertainty," The Independent Review, Vol. I, No. 4, Spring 1997). 

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Thursday, January 7, 2010

The Nanny State and Tax Returns

The Obama administration does not believe that consumers are sufficiently wise to select tax preparers.  The Review & Outlook section of the Wall Street Journal reports and comments on the news in "H&R Blockheads."
We're guessing that when Americans think of outlaw industries, tax preparers aren't the first rogues that come to mind. But lo, the nation's green eyeshades are now destined to come under the regulatory rule of the Internal Revenue Service as part of the Obama Administration's latest revenue grab.

Under the plan, which would begin with the 2011 tax season, anyone who takes money to help people with their taxes will have to register with the IRS, and eventually pass competency tests and sign up for continuing education. So having made tax filing so complicated that most Americans need help with their forms, Washington now wants to raise the price of such counsel by regulating advisers in a way that may reduce their supply.
Defending the undefendable is a fools errand, but Commissioner Shulman is up to the task...
Defending the decision, IRS Commissioner Douglas Shulman declared that regulating tax preparers was reasonable because "In most states you need a license to cut someone's hair." Yes, the cosmetology guild does like to raise the barriers to entry for competitors.
Elaborating on the Journal's point, we do not need to license cosmetologist because we can and do readily view a bad haircut.  A bad cosmetologist would be out of business pronto.  Besides Commissioner Shulman, didn't your mother ever tell you that two wrongs don't make a right?

H&R Block likes the regulation.
Cheering the new regulations are big tax preparers like H&R Block, who are only too happy to see the feds swoop in to put their mom-and-pop seasonal competitors out of business. Kathryn Fulton, senior vice president for government relations, told the Washington Post the company was glad to support rules that meant H&R Block "won't be competing against people who aren't regulated and don't have the same standards as we do." With fewer tax preparers in the market, H&R Block will find it easier to raise prices.
In an EconTalk interview conducted by Russ Roberts, Milton Friedman observed that,'s always been true that business is not a friend of a free market. I have given a lecture from time to time under the title Suicidal Impulses of the Business Community, something like that, and it's true. 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.
It may get worse.  The Senate's odd couple, Max Baucus and Chuck Grassley are working on a project to let the IRS compute your taxes.
The feds are now getting in on this act, with Montana Democrat Max Baucus and Iowa Republican Chuck Grassley supporting a free e-file portal at the IRS Web site that would compete directly with private tax preparation software. In March, Treasury Secretary Timothy Geithner told a Ways and Means Committee hearing that he'd also like the IRS to begin sending taxpayers pre-completed returns.
The government could probably reduce the cost of criminal justice by doing away with juries and letting the prosecuting attorneys determine guilt or innocence, but I don't think that is a good idea either.

The Journal concludes that the Obama administration is trying to increase tax revenues without going to Congress for a new law.  I concur. 

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