Drill Baby, Drill

It's amazing what the expectation of higher prices will do for oil exploration; people do respond to incentives. Sarah Wolfe writes for Energy Digital in "US crude oil production could see largest increase in four decades, says Platts analysis," that

According to a recent analysis from Platts , a leading global provider of energy and metals information, the United States is primed to see its largest one-year increase since 1970 in crude oil production.

The US averaged 5.268 million barrels per day through the month of October. With this amount, this year’s overall gain is the highest since the country produced 9.637 million barrels per day in 1970, according to Platts’ summary of data released by the US Energy Information Administration.

According to Platts, if the 5.2687 million barrels per day output continues through the end of December, there could be a 6.4 percent jump over 2008’s 4.95 million average. This year would then rank as the best in US oil production since 2004, when the average output was 5.419 million barrels per day.

A major cause for the oil production increase is more activity in the Gulf of Mexico. The industry has bounced back in the region since last year’s hurricane season and a group of new deepwater fields are emerging.

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Banks and the Importance of Equity

Principles of economics textbooks generally omit equity from the balance sheet equation, Assets=Liabilities+Equity, to focus on money creation. Given the financial crisis that became manifest in September 2008 and its continuing aftermath, this post reinserts equity or capital to focus on the risk of insolvency bankers take in lending. The example is provided by Juliusz Jabtecki and Mateusz Machaj, "The Regulated Meltdown of 2008," Critical Review, 21(2-3): 301-328, 2009. The article often refers to capital, a richer term than equity, the term used in class. When reading the quote, you can replace capital with equity with no loss of understanding. I added Figure 2 to the quote.

Figure 1

Assets		Liabilities
Cash	$10	Equity	$5
Loans	$90	Deposits	$95
Total	$100	Total	$100

Generally speaking, "capital" is the portion of a bank's assets that does not have to be ultimately repaid to creditors--such as depositors, who are, after all, merely loaning their funds to a bank. To see why capital should offer protection against unexpected losses, consider the following simple example of a bank's balance sheet (Figure 1).

The balance sheet consists of the bank's sources of funds (liabilities) and the uses to which those funds are put (assets). By definition, the two must be equal at all times We can see that our bank has collected $100 of funds: $95 in deposits from retail customers, representing liabilities; and $5 in "capital" which for the moment, we will assume is equity capital: income from issuing shares of common stock in the bank. Such income does not have to be repaid: Shareholders have no legal right to be paid dividends; and common shares have the lowest-priority claim on other assets in case of bankruptcy.

Of the $100 of liabilities (including the $5 in capital), 90 percent is then turned into credit by being loaned out, while 10 percent is held as cash in the bank's vault as cash reserves against potential withdrawals from depositors of a portion of the $95 they have lent to the bank. A bank's loans plus its cash reserves constitute its assets.

Figure 2

Assets		Liabilities
Cash	$10	Equity	$3
Loans	$88	Deposits	$95
Total	$98	Total	$98

Now imagine that some of those to whom the bank has loaned money unexpectedly default, rendering $2 of loaned assets worthless (Figure 2). The bank has to write off these losses, diminishing the total value of assets to $98. But while the value of the bank's assets has declined by $2, the amount that it owes depositors remains exactly the same ($95). Thus, for assets ($98) to continue to equal liabilities, capital must fall to $3. Suppose, by contrast, that the bank didn't initially have any capital, and that its assets ($90 in loans plus $10 in cash) were financed fully by the collection of $100 in deposits. Any unexpected (and unaccounted for) loss would then render the bank immediately insolvent, as the assets--all that the bank has--would not suffice to pay off all that it owes.

It is only due to the fact that a portion of its financing does not have to be repaid (e.g., the portion obtained from issuing stock) that the bank has the capacity to withstand unexpected losses on the investments that it makes with the funds entrusted to it. That is the primary reason that bank regulators believe it necessary to control the amount of capital that financial institutions hold. On the other hand, holding capital constrains risk-taking (and thus, potentially, profitability); that is the point of the capital regulations. To the extent that bank managers view regulatory capital as a tax imposed on them, they will tend to see capital regulations as obstacles to be gotten around.

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Acemoglu on Wealth Creation

(HT Mankiw) In, "What Makes a Nation Rich? One Economist's Big Answer," written for Esquire, Daron Acemoglu of MIT, one of the word's best economists and a favorite of mine, explains how a poor nation can become rich. The name, Acemoglu, and his answer, change incentives, will sound familiar to my students.

People need incentives to invest and prosper; they need to know that if they work hard, they can make money and actually keep that money. And the key to ensuring those incentives is sound institutions — the rule of law and security and a governing system that offers opportunities to achieve and innovate. That's what determines the haves from the have-nots — not geography or weather or technology or disease or ethnicity.

Put simply: Fix incentives and you will fix poverty. And if you wish to fix institutions, you have to fix governments.

Acemoglu also describes policies that the U.S. should avoid and advance in promoting wealth creation.

If we know why nations are poor, the resulting question is what can we do to help them. Our ability to impose institutions from the outside is limited, as the recent U. S. experiences in Afghanistan and Iraq demonstrate. But we are not helpless, and in many instances, there is a lot to be done. Even the most repressed citizens of the world will stand up to tyrants when given the opportunity. We saw this recently in Iran and a few years ago in Ukraine during the Orange Revolution.

The U. S. must not take a passive role in encouraging these types of movements. Our foreign policy should encourage them by punishing repressive regimes through trade embargoes and diplomacy. The days of supporting dictators because they bolster America's short-term foreign-policy goals, like our implicit support of Muhammad Zia-ul-Haq in Pakistan starting in the 1970s, and our illicit deals with Mobutu's kleptocratic regime in the Congo from 1965 to 1997, must end. Because the long-term consequences — entire nations of impoverished citizens, malnourished and hungry children, restive, discontented youngsters ripe to be drawn toward terrorism — are too costly. Today that means pushing countries such as Pakistan, Georgia, Saudi Arabia, Nigeria, and countless others in Africa toward greater transparency, more openness, and greater democracy, regardless of whether they are our short-term allies in the war on terror.

At the microlevel, we can help foreign citizens by educating them and arming them with the modern tools of activism, most notably the Internet, and perhaps even encryption technology and cell-phone platforms that can evade firewalls and censorship put in place by repressive governments, such as those in China or Iran, that fear the power of information.

There's no doubt that erasing global inequality, which has been with us for millennia and has expanded to unprecedented levels over the past century and a half, won't be easy. But by accepting the role of failed governments and institutions in causing poverty, we have a fighting chance of reversing it.

Acemoglu is writing a book about his theory of inequality with James Robinson; a book that I will both buy and read.
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Log Rolling Landrieu

From Jonathan Karl of ABC News ("The $100 Million Health Care Vote?") via the Drudge Report, we learn,

On page 432 of the Reid bill, there is a section increasing federal Medicaid subsidies for “certain states recovering from a major disaster.”

The section spends two pages defining which “states” would qualify, saying, among other things, that it would be states that “during the preceding 7 fiscal years” have been declared a “major disaster area.”

I am told the section applies to exactly one state: Louisiana, the home of moderate Democrat Mary Landrieu, who has been playing hard to get on the health care bill.

In other words, the bill spends two pages describing would could be written with a single world: Louisiana. (This may also help explain why the bill is long.)

Senator Harry Reid, who drafted the bill, cannot pass it without the support of Louisiana’s Mary Landrieu.

How much does it cost? According to the Congressional Budget Office: $100 million.

Log rolling is a legal and at times may be a useful legislative tool, but a $100 million payment to buy or sell a vote for a bill that will fundamentally change health care for 300 million Americans is immoral . It's like selling a vote to go to war. From Harry Reid's perspective, its cheap; thirty cents per American is a small price for Americans to pay to pass legislation that you support, particularly considering that it is other people's money. It also reveals that Reid is more concerned with "reforming" health care than with fiscal responsibility. It may also reveal Mary Landrieu's true measurement of the value of the bill. If Landrieu acted honestly for Louisiana's citizens and if Reid negotiated well for the rest of the country, the $100 million represents the state's opportunity cost. The people of Louisiana would be $100 million better off if the legislation fails.

In an earlier post, "Riddle Me This," I asked what is worse than Congress voting on bills that they have not read? My answer was proposing bills that cannot be understood if read. In that post, I referenced Nicholas Ballasy of CNSNews, ("Finance Committee Democrat Won’t Read Text of Health Bill, Says Anyone Who Claims They’ll Understand It ‘Is Trying to Pull the Wool Over Our Eyes’,") who quoted Sen. John Cornyn (Texas).

...the descriptive language the committee is working with is not good enough because things can get slipped into the legislation unseen.

“The conceptual language is not good enough,” said Cornyn. “We’ve seen that there are side deals that have been cut, for example, with some special interest groups like the hospital association to hold them harmless from certain cuts that would impact how the CBO scores the bill or determines cost. So we need to know not only the conceptual language, we need to know the detailed legislative language, and we need to know what kind of secret deals have been cut on the side which would have an impact on how much this bill is going to cost and how it will affect health care in America.”

Complex language may be part and parcel of writing legislation, but it also hides political payments that may be unpopular taxpayers. Perhaps this is why Reid is rushing the senate vote.
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Colorado and Medical Marijuana

From the Denver Post (Tim Hoover, "Suthers: Medical marijuana dispensaries subject to sales tax, retail license laws")via the Drudge Report,

Attorney General John Suthers said in a legal opinion released late today that the sale of medical marijuana is subject to taxation.

Responding to a query from Gov. Bill Ritter's office, Suthers, a Republican, said, "Medical marijuana is tangible property that is generally subject to state sales tax."

The opinion also said medical marijuana dispensaries must obtain retail sales licenses from the state.

Medical marijuana advocates applauded the opinion as a step in the right direction, saying the industry had been working on proposals to enact some sort of tax.

"I think the community is willing to pay taxes if it will help prove the legitimacy of their efforts," said Courtney Tanning, executive director of the Colorado Wellness Association, which represents medical marijuana dispensaries and the patients and doctors that deal with them.

"It (medical marijuana) has been an underground, black market community for so long that I think they're really willing to come out and pay dues to be taken seriously."

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Fiscal Policy

I have not taught fiscal policy in my principles classes for some time.  There seemed little need.  My reading of the macroeconomics literature was that the efficacy of fiscal policy was limited to the rare occurrence of a deep and long recession.  Based on the length of the Great Moderation, a period of low inflation, strong economic growth and high employment, I believed that monetary economists working inside the Federal Reserve had learned to better manage the business cycle.

A recession began when the housing bubble burst in 2007, straining our highly leveraged financial sector.  The economy headed south, leaving the desiccated memory of the Great Moderation in the dust, and beginning what many have termed the Great Recession, both long and deep, the conditions required for effective fiscal policy.

Fiscal policy is the sue of the federal government's taxing and spending authority to achieve or maintain full employment or price stability.  In times of recession, the government creates or enlarges deficits to maintain aggregate demand, the total level of demand for all goods and services throughout the economy.  Policy makers can cut taxes, increase spending or some combination of the two to reach desired deficits.  The additional spending by the government or recipients of tax cuts has a multiplied impact through the economy.  For example, Ben gets a $100 tax cut which he uses to buy a new Sony DVD player.  Sony uses the extra money to buy $90 of labor.  The $90 of wages buys $80 of groceries and so on. 

All theories are just good stories until empirically verified.  The focus of the empirical debate has turned on the size of the multipliers.  Multipliers greater than one stimulate growth while those less than one restrain growth.  Robert Barro and Charles Redlick describe the literature on empirically estimated multipliers as "thin" in "Macroeconomic Effects from Government Purchases and Taxes," NBER Working Paper No. 15369.  The authors estimate the multiplier at .7 when the economy is experiencing unemployment of 5.6%.  It increases .1 for every 2% increase in unemployment, implying that stimulus spending becomes beneficial (multiplier greater than 1) when the economy is experiencing 12% or greater unemployment.  In a Wall Street Journal article (Stimulus Spending Doesn't Work) that presents their findings, they conclude,

The bottom line is this: The available empirical evidence does not support the idea that spending multipliers typically exceed one, and thus spending stimulus programs will likely raise GDP by less than the increase in government spending. Defense-spending multipliers exceeding one likely apply only at very high unemployment rates, and nondefense multipliers are probably smaller. However, there is empirical support for the proposition that tax rate reductions will increase real GDP. 

Barro and Redlick have not given the final word on multipliers but their research is a good starting point for evaluating the effectiveness of fiscal policy and the size of multipliers
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Nice and the Creeping Nanny State

If any of the health care proposals before Congress pass and is signed into law, we will soon have a committee tasked with reducing health care expenditures similar to Britain's National Institute for Health and Clinical Excellence (Nice).  Some might remember Nice as the organization unwittingly killing patients who are terminally ill (see my previous post for more details and a Monty Python clip).  Nice takes its job seriously.  Robert Watts of Timesonline describes a new policy proposal in, "Health and safety snoops to enter family homes."

Health and safety inspectors are to be given unprecedented access to family homes to ensure that parents are protecting their children from household accidents.

New guidance drawn up at the request of the Department of Health urges councils and other public sector bodies to “collect data” on properties where children are thought to be at “greatest risk of unintentional injury”.

Council staff will then be tasked with overseeing the installation of safety devices in homes, including smoke alarms, stair gates, hot water temperature restrictors, oven guards and window and door locks.

The draft guidance by a committee at the National Institute for Health and Clinical Excellence (Nice) has been criticised as intrusive and further evidence of the “creeping nanny state”.

Creeping nanny state?  Daya think?  Matthew Elliot, a new found friend of freedom, nicely sums up problems with the proposal.

Matthew Elliott, of the TaxPayers’ Alliance, said: “It is a huge intervention into family life which will be counter-productive.

“Good parents will feel the intrusion of the state in their homes and bad parents will now have someone else to blame if they don’t bring up their children in a sensible, safe environment.”

Let me add my two bits to Elliot's.  Setting aside the insult to parents Nice's administrative shortcomings and the real possibility that collecting the information and applying safety equipment to households in Britain might well me more expensive then the medical costs, the plan has other problems.  The state officials know of safety devices, but not the household specific information about the children or their parents.  For example, a child may be a climber, and the state might notice that the parents don't have electrical socket plug covers.  The state might find the home safe but not know that the child spends ten hours a day with grandma.  Parents have that information, and nearly all parents love their children and are concerned about their welfare.  As Elliot suggests, why not let parents raise their kids?
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