Rewrite of Political Chicken and the Debt Ceiling

This post is a rewrite and combination of two recent posts that evaluate the debt ceiling impasse as a game of political chicken.  This first (here) was incomplete and the second (here) completed the game but required readers to view two posts.

Congress is engaged in a game of political chicken over raising the debt ceiling.  Instead of two cars racing toward each other in a single lane, Republicans and Democrats are screaming at each other across the aisle about conditions that they will require to raise the ceiling.  If left unresolved, this political crisis will precipitate an economic crisis.  Leaders in both parties acknowledge that the ceiling must be raised or the government will not be able to use debt to meet its financial obligations, and both sides know that the government could not simply cut more than a trillion dollars from this year’s budget to remove the need to borrow.  In short, if a political solution is not found the government will default on its obligations.

This is where the game of chicken begins.  Both parties are attempting to use the current crisis as a fulcrum to leverage future budget negotiations over a bigger looming economic crisis caused by unfunded entitlement programs, the big three being Social Security, Medicare and Medicaid.  To greatly simplify arguments, the Republicans prefer to cut spending and reduce the federal government’s size and scope through reform of entitlement programs[1].  Democrats want the federal government to retain its size and scope and would rather close deficits with increased taxes[2]; their reforms to entitlements would attempt to cut expenditures through government reform.  It is beyond the scope of this post to comment on the merit of their agendas. 

Incumbents in both parties are wooing voters through political theater and both parties will gain or lose support depending on the actions of the other party and the economic outcome of those actions.  The following political outcomes are pure conjecture, and are only meant to illustrate the game.  If both parties stay the course causing a financial meltdown, incumbents in both parties will lose votes, say 10 million nationally.  If Democrats stay the course and Republicans capitulate, Democrats will gain 2 million votes and Republicans will lose 2 million votes.  If Republicans stay the course and Democrats swerve, the opposite outcome occurs (Democrats lose 2 million votes and Republicans gain 2 million).  If the parties compromise neither party gains or loses votes.Voters are affected by the economic outcomes of political actions.  The best outcome depends on the economic effectiveness and political sustainability of each party’s solution and the compromise solution.  Voters are members of a party because they believe that it offers the best economic solutions.  Their beliefs may or may not be correct but the implications of this assertion on the political game of chicken are clear.  The best outcome for a Democratic voter would be for Congressional Republicans to swerve and Congressional Democrats to stay the course.  The best outcome for a Republican voter would be the reverse.  Voters from both parties benefit from a compromise but less so than if their party holds the course and the other swerves.  The worst outcome for voters is for both parties to hold their course and fail to raise the debt ceiling because the impasse would trigger a financial crisis.     

I believe that tying the increase in the national debt ceiling to spending cuts and market oriented institutional reforms to entitlements is the best economic solution.  On this issue, I hew closer to Republicans.  I believe that it would cause the greatest level of economic growth and that growth would be balanced.  I would hope that the subsequent prosperity would be sufficient to make a more limited government politically sustainable.  I fear that my preferred solution or any political solution offered by one party is not politically sustainable or even attainable.  Our country is politically divided.  Republicans hold the House and the Democrats, the Senate and the executive branch.  A compromise solution that acknowledges this fact and takes the best elements of each party’s offerings represents the least political risk and offers a reasonable economic outcome.   

[1] A small group of Republicans insist that they will not support an increase in the debt ceiling under any circumstance.  I am not sure if this is a negotiating stance or a statement on their future vote.  I do not know if an economist that supports this position or believes that not raising the debt ceiling will have anything less than major costs to the economy.

[2] A small group of Democrats that they will not support an increase in the debt ceiling that reduces entitlement benefits or increases taxes on anybody but the wealthy.  The wealthy do not earn enough to make projected levels of entitlement programs financially sustainable.
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The IMF and S&P on Playing Chicken

In “Political Chicken and the Debt Ceiling” I compared the current impasse between Democrats and Republicans were playing a game of chicken.  Incumbent politicians, the drivers and voters, the bystanders are affected.  The outcomes for voters differ from those of politicians and depend more on the economic outcome of the political game.  Incumbent politicians gain or lose votes depending on the outcome of the game and voters gain or lose from the nation’s change in financial stability which is again an outcome of the game.  Both parties are using the debt ceiling crisis to leverage a solution to the larger and looming sovereign debt crisis. 

The worst outcome is for both parties to hold their course and fail to raise the debt ceiling.  Incumbent politicians in both parties lose votes.  Voters lose as well because the impasse would trigger a financial crisis.  The best outcome for a party is for the other party to swerve or capitulate, accepting the other party’s solution.  Voters gain or lose depending on which party’s plan best solves the sovereign debt crisis.  A compromise does not affect incumbents but is better for voters than a political impasse and has the potential to be better or worse than one party capitulating to the other.  Hopefully, a compromise might include the best ideas of both parties but could include the worst, or more likely still, something between the best and worst of each plan.

I prefer tying the increase in the debt limit to cutting the budget deficit.  The remainder of the post quotes to articles, one I believe that supports my position and another that does not.  In “IMF cuts U.S. growth forecast, warns of crisis,” Luciana Lopez writesblockquote>SAO PAULO (Reuters) - The International Monetary Fund cut its forecast for U.S. economic growth on Friday and warned Washington and debt-ridden European countries that they are "playing with fire" unless they take immediate steps to reduce their budget deficits. Yet that relatively benign global outlook could quickly fall apart if politicians in the United States and Europe do not start showing more leadership in addressing their countries' debt problems, the fund warned...

"You cannot afford to have a world economy where these important decisions are postponed, because you're really playing with fire," said Jose Vinals, director of the IMF's monetary and capital markets department.

"We have now entered very clearly into a new phase of the (global) crisis, which is, I would say, the political phase of the crisis," he said in an interview in Sao Paulo, where the updates to the IMF's World Economic Outlook and Global Financial Stability Report were published.In “S&P restates political threat to U.S. AAA rating,” William James and Emelia Sithole-Matarise write

The risks of the U.S. losing its prized triple-A rating over the medium term have increased as the country faces a political impasse and nears its debt ceiling, Standard and Poor's said on Tuesday.


While the ability to adapt both fiscal and monetary policy was a positive for the United States, the risk of a credit rating downgrade had increased due to a lack of political consensus on how to employ that flexibility, Moritz Kraemer, head of sovereign credit ratings for Europe at Standard & Poor's, said on Tuesday.


"The problem is this flexibility needs to be employed and for that you need political consensus. That's not very visible right now," he said.

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Political Chicken and the Debt Ceiling

Congress is engaged in a game of political chicken.  Instead of two cars racing toward each other in a single lane, our two parties are screaming at each other across the aisle about conditions that they will require to raise the federal debt ceiling.  Democrats and Republicans alike acknowledge that the ceiling must be raised or the government will not be able to use debt to meet its financial obligations and both sides know that the government could not simply cut more than a trillion dollars from this year’s budget.  

This is where the game of chicken begins.  Both parties are attempting to use the current crisis as a fulcrum to leverage future budget negotiations over a bigger looming crisis caused by unfunded entitlement programs, the big three being Social Security, Medicare and Medicaid.  To greatly simplify arguments, the Republicans want to cut spending and reduce the federal government’s size and scope through reform of entitlement programs.  Democrats want the federal government to retain its size and scope and would rather close deficits with increased taxes; their reforms to entitlements would attempt to cut expenditures through government reform.  It is beyond the scope of this blog post to comment on the merit of their agendas.  

Incumbents in both parties are wooing voters through political theater and both parties will gain are lose support depending on the actions of the other party.  If both parties stay the course causing a financial meltdown, incumbents in both parties will lose support (say 10 million national).  If Democrats stay the course and Republicans capitulate, Democrats will gain votes and Republicans will lose votes (say Democrats gain 2 million and Republicans lose 2 million).  If Republicans stay the course and Democrats swerve, the opposite outcome occurs (Democrats lose 2 million votes and Republicans gain 2 million).  If the parties compromise neither party gains or loses votes. 

Pick one side or the other.  I would like to see smaller government so on this issue I tend to support the Republicans.  I want Democrats to swerve.  Federal Reserve Chairman Ben Bernanke wants Republicans to swerve.  Yesterday, he urged Republicans to not block legislation tying deeper cuts in spending to passage of legislation raising the debt ceiling (“Bernanke urges GOP to support raising debt ceiling”).  On this issue, he prefers the Democrat’s position.  I believe that we would both prefer a quick compromise.  Let’s just be honest and admit that both Republicans and Democrats are playing chicken and that the stakes are high.Replace this text with...
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Wheelan and the Little League Arms Race

(HT Mankiw) I have a son who has come up through the modern Little League making Charles Wheelan's remarks in "Stop the Little League Arms Race," posted by Yahoo Finance on July 23, 2009 of personal as well as professional interest.   He begins by explaining how economists define an arms race and how it applies to youth athletics.

Economists use "arms race" to describe any situation in which some competition leads to a bad outcome for all the parties involved...

I'm convinced that young athletes (or, more accurately, their parents) are locked in an arms race...In any case, the youth sports competition could leave all our kids worse off, [Wheelan later mentions injuries that were uncommon in youth players not long ago.] not entirely unlike bankrupt airlines or countries struggling to manage huge defense budgets.

I have heard the same complaint over and over again since becoming a parent:  kids' sports are becoming ridiculously competitive.  There are 8-year-olds with private hitting coaches, and 9-year-olds being told that they have no future in a sport if they are not playing in competitive leagues during the off-season...

If everyone practices three times as much, the same folks will probably end up with the scholarships, prize money and Nike endorsements.  And if we assume that the extra practice, coaching and spending on equipment comes at the expense of other things (like riding a bike for fun, playing other sports or doing something really crazy like playing "kick the can" in the backyard for a few hours), then our kids' lives are worse for it.

But no one alone can stop what is going on in youth sports.  That's the insidious part of an arms race or a price war.  If you are the only family who pulls your kid out of winter Little League, then he is going to do poorly relative to other kids who play year-round.

One of my sons is very competitive and loves baseball.  He is a bright child, and realizes just how unique professional players are, and harbors little hope of a professional career.  He does hope to play high school baseball, and that even being a competitive player at this level will be difficult.  He is dropping out of football to concentrate on baseball.  To aid him in his goals, I have become a minor participant in the arms race, I can attest to its high cost.  I have purchased good equipment but generally not the best: two bats, a thin barrel for Little League, and a big barrel for select, a fielder's glove, first basemen's glove, and catchers mitt as well as other catcher's gear, shoes, well over 100 balls, team dues, uniforms, and from time to time I have paid for hitting, fielding and pitching lessons.  For those who have not priced equipment, and good bat cost about $200 and needs to be replaced about every 18 months as a child grows.  He has played in the Little League for 6 years and on a select team for two.  Finding a select team for him to play on was difficult because we place church activities above sports and select teams play in tournaments that begin on Saturday and end on Sunday.  Few teams want a Saturday only player.  It has hurt him competitively. 

Wheelan identifies a potential problem.

If all of this makes kids and young families happier than they were 20 years ago, terrific.  But I don't think that's what is going on.  As far as I can tell, sports have three purposes: To get exercise, to have fun or to get your kid into college, earn a scholarship, turn professional and become rich and famous.

The evolution in youth sports appears to be mostly about the third one.  Here's the problem with that:  The number of scholarships (and college athletes) is more or less fixed.  So is the number of professional athletes and the total amount of money to be won on the PGA Tour.

I believe that Wheelan has correctly identified the three purposes of youth sports, but I do not agree that most parents involve their kids in athletics for scholarships and big money alone.  I know dozens of young baseball players and their parents and although many parents and players hope for fame and fortune, all the players enjoy high levels of competition.  These players are not just competitive in baseball, they are competitive in everything they believe is important.

Wheelan is certainly correct when he states that the number is scholarships and positions in professional athletics is more or less fixed and if parents are engaged in a battle to win those positions they are truly participating in a zero sum game with escalating costs.  He correctly points out that education is more likely to benefit our youth.

It's crucial to recognize the difference between intensive athletic practices and something like studying.  Competitive athletic success is a zero sum game.  There will be the same number of major league players making the same salaries if everyone in the world became twice as good at playing baseball.  A-Rod would still be on the Yankees, not you.  He'd just be twice as good as he is now.

Studying, on the other hand, makes people smarter, more educated and more productive.  And that makes your life better, regardless of what everyone else is doing.  Economic productivity is not a zero sum game.  If we all became twice as smart, we would all be richer, healthier, safer and so on.  As the United States became steadily more educated and richer over the past 200 years, no one on the planet had to get poorer.

From my small sample, youth baseball players are in the top half of their classes academically.  Parents certainly value education even if they underestimate its value in comparison to baseball or overestimate its value in earning an education.  In the end, Wheelan's question must be answered empirically.  Why do parents pay so much for their kids to play baseball?

The arms race in baseball may also say something about the future typical player.  Major League Baseball players may come from average to above average income homes because parents on the lower end of the income distribution cannot compete in the arms race.
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Israel, Hamas, War and Peace

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

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

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

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

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

To summarize his conclusions, Hirshleifer offers the following proposition,

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

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

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

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

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

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OPEC Cuts Production and Prices Fall

When oil prices rise, it seems like OPEC is in control of oil markets. When prices fall, it does not. Today, OPEC announced a 2 million barrel a day cut in production beginning in January of the new year and oil prices are falling. If other variables affecting the oil market do not change, prices rise as supply falls.

But other variables are changing. As the economy slides deeper into recession, businesses and households demand less oil based products. The Energy Information Administration announcement a 1.3 million barrel increase in gasoline stocks, and a 2.9 billion barrel increase in distillate stocks that are used to make refined oil products. The same buildup of stocks is probably occurring world over. As demand decreases, prices fall.

OPEC's ability to cut production is also suspect, particularly as prices fall. The cartel suffers from the prisoners' dilemma problem. OPEC members earn higher profits if they all cut production. If one country cheats by not cutting production, and the rest do not, the cheating country benefits at the expense of the others. If they all cheat, oil prices and profits continue to fall.

Oil trades apparently believe that oil stocks demand is likely to fall faster than oil supply. I hope they are right.

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