“Economics” Category

Confused Indeed, Mr. Krugman

Paul Krugman, in 2009:

Why, people ask, would I want to compare us to Belgium and Italy? Both countries are a mess!

Um, guys, that’s the point. Belgium is politically weak because of the linguistic divide; Italy is politically weak because it’s Italy. If these countries can run up debts of more than 100 percent of GDP without being destroyed by bond vigilantes, so can we.

Thanks for the advice, Paul.

November 21st, 2011

The Financial Transaction Tax, the Silver Bullet

Financial transaction taxes are no panacea. Kenneth Rogoff:

Such taxes surely reduce liquidity in financial markets. With fewer trades, the information content of prices is arguably reduced. But both theoretical and simulation results suggest no obvious decline in volatility. And, while raising so much revenue with so low a tax rate sounds grand, the declining volume of trades would shrink the tax base precipitously. As a result, the ultimate revenue gains are likely to prove disappointing, as Sweden discovered when it attempted to tax financial transactions two decades ago.

Worse still, over the long run, the tax burden would shift. Higher transactions taxes increase the cost of capital, ultimately lowering investment. With a lower capital stock, output would trend downward, reducing government revenues and substantially offsetting the direct gain from the tax. In the long run, wages would fall, and ordinary workers would end up bearing a significant share of the cost. More broadly, FTTs violate the general public-finance principle that it is inefficient to tax intermediate factors of production, particularly ones that are highly mobile and fluid in their response.

A large part of the support for these kinds of taxes seems to come out of a desire to punish traders. Any time a policy is supported because it makes certain people suffer, rather than it’s sound policy, it’s probably time to reconsider it.

October 13th, 2011

California and Teachers Union Move Education Into the Future

No, public control and unions don’t reduce innovation:

The University of California last week tentatively agreed to a deal with UC-AFT that included a new provision barring the system and its campuses from creating online courses or programs that would result in “a change to a term or condition of employment” of any lecturer without first dealing with the union.

Bob Samuels, the president of the union, says this effectively gives the union veto power over any online initiative that might endangers the jobs or work lives of its members. “We feel that we could stop almost any online program through this contract,” Samuels told Inside Higher Ed.

(Via Tyler Cowen.)

What a triumph.

October 13th, 2011

The Age of Insight

Seth Godin argues we’re at a juncture in economic history, just like the rise of mass production in the twentieth century:

The industrial age, the one that started with the industrial revolution, is fading away. It is no longer the growth engine of the economy and it seems absurd to imagine that great pay for replaceable work is on the horizon.

This represents a significant discontinuity, a life-changing disappointment for hard-working people who are hoping for stability but are unlikely to get it. It’s a recession, the recession of a hundred years of the growth of the industrial complex.

Mass production of standardized goods—underpinned by workers doing very tightly defined jobs that can, with relatively minimal training, be done by anyone—provided incredible value. This was because up until then, goods were largely made individually with poorly defined standards and processes, so they were expensive and time consuming to make. Mass production made goods cheap and plentiful because the processes for making them were standardized so that anyone could do it. The twentieth century was almost entirely about turning people into cogs in a machine in order to squeeze as much efficiency out of each one as possible.

Because there were so many gains to be made by using mass production for goods, it helped create an explosion of economic growth and development and, along with it, jobs. We needed cogs for those production processes. This was very beneficial for workers; because there was so much value created by mass production, companies could afford to pay very respectable wages and salaries and provide long-term benefits, all while the worker was responsible for very little more than following a series of steps.

But those gains have now been used up. There’s no more potential for growth in mass production, except in countries where labor costs are lower than others, and that will be used up in time, too. In manufacturing, it’s a race toward eliminating cost as much as possible, and that inevitably means eliminating people altogether.

What Godin argues is that the idea of long-term, stable jobs where individuals are responsible for very little besides doing their very specific job—an idea we grew up believing to be true because that’s what we saw in the twentieth century—is a myth created by the temporary explosion of economic productivity unleashed by mass production. It isn’t something we can always have or something we will soon get back to after this recession is over. It no longer exists.

This means suffering for many people, as we are seeing. Our society has been built on the assumption that, if only we do well in school, there’ll be a stable and respectable job waiting for us. That is no longer the case, and now people will have to adjust to it. A high school diploma and a college degree is no longer a ticket to a comfortable future. Rather than simply put in the time and work to be comfortable, we must now find insights into the world that will make us all better off. That’s the new frontier.

The Age of Insight

The nineteenth century was the age of the industrial revolution, the twentieth the age of mass production, and the twenty-first will be a new age, too, of the same scale.

Godin continues:

When everyone has a laptop and connection to the world, then everyone owns a factory. Instead of coming together physically, we have the ability to come together virtually, to earn attention, to connect labor and resources, to deliver value.

Stressful? Of course it is. No one is trained in how to do this, in how to initiate, to visualize, to solve interesting problems and then deliver. Some see the new work as a hodgepodge of little projects, a pale imitation of a ‘real’ job. Others realize that this is a platform for a kind of art, a far more level playing field in which owning a factory isn’t a birthright for a tiny minority but something that hundreds of millions of people have the chance to do.

Whereas the last century was about making goods—food, clothing, cars, toys—cheap and plentiful, the twenty-first century will be about making insights into what will truly make us better off.

It was easy to make huge gains in quality of life in the early twentieth century: providing any kind of affordable clothing, food and car was a giant leap forward. We can’t make those same gains now. That trick only works once.

Now, we have to be smarter. Now, we have to figure out what’s a better use of resources. We have to figure out what kind of car will both be more environmentally efficient and delight its owners. We have to think about completely disparate fields—say, manufacturing, software development, design, and psychology—and combine them to make products that conform themselves to humans, rather than making humans contort themselves to the product in order to use it. We must think about big ideas—ideas that will change society and how people interact—and the little ideas that merely improve people’s lives just a little.

We have to think. This is an age where all of our gains will come from insights into what make products, services, processes, and structures fundamentally better for us. Whereas the twentieth century was about standardization and following a series of steps in a well-defined process, in this new century, there are no defined processes. Everything is to be questioned, re-thought, re-made, or even thrown out altogether.

This century is about having a vision for the way things should be, and the audacity to make it so. Just a decade or two ago, it took immense amounts of capital to launch an idea that could change the world. Now, it takes a few people with an idea, a computer, and the willingness to learn how to build it.

The only thing holding us back now is ourselves.1 We are all artists, designers, manufacturers, managers, musicians, writers, creators—if we choose to be. And that is the fundamental difficulty of this new age: we all are responsible for our own success.

The twentieth century had a well-trodden path for people to follow: you graduate from high school, go to college, you’ll get a respectable and stable job, and you’ll live in comfort. Our responsibility did not extend beyond following that path.

That will no longer work. We will all have to take responsibility for ourselves, our future, and our ideas. We have to learn to think this way—to think critically of the things we see, of how they could be better and how we could make it so, and thus to see opportunities for ourselves.

We have to change how we think to be successful in this century, and we have to re-design our schools to prepare people for it. I have some ideas for how to do that, but what’s obvious is we aren’t ready for it yet. Not even close. We’re still preparing kids for the last century.

This is a new age, and we better start thinking about it that way.

  1. This is not, unfortunately, true for everyone. Poverty and lack of opportunity takes on a new meaning in this century. Rather than hold people back from an education and access to well-paying jobs, it now means holding people back from education that gives them the opportunity to discover a passion from something and discover a way to make something better and, therefore, make a living for themselves, because they are too busy simply trying to survive. This creates two very different classes in society, and is a fundamental threat to it. This, I think, will be one of the great challenges for our century: how do we not only revamp our educational system for a new economic age, but how do we truly make education available to everyone so everyone can participate? []
September 29th, 2011

Krugman’s War Won’t Avert Depression

Michael Pento:

Krugman argued that inflation would address our debt problem by reducing our bill in current dollar terms and that the Second World War was a giant stimulus plan that actually worked. Thankfully, he added the refrain, “Hopefully we don’t need a world war to get there,” but I sensed a tinge of regret in his voice. After all, the Keynesian economist’s favorite pastime is seeing people waste their lives digging holes in the ground or sacrifice their lives in war. Both acts create economic growth according to the topsy-turvy logic of men like Krugman.

The truth is that wars are a miserable misallocation of capital and usually leave financial ruin in their wake. The US did not boom in the ’50s because we fought World War II, but because we resoundingly won. It was the byproduct of having an unscathed manufacturing base, solid infrastructure, an intact military, most of the world’s gold, and the only reserve currency.

Not all work is work you want. What you’re allocating capital toward matters.

August 18th, 2011

Medicare Regulation and Unintended Consequences

There’s been a rash of cancer drug shortages, including drugs used to treat leukemia, lymphoma, and testicular cancer. These shortages aren’t due to shortages of raw materials used to make them. They’re due to Medicare regulation introduced in the Bush administration’s Medicare prescription drug bill.

Ezekiel Emanuel—not exactly someone concerned about technocratic health care regulation—explains why:

The underlying reason for this is that cancer patients do not buy chemotherapy drugs from their local pharmacies the way they buy asthma inhalers or insulin. Instead, it is their oncologists who buy the drugs, administer them and then bill Medicare and insurance companies for the costs.

Historically, this “buy and bill” system was quite lucrative; drug companies charged Medicare and insurance companies inflated, essentially made-up “average wholesale prices.” The Medicare Prescription Drug, Improvement and Modernization Act of 2003, signed by President George W. Bush, put an end to this arrangement. It required Medicare to pay the physicians who prescribed the drugs based on a drug’s actual average selling price, plus 6 percent for handling. And indirectly — because of the time it takes drug companies to compile actual sales data and the government to revise the average selling price — it restricted the price from increasing by more than 6 percent every six months.

The act had an unintended consequence. In the first two or three years after a cancer drug goes generic, its price can drop by as much as 90 percent as manufacturers compete for market share. But if a shortage develops, the drug’s price should be able to increase again to attract more manufacturers. Because the 2003 act effectively limits drug price increases, it prevents this from happening. The low profit margins mean that manufacturers face a hard choice: lose money producing a lifesaving drug or switch limited production capacity to a more lucrative drug.

There will always be unintended consequences when we attempt to control complex systems. Those regulations seem, on their face, to be perfectly logical, but what effect they will have is rarely understood before they are implemented.

Emanuel begins his editorial by quipping that Obama administration critics must be disappointed they can’t pin these shortages on Obama, but this is a perfect example of concerns critics—including me—had about the President’s health care reform. The PPACA’s main cost control mechanism is the Independent Payment Advisory Board (IPAB), an unelected board with the power to reduce Medicare payments to providers, and there is no reason to think they won’t fall into this same trap.

Emanuel seems blind to the similarities between these regulations introduced by the Bush administration and the IPAB; he says these shortages are caused by government interfering with natural market functions, yet he is a large proponent of an unelected board of technocrats with the power to decide what drugs and treatments are and are not supported by Medicare.

(Via Megan McArdle.)

August 9th, 2011

You Mean Forcing Illegal Immigrants Out is a Bad Idea?

Georgia passed a tough anti-illegal immigration law that, among other things, makes using fake identification to get a job punishable by up to 15-years in prison, and here are the results:

Thanks to the resulting labor shortage, Georgia farmers have been forced to leave millions of dollars’ worth of blueberries, onions, melons and other crops unharvested and rotting in the fields. It has also put state officials into something of a panic at the damage they’ve done to Georgia’s largest industry.

So, the state passes a bill to push illegal immigrants out of the state to reduce their use of government services, and torpedoes their agricultural industry. I’m just shocked.

Smart move, there. I suppose this settles the “if we just get rid of illegal immigrants our problems are solved” myth that’s so prevalent on the right. (Or, more likely, not.)

June 21st, 2011

Keynes vs. Hayek

There’s a fantastic video about Keynes versus Hayek. Very well done and very well written.

Here’s the first one if you haven’t seen it. Highly recommended.

April 28th, 2011

Unemployment Isn’t just a Demand Problem

The typical solution to recessions is to increase demand; as demand increases, companies will hire more workers to fulfill it, leading to more demand which creates more jobs. Krugman, and others, think a lack of demand is precisely the cause of our unemployment.

Jim Tankersley suggests it isn’t that simple. He writes:

Groshen and Potter noted that after the past two recessions, in 1990-91 and 2001, economic growth had picked up long before jobs began to reappear, bucking a long historical trend of growth and jobs returning in tandem. The explanation, Groshen and Potter said, was a shift away from the time-honored American tradition of laying off workers in bad times and recalling them when the clouds parted.
“Most of the jobs added during the recovery have been new positions in different firms and industries, not rehires,” they wrote. “In our view, this shift to new jobs largely explains why the payroll numbers have been so slow to rise: Creating jobs takes longer than recalling workers to their old positions and is riskier” when recovery still appears fragile.
In other words, American companies had adopted a more cold-blooded attitude toward recessions, one that fit the new model of globalization and automation. Technology made it easier to lay off your 100 least-effective workers and ship their jobs to India, or to replace them with a software program that made your remaining workforce dramatically more productive.

This might be okay if our economy was dynamic and generated new kinds of jobs rapidly, but that isn’t the case:

One baffling aspect of the current recovery is why U.S. companies continue to sideline nearly $2 trillion in cash instead of using it to buy equipment or hire workers. That hoarding turns out to be a piece of a decades-long investment puzzle. American corporate spending on nonresidential plant equipment—factories and equipment, not houses or shopping malls—has fallen to its lowest rate as a share of the economy in 40 years. Businesses aren’t investing in American workers, either. The major productivity gains of the fledgling recovery, and in the 2000s in general, came largely from companies producing more with fewer employees.

The simple truth is that American firms are either returning the spoils of globalization and technology to their shareholders, spending them on new projects abroad, or both. “Globalization isn’t the problem,” says Howard F. Rosen, a labor economist and visiting fellow at the Peterson Institute. “U.S. companies are investing in plants and equipment, just not in our borders.… They are privatizing the gains of globalization. That’s really it. They’re our gains!”

The question is why. Demand is certainly a part of it, but not the entire answer. This seems to reflect a view of the U.S. economy as staid and moribund.

January 21st, 2011

A Study of the Financial Crisis

In January 2009, just months after the 2008 financial crisis, I wrote a lengthy (9,000 word) study of the financial crisis—analyzing what happened, what caused it, and what I thought we should do to prevent it from happening again.

Below I am publishing the study in its entirety. If you are interested in what what led to the financial crisis in 2009, and enjoy extensive detail, send it to Instapaper—this is for you.


Homeowners and home buyers were convinced home prices would continue to rise. Indeed, the entire market was convinced. People bought homes with mortgages they could not afford, because their home equity would pay for the loan; lenders made loans without verification of the recipient’s income or credit; financial groups poured money into mortgage-backed securities, and Fannie Mae and Freddie Mac bought and securitized an incredible number of mortgages — roughly half of the U.S.’s $12 trillion mortgage market (Duhigg).

A “bubble” was created in the housing industry, a market condition where one industry receives too much investment and, like a plane flying straight up, must stall and come down quickly. Alan Greenspan called it “irrational exuberance,” and that is an apt description — people disregard logic and invest wildly into one industry. For a time, as everyone is investing in it, this works and everyone makes money; but eventually, the rapid rise must turn into a rapid decline.

Usually, bubbles are contained in one industry. This bubble, however, was different. In this case, the entire United States economy and, indeed, the world economy, was involved. For years, the savings rate for U.S. households declined, as home prices rose. Rather than use their income to save, U.S. households used their home equity as their savings, using income they would normally save for consumption.

Moreover, after the technology bubble collapsed in 2000, investment firms moved their capital into mortgage-backed securities, and foreign central and private banks and firms, too, invested in mortgage-backed securities and related securities. China, using the vast dollar reserves it accumulates from trade with the U.S., was one of the largest state investors in related securities, owning $376 billion of Government Sponsored Enterprise-issued securities. Asia as a whole owned $800 billion in 2007 (Timmons).

Consumer spending (which largely fueled economic growth since 2000) and the finance industry (whose lending is integral for the overall economy to function) were directly tied to housing prices. Moreover, the Chinese economy’s fortune is vitally dependent on U.S. consumer spending, and the world had invested in the U.S. housing boom. Thus, because economic growth in the U.S. and world was so dependent on the housing market, the housing bubble’s collapse in 2006 not only threatened the U.S. economy, but the entire world economy.

The resulting stock market collapse in 2008 has caused severe losses in the U.S. and across the world. World stock markets, overall, declined by 48 percent in 2008; China, whose economy is dependent on exports, saw exports decrease nearly 3 percent in December 2008 (“Economic Crisis Hits Exports”); and Iceland’s government, hit by criticism over the effects of the financial crisis, collapsed January 26.

This paper will consider both the short and long-term causes of the 2008 financial crisis and, based on these causes, note the lessons we can derive from them, both for government and companies.

Continue reading →

December 6th, 2010

Fed-Induced Recession

The Federal Reserve is purchasing $600 billion long-term treasury bonds in an attempt to drive long-term interest rates down, and thus to encourage lending and borrowing. That’s the official reason; causing moderate inflation in the short-term, which reduces the cost of debt for borrowers at the expenses of lenders, and devaluing the dollar against foreign currencies and thus making U.S. exports more competitive are both reasons for it, too.

Those that support it say there really is no chance of it causing harmful amounts of inflation, because inflation is already so low right now. I agree with them in the short-term; I don’t think it will cause harmful amounts of inflation right now, especially because banks are sitting on cash reserves as it is, and I don’t think providing them with even more reserves is going to suddenly cause them to change their minds. The reason they aren’t lending isn’t for a want of capital—it’s because of an uncertain economy. So that part is correct.

But in the longer-term, damaging inflation is a very serious worry. Let’s say that, in two years, the economy moderately recovers and begins a steady incline, as it should. This would cause banks to substantially increase lending, especially because their cash reserves are so strong. At this point, we would have the potential for terribly damaging inflation.

Richard Posner explains:

Suppose businesses and consumers increase their spending, and the banks lend the $1 trillion they’re holding in excess reserves (accounts in federal reserves banks, equivalent to cash). The ratio of money in circulation to goods and services will rise, and inflation will tick upward, perhaps more than desired. The Fed can reduce the money in circulation by selling some of its huge inventory of bonds, but by doing so it will raise interest rates (just as increasing the demand for bonds lowers interest rates, increasing the supply raises them), which may choke off the economic recovery. If it hesitates to sell bonds and retire the cash it receives from the sales, expectations of inflation may soar, and inflation rise to a dangerous level; and to bring it down the Fed will then have to sell bonds after all, draining money out of the private economy at a rate that brings on the kind of very sharp recession that the nation experienced in the early 1980s. 

In other words, a program meant to drag us out of one recession may push us into another one. That’s not especially shocking; it’s difficult to predict just what the economy is doing at any one time and guide it along. Attempting to direct the overall tenor of the economy, as the Federal Reserve does, is a business fraught with potential for serious error.

November 23rd, 2010

Many Are the Errors (Made By Paul Krugman)

Finance Professor Rafghuram Rajan wrote in his book Fault Lines that the GSEs and the Fed’s low interest rates helped cause the housing bubble, so Paul Krugman “reviewed” it, trotting out his inaccurate analysis that the GSEs had little to do with it.

Rajan responsed to the review by showing why the GSEs and the Fed’s interest rates policy did contribute. Well written and well argued.

September 20th, 2010

Kling’s Knowledge-Power Discrepancy and Statism

Arnold Kling discusses the use of experts by government to control certain sectors:

We live in an increasingly complex world. We depend on experts more than ever. Yet experts are prone to failure, and there are no perfect experts.

Given the complexity of the world, it is tempting to combine expertise with power, by having government delegate power to experts. However, concentration of power makes our society more brittle, because the mistakes made by government experts propagate widely and are difficult to correct.

It is unlikely that we will be able to greatly improve the quality of government experts.

Instead, if we wish to reduce the knowledgepower discrepancy, we need to be willing to allow private-sector experts to grope toward solutions to problems, rather than place unwarranted faith in experts backed by the power of the state.

This is a fascinating use to Hayek’s basic argument that markets are the spontaneous order created by the interconnection of knowledge distributed throughout many minds, and it is impossible for any one person or group to have all knowledge necessary to make the same decisions a market makes through these interconnections (e.g. the price of lead).

Kling’s addition is that this dispersion of knowledge is accelerating, so this is getting even more difficult than before, but there is a parallel trend of government putting experts in certain fields in charge of controlling some part of that field. Kling’s argument is that it is fallacious to assume they can make those judgments, and as time passes it only becomes less viable.

This trend troubles me, too, because the premise underlying it is that these experts (the ones chosen) know so much that they can make legally-binding decisions for everyone else. If we accept this, then we also accept that others should be making decisions for how we live our lives that we have no choice in. If we accept that, than why shouldn’t we also accept a planned society?

September 15th, 2010

Home Sales Fall Off of a Cliff

Home sales declined precipitously in July:

Economists and forecasters were predicting an awful 13% decline in existing home sales for July, to 4.65 million units.  This, we were told solemnly, would be the worst since 2009.

In hindsight, those making the predictions seem to have been the sort of wild-eyed optimists whose sunny belief in the strength of the housing market got us into this mess in the first place.  The actual figure for home sales, according to the National Association of Realtors, was 3.83 million–a 27% decline.

The home buyers tax credit ended in April and this is the result. The credit didn’t create new demand—it took existing demand and artificially compressed it into a smaller period of time. In this way, it inflated demand while it was in effect and inflated housing prices as well, and thus put off (but didn’t avoid) a necessary contraction after the 1997-2006 housing bubble. We will now live through that contraction.

We could have suffered through it earlier, but we decided to delay the pain.

August 24th, 2010

When Labor Is Capital

Arnold Kling:

The suddenly unsustainable housing and mortgage boom comes atop the ongoing obsolescence of various patterns of specialization, as the Internet and globalization continue to foster new forms of organization and competition. The result of the boom-bust cycle superimposed on the ongoing obsolescence is to overload the market’s ability to reconfigure production patterns so that workers are fully employed.

The market needs to undertake a recalculation in order to deploy workers in a new, sustainable pattern of specialization and trade. The process involves gradual, decentralized trial and error. Firms need to be launched by entrepreneurs, who will make risky investments in employees. The failure rate will be high, but eventually the successes will have a cumulative effect that brings about more economic activity.

Fabulous article.

August 10th, 2010