You are currently browsing the monthly archive for July 2009.

The ongoing obesity debate at the Atlantic has been great. I particularly enjoyed Megan McArdles last offering.

An important point, however, needs to be made. Everyone in the conversation seemed to accept that obesity itself is a health problem. On a superficial level this is clearly true – most fat people don’t want to be fat, therefore being fat is a problem. Yet, I don’t think this what most anti-obesity advocates have in mind. They cite the link between obesity and other health problems, most notably type II diabetes.

If obesity were the problem, however, then large volume liposuction would be the cure. People have too much fat? No problem ,we just remove the fat.  All better now. Except, it doesn’t work that way. Liposuction has not shown significant health benefits.

This is an important piece of evidence, especially when we note that surgically removing a malignant tumor does do wonders for the patient. Indeed, surgically clearing a person’s arteries of accumulated plaque can stop an otherwise fatal heart attack.

When body tissue is the problem, removing it is the cure.

This doesn’t work with fat and so its likely that being fat is not the underlying problem. Just as taking a cough suppressant doesn’t make the flu go away, cutting away fat doesn’t make obesity related health problems go away.

Personally, I am sympathetic to the notion that obesity may often be a symptom of hyperinsulinemia which in turn is a pre-diabetic condition. The evidence, however, is mixed. There is some recent research that that suggests some obesity and type-II diabetes are autoimmune in origin.

In any case we should not approach this as if the problem was people getting fat, any more than we should approach bird flu as if the problem were people coughing all the time. There is some underlying disease that appears related to obesity and to affect long term health. If the core disease is some part of the diabetes process then we should work to understand it and arrest it. If the core problem is not diabetes related then we need to find out what it is.

What we don’t need to do is expend a lot of moral outrage over national fatness when we are not even sure what the causes and consequences of obesity are.

New claims for unemployment insurance rose by 25K last week from a revised 559K to 584K. The four week moving average fell from 567K to 559K.

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Though we’ve seen an uptick in the weekly numbers over the past two weeks I don’t think its yet anything to be concerned about. The four week moving average is still headed down at a fair pace and there is of course variation.

Those who were concerned about the seasonal adjustment can take comfort in the fact that unadjusted claims have fallen by rough 160K over the last few weeks.

Here is the long view.

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In a though provoking post Scott Sumner goes into detail about his difficulties getting students to really get Supply and Demand. He asks how other professors do it.

Here is my take:

I always start with auctions. I am not convinced that students can get what’s going on any other way.

Students, have a tendency to think of price in particular as given. I want them to get intuition about an environment where nothing is given. Where price and quantity emerge. This comes naturally from a repeated auction.

Its very easy for students to see that no one “sets” a price at auction. It depends on who is the room and what strategy the buyers take. The more buyers who really want something will provide a higher price.

Talking through the TV show Cash in the Attic , I try to make it clear that no one sets the quantity at an auction either. If people hear that you can sell a bunch of stuff at auction and make a lot of money makes you a lot more likely to rummage through your old stuff and bring it to auction.

So the auction helps them begin to understand that both price and quantity are determined by interactions between people.

There is much more, however, because not everyone at the auction is willing to bid the same amount. This helps us break a part the notions of value and price. Until I started relying heavily on auctions it was like pulling teeth to get students to see that no only are value and price fundamentally different concepts, but if everything every individual valued everything the same and that value was the price there would be no point to trade or economics.

Different values are a necessity for trade just as you must have different values to make an auction work. If I value my old radio at $10 and every other person in the world also values it a $10 what is the point of me trying to sell it and how do I do myself any good by taking it to an auction?

Individual valuation is a gold mine. Because then I just stack the individual valuations up on a bar graph and rank them from highest to lowest. Sometimes I even put a name beside each bar to indicate that this is a real person valuation.

I then step back and say this is a demand curve, of the famous “Supply and Demand” curves.

Because students have already played with Dutch Auctions it is clear to them that if they are five items to be sold then the price at auction will turn out to be the fifth highest valuation. It is also immediately clear that four of the people got a good deal. They paid less than their valuation. Immediately we have an emotional support for consumer surplus.

I go on to have them play with the supply and demand graphs but always with an eye to the auction. Every spot of a demand curve represents a person and how much she values that item.

If the demand curves shift you must be able to tell me a story about that woman. If the supply curve shifts what does it mean relative to that woman. How does the auction end now?

A point that I think I need to make more, to help students with future economics course or applications, is that nothing ever happens because of price. Nothing ever happens because of quantity sold. Price and quantity sold happen because of other things.

I try to keep that perspective in my class but I am sure someone will as them a “if the price goes down then what will happen to . . . “ question when they leave. I need to make sure they understand that this question makes no more sense than saying “if the auctions for Nolan Ryan Rookie Cards start settling at lower prices then what will happen to. . . “

Obviously, the second question immediately prompts one to ask, “wait a minute, what happened to make those Rookie Cards settle a lower price?”

The North Carolina General Assembly is considering major sales tax reform in the wake of the economic crisis and this is taking up most of my days. Consequently posting will may be light this week.

 

New Home Sales: We had a good 11% jump in June and I’ll borrow a few graphs from Calculated Risk rather than make my own.

 

New Home Sales and Recessions

 

The up turn is tiny but there are reasons to be cautiously optimistic

  • Most obviously, turning points have to start somewhere and this is not bad
  • Even an end to the decline in housing construction will be a boon to growth and employment, as housing has been subtracting from both for some time.
  • Lastly, the absolute level of inventories is relatively low

New Home Sales Inventory

 

and thus we could see rapidly falling months of supply as sales rise

New Home Months of Supply and Recessions

Months of supply is a key variable for home builders deciding to expand or shrink.

Jobless Recovery: The conventional wisdom is that this recession will see a jobless recovery similar to the last two. I’m not so sure. Right now its just a hunch but I want to break down the employment data by sector and see if that can tell me more. In short, jobless recovery’s of the past  may have resulted from recessions that were unusually white collar. This looks like a more typical blue collar recession and might produce a swifter turn around.

Of course, the consumer remains under pressure but I am still unclear how to weigh this. In theory it doesn’t necessarily matter because any combination of higher investment spending, higher government spending or lower net imports can make up for that.

Its fairly easy to tell a story about higher government spending and lower net imports. The investment story is a bit more complicated but not implausible.

Home Prices: Home prices for May were up and that is good news. We have been seeing a slowdown in the rate of home price decline for some time and so this is an expected part of the turn around process.

What makes it particularly welcome is that this data is two months old at this point. It contributes to what is increasingly looking like a consistent economic story. The economy began to bottom in April and by the end of July was poised for recovery. Which brings me to my last point.

Recession’s End:  I have been telling friends offline that I expect the last month of the recession to be July 2009. Though, I don’t have a hard forecast the storyline behind the data is strong enough for me to start saying it online.

A cursory look at the data suggests that under the best case scenario: employment will fall somewhere in the 200K range for July, be roughly flat for August and begin a modest (<50K) rise in September.

Just as a note, rising productivity means that the economy will turn positive before job growth turns positive.

Hal Varian has a paper out on Google Trends predicting changes in New Claims for Unemployment Benefits. I haven’t actually read it yet but the post announcing it was so exciting that I went ahead and downloaded some data.

I am sure Varian has much more to say but this initial run was just too cool not to post

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The blue line is people actual New Claims data, unadjusted for seasonal changes. The red line is the relative number of people searching for “Unemployment Benefits.” There may be a better search query but this is the first thing that occurred to me.

The relationship between the curves is so striking. This is just people searching for the term “unemployment benefits!” This is not adjusted by news items which might effect the number of searches. It also not a more concentrated search like “how to file.” I will read and post more later but this is just too cool!

I have to repeat, the red line has not been adjusted or econometrically fit in any way. This is a simple raw query! Imagine the possibilities!

HT: Econbrowser

There are a couple of things I want to look at in regards to unemployment growth over the last recession. The first is taking the relationship between unemployment and job growth examined in a previous post and breaking it out by educational attainment.

Examining educational attainment means that we are going to need at least two graphs to keep things from getting completely messy. First lets look at the relationship before the current recession. The data only go back to 1992 but the pattern is clear.

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The color coded lines represent the linear relationship between job growth and unemployment since 1992.

  • Blue is less than high school diploma
  • Red is high school but no college
  • Green is some college
  • Purple is college graduates

The lines are stacked in our expected order but the slopes are nearly identical.  That is, as job loss increases the same number of unemployed are added to each category. Its just that there seems to be more structural unemployment among those with lower educational attainment.

The pattern from this recession seems different.

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In this case we have divergent relationships. Workers with lower educational attainment start out with higher unemployment and add more unemployed workers as the economy worsens. This would imply not just greater structural unemployment but greater cyclical sensitivity.

Now there are a couple of serious caveats. First and most obviously the 2001 recessions was concentrated in Information Technology. This may mean that the relationship in the first graph is artificially weak.

Second, and more technically there may be an errors in variables problem in the first graph that is downwardly biasing the coefficient. Examining that is probably more than I want to get into but keep in mind that all of this very rough.

Brad Delong beats me to a little bit of analysis I was planning for today.

Economagic: Economic Chart Dispenser

 

It looks like New Claims has to hit the 400K or so range before we can expect payroll growth. We always want to keep in mind that even during the Great Depression new businesses started every day.  The entire economy looses jobs not because people are getting laid off but because so many people are getting laid off that new job creation can’t keep up.

There are recent arguments that more and more of the fluctuation is in new job creation rather than the loss of old jobs but I want to look into that more carefully before commenting on it.

Still, I hope to get to a few new charts today and tomorrow looking at New Claims and overall growth as well as New Claims and the Unemployment Rate. New Claims are our most frequent data series and our best forecaster, so it pays to nail down some of those relationships.

New claims for unemployment insurance were up this week to 554K. Last week was revised upwards from 520K to 524K.  As expected we gave back some of last weeks big drop but maintained a steady downward momentum.

The four week moving average, my preferred measure, tends to smooth out a lot of that week to week noise. It dropped for the 6th straight week in a row, falling from 579K to 566K.

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This is all consistent with a steady improvement in the economy and the beginning stages of recovery.

I have thought for some time that the credit crisis qua credit crisis was over.  What we should expect then is relief from the recession within in recession. That is, we should recover from the massive step down that we took in September.

However, the economy was shedding in jobs in September, so going back to that level isn’t enough to get us out of the hole. We are now roughly half way back to that level. So, it will probably by 4 or 5 weeks at least before we can test it.

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Here is a look at the longer view. You can see how pronounced the downward trend is, in a historical context.

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In response to my response to Thoma, Free Exchange writes

Even if we assume that the there is no net negative effect from the loss of housing wealth, the decline in home prices would be very damaging. For one thing, prices in most markets would immediately fall to below replacement cost level, which would mean a sudden stop in residential investment and the loss of hundreds of thousands of jobs. Markets would only clear in some areas at prices near zero. In others, it’s uncertain whether markets clear at positive prices.

In a world where housing prices are the only fully flexible price this is true. I wouldn’t argue that stock market crashes can’t induce recessions just because  the stock market, by design, always clears.

However, if all prices were fully flexible then the replacement cost of housing will fall as the demand for new homes falls. The price of materials will fall. The price of labor will fall.  Contractors will find it cheaper to do business as business declines.  Construction would shed labor, but it would be because many construction workers wouldn’t keep working as their wage collapsed.

This would be a cause for concern, but it would not be a recession. The key feature of a recession is that there are many people who want to work but cannot find work.

Look at a similar phenomenon going on right now. The unemployment rate for workers with a bachelor’s degree is 4.6 percent. That’s higher than normal but its not even approaching the 14% unemployment of those without a high school diploma. 

This is not to say that the market for those with bachelor’s degrees is not lousy. It may very well be. What that often means, however,  is that individuals with bachelor’s degrees have to  take jobs they wouldn’t otherwise take. They take jobs with worse pay, worse conditions and less career advancement. In short, they see their real wage drop. This is bad, but its not the haven’t-been-able-to-find-work-for-over-a-year bad that many less educated people experience.

That’s the difference between a world with flexible prices and one with rigid prices. In the flexible price world, when the demand for the service you used to provide goes away, you wind up doing something you’d rather not do or getting paid less. In the rigid price world you end up in the bread line or at least the unemployment line, for as long your unemployment benefits last.

Free Exchange continues

For another thing, you’d still have a lot of suddenly insolvent banks, due to the massive number of individuals unable to pay off their mortgages at market-clearing sale prices. Granted, an immediate market clearing should make it obvious right away which banks were insolvent and which were all right, but even in an ideal world it would be difficult to manage the winding down or sale of failed banks without some hit to the real economy. Just taking the above factors alone gets us a pretty nice recession.

Do massive unexpected defaults matter produce recessions in a world with fully flexible prices? This is a big question and one that I’ve struggled with. If they do then, as Thoma seems to suggest, we need a whole knew Macro. We know that waves of defaults can cause bank failures and bank failures can cause crippling recessions.  If this process doesn’t work through a channel involving sticky prices then New Keynesian theory can’t explain why it happens at all.

Perhaps ironically, this turns on the question of adjustable rate loans. In a fully flexible price world all loans would (at least effectively) have adjustable rates. If not then there is at least one very important price which can’t be adjusted.

In theory, and I apologize for going quickly but there is a lot here for a blog post, the following would happen. A huge drop in demand for houses and other durable goods would lead to an instant drop in the price level. This leads to an expansion of the real money supply. A rapidly expanding real money supply drives down interest rates. Collapsing interest rates suddenly bring down payments for many people living in their homes. This implies that many less are pushed into default and those not near default see their disposable income rise. In short, we have the equivalent of automatic monetary and fiscal stimulus. The very forces that started the financial crisis work to end it.

What concerns me about this story is the zero lower bound. Suppose that interest rates really need to fall to –5% for the money market to clear. That way some people would actually be getting paid to have a mortgage.

While prices for goods can fall below zero — i.e. the garbage collector — it is difficult for nominal interest rates to fall below zero. I could simply say, “well then the nominal interest rate is a sticky price.” To some extent that’s true but its also a cop out. The zero lower bound is not usually what we think of when we talk about the sticky price mechanism.

So, perhaps we need a theory based on sticky prices and the zero lower bound. However, ad hoc additions to deal with very specific problems make me uncomfortable as well. It works but its uncomfortable.

Lastly Free exchange writes

And then of course you have to remember James Hamilton’s point—that modeling the macroeconomic effect of the 2008 oil price spike predicts a recession that looks very much like the one we got, all without recourse to market crashes and credit crises.

I don’t mess with Jim Hamilton.

What is up with Matt Yglesias always posting things that I am thinking or have thought but are not articulate enough to express. Or, perhaps this is some sort of digital Socratic method in which I am fooled into thinking I always believed it.  Here is a three-fer from today

 

Cultural Norms:

There’s really nothing I find more annoying that the lazy attribution of policy differences to vaguely defined “cultural” norms. For example, Jacob Weisberg writes that:

Health care systems are not just policy choices but expressions of national character and values. The alternatives he describes work better than ours not just because they’re well-designed and competently managed but because they reflect the expectations and traditions of their societies.

Now the implication of the Weisberg Thesis is that the UK is more culturally aligned with Spain than it is with Canada. And that Canada is more aligned with South Korea than with the UK. And that the Netherlands has more in common with Japan than with Scandinavia. I don’t think that outside of the context of trying to make a cute point about health care, anyone would seriously try to argue in favor of any of those claims.

Federalism

Strong federalism is even the enemy of sensible decentralization. Since the states are “sovereign” and represented as such in the Congress, there’s no way to reorganize America’s administrative subdivisions no matter how anachronistic they’ve become. Thus some states, like California and Texas, have grown to immense proportions while other states (Wyoming, e.g.) are tiny and shrinking. And we can’t set up sensible administrative units that might reflect how people’s lives are actually lived. Hoboken and Manhattan are in totally different jurisdictions even while New York City can have its local transportation ideas foiled by state legislators from Rochester. Some parts of the DC suburbs are involved in the governance of Norfolk and other parts of the DC suburbs are involved in the governance of Annapolis, but there’s no level of government at which DC and its suburbs can collaborate on common issues

 

High Earning Union Members

But it doesn’t follow that tax policy should cater to the idiosyncratic interests of high-earning union members any more than it should cater to the idiosyncratic interests of high-earning people in general. Over the long-term, organizing health care around employment is a bad idea. And financing health care through giant hidden tax subsidies is also a bad idea. But eliminating the tax exclusion in one fell swoop would be unfair and politically infeasible. Curbing its applicability to high earners would, however, be a step in the right direction, raise some necessary funds for health reform, and help put us on the road to cost control.

Mark Thoma asks

But do people really think that all would be fine right now if prices – and they must have housing prices in mind when they think about sticky prices as an explanation for the current episode – had only adjusted faster? If housing prices had dropped even faster than they have already, all would be well in the world?

I don’t know if all would be well in the world but we probably wouldn’t have a recession, at least not in the current sense of the word.

I line up pretty strongly with Brad Delong and Paul Krugman when in comes to Purists vs. Pragmatists. I think the profession went off the rails a little bit when it came to faith in some of the models as an accurate representation of reality rather than a tool to think through problems and conduct thought experiments.

I was going to write a post entitled: Real Business Cycle Models and Other Exercises in Cranial-Rectal Inversion, but though better about it before getting too far. The fact is Kydland, Prescott and the rest did make some serious contributions even if they went a little crazy about the implications.

That having been said, much of the problem in business cycle theory is that markets do not clear. Price does not move to equilibrate supply and demand. If it did, it would be hard to imagine why there would cyclical unemployment. If it did, it would be hard to imagine why there would be an output gap.

As for the current environment, a collapse in housing prices would be really bad for homeowners, but it shouldn’t introduce the kind of paralysis that it did. For one, it wouldn’t have much of an effect on homebuilding and the durable goods market that depends on homebuilding.

Prices would immediately collapse to their long run path and at that point those lenders who were still in business would have no reason not to lend. Buyers would have no reason not buy. Those whose wealth was devastated would have reason to save but those who saw houses suddenly more affordable would have reason to spend. In short, the world would work the way a surprising – well surprising to me anyway – number of economists seem to think it works.

But, that’s not the way the world works. In the real world houses drift down in price and no one knows where the bottom is and no one knows which lenders are really in trouble and few people want to buy a house when they are only getting cheaper every month.

In the real world the price of the land, materials and labor necessary to build a new factory don’t collapse so fast that in a recession building a factory is a no brainer. In the real world inventories do pile up. Companies do find it easier to layoff workers rather than give everyone a pay cut. Real wages decline because inflation isn’t squeezed out of the system as fast as output.

All of these happen because markets don’t always clear. Prices don’t always equilibrate supply and demand. At the deepest level this is the problem of business cycles and this is why we need models that can try to ferret out all the possible things that can go wrong when prices it happens. Its that second part – figuring all the possible things that could wrong — that’s really hard.

UPDATE:  Free Exchange Responds. My reply

UPDATE II: I realized that I quoted Thoma poorly and that may have lead some people to believe I was thinking only of house prices being flexible. Here is the rest of the quote that gives a fuller context.

Okay, so maybe they don’t have housing prices in mind. Still, do we really think that sluggish price adjustment is the main mechanism at work in the present crisis? If not, then what use is the evidence from those models? Why do we keep hearing about theoretical simulations that give values for the multiplier that are small, large, zero, less than one, whatever? Do we really think that sluggish price adjustment captures the essence of the factors driving the present crisis? I don’t.[Emphasis Mine]

On one level this is a genuine question. I am not sure if this violates any trade agreements to which we are signatories or if it would destabilize our relationship with Saudi Arabia in a way that is net counterproductive.

However, on another level its a policy proposal.  There is widespread intellectual support for increases in the gas tax. Popular support seems less forthcoming.

However, taxing imported oil seems like something the populace could go for. It takes advantage of anti-foreign bias and uses it for good. It also raises revenue and if paired with a reduction in subsidies to oil and gas it could reduce spending. It discourages the externalities associated with driving and the non-trivial externalities associated with foreign wars.

One obvious disadvantage is that it generates enormous economic profits for domestic oil produces and gets them even deeper into the rent seeking game. This is always a cause for concern. However, it does pull them in on the side of policies which will result in lower consumption of gasoline.

It also creates more stable gas prices. A larger portion of the price of gas will be fixed, reducing uncertainty for households.

Taxing imported oil would also go a long way towards unwinding international trade imbalances. The majority of the US’s trade deficit is petroleum. That is, to say without imported oil or trade deficit would be cut by more than half.

I’m not sure this is a good idea, but I’m not certain its a bad one either. It does, however, seem like an idea the public might go for.

Ezra Klein points out that the largest increases in inequality have preceded large financial crises.

That chart, released in 2008 by the Center for Budget and Policy Priorities, trumpeted the finding that inequality was at its highest level since 1928. And indeed it was. We all know what happened in 1929, of course. And at this point, we also know what happened in 2008.

Now, it might be a coincidence that the two mega-crashes of the last 100 years were preceded by unparalleled concentrations of domestic wealth. But that seems like a pretty big coincidence.

I don’t think its a coincidence but I don’t think its particularly revealing either. Essentially, what you are saying is that periods in which people are making a oversized and unsustainable profits trading some asset is a period in which some people will have lots more money than others.

In some ways this would tend to lessen our concern on about inequality as a sign of a deeper problem within the system. This would suggest that movements in inequality don’t have much to do with the long term trends working people face but the short term booms and busts that the wealthy face.

This is consistent with the smaller boom and bust associated with the dot-com bubble. Inequality increased sharply during the 90s but a good chunk of that was taken right back when the market crashed.

Megan McArdle is largely right in her response to Alex Tabarrok on the importance of an independent central bank.

I would add that you don’t have to get into a creditor vs. debtor analysis to understand the temptation towards high inflation rates. Increasing the rate at which the Fed prints money lowers unemployment in the shirt run but raises the long run rate of inflation. Each time the Fed increases the speed of printing we get a boost that is temporary but an increase in inflation that is permanent.

Electoral politics is notoriously shortsighted. Thus if central bankers are operating in the same what-have-you-done-for-me-lately world as Congress they will tend towards high rates of inflation.

Exacerbating that problem is that the central bank needs to be highly creditable. If people believe that the  Fed will slow the rate a which it prints money in the future that can keep inflation from perking up during the periods in which the Fed needs to print more rapidly. It is difficult for Congress to have that same  level of credibility because much of Congress is up for re-lection every two years and members are especially likely to lose their reelection bids if unemployment is high.

A number of sources have cautioned that the seasonal adjustment was behind last weeks goof New Claims report and that we should be cautious.

We should always be cautious yes, and the moving averages do a lot better than the week to week and even then trend spotting takes patients and humility.

However, I don’t think we should get too worked up over it. Check out the graph of seasonally adjusted versus not adjusted numbers.

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There are a couple of things to look at. One, if you look at the green arrow you can see that in the late summer of last year unadjusted claims were falling but the adjustment said things were getting worse. Just like now its because unadjusted claims were moving in the expected direction fast enough.

The story told by the adjustment turned out to be correct.

Two, the pair of black arrows show that unadjusted claims deviated from adjusted claims in opposite directions in May and June.  In May Chrysler and GM had early shutdowns and so New Claims didn’t fall as much as the seasonal adjustment expected. The seasonally adjusted trend flattened out and caused a lot of heartache over “withering shoots”

However, that also meant less need for standard retooling shutdowns in June and so that layoffs are now rising less than expected. The net effect has been to send the seasonally adjusted numbers down to a level more consistent the pre-stages of recovery.

We can’t know for sure, but my sense is that taken together these two moves about cancel each other out and the seasonally adjusted number is probably on track.

The link to the actual Crusoe model was broken in the last page and I figure that’s probably the most interesting part to most people, so here it is fixed

http://sites.google.com/site/modeledbehavior/crusoe/crusoe1.pdf

UPDATE: Crusoe pdf link fixed

Tyler Cowen posted Saturday arguing that a consistent theory of human welfare would mean that either

  • Rich people really like being rich and so higher taxes will make them much worse off but won’t cause them to loose their ambitions

or

  • Rich people don’t really care that much about being rich in which case higher taxes aren’t that bad but will really discourage work effort.

It seemed to me the standard cardinal approach to human welfare could easily produce someone who didn’t care much about being rich and who wasn’t that impacted by taxes.

However,  I wanted to build a model to see how that panned out. So I modeled a single person, Crusoe, who pays taxes and receives government services. He decides how much to work and because I created his utility function we can see how damaged he is from taxation.

Here is a snapshot of the results

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The take away relative to Cowen’s post is that Crusoe is relatively insensitive both to the tax rate when it comes to labor supply and utility. In fact a 35% tax rate hardly makes a ding in his utility.  So we know that such people can easily exist. Whether they do exist is another matter.

A few things that I found out from playing with the model (but perhaps should have already known).

  • Without government services, taxes or wages make no difference in Crusoe’s labor supply choice. That is, if Crusoe has to work for everything he consumes then the substitution and income effects exactly cancel out. This extends from the log utility function.
  • Government services, however, throw a wrench in things. Now Crusoe can kick back and still have some guaranteed income. He takes advantage of that.
  • The tax and government services effects interact. The more government services the more taxes effect labor supply. The higher taxes, the more government services effect labor supply.

Of course, Cursoe is about as simple of a guy as you can get. I’d like to expand him out with a more general utility function and perhaps more complex tax code as well as an additional person to look at specific efforts to counteract inequality.

One cute thing to note is that Crusoe does indeed have a Laffer Curve and with the default settings it tops out at tax rates somewhere in the high 60s. The Laffer Curve peak will move as the ratio of government services to the wage changes.

I embedded Crusoe into a pdf which allows me to share him on the blog. You can play around with the model here.

Now for the nerdier among you here are some details on Crusoe

  • He has log utility which of course satisfies all of the derivative conditions
  • His utility is additively separate in consumption and leisure
  • He takes the real wage and government services as given
  • His utility is scaled up by a factor 15 to make the scale on par with hours

 

Note: Leisure preference is how is much weight leisure has in Crusoe’s utility function. Without a weighting he will spend much more time working than people really do. This is impart because he doesn’t need any down at all. In the model the only reason he stops working is because he enjoys leisure. He could work 24 hours a day if he wanted and not suffer any loss in productivity. This, of course is unrealistic.

You can adjust this to see how people who tend to work more would respond to taxes.

Will Wilkinson argues that the Federal Reserve needs to be audited so that we know for sure it is independent. I hadn’t thought of that and it is a reasonable point. Still, I am skeptical of the precedent set by Congress auditing the Fed before the body is even cold. No one can say with confidence what actions were justified because we do not yet know how the consequences will play out.

Will further suggests that

The attitude of many macro and monetary economists about the operation of the Fed reminds me more than a little bit of the attitude of neocons about defense and foreign policy. Something with the flavor of: “You people are too stupid to understand the real existential threats out there–to understand how we, the big boys, are keeping you safe. You should be grateful, but we don’t ask for gratitude. We’re just asking you to shut up and believe what we, The Serious People, tell you to believe. Or else.”

This seems a bit unfair. First, not to wax too political but I think the grown-ups were highly skeptical about invading Iraq. If memory and Google serve me correctly the neo-cons were making arguments about good vs. evil.

Second, I think most economists are more than happy to debate why the financial crisis happened and whether or not the Fed’s actions were appropriate.

What I would not like to see is the Fed singled out for public examination by Congress. What I also think is unnecessary are any audits into the money trail behind those loans that are repaid. If the taxpayer does not end up short on a transaction with a bank then I don’t see a justification for breaking confidentiality.

There is steadily rising hysteria surrounding Goldman Sachs. Free Exchange quotes Paul Krugman and responds

Paul Krugman writes today that:

The American economy remains in dire straits, with one worker in six unemployed or underemployed. Yet Goldman Sachs just reported record quarterly profits — and it’s preparing to hand out huge bonuses, comparable to what it was paying before the crisis. What does this contrast tell us?

First, it tells us that Goldman is very good at what it does. Unfortunately, what it does is bad for America.

What it does is bad for America. Not "some of what it does is bad for America". Not "the legal, profit-seeking behaviour of large investment banks may have some negative externalities that should be addressed by government regulators, in the following ways".

This is no way to have a policy discussion.

I don’t know enough about health care to render a definite verdict on future US policy. My baseline preferences were almost identical to what Brad Delong proposes, minus the nanny state vans of medical professionals and not-necessarily-well-supported sin taxes.  This, however, is based solely on my basic intuition about incentives and behavioral economics.  There’s no real nitty gritty analysis behind it.

I am swayed by the fact the people like Ezra Klein, who do know the nitty-gritty, seem to be in favor of a more traditional single-payer program. What doesn’t sit well with me are some the arguments from those who are opposed to single payer.

Everyone seems to accept that the United States has a lower life expectancy than most OECD nations but pays much more, in some cases twice as much, for health care. This is a damning piece of evidence on its face.

The claim by some commentators such Megan McArdle and Greg Mankiw is that this fact should be disregarded because the US does much of the medical innovation and has worse health habits. Yet, the claim that we should disregard this key fact — that we pay much more and our primary outcome indicator is worse — is an extraordinary one.  I have not yet seen extraordinary evidence to support it.

Its not enough to point to some factors which might justify a higher expense for seemingly no gain. You need to show that these factors really do add up to the gap between Europe and the US. Otherwise, the weight of the evidence still falls in favor of those who want a more European style health care system.

I’m not sure I buy James Kwak’s argument that high Price-to-Rent ratios in housing are not a fundamental sign of a bubble. He writes:

I say this approach is partial but not perfect because current potential rental income is a poor proxy for the long-term value of a house. The fact is that most people buying houses aren’t going to be renting them out, and what they care about is the price at which they will be able to sell that house in 10 years, which depends in part on the price at which that buyer will be able to sell the house 10 years after that, and so on.

When people asked me about the wisdom of home buying during the bubble my stock response was, “think of your house as a place to live.”

That is, overwhelming the returns that come from owning a home are going to come from the “real dividend” of actually living in the house. In the long run prices may rise and prices may fall but your primary concern has to be keeping your family warm and dry.

In this context, the first time homebuyer in particular is going to be choosing between renting a home and buying a home.  Its true that homes are rarely rented in the suburbs, though to some extent that’s a function of costs and preferences. However, fundamentally a first time homebuyer is choosing between continuing to rent and living in the spaces that are available to rent or choosing to buy and living in their own home.

If buying is a lot more expensive than renting there will be a tendency for potential first time homebuyers to continue renting.  New homebuyers are key to the entire market for housing for several reasons.

One, move-up buyers need to sell there house to someone. Unless there are enough move-down buyers to replace each move-up buyer, the move-up buyer must be selling to a first time homebuyer.  Fewer first time homebuyers mean fewer move-up buyers and a weaker overall market.

Second, there are always people exiting the home market because of death. If there is a shortage of new homebuyers then the overall number of homeowners will eventually fall.

So the choice of renting versus buying is key to supporting the entire home market. Additionally, there are people savvy enough to exist the home market if prices become too inflated, though I give that they are a rarity.

Now James makes the additional point that

it’s entirely possible that the relationship between house prices and rents could change over that timeframe due to any number of economic factors – the homeownership ratio; shifts between the exurbs, suburbs, and cities; the aging of the population; and so on. There’s no axiom that says that these ratios – price-to-rent or price-to-income or price-to-earnings for that matter – have to remain constant over the long term.

True, but you need to make a case for this. Price-to-rent ratio reflects a fundamental relationship in the market and if you believe the fundamentals have changed then you need to say why. If price-to-rent ratio is skyrocketing as it did during this bubble then you need to be able to explain why the fundamentals are shifting so rapidly.

Suggesting that the fundamentals of housing have shifted so much that in a few years time the price-to-rent ratio has doubled is an extraordinary claim and thus requires extraordinary evidence. Flashing a big warning sign that requires substantial justification is the value of important ratios like price-to-rent or price-to-earnings.

You gotta love this headline from CNBC

Paulson: Threats to Ken Lewis On Merrill Deal Were Justified

Former Treasury Secretary Henry Paulson said he was justified last year in suggesting that Bank of America’s chief executive could lose his job if the bank backed out on plans to buy troubled Merrill Lynch.

Paulson said he told Bank of America CEO Kenneth Lewis last year that reneging on his promise to purchase Merrill would show a "colossal lack of judgment."

Paulson said that "under such circumstances," the Federal Reserve would be justified in removing management at the bank.

Of course, you know scientists hate the idea of empirical proof, but this is quite strongly suggestive. Yes, quite strongly.

Felix Salmon:

Andrew Baston reports on China’s 7.9% GDP growth in the second quarter:

China’s government only reports year-on-year growth estimates. But when measured in the same terms as other major economies—an annualized quarter-on-quarter comparison—China’s growth in the second quarter could be on the order of 15%, some private economists estimate.

This is proof, I think, that stimulus programs can have spectacular effects, at least in the short term. Although once again

Jobless Claims now clearly over the hump. Department of Labor reports 522K new claims this week and an upward revision of last weeks number from 565K to 569K

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The decline is proceeding at a rate consistent with ‘’Green Shoots.’ Part of the issue may have been that the auto layoffs earlier this year put in an artificial plateau. This caused us to think the shoots might be withering. Things have looked much better these past few weeks.

We  also want to look closely at the New Claims numbers over the coming weeks to verify the jobless recovery hypothesis. A continuing sharp decline will fight against that hypothesis. Look at the last two jobless recoveries.

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An initial fall and then the improvement flattens out.

She just might. James Kirchick of Out magazine reports:

Yet even as the balance begins to shift, the old guard is still yapping in the foreground. Shortly before McCain sat for this interview, Samuel Wurzelbacher, aka Joe the Plumber, gave an interview to Christianity Today in which he complained about “queers” and declared, “I wouldn’t have them anywhere near my children.” Unprompted, McCain rails against the man her father’s presidential campaign touted as an American everyman and made a showpiece in the weeks before the election. “Joe the Plumber — you can quote me — is a dumbass. He should stick to plumbing.”

HT: Delong

Wells Fargo is letting go of $600 Million in unsecuritized loans at 35 cents on the dollar.  Take a moment to think about how bad that it is.  This isn’t a tranche, this is just a pool of loans.

Even if every single loan went bad they would have to only get 35 cents on recovery. That is after the bank forecloses it will only get 35 cents on the dollar back.

But, actually its worse than that. Typically, we would think of the interest rates for mortgages as being equal to the interest rate on the 10 year Treasury note plus an adjustment for the fact that mortgages are riskier..

I’m not sure exactly when these loans were made but the originator was Accredited Home Loans. If I remember they went out of business well over a year ago, maybe two. Well, in the last year the 10 year Treasury has been at its lowest rate in history.

This implies that, if we forget about about credit risk for a second, the interest rate on mortgages like these should have fallen. Interest rates and bond prices move in opposite directions.  So, forgetting about credit risk, the value of the mortgages should have gone up. This implies that we need even less than 35% recovery for the loans to be worth only 35 cents on the dollar.

Its actually even even worse than that when you factor in that the original loans had some risk of default built in.

So the Administration is taking a lot of flack for this graph

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and the fact that unemployment is already at 9.5%. The common explanation is that the administration misread the economy.

A simpler one, however, is that given the economy unemployment is just unexpectedly high

Here is a scatter plot of unemployment since 1948, when data was first collected, and year over year job growth.

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The economy has shed 4.1% of its jobs over the last year. Thus by a very rough estimate unemployment should be just about 8%, which is exactly what the administration predicted.

Now, I used a second order polynomial for my trend line to account for that flattening out in the bottom right of the graph.  Unemployment can’t go but so low even in a scorching economy because it takes some amount of time for people who relocate or quit to find new jobs. During the search period they are unemployed.

However, I know polys make some people suspicious so here is the linear trend.

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It actually predicts lower unemployment, in large part because that flat section is flattening out the trend line.

Here, is another thing two. The red dots that represent the current recession are in chronological order from bottom to top because unemployment has risen throughout this entire recession.

The slope of this recession is much steeper than the slope of the basic relationship. This implies that given the very low levels of unemployment we started with, these high levels are quite surprising, even though we’ve had very bad payroll growth.

All of this is of course extremely rough but it seems to me the most parsimonious explanation for high unemployment is that more people are in the job market than we would predict. That is, unemployment is unexpectedly high given the level of job losses because not as many people are dropping out of the workforce as we would expect.

Maybe they can’t drop out because their retirement savings was lost when their house and 401K collapsed in value.

I am seriously asking here because I haven’t been following him long enough to fully understand his views. I was shocked, though when he wrote

But whatever the [famous vet spending] graph’s problems, the sudden acceleration in medical spending on pets does offer insight into spending on people. If you took a limping Fido to the vet and were informed he had a malignant tumor in his foot and three months to live, you would cry, and feel terrible about it, but that was basically that. But what if you were told that there’s a $5,000 treatment that could potentially save your dog?

Suddenly, you have a choice. It’s not just how much your dog’s life is worth to you. It’s how much it’s worth to you to feel like you didn’t decide to let your dog die. A treatment that isn’t strictly "worth it" in economic terms — a treatment that may not even save your dog — may be worth it to you, because you want to feel like you did everything you could. You want your economic decisions to line up with your emotions.

The rise in health-care spending is not simply that we have trouble saying "no." It’s that the march of health-care technology has forced us to make a lot more decisions. Conditions that would have simply, sadly, killed people 30 years ago have treatments — which may or may not be effective — today. And it’s hard to say "no" to those options. But the crucial point isn’t when we accept or reject the treatment. it’s when we’re faced with a treatment to accept or reject. It’s when death begins to look like a decision.

This strikes me as an articulate illumination of Robin Hanson’s theory. However, that theory usually leads people to conclude that cost control is the answer and thus people need less insurance, not more. The more insurance we have, the more it encourages to spend, the more it encourages hospitals to invest in life saving technology that we will feel guilty for not buying.

Its like if you thought that people only buy things from telemarketers because they are under pressure and so the solution is for the government to provide everyone with funds anytime they are corner by a telephone salesperson. Won’t this just encourage more telemarketing?

How is this circle squared?

The headlines today are that inflation is still tame rising at 0.7%. I am still, however, concerned with deflation pressures.

Here is the year over year raw CPI.

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And the close up showing sustained raw deflation.

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A lot of this is clearly the decline in oil prices and the core has been much much more stable – riding under 2% as of late.

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However, as Calculated Risk notes the Owner’s Equivalent Rent (OER) portion of the CPI is still clocking in with a 1.9% rise while all other evidence seems to show that rents are falling. When OER turn negative it will drag the index way down. OER accounts for somewhere around a third of the index’s weight.  A sustained fall in rents at a 2% annual rate will knock 1.2% off of inflation and leave us with little margin for error.

UPDATE: Somehow I forgot to change the Y-axis on the close-up industrial production chart. Then line in fact measures the change over the last 40 years not 1919 – 1959. It should be fixed now, though.

 

Down 0.4% from last month and 14.6% from this time one year ago.

The long chart gives a sense of the connection between Industrial Production and recessions.

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We have this one going back even before the Great Depression, so you can get a real sense of the relationship. It gives a very strong sense of the intensity of a recession. The 2001 recession being barely a blip and the Great Depression an enormous gash.

A close look at recent recessions.

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We can see that Industrial Production is coincident indicator. It turns when the recession turns. So we don’t get a lot of heads up from the number itself.

It does however, have some pretty strong third derivative action. That is, if you look at this chart a leveling out precedes recoveries. There are no significant false positives or times when leveling out did not proceed a recovery.

For geeks. This chart measures the change in industrial production so the reading itself is a first derivative measure. The slope on this chart is thus a second derivative measure. The curvature of this chart is then a third derivative measure.

CNBC on TV is reporting that Discover charge offs are lower. Capital One thirty day delinquencies are falling. And, in general consumer credit in Jun was better than estimates.

Chicago Fire, 1871

One of the fundamental problems in macroeconomics is understanding and modeling the financial externality.  I would argue that on some level most, if not all, macroeconomists accept that there is some kind of fundamental externality in financial markets and it is this externality that makes Central Banking, ie the Federal Reserve, useful.  What we haven’t been able to do is model that externality completely and successfully.

Mike Rorty provides a narrative in his discussion of the shadow banking system

AIGFP created systemic risk out of nothing by mispricing CDS contracts over a few year period. Systemic risk is the risk that effects us all, the risk we can’t diversify or innovate our investments away. It’s the risk that hits my boring index fund of stocks that I want to use to retire.

How do they do that? By underpricing CDS contracts – charge 2 or 15 bp on some accounts – they encourage people on the other end to take on more risk thinking they are insured, when they are not. This chains through the system to the point where it hits my boring index fund.

This point is really important, so I’m going to harp on it. Think if you got fire insurance on your home cheap, really cheap, but the fire insurance firm has no intention of paying it out. Since you feel more secure, you smoke in bed and leave oily rags around the furnace and use the smoke alarm batteries for the remote, and sure enough your house catches on fire. You aren’t going to get paid, but that’s a your problem at that point – however now your house is on fire, and your neighbors houses are catching on fire. Other fire insurance companies, not capitalized to handle this sudden wave of fires, start going bankrupt. This metaphor may seem a bit much, but that’s what happens in financial firms.

AIGFP entered into a contract and because of that contract you and I face more risk. This is the essence of the big externality. I’d change the fire analogy a bit to say that the problem was that people sold cheap private fire department services. AIGFP told investment banks not to worry. If their house caught on fire AIGFP would come put it out. So, the banks start to feel comfortable taking more risks, smoking in bed etc.

Now the house catches fire but AIGFP doesn’t show up. Perhaps, they’ve sold fire department services to the whole town but they only have one truck. Two or three houses catch on fire and now there is nothing they can do to put out all of them. One or two of the houses have to burn and those houses catch more houses on fire until eventually the whole town is in an uncontrollable blaze.

The mistake a lot of economists made in the run-up to this crisis is in thinking the financial externality only applied to traditional banks and their relationships with depositors.

In some sense this is like believing that the problem with a private fire department is that those who smoke in bed might not get rescued. That’s not the problem. The problem is that if the smokers have poor fire service the whole town will go up.

To wit, it doesn’t matter what mechanism it works through, if someone is taking on liquidity risk and solvency risks then the whole town is taking on risks.

The deep question is why does this process have to work through the chain? Our basic intuition about markets would say ok, “I know that you are taking on this risks. I know that you have cheap CDS so I am going to limit my exposure to you.”

Perhaps there is an information problem. I might not know exactly what risks my counterparties are taking on. Why then don’t I say “Unless I can understand your risks I am going to assume that they are high and limit my exposure to you” Why doesn’t that mechanism work?

Somehow the risks or false senses of security have to amplify one another so that this kind of hedging doesn’t take place or doesn’t take place effectively. I have some theories on how that might happen but I don’t really know for sure.

In response to Bruce Charlton’s paper arguing that psychometrics should replace education Kling writes

I think that the probability that Charlton’s Caplan-esque views become widely accepted is about one in ten thousand. I would say there is a slightly higher chance, about five in ten thousand, that someday he will be imprisoned for his views

I am not sure if Arnold meant for that paragraph to be funny, but it made me laugh out loud. Its true, of course. But, still funny.

Real retails sales are off roughly 9% for the 9th month in row. When will they rebound? Perhaps never.

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Take a look at a chart of consumption spending as percentage of GDP.

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The norm that prevailed throughout the 50s, 60 and 70s was roughly 62%. A little less than two thirds of our economy was accounted for by consumer spending.

Beginning in the early eighties that percentage started to rise, reaching its recent plateau around 2001. Why this happened is an interesting question in its own right, but I want to think about is whether or not the pattern is reversing itself quickly as it appeared to do in the late 1940s.

Our current retail spending is roughly 9% lower than last year. If we take the consumption spending  from the last 20 years and lower it 9% we get this.

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A reduction in consumer spending by 9% takes us back to the levels that prevailed for decades. The question is that if consumer spending is going to follow a permanently lower path, what is going to take up the slack?

 

whitney So there was some handwringing around the blogosphere about Meredith Whitney’s forecast that Goldman Sachs would blowout profit estimates. Had  she sold out now that she has her own firm? Is it just impossible for a  bear to stay bearish?

Well, it looks like as usual the answer is that she just knew what she was talking about.

Greg Mankiw points to a Zingales quote that has more than one thing going against it.

The biggest threat of all to the Big Apple’s financial supremacy, however, comes from Washington. The Founding Fathers wisely decided that the nation’s political capital should be separate from its financial capital (in both senses of the word). Now this splendid segregation has ended. If the outcome of the Chrysler bankruptcy is any indication, Washington is willing to flex its muscle in financial decisions, altering the substance of contracts freely agreed to by private parties. In so doing, the national government has undermined the certainty of the rule of law, which was the American capital market’s strongest asset.

First, is the “decision” to separate financial and political capitals particularly wise. Think of nations where the financial and political capitals are one, the United Kingdom, France, Singapore, South Korea or Japan. Then look at nations where they are separate, the United States, Italy, Germany and China. Is it clear that the latter group of markets operates any more efficiently than the former.

My rough guess from thinking about it causally is that separating the financial and political capitals dilutes free market impulses. Essentially, you have to have pro-market advocates in two places. When you control for the political sentiment of the people my guess is that the group of countries where the financial and political capitals are coterminous are significantly more market friendly.

Second, this wasn’t the founders intention. Obviously at the founding of the country Philadelphia and not New York was the commercial center. However, the moving of the capital from Philadelphia to Washington wasn’t about separating commercial and political interests. It was about good old fashioned pork and backroom politics.

In the Compromise of 1790 Madison and Jefferson agreed to the federal government taking on state war debt, in exchange for locating the nation’s capital in the South.

Peter Berkowitz writes in the Wall Street Journal

The political science departments at elite private universities such as Harvard and Yale, at leading small liberal arts colleges like Swarthmore and Williams, and at distinguished large public universities like the University of Maryland and the University of California, Berkeley, offer undergraduates a variety of courses on a range of topics. But one topic the undergraduates at these institutions — and at the vast majority of other universities and colleges — are unlikely to find covered is conservatism.

While ignoring conservatism, the political theory subfield regularly offers specialized courses in liberal theory and democratic theory; African-American political thought and feminist political theory; the social theory of Karl Marx, Emile Durkheim, Max Weber and the neo-Marxist Frankfurt school; and numerous versions of postmodern political theory.

But they will learn very little about the constellation of ideas and thinkers linked in many cases by a common concern with the dangers to liberty that stem from the excesses to which liberty and equality give rise.

That constellation begins to come into focus at the end of the 18th century with Edmund Burke’s "Reflections on the Revolution in France." It draws on the conservative side of the liberal tradition, particularly Adam Smith and David Hume and includes Tocqueville’s great writings on democracy and aristocracy and John Stuart Mill’s classical liberalism.

I didn’t go to one of the universities that Berkowitz mentions, but my experience was very different.  Feminism, African-American liberation, Marxism, etc where in the ether. I knew of them from friends, relatives and my own reading as an adolescent. I first heard about Burke, Hume, Tocqueville and Mill in my college courses.

Not only was the university not suppressing conservative thought, it was just about the only source for it.

We have a problem. The Federal Reserve has lowered interest rates as far as they can go. The specter of rising oil and food prices limit how much quantitative easing the Federal Reserve is willing to do. The Administration has already produced one stimulus package of debatable effectiveness.

If the economy doesn’t turn around in the third or fourth quarter what is our plan B plan G?

Many commentators won’t like the answer. It reminds them of guy from Crawford whom they are none to fond of. It reminds them of the bad old days.

The answer is swift, aggressive, pervasive tax cuts. My baseline recommendation: a one year suspension of the payroll tax. Its big. Its expensive and its likely to be controversial.

First, a few details. Rather than simply “cut” the payroll tax for one year, it probably make more sense for the Treasury to pay each taxpayers payroll tax for one year. This gets around the problem of employees potentially loosing credit against retirement benefits for the year. It gets around the problem of messing with Social Security and Medicare trust funds.

It makes it clear that the itself Treasury is taking on this burden. If this has to be done as some sort of rebate or tax credit then that is fine, so long as it goes into the pockets of businesses and consumers immediately.

Second, the cost will be large, somewhere in the neighborhood of $900 Billion. That means a deficit well in excess of $2 Trillion this year and perhaps approaching the $2 Trillion mark next year.

The principle advantage of tax cuts, however, is that we don’t have to worry as much about where the money goes. We would like to think the employer side cut will do larger to retaining workers. We would hope that the employee side cut goes to spending.

However, in either case the funds will either be spent or they will be saved. If they are spent we have stimulus. What they’re spent on influences how powerful the stimulus will be but there is likely to be some stimulus.

If the tax cuts are saved this isn’t ideal, but its not the end of the world either. The net savings position of the US does not change when tax cuts are saved. The US government is in deeper debt, but US consumers are in less debt.

For reasons I’ve listed before, however, I think that the fear that consumers will save their tax cuts is probably overblown.

Ryan Avent points to this paper by Robert Stavins on cost-benefit analysis. In particular highlighting this passage:

Although formal benefit-cost analysis should not be viewed as either necessary or sufficient for designing sensible public policy, it can provide an exceptionally useful framework for consistently organizing disparate information, and in this way, it can greatly improve the process and hence the outcome of policy analysis

There is little that I could disagree with in this passage or in Stavin’s full post. Cost-Benefit analysis is useful but it is not everything. I, myself,  tried to illuminate some of the limitations to pure cost-benefit analysis in this paper.

On the other hand, one of the principle advantages of of cost-benefit analysis is that it forces us to be explicit about our assumptions. To build a model we must write down exactly what we are assuming and proceed only from those assumption.

Once, the model is done, we may not be satisfied. We may feel it fails to capture key elements. But, then we must be prepared to state explicitly what key elements are missing and why we think they overwhelm the conclusion of the model.

What I’ve tried to do in the climate change debate is shine a harsh light on the latter stages of this process. Waxman-Markey doesn’t do well under traditional cost-benefit analysis. Supporter, however, argue that this doesn’t matter because of the overwhelming narrative in support of carbon restrictions: Without significant reductions in carbon emissions we will wind up devastating the developing world.

Very well, I’ve argued, but there is a competing narrative in which carbon restrictions themselves harm the developing world. Carbon restrictions potentially reduce growth rates and slow the transition to an industrial economy.

We could exempt the poorest nations from international carbon restrictions, but this has two problems. First, it assumes that business interests in the developed world will go along with this. It assumes that companies will accept a competitive disadvantage and that the public will be insensitive to cries that we are loosing our jobs to counties with lax environmental regulations.

Second, we can’t ignore the emissions from China and India, which together are  home to hundreds of millions of the world’s poor.  Indeed, until recently the China and India were home to the majority of those in poverty. Heavy industry and high carbon emissions are part of the story of how over half of a billion people were lifted out of poverty in the last 25 years.

This doesn’t mean that there is no role for emissions restrictions. This doesn’t mean that we should forget about cap and trade. It does, however, mean that we need a careful and explicit effort to balance competing concerns. 

If we believe that damage from climate change will overwhelm the damage from emissions restrictions then we have to be clear as to why. What scenarios are we envisioning? What assumptions are we making?

Likewise, if we want to close the door on emission restrictions we have to be explicit as to why the benefits from potentially higher growth outweigh the possibility of devastation later.

The fact that both climate change and economic growth are non-linear processes with tipping points and varying dynamic regimes makes this thought exercise excruciatingly hard. It is, however, excruciatingly important.

Its easy to confuse what is what is good for a market economy vs. what is good for the stock market. Daniel Indivglio wonders why the Wall Street Journal is so down on anti-trust

Markets more likely shrug off antitrust action because they like it. Anyone who’s taken intro level economics knows that monopolies and anticompetitive activity are actually bad for the market. So while monopolies might not like it, the rest of the overall economy should be very happy when antitrust regulators do their jobs.

Its pretty clear that monopoly is bad for a market economy. Its not so clear that its bad for the stock market. First, monopolies increase profits at the expense of consumer surplus. This makes society as a whole worse off. But, it makes the owners of the monopoly better off. If the monopoly’s stock price should benefit when it is able to extract more profit.

Now, its not just consumers who are worse off under monopoly. Other companies are prevented from entering the space and this lowers their potential profits. However, these companies are more likely to be upstarts and not publically traded.

Thus, on net anti-trust action should benefit firms not counted in stock market indices at the expense of firms that are counted in market in is dices. The “market” one would guess, is made worse off by anti-trust action even if the market economy does better.

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